The unaudited Condensed Consolidated Financial Statements include the accounts of Hurco Companies, Inc. and its consolidated subsidiaries.  As used in this report, and unless the context indicates otherwise, the terms “we”, “us”, “our” and similar language refer to Hurco Companies, Inc. and its consolidated subsidiaries. We design and produce computerized machine tools, interactive computer control systems and software for sale through our distribution network to the worldwide metal cutting market. We also provide software options, computer control upgrades, accessories and replacement parts for our products, as well as customer service and training support.

The condensed financial information as of April 30,July 31, 2008 and for the three and sixnine months ended April 30,July 31, 2008 and April 30,July 31, 2007 is unaudited; however, in our opinion, the interim data includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of our results for, and our financial position at the end of the interim periods.  We suggest that you read these condensed consolidated financial statements in conjunction with the financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended October 31, 2007.

Certain prior year amounts have been reclassified to conform to the current year presentation. These changes had no impact on previously reported net income or shareholders' equity.

At January 31, 2008, we made a reclassification in the Condensed Consolidated Balance Sheet and Condensed Consolidated Statement of Cash Flows to record investments in auction rate securities as Short-term Investments instead of Cash and Cash Equivalents, as previously reported.  This reclassification did not have any impact on our Condensed Consolidated Statement of Operations, cash provided by operating activities, total current assets, working capital, total assets or shareholders’ equity.  The following is a summary of the effects of this reclassification on our Condensed Consolidated Balance Sheet as of October 31, 2007 and the Condensed Consolidated Statement of Cash Flows as of January 31, 2008.

As of April 30,July 31, 2008 and October 31, 2007, we held $8.5$6.7 million and $10.0 million, respectively, of investments in auction rate securities, which represented investments in student loan obligations and municipal bonds.  These auction rate securities are intended to provide liquidity via an auction process that resets the applicable interest rate at predetermined intervals allowing us to either roll over the holdings or sell the investment at par value.  All income generated from these auction rate securities was recorded as Investment Income.

The recent uncertainties in the credit markets have adversely affected the liquidity of our holdings in auction rate securities, and multiple auctions for these securities have been unsuccessful.  Consequently, approximately $4.8 million of these investments in student loan obligations are currently not liquid and we will not be able to access these funds until a future auction of these investments is successful. The remaining $3.7$1.9 million of the auction rate securities, as of April 30,July 31, 2008, are in a municipal bond. This municipal bond that has had recent auction sales, at par value, totaling $525,000$2.3 million since January 31, 2008.  All of the auction rate securities are “AAA” rated and were in compliance with our investment policy at the time of the acquisition.  We currently have the ability and intent to hold these auction rate securities until a recovery of the auction process takes place or the securities mature, which could be greater than twelve months.  As of April 30,July 31, 2008, we reclassifiedhave classified the student loan obligations of $4.8 million toas long-term investments due to the inability to determine when the investments will settle,be liquidated, and continuedcontinue to carry the $3.7$1.9 million municipal bond as a short-term investment based upon the most recent trading activity.

We classify our auction rate securities as “available for sale” in accordance with the provisions of Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities”.  Due to the lack of observable quotes in the market, we engaged an independent registered investment advisor to provide expert investment information in order to determineestimate the fair value of our auction rate securities.  In estimating the fair value of these securities, each prospectus was researched, recent auction history was reviewed, and current collateral performance was examined. The underlying collateral for these securities was compared to other securities currently trading in the market, as well as, non-auction based debt with similar characteristics.  The estimated fair value of our auction rate securities as of April 30, 2008 was $8.5 million compared to par value or stated cost of $8.8 million.  Although these securities continue to pay interest according to their stated terms, during the second quarter of fiscal 2008 we recorded an unrealized loss of $202,000, net of tax in Accumulated Other Comprehensive Loss, reflecting adjustments to our auction rate securities to record what we have concluded is a temporary decline in estimated fair value.  At the end of the second quarter, these securities had a weighted average tax exempt interest rate of approximately 4%. We have deemed this impairment as temporary because the underlying reason for the impairment is primarily related to liquidity, as there has not been a change in credit risk of the investment since acquisition, the severity of the impairment is not significant compared to the total investment balance, and we do not intendcurrently expect to sell these investments for less than par value.  The estimated fair value of our auction rate securities as of July 31, 2008 was $6.7 million compared to par value or stated cost of $7.0 million.  At the end of the third quarter, these securities had a weighted average tax exempt interest rate of approximately 3.6%.

We enter into foreign currency forward exchange contracts periodically to hedge certain forecasted inter-company sales and forecasted inter-company and third party 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 Condensed Consolidated Balance Sheets at fair value in Other Current Assets and Accrued Expenses.  Gains and losses resulting from 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 in the period that the sale 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.

At April 30,July 31, 2008, we had $3.3$3.1 million of losses, net of tax, related to cash flow hedges deferred in Accumulated Other Comprehensive Loss, net of tax.  Of this amount, $2.1$1.6 million represents unrealized losses, net of tax, related to future cash flow hedge instruments that remain subject to currency fluctuation risk.  These deferred losses will be recorded as an adjustment to Cost of Sales in the periods through AprilJuly 2009, in which the sale that is the subject of the related hedge contract is recognized, as described above.  Net losses on cash flow hedge contracts, which we reclassified from Accumulated Other Comprehensive Loss to Cost of Sales in the quarter ended April 30,July 31, 2008, were $1.2 million$978,000 compared to net losses of $273,000$337,000 for the same period in the prior year.

We also 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 Statement of Financial Accounting Standards No. 133, “Accounting Standards for Derivative Instruments and Hedging Activities,” and, as a result, changes in their fair value are reported currently as Other Expense (Income), Net in the Condensed Consolidated Statement of Operations consistent with the transaction gain or loss on the related foreign denominated receivable or payable and non-hedged foreign currency gains and losses.  We recorded net transaction losses of $299,000 and $27,000$462,000 for the quartersquarter ended April 30,July 31, 2008, and 2007, respectively.compared to net gains of $17,000 for the same period in the prior year.

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 on November 26, 2007 with a notional amount of €3.0 million.  We have designated this forward contract as a hedge of our net investment in Euro denominated assets.  We have selected the forward method under the guidance of the Derivatives Implementation Group Statement 133 Issue H8, “Foreign Currency Hedges: Measuring the Amount of Ineffectiveness in a Net Investment Hedge”. The forward method requires all changes in the fair value of the forward 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. As of April 30,July 31, 2008, we had a loss of $133,000,$123,000, net of tax, recorded as a cumulative translation adjustment in Accumulated Other Comprehensive Loss, net of tax, related to the forward contract.

In March 2008, we adopted the Hurco Companies, Inc. 2008 Equity Incentive Plan (the “2008 Plan”), which allows us to grant awards of stock options, Stock Appreciation Rights settled in stock (SARs), restricted shares, performance shares and performance units.  The 2008 Plan replacesreplaced the 1997 Stock Option and Incentive Plan (the “1997 Plan”) which expired in March 2007.  The Compensation Committee of the Board of Directors has authority to determine the officers, directors and key employees who will be granted awards; 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 stock options under both Plans which 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 total number of shares of our common stock that may be issued as awards under the 2008 Plan is 750,000.  The market value of a share of our common stock, for purposes of the 2008 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.

During the first sixnine months of fiscal 2008, options to purchase 28,631 shares were exercised, resulting in cash proceeds of approximately $151,000 and an additional tax benefit of approximately $36,000, compared to 43,200 shares exercised in the prior year period resulting in cash proceeds of $119,000 and an additional tax benefit of approximately $268,000.$299,000.

Effective November 1, 2005, we adopted SFAS No. 123(R), “Share Based Payment,” using the modified prospective method, and began applying its provisions to all options granted, as well as, to the nonvested portion of previously granted options outstanding at that date.  Compensation expense is determined at the date of grant using the Black-Scholes valuation model.

During the first six months of fiscal 2007,On May 28, 2008, the Compensation Committee granted fully vested options with respect to 40,0005,000 shares under the 19972008 Plan to certain employees andeach of the two new directors.  The fair value of thesethe options was estimated on the date of grant using a Black-Scholes valuation model with assumptions for expected volatility based on the historical volatility of our common stock, the ten year contractual term of the options and a risk-free interest rate based upon a three-year U.S. Treasury yield as of the date of grant.  The options granted to employees vest in three equal annual installments andBased upon the directors’ options were granted with immediate vesting asforegoing factors, the fair value of the date of grant.options was determined to be $30.71 per share.

During the first sixnine months of fiscal 2008, approximately $114,000$478,000 of stock-based compensation expense was recorded related to options grantedgrants under the 1997 PlanPlans compared to $366,000$422,000 for the same period in the prior year.  As of April 30,July 31, 2008, there was approximately $342,000$286,000 of total unrecognized stock-based compensation cost that we expect to recognize overby the next twoend of fiscal years.2009.

The total intrinsic value of stock options exercised during the six-monthnine-month periods ended April 30,July 31, 2008 and 2007 was approximately $1.2 million$685,000 and $1.8$1.9 million, respectively. The intrinsic value is calculated as the difference between the stock price as of April 30, 2008July 31 and the exercise price of the stock option multiplied by the number of shares exercised.

Summarized information about outstanding stock options as of April 30,July 31, 2008, that are already vested and those that we expect to vest, as well as stock options that are currently exercisable, is as follows:

Basic and diluted earnings per common share are based on the weighted average number of shares of our common stock outstanding.  Diluted earnings per common share give effect to outstanding stock options using the treasury method.  The dilutive number of shares for the three months ended April 30,July 31, 2008 and 2007 was 34,00025,000 and 58,000,61,000, respectively.

Accounts receivable are net of allowances for doubtful accounts of $610,000$588,000 as of April 30,July 31, 2008 and $751,000 as of October 31, 2007.

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

We operate in a single segment: industrial automation systems. We design and produce interactive computer control systems and software and computerized machine tools for sale through our own distribution network to the worldwide metal workingmetal-working market. We also provide software options, control upgrades, accessories and replacement parts for our products, as well as customer service and training support.

From time to time, our subsidiaries guarantee third party payment obligations in connection with the sale of certain machines to customers that use lease financing.  At April 30,As of July 31, 2008, we had 5659 outstanding third party guarantees totaling approximately $1.6$1.8 million. The terms of our subsidiaries’ guarantees are consistent with the underlying customer financing terms. Upon shipment, the customer has the risk of ownership, but does not obtain title until the machine lease is paid in full.  A retention of title clause allows us to recover the machine if the customer defaults on the lease. We believe that the proceeds obtained from liquidation of the machine would cover any payments required by the guarantee.

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 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):

On November 1, 2007, we adopted the provisions of Financial Accounting Standards Board Interpretation No. 48 "Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement No. 109," (FIN 48).  As a result of the adoption, there was no change to beginning retained earnings.  Our total balance of unrecognized tax benefits as of April 30,July 31, 2008 was approximately $639,000,$654,000, which included accrued interest.

We accrue interest related to unrecognized tax benefits as a component of our income tax provision. We believe there is substantial support for taking these tax benefits and therefore have estimated no tax penalties. As of April 30,July 31, 2008, we had approximately $61,000$72,000 of accrued interest, which did not include the federal tax benefit of interest deductions.  

We file income tax returns in U.S. federal jurisdiction and various state, local and foreign jurisdictions. The statute of limitation will expire between July 2009 and July 2010 with respect to unrecognized tax benefits related to FIN 48.

Hurco Companies, Inc. is an industrial technology company operating in a single segment. We design and produce computerized machine tools, featuring our proprietary computer control systems and software, for sale through our own distribution network to the worldwide metal cutting market. We also provide software options, control upgrades, accessories and replacement parts for our products, as well as customer service and training support.

Our strategy is to design manufacture and sell to the global metalworking marketmanufacture a comprehensive line of computerized machine tools that incorporateincorporates our proprietary, interactive computer control technology.technology and sell those machine tools on a global basis. We design our technology to enhance the machine tool user's productivity through ease of operation and higher levels of machine performance (speed, accuracy and surface finish quality). We use an open system software architecture that permits our computer control systems and software to be produced using standard PC hardware. We have emphasized a “user-friendly” design that employs both interactive conversational and graphical programming software. Each year since 2002, we have expanded our product offering to meet customer needs, which has led us to design and manufacture more complex machining centers with advanced capabilities.  We utilize a disciplined approach to strategically enter new geographic markets, as appropriate.  Our introduction of new, technologically advanced products, combined with our expansion into new markets, has resulted in our significant growth over the last several years.  In addition to this strong organic growth, our recent performance and current financial strength also provide us with the capability to pursue opportunistic acquisitions that are consistent with our strategic focus on expandingto expand our product line and enteringenter new markets.

Our computerized metal cutting machine tools are manufactured in Taiwan to our specifications by our wholly owned subsidiary, Hurco Manufacturing Limited (HML), and by an affiliated contract manufacturer. We sell our products through more than 170 independent agents and distributors in countries throughout North America, Europe and Asia. We also have our own direct sales and service organizations in Canada, England, France, Germany, Italy, Singapore and China.

Approximately 89% of the worldwide demand for machine tools comes from outside the United States.  During fiscal 2006 and 2007, more thanIn recent years, approximately two-thirds of our revenues werehave been attributable to customers located abroad.  DeterioratingSince the beginning of fiscal 2008, deteriorating conditions in the United States economy have significantly reduced demand for machine tools in the North American market, since the beginning of 2008.  European marketwhile demand has remained strong however.in the European and Asia Pacific markets.  As a result, during the past nine months the percentage of our revenues attributable to customers located abroad increased during the past six months tohas been approximately 80%.  Our sales to foreign customers are denominated, and payments by those customers are madepaid, in the prevailing currencies—primarily the Euro and Pound Sterling—prevailing in the countries in which those customers are located, and ourmarkets where sold.  Our product costs are incurred and paid primarily in the New Taiwan Dollar and the U.S. Dollar.  Changes in currency exchange rates may have a material effect on our operating results and consolidated balance sheets as reported under U.S. Generally Accepted Accounting Principles.  For example, when a foreign currency increases in value relative to the U.S. Dollar, sales made (and expenses incurred) in that currency, when translated to U.S. Dollars for reporting in our financial statements, are higher than would be the case when that currency has a lower value relative to the U.S. Dollar.  In our comparison of period-to-period results, we discuss not only the increases or decreases in those results as reported in our financial statements (which reflect translation to U.S. Dollars at prevailing exchange rates), but also the effect that changes in exchange rates had on those results.

Our high levels of foreign manufacturing and sales also subject us to cash flow risks due to fluctuating currency exchange rates.  We seek to mitigate those risks through the use of various derivative instruments-instruments, principally, foreign currency forward exchange contracts.

Our financial results for the secondthird quarter of fiscal 2008 reflect increased revenues and operating income compared to the corresponding period of the prior year driven bybecause of strong demand in European markets and targeted expansion into the Asia Pacific region, which offset a marked decrease in demand in the North American region.  The secondthird quarter results also reflect the benefit of a weaker U.S. Dollar when translating foreign sales for financial reporting purposes.

The following tables set forth net sales (in thousands) by geographic region and product category for the secondthird quarter of 2008 and 2007:

Growth was primarily driven by strong demandUnit shipments for the third quarter increased in existing European markets and expansion into Eastern European markets.  Growth in the Asia Pacific region was primarily due to targeted penetration into new markets.markets by 9% and 54%, respectively over the third quarter of fiscal 2007.  The effecteffects of a weaker U.S. Dollar when translating fiscal 2008 foreign sales into U.S. Dollars for financial reporting purposes had a favorable impact of approximately 17%14% on the year-over-year increase in Europeboth the European and 14% in the Asia Pacific market.markets. Sales in North America reflected continued market softness primarily attributableweakness throughout the United States due to customer concerns over unfavorable economic uncertainty.conditions. Unit shipments for the third quarter decreased in North America by 29% compared to the same period in the prior year, but the decrease was partially offset by a more favorable sales mix of larger machines.

Sales of computerized machine tools during the secondthird quarter of fiscal 2008 increased 40%19% over the corresponding period in fiscal 2007. The year-over-year increase was driven by a 15% increase in overallprimarily attributable to increased unit shipments combined within European and Asia Pacific markets and the favorable impact of a favorable product mix, particularly higher-priced VMX machines.weaker U.S. Dollar when translating foreign sales into U.S. Dollars for financial reporting purposes.