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 JulyJanuary 31, 20102011 and for the three and nine months ended JulyJanuary 31, 20102011 and JulyJanuary 31, 20092010 is unaudited; however, in our opinion, the interim data includes all adjustments, consisting only of normal recurring adjustments, necessary to present fairly our consolidated financial position, results of operations, changes in shareholders’ equity and cash flows 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, 2009.

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,subsidiary’s gross profit and net earnings, 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, Canadian Dollars, South African Rand, Singapore Dollars and New Taiwan Dollars.

We record all derivative instruments as assets or liabilities at fair value.

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 Condensed 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 JulyJanuary 31, 2010,2011, denominated in Euros, Pounds Sterling and New Taiwan Dollars with set maturity dates ranging from August 2010February 2011 through July 2011.January 2012.  The contract amounts, expressed at forward rates in U.S. Dollars at JulyJanuary 31, 2010,2011, were $20.4$31.8 million for Euros, $5.2$8.9 million for Pounds Sterling and $22.1$30.6 million for New Taiwanese Dollars.    At JulyJanuary 31, 2010,2011, we had approximately $42,000$330,000 of losses,gains, net of tax, related to cash flow hedges deferred in Accumulated other comprehensive loss.  Of this amount, $275,000$89,000 represents unrealized losses,gains, net of tax, related to cash flow hedge instruments that remain subject to currency fluctuation risk.  The majority of these deferred lossesgains will be recorded as an adjustment to Cost of sales and service in periods through July 2011,January 2012, when the corresponding inventory that is the subject of the related hedge contract is sold, as described above.

We are also exposed to foreign currency exchange risk related to our investment in net assets in foreign countries.   To manage this risk, we have maintained a forward contract with a notional amount of €3.0 million.  We designated this forward contract as a hedge of our net investment in Euro denominated assets.  We selected the forward method under 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 on November 24, 2009 and we entered into a new forward contract for the same notional amount that is set to maturematures in November 2010.2011.  At JulyJanuary 31, 2010,2011, we had $23,000$216,000 of realized lossesgains and $343,000$14,000 of unrealized gains,losses, net of tax, recorded as cumulative translation adjustments in Accumulated other comprehensive loss related to this forward contract.

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 FASB guidance and, as a result, changes in their fair value are reported currently as Other (income) expense, net in the Condensed Consolidated Statements of Operations consistent with the transaction gain or loss on the related receivables and payables denominated in foreign currencies.

We had forward contracts outstanding as of JulyJanuary 31, 2010,2011, in Euros, Pounds Sterling, Canadian Dollars, South African Rand, Singapore Dollars and New Taiwan Dollars with set maturity dates ranging from August 2010February 2011 through MarchApril 2011.  The amounts of these contracts at forward rates in U.S. Dollars at JulyJanuary 31, 20102011 for Euros, Pounds Sterling, Canadian Dollars, South African Rand, New Taiwan Dollars and Singapore Dollars totaled $18.9$20.8 million.

We recognize the fair value of derivative instruments as assets and liabilities on a gross basis on our Condensed Consolidated Balance Sheets.  As of JulyJanuary 31, 20102011 and October 31, 2009,2010, all derivative instruments were recorded at fair value on the balance sheets as follows (in thousands):

Derivative instruments had the following effects on our Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Changes in Shareholders’ Equity and Operations during the three months ended JulyJanuary 31, 20102011 and 20092010 (in thousands):

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 replaced 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.outstanding and restricted shares under the 2008 Plan.  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.

Summarized information about outstanding stock options as of JulyJanuary 31, 2010,2011, those are already vested and those that are expected to vest, as well as stock options that are currently exercisable, are as follows:

Basic earnings (losses) per share is calculated by dividing net income (loss) associated with common share are based onshareholders by the weighted averageweighted-average number of shares of our common stockshares outstanding during the period. Diluted earnings (losses) per share assumes the issuance of additional shares of common share give effect to shares underlyingstock upon exercise of all outstanding stock options usingand contingently issuable securities if the effect is dilutive, in accordance with the treasury stock method when applied to our basic earnings (losses) per share.discussed in FASB issued guidance ASC 260-10, “Earnings Per Share”.   The following table presents a reconciliation of our basic and diluted earnings (losses) per share computation:

Accounts receivable are net of allowances for doubtful accounts of $546,000$550,000 as of JulyJanuary 31, 20102011 and $809,000$497,000 as of October 31, 2009.2010.

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-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 machines to customers that use financing.  We follow FASB guidance for accounting for contingencies with respect to these guarantees.   As of JulyJanuary 31, 2010,2011, we had 3430 outstanding third party payment guarantees totaling approximately $1.8$1.7 million. The terms of these guarantees are consistent with the underlying customer financing terms.  Upon shipment of a machine, the customer has the risk of ownership. The customer does not obtain title, however, until it 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 for potential liabilities under these guarantees when we believe a loss is probable and can be estimated.

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.  The increased provision in the three months ended January 31, 2011 reflects the increased production and sales occurring in the period as compared to the three months ended January 31, 2010. A reconciliation of the changes in our warranty reserve is as follows (in thousands):

We are party to an unsecured domestic credit agreement that provides us with a $15.0 million unsecured revolving credit facility and maximum outstanding letters of credit of $3.0 million.  The domestic credit agreementWe also provides for a separatehave an uncommitted demand credit facility in Taiwan in the amount of 100.0 million New Taiwan Dollars.  We also haveDollars (approximately $3.0 million) in addition to a £1.0 million revolving credit facility in the United Kingdom and a €1.5 million revolving credit facility in Germany.  The domestic and United Kingdom facilities mature on December 7, 2012.  The revolving credit facility in Germany does not have an expiration date.

Borrowings under the domestic facility may be used for general corporate purposes and bear interest at a floating rate, based either on LIBOR or the prime rate, plus an applicable margin.  The domestic credit agreement restricts our ability to declare and pay dividends, incur additional indebtedness other than under this facility and make acquisitions whenever we have a cumulative net loss for the most recent four consecutive quarters and for so long thereafter as the cumulative loss continues.  These restrictions are currently in effect as we have a cumulative net loss for the most recent four consecutive quarters.  The domestic credit agreement contains a financial covenant that requires no less than a 1:00 to 1:00 ratio of excess cash (defined as cash minus debt) to an annualized net loss (defined as a net loss for the two most recent consecutive quarters multiplied by two).  After achieving cumulative income for four consecutive quarters we are required to maintain a ratio of 0.5 to 1.0 of total indebtedness to the sum of total indebtedness and net worth.

As of JulyJanuary 31, 20102011 and October 31, 2009,2010, we had no debt or borrowings outstanding under any of our credit facilities and no outstanding letters of credit.  As of JulyJanuary 31, 2010,2011, we had unutilized credit facilities of $21.6$22.1 million available for either direct borrowings or commercial letters of credit.

Our unrecognized tax benefits were $195,000$207,000 as of JulyJanuary 31, 20102011 and $670,000$196,000 as of October 31, 2009,2010, and in each case included accrued interest.    During the third quarter of fiscal 2010, we recorded a benefit for income taxes of $495,000 due to the expiration of statutes of limitations on uncertain tax benefits which resulted in an increase in our effective tax rate for the three and nine months ended July 31, 2010 compared to same periods in prior year.  

We recognize accrued interest and penalties related to unrecognized tax benefits as components of our income tax provision.  We believe our unrecognized tax positions meet the minimum statutory threshold to avoid payment of penalties and, therefore, no tax penalties have been estimated.  As of JulyJanuary 31, 2010,2011, the gross amount of interest accrued, reported in Accrued expenses and other, was approximately $16,000,$20,000, 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 20112012 and August 2013.2014.