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 January 31,April 30, 2011 and for the three and six months ended January 31,April 30, 2011 and January 31,April 30, 2010 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, 2010.

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 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 January 31,April 30, 2011, denominated in Euros, Pounds Sterling and New Taiwan Dollars with set maturity dates ranging from FebruaryMay 2011 through JanuaryApril 2012.  The contract amounts, expressed at forward rates in U.S. Dollars at January 31,April 30, 2011, were $31.8$38.4 million for Euros, $8.9$10.5 million for Pounds Sterling and $30.6$33.5 million for New Taiwanese Dollars.    At January 31,April 30, 2011, we had approximately $330,000$1.6 million of gains,losses, net of tax, related to cash flow hedges deferred in Accumulated other comprehensive loss.  Of this amount, $89,000$1.4 million represents unrealized gains,losses, net of tax, related to cash flow hedge instruments that remain subject to currency fluctuation risk.  The majority of these deferred gainslosses will be recorded as an adjustment to Cost of sales and service in periods through JanuaryApril 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 matures in November 2011.  At January 31,April 30, 2011, we had $216,000 of realized gains and $14,000$226,000 of unrealized 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 guidance of the Financial Accounting Standards Board, or 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 January 31,April 30, 2011, in Euros, Pounds Sterling, Canadian Dollars, South African Rand, Singapore Dollars and New Taiwan Dollars with set maturity dates ranging from FebruaryMay 2011 through AprilSeptember 2011.  The amounts of these contracts at forward rates in U.S. Dollars at January 31,April 30, 2011 for Euros, Pounds Sterling, Canadian Dollars, South African Rand, New Taiwan Dollars and Singapore Dollars totaled $20.8$28.3 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 January 31,April 30, 2011 and October 31, 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 threesix months ended January 31,April 30, 2011 and 2010 (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 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.

A summary of stock option activity for the three-monthsix-month period ended January 31,April 30, 2011, is as follows:

Summarized information about outstanding stock options as of January 31,April 30, 2011, thosethat are already vested and those that are expected to vest, as well as stock options that are currently exercisable, are as follows:

On December 22, 2010, the Compensation Committee granted a total of 25,000 shares of restricted stock to our executive officers.  The restricted stock vests in full three years from the date of grant provided the recipient remains employed by us through that date.  The grant date fair value of the restricted stock is based on the closing sales price of our common stock on the grant date which was $23.10 per share.

During the first threesix months of fiscal 2011 and 2010, we recorded approximately $71,000$194,000 and $19,000,$49,000, respectively, of stock-based compensation expense related to grants of stock options and shares of restricted stock under the plans.  As of January 31,April 30, 2011, there was approximately $975,000$1.0 million of total unrecognized stock-based compensation cost that we expect to recognize by the end of fiscal 2014.

Basic earnings (losses)(loss) per share is calculated by dividing net income (loss) associated with common shareholders by the weighted-average number of common shares actually outstanding during the period. Diluted earnings (loss) 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 issued guidance ASC 260-10,on “Earnings Per Share”.   The impact of stock options and restricted stock on weighted average shares for the three and six months ended April 30, 2011 and 2010 did not change the income (loss) per share.  The following table presents a reconciliation of our basic and diluted earnings (losses)(loss) per share computation:

Accounts receivable are net of allowances for doubtful accounts of $550,000$295,000 as of January 31,April 30, 2011 and $497,000 as of October 31, 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 January 31,April 30, 2011, we had 3029 outstanding third party payment guarantees totaling approximately $1.7$1.6 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 threesix months ended January 31,April 30, 2011 reflects the increased production and sales occurring in the period as compared to the threesix months ended January 31,April 30, 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.  We also have an uncommitted demand credit facility in Taiwan in the amount of 100.0 million New Taiwan Dollars (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.

On March 7, 2011 we entered into an uncommitted demand credit facility in China in the amount of 2020.0 million Chinese Yuan (approximately $3.0 million) and amended our unsecured domestic credit agreement to accommodate the new facility.  This facility expires on February 24, 2012.

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.  ThePrior to the second quarter of fiscal 2011, the domestic credit agreement restrictsrestricted our ability to declare and pay dividends, incur additional indebtedness other than under this facility and make acquisitions wheneverbecause we havehad reported a cumulative net loss for the most recentfour consecutive quarters.   When we report cumulative net losses for 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).  These restrictions are no longer in effect as we moved to a cumulative net income for four consecutive quarters.  After achievingreporting 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.  At April 30, 2011, we were in compliance with the covenants contained in our credit facilities.

As of January 31,At April 30, 2011, and October 31, 2010, we had no$647,000 of borrowings outstanding under our credit facility in China, but had no other debt or borrowings under any of our other bank credit facilities and no outstanding letters of credit.facilities.  As of January 31,April 30, 2011, we had unutilized credit facilities of $22.1 million available for either direct borrowings or commercial letters of credit.$24.5 million.

Our unrecognized tax benefits were $207,000$217,000 as of January 31,April 30, 2011 and $196,000 as of October 31, 2010, and in each case included accrued interest.   

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 January 31,April 30, 2011, the gross amount of interest accrued, reported in Accrued expenses and other, was approximately $20,000,$23,000, 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 2012 and August 2014.

The carrying amounts for our trade receivables and payables approximate their fair values.  We also have financial instruments in the form of foreign currency forward exchange contracts as described in Note 2.  The U.S. Dollar equivalent notional amount of these contracts was $93.5$109.5 million and $89.1 million at January 31,April 30, 2011 and October 31, 2010, respectively.  The fair value of Derivative assets recorded on our Condensed Consolidated Balance Sheets at January 31,April 30, 2011 and October 31, 2010 was $1.4$1.5 million and $905,000, respectively.  The fair value of Derivative liabilities recorded on our Condensed Consolidated Balance Sheets at January 31,April 30, 2011 and October 31, 2010 was $1.8$4.2 million and $2.1 million, respectively.

The future 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 counterparties to these contracts are substantial and creditworthy financial institutions.  We do not consider either the risk of counterparty non-performance or the economic consequences of counterparty non-performance as material risks.

FASB fair value guidance established 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,April 30, 2011 and October 2010 (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 which are readily available.   Included as Level 2 fair value measurements are derivative assets and liabilities related to hedged and unhedged 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.

During fiscal 2011, we did not have any significant non-recurring measurements of nonfinancial assets and nonfinancial liabilities.

We have defined contribution plans that include a majority of our employees, under which our matching contributions are primarily discretionary.  The purpose of these plans is generally to provide additional financial security during retirement by providing employees with an incentive to save throughout their employment.  Our matching contributions to the plans are based on employee contributions or compensation.   From April 1, 2009 to December 31, 2010 we suspended our discretionary contributions to the U.S. plan as a cost reduction measure, however effective January 1, 2011 we reinstated our matching contributions to that plan in an amount equal to 25% of the first 6% of a participant’s annual earnings contributed, up to the maximum permitted by law.  Our contributions totaled approximately $130,000 and $76,000, for the six months ended April 30, 2011 and 2010, respectively.