** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C.  20549**

**FORM 10-Q**

** **
| **x**                                          | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES**  |
|------------------------------------------------|------------|--------------------------------------------------------------------------|
| ** **                                     | ** ** | **EXCHANGE ACT OF 1934**                                                 |
|                                           |
| For the  quarterly period ended March 31, 2007 |
|                                           |
| OR                                             |
|                                           |
| **o**                                          | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES** |
| ** **                                     | ** ** | **EXCHANGE ACT OF 1934**                                                 |

 

For the transition periodfrom                            to                       

 

Commission File Number: **1-4252**

 

**UNITED INDUSTRIAL CORPORATION**

(Exact name of registrant as specified in its charter)
| **Delaware**                                                                        | ** ** | **95-2081809**                        |
|-------------------------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization)                     |       | (I.R.S. Employer  Identification No.) |
|                                                                                |       |                                  |
| **124  Industry Lane, Hunt Valley, Maryland**                                       |       | **21030**                             |
| (Address of principal executive offices)                                            |       | (Zip Code)                            |
|                                                                                |       |                                  |
| **(410)  628-3500**                                                                 |
| (Registrant’s  telephone number, including area code)                          |
|                                                                                |       |                                  |
| **Not  Applicable**                                                                 |
| (Former name, former address and former  fiscal year, if changed since last report) |
| ** **                                                                          |       |                                  |

 

Indicateby check mark whether the registrant: (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes x   No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Checkone):

 

Large accelerated filer o         Acceleratedfiler x         Non-accelerated filer o

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).  Yes o   No x

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date: 10,512,579 shares of common stock as of May 2, 2007.

 

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**UNITED INDUSTRIALCORPORATION**

**INDEX**
|                               | ** ** | ** **                                                                                                 | ** ** | **Page** |
|------------------------------------|------------|------------------------------------------------------------------------------------------------------------|------------|----------|
| PART  I—FINANCIAL INFORMATION |       |                                                                                                       |
|                               |       |                                                                                                       |
| Item  1.                           |       | Financial  Statements                                                                                      |       |     |
|                               |       |                                                                                                       |       |     |
|                               |       | Consolidated Condensed Balance Sheets -  March 31, 2007 (unaudited) and December 31, 2006                  |       | 2        |
|                               |       |                                                                                                       |       |     |
|                               |       | Consolidated Condensed Statements of Operations (unaudited)  -  Three Months Ended March 31, 2007 and 2006 |       |     |
|                               |       |                                                                                                       |       | 3        |
|                               |       | Consolidated Condensed Statements of Cash Flows  (unaudited) -  Three Months Ended March 31, 2007 and 2006 |       | 4        |
|                               |       |                                                                                                       |       |     |
|                               |       | Notes to Consolidated Condensed Financial Statements  (unaudited)                                          |       | 5        |
|                               |       |                                                                                                       |       |     |
| Item 2.                            |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                |       | 22       |
|                               |       |                                                                                                       |       |     |
| Item 3.                            |       | Quantitative and Qualitative Disclosures About Market  Risk                                                |       | 31       |
|                               |       |                                                                                                       |       |     |
| Item 4.                            |       | Controls and Procedures                                                                                    |       | 31       |
|                               |       |                                                                                                       |       |     |
| PART  II - OTHER INFORMATION       |       |                                                                                                       |
|                               |       |                                                                                                       |
| Item  1.                           |       | Legal  Proceedings                                                                                         |       | 32       |
|                               |       |                                                                                                       |       |     |
| Item 2.                            |       | Unregistered Sales of Equity Securities and Use of  Proceeds                                               |       |     |
|                               |       |                                                                                                       |       |     |
| Item 6.                            |       |  Exhibits                                                                                             |       | 32       |
|                               |       |                                                                                                       |       |     |
| SIGNATURES                         |       | 33                                                                                                         |
|                                    |            |                                                                                                            |            |          |  |

 

1

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**PART I—FINANCIALINFORMATION**

**Item 1.—Financial Statements**

(Dollars in thousands, except share and per shareamounts, or unless otherwise noted)

**UNITED INDUSTRIAL CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDCONDENSED BALANCE SHEETS**
| ** **                                                                                                                                                                                               | ** ** | **March 31,**   | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|------------------|------------|
| ** **                                                                                                                                                                                               | ** ** | **2007**        | ** ** | **2006**         | ** ** |
| **ASSETS**                                                                                                                                                                                               | ** ** | **(Unaudited)** | ** ** | ** **       | ** ** |
| Current assets:                                                                                                                                                                                          |       |            |       |             |       |
| Cash and cash  equivalents                                                                                                                                                                               |       | $4,797          |       | $39,158          |       |
| Accounts receivable,  net                                                                                                                                                                                |       | 52,665          |       | 71,503           |       |
| Note receivable                                                                                                                                                                                          |       | 833             |       | 833              |       |
| Inventories                                                                                                                                                                                              |       | 95,058          |       | 73,700           |       |
| Prepaid expenses and  other current assets                                                                                                                                                               |       | 10,240          |       | 10,102           |       |
| Assets of discontinued  operations                                                                                                                                                                       |       | 12,030          |       | 11,996           |       |
| Total current assets                                                                                                                                                                                     |       | 175,623         |       | 207,292          |       |
| Marketable equity securities                                                                                                                                                                             |       | 10,991          |       | 11,392           |       |
| Deferred income taxes, net of valuation allowance                                                                                                                                                        |       | 4,448           |       | 4,073            |       |
| Note receivable                                                                                                                                                                                          |       | 4,167           |       | 4,167            |       |
| Intangible assets, net                                                                                                                                                                                   |       | 26,450          |       | 27,894           |       |
| Goodwill                                                                                                                                                                                                 |       | 51,586          |       | 51,314           |       |
| Other assets                                                                                                                                                                                             |       | 5,207           |       | 5,466            |       |
| Property and equipment, net                                                                                                                                                                              |       | 46,395          |       | 47,042           |       |
| Total assets                                                                                                                                                                                             |       | $324,867        |       | $358,640         |       |
|                                                                                                                                                                                                     |       |            |       |             |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                                            |       |            |       |             |       |
| Current liabilities:                                                                                                                                                                                     |       |            |       |             |       |
| Current portion of  long-term debt                                                                                                                                                                       |       | $21             |       | $2,896           |       |
| Accounts payable                                                                                                                                                                                         |       | 34,232          |       | 39,578           |       |
| Accrued employee  compensation and taxes                                                                                                                                                                 |       | 18,355          |       | 17,506           |       |
| Customer advances                                                                                                                                                                                        |       | 32,936          |       | 29,410           |       |
| Borrowings under  revolving credit facility                                                                                                                                                              |       | 5,000           |       | —           |       |
| Post-retirement benefit  obligation other than pension                                                                                                                                                   |       | 2,118           |       | 2,118            |       |
| Other current  liabilities                                                                                                                                                                               |       | 16,522          |       | 16,971           |       |
| Liabilities of  discontinued operations                                                                                                                                                                  |       | 12,494          |       | 12,113           |       |
| Total current  liabilities                                                                                                                                                                               |       | 121,678         |       | 120,592          |       |
| Long-term debt                                                                                                                                                                                           |       | 120,026         |       | 120,030          |       |
| Post-retirement benefit obligation other than pension                                                                                                                                                    |       | 13,873          |       | 14,052           |       |
| Unfunded status of pension liability                                                                                                                                                                     |       | 38,430          |       | 37,830           |       |
| Other liabilities                                                                                                                                                                                        |       | 3,321           |       | 2,837            |       |
| Total liabilities                                                                                                                                                                                        |       | 297,328         |       | 295,341          |       |
| Shareholders’ equity:                                                                                                                                                                               |       |            |       |             |       |
| Preferred stock, par  value $1.00 per share; 1,000,000 shares authorized; none issued and  outstanding                                                                                                   |       | —          |       | —           |       |
| Common stock, par value  $1.00 per share; 30,000,000 shares authorized; 10,503,312 and 11,320,095  shares outstanding at March 31, 2007 and December 31, 2006, respectively (net  of shares in treasury) |       | 14,374          |       | 14,374           |       |
| Additional capital                                                                                                                                                                                       |       | 87,161          |       | 86,471           |       |
| Retained earnings                                                                                                                                                                                        |       | 90,562          |       | 82,337           |       |
|                                                                                                                                                                                                     |       |            |       |             |       |
| Treasury stock, at  cost; 3,870,836 and 3,054,053 shares at March 31, 2007 and December 31, 2006,  respectively                                                                                          |       | (122,916        | )          | (78,505          | )          |
| Accumulated other  comprehensive loss, net of income tax                                                                                                                                                 |       | (41,642         | )          | (41,378          | )          |
| Total shareholders’  equity                                                                                                                                                                         |       | 27,539          |       | 63,299           |       |
| Total liabilities and  shareholders’ equity                                                                                                                                                         |       | $324,867        |       | $358,640         |       |

 

See accompanying notes tothe consolidated condensed financial statements.

2

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**UNITED INDUSTRIALCORPORATION AND SUBSIDIARIESCONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS(Unaudited)**
| ** **                                                                                                                                                              | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                                                                              | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Net sales                                                                                                                                                               |       | $                                                | 160,846    |   | $ | 128,701 |   |
| Operating costs  and expenses                                                                                                                                           |       | 144,100                                          |       | 115,296 |   |
| Operating income                                                                                                                                                        |       | 16,746                                           |       | 13,405 |   |
| Non-operating  income and (expense):                                                                                                                                    |       |                                             |       |   |   |
| Interest income                                                                                                                                                         |       | 542                                              |       | 925 |   |
| Interest expense                                                                                                                                                        |       | (1,443                                           | )          | (1,383 | ) |
| Other income (expense), net                                                                                                                                             |       | 77                                               |       | (585 | ) |
|                                                                                                                                                                    |       | (824                                             | )          | (1,043 | ) |
| Income from  continuing operations                                                                                                                                      |       |                                             |       |   |   |
| before income  taxes                                                                                                                                                    |       | 15,922                                           |       | 12,362 |   |
| Provision for income  taxes                                                                                                                                             |       | 5,897                                            |       | 4,710 |   |
| Income from  continuing operations                                                                                                                                      |       | 10,025                                           |       | 7,652 |   |
| (Loss) income  from discontinued operations, net of income tax benefit (provision) of $447  and $(523) for the three months ended March 31, 2007 and 2006, respectively |       | (830                                             | )          | 916 |   |
| Net income                                                                                                                                                              |       | $                                                | 9,195      |   | $ | 8,568 |   |
|                                                                                                                                                                    |       |                                             |       |   |   |
| Basic earnings  per share:                                                                                                                                              |       |                                             |       |   |   |
| Income from continuing operations                                                                                                                                       |       | $                                                | 0.90       |   | $ | 0.68 |   |
| (Loss) income from discontinued operations                                                                                                                              |       | (0.07                                            | )          | 0.08 |   |
| Net income                                                                                                                                                              |       | $                                                | 0.83       |   | $ | 0.76 |   |
| Diluted earnings  per share:                                                                                                                                            |       |                                             |       |   |   |
| Income from continuing operations                                                                                                                                       |       | $                                                | 0.75       |   | $ | 0.61 |   |
| (Loss) income from discontinued operations                                                                                                                              |       | (0.06                                            | )          | 0.06 |   |
| Net income                                                                                                                                                              |       | $                                                | 0.69       |   | $ | 0.67 |   |

 

See accompanying notes tothe consolidated condensed financial statements.

3

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**UNITED INDUSTRIALCORPORATION AND SUBSIDIARIESCONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS(Unaudited)**
| ** **                                                                         | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                                         |       |                                             |       |   |   |
| Net income                                                                         |       | $                                                | 9,195      |   | $ | 8,568 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                             |       |   |   |
| Loss (income) from discontinued operations, net of  income tax benefit (provision) |       | 830                                              |       | (916 | ) |
| Amortization of debt issuance costs and  deferredfinancing costs                   |       | 305                                              |       | 309 |   |
| Depreciation and amortization                                                      |       | 3,941                                            |       | 2,767 |   |
| Stock-based compensation                                                           |       | 798                                              |       | 362 |   |
| Deferred income tax benefit                                                        |       | (308                                             | )          | (109 | ) |
| Excess tax benefit from stock-based compensation                                   |       | (9                                               | )          | (764 | ) |
| Other, net                                                                         |       | (12                                              | )          | (5 | ) |
| Changes in operating assets and liabilities:                                       |       |                                             |       |   |   |
| Decrease (increase) in accounts receivable                                         |       | 18,838                                           |       | (3,150 | ) |
| Increase in inventories                                                            |       | (21,254                                          | )          | (9,354 | ) |
| Increase in prepaid expenses and other current  assets                             |       | (80                                              | )          | (85 | ) |
| (Decrease) increase in accounts payable, accruals  and other current liabilities   |       | (4,863                                           | )          | 3,824 |   |
| Increase in customer advances                                                      |       | 3,526                                            |       | 2,371 |   |
| Increase in long-term liabilities                                                  |       | 905                                              |       | 2,335 |   |
| Net cash  provided by operating activities from continuing operations              |       | 11,812                                           |       | 6,153 |   |
| Net cash (used  in) provided by operating activities from discontinued operations  |       | (483                                             | )          | 1,697 |   |
| Net cash  provided by operating activities                                         |       | 11,329                                           |       | 7,850 |   |
| ** **                                                                         |       |                                             |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                         |       |                                             |       |   |   |
| Purchases of  property and equipment                                               |       | (2,192                                           | )          | (1,453 | ) |
| Net cash used in  investing activities from discontinuedoperations                 |       | —                                           |       | (13 | ) |
| Net cash used in  investing activities                                             |       | (2,192                                           | )          | (1,466 | ) |
| ** **                                                                         |       |                                             |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                         |       |                                             |       |   |   |
| Borrowings under  revolving credit facility                                        |       | 5,000                                            |       | — |   |
| Repayment of  long-term debt                                                       |       | (2,879                                           | )          | (321 | ) |
| Decrease in  deposits and restricted cash                                          |       | —                                           |       | 2,295 |   |
| Proceeds from  exercise of stock options                                           |       | 165                                              |       | 1,222 |   |
| Excess tax  benefit from stock-based compensation                                  |       | 9                                                |       | 764 |   |
| Dividends paid                                                                     |       | (1,100                                           | )          | (1,127 | ) |
| Purchase of  treasury shares                                                       |       | (44,693                                          | )          | — |   |
| Net cash (used  in) provided by financing activities                               |       | (43,498                                          | )          | 2,833 |   |
| (Decrease)  increase in cash and cash equivalents                                  |       | (34,361                                          | )          | 9,217 |   |
| Cash and cash  equivalents at beginning of year                                    |       | 39,158                                           |       | 77,496 | (1) |
| Cash and cash  equivalents at end of period                                        |       | $                                                | 4,797      |   | $ | 86,713 |   |

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(1) Includes cash reported in assets held for sale of$14,363 at January 1, 2006.

See accompanying notes to the consolidated condensedfinancial statements.

4

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**UNITED INDUSTRIALCORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS(Dollars in thousands, except share and per share amounts or unless otherwisenoted)**

**Note A—Basisof Presentation and Nature of Operations**

United IndustrialCorporation (“United Industrial”) designs, produces and supports aerospace anddefense systems through its wholly owned subsidiary AAI Corporation, and AAICorporation’s direct and indirect wholly owned subsidiaries, AAI ServicesCorporation, Aerosonde Pty Ltd, Aerosonde North America Incorporated (togetherwith Aerosonde Pty Ltd, “Aerosonde”), ESL Defence Limited (“ESL”), McTurbineInc. (“McTurbine”) and Symtx, Inc. (“Symtx”) (collectively with AAICorporation, “AAI”).  The company’shigh-technology products and services include unmanned aircraft systems,training and simulation systems, automated aerospace test and maintenanceequipment, armament systems, aviation ground support equipment, logistical andengineering services, and maintenance, repair and overhaul activities.

The company’s transportationoperation and former energy operation are accounted for as discontinuedoperations. United Industrial divested its energy segment (operated throughDetroit Stoker Company) on December 29, 2006 as part of its ongoingstrategy to focus the company on its core aerospace and defense business. Thehistorical results of operations of the discontinued energy operation have beenreported in the accompanying consolidated statements of operations and cashflows for the three months ended March 31, 2006. (See Notes J and K foradditional information.)

The accompanying Consolidated CondensedFinancial Statements of the company have been prepared in accordance withaccounting principles generally accepted in the United States of America (GAAP)for interim financial information and with the instructions to Form 10-Q andRule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notesrequired by GAAP for complete financial statements.  In the opinion of management, all adjustments(consisting of normal recurring items) considered necessary for a fairpresentation have been included. Operating results for the three-month period ended March 31, 2007 are notnecessarily indicative of the results that may be expected for the year endingDecember 31, 2007.  These unauditedConsolidated Condensed Financial Statements should be read in conjunction withthe Consolidated Financial Statements and notes thereto included in the company’sAnnual Report on Form 10-K for the year ended December 31, 2006.

On November 28, 2006, AAICorporation acquired Symtx.  Theoperating results of Symtx have been included in the consolidated financialstatements of United Industrial since November 28, 2006.  On November 14,2006, the company acquired McTurbine. The operating results of McTurbine have been included in theconsolidated financial statements of United Industrial since November 14,2006.  On June 19, 2006, the companyacquired Aerosonde.  The operatingresults of Aerosonde have been included in the consolidated financialstatements of the company since June 19, 2006.

The company had two reportable segments, Defense and Energy, prior tothe divestiture of Detroit Stoker Company on December 29, 2006.  The company’s President and Chief ExecutiveOfficer, the chief operating decision maker, views the company’s aerospace anddefense business as a single business segment that addresses a single customerbase through the same distribution system. The President and Chief ExecutiveOfficer evaluates both consolidated and disaggregated financial information,primarily product line orders, revenues and the operating performance ofindividual long-term contracts across all product lines, in deciding how toallocate resources and assess performance. The company’s product lines havesimilar long-term economic characteristics and are similar in relation to thenature of their products and customers. These product lines generally share asingle production and distribution process. In addition, the budgeting processis primarily based on the entire company, except for orders and revenue, whichare budgeted separately for each product line. Accordingly, as ofDecember 31, 2006, the company operates as a single integrated businessand has one operating segment.

5

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Thefollowing table summarizes the company’s sales by product line for the threemonths ended March 31, 2007 and 2006:

|                        | ** ** | **March 31,** | ** ** |
|------------------------|------------|--------------------|------------|
| ** **             | ** ** | **2007**           | ** ** | **2006** | ** ** |
| Unmanned Systems       |       | $                  | 93,384     |   | $ | 91,590 |   |
| Services and Logistics |       | 39,102             |       | 19,799 |   |
| Test Systems           |       | 21,203             |       | 8,929 |   |
| Training Systems       |       | 2,394              |       | 3,632 |   |
| Advanced Programs      |       | 4,147              |       | 3,957 |   |
| Other                  |       | 616                |       | 794 |   |
|                   |       | $                  | 160,846    |   | $ | 128,701 |   |

 

The preparation of financial statementsin conformity with GAAP requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements, aswell as reported amounts of revenues and expenses during the reporting period.  Actual results could differ from theseestimates and those differences could be material.  Certain prior year amounts have beenreclassified to conform to current year presentation.

**Note B—****New Accounting Pronouncement**

On February 15, 2007, Statement of Financial Accounting Standard No.159, The Fair Value Option for Financial Assets and Financial Liabilities —Including an Amendment of FASB Statement No. 155 (“SFAS No. 159”), wasissued.  SFAS 159 is effective as of thebeginning of the first fiscal year that begins after November 15, 2007.  SFAS No. 159 permits an entity to choose tomeasure many financial instruments and certain other items at fair value.  The company is currently evaluating whetherto elect the option provided for in this standard.

**Note C—EarningsPer Share**

Basic earnings pershare for all periods presented was computed by dividing net earnings for therespective period by the weighted average number of shares of the company’scommon stock, par value $1.00 per share (“Common Stock”) outstanding during theperiod.  Diluted earnings per share wascomputed by dividing net earnings during the period, adjusted to add back theafter-tax interest and other charges related to the company’s $120,000aggregate principal amount of 3.75% Convertible Senior Notes due September 15,2024 (“3.75% Convertible Senior Notes”), by the weighted average number ofshares of Common Stock outstanding during the period, adjusted to add theweighted average number of potential dilutive shares of Common Stock that wouldhave been outstanding upon the assumed exercise of stock options using thetreasury stock method and conversion of the 3.75% Convertible Senior Notes intoCommon Stock.

Options topurchase 69,628 shares of the company’s Common Stock for the three months endedMarch 31, 2007 and options to purchase 21,727 shares of the company’s CommonStock for the three months ended March 31, 2006 were not included in thecomputation of diluted earnings per share because their impact would beanti-dilutive.

6

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Basic and diluted earnings per share amounts werecomputed as follows:
| ** **                         | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|
| ** **                         | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                         | ** ** | **Earnings**                                         | ** ** | **Shares** | ** ** | **Per Share** | ** ** | **Earnings** | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
|                               |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Basic Earnings  Per Share          |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Income from continuing operations  |       | $                                                    | 10,025     |   | 11,093,009 |   | $ | 0.90 |   | $ | 7,652 |   | 11,289,402 |   | $ | 0.68 |   |
|                               |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Effect of  Dilutive Securities     |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Stock Options                      |       | —                                               |       | 383,956 |   |   |   | — |   | 429,694 |   |   |   |
| 3.75% Convertible Senior Notes     |       | 876                                                  |       | 3,058,356 |   |   |   | 1,310 |   | 3,058,356 |   |   |   |
| Diluted Earnings  Per Share        |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Income from  continuing operations |       | $                                                    | 10, 901    |   | 14,535,321 |   | $ | 0.75 |   | $ | 8,962 |   | 14,777,452 |   | $ | 0.61 |   |

 

**Note D—Stock-BasedCompensation**

Stock-based compensation expense of $798 and $362 for the three monthsended March 31, 2007 and 2006, respectively, was recorded in operating costsand expenses included in operating income. Additional compensation cost will berecognized as new options are awarded. As of March 31, 2007, there was $5,370of total unrecognized compensation cost related to unvested share-basedcompensation arrangements granted under the company’s equity compensation plan.That cost is expected to be recognized over a three-year period.

A summary of stock optionactivity during the three months ended March 31, 2007 under the company’sequity compensation plan is as follows:

|                                       | ** ** | **Number of   Shares  (in thousands)** | ** ** |
|---------------------------------------|------------|-------------------------------------------------------|------------|
| Number of shares under option:        |       |                                                  |       |
| Outstanding at January  1, 2007       |       | 1,020                                                 |       |
| Granted                               |       | 131                                                   |       |
| Exercised                             |       | (11                                                   | )          |
| Cancelled                             |       | (3                                                    | )          |
| Outstanding at March  31, 2007        |       | 1,137                                                 |       |
|                                  |       |                                                  |       |
| Exercisable at  March 31, 2007   |       | 745                                                   |       |
| Unexercisable at  March 31, 2007 |       | 392                                                   |       |
| Available for future grants           |       | 634                                                   |       |

 

##### **NoteE—Marketable Equity Securities**

The company’s investment inmarketable equity securities consists of an investment in common stock of onecompany in the Aerospace and Defense industry. Unrealized holding gains and losses deemed temporary onavailable-for-sale securities are excluded from earnings and are reported as aseparate component of other comprehensive income until realized. If anunrealized holding loss is deemed to be other-than-temporary, such unrealizedloss is charged to earnings when identified. The company’s cost basis in theinvestment is $12,602 and the carrying value (fair market value) was $10,991 atMarch 31, 2007.

7

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In June 2006, theinvestee company disclosed the indictment of the investee company and itschairman and suspension of certain of its plants from receiving U.S. Governmentcontracts, and possible delisting of its common stock. In October 2006,the investee company announced that the suspension of certain of its plantsfrom receiving U.S. Government contracts had been lifted, although a governmentinvestigation is still pending. Management continues to evaluate the financial stabilityof the investee company in relation to the severity and duration of theunrealized loss. Based on that evaluation and the company’s ability and intentto hold the investment for a reasonable period of time sufficient for aforecasted recovery of fair value, the company does not consider thisinvestment to be other-than-temporarily impaired at March 31, 2007. At March31, 2007 the cumulative net unrealized loss recorded in accumulated othercomprehensive loss was $1,611.

##### **NoteF—Supplemental Balance Sheet and Cash Flow Information**

Inventoriesconsisted of the following components for the periods specified:

|                         | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **              | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| Work-in-process         |       | $                  | 74,820     |                  | $          | 60,194 |   |
| Materials and  supplies |       | 20,238             |       | 13,506                |       |
| Total inventories       |       | $                  | 95,058     |                  | $          | 73,700 |   |

 

Cash paid for Federalincome taxes during the three months ended March 31, 2007 was $3,000.  No federal income taxes were paid during thethree months ended March 31, 2006.  Cashpaid for interest during the three months ended March 31, 2007 and 2006 was$2,256 and $2,260, respectively.

**Note G—Pension and OtherPost-retirement Benefits**

On December29, 2006, United Industrial completed the sale of its wholly ownedsubsidiary, Detroit Stoker Company (“Detroit Stoker”). Detroit Stokermaintained its own tax-qualified defined benefit plan for union employees andunfunded post-retirement benefit plans for eligible employees.  The assets and liabilities of these planswere transferred with Detroit Stoker to the new owner as part of the saletransaction. In addition, on April 30, 2007 United Industrial transferred theportion of the assets ($2,199) and liabilities ($2,199) in the company’stax-qualified defined benefit plan attributable to the frozen accrued pensionbenefits of active Detroit Stoker non-union employees, determined as of theclosing date of the sale transaction, to a new pension plan established byDetroit Stoker.   All amounts in thetables below for the three months ended March 31, 2006 have been adjusted toreflect the transfer of these assets and liabilities of the Detroit Stokerplans with the exception of the transferred portion attributable to the frozenaccrued pension benefits of active Detroit Stoker non-union employees. Pensionexpense related to Detroit Stoker has been reported in income from discontinuedoperations for the three months ended March 31, 2006.

The following table provides thecomponents of net periodic pension benefit cost for the three months endedMarch 31, 2007 and 2006:

|                                     | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------|------------|--------------------------------------------------|------------|
| ** **                          | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
|                                |       |                                             |       |   |   |
| Service cost                        |       | $                                                | 1,209      |   | $ | 1,175 |   |
| Interest cost                       |       | 2,783                                            |       | 2,500 |   |
| Expected return  on plan assets     |       | (3,229                                           | )          | (3,100 | ) |
| Amortization of  prior service cost |       | 166                                              |       | 175 |   |
| Amortization of  actuarial loss     |       | 1,076                                            |       | 1,225 |   |
| Net periodic  pension benefit cost  |       | $                                                | 2,005      |   | $ | 1,975 |   |

 

8

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The following table provides thecomponents of post-retirement benefit obligation cost other than pension forthe three months ended March 31, 2007 and 2006:

|                                                  | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                       | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
|                                             |       |                                             |       |   |   |
| Service cost                                     |       | $                                                | 17         |   | $ | 23 |   |
| Interest cost                                    |       | 223                                              |       | 226 |   |
| Amortization of prior service cost               |       | 3                                                |       | 3 |   |
| Amortization of actuarial loss                   |       | 37                                               |       | 33 |   |
|                                             |       |                                             |       |   |   |
| Net periodic  other post-retirement benefit cost |       | $                                                | 280        |   | $ | 285 |   |

 

The followingtable provides the company’s contributions to and benefits paid under pensionand post-retirement benefit plans for the three months ended March 31, 2007 and2006:
| ** **                                                                 | ** ** | **Pension Benefits  Three Months Ended  March 31,** | ** ** | **Post-retirement Benefit   Obligation Other ThanPension  Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2007**                                                                | ** ** | **2006**                                                                                                                     | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                       |       |                                                                    |       |                                                                                                                         |       |   |   |   |   |
| Expected fiscal  year contributions reported at the end of the prior year: |       |                                                                    |       |                                                                                                                         |       |   |   |   |   |
| Employer                                                                   |       | $                                                                       | 5,200      |                                                                                                                         | —     |   | $ | 2,118 |   | $ | 2,236 |   |
| Employee                                                                   |       | —                                                                  |       | —                                                                                                                       |       | — |   | — |   |
| Total expected  contributions at end of prior year                         |       | 5,200                                                                   |       | —                                                                                                                       |       | 2,118 |   | 2,236 |   |
|                                                                       |       |                                                                    |       |                                                                                                                         |       |   |   |   |   |
| Actual  contributions made in the current year                             |       | —                                                                  |       | —                                                                                                                       |       | 459 |   | 561 |   |
| Remaining  contributions expected to be made in the current year           |       | 4,215                                                                   |       | —                                                                                                                       |       | 1,511 |   | 1,590 |   |
| Total expected  current year contributions                                 |       | 4,215                                                                   |       | —                                                                                                                       |       | 1,970 |   | 2,151 |   |
| Difference from  expectations at end of the prior year                     |       | $                                                                       | (985       | )                                                                                                                            | —     |   | $ | (148 | ) | $ | (85 | ) |

 

##### **Note H—Comprehensive Income**

The following table sets forth the components of othercomprehensive income and total comprehensive income for the periods specified:

|                                                                       | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                            | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| ** **                                                            | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Net income                                                            |       | $                                                | 9,195      |   | $ | 8,568 |   |
| Other  comprehensive income:                                          |       |                                             |       |   |   |
| Unrealized (loss) gain on marketable securities, net  of income taxes |       | (401                                             | )          | 1,999 |   |
| Gain on foreign currency translation                                  |       | 137                                              |       | 106 |   |
| Total  comprehensive income                                           |       | $                                                | 8,931      |   | $ | 10,673 |   |

 

9

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#####  

##### **Note I — Income Tax**

On July 13, 2006, Financial Standards Accounting Board InterpretationNo. 48 Accounting for Uncertainty in Income Taxes (“FIN 48”), an interpretationof FASB Statement No. 109 (“SFAS 109”) was issued.  The provisions of FIN 48 are effective forfiscal years beginning after December 15, 2006. FIN 48 clarifies the accounting for uncertainty in income taxesrecognized in an enterprise’s financial statements in accordance with FASBStatement No. 109, Accounting for Income Taxes. It also prescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return.

The company adopted the provisions of FIN 48 on January 1, 2007. As aresult of the implementation of FIN 48, the company recognized no materialadjustment in the liability for unrecognized income tax benefits. At theadoption date of January 1, 2007, the company had $4,829 of unrecognized taxbenefits, all of which would affect the company’s effective tax rate ifrecognized. At March 31, 2007, the company had $5,142 of unrecognized taxbenefits.

The company recognizes interest and penalties related to uncertain taxpositions in income tax expense. As of March 31, 2007, the company hadapproximately $2,215 of accrued interest related to uncertain tax positions.

In connection with the Internal Revenue Service (“IRS”) examination ofthe company’s 2002 and 2003 income tax returns, the IRS has proposed certainadjustments related to deductions taken for losses arising from the company’sdiscontinued transportation operation. The company has appealed those proposed adjustments. The company doesnot anticipate that any resulting adjustments would materially impact itsfinancial position.

##### **Note J—Discontinued Operations**

**Discontinued Energy Operation**

*Sale of Energy Segment*

United Industrial divestedits energy segment (operated through Detroit Stoker Company) on December 29,2006.    For additionalinformation, please see Note 19 to the Consolidated Financial Statementsincluded in Part II, Item 8 of the company’s Annual Report on Form 10-K for theyear ended December 31, 2006.

The results of operations ofthe discontinued energy operation have been reported in the accompanyingconsolidated statement of operations and cash flows for the three months endedMarch 31, 2006.

Summary results of the discontinued energy operation, which have beenreported separately as income from discontinued operations in the accompanyingConsolidated Statements of Operations, were as follows:

|                                 | ** ** | **Three Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **March 31, 2006**     | ** ** |
|                            |       |                             |       |
| Net sales                       |       | $                                | 8,918      |   |
| Operating costs  and expenses   |       | 7,211                            |       |
| Operating income                |       | 1,707                            |       |
| Other income and  expenses, net |       | 174                              |       |
| Income before  income taxes     |       | 1,881                            |       |
| Provision for  income taxes     |       | 678                              |       |
| Net income                      |       | $                                | 1,203      |   |

 

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The following table provides the sources and uses of net cash flows forthe discontinued energy operation, which are aggregated and reported separatelyas net cash used in operating activities from discontinued operations in theaccompanying Consolidated Statements of Cash Flows:

|                                                                                                                | ** ** | **Three Months Ended  March 31, 2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| Net income                                                                                                     |       | $                                                          | 1,203      |   |
| Changes in  operating assets and liabilities                                                                   |       | 1,000                                                      |       |
| Net cash  provided by operating activities from discontinued energy operation                                  |       | 2,203                                                      |       |
| Net cash used in  investing activities from discontinued energy operation, purchase of property  and equipment |       | (13                                                        | )          |
| Net increase in cash  and cash equivalents from discontinued energy operation                                  |       | $                                                          | 2,190      |   |

 

There were no cash flowsfrom financing activities from the discontinued energy operation for the threemonths ended March 31, 2006.

**Discontinued TransportationOperation**

In December 2001,United Industrial’s Board of Directors decided to discontinue thetransportation business.  The companyceased to accept new transportation business at that time and it was decided tosell all or part of the transportation business and “runoff” the operations forany remaining contractual obligations. As of March 31, 2007, the company’sdiscontinued transportation operation consists primarily of its investment inElectric Transit, Inc. (“ETI”).  ETI isowned 35% by AAI Corporation and 65% by Skoda, a Czech company.  AAI Corporation’s last commitment to ETIexpired in April 2006.  (See Note K foradditional information.)

Thecompany has determined that ETI is a variable interest entity, for which thecompany is the primary beneficiary, in accordance with the FASB issuedInterpretation No. 46 (revised December 2003), Consolidation ofVariable Interest Entities, an Interpretation of Accounting Research BulletinNo. 51** (“FIN 46R”), which became effective for yearsbeginning after December 31, 2002. The financial statements for ETI havebeen consolidated for all periods presented. The company accounts for itsremaining transportation operation as a discontinued operation, including theconsolidation of ETI as a variable interest entity.

Summary results of the discontinued transportationoperation, which have been reported separately as loss from discontinuedoperations in the accompanying Consolidated Statements of Operations, were asfollows:

|                                                                             | ** ** | **March 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                  | ** ** | **2007**           | ** ** | **2006** | ** ** |
| Sales                                                                       |       | $                  | 372        |   | $ | 393 |   |
| Cost of sales                                                               |       | (322               | )          | (255 | ) |
| General and  administrative expenses                                        |       | (1,307             | )          | (561 | ) |
| Other expense                                                               |       | (20                | )          | (19 | ) |
| Loss before  income taxes                                                   |       | (1,277             | )          | (442 | ) |
| Benefit from  income taxes                                                  |       | 447                |       | 155 |   |
| Loss from discontinued  transportation operation, net of income tax benefit |       | $                  | (830       | ) | $ | (287 | ) |

 

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The following table provides the sources and uses of net cash flows forthe discontinued transportation operation, which are aggregated and reportedseparately as net cash used in discontinued operations in the accompanyingConsolidated Statements of Cash Flows:

|                                                                                   | ** ** | **March 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                        | ** ** | **2007**           | ** ** | **2006** | ** ** |
| Net loss                                                                          |       | $                  | (830       | ) | $ | (287 | ) |
| Changes in  operating assets and liabilities                                      |       | 347                |       | (266 | ) |
| Deferred income  taxes                                                            |       | —             |       | 47 |   |
| Net cash used in  operating activities from discontinued transportation operation |       | $                  | (483       | ) | $ | (506 | ) |

 

**Therewere no cash flows from financing or investing activities from the discontinuedtransportation operation for the three months ended March 31, 2007 or 2006.**

**Assetsand liabilities of the discontinued transportation operation, which have been reportedand summarized in the accompanying Consolidated Balance Sheets as Assets andLiabilities of discontinued operations, respectively, were as follows:**

|                                           | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| Current Assets:                           |       |               |       |                  |       |
| Cash                                      |       | $                  | 265        |                  | $          | 387 |   |
| Accounts receivable                       |       | 292                |       | 206                   |       |
| Prepaid expenses and other current assets |       | 168                |       | 98                    |       |
| Deferred income taxes                     |       | 11,305             |       | 11,305                |       |
|                                      |       | $                  | 12,030     |                  | $          | 11,996 |   |
| Current  Liabilities:                     |       |               |       |                  |       |
| Accounts payable                          |       | $                  | 406        |                  | $          | 61 |   |
| Accrued employee compensation and taxes   |       | 156                |       | 150                   |       |
| Other current liabilities                 |       | 11,875             |       | 11,779                |       |
| Accrual for contract losses               |       | 57                 |       | 123                   |       |
|                                      |       | $                  | 12,494     |                  | $          | 12,113 |   |

 

**Note K — Commitments and Contingencies**

In the normal course of itscontinuing and discontinued operations, various lawsuits, claims and legalproceedings have been or may be instituted or asserted against or by thecompany. Based on currently available facts, the company believes, except asotherwise set forth below, that the disposition of matters pending or assertedagainst the company will not have a material adverse effect on the company’sfinancial position, results of operations or liquidity.

**ASBESTOS**

UnitedIndustrial and Detroit Stoker (which was acquired by a newly formed corporationaffiliated with a private investment group (“Merger Parent”) onDecember 29, 2006 by way of a merger of Bram Acquisition Corp. (“MergerSub”) with and into Detroit Stoker, with Detroit Stoker being the survivingcorporation (“the Merger”)) have been, and may in the future be, named asdefendants in asbestos-related personal injury litigation arising out ofcommercial stoker products manufactured by United Industrial and DetroitStoker, some of the parts and components of which used asbestos-containingmaterial fabricated and provided by third parties. The use ofasbestos-containing materials ceased in approximately 1981. The insurancecoverage potentially available to United Industrial is substantial.

Pursuantto the Merger Agreement, Merger Parent and the surviving corporation agreed toindemnify United Industrial for any asbestos-related litigation liabilities,including without limitation, any asbestos liabilities arising from DetroitStoker’s operation as a division of United Industrial and United Industrial’sown operations. To secure these indemnity obligations, Merger Parentestablished an escrow account for the sole benefit of United Industrial.

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If MergerParent and the surviving corporation do not honor their indemnity obligationsto United Industrial, and the available escrow funds and insurance areinsufficient to satisfy United Industrial’s asbestos-related litigationliabilities (if any), successful claims against United Industrial could have amaterial adverse effect on United Industrial’s financial condition, results ofoperations and liquidity. In addition, if the surviving corporation or MergerParent were to file for bankruptcy, creditors could, among other things, seekto have the indemnity and the escrow agreement declared unenforceable and seekto recover amounts paid to United Industrial by Merger Parent or the survivingcorporation.

**STATE OFARIZONA DEPARTMENT OF ENVIRONMENTAL QUALITY V. UIC, ET AL.**

OnMay 19, 1993, United Industrial was named as one of three defendants in acivil action brought pursuant to the Comprehensive Environmental ResponseCompensation and Liability Act (“CERCLA”) by the Arizona Department ofEnvironmental Quality (“ADEQ”) in the United States District Court for theDistrict of Arizona. ADEQ sought remediation of a manufacturing site in theState of Arizona operated by U.S. Semiconductor Products, Inc. (“U.S.Semiconductor”), a manufacturer of semiconductors formerly owned by UnitedIndustrial. ADEQ alleged that from 1959 until United Industrial sold U.S.Semiconductor in 1961, U.S. Semiconductor disposed of tricholoroethylene, a “hazardoussubstance,” and other hazardous substances under CERCLA, onto the ground andinto various pits and drains located on the site.

In 1996, United Industrial entered into a consent decree with ADEQ. Pursuantto the consent decree, United Industrial is required to complete a RemedialInvestigation/Feasibility Study (“RI/FS”), pay $125 for past response costs,pay quarterly Arizona oversight costs (averaging less than $13 annually) andpay $125 for future response costs plus a graduated percentage of the cleanupcosts for the site if those costs are in excess of $10,000 but less than$40,000. United Industrial’s liability for future response costs under theconsent decree is capped at $1,780 in addition to the $125 that United Industrialhas already paid. In connection with the RI/FS, United Industrial has retainedand is paying for an environmental consultant. The Remedial Investigation wassubmitted to ADEQ for approval on March 31, 2004 and was approved by ADEQon August 9, 2004. In March 2005, ADEQ issued its Proposed RemedialObjectives Report for public comment. ADEQ received no substantive commentsregarding the report, and in May 2005, ADEQ issued its final RemedialObjectives Report. United Industrial is required to submit to ADEQ aFeasibility Study and Proposed Remedies to meet ADEQ’s May 2005 RemedialObjectives.  Management believes it canreach closure with ADEQ on all RI/FS issues on an acceptable basis to UnitedIndustrial following approval of the Feasibility Study. No assurances can begiven, however, as to the timing of the approval of a Feasibility Study or theactual extent to which United Industrial may be determined to have furtherliability, if at all. Management believes it has appropriately accrued for thismatter.

**OTHER LEGAL MATTERS**

Departmentsand agencies of the U.S. Government have the authority at many levels toinvestigate transactions and operations of the company, and the results of suchinvestigations may lead to administrative, civil or criminal proceedings, theultimate outcome of which could be fines, penalties, repayments or compensatoryor treble damages. Agencies that oversee contract performance include: theDefense Contract Audit Agency, the Department of Defense Inspector General, theGeneral Accounting Office, the Department of Justice, the Department of Stateand Congressional committees. U.S. Government regulations provide that certainfindings against a contractor may lead to suspension or debarment from futureU.S. Government contracts or the loss of export privileges for a company or anoperating division or subdivision.

Thecompany has in place international and domestic compliance policies andprocedures, including training of employees. From time to time, the company receives allegations of improper conductrelating to its operations, including operations subject to the U.S. ForeignCorrupt Practices Act, export control and licensing regulations and other U.S.domestic and international laws. When the company receives any such allegations,it conducts internal (and if necessary, external) investigations to determinewhether there is support for any such allegations, and takes corrective actionwhen warranted. An investigation is ongoing in response to allegations providedto company management of improper payments to foreign government officials andimproper invoicing. External counsel has been retained by the Audit Committeeof United Industrial’s Board of Directors to determine if there is support forany such allegations, and to review the company’s compliance policies andprocedures, and the company is cooperating fully with counsel. In addition,appropriate government agencies have been advised of this investigation. Thecompany is cooperating with their requests for information. The investigationby external counsel, which is continuing, has thus far not revealed any priorinvolvement or knowledge regarding the allegations by any officer or directorof United Industrial. At the current stage of this investigation, any ultimateliability is not presently determinable.

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**PERFORMANCE GUARANTIES**

Inconnection with certain contracts, United Industrial’s operating subsidiarieshave committed to certain performance guaranties existing at March 31,2007. The ability to perform under these guaranties may, in part, be dependenton the performance of other parties, including partners and subcontractors. IfUnited Industrial’s operating subsidiaries are unable to meet these performanceobligations, the performance guaranties could have a material adverse effect onprofit margins and the company’s results of operations, liquidity or financialposition. United Industrial’s operating subsidiaries monitor the progress oftheir partners and subcontractors, and United Industrial and its operatingsubsidiaries do not believe that the performance of these partners andsubcontractors will adversely affect these contracts. No assurances can begiven, however, as to the liability of United Industrial’s operatingsubsidiaries if partners or subcontractors are unable to perform theirobligations.

**LABOR AND MATERIALS BOND CLAIM**

AAICorporation’s discontinued transportation operation consists of a 35% interestin ETI held by AAI Corporation.  Skoda, aCzech company, owns the remaining 65% of ETI. One of ETI’s contracts involvedthe design and manufacture of 273 electric trolley buses for the San FranciscoMunicipal Railway (“MUNI”). In executing its contract with MUNI, ETI enteredinto subcontracts with AAI Corporation, certain Skoda operating affiliates andothers.  All remaining ETI and AAIcontractual performance obligations to MUNI concluded on April 22, 2007.

Asoriginally required by MUNI, ETI obtained a surety bond to guaranty payment toall those providing labor and materials to ETI in furtherance of its performanceunder the MUNI contract. AAI Corporation agreed to indemnify the surety, ifnecessary, for up to $14,800 on this labor and materials bond, representing 35%of the original face value of the bond (in proportion to AAI Corporation’sequity interest in ETI). On November 18, 2003, AAI Corporation made aclaim against the labor and materials bond for unpaid receivables in connectionwith AAI Corporation’s MUNI subcontract from ETI, totaling in excess of$47,000, the maximum penal sum of the labor and materials bond. AAI Corporation’spayment rights under the labor and materials bond (among other claims) arecurrently at issue in a case before the United States District Court for theNorthern District of California. Prior to final adjudication of this case, therecan be no assurances as to the amount or timing of a recovery by AAICorporation, if any, on its claim on the labor and materials bond. To date, noamount of recovery has been recorded.

##### **Note L — Dividends**

In the first quarter of 2007 and 2006, United Industrial’s Board ofDirectors declared and paid a dividend of $0.10 per share on its Common Stock.

| Quarter ended  | ** ** | **Total amount dividends paid** | ** ** | **Date dividends were paid** |
|----------------|------------|---------------------------------|------------|------------------------------|
|           |       |                            |       |                         |
| March 31, 2007 |       | $1,100                          |       | March 26, 2007               |
| March 31, 2006 |       | $1,127                          |       | March 27, 2006               |
|           |       |                            |       |                         |

 

**Note M — Treasury Stock**

On November 17, 2006, United Industrial’s Board of Directorsauthorized a stock purchase plan for up to $50,000. At December 31, 2006,$44,719 remained available under the stock purchase plan.  During the three months ended March 31, 2007,United Industrial purchased 827,438 shares at an average market price of $54.04utilizing the remaining funds available under the plan.

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**NoteN— Long Term Debt and Credit Arrangements**

As of March 31, 2007, the company had $1,941 outstanding under itsletter of credit subfacility.  On March23, 2007, the company borrowed $5,000 under its revolving credit facility for30 days at an annual rate of 6.57%.

The holders of the 3.75% Convertible Senior Notes can convert theirSenior Notes into shares of Common Stock during the calendar quarter from April1, 2007 through June 30, 2007.  Thisevent was triggered by United Industrial’s stock price remaining above $47.09(120% of the initial conversion price) for at least 20 consecutive trading daysduring the last 30 trading days of the quarter ended March 31, 2007.

** Note O — Supplemental Guarantor Information**

In September 2004,United Industrial issued and sold $120,000 aggregate principal amount of 3.75%Convertible Senior Notes, which are fully and unconditionally guaranteed byAAI. The following condensed consolidating financial information sets forthsupplemental information for United Industrial, the parent company, AAI, theguarantor subsidiary, and Detroit Stoker, the non-guarantor subsidiary (priorto its sale), as of March 31, 2007 and December 31, 2006, and for the threemonths ended March 31, 2007 and 2006.

 

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**CONDENSED CONSOLIDATING FINANCIAL INFORMATIONCONDENSED CONSOLIDATING BALANCE SHEETSAs of March 31, 2007  (Unaudited)**
| ** **                                       | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
| ASSETS                                           |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Current Assets                                   |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Cash and cash  equivalents                       |       | $                                             | 392        |                                                 | $          | 4,405            |       | $                                                      | —     |   | $ | 4,797 |   |
| Accounts  receivable, net                        |       | 821                                           |       | 51,844                                               |       | —           |       | 52,665                                                 |       |
| Note receivable                                  |       | 833                                           |       | —                                               |       | —           |       | 833                                                    |       |
| Inventories                                      |       | —                                        |       | 95,058                                               |       | —           |       | 95,058                                                 |       |
| Other current  assets                            |       | 3,752                                         |       | 6,488                                                |       | —           |       | 10,240                                                 |       |
| Assets of  discontinued operations               |       | —                                        |       | 12,030                                               |       | —           |       | 12,030                                                 |       |
| Total current  assets                            |       | 5,798                                         |       | 169,825                                              |       | —           |       | 175,623                                                |       |
| Property and equipment,  net                     |       | —                                        |       | 46,395                                               |       | —           |       | 46,395                                                 |       |
| Other assets                                     |       | 19,381                                        |       | 106,123                                              |       | (22,655          | )          | 102,849                                                |       |
| Investment in consolidated  subsidiaries         |       | 160,677                                       |       | —                                               |       | (160,677         | )          | —                                                 |       |
| Total assets                                     |       | $                                             | 185,856    |                                                 | $          | 322,343          |       | $                                                      | (183,332   | ) | $ | 324,867 |   |
|                                             |       |                                          |       |                                                 |       |             |       |                                                   |       |
| LIABILITIES AND  SHAREHOLDERS’EQUITY        |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Current portion of  long-term debt               |       | $                                             | —     |                                                 | $          | 21               |       | $                                                      | —     |   | $ | 21 |   |
| Other current  liabilities                       |       | 11,442                                        |       | 144,059                                              |       | (46,338          | )          | 109,163                                                |       |
| Liabilities of  discontinued operations          |       | —                                        |       | 12,494                                               |       | —           |       | 12,494                                                 |       |
| Total current  liabilities                       |       | 11,442                                        |       | 156,574                                              |       | (46,338          | )          | 121,678                                                |       |
| Long-term debt                                   |       | 120,000                                       |       | 26                                                   |       | —           |       | 120,026                                                |       |
| Other long-term  liabilities                     |       | 7,534                                         |       | 70,746                                               |       | (22,656          | )          | 55,624                                                 |       |
| Intercompany  (receivables) payables             |       | 18,081                                        |       | (64,444                                              | )          | 46,363           |       | —                                                 |       |
| Shareholders’ equity  (deficit)             |       | 28,799                                        |       | 159,441                                              |       | (160,701         | )          | 27,539                                                 |       |
| Total liabilities and  shareholders’ equity |       | $                                             | 185,856    |                                                 | $          | 322,343          |       | $                                                      | (183,332   | ) | $ | 324,867 |   |

 

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**CONDENSED CONSOLIDATINGFINANCIAL INFORMATIONCondensed Consolidating Balance SheetsAs of December 31, 2006**
| ** **                                       | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
| ASSETS                                           |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Current assets:                                  |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Cash and cash equivalents                        |       | $                                             | 40,068     |                                                 | $          | (910             | )          | $                                                      | —     |   | $ | 39,158 |   |
| Accounts receivable, net                         |       | 1,715                                         |       | 69,706                                               |       | 82               |       | 71,503                                                 |       |
| Note receivable                                  |       | 833                                           |       | —                                               |       | —           |       | 833                                                    |       |
| Inventories                                      |       | —                                        |       | 73,700                                               |       | —           |       | 73,700                                                 |       |
| Other current assets                             |       | 4,479                                         |       | 5,623                                                |       | —           |       | 10,102                                                 |       |
| Assets of discontinued operations                |       | —                                        |       | 11,996                                               |       | —           |       | 11,996                                                 |       |
| Total current assets                             |       | 47,095                                        |       | 160,115                                              |       | 82               |       | 207,292                                                |       |
| Property and  equipment, net                     |       | —                                        |       | 47,042                                               |       | —           |       | 47,042                                                 |       |
| Other assets                                     |       | 19,893                                        |       | 107,502                                              |       | (23,089          | )          | 104,306                                                |       |
| Investment in  consolidated subsidiaries         |       | 160,676                                       |       | —                                               |       | (160,676         | )          | —                                                 |       |
| Total assets                                     |       | $                                             | 227,664    |                                                 | $          | 314,659          |       | $                                                      | (183,683   | ) | $ | 358,640 |   |
|                                             |       |                                          |       |                                                 |       |             |       |                                                   |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY       |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Current  liabilities:                            |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Current portion of long-term debt                |       | $                                             | —     |                                                 | $          | 2,896            |       | $                                                      | —     |   | $ | 2,896 |   |
| Other current liabilities                        |       | 9,884                                         |       | 135,739                                              |       | (40,040          | )          | 105,583                                                |       |
| Liabilities of discontinued operations           |       | —                                        |       | 12,113                                               |       | —           |       | 12,113                                                 |       |
| Total current liabilities                        |       | 9,884                                         |       | 150,748                                              |       | (40,040          | )          | 120,592                                                |       |
| Long-term debt                                   |       | 120,000                                       |       | 30                                                   |       | —           |       | 120,030                                                |       |
| Other long-term  liabilities                     |       | 7,855                                         |       | 69,953                                               |       | (23,089          | )          | 54,719                                                 |       |
| Intercompany  (receivables) payables             |       | 14,382                                        |       | (54,529                                              | )          | 40,147           |       | —                                                 |       |
| Shareholders’  equity (deficit)             |       | 75,543                                        |       | 148,457                                              |       | (160,701         | )          | 63,299                                                 |       |
| Total liabilities and  shareholders’ equity |       | $                                             | 227,664    |                                                 | $          | 314,659          |       | $                                                      | (183,683   | ) | $ | 358,640 |   |

 

17

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**CONDENSEDCONSOLIDATING FINANCIAL INFORMATION - CONTINUEDCONDENSED CONSOLIDATING STATEMENTS OFOPERATIONSThree Months Ended March 31, 2007  (Unaudited)**
| ****                                                          | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
| Net sales                                                     |       | $                                             | —     |                                                 | $          | 160,846          |       | $                                                      | —     |   | $ | 160,846 |   |
| Operating costs and  expenses                                 |       | (870                                          | )          | (143,230                                             | )          | —           |       | (144,100                                               | )          |
| Operating income                                              |       | (870                                          | )          | 17,616                                               |       | —           |       | 16,746                                                 |       |
| Non-operating income  and (expense):                          |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Interest income                                               |       | 290                                           |       | 252                                                  |       | —           |       | 542                                                    |       |
| Interest expense                                              |       | (1,373                                        | )          | (70                                                  | )          | —           |       | (1,443                                                 | )          |
| Other income  (expense), net                                  |       | (82                                           | )          | 159                                                  |       | —           |       | 77                                                     |       |
|                                                          |       | (1,165                                        | )          | 341                                                  |       | —           |       | (824                                                   | )          |
| (Loss) income from  continuing operations before income taxes |       | (2,035                                        | )          | 17,957                                               |       | —           |       | 15,922                                                 |       |
| Benefit from (provision  for) income taxes                    |       | 384                                           |       | (6,281                                               | )          | —           |       | (5,897                                                 | )          |
| (Loss) income from  continuing operations                     |       | (1,651                                        | )          | 11,676                                               |       | —           |       | 10,025                                                 |       |
| Loss from discontinued  operations, net of income tax benefit |       | —                                        |       | (830                                                 | )          | —           |       | (830                                                   | )          |
| Income from investment  in subsidiaries                       |       | 10,846                                        |       | —                                               |       | (10,846          | )          | —                                                 |       |
| Net income                                                    |       | $                                             | 9,195      |                                                 | $          | 10,846           |       | $                                                      | (10,846    | ) | $ | 9,195 |   |

 

18

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**CONDENSEDCONSOLIDATING FINANCIAL INFORMATION - CONTINUEDCONDENSED CONSOLIDATING STATEMENTS OFOPERATIONSThree Months Ended March 31, 2006  (Unaudited)**
| ****                                                                               | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Detroit Stoker  Company  (Non-Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
| Net sales                                                                          |       | $                                             | —     |                                                 | $          | 128,701                                           |       | $                | —     |                                                   | $          | — |   | $ | 128,701 |   |
| Operating costs  expenses                                                          |       | 250                                           |       | 115,046                                              |       | —                                            |       | —           |       | 115,296                                                |       |
| Operating (loss)  income                                                           |       | (250                                          | )          | 13,655                                               |       | —                                            |       | —           |       | 13,405                                                 |       |
| Non-operating  income and (expense):                                               |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| Interest income                                                                    |       | 612                                           |       | 313                                                  |       | —                                            |       | —           |       | 925                                                    |       |
| Interest expense                                                                   |       | (1,370                                        | )          | (13                                                  | )          | —                                            |       | —           |       | (1,383                                                 | )          |
| Intercompany interest income (expense)                                             |       | 15                                            |       | —                                               |       | —                                            |       | (15              | )          | —                                                 |       |
| Other income (expense), net                                                        |       | (645                                          | )          | 60                                                   |       |                                              |       | —           |       | (585                                                   | )          |
|                                                                               |       | (1,388                                        | )          | 360                                                  |       | —                                            |       | (15              | )          | (1,043                                                 | )          |
| (Loss) income  from continuing operations before income taxes                      |       | (1,638                                        | )          | 14,015                                               |       | —                                            |       | (15              | )          | 12,362                                                 |       |
| Benefit from  (provision for) income taxes                                         |       | 313                                           |       | (5,023                                               | )          | —                                            |       | —           |       | (4,710                                                 | )          |
| (Loss) income  from continuing operations                                          |       | (1,325                                        | )          | 8,992                                                |       | —                                            |       | (15              | )          | 7,652                                                  |       |
| (Loss) income  from discontinued operations, net of income tax benefit (provision) |       | —                                        |       | (287                                                 | )          | 1,188                                             |       | 15               |       | 916                                                    |       |
| Income from  investment in subsidiaries                                            |       | 9,893                                         |       | —                                               |       | —                                            |       | (9,893           | )          | —                                                 |       |
| Net income                                                                         |       | $                                             | 8,568      |                                                 | $          | 8,705                                             |       | $                | 1,188      |                                                   | $          | (9,893 | ) | $ | 8,568 |   |

 

19

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**CONDENSEDCONSOLIDATING FINANCIAL INFORMATION - CONTINUEDCONDENSED CONSOLIDATING STATEMENTS OFCASH FLOWSThree Months Ended March 31, 2007  (Unaudited)**
| ****                                                                  | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
| OPERATING  ACTIVITIES:                                                |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Cash flows  provided by continuing operations                         |       | $                                             | 943        |                                                 | $          | 10,869           |       | —                                                 |       | $ | 11,812 |   |
| Cash flows used  in operating activities from discontinued operations |       | —                                        |       | (483                                                 | )          | —           |       | (483                                                   | )          |
| Net cash provided by operating activities                             |       | 943                                           |       | 10,386                                               |       | —           |       | 11,329                                                 |       |
| INVESTING  ACTIVITIES:                                                |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Purchase of  property and equipment                                   |       | —                                        |       | (2,192                                               | )          | —           |       | (2,192                                                 | )          |
| Net cash used in investing activities                                 |       | —                                        |       | (2,192                                               | )          | —           |       | (2,192                                                 | )          |
| FINANCING  ACTIVITIES:                                                |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Borrowings under  revolving credit facility                           |       | 5,000                                         |       | —                                               |       | —           |       | 5,000                                                  |       |
| Repayment of  long-term debt                                          |       |                                          |       | (2,879                                               | )          | —           |       | (2,879                                                 | )          |
| Proceeds from  exercise of stock options                              |       | 165                                           |       | —                                               |       | —           |       | 165                                                    |       |
| Excess tax benefit  from stock-based compensation                     |       | 9                                             |       | —                                               |       | —           |       | 9                                                      |       |
| Dividends paid                                                        |       | (1,100                                        | )          | —                                               |       | —           |       | (1,100                                                 | )          |
| Purchases of  treasury shares                                         |       | (44,693                                       | )          | —                                               |       | —           |       | (44,693                                                | )          |
| Net cash used in financing activities                                 |       | (40,619                                       | )          | (2,879                                               | )          | —           |       | (43,498                                                | )          |
| (Decrease)  increase in cash and cash equivalents                     |       | (39,676                                       | )          | 5,315                                                |       | —           |       | (34,361                                                | )          |
| Cash and cash  equivalents at beginning of year                       |       | 40,068                                        |       | (910                                                 | )          | —           |       | 39,158                                                 |       |
| Cash and cash  equivalents at end of period                           |       | $                                             | 392        |                                                 | $          | 4,405            |       | —                                                 |       | $ | 4,797 |   |

 

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**CONDENSEDCONSOLIDATING FINANCIAL INFORMATION - CONTINUEDCONDENSED CONSOLIDATING STATEMENTS OFCASH FLOWSThree Months Ended March 31, 2006  (Unaudited)**
| ****                                                                                | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Detroit Stoker  Company  (Non-Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|-------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
| ** **                                                                          | ** ** | ** **                                    | ** ** | ** **                                           | ** ** | ** **                                        | ** ** | ** **       | ** ** | ** **                                             | ** ** |
| OPERATING  ACTIVITIES:                                                              |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| Cash flows (used  in) provided by continuing operations                             |       | $                                             | (2,838     | )                                                    | $          | 8,991                                             |       | $                | —     |                                                   | $          | — |   | $ | 6,153 |   |
| Cash flows (used  in) provided by operating activities from discontinued operations |       | —                                        |       | (506                                                 | )          | 2,203                                             |       | —           |       | 1,697                                                  |       |
| Net cash (used in) provided by operating activities                                 |       | (2,838                                        | )          | 8,485                                                |       | 2,203                                             |       | —           |       | 7,850                                                  |       |
| INVESTING  ACTIVITIES:                                                              |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| Purchase of  property and equipment                                                 |       | —                                        |       | (1,453                                               | )          | —                                            |       | —           |       | (1,453                                                 | )          |
| Net cash used in investing activities from  discontinued operations                 |       | —                                        |       | —                                               |       | (13                                               | )          | —           |       | (13                                                    | )          |
| Net cash used in investing activities                                               |       | —                                        |       | (1,453                                               | )          | (13                                               | )          | —           |       | (1,466                                                 | )          |
| FINANCING  ACTIVITIES:                                                              |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| Repayment of  long-term debt                                                        |       | —                                        |       | (321                                                 | )          | —                                            |       | —           |       | (321                                                   | )          |
| Decrease in  deposits and restricted cash                                           |       | —                                        |       | 2,295                                                |       | —                                            |       | —           |       | 2,295                                                  |       |
| Proceeds from  exercise of stock options                                            |       | 1,222                                         |       | —                                               |       | —                                            |       | —           |       | 1,222                                                  |       |
| Excess tax  benefit from stock-based compensation                                   |       | 764                                           |       | —                                               |       | —                                            |       | —           |       | 764                                                    |       |
| Dividends paid                                                                      |       | (1,127                                        | )          | —                                               |       | —                                            |       | —           |       | (1,127                                                 | )          |
| Intercompany  activities                                                            |       | 2,442                                         |       | (2,442                                               | )          | —                                            |       | —           |       | —                                                 |       |
| Net cash provided  by (used in) financing activities                                |       | 3,301                                         |       | (468                                                 | )          | —                                            |       | —           |       | 2,833                                                  |       |
| Increase in cash  and cash equivalents                                              |       | 463                                           |       | 6,564                                                |       | 2,190                                             |       | —           |       | 9,217                                                  |       |
| Cash and cash  equivalents at beginning of year                                     |       | 54,365                                        |       | 8,768                                                |       | 14,363                                            | (1)        | —           |       | 77,496                                                 |       |
| Cash and cash  equivalents at end of period                                         |       | $                                             | 54,828     |                                                 | $          | 15,332                                            |       | $                | 16,553     |                                                   | $          | — |   | $ | 86,713 |   |

----

(1)             Reportedin assets held for sale at January 1, 2006.

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**Item 2.—Management’sDiscussion and Analysis of Financial Condition and Results of Operations (Dollarsin thousands, except per share amounts or unless otherwise noted)**

###### **Forward-Looking Information**

This Quarterly Report on Form 10-Q contains “forward-looking statements”within the meaning of the Private Securities Litigation Reform Act of 1995.Such forward-looking statements are based on management’s expectations,estimates, projections and assumptions. Words such as “expects,” “anticipates,”“intends,” “plans,” “believes,” “estimates” and variations of such words andsimilar expressions are intended to identify such forward-looking statements,which include, but are not limited to, growth and business strategies to beimplemented and projections of revenues, earnings, performance, cash flows andcontract awards. These forward-looking statements are subject to risks anduncertainties, which could cause the actual results or performance of thecompany to differ materially from those expressed or implied in suchstatements. These risks and uncertainties include, but are not limited to, thefollowing:

·       the company’s successful execution of internal performance plans;

·       changing priorities or reductions in the U.S. Government defensebudget, including those related to Operation Iraqi Freedom, Operation EnduringFreedom and the Global War on Terrorism;

·       performance issues with key suppliers, subcontractors and businesspartners;

·       the company’s ability to recruit and retain qualified personnel;

·       the ability to negotiate financing arrangements with lenders;

·       the outcome of current and future litigation, proceedings andinvestigations;

·       product demand and market acceptance risks;

·       the effect of economic conditions;

·       the impact of competitive products and pricing;

·       product development, commercialization and technological difficulties;

·       capacity and supply constraints or difficulties;

·       the integration of acquisitions;

·       legislative or regulatory actions impacting defense operations;

·       U.S. and foreign military budget constraints and determinations; and

·       contract continuation and future contract awards.

The company intends that allforward-looking statements it makes will be subject to the safe harborprotection of the federal securities laws found in Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended.

Thesestatements speak only as to the date when they are made.  The company makes no commitment to update anyforward-looking statement or to disclose any facts, events or circumstancesafter the date hereof that may affect the accuracy of any forward-lookingstatements.  See “Risk Factors” underItem 1A of the company’s Annual Report on Form 10-K for the year ended December31, 2006, for important factors that could cause the company’s actual resultsto differ materially from those suggested by the company’s forward-lookingstatements contained in this Quarterly Report on Form 10-Q.

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***ManagementOverview***

**Introduction**

The company designs,produces and supports aerospace and defense systems. The company’shigh-technology products and services include unmanned aircraft systems,training and simulation systems, automated aerospace test and maintenanceequipment, armament systems, aviation ground support equipment, logistical andengineering services, and maintenance, repair and overhaul activities.

The company’s transportationoperation and former energy operation are accounted for as discontinuedoperations, and are discussed separately in the information that follows. Thecompany divested its energy operation on December 29, 2006.

Thefollowing discussion should be read in conjunction with the company’sConsolidated Financial Statements and related notes thereto contained in thisQuarterly Report on Form 10-Q for the quarterly period ended March 31, 2007,and the discussion included in its Annual Report on Form 10-K for the yearended December 31, 2006.

**Defense Industry Considerations**

The U.S. Government, principally the U.S. Department of Defense (“DoD”),is the company’s largest customer, and the company expects that direct andindirect sales to the DoD will be its primary source of revenue for theforeseeable future.  The company’slargest product area includes the development, manufacture and support ofUnmanned Aircraft Systems (“UAS”), including the Shadow® 200 Tactical UnmannedAircraft System (“TUAS”), which is the U.S. Army’s tactical UAS platform. AAIis one of a limited number of companies to have entered full-rate productionand successfully fielded operational UAS for the DoD.

**Company Strategy**

The Global War on Terrorism,Operation Iraqi Freedom, Operation Enduring Freedom and homeland defenseconcerns have focused the U.S. Government’s efforts on ensuring that U.S. armedforces are equipped and trained to prevail in large-scale and small-scaleconflicts around the world. At the same time, the DoD is committed totransforming the military into a more agile, responsive, lethal and survivableforce for future engagements. The company believes that a key element of theDoD’s strategy is the use of unmanned systems, including UAS. Current marketanalyses performed by AAI, based on information gathered from budgets andforecasts reported by the DoD, continue to indicate near-term growth in UASprograms. However, as a consequence of this growth, larger manufacturers haveentered the marketplace. Some of these new competitors are the major aircraftmanufacturers, including The Boeing Company and Northrop Grumman Corporation.In addition, the DoD is seeking new and more cost-effective methods ofsustaining its systems in the field. Increasingly, the DoD is seekingcontractors to provide innovative logistics, field service and trainingsolutions in support of procured systems in order to reduce overall maintenanceand operational costs, as well as improve operational effectiveness of thesesystems.

The company intends tostrengthen its competitive advantage by continuously improving operationalexcellence and continuing to invest in research and development initiatives tomaintain its track record and technological edge over its competitors in thecompany’s niche markets. The company also intends to grow its business andplans to use its position as a prime contractor to work with its customers toexpand markets for current products, develop upgrades to extend product lifeand develop the requirements for future systems. Additionally, the companyintends to leverage its expertise, resources and capabilities to expand itsengineering and services offerings by addressing product support, logistics,fielding and upgrade needs in order to support a greater portion of the productlife cycle. The company plans to maintain a diversified and broad business mix,a favorable balance of cost-reimbursable and fixed-price type contracts, asignificant follow-on business and positive customer relationships.  Finally, the company intends to complementits growth strategy through select acquisitions that broaden its product andservice offerings, deepen its capabilities and provide entry into new markets.

**Acquisitions and Dispositions**

OnDecember 29, 2006, United Industrial completed the sale of its whollyowned energy subsidiary, Detroit Stoker Company, for total consideration of$22,200, consisting of$17,200 cash and a promissory note of $5,000. The transactionresulted in an $8,390 gain, net of tax. Prior to the sale, the energy segment was reported as continuingoperations; the historical operating results are now reported in discontinuedoperations.

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OnNovember 28, 2006, AAI acquired Symtx, Inc. for a cash purchase priceof $34,300 (exclusive of acquisition costs), with the potential for anadditional payment of up to $5,000 based upon the achievement of a certainfinancial target in 2007.  Symtxcontributed net sales of $12,363 in the first quarter of 2007.

OnNovember 14, 2006, the company acquired McTurbine Inc. for a cash purchaseprice of $31,000 (exclusive of acquisition costs) subject to increase ordecrease based upon the closing net worth of McTurbine.  McTurbine contributed net sales of $6,001 inthe first quarter of 2007.

OnJune 19, 2006, the company acquired Aerosonde Pty Ltd. and Aerosonde NorthAmerica, Incorporated in stock purchase transactions for an aggregate cashpurchase price of $6,338 (exclusive of acquisition costs), with additionalconsideration payable upon the achievement of certain milestones. One of thesemilestones was achieved and resulted in a $500 payment by the company inFebruary 2007.  Aerosonde contributed netsales of $138 in the first quarter of 2007.

**Other Business Considerations**

The company’s programsgenerally are implemented by the award of individual contracts and subcontractsand are subject to congressional appropriations. Congress generallyappropriates funds on a fiscal year basis even though a program may extend forseveral years. Consequently, programs are often only partially fundedinitially, and additional funds are committed only as Congress makes furtherappropriations. U.S. Government contracts and subcontracts under a program aresubject to termination or adjustment if appropriations for such program are notavailable or change, and are subject to oversight audits and contractualtermination. Failure to comply with U.S. Government regulations could lead tosuspension or debarment from U.S. Government contracting.

Sales to the U.S. Governmentmay be affected by changes in procurement policies, budget considerations,changing defense requirements and political developments. The influence ofthese factors, which are largely beyond the company’s control, could impact thecompany’s financial position or results of operations.

In addition, the company’sprograms typically involve the development, application and manufacturing ofadvanced defense and technology systems and products aimed at achievingchallenging goals. New technologies may be untested or unproven. In someinstances, product requirements or specifications may be modified. As a result,the company may experience technological and other performance difficulties,which may result in delays, setbacks, cost overruns and product failures inconnection with its programs.

As a U.S. Governmentcontractor, the company is subject to specific import and export, procurementand other regulations and requirements. Failure to comply with theseregulations and requirements could result in reduced contractual value,contract modifications or termination, and the assessment of penalties andfines, and could lead to suspension or debarment, for cause, from governmentcontracting or subcontracting for a period of time. Potential grounds fordebarment include violations of various statutes, including those related toprocurement integrity, export control, government security regulations,employment practices, the protection of the environment, the accuracy ofrecords and the recording of costs. Under many government contracts, thecompany is required to maintain facility and personnel security clearancescomplying with DoD requirements.

The company is also subjectto routine audits and investigations by U.S. Government agencies such as theDefense Contract Audit Agency (“DCAA”). These agencies review a contractor’sperformance under its contracts, cost structure and compliance with applicablelaws, regulations and standards. The DCAA also reviews the adequacy of, and acontractor’s compliance with, its internal control systems and policies,including the contractor’s purchasing, property, estimating, compensation andmanagement information systems. Any costs found to be improperly allocated to aspecific contract will not be reimbursed or must be refunded if alreadyreimbursed. If an audit uncovers improper or illegal activities, the companymay be subject to civil and criminal penalties and administrative sanctions,which could include: termination of contracts; forfeiture of profits;suspension of payments; fines; and suspension or prohibition from doingbusiness with the U.S. Government.

***Results of Operations***

The company’s operatingcycle is longer than one year and involves various types of productioncontracts and varying production delivery schedules.  Accordingly, operating results of aparticular quarter or year, or quarter-to-quarter or year-to-year comparisonsof recorded revenues, earnings and cash flows, may not be indicative of futureoperating results. The following comparative analysis should be viewed in thiscontext.

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The following informationrelates to the continuing operations of the company and its consolidatedsubsidiaries, except where references are made to discontinued operations. Theformer energy operation and the transportation operation are accounted for asdiscontinued operations in the company’s consolidated financial statements forthe three months ended March 31, 2006 and 2007 and for the year endedDecember 31, 2006.

**Consolidated Results of Operations**

***Continuing Operations***

The followingdiscussion provides an overview of the company’s consolidated results ofoperations from continuing operations for the three months ended March 31,2007.

Certainreclassifications were made to prior periods to conform to current periodpresentation.

***Summary for the Three Months EndedMarch 31, 2007 Compared to the Three Months Ended March 31, 2006***

Summary financial resultsfor the first quarter of 2007 and 2006 are as follows:

|                                                                                    | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase  (Decrease)** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                         | ** ** | **2006**                 | ** ** | **$** | ** ** | **%** | ** ** |
|                                                                               |       |                                             |       |                     |       |   |   |   |   |
| Net sales                                                                          |       | $                                                | 160,846    |                     | $          | 128,701 |   | $ | 32,145 |   | 25.0 | % |
| Operating costs  and expenses                                                      |       | 144,100                                          |       | 115,296                  |       | 28,804 |   | 25.0 |   |
| Operating income                                                                   |       | 16,746                                           |       | 13,405                   |       | 3,341 |   | 24.9 |   |
| Operating margin                                                                   |       | 10.4                                             | %          | 10.4                     | %          | — |   | — |   |
| Non-operating  expense                                                             |       | (824                                             | )          | (1,043                   | )          | 219 |   | 21.0 |   |
| Income from  continuing operations, net of income taxes                            |       | 10,025                                           |       | 7,652                    |       | 2,373 |   | 31.0 |   |
| (Loss) income  from discontinued operations, net of income tax benefit (provision) |       | (830                                             | )          | 916                      |       | (1,746 | ) | (190.6 | ) |
| Net income                                                                         |       | 9,195                                            |       | 8,568                    |       | 627 |   | 7.3 |   |
|                                                                                    |            |                                                  |            |                          |            |  |  |  |  |  |  |  |

 

***Three Months Ended March 31, 2007 Compared to the ThreeMonths Ended March 31, 2006***

Net sales for thefirst quarter of 2007 increased 25.0% to $160,846, from $128,701 during thesame period in 2006.  The growth in net sales was primarily due to $10,717increased volume on aircraft Maintenance Training Device (“MTD”) programs, $7,717of increased sales for the UAS One System®ground control system including greater developmental efforts supporting theExtended Range Multi-Purpose UAS program and production of the new Remote VideoTerminal ground control systems, an increase of $6,348 in logistical supportfor fielded Shadow® 200 Tactical Unmanned Aircraft Systems (“Shadow 200 TUAS”),and a $2,528 increase in engineeringactivities primarily related to new UAS initiatives.  Inaddition, the company’s 2006 acquisitions contributed $18,502 to net sales inthe first quarter of 2007.  Theseincreases were partially offset by adecrease of $13,816 in the Shadow 200 TUAS production program, primarily due tothe timing of material requirements in the first quarter of 2007.

Operating margin for the first quarter of 2007 was10.4% and was essentially unchanged from the first quarter of 2006.  Favorable performance on UAS contracts had apositive impact on operating margin in 2007, offset primarily by increased intangibleasset amortization expense and other costs associated with the integration ofacquisitions made after the first quarter of 2006, and the timing of award feeincome recognition for the Biological Detection Systems (“BDS”) program.  In 2006, the 

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company beganaccruing award fees for the BDS program instead of recognizing such award feesupon notification of the customer. This change was deemed appropriate becausehistorical performance provided a reasonable basis to estimate revenue andincome, which resulted in the income being recognized throughout the year.  In the first quarter of 2006, in addition toan estimated award for that period, an award fee representing six months ofprior period performance was recorded upon notification of the award.

Net income from continuing operations for the first quarter of 2007increased 31.0% to $10,025, or $0.75 per diluted share, from $7,652, or $0.61 perdiluted share, during the same period in 2006.

Net income, including results of both continuing and discontinuedoperations, for the first quarter of 2007 increased 7.3% to $9,195, or $0.69per diluted share, from $8,568, or $0.67 per diluted share, during the sameperiod in 2006.

**Discontinued Operations**

***Energy Operation***

OnDecember 29, 2006, United Industrial completed the sale of Detroit StokerCompany, which constituted the energy operation. The company’s discontinued energy operationreported income of $1,203, net of income tax for the three months ended March31, 2006.  For additional informationregarding the discontinued energy operations, see Note J to the ConsolidatedCondensed Financial Statements included in this Quarterly Report on Form 10-Q.

***Transportation Operation***

***Three Months Ended March 31,2007 Compared to Three Months Ended March 31, 2006***

The company’s discontinuedtransportation operation reported a loss of $830 net of income tax benefit forthe three months ended March 31, 2007, compared to a loss of $287 net of incometax benefit for the same period in 2006.

The company’s discontinuedtransportation operation incurred $1,116 of pretax general and administrativeexpenses attributable to on-going litigation involving AAI Corporation’s claimsunder a labor and materials bond and a loss of $161 reported by ETI for thethree months ended March 31, 2007.  Thecompany’s discontinued transportation operation incurred $444 of pretax generaland administrative expenses to wind down its operations, partially offset bynet income of $2 reported by ETI, for the three months ended March 31, 2006.

For additional information regarding thediscontinued transportation operations, see Note J to the ConsolidatedCondensed Financial Statements included in this Quarterly Report on Form 10-Q.

**FundedBacklog**

The company’s funded backlog represents the estimated remaining salesvalue of work to be performed under contracts for which funds have beenappropriated or purchase orders received. Backlog at March 31, 2007 andDecember 31, 2006 was as follows:

|            | ** ** | **March 31,** | ** ** | **December 31,** | ** ** | **Increase** | ** ** |
|------------|------------|--------------------|------------|-----------------------|------------|--------------|------------|
| ** ** | ** ** | **2007**           | ** ** | **2006**              | ** ** | **$**        | ** ** | **%** | ** ** |
|       |       | $                  | 717,091    |                  | $          | 662,244      |       | $ | 54,847 |   | 8.3 | % |
|            |            |                    |            |                       |            |              |            |  |  |  |  |  |

 

The increase in fundedbacklog at March 31, 2007 compared to December 31, 2006 was generallydue to an increase in U.S. Army orders for continued logistical supportservices for delivered Shadow 200 TUAS systems, including systems deployed inOperation Iraqi Freedom, and new Shadow 200 TUAS production.

The companyreceived $215,693 of funded new orders for products and services during thefirst quarter of 2007, an increase of $48,615, or 29.1 %, compared to $167,078for the same period in 2006.

 

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**Liquidity and Capital Resources**

**Overview**

The company’s principal sources of liquidity are cash on hand, cashgenerated from operations and a revolving credit facility. On July 18,2005, United Industrial and AAI entered into a $100,000 four year revolvingcredit agreement (the “Credit Agreement”) with a syndicate of six banks,consisting of SunTrust Bank, as administrative agent and issuing bank,Citibank, F.S.B., Key Bank, PNC Bank, Commerce Bank and Provident Bank. TheCredit Agreement provides for a credit facility consisting of a $100,000 seniorsecured revolving credit facility with a $5,000 swing line and a $100,000letter of credit subfacility (collectively, the “Credit Facility”). Theinterest rate for loans made under the Credit Facility is thirty day LIBOR plusan applicable margin between 1.25% and 2.00% based upon the company’s leverageratio. On March 23, 2007, the company borrowed $5,000 under the revolvingcredit facility for 30 days at an annual rate of 6.57%. As of March 31, 2007,the company had $1,941 outstanding under the letter of credit subfacility,leaving $93,059 available under the Credit Facility. Pursuant to the terms ofthe Credit Agreement and a parent guaranty, United Industrial has guarantiedAAI’s obligations under the Credit Facility. The proceeds of the CreditFacility may be used to fund future acquisitions, to support future purchasesof the company’s Common Stock, finance capital expenditures, provide workingcapital, fund letters of credit and for other general corporate purposes. Basedon cash on hand, future cash expected to be generated from operations and theCredit Facility, the company expects to have sufficient cash to meet itsrequirements for at least the next twelve months. The company was in compliancewith all of the covenants in the Credit Agreement at March 31, 2007.

The company seeks tocomplement its growth strategy through select acquisitions that broaden itsproduct and service offerings, deepen its capabilities and allow entry into newmarkets. Acquisition candidates may include public and private companies anddivisions, subsidiaries and product lines of such companies. In accordance withthis initiative, the company acquired ESL on April 4, 2005, Aerosonde onJune 19, 2006, McTurbine on November 14, 2006 and Symtx onNovember 28, 2006.

Further acquisitions depend,in part, on the availability of financial resources at an acceptable cost ofcapital. The company expects to utilize cash on hand and generated byoperations, as well as cash available under the Credit Facility, which mayinvolve negotiation of a new credit facility or the renegotiation of creditlimits to finance future acquisitions as well as purchases of the company’sCommon Stock and for other general corporate purposes.  Other sources of capital could include theissuance of common and/or preferred stock, and the placement of debt. Thecompany periodically evaluates capital markets and may access such markets whencircumstances appear favorable. The company believes that sufficient capital resourceswill be available from one or several of these sources to finance futureacquisitions. However, no assurances can be made that acceptable financing willbe available, or that acceptable acquisition candidates will be identified, orthat any such acquisitions will be accretive to earnings.

The company conducts asignificant amount of business with the U.S. Government. There are currently noindications of a significant change in the status of government funding for anyof the company’s programs. However, should a change in government fundingoccur, the company’s results of operations, financial position and liquiditycould be materially and adversely affected. Such a change could have asignificant, adverse impact on the company’s profitability and stock price.

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**Sources and Uses of Cash**

The following is a discussion of thecompany’s major operating, investing and financing activities for thethree-month periods ended March 31, 2007 and 2006.  The financial information presented in thetable below is summarized from the company’s Consolidated Condensed Statementsof Cash Flows for the periods presented.

|                                                                                   | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                        | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Operating  activities:                                                            |       |                                             |       |   |   |
| Net cash provided by continuing operations                                        |       | $                                                | 11,812     |   | $ | 6,153 |   |
| Net cash (used in) provided by operating activities  from discontinued operations |       | (483                                             | )          | 1,697 |   |
| Net cash  provided by operating activities                                        |       | 11,329                                           |       | 7,850 |   |
| Net cash used in  investing activities by continuing operations                   |       | (2,192                                           | )          | (1,453 | ) |
| Net cash used in  investing activities from discontinued operations               |       | —                                           |       | (13 | ) |
| Net cash (used  in) provided by financing activities by continuing operations     |       | (43,498                                          | )          | 2,833 |   |
| (Decrease)  increase in cash and cash equivalents                                 |       | $                                                | (34,361    | ) | $ | 9,217 |   |

 

## ***Operating Activities***

Netcash provided by continuing operations in the three months ended March 31, 2007increased $5,659 compared to the three months ended March 31, 2006.  This increase was generally due to higher netincome and the timing of cash receipts related to milestone billings, offset byinventory purchases and a reduction in accounts payable.

Thecompany’s cash flows from operations are dependent on the timing of receiptsfrom various U.S. government payment offices and, as a result, may differ fromperiod to period and such differences could be significant.

Net cash used by the discontinued Transportation operation in the threemonths ended March 31, 2007 primarily related to expenses attributable toongoing litigation involving AAI’s claims under a labor and materials bond, asdiscussed in Note 17 to the Consolidated Financial Statements included in PartII, Item 8 of the company’s Annual Report on Form 10-K for the year endedDecember 31, 2006 and Note K to the Consolidated Condensed Financial Statementsincluded in part I, Item 1 of this Quarterly Report on Form 10-Q.

## ***Investing Activities***

For the threemonths ended March 31, 2007 and 2006, investing activities were limited topurchases of property and equipment.

## ***Financing Activities***

The company’sfinancing activities in the three months ended March 31, 2007 included the useof $44,693 for the purchase of the company’s Common Stock, $2,879 for therepayment of long-term debt and $1,100 for dividends paid, offset by proceedsfrom borrowings under the Credit Facility of $5,000 and proceeds from theexercise of stock options of $165.

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The company’sfinancing activities in the three months ended March 31, 2006 included adecrease in restricted cash of $2,295, proceeds from the exercise of stockoptions of $1,222 and excess tax benefits from stock-based payment arrangementsof $764, offset by cash used for the payment of dividends of $1,127 and therepayment of long-term debt of $321.

**Debt and Related Covenants**

On September 15, 2004,United Industrial issued and sold $120,000 aggregate principal amount of the3.75% Convertible Senior Notes. Under specific circumstances, United Industrialmay have to pay, in cash or a combination of cash and Common Stock, amounts inaddition to the 3.75% fixed interest rate. Such payments, which are defined inthe Indenture governing the 3.75% Convertible Senior Notes, include ContingentInterest, Additional Interest, a Make-Whole Interest Payment and a RepurchaseEvent Make-Whole Premium. See Note 7 to the Consolidated Financial Statementsincluded in Part II, Item 8 of the company’s Annual Report on Form 10-Kfor the year ended December 31, 2006 for a more detailed discussion of theamounts of these contingent payments and the circumstances that would triggersuch additional payments.

On July 18, 2005,United Industrial and AAI entered into a $100,000 four year revolving CreditAgreement with a syndicate of six banks. The company was in compliance with allof the covenants in the Credit Agreement at March 31, 2007.

**Cash Requirements**

***Capital Expenditures***

Capitalexpenditures in 2007 are expected to be primarily in support of UAS, facilitiesand information technology projects.

***Other Cash Requirements***

On November 17, 2006, United Industrial’sBoard of Directors authorized a stock purchase plan for up to $50,000.  As of March 31, 2007, United Industrial hadpurchased a total of 933,174 shares at an average market price of $53.58,utilizing all funds available under the plan.

During the threemonths ended March 31, 2007, the company paid cash dividends of $0.10 per sharefor an aggregate amount of $1,100.  OnMay 9, 2007, the company’s Board of Directors declared a dividend of $0.10 pershare on its Common Stock, payable May 30, 2007 to shareholders of record atthe close of business on May 22, 2007.  The payment of anyfuture dividends will be at the discretion of the Board of Directors and willdepend upon, among other things, the company’s corporate strategy, futureearnings, operations, capital requirements and the company’s financial conditionand general business conditions.  Shouldthe company distribute a cash dividend in any quarterly period in excess of$0.10 per share, the conversion rate provided for in the Indenture governingthe 3.75% Convertible Senior Notes would be adjusted.  In addition, the company’s Credit Facilityimposes certain restrictions on the payment of dividends.

The company does notexpect additional cash requirements to exit the discontinued Transportationoperation subsequent to March 31, 2007, except for legal fees to be incurredrelated to claims made by AAI Corporation in pursuit of payment under a suretybond. (See Note K to the Consolidated Condensed Financial Statements includedin this Quarterly Report on Form 10-Q for a discussion of AAI Corporation’s claims.)

For additional information regarding the company’scontingencies, please see the discussion under the heading “*Contingent Matters*” below.

During2007 the company expects to contribute $4,215 to the UIC Retirement Plan.  No such contributions were made during thethree months ended March 31, 2007. Further, the company expects to pay other post-retirement benefits ofapproximately $1,970 in 2007, of which $459 was paid during the three monthsended March 31, 2007.

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**ContingentMatters**

**Off-Balance Sheet Arrangements**

In connection with certaincontracts, the company has committed to certain performance guarantees. Theability to perform under these guarantees may, in part, be dependent on theperformance of other parties, including partners and subcontractors. If thecompany is unable to meet these performance obligations, the performanceguarantees could have a material adverse effect on product margins and thecompany’s results of operations, liquidity or financial position. The companymonitors the progress of its partners and subcontractors, and as of March 31,2007 does not believe that the performance of these partners and subcontractorswill adversely affect these contracts. No assurances can be given, however, asto the liability of the company if partners or subcontractors are unable toperform their obligations.

For a discussion of AAICorporation’s and United Industrial’s indemnity obligations relating to ETI,35% of which is owned by AAI Corporation, see Note K to the ConsolidatedFinancial Statements included in Part I, Item 1 of this quarterly reporton Form 10-Q.

**Other Contingent Matters**

The company is involved invarious lawsuits and claims. There have been no material changes in anylegal proceedings since the company filed its Annual Report on Form 10-K forthe year ended December 31, 2006.  For further information, refer to theConsolidated Financial Statements and Notes thereto included in the company’sAnnual Report on Form 10-K for the year ended December 31, 2006 and see Note Kto the Consolidated Financial Statements included in Part I,  Item 1 of this Quarterly Report on Form 10-Q.

##### **MarketableEquity Securities**

The company’s investment inmarketable equity securities consists of an investment in common stock of onecompany in the Aerospace and Defense industry. Unrealized holding gains and losses deemed temporary onavailable-for-sale securities are excluded from earnings and are reported as aseparate component of other comprehensive income until realized. If anunrealized holding loss is deemed to be other-than-temporary, such unrealizedloss is charged to earnings when identified. The company’s cost basis in theinvestment is $12,602, and the carrying value (fair market value) was $10,991at March 31, 2007.

In June 2006, theinvestee company disclosed the indictment of the investee company and itschairman and suspension of certain of its plants from receiving U.S. Governmentcontracts, and possible delisting of its common stock. In October 2006,the investee company announced that the suspension of certain of its plantsfrom receiving U.S. Government contracts had been lifted, although a governmentinvestigation is still pending. Management continues to evaluate the financialstability of the investee company in relation to the severity and duration ofthe unrealized loss. Based on that evaluation and the company’s ability andintent to hold the investment for a reasonable period of time sufficient for aforecasted recovery of fair value, the company does not consider thisinvestment to be other-than-temporarily impaired at March 31, 2007. At March31, 2007 the cumulative net unrealized loss recorded in accumulated othercomprehensive loss was $1,611.

**Critical Accounting Policies**

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions.  These estimates andassumptions affect the reported amounts of assets and liabilities and disclosureof contingent assets and liabilities at the date of the financial statements,as well as reported amounts of revenues and expenses during the reportingperiod.  Judgments and assessments ofuncertainties are required in applying the company’s accounting policies inmany areas.  Actual results could differfrom these estimates.

There have been norevisions to the Critical Accounting Policies as disclosed in the company’sAnnual Report on Form 10-K for the year ended December 31, 2006.

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**Item3.—Quantitative and Qualitative Disclosures about Market Risk**

**InterestRate**

OnSeptember 15, 2004, the company issued and sold $120,000 of 3.75% ConvertibleSenior Notes.  Several features containedin the indenture governing the 3.75% Convertible Senior Notes are consideredembedded derivative instruments and are being accounted for as derivativeinstruments separate from the host contract (i.e., the 3.75% Convertible SeniorNotes). The company will record gains or losses in its Consolidated CondensedStatements of Operations for changes in the fair value of these embeddedderivatives.  The aggregate fair valueassigned to these embedded derivatives at March 31, 2007 was approximately $381and at December 31, 2006 was approximately $403.  Accordingly, the company recognized a gain of$22 for the three months ended March 31, 2007 as the result of the change infair value of the embedded derivatives.

Each of theembedded derivatives may result in certain payments to the holders of the 3.75%Convertible Senior Notes.

There has been no material change in theinterest rate market risk or contingent payment features from December 31, 2006(see Item 7A in the company’s Annual Report on Form 10-K for the year endedDecember 31, 2006).

**Foreign Currency**

Therehas been no material change in foreign currency risk from December 31,2006.  (See Item 7A in the company’sAnnual Report on Form 10-K for the year ended December 31, 2006.)

**Marketable Equity Securities**

For a discussionof market risk related to an investment in a marketable equity security of onecompany, see Note E to the Consolidated Condensed Financial Statements includedin Part I, Item 1 of this Quarterly Report on Form 10-Q.

**Item4.—Controls and Procedures**

The company’s management,under the supervision and with the participation of the Chief Executive Officerand the Chief Financial Officer, evaluated the effectiveness of the design andoperation of the company’s disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, asamended (the “Exchange Act”)) as of March 31, 2007. Based on this evaluation,the Chief Executive Officer and Chief Financial Officer concluded that, as ofMarch 31, 2007, the company’s disclosure controls and procedures were effectiveto ensure that information required to be disclosed by the company in thereports that the company files or submits under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms, and that such informationis accumulated and communicated to the company’s management (including theChief Executive Officer and Chief Financial Officer) to allow timely decisionsregarding required disclosures. Based on such evaluation, the Chief ExecutiveOfficer and Chief Financial Officer have concluded that the company is incompliance with Rule 13a-15(e) of the Exchange Act.

There has been nochange in the company’s internal control over financial reporting (as definedin Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred duringthe company’s fiscal quarter ended March 31, 2007, that has materiallyaffected, or is reasonably likely to materially affect, the company’s internalcontrol over financial reporting.

 

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**PART II—OTHER INFORMATION**

##### **Item 1.—Legal Proceedings**

Reference is made to theinformation contained in the section entitled “*Management’sDiscussion and Analysis of Financial Condition and Results of Operations*”set forth above in Item 2 of Part I and Note K to the Consolidated CondensedFinancial Statements included in Part I, Item 1 of this Quarterly Report onForm 10-Q.

**Item2.—Unregistered Sales of Equity Securities and Use of Proceeds**

On December 1,2006, the company publicly announced a program to acquire $50,000 of thecompany’s Common Stock.  This program wascompleted with the purchase of 827,438 shares of Common Stock during the firstquarter of 2007.  For further informationregarding the company’s purchases of its equity securities, see Note 11 to theConsolidated Financial Statements included in Part II, Item 8 of thecompany’s Annual Report on Form 10-K for the year ended December 31, 2006 andNote M to the Consolidated Condensed Financial Statements included in part I,Item 1 of this Quarterly Report on Form 10-Q.

ISSUERPURCHASES OF EQUITY SECURITIES
| ** **                | **Period** | ** ** | ** ** | **Total  Number of   Shares  Purchased** | ** ** | **Average Price  Paid   per Share** | ** ** | **Total Number of   Shares Purchased   as a Part of   Publicly   Announced   Programs** | ** ** | **Approximate Dollar  Value of Shares   That May Yet Be   Purchased Under  The Program** | ** ** |
|---------------------------|------------|------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------|------------|
| 1/1/07 **–** 1/31/07 |       | 168,804    |       | $                                                  | 49.98      |                                               | 168,804    |                                                                                                                                           | $          | 36,285                                                                                                                                     |       |
| 2/1/07 – 2/28/07     |       | —     |       | —                                             |       | —                                             |       | $                                                                                                                                              | 36,285     |                                                                                                                                       |
| 3/1/07 – 3/31/07     |       | 658,634    |       | $                                                  | 55.09      |                                               | 658,634    |                                                                                                                                           | $          | —                                                                                                                                     |       |

 

**Item6.—Exhibits**

31.1   Rule 13a-14(a)/15d-14(a)Certification by the Chief Executive Officer of the Company.

31.2   Rule 13a-14(a)/15d-14(a)Certification by the Chief Financial Officer of the Company.

32.1   Section 1350 Certification bythe Chief Executive Officer of the Company.

32.2   Section 1350 Certification bythe Chief Financial Officer of the Company.

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**SIGNATURE**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.
|                   |   | UNITED INDUSTRIAL CORPORATION |
|-------------------|--------|-------------------------------|
|              |   |                          |   |   |
|              |   |                          |   |   |
|              |   |                          |   |   |
| Date: May 9, 2007 |   | By:                           |   | /s/ James H. Perry |
|              |   |                          |   | James H. Perry |
|              |   |                          |   | Vice President, Chief Financial Officer, |
|              |   |                          |   | and Controller |
|              |   |                          |   | (as duly authorized officer and principal accounting  officer) |

 

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**INDEX OFEXHIBITS FILED HEREWITH**
| Exhibit No. | ** ** | ** **                                                                             |
|-------------|------------|----------------------------------------------------------------------------------------|
| 31.1        |       | Rule 13a-14(a)/15d-14(a) Certification by the Chief  Executive Officer of the Company. |
|        |       |                                                                                   |
| 31.2        |       | Rule 13a-14(a)/15d-14(a) Certification of the Chief  Financial Officer of the Company. |
|        |       |                                                                                   |
| 32.1        |       | Section 1350 Certification of the Chief Executive  Officer of the Company.             |
|        |       |                                                                                   |
| 32.2        |       | Section 1350 Certification of the Chief Financial  Officer of the Company.             |

 

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