** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q**

 

**ý****                                ****QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the quarterly period ended June 30,2005**

 

**or**

 

**o****                                ****TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the transition period from                       to                         **

 

**Commission File Number: 1-4252**

 

**UNITED INDUSTRIAL CORPORATION**

(Exactname 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) |

 

Indicate bycheck mark whether the registrant: (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.                                                                                                                                                                                Yes  ý    No o

 

Indicate bycheck mark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).                                                                                                                                                                                Yes ý    No o

 

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date: 11,682,506 shares of common stock as of July 27,2005.

 

 

----

 

# **UNITEDINDUSTRIAL CORPORATION**

 

INDEX

 
| PART I - FINANCIAL INFORMATION                                                                              |   |
|------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                             |   |
| Item 1. Financial Statements                                                                                     |   |
|                                                                                                             |   |
| Consolidated  Condensed Balance Sheets - June 30, 2005 and December 31, 2004                           |   |
|                                                                                                             |   |
| Consolidated  Condensed Statements of Operations - Three Months and Six Month Ended  June 30, 2005 and 2004 |   |
|                                                                                                             |   |
| Consolidated  Condensed Statements of Cash Flows - Six Months Ended June 30, 2005 and  2004                 |   |
|                                                                                                             |   |
| Notes  to Consolidated Condensed Financial Statements                                                            |   |
|                                                                                                             |   |
| Item 2. Management’s Discussion and Analysis of Financial Condition  and Results of Operations              |   |
|                                                                                                             |   |
| Item 3. Quantitative and Qualitative Disclosures About Market Risk                                               |   |
|                                                                                                             |   |
| Item 4. Controls and Procedures                                                                                  |   |
|                                                                                                             |   |
| PART II - OTHER INFORMATION                                                                                 |   |
|                                                                                                             |   |
| Item 1. Legal Proceedings                                                                                        |   |
|                                                                                                             |   |
| Item 2. Unregistered Sales  of Equity Securities and Use of Proceeds                                             |   |
|                                                                                                             |   |
| Item 4. Submission of  Matters to a Vote of Security Holders                                                     |   |
|                                                                                                             |   |
| Item 6. Exhibits                                                                                                 |   |
|                                                                                                             |   |
| SIGNATURE                                                                                                        |   |

 

1

----

 

**PART I - FINANCIAL INFORMATION**

 

**Item1. - Financial Statements**

 

UNITED INDUSTRIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

*(Dollars in thousands)*

 
| ** **                                                                                                                                                                                                        | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                        | ** ** | **(Unaudited)**         | ** ** | ** **                  | ** ** |
| ASSETS                                                                                                                                                                                                            |       |                    |       |                        |       |
| Current assets:                                                                                                                                                                                                   |       |                    |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                         |       | $                       | 73,912     |                        | $          | 80,679 |   |
| Marketable equity securities                                                                                                                                                                                      |       | 12,835                  |       | —                      |       |
| Securities pledged to creditors                                                                                                                                                                                   |       | —                  |       | 124,626                     |       |
| Restricted cash                                                                                                                                                                                                   |       | 4,799                   |       | 33,845                      |       |
| Trade receivables, net                                                                                                                                                                                            |       | 61,700                  |       | 46,658                      |       |
| Inventories                                                                                                                                                                                                       |       | 22,958                  |       | 34,639                      |       |
| Prepaid expenses and other current assets                                                                                                                                                                         |       | 8,799                   |       | 12,465                      |       |
| Assets of discontinued operations                                                                                                                                                                                 |       | 12,261                  |       | 13,545                      |       |
| Total current  assets                                                                                                                                                                                             |       | 197,264                 |       | 346,457                     |       |
| Deferred income taxes                                                                                                                                                                                             |       | 11,529                  |       | 13,930                      |       |
| Goodwill                                                                                                                                                                                                          |       | 5,478                   |       | —                      |       |
| Other assets                                                                                                                                                                                                      |       | 13,496                  |       | 11,953                      |       |
| Insurance receivable - asbestos litigation                                                                                                                                                                        |       | 20,343                  |       | 20,343                      |       |
| Property and equipment - less accumulated  depreciation (2005-$85,321; 2004-$85,762)                                                                                                                              |       | 36,719                  |       | 27,645                      |       |
|                                                                                                                                                                                                              |       | $                       | 284,829    |                        | $          | 420,328 |   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                                                                                         |       |                    |       |                        |       |
| Current liabilities:                                                                                                                                                                                              |       |                    |       |                        |       |
| Current portion of long-term debt                                                                                                                                                                                 |       | $                       | 970        |                        | $          | 958 |   |
| Payable under securities loan agreement                                                                                                                                                                           |       | —                  |       | 124,619                     |       |
| Accounts payable                                                                                                                                                                                                  |       | 21,493                  |       | 21,664                      |       |
| Accrued employee compensation and taxes                                                                                                                                                                           |       | 16,769                  |       | 13,706                      |       |
| Other current liabilities                                                                                                                                                                                         |       | 9,886                   |       | 14,942                      |       |
| Liabilities of discontinued operations                                                                                                                                                                            |       | 14,493                  |       | 18,566                      |       |
| Total current liabilities                                                                                                                                                                                         |       | 63,611                  |       | 194,455                     |       |
| Long-term debt                                                                                                                                                                                                    |       | 121,362                 |       | 122,000                     |       |
| Postretirement benefit obligation, other  than pension, and other long-term liabilities                                                                                                                           |       | 21,618                  |       | 22,942                      |       |
| Minimum pension  liability                                                                                                                                                                                        |       | 20,028                  |       | 17,513                      |       |
| Asbestos litigation liability                                                                                                                                                                                     |       | 31,852                  |       | 31,852                      |       |
| Total liabilities                                                                                                                                                                                                 |       | 258,471                 |       | 388,762                     |       |
| 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; 11,666,306 and 12,291,951 shares outstanding at  June 30, 2005 and December 31, 2004, respectively (net of shares in  treasury) |       | 14,374                  |       | 14,374                      |       |
| Additional capital                                                                                                                                                                                                |       | 83,321                  |       | 84,296                      |       |
| Retained earnings                                                                                                                                                                                                 |       | 22,148                  |       | 3,499                       |       |
| Treasury stock, at cost; 2,707,842 and  2,082,197 shares at June 30, 2005 and December 31, 2004,  respectively                                                                                          |       | (62,814                 | )          | (40,019                     | )          |
| Accumulated other comprehensive loss, net  of tax                                                                                                                                                                 |       | (30,671                 | )          | (30,584                     | )          |
| Total shareholders’ equity                                                                                                                                                                                   |       | 26,358                  |       | 31,566                      |       |
| Total liabilities and shareholder’s equity                                                                                                                                                                   |       | $                       | 284,829    |                        | $          | 420,328 |   |

 

See accompanying notes to the consolidated condensed financialstatements.

 

2

----

 

UNITED INDUSTRIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

*(Dollars in thousands, except per shareamounts)*

(Unaudited)

 
| ** **                                                                                                                                                                                                                                                                   | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                   | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net sales                                                                                                                                                                                                                                                                    |       | $                                    | 119,928    |                               | $          | 109,560 |   | $ | 227,476 |   | $ | 191,208 |   |
| Cost of sales                                                                                                                                                                                                                                                                |       | 89,643                               |       | 81,510                             |       | 171,148 |   | 145,671 |   |
| Gross profit                                                                                                                                                                                                                                                                 |       | 30,285                               |       | 28,050                             |       | 56,328 |   | 45,537 |   |
| Selling and administrative expenses                                                                                                                                                                                                                                          |       | 17,315                               |       | 11,970                             |       | 30,950 |   | 22,198 |   |
| Other operating expenses, net                                                                                                                                                                                                                                                |       | 354                                  |       | 90                                 |       | 524 |   | 186 |   |
| Operating income                                                                                                                                                                                                                                                             |       | 12,616                               |       | 15,990                             |       | 24,854 |   | 23,153 |   |
| Non-operating income and (expense):                                                                                                                                                                                                                                          |       |                                 |       |                               |       |   |   |   |   |
| Interest income                                                                                                                                                                                                                                                              |       | 698                                  |       | 66                                 |       | 1,749 |   | 130 |   |
| Interest expense                                                                                                                                                                                                                                                             |       | (1,390                               | )          | (13                                | )          | (3,218 | ) | (26 | ) |
| Gain on sale of property                                                                                                                                                                                                                                                     |       | —                               |       | —                             |       | 7,152 |   | — |   |
| Equity in net income of joint venture                                                                                                                                                                                                                                        |       | 38                                   |       | 45                                 |       | 52 |   | 60 |   |
| Other income (loss), net                                                                                                                                                                                                                                                     |       | 215                                  |       | (31                                | )          | 837 |   | 88 |   |
|                                                                                                                                                                                                                                                                         |       | (439                                 | )          | 67                                 |       | 6,572 |   | 252 |   |
| Income from continuing operations before  income taxes                                                                                                                                                                                                                       |       | 12,177                               |       | 16,057                             |       | 31,426 |   | 23,405 |   |
| Provision for income taxes                                                                                                                                                                                                                                                   |       | 3,876                                |       | 5,734                              |       | 10,501 |   | 8,360 |   |
| Income from continuing operations                                                                                                                                                                                                                                            |       | 8,301                                |       | 10,323                             |       | 20,925 |   | 15,045 |   |
| Income (loss) from discontinued operations,  net of income tax benefit of $123 and income tax provision of $406 for the  three and six months ended June 30, 2005 and tax benefit of $102 and  $358 for the three and six months ended June 30, 2004, respectively |       | 145                                  |       | (190                               | )          | 193 |   | (665 | ) |
| Net income                                                                                                                                                                                                                                                                   |       | $                                    | 8,446      |                               | $          | 10,133 |   | $ | 21,118 |   | $ | 14,380 |   |
|                                                                                                                                                                                                                                                                         |       |                                 |       |                               |       |   |   |   |   |
| Basic earnings per share:                                                                                                                                                                                                                                                    |       |                                 |       |                               |       |   |   |   |   |
| Income from continuing operations                                                                                                                                                                                                                                            |       | $                                    | 0.69       |                               | $          | 0.80 |   | $ | 1.72 |   | $ | 1.15 |   |
| Income (loss) from discontinued operations                                                                                                                                                                                                                                   |       | 0.01                                 |       | (0.01                              | )          | 0.01 |   | (0.05 | ) |
| Net income                                                                                                                                                                                                                                                                   |       | $                                    | 0.70       |                               | $          | 0.79 |   | $ | 1.73 |   | $ | 1.10 |   |
| Diluted earnings per share:                                                                                                                                                                                                                                                  |       |                                 |       |                               |       |   |   |   |   |
| Income from continuing operations                                                                                                                                                                                                                                            |       | $                                    | 0.60       |                               | $          | 0.78 |   | $ | 1.44 |   | $ | 1.13 |   |
| Income (loss) from discontinued operations                                                                                                                                                                                                                                   |       | 0.01                                 |       | (0.01                              | )          | 0.01 |   | (0.05 | ) |
| Net income                                                                                                                                                                                                                                                                   |       | $                                    | 0.61       |                               | $          | 0.77 |   | $ | 1.45 |   | $ | 1.08 |   |

 

See accompanying notes to the consolidated condensed financialstatements.

 

3

----

 

UNITED INDUSTRIAL CORPORATION ANDSUBSIDIARIES

CONSOLIDATEDCONDENSED STATEMENTS OF CASH FLOWS

*(Dollars in thousands)*

(Unaudited)

 
| ** **                                                                         | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                          |       |                               |       |   |   |
| Net income                                                                         |       | $                                  | 21,118     |   | $ | 14,380 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                               |       |   |   |
| (Income) loss from discontinued operations,  net of taxes                          |       | (193                               | )          | 665 |   |
| Depreciation and amortization                                                      |       | 4,010                              |       | 2,762 |   |
| Gain on sale of property                                                           |       | (7,152                             | )          | — |   |
| Pension expense                                                                    |       | 2,515                              |       | 1,923 |   |
| Deferred income taxes                                                              |       | 2,816                              |       | 934 |   |
| Income from equity investment in joint  venture                                    |       | (52                                | )          | (60 | ) |
| Changes in operating assets and  liabilities:                                      |       |                               |       |   |   |
| Increase in trade receivables                                                      |       | (12,670                            | )          | (7,260 | ) |
| Decrease (increase) in inventories                                                 |       | 12,362                             |       | (14,001 | ) |
| Decrease (increase) in prepaid expenses and  other current assets                  |       | 2,846                              |       | (1,776 | ) |
| (Decrease) increase in customer advances                                           |       | (4,011                             | )          | 675 |   |
| Increase in accounts payable, accruals and  other current liabilities              |       | 130                                |       | 17,677 |   |
| Decrease in long-term liabilities                                                  |       | (1,324                             | )          | (350 | ) |
| Other – net                                                                   |       | 857                                |       | 39 |   |
| Net cash provided by operating activities  from continuing operations              |       | 21,252                             |       | 15,608 |   |
| Net cash used in discontinued operations                                           |       | (2,596                             | )          | (1,219 | ) |
| Net cash provided by operating activities                                          |       | 18,656                             |       | 14,389 |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                          |       |                               |       |   |   |
| Purchases of property and equipment                                                |       | (12,591                            | )          | (3,482 | ) |
| Proceeds from sale of available-for-sale  securities                               |       | 124,626                            |       | — |   |
| Purchase of marketable equity securities                                           |       | (12,684                            | )          | — |   |
| Business acquisition, net of cash acquired                                         |       | (9,883                             | )          | — |   |
| Proceeds from sale of property                                                     |       | 7,555                              |       | — |   |
| Net cash provided by (used in) investing  activities                               |       | 97,023                             |       | (3,482 | ) |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                          |       |                               |       |   |   |
| Repayment of long-term debt                                                        |       | (638                               | )          | — |   |
| Repayment of collateral received from  securities lending transaction              |       | (124,619                           | )          | — |   |
| Decrease in restricted cash                                                        |       | 29,046                             |       | — |   |
| Proceeds from exercise of stock options                                            |       | 1,208                              |       | 2,862 |   |
| Dividends paid                                                                     |       | (2,465                             | )          | (2,609 | ) |
| Purchase of treasury shares                                                        |       | (24,978                            | )          | (10,486 | ) |
| Net cash used in financing activities                                              |       | (122,446                           | )          | (10,233 | ) |
| (Decrease) increase in cash and cash  equivalents                                  |       | (6,767                             | )          | 674 |   |
| Cash and cash equivalents at beginning of  year                                    |       | 80,679                             |       | 24,138 |   |
| Cash and cash equivalents at end of period                                         |       | $                                  | 73,912     |   | $ | 24,812 |   |

 

See accompanying notes to the consolidated condensed financialstatements.

 

4

----

 

UNITED INDUSTRIAL CORPORATION ANDSUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

 

**Note A - Basis of Presentation and Nature ofOperations**

 

Theaccompanying unaudited Consolidated Condensed Financial Statements of UnitedIndustrial Corporation (“United Industrial”) and its subsidiaries(collectively, the “Company”) have been prepared in accordance with accountingprinciples generally accepted in the United States for interim financialinformation and with the instructions to Form 10-Q and Rule 10-01 ofRegulation S-X.  Accordingly, they do notinclude all of the information and notes required by accounting principlesgenerally accepted in theUnited States 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 and six-month periods ended June 30,2005, are not necessarily indicative of the results that may be expected forthe year ending December 31, 2005. These unaudited Consolidated Condensed Financial Statements should beread in conjunction with the Consolidated Financial Statements and notesthereto included in the Company’s Annual Report on Form 10-K for the yearended December 31, 2004.

 

The Company conducts a significant amount of business with the U.S.Government. No single customer other than the U.S. Government accounted for tenpercent or more of consolidated net sales in any year.

 

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America 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 these estimates and those differences could bematerial.

 

**Note B - Segment Information - ContinuingOperations**

 

The Company has two reportable segments: Defense and Energy.  The operations of the Defense and Energysegments are conducted principally through two wholly-owned subsidiaries, AAICorporation and its subsidiaries (“AAI”) and Detroit Stoker Company (“DetroitStoker”), respectively. The Company measures its segment performance based onincome (loss) before income taxes. Costs related to the continuing operationsthat are not identified with the two business segments primarily relate tofinancing costs and are grouped under the heading Other.  The Company has a transportation operationthat is accounted for as discontinued operations in the accompanyingConsolidated Condensed Financial Statements.

 
| **(Dollars in thousands)**                      | ** ** | **Defense** | ** ** | **Energy** | ** ** | **Other** | ** ** | **Totals** | ** ** |
|-------------------------------------------------|------------|-------------|------------|------------|------------|-----------|------------|------------|------------|
| Three Months Ended June 30, 2005           |       |        |       |       |       |      |       |       |       |
| Net sales                                       |       | $           | 111,614    |       | $          | 8,314     |       | $          | —     |   | $ | 119,928 |   |
| Gross profit                                    |       | 27,176      |       | 3,109      |       | —    |       | 30,285     |       |
| Income from equity investment in joint  venture |       | 38          |       | —     |       | —    |       | 38         |       |
| Interest income (expense), net                  |       | 110         |       | 49         |       | (851      | )          | (692       | )          |
| Depreciation and amortization expense           |       | 1,991       |       | 75         |       | —    |       | 2,066      |       |
| Income (loss) before income taxes               |       | 12,212      |       | 915        |       | (950      | )          | 12,177     |       |
|                                            |       |        |       |       |       |      |       |       |       |
| Six Months Ended June 30, 2005             |       |        |       |       |       |      |       |       |       |
| Net sales                                       |       | $           | 211,771    |       | $          | 15,705    |       | $          | —     |   | $ | 227,476 |   |
| Gross profit                                    |       | 50,737      |       | 5,591      |       | —    |       | 56,328     |       |
| Income from equity investment in joint  venture |       | 52          |       | —     |       | —    |       | 52         |       |
| Interest income (expense), net                  |       | 116         |       | 87         |       | (1,672    | )          | (1,469     | )          |
| Depreciation and amortization expense           |       | 3,860       |       | 150        |       | —    |       | 4,010      |       |
| Income (loss) before income taxes               |       | 31,659      |       | 1,090      |       | (1,323    | )          | 31,426     |       |
|                                            |       |        |       |       |       |      |       |       |       |
| Three Months Ended June 30, 2004           |       |        |       |       |       |      |       |       |       |
| Net sales                                       |       | $           | 101,561    |       | $          | 7,999     |       | $          | —     |   | $ | 109,560 |   |
| Gross profit                                    |       | 24,999      |       | 3,051      |       | —    |       | 28,050     |       |
| Income from equity investment in joint  venture |       | 45          |       | —     |       | —    |       | 45         |       |
| Interest income (expense), net                  |       | 39          |       | 14         |       | —    |       | 53         |       |
| Depreciation and amortization expense           |       | 1,351       |       | 87         |       | —    |       | 1,438      |       |
| Income (loss) before income taxes               |       | 15,046      |       | 1,059      |       | (48       | )          | 16,057     |       |
|                                            |       |        |       |       |       |      |       |       |       |
| Six Months Ended June 30, 2004             |       |        |       |       |       |      |       |       |       |
| Net sales                                       |       | $           | 176,367    |       | $          | 14,841    |       | $          | —     |   | $ | 191,208 |   |
| Gross profit                                    |       | 39,824      |       | 5,713      |       | —    |       | 45,537     |       |
| Income from equity investment in joint  venture |       | 60          |       | —     |       | —    |       | 60         |       |
| Interest Income (expense), net                  |       | 76          |       | 28         |       | —    |       | 104        |       |
| Depreciation and amortization expense           |       | 2,590       |       | 172        |       | —    |       | 2,762      |       |
| Income (loss) before income taxes               |       | 22,235      |       | 1,463      |       | (293      | )          | 23,405     |       |

 

5

----

 

##### **Note C - Earnings Per Share**

 

Basic earnings per share for all periods presented was computed bydividing net earnings for the respective period by the weighted-average numberof shares of the Company’s par value $1.00 per share common stock (“CommonStock”) outstanding during the period. Diluted earnings per share was computed by dividing (i) netearnings during the period, adjusted in 2005 to add back the after-tax interestcharges incurred on the Company’s $120,000,000 aggregate principal amount of3.75% convertible senior notes due September 15, 2024, by (ii) theweighted-average number of shares of Common Stock outstanding during theperiod, adjusted to add the weighted-average number of potential dilutivecommon shares that would have been outstanding upon the assumed exercise ofstock options and conversion of the 3.75% Convertible Senior Notes for CommonStock.

 

Options to purchase 189,000 shares of the Company’s Common Stock forthe three and six months ended June 30, 2005 and options to purchase30,000 shares of the Company’s Common Stock for the three and six months ended June 30,2004 were not included in the computation of diluted earnings per share becausethe options’ exercise price was in excess of the average market price of theCommon Stock during the period and therefore would be anti-dilutive.  The 189,000 options, which were grantedduring 2005 and expire five years from the grant date, were outstanding at June 30,2005.  The 30,000 options, which weregranted during 2004 and expire five years from the grant date, were outstandingat June 30, 2004.

 

Basic and diluted earnings per share amounts were computed as follows:

** **
| ** **                                         | ** ** | **Three Months Ended June 30,** | ** ** |
|----------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                         | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| **(Dollars in thousands, except  per share data)** | ** ** | **Earnings**                         | ** ** | **Shares** | ** ** | **Per  Share** | ** ** | **Earnings** | ** ** | **Shares** | ** ** | **Per  Share** | ** ** |
|                                               |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Basic Earnings Per Share                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Income from continuing operations                  |       | $                                    | 8,301      |   | 12,077,612 |   | $ | 0.69 |   | $ | 10,323 |   | 12,929,104 |   | $ | 0.80 |   |
|                                               |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Effect of Dilutive Securities                      |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Stock Options                                      |       | —                               |       | 410,267 |   |   |   | — |   | 332,575 |   |   |   |
| 3.75% Convertible Senior Notes                     |       | 989                                  |       | 3,058,356 |   |   |   | — |   | — |   |   |   |
| Diluted Earnings Per Share                         |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Income from continuing operations                  |       | $                                    | 9,290      |   | 15,546,235 |   | $ | 0.60 |   | $ | 10,323 |   | 13,261,679 |   | $ | 0.78 |   |

 

6

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| ** **                                         | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------|------------|------------------------------------|------------|
| ** **                                         | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| **(Dollars in thousands, except  per share data)** | ** ** | **Earnings**                       | ** ** | **Shares** | ** ** | **Per  Share** | ** ** | **Earnings** | ** ** | **Shares** | ** ** | **Per  Share** | ** ** |
|                                               |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| Basic Earnings Per Share                           |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| Income from continuing operations                  |       | $                                  | 20,925     |   | 12,196,224 |   | $ | 1.72 |   | $ | 15,045 |   | 13,032,784 |   | $ | 1.15 |   |
|                                               |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| Effect of Dilutive Securities                      |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| Stock Options                                      |       | —                             |       | 426,328 |   |   |   | — |   | 301,440 |   |   |   |
| 3.75% Convertible Senior Notes                     |       | 1,596                              |       | 3,058,356 |   |   |   | — |   | — |   |   |   |
| Diluted Earnings Per Share                         |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| Income from continuing operations                  |       | $                                  | 22,521     |   | 15,680,908 |   | $ | 1.44 |   | $ | 15,045 |   | 13,334,224 |   | $ | 1.13 |   |

 

##### **Note D - Stock-Based Compensation**

 

Foreach of the three and six month periods ended June 30, 2005 and 2004, theCompany accounted for its stock-based compensation plans in accordance withAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees” (“APB No. 25”), and its related implementation guidance,whereby compensation cost for stock options is recognized in earnings based onthe excess, if any, of the quoted market price of the stock at the grant dateof the award or other measurement date over the amount an employee must pay toacquire the stock.  Had compensation costbeen determined consistent with the fair value method set forth under Statementof Financial Accounting Standards (“SFAS”) No. 123, “Accounting forStock-Based Compensation” (“SFAS No. 123”), as amended by SFAS No. 148,“Accounting for Stock-Based Compensation – Transition and Disclosure” (“SFAS No. 148”),for all awards under the plans, income and earnings per share from continuingoperations would have decreased to the pro forma amounts indicated below:

 
| ** **                                                                                                             | ** ** | **Three Months Ended   June 30,** | ** ** | **Six Months Ended   June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| **(Dollars in thousands, except  per share data)**                                                                     | ** ** | **2005**                               | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Income from continuing operations:                                                                                     |       |                                   |       |                                 |       |   |   |   |   |
| As reported                                                                                                            |       | $                                      | 8,301      |                                 | $          | 10,323 |   | $ | 20,925 |   | $ | 15,045 |   |
| Deduct: Total employee stock-based compensation  expense determined under fair value method for all awards, net of tax |       | (259                                   | )          | (156                                 | )          | (467 | ) | (252 | ) |
| Pro forma                                                                                                              |       | $                                      | 8,042      |                                 | $          | 10,167 |   | $ | 20,458 |   | $ | 14,793 |   |
| Earnings per share from continuing  operations:                                                                        |       |                                   |       |                                 |       |   |   |   |   |
| As reported:                                                                                                           |       |                                   |       |                                 |       |   |   |   |   |
| Basic                                                                                                                  |       | $                                      | 0.69       |                                 | $          | 0.80 |   | $ | 1.72 |   | $ | 1.15 |   |
| Diluted                                                                                                                |       | 0.60                                   |       | 0.78                                 |       | 1.44 |   | 1.13 |   |
| Pro forma:                                                                                                             |       |                                   |       |                                 |       |   |   |   |   |
| Basic                                                                                                                  |       | $                                      | 0.67       |                                 | $          | 0.79 |   | $ | 1.68 |   | $ | 1.14 |   |
| Diluted                                                                                                                |       | 0.58                                   |       | 0.77                                 |       | 1.41 |   | 1.11 |   |

 

OnDecember 16, 2004, the Financial Accounting Standards Board (“FASB”)issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”),which replaced SFAS No. 123 and superseded SFAS No. 148 and APB No. 25and its related implementation guidance. SFAS No. 123R requires entities to recognize in their financialstatements the cost of employee services received in exchange for awards ofequity instruments based on the grant-date fair value of those awards (withlimited exceptions).  SFAS No. 123Ris effective for the Company as of the interim period that begins January 1,2006. The Company continues to evaluate which transition method it will select.

 

7

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##### **Note E – Marketable Equity Securities**

 

##### **Available-for-salesecurities are recorded at fair value. Unrealized holding gains and losses, net of the related tax effect, onavailable-for-sale securities are excluded from earnings and are reported as aseparate component of other comprehensive income until realized.  Realized gains and losses from the sale ofavailable-for-sale securities are determined on a specific-identificationbasis.  Marketable equity securities at June 30,2005, represent common stock of one entity. An unrealized gain of $151,000 was recorded in other comprehensiveincome at June 30, 2005.**

 

##### **Note F - Supplemental Balance Sheet and CashFlow Information**

 

Inventories consisted of the following components:

 
| **(Dollars in thousands)**         | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Finished goods and work-in-process |       | $                       | 20,954     |                        | $          | 33,384 |   |
| Materials and supplies             |       | 2,004                   |       | 1,255                       |       |
| Total inventories                  |       | $                       | 22,958     |                        | $          | 34,639 |   |

Other assets consisted of the following components:
| **(Dollars in thousands)**  | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------------|------------|-------------------------|------------|------------------------|------------|
| Intangibles, net            |       | $                       | 6,263      |                   | $          | 4,060 |   |
| Debt issuance costs, net    |       | 4,129                   |       | 4,620                  |       |
| Investment in joint venture |       | 1,668                   |       | 1,616                  |       |
| Other                       |       | 1,436                   |       | 1,657                  |       |
| Total other assets          |       | $                       | 13,496     |                   | $          | 11,953 |   |

Other current liabilities consisted of the following components:
| **(Dollars in thousands)**      | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Customer advances               |       | $                       | 1,565      |                        | $          | 5,576 |   |
| Reserve for contract losses     |       | 1,740                   |       | 1,680                       |       |
| Accrued interest expense        |       | 1,349                   |       | 1,364                       |       |
| Accrued liabilities             |       | 3,999                   |       | 2,864                       |       |
| Other                           |       | 1,233                   |       | 3,458                       |       |
| Total other current liabilities |       | $                       | 9,886      |                        | $          | 14,942 |   |

 

Cashpaid for Federal income taxes during the six months ended June 30, 2005and 2004 was $ 6,500,000 and $3,580,000, respectively.  Cash paid for interest during the six monthsended June 30, 2005 and 2004 was $2,286,000 and $ 26,000, respectively.

 

##### **Note G – Secured Borrowing**

#####  

OnDecember 29, 2004, the Company purchased $125,000,000 aggregate principalamount at maturity of U.S. treasury bills for $124,619,000, which matured on February 24,2005.  The Company classified thisinvestment as available-for-sale, which required it to be reported at estimatedfair value, with unrealized gains and losses, net of tax, reported as aseparate component of Accumulated Other Comprehensive Loss in Shareholders’Equity until realized.  Concurrently withthe purchase of the U.S. treasury bills on December 29, 2004, the Companyentered into a securities lending transaction with its broker-dealer, whichmatured on February 23, 2005 and was accounted for as a secured borrowing.  In exchange for lending the U.S. treasurybills to its broker-dealer, the Company received cash collateral from itsbroker-dealer in an amount equal to 100% of the fair value of the securitiesloaned, net of a $25,000,000 refundable deposit that remained at itsbroker-dealer in a segregated, interest-bearing account.  At maturity on February 23, 2005, theCompany repaid the cash collateral received, together with approximately$444,000 of related interest charges. Also at maturity, the Company collected its $25,000,000 refundabledeposit, together with approximately $86,000 of related interest incomeearned.  During the first quarter of2005, the Company realized a $7,500 loss on this investment, excluding approximately$373,000 of interest income received.

 

8

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**Note H - Pension and Other PostretirementBenefits**

 

Thefollowing table provides the components of net periodic pension benefit costfor the three and six months ended June 30, 2005 and 2004:

 
| ** **                         | ** ** | **Pension Benefits  Three Months Ended  June 30,** | ** ** | **Pension Benefits  Six Months Ended  June 30,** | ** ** |
|------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------|------------|
| **(Dollars in thousands)**         | ** ** | **2005**                                                | ** ** | **2004**                                              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                               |       |                                                    |       |                                                  |       |   |   |   |   |
| Service cost                       |       | $                                                       | 809        |                                                  | $          | 751 |   | $ | 1,618 |   | $ | 1,500 |   |
| Interest cost                      |       | 2,579                                                   |       | 2,571                                                 |       | 5,158 |   | 5,143 |   |
| Expected return on plan assets     |       | (3,209                                                  | )          | (3,157                                                | )          | (6,419 | ) | (6,314 | ) |
| Net amortization and deferral:     |       |                                                    |       |                                                  |       |   |   |   |   |
| Amortization of prior service cost |       | 69                                                      |       | 45                                                    |       | 138 |   | 90 |   |
| Amortization of actuarial loss     |       | 1,054                                                   |       | 846                                                   |       | 2,108 |   | 1,687 |   |
|                               |       |                                                    |       |                                                  |       |   |   |   |   |
| Net periodic pension benefit cost  |       | $                                                       | 1,302      |                                                  | $          | 1,056 |   | $ | 2,603 |   | $ | 2,106 |   |

 

Thefollowing table provides the components of other postretirement benefit costfor the three and six months ended June 30, 2005 and 2004:

 
| ** **                            | ** ** | **Other Postretirement  Benefits  Three Months Ended  June 30,** | ** ** | **Other Postretirement  Benefits  Six Months Ended  June 30,** | ** ** |
|---------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| **(Dollars in thousands)**            | ** ** | **2005**                                                              | ** ** | **2004**                                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                  |       |                                                                  |       |                                                                |       |   |   |   |   |
| Service cost                          |       | $                                                                     | 48         |                                                                | $          | 48 |   | $ | 95 |   | $ | 93 |   |
| Interest cost                         |       | 297                                                                   |       | 312                                                                 |       | 593 |   | 625 |   |
| Net amortization and deferral:        |       |                                                                  |       |                                                                |       |   |   |   |   |
| Amortization of prior service cost    |       | (5                                                                    | )          | (10                                                                 | )          | (9 | ) | (20 | ) |
| Amortization of actuarial loss (gain) |       | 3                                                                     |       | (21                                                                 | )          | 6 |   | (41 | ) |
|                                  |       |                                                                  |       |                                                                |       |   |   |   |   |
| Other post retirement benefit cost    |       | $                                                                     | 343        |                                                                | $          | 329 |   | $ | 685 |   | $ | 657 |   |

 

The following table provides the Company’s contributions to andbenefits paid under pension and other postretirement benefit plans:

 
| ** **                                                                 | ** ** | **Pension Benefits  Six Months Ended  June 30,** | ** ** | **Other Postretirement  Benefits  Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| **(Dollars in thousands)**                                                 | ** ** | **2005**                                              | ** ** | **2004**                                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                       |       |                                                  |       |                                                                |       |   |   |   |   |
| Expected fiscal year contributions reported  at the end of the prior year: |       |                                                  |       |                                                                |       |   |   |   |   |
| Employer                                                                   |       | $                                                     | 244        |                                                                | $          | 259 |   | $ | 3,007 |   | $ | 2,572 |   |
| Employee                                                                   |       | —                                                |       | —                                                              |       | — |   | 172 |   |
|                                                                       |       | 244                                                   |       | 259                                                                 |       | 3,007 |   | 2,744 |   |
|                                                                       |       |                                                  |       |                                                                |       |   |   |   |   |
| Actual contributions made in the current  year                             |       | 88                                                    |       | 37                                                                  |       | 1,844 |   | 1,372 |   |
| Remaining contributions expected to be made  in the current year           |       | 156                                                   |       | 222                                                                 |       | 1,504 |   | 1,372 |   |
| Total expected current year contributions                                  |       | 244                                                   |       | 259                                                                 |       | 3,348 |   | 2,744 |   |
| Difference from expectations at end of the  prior year                     |       | $                                                     | —     |                                                                | $          | — |   | $ | 341 |   | $ | — |   |

 

EffectiveJuly 1, 2004, the Company adopted FSP No. FAS 106-2 and includes theeffects of the Medicare Act of 2003 in its measurement of net periodicpostretirement benefit cost and accumulated postretirement benefit obligations(“APBO”).

 

9

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**Note I - Other Operating Expenses, Net andOther Non-Operating Income, Net**

 
| ** **                                                                               | ** ** | **Three Months Ended   June 30,** | ** ** | **Six Months Ended   June 30,** | ** ** |
|------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| **(Dollars in thousands)**                                                               | ** ** | **2005**                               | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Other operating expenses, net                                                            |       |                                   |       |                                 |       |   |   |   |   |
| Amortization of intangible assets                                                        |       | $                                      | 55         |                                 | $          | 56 |   | $ | 110 |   | $ | 111 |   |
| Amortization of facility consolidation  costs                                            |       | 47                                     |       | 73                                   |       | 89 |   | 146 |   |
| Amortization of deferred compensation  liability                                         |       | (16                                    | )          | (24                                  | )          | (32 | ) | (56 | ) |
| Asbestos litigation expense                                                              |       | 124                                    |       | —                               |       | 214 |   | — |   |
| Other income (expense), net                                                              |       | 144                                    |       | (15                                  | )          | 143 |   | (15 | ) |
| Total other operating expenses, net                                                      |       | $                                      | 354        |                                 | $          | 90 |   | $ | 524 |   | $ | 186 |   |
|                                                                                     |       |                                   |       |                                 |       |   |   |   |   |
| Other non-operating income, net                                                          |       |                                   |       |                                 |       |   |   |   |   |
| Royalties and commissions                                                                |       | $                                      | —     |                                 | $          | 19 |   | $ | 18 |   | $ | 56 |   |
| Rental income                                                                            |       | 16                                     |       | 14                                   |       | 30 |   | 28 |   |
| (Loss) gain from change in fair value of embedded  derivatives underlying long-term debt |       | (137                                   | )          | —                               |       | 301 |   | — |   |
| Other income (expense), net                                                              |       | 336                                    |       | (64                                  | )          | 488 |   | 4 |   |
| Total other income (expense), net                                                        |       | $                                      | 215        |                                 | $          | (31 | ) | $ | 837 |   | $ | 88 |   |

 

##### **Note J - Comprehensive Income**

 

The following table sets forth the components of other comprehensiveincome and total comprehensive income:

 
| ** **                                             | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **(Dollars in thousands)**                             | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                             | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                             |       | $                                     | 8,446      |                                | $          | 10,133 |   | $ | 21,118 |   | $ | 14,380 |   |
| Other comprehensive income, net of tax:                |       |                                  |       |                                |       |   |   |   |   |
| Minimum pension liability, Net of tax of  $627 in 2004 |       | —                                |       | 627                                 |       | — |   | 627 |   |
| Unrealized gain on marketable securities               |       | 151                                   |       | —                              |       | 155 |   | — |   |
| Loss on foreign currency translation                   |       | (242                                  | )          | —                              |       | (242 | ) | — |   |
| Total comprehensive income                             |       | $                                     | 8,355      |                                | $          | 10,760 |   | $ | 21,031 |   | $ | 15,007 |   |

 

**Note K – Acquisitions**

 

On April 4,2005, the Company acquired ESL Defence Limited (“ESL”), an electronic warfaresystems company based in theUnited Kingdom.  The purchase price was$10,515,000 in cash.  The operatingresults of ESL have been included in the consolidated financial statements ofthe Company since April 4, 2005.  Thepurchase price of this business has been allocated to the estimated fair valueof net tangible and intangible assets acquired, with any excess recorded asGoodwill.  The estimates related to theacquisition are still preliminary at June 30, 2005. The Company isawaiting the completion of the identification and valuation of intangibleassets acquired.  On April 4, 2005,the Goodwill and intangible assets were recorded at $5,684,124 and $2,486,370,estimated respectively of the purchase price. The Company expects these analyses to be completed by December 2005.

 

10

----

 

Thefollowing table summarizes the estimated fair value of the assets andliabilities assumed at April 4, 2005.

 

| **(Dollars in thousands)** | ** ** | **At April 4, 2005** | ** ** |
|----------------------------|------------|---------------------------|------------|
| ** **                 | ** ** | ** **                | ** ** |
| Cash and equivalents       |       | $                         | 479        |   |
| Current assets             |       | 3,054                     |       |
| Property and equipment     |       | 384                       |       |
| Intangible assets          |       | 2,486                     |       |
| Goodwill                   |       | 5,684                     |       |
| Total assets acquired      |       | 12,087                    |       |
|                       |       |                      |       |
| Current liabilities        |       | 1,724                     |       |
| Total liabilities assumed  |       | 1,724                     |       |
| Net assets acquired        |       | $                         | 10,363     |   |

 

Theacquired intangible assets, all of which are being amortized and relateprimarily to contract related intangibles have an estimated weighted averageuseful life of approximately seven years. The goodwill is expected to be fully deductible for U.S. tax purposes.Aggregate amortization expense for amortizing intangible assets was $87,329 at June 30,2005.  Estimated amortization expense forthe next five years is $258,691 in 2005, $342,724 in 2006, $342,724 in 2007,$342,724, in 2008, and $342,724 in 2009. This acquisition is not considered to be material, therefore, pro-formainformation is not presented.

 

##### **Note L - Discontinued Operations**

#####  

Assetsand liabilities of the discontinued transportation operations, which have beenreclassified to Assets of discontinued operations and Liabilities ofdiscontinued operations and summarized in the accompanying ConsolidatedCondensed Balance Sheets, respectively, were as follows:

 
| **(Dollars in thousands)**                | ** ** | **June 30,  2005** | ** ** | **December 31  2004** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| Current assets:                           |       |                    |       |                       |       |
| Trade receivables from affiliate          |       | $                       | 39,322     |                       | $          | 39,322 |   |
| Less allowances                           |       | (39,322                 | )          | (39,322                    | )          |
| Prepaid expenses and other current assets |       | 51                      |       | 51                         |       |
| Deferred taxes                            |       | 12,210                  |       | 13,494                     |       |
| Other receivables from affiliate          |       | 12,793                  |       | 11,278                     |       |
| Less allowances                           |       | (12,793                 | )          | (11,278                    | )          |
| Total current assets                      |       | $                       | 12,261     |                       | $          | 13,545 |   |
| Current liabilities:                      |       |                    |       |                       |       |
| Accounts payable                          |       | $                       | 407        |                       | $          | 937 |   |
| Accrued employee compensation and taxes   |       | 129                     |       | 164                        |       |
| Other current liabilities                 |       | 11,270                  |       | 11,270                     |       |
| Accrual for contract losses               |       | 2,687                   |       | 6,164                      |       |
| Other                                     |       | —                  |       | 31                         |       |
| Total current liabilities                 |       | $                       | 14,493     |                       | $          | 18,566 |   |

 

11

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Summaryresults of the transportation operations, which have been classified separatelyas discontinued operations, were as follows:

 
| ** **                                                                      | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **(Dollars in thousands)**                                                      | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue                                                                         |       | $                                     | —     |                                | $          | — |   | $ | — |   | $ | — |   |
| Income (loss) before income taxes                                               |       | 22                                    |       | (292                                | )          | 599 |   | (1,023 | ) |
| (Provision for) benefit from income taxes                                       |       | 123                                   |       | 102                                 |       | (406 | ) | 358 |   |
| Income (loss) from discontinued  transportation operations, net of income taxes |       | $                                     | 145        |                                | $          | (190 | ) | $ | 193 |   | $ | (665 | ) |

 
| ** **                                               | ** ** | **Six Months Ended   June 30,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------|------------|
| **(Dollars in thousands)**                               | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| Net cash provided by (used in) discontinued  operations: |       |                                 |       |   |   |
| Net income (loss)                                        |       | $                                    | 193        |   | $ | (665 | ) |
| Changes in operating assets and liabilities              |       | (565                                 | )          | (353 | ) |
| Increase in deferred income taxes                        |       | 1,284                                |       | 316 |   |
| Decrease in accrual for contract losses and  other       |       | (3,508                               | )          | (517 | ) |
| Net cash used in discontinued  transportation operations |       | $                                    | (2,596     | ) | $ | (1,219 | ) |

 

**Note M - Commitments and Contingencies**

 

Inthe normal course of its continuing and discontinued business, variouslawsuits, claims and procedures have been or may be instituted or assertedagainst or by the Company.  Based oncurrently available facts, the Company believes, except as otherwise set forthbelow, that the disposition of matters pending or asserted against the Companywill not have a material adverse effect on the Company’s financial position,results of operations or liquidity.

 

ASBESTOS

 

History

 

United Industrial and Detroit Stoker Company (“Detroit Stoker”), awholly-owned subsidiary of United Industrial, have been named as defendants inasbestos-related personal injury litigation. Neither United Industrial norDetroit Stoker fabricated, milled, mined, manufactured or marketed asbestos,and neither United Industrial nor Detroit Stoker made or sold insulationproducts or other construction materials that have been identified as theprimary cause of asbestos-related disease in the vast majority of claimants.Rather, United Industrial and Detroit Stoker made several products, some of theparts and components of which used asbestos-containing material fabricated andprovided by third parties. The use of asbestos-containing materials ceased inapproximately 1981.

 

Cases involving United Industrial and Detroit Stoker typically name 80to 120 defendants, although some cases have as few as 6 and as many as 250defendants. As of this date, United Industrial and Detroit Stoker have not goneto trial with respect to any asbestos-related personal injury claims, althoughthere is no assurance that trials may not occur in the future. Accordingly, asof this date, neither United Industrial nor Detroit Stoker have been requiredto pay any punitive damage awards, although there can be no assurance thismight not occur in the future. In addition, as of this date, some previouslypending claims have been settled or dismissed (with or without prejudice).  There is no assurance, however, thatdismissals and settlements will occur at the same rate, if at all, or thatclaims that have been dismissed without prejudice will not be re-filed.

 

12

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Defenses

 

Management continues to believe that a majority of the claimants inpending cases will not be able to demonstrate that they have been exposed toUnited Industrial’s or Detroit Stoker’s asbestos-containing products orsuffered any compensable loss as a result of any such exposure. This belief isbased in large part on two factors: the limited number of asbestos-containingproducts and betterments sold by United Industrial and Detroit Stoker andUnited Industrial’s and Detroit Stoker’s access to sales, service, and otherhistorical business records going back over 100 years, which allow UnitedIndustrial and Detroit Stoker to determine to whom products were sold, the dateof sale, the installation site and, in some instances, the date products wereremoved from service. In addition, because of the limited and restrictedplacement of the asbestos-containing products, even at sites where a claimantcan verify his or her presence during the same period those products wereinstalled, liability cannot be presumed because, even if an individualcontracted an asbestos-related disease, not everyone who was employed at a sitewas exposed to United Industrial’s or Detroit Stoker’s asbestos-containingproducts.

 

These factors have allowed United Industrial and Detroit Stoker toeffectively manage their asbestos-related claims.

 

Settlements

 

To date, settlements of claims against UnitedIndustrial and/or Detroit Stoker have been made without any admission ofliability by United Industrial and/or Detroit Stoker. Settlement amounts mayvary depending upon a number of factors, including the jurisdiction where theaction was brought, the nature and extent of the disease alleged and theassociated medical evidence, the age and occupation of the claimant, theexistence or absence of other possible causes of the claimant’s allegedillness, and the availability of legal defenses, as well as whether the actionis brought alone or as part of a group of claimants. Before paying anysettlement amount, United Industrial and/or Detroit Stoker require proof ofexposure to their asbestos-containing products and proof of injury to theplaintiff. In addition, the claimant is required to execute a full andunconditional release of United Industrial, Detroit Stoker and associatedparties, from any liability for asbestos-related injuries or claims.

 

Insurance Coverage

 

The insurance coverage potentially available to United Industrial andDetroit Stoker is substantial. Following the institution of asbestoslitigation, an effort was made to identify all of United Industrial’s andDetroit Stoker’s primary and excess insurance carriers from 1940 through 1990.There were approximately 40 such carriers, all of which were put on notice ofthe litigation. In November of 1999, a Participation Agreement was enteredinto among United Industrial, Detroit Stoker and their primary insurancecarriers. The Participation Agreement is an advance understanding thatsupplements all of the contracts of insurance, without altering the coverage ofthose contracts, that creates an administrative framework within which theinsurers and United Industrial and Detroit Stoker can more efficiently andeffectively manage the large quantity of on-going litigation.

 

Any party may terminate the Participation Agreement, without cause, bygiving the other parties 60 days prior written notice. Termination of theParticipation Agreement does not affect any rights or obligations of theparties that have accrued under the Participation Agreement on or before theeffective date of the termination, nor does it affect any rights outside of theParticipation Agreement.

 

Although the carriers can opt out of the Participation Agreement on 60days notice, management does not believe that this will occur in the immediateor near term. For example, unless a carrier professes to have met the limits ofits liability, it would have to consider the potentially greater costs ofpermitting United Industrial and Detroit Stoker to handle their own cases.Further, opting out of the Participation Agreement does not exculpate liabilityon the part of the carrier.

 

United Industrial’s counsel retained a consulting firm with expertisein the field of evaluating insurance coverage and the likelihood of recoveryfor claims, such as costs incurred in connection with asbestos-related injuryclaims. In 2002, that firm worked with United Industrial to project theinsurance coverage of United Industrial and Detroit Stoker for asbestos-relatedclaims. The insurance consultant’s conclusions were based primarily on a reviewof United Industrial’s and Detroit Stoker’s coverage history, application ofreasonable assumptions on the allocation of coverage consistent with industrystandards, an assessment of the creditworthiness of the insurance carriers, andthe experience of and a review of the report of the asbestos liabilityconsultant described below. The insurance consultant also considered theParticipation Agreement.

 

13

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Based on the assumptions employed by and the report prepared by theinsurance consultant, other variables, and the report prepared by the asbestosliability consultant, which is discussed below, the Company recorded anestimated insurance recovery as of December 31, 2002, of $20,343,000reflecting the estimate determined to be probable of being available tomitigate United Industrial’s and Detroit Stoker’s potential asbestos liabilitythrough 2012.  The Company continuouslyevaluates this insurance receivable and believes it is appropriately valued at June 30,2005.

 

Quantitative Claims Information

 

As of June 30, 2005, United Industrial and/or Detroit Stoker werenamed in asbestos litigation pending in Arkansas, California, Louisiana,Michigan, Minnesota, Mississippi, New Jersey, New York and North Dakota. As of June 30,2005, there were approximately 13,750 pending claims, compared to approximately21,123 pending claims as of December 31, 2004 and approximately 20,485pending claims as of June 30, 2004. During 2004, Detroit Stoker was named as a defendant in two cases inArkansas alleging personal injuries to one and approximately 199 plaintiffs,respectively, as a result of silica and/or refractory ceramic fiber exposure inaddition to asbestos exposure.  Thepleadings in these two cases name approximately 32 and 68 defendants,respectively, and include no allegations specific to Detroit Stoker.  Because claims are often filed and disposedof by dismissal or settlement in large numbers, the amount and timing of settlementsand the number of open claims during a particular period can fluctuate fromperiod to period. In addition, most of these lawsuits do not include specificdollar claims for damages, and many include a number of plaintiffs and multipledefendants. Therefore, the Company cannot provide any meaningful disclosureabout the total amount of the damages sought. In addition, the directasbestos-related expenses of United Industrial and Detroit Stoker for defenseand indemnity for the past five years were not material.

 

A significant increase in the volume of asbestos-related bodily injurycases arose in Mississippi beginning in 2002 and extended through mid-year2003. Management believes this peak in the volume of claims in Mississippi wasdue to the passage of tort reform legislation (applicable to asbestos-relatedinjuries), which became effective at the end of 2002 and which resulted in alarge number of claims being filed in Mississippi by plaintiffs seeking toensure their claims would be governed by the law in effect prior to the passageof tort reform.

 

In 2002, United Industrial’s counsel engaged a consulting firm withexpertise in the field of evaluating asbestos bodily-injury claims to assistUnited Industrial in projecting the future asbestos-related liabilities anddefense costs of United Industrial and Detroit Stoker. The methodology used bythis asbestos liability consultant to project future asbestos-related costs isbased primarily on estimates of the labor force exposed to asbestos in UnitedIndustrial’s and Detroit Stoker’s products, epidemiological modeling ofasbestos-related disease manifestation, and estimates of claim filings andsettlement and defense costs that may occur in the future. Using thisinformation, the asbestos liability consultant estimated the number of futureclaims that would be filed, as well as the related costs that would be incurredin resolving those claims. United Industrial’s and Detroit Stoker’s claimshistory prior to 2002 was not a significant variable in developing theestimates because such history was not significant as compared to the number ofclaims filed in 2002.

 

Projecting future asbestos costs is subject to numerous variables thatare extremely difficult to predict. In addition to the significantuncertainties surrounding the number of claims that might be received, othervariables include the type and severity of the disease alleged by eachclaimant, the long latency period associated with asbestos exposure, dismissalrates, costs of medical treatment, the impact of bankruptcies of other companiesthat are co-defendants in claims, uncertainties surrounding the litigationprocess from jurisdiction to jurisdiction and from case to case, and the impactof potential changes in legislative or judicial standards. Furthermore, anypredictions with respect to these variables are subject to even greateruncertainty as the projection period lengthens. In light of these inherentuncertainties, United Industrial’s and Detroit Stoker’s limited claims historyprior to 2002 and consultation with the asbestos and insurance consultants, theCompany believes that ten years is the most reasonable period for recognizing areserve for future costs, and that costs that might be incurred after thatperiod were not reasonably estimable.  Asa result, the Company also believes that its ultimate net asbestos-relatedcontingent liability (i.e. its indemnity or other claim disposition costs plusrelated legal fees less insurance recoveries) cannot be estimated withcertainty.

 

Based on the assumptions employed by and the report prepared by theasbestos liability consultant and other variables, the Company recorded anundiscounted liability for its best estimate of bodily injury liabilities forasbestos-related matters in the amount of $31,852,000 as of December 31,2002, including damages and defense costs.

 

14

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Given the inherent uncertainty in making future projections and thatUnited Industrial and Detroit Stoker periodically receive potentially materialnew information from claimants and their counsel that relates to the factualbasis of their asserted and unasserted claims, United Industrial and DetroitStoker plans on a periodic basis, to have either (1) the key assumptionsused in projecting the future asbestos-related liabilities and defense costs ofUnited Industrial and Detroit Stoker validated or (2) the projections ofcurrent and future asbestos claims re-examined, and United Industrial andDetroit Stoker will update them if needed based on the experience of UnitedIndustrial and Detroit Stoker and other relevant factors, such as changes inthe tort system and the resolution of bankruptcies of various asbestosdefendants.

 

In connection with the preparation of its annual report on Form 10-Kfor the year ended December 31, 2004, United Industrial provided theasbestos consulting firm with updated information regarding asbestos casesfiled against United Industrial and/or Detroit Stoker, and asked the consultingfirm to perform a validation of its 2002 report.  In particular, the consulting firm was askedif it would use the same methodology to calculate future asbestos liability andif the assumptions used in 2002 are still valid.  The consulting firm reported that nothing hadcome to their attention in the intervening period that would call into questionthe central assumptions underlying the report, or the report’s ten-yearestimate of United Industrial’s and Detroit Stoker’s future potentialliability.

 

The Company’s asbestos liability was $31,852,000 and $31,437,000 at June 30,2005 and 2004, respectively, and its insurance receivables for asbestos-relatedliabilities were $20,343,000 and $20,256,000 at June 30, 2005 and 2004,respectively.  These figures reflect theCompany’s policy to maintain a ten-year estimate of future liability, theperiod in which such costs are deemed to be reasonably estimable.

 

In light of the asbestos liability consultant’s reports and based uponthe facts as now known, including the reasonable possibility that claims willbe received and paid over the next 50 year period, the Company believes thatalthough asbestos claims could have a material adverse effect on the Company’sfinancial condition or results of operations in a particular reporting period,asbestos claims should not have a material adverse effect on the Company’s longterm financial condition, liquidity or results of operations. No assurances canbe given, however, as to the actual amount of United Industrial’s and DetroitStoker’s liability for such present and future claims or the amount ofinsurance recoveries (including any recoveries from liquidating excessinsurance carriers), and the differences from estimated amounts could bematerial.

 

Reform Legislation

 

The outlook for federal legislation to provide national asbestoslitigation reform continues to be uncertain. Also uncertain is whether, and towhat extent, United Industrial and Detroit Stoker would be required to makecontributions to a prospective national asbestos trust pursuant to suchlegislation. No assurances can be given that a proposed trust or any otherasbestos legislation will ultimately become law, or when such action mightoccur.

 

STATE OF ARIZONA DEPARTMENT OF ENVIRONMENTAL QUALITY V. UIC, ET AL.

 

On May 19, 1993, United Industrial was named as one of threedefendants in a civil action brought pursuant to the ComprehensiveEnvironmental Response Compensation and Liability Act (“CERCLA”) by the ArizonaDepartment of Environmental Quality (“ADEQ”) in the United States DistrictCourt for the District of Arizona. ADEQ sought remediation of a manufacturingsite in the State of Arizona operated by U.S. Semiconductor Products, Inc.(“U.S. Semiconductor”), a manufacturer of semiconductors formerly owned byUnited Industrial. ADEQ alleged that from 1959 until United Industrial soldU.S. Semiconductor in 1961, U.S. Semiconductor disposed of tricholoroethylene,a “hazardous substance,” and other hazardous substances under CERCLA, onto theground and into various pits and drains located on the site.

 

In 1996, United Industrial entered into a consent decree with ADEQ.Pursuant to the consent decree, United Industrial is required to complete aRemedial Investigation/Feasibility Study (“RI/FS”), pay $125,000 for pastresponse costs, pay quarterly Arizona oversight costs (averaging less than$10,000 annually) and pay $125,000 for future response costs plus a graduatedpercentage of the cleanup costs for the site if those costs are in excess of$10,000,000 but less than $40,000,000. United Industrial’s liability for futureresponse costs under the consent decree is capped at $1,780,000 in addition tothe $125,000 that United Industrial has already paid. In connection with theRI/FS, United Industrial has retained a consultant at an average annual cost ofapproximately $200,000. The Remedial Investigation was submitted to ADEQ forapproval on March 31, 2004 and was approved by ADEQ on August 9,2004.  In March 2005, ADEQ issuedits Proposed Remedial Objectives Report for public comment.  ADEQ received no substantive commentsregarding the report, and in May 2005,

 

15

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ADEQ issued is final Remedial Objectives Report.  United Industrial is required to submit toADEQ a Feasibility Study and Proposed Remedies to meet ADEQ’s May 2005Remedial Objectives.  United Industrialexpects to submit the Feasibility Study sometime in September of2005.  Management believes that it willreach closure with ADEQ on all RI/FS issues on an acceptable basis to UnitedIndustrial following approval of the Feasibility Study.  No assurances can be given, however, as tothe actual extent to which United Industrial may be determined to have furtherliability, if at all.

 

MICHIGAN DEPARTMENT OF NATURAL RESOURCES

 

DetroitStoker was notified in March 1992 by the Michigan Department of NaturalResources (“MDNR”) that it is a potentially responsible party in connectionwith the cleanup of a former industrial landfill located in Port of Monroe,Michigan. MDNR is treating the Port of Monroe landfill site as a contaminatedfacility within the meaning of the Michigan Environmental Response Act (“MERA”).Under MERA, if a release or potential release of a discarded hazardoussubstance is or may be injurious to the environment or to the public health,safety or welfare, MDNR is empowered to undertake or compel investigation andresponse activities in order to alleviate any contamination threat.  Management believes Detroit Stoker would beconsidered a de minimis potentially responsible party and does not believe thatthe resolution of this matter will have a materially adverse effect on UnitedIndustrial’s or Detroit Stoker’s financial condition or results of operations.Detroit Stoker intends to aggressively defend these claims. No assurances canbe given, however, as to the actual extent to which Detroit Stoker may bedetermined to be liable, if at all.

 

OTHER LEGAL MATTERS

 

Departments and agencies of the U.S. Government have the authority atmany levels to investigate transactions and operations of the Company, and theresults of such investigations may lead to administrative, civil, or criminalproceedings, the ultimate outcome of which could be fines, penalties,repayments or compensatory or treble damages. Agencies that oversee contractperformance include: the Defense Contract Audit Agency, the Department ofDefense Inspector General, the General Accounting Office, the Department ofJustice, the Department of State, and 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.

 

The Company has in place international and domestic compliance policiesand procedures, including training of employees. From time to time, the Companyreceives allegations of improper conduct relating to its operations, includingoperations subject to the U.S. Foreign Corrupt Practices Act and other U.S.domestic and international laws. When the Company receives any suchallegations, it conducts internal (and if necessary, external) investigationsto determine whether there is support for any such allegations.  An investigation is ongoing in response toallegations provided to Company management of improper payments to foreigngovernment officials and improper invoicing. External counsel has been retainedby the Audit Committee of the Company’s Board of Directors to determine ifthere is support for any such allegations, and to review the Company’s compliancepolicies and procedures, and the Company is cooperating fully withcounsel.  In addition, appropriategovernment agencies have been advised of this investigation. The Company iscooperating with their requests for information. The investigation by externalcounsel, which is continuing, has thus far not revealed any prior involvementor knowledge regarding the allegations by any officer or director of UnitedIndustrial. At the current stage of this investigation, any ultimate liabilityis not presently determinable.

 

PERFORMANCE GUARANTEES

 

In connection with certain contracts, United Industrial’s operatingsubsidiaries have committed to certain performance guarantees existing at June 30,2005. The ability to perform under these guarantees 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 guarantees 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 be given, however, as tothe liability of United Industrial’s operating subsidiaries if partners orsubcontractors are unable to perform their obligations.

 

16

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DISCONTINUED TRANSPORTATION OPERATION

 

## MUNI Contract

 

In connection with the discontinued Transportation operations, AAI owns35% of Electric Transit, Inc. (“ETI”). Skoda a.s. (“Skoda”), a Czech company, owns the remaining 65% ofETI.  ETI’s one remaining productioncontract with the San Francisco Municipal Railway (“MUNI”) involves the designand manufacture of 273 electric trolley buses (“ETBs”). In executing itscontract with MUNI, ETI entered into subcontracts with AAI, certain Skodaoperating affiliates and others. Both AAI and the Skoda operating affiliateshave completed delivery of the ETB’s and the Skoda operating affiliates are nowsubject to warranty requirements. Skoda’s operating affiliates have continuedto deliver products and services under their subcontracts with ETI through June 2005.

 

Following Skoda’s bankruptcy declaration in 2001 in the Czech Republic,effective as of 2002, AAI began recording 100%, instead of 35%, of ETI’s lossesand income in accordance with the equity method accounting applicable tominority shareholders.  Although AAI hascompleted performance on its subcontract with ETI on the MUNI contract, AAI hascontinued to provide ETI with personnel and other financial support in order toenable ETI to satisfy certain of its remaining commitments to MUNI.

 

As of April 22, 2004, ETI and MUNI finalized an agreement tomodify the original MUNI contract (“Modification No. 6”) under which ETIassigned its remaining subcontractor obligations and MUNI relieved ETI of itswarranty, performance and certain related bonding obligations, as well as otherobligations under its ETB contract with MUNI, except for the performance of adefined scope of work related to modifications of ETB hardware.

 

In conjunction with Modification No. 6, AAI executed a guarantyagreement with MUNI as of April 22, 2004 (the “Guaranty Agreement”) thatassures performance of certain of ETI’s obligations under Modification No. 6.In conjunction with the Guaranty Agreement, AAI assigned its remainingsubcontractor obligations to MUNI and obtained a release from its subcontractorwarranty and all further obligations under its subcontract with ETI in exchangefor a cash payment to MUNI of $500,000 and other consideration.  The Company believes that it has adequatelyprovided for its obligations under the Guaranty Agreement in its existing lossreserves. No assurances can be given, however, as to the actual amount of AAI’sliability to exit the discontinued Transportation operations.

 

As required by MUNI, ETI obtained a surety bond to guarantee payment toall those providing labor, materials, provisions or other supplies to ETI infurtherance of its performance under the MUNI contract.  AAI agreed to indemnify the surety, ifnecessary, for up to $14,800,000, representing 35% of the original face valueof the labor and materials bond (in proportion to AAI’s equity interest inETI). On November 18, 2003, AAI provided the surety with notice of itsclaim on the labor and materials bond for unpaid receivables in connection withAAI’s MUNI subcontract from ETI, totaling in excess of $47,000,000, the maximumpenal sum of the labor and materials bond. AAI’s payment rights under the laborand materials bond (among other claims) are currently at issue in a case beforethe Federal court in the Northern District of California.  Prior to final adjudication of this case,there can be no assurances as to the amount or timing of a recovery by AAI, ifany, on its claim on the labor and materials bond.  To date no amount of recovery has beenrecorded by AAI.

 

##### **Note N - Dividends**

#####  

TheCompany’s Board of Directors declared a dividend of $0.10 per share on itscommon stock on March 10, 2005 and again on May 6, 2005.  Dividends of $1,234,479 and $1,230,089 werepaid on March 31, 2005 and May 30, 2005, respectively.  Dividends of $1,313,236 and $1,292,646 werepaid on March 31, 2004 and May 28, 2004, respectively.

 

**Note O – Issuer Purchases of EquitySecurities**

 

In November 2003, the Board of Directors of the Company authorizedthe purchase of up to $10,000,000 of the Company’s Common Stock.  On March 10, 2004, the Company’s Boardof Directors extended the plan for one additional year through March 15,2005, and authorized the purchase of up to an additional $10,000,000 of CommonStock.  From inception of this plan in November 2003to its expiration on March 15, 2005, the Company had purchased a total of917,700 shares for $16,522,000, or an average of $18.00 per share.  The remaining $3,478,000 was not used andexpired on March 15, 2005.

 

17

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On March 10, 2005, the Company’s Board of Directors authorized anew stock purchase plan for up to $25,000,000. For the six months ended June 30, 2005, a total of 735,345 shareshave been repurchased under the plan for an aggregate amount of $25,000,000, oran average price of $33.97 per share, utilizing all funds available under the March 10,2005 stock purchase plan.

 

**Note P - Restructuring Charges**

 
| **(Dollars in thousands)**                | ** ** | **Severance** | ** ** | **Employee  Relocation** | ** ** | **Facility  Relocation** | ** ** | **Facility  Closing  Costs** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|---------------|------------|--------------------------|------------|--------------------------|------------|------------------------------|------------|-----------|------------|
|                                      |       |          |       |                     |       |                     |       |                         |       |      |       |
| **Defense segment**                       |       |          |       |                     |       |                     |       |                         |       |      |       |
| Reserve balance at December 31, 2004 |       | $             | 160        |                     | $          | 169                      |       | $                            | 74         |      | $          | — |   | $ | 403 |   |
| Restructuring charges                     |       | 353           |       | 375                      |       | —                   |       | 1,161                        |       | 1,889     |       |
| Paid or otherwise settled                 |       | (286          | )          | (544                     | )          | (52                      | )          | (1,161                       | )          | (2,043    | )          |
| Reserve balance at June 30, 2005     |       | $             | 227        |                     | $          | —                   |       | $                            | 22         |      | $          | — |   | $ | 249 |   |
|                                      |       |          |       |                     |       |                     |       |                         |       |      |       |
| **Energy segment**                        |       |          |       |                     |       |                     |       |                         |       |      |       |
| Reserve balance at December 31, 2004 |       | $             | —     |                     | $          | —                   |       | $                            | —     |      | $          | — |   | $ | — |   |
| Restructuring charges                     |       | 61            |       | —                   |       | 63                       |       | 44                           |       | 168       |       |
| Paid or otherwise settled                 |       | (61           | )          | —                   |       | (63                      | )          | (44                          | )          | (168      | )          |
| Reserve balance at June 30, 2005     |       | $             | —     |                     | $          | —                   |       | $                            | —     |      | $          | — |   | $ | — |   |

 

**Note Q - Supplemental Guarantor Information**

 

InSeptember 2004, United Industrial issued and sold $120,000,000 aggregateprincipal amount of 3.75% Convertible Senior Notes, which are fully andunconditionally guaranteed by AAI, the Company’s wholly-owned subsidiary thatconstitutes the Defense segment.  The3.75% Convertible Senior Notes are not guaranteed by Detroit Stoker, theCompany’s wholly-owned subsidiary that constitutes the Energy segment.  The following condensed consolidatingfinancial information sets forth supplemental information for UnitedIndustrial, the parent company, AAI, the guarantor subsidiary, and DetroitStoker, the non-guarantor subsidiary, as of June 30, 2005 and December 31,2004, and for the three- month and six-month periods ended June 30, 2005and 2004.

 

18

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CONDENSED CONSOLIDATING FINANCIAL INFORMATION(UNAUDITED)

 

CONDENSED CONSOLIDATING BALANCE SHEETS

As of June 30, 2005

 
| **(Dollars in thousands)**                      | ** ** | **United Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Detroit  Stoker  Company  (Non-  Guarantor)** | ** ** | **Elimi-  nations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------------------|------------|-------------------------------------------------|------------|---------------------|------------|--------------------------------------------------------|------------|
|                                            |       |                                         |       |                                                 |       |                                            |       |                |       |                                                   |       |
| ASSETS                                          |       |                                         |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Current Assets                                  |       |                                         |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Cash and cash equivalents                       |       | $                                            | 161        |                                                 | $          | 65,154                                          |       | $                   | 8,597      |                                                   | $          | — |   | $ | 73,912 |   |
| Marketable equity securities                    |       | 12,835                                       |       | —                                               |       | —                                          |       | —              |       | 12,835                                                 |       |
| Restricted cash                                 |       | —                                       |       | 4,799                                                |       | —                                          |       | —              |       | 4,799                                                  |       |
| Trade receivables, net                          |       | 441                                          |       | 56,913                                               |       | 4,346                                           |       | —              |       | 61,700                                                 |       |
| Inventories                                     |       | (609                                         | )          | 20,795                                               |       | 2,772                                           |       | —              |       | 22,958                                                 |       |
| Other current assets                            |       | 1,229                                        |       | 6,805                                                |       | 869                                             |       | (104                | )          | 8,799                                                  |       |
| Assets of discontinued operations               |       | —                                       |       | 12,261                                               |       | —                                          |       | —              |       | 12,261                                                 |       |
| Total current  assets                           |       | 14,057                                       |       | 166,727                                              |       | 16,584                                          |       | (104                | )          | 197,264                                                |       |
| Insurance receivable – asbestos litigation |       | —                                       |       | —                                               |       | 20,343                                          |       | —              |       | 20,343                                                 |       |
| Property and equipment, net                     |       | —                                       |       | 34,872                                               |       | 1,847                                           |       | —              |       | 36,719                                                 |       |
| Other assets                                    |       | 11,765                                       |       | 33,118                                               |       | 2,493                                           |       | (16,873             | )          | 30,503                                                 |       |
| Intercompany receivables                        |       | —                                       |       | 265                                                  |       | —                                          |       | (265                | )          | —                                                 |       |
| Investment in consolidated subsidiaries         |       | 76,806                                       |       | —                                               |       | —                                          |       | (76,806             | )          | —                                                 |       |
|                                            |       | $                                            | 102,628    |                                                 | $          | 234,982                                         |       | $                   | 41,267     |                                                   | $          | (94,048 | ) | $ | 284,829 |   |
|                                            |       |                                         |       |                                                 |       |                                            |       |                |       |                                                   |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY       |       |                                         |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Current portion of long-term debt               |       | $                                            | —     |                                                 | $          | 970                                             |       | $                   | —     |                                                   | $          | — |   | $ | 970 |   |
| Other current liabilities                       |       | 3,703                                        |       | 49,588                                               |       | 4,671                                           |       | (9,814              | )          | 48,148                                                 |       |
| Liabilities of discontinued operations          |       | —                                       |       | 14,493                                               |       | —                                          |       | —              |       | 14,493                                                 |       |
| Total current liabilities                       |       | 3,703                                        |       | 65,051                                               |       | 4,671                                           |       | (9,814              | )          | 63,611                                                 |       |
| Long-term debt                                  |       | 120,000                                      |       | 1,362                                                |       | —                                          |       | —              |       | 121,362                                                |       |
| Reserve for asbestos litigation                 |       | —                                       |       | —                                               |       | 31,852                                          |       | —              |       | 31,852                                                 |       |
| Other long-term liabilities                     |       | 2,543                                        |       | 44,101                                               |       | 11,875                                          |       | (16,873             | )          | 41,646                                                 |       |
| Intercompany (receivables) payables             |       | (26,999                                      | )          | 17,240                                               |       | 289                                             |       | 9,470               |       | —                                                 |       |
| Shareholders’ equity (deficit)             |       | 3,381                                        |       | 107,228                                              |       | (7,420                                          | )          | (76,831             | )          | 26,358                                                 |       |
|                                            |       | $                                            | 102,628    |                                                 | $          | 234,982                                         |       | $                   | 41,267     |                                                   | $          | (94,048 | ) | $ | 284,829 |   |

 

19

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CONDENSED CONSOLIDATING FINANCIAL INFORMATION

 

CONDENSED CONSOLIDATING BALANCE SHEETS

As of December 31, 2004

 
| **(Dollars  in thousands)**                 | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Detroit  Stoker  Company  (Non-****Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|---------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
|                                        |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| ASSETS                                      |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| Current  assets:                            |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| Cash and cash  equivalents                  |       | $                                             | 129        |                                                 | $          | 72,269                                            |       | $                | 8,281      |                                                   | $          | — |   | $ | 80,679 |   |
| Securities pledged  to creditors            |       | 124,626                                       |       | —                                               |       | —                                            |       | —           |       | 124,626                                                |       |
| Restricted cash                             |       | 25,000                                        |       | 8,845                                                |       | —                                            |       | —           |       | 33,845                                                 |       |
| Trade receivables,  net                     |       | 17                                            |       | 44,152                                               |       | 2,489                                             |       | —           |       | 46,658                                                 |       |
| Inventories                                 |       | —                                        |       | 31,957                                               |       | 2,682                                             |       | —           |       | 34,639                                                 |       |
| Other current assets                        |       | 3,295                                         |       | 8,283                                                |       | 909                                               |       | (22              | )          | 12,465                                                 |       |
| Assets of  discontinued operations          |       | —                                        |       | 13,545                                               |       | —                                            |       | —           |       | 13,545                                                 |       |
| Total  current assets                       |       | 153,067                                       |       | 179,051                                              |       | 14,361                                            |       | (22              | )          | 346,457                                                |       |
| Insurance receivable  - asbestos litigation |       | —                                        |       | —                                               |       | 20,343                                            |       | —           |       | 20,343                                                 |       |
| Property and  equipment, net                |       | —                                        |       | 25,643                                               |       | 2,002                                             |       | —           |       | 27,645                                                 |       |
| Other assets                                |       | 12,258                                        |       | 25,844                                               |       | 2,499                                             |       | (14,718          | )          | 25,883                                                 |       |
| Intercompany  receivables                   |       | —                                        |       | 141                                                  |       | —                                            |       | (141             | )          | —                                                 |       |
| Investment in  consolidated subsidiaries    |       | 78,050                                        |       | —                                               |       | —                                            |       | (78,050          | )          | —                                                 |       |
|                                        |       | $                                             | 243,375    |                                                 | $          | 230,679                                           |       | $                | 39,205     |                                                   | $          | (92,931 | ) | $ | 420,328 |   |
|                                        |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY  |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| Current liabilities:                        |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| Current portion of  long-term debt          |       | $                                             | —     |                                                 | $          | 958                                               |       | $                | —     |                                                   | $          | — |   | $ | 958 |   |
| Payable under  securities loan agreement    |       | 124,619                                       |       | —                                               |       | —                                            |       | —           |       | 124,619                                                |       |
| Other current  liabilities                  |       | 5,466                                         |       | 41,179                                               |       | 3,689                                             |       | (22              | )          | 50,312                                                 |       |
| Liabilities of  discontinued operations     |       | —                                        |       | 18,566                                               |       | —                                            |       | —           |       | 18,566                                                 |       |
| Total current  liabilities                  |       | 130,085                                       |       | 60,703                                               |       | 3,689                                             |       | (22              | )          | 194,455                                                |       |
| Long-term debt                              |       | 120,000                                       |       | 2,000                                                |       | —                                            |       | —           |       | 122,000                                                |       |
| Reserve for asbestos  litigation            |       | —                                        |       | —                                               |       | 31,852                                            |       | —           |       | 31,852                                                 |       |
| Other long-term  liabilities                |       | 2,152                                         |       | 41,253                                               |       | 11,768                                            |       | (14,718          | )          | 40,455                                                 |       |
| Intercompany  (receivables) payables        |       | (40,428                                       | )          | 40,528                                               |       | 41                                                |       | (141             | )          | —                                                 |       |
| Shareholders’ equity  (deficit)        |       | 31,566                                        |       | 86,195                                               |       | (8,145                                            | )          | (78,050          | )          | 31,566                                                 |       |
|                                        |       | $                                             | 243,375    |                                                 | $          | 230,679                                           |       | $                | 39,205     |                                                   | $          | (92,931 | ) | $ | 420,328 |   |

 

20

----

 

CONDENSED CONSOLIDATING FINANCIAL INFORMATION (UNAUDITED)

 

CONDENSED CONSOLIDATING STATEMENTS OFOPERATIONS

Three Months Ended June 30, 2005

 
| **(Dollars in thousands)**                                            | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Detroit  Stoker  Company  (Non-  Guarantor)** | ** ** | **Elimi-  nations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|-------------------------------------------------|------------|---------------------|------------|--------------------------------------------------------|------------|
|                                                                  |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Net sales                                                             |       | $                                             | —     |                                                 | $          | 111,614                                         |       | $                   | 8,314      |                                                   | $          | — |   | $ | 119,928 |   |
| Cost of sales                                                         |       | —                                        |       | 84,438                                               |       | 5,205                                           |       | —              |       | 89,643                                                 |       |
| Gross profit                                                          |       | —                                        |       | 27,176                                               |       | 3,109                                           |       | —              |       | 30,285                                                 |       |
| Selling and administrative expenses                                   |       | —                                        |       | 15,215                                               |       | 2,100                                           |       | —              |       | 17,315                                                 |       |
| Other operating income (expense) - net                                |       | 16                                            |       | (260                                                 | )          | (110                                            | )          | —              |       | (354                                                   | )          |
| Total operating income                                                |       | 16                                            |       | 11,701                                               |       | 899                                             |       | —              |       | 12,616                                                 |       |
| Non-operating income and (expense):                                   |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Interest income                                                       |       | 521                                           |       | 128                                                  |       | 49                                              |       | —              |       | 698                                                    |       |
| Interest expense                                                      |       | (1,372                                        | )          | (18                                                  | )          | —                                          |       | —              |       | (1,390                                                 | )          |
| Intercompany interest income (expense)                                |       | 2                                             |       | —                                               |       | (2                                              | )          | —              |       | —                                                 |       |
| Other income (expense) - net                                          |       | (117                                          | )          | 401                                                  |       | (31                                             | )          | —              |       | 253                                                    |       |
|                                                                  |       | (966                                          | )          | 511                                                  |       | 16                                              |       | —              |       | (439                                                   | )          |
| (Loss) income from continuing operations  before income taxes         |       | (950                                          | )          | 12,212                                               |       | 915                                             |       | —              |       | 12,177                                                 |       |
| Benefit from (provision for) income taxes                             |       | 311                                           |       | (3,886                                               | )          | (301                                            | )          | —              |       | (3,876                                                 | )          |
| (Loss) income from continuing operations                              |       | (639                                          | )          | 8,326                                                |       | 614                                             |       | —              |       | 8,301                                                  |       |
| Income from discontinued operations – net  of income tax benefit |       | —                                        |       | 145                                                  |       | —                                          |       | —              |       | 145                                                    |       |
| Income from investment in subsidiaries                                |       | 9,085                                         |       | —                                               |       | —                                          |       | (9,085              | )          | —                                                 |       |
| Net income (loss)                                                     |       | $                                             | 8,446      |                                                 | $          | 8,471                                           |       | $                   | 614        |                                                   | $          | (9,085 | ) | $ | 8,446 |   |

 

21

----

CONDENSED CONSOLIDATING FINANCIAL INFORMATION(UNAUDITED)

 

CONDENSED CONSOLIDATING STATEMENTS OFOPERATIONS

Three Months Ended June 30, 2004

 
| **(Dollars in thousands)**                                     | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Detroit  Stoker  Company  (Non-  Guarantor)** | ** ** | **Elimi-  nations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|-------------------------------------------------|------------|---------------------|------------|--------------------------------------------------------|------------|
|                                                           |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Net sales                                                      |       | $                                             | —     |                                                 | $          | 101,561                                         |       | $                   | 7,999      |                                                   | $          | — |   | $ | 109,560 |   |
| Cost of sales                                                  |       | —                                        |       | 76,562                                               |       | 4,948                                           |       | —              |       | 81,510                                                 |       |
| Gross profit                                                   |       | —                                        |       | 24,999                                               |       | 3,051                                           |       | —              |       | 28,050                                                 |       |
| Selling and administrative expenses                            |       | 80                                            |       | 9,846                                                |       | 2,044                                           |       | —              |       | 11,970                                                 |       |
| Other operating income (expense)- net                          |       | 24                                            |       | (127                                                 | )          | 13                                              |       | —              |       | (90                                                    | )          |
| Total operating income                                         |       | (56                                           | )          | 15,026                                               |       | 1,020                                           |       | —              |       | 15,990                                                 |       |
| Non-operating income and (expense):                            |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Interest income                                                |       | —                                        |       | 52                                                   |       | 14                                              |       | —              |       | 66                                                     |       |
| Interest expense                                               |       | —                                        |       | (13                                                  | )          | —                                          |       | —              |       | (13                                                    | )          |
| Intercompany interest income (expense)                         |       | 9                                             |       | —                                               |       | (9                                              | )          | —              |       | —                                                 |       |
| Other income - net                                             |       | (1                                            | )          | (19                                                  | )          | 34                                              |       | —              |       | 14                                                     |       |
|                                                           |       | 8                                             |       | 20                                                   |       | 39                                              |       | —              |       | 67                                                     |       |
| (Loss) income from continuing operations  before income taxes  |       | (48                                           | )          | 15,046                                               |       | 1,059                                           |       | —              |       | 16,057                                                 |       |
| Benefit from (provision for) income taxes                      |       | 18                                            |       | (5,348                                               | )          | (404                                            | )          | —              |       | (5,734                                                 | )          |
| (Loss) income from continuing operations                       |       | (30                                           | )          | 9,698                                                |       | 655                                             |       | —              |       | 10,323                                                 |       |
| Loss from discontinued operations - net of  income tax benefit |       | —                                        |       | (190                                                 | )          | —                                          |       | —              |       | (190                                                   | )          |
| Income from investment in subsidiaries                         |       | 10,163                                        |       | —                                               |       | —                                          |       | (10,163             | )          | —                                                 |       |
| Net income (loss)                                              |       | $                                             | 10,133     |                                                 | $          | 9,508                                           |       | $                   | 655        |                                                   | $          | (10,163 | ) | $ | 10,133 |   |

 

22

----

 

CONDENSED CONSOLIDATING FINANCIAL INFORMATION (UNAUDITED)

 

CONDENSED CONSOLIDATING STATEMENTS OFOPERATIONS

Six Months Ended June 30, 2005

 
| **(Dollars in thousands)**                                        | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Detroit  Stoker  Company  (Non-  Guarantor)** | ** ** | **Elimi-  nations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|-------------------------------------------------|------------|---------------------|------------|--------------------------------------------------------|------------|
|                                                              |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Net sales                                                         |       | $                                             | —     |                                                 | $          | 211,771                                         |       | $                   | 15,705     |                                                   | $          | — |   | $ | 227,476 |   |
| Cost of sales                                                     |       | —                                        |       | 161,034                                              |       | 10,114                                          |       | —              |       | 171,148                                                |       |
| Gross profit                                                      |       | —                                        |       | 50,737                                               |       | 5,591                                           |       | —              |       | 56,328                                                 |       |
| Selling and administrative expenses                               |       | —                                        |       | 26,561                                               |       | 4,389                                           |       | —              |       | 30,950                                                 |       |
| Other operating income (expense), net                             |       | 32                                            |       | (357                                                 | )          | (199                                            | )          | —              |       | (524                                                   | )          |
| Total operating income                                            |       | 32                                            |       | 23,819                                               |       | 1,003                                           |       | —              |       | 24,854                                                 |       |
| Non-operating income and (expense):                               |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Interest income                                                   |       | 1,436                                         |       | 226                                                  |       | 87                                              |       | —              |       | 1,749                                                  |       |
| Interest expense                                                  |       | (3,108                                        | )          | (110                                                 | )          | —                                          |       | —              |       | (3,218                                                 | )          |
| Intercompany interest (expense) income                            |       | 1                                             |       | —                                               |       | (1                                              | )          | —              |       | —                                                 |       |
| Other (expense) income, net                                       |       | 316                                           |       | 7,724                                                |       | 1                                               |       | —              |       | 8,041                                                  |       |
|                                                              |       | (1,355                                        | )          | 7,840                                                |       | 87                                              |       | —              |       | 6,572                                                  |       |
| (Loss) income from continuing operations  before income taxes     |       | (1,323                                        | )          | 31,659                                               |       | 1,090                                           |       | —              |       | 31,426                                                 |       |
| Benefit from (provision for) income taxes                         |       | 442                                           |       | (10,575                                              | )          | (368                                            | )          | —              |       | (10,501                                                | )          |
| (Loss) income from continuing operations                          |       | (881                                          | )          | 21,084                                               |       | 722                                             |       | —              |       | 20,925                                                 |       |
| Income from discontinued operations, net of  income tax provision |       | —                                        |       | 193                                                  |       | —                                          |       | —              |       | 193                                                    |       |
| Income from investment in subsidiaries                            |       | 21,999                                        |       | —                                               |       | —                                          |       | (21,999             | )          | —                                                 |       |
| Net income (loss)                                                 |       | $                                             | 21,118     |                                                 | $          | 21,277                                          |       | $                   | 722        |                                                   | $          | (21,999 | ) | $ | 21,118 |   |

 

23

----

 

CONDENSED CONSOLIDATING FINANCIAL INFORMATION (UNAUDITED)

 

CONDENSED CONSOLIDATING STATEMENTS OFOPERATIONS

Six Months Ended June 30, 2004

 
| **(Dollars in thousands)**                                    | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Detroit  Stoker  Company  (Non-  Guarantor)** | ** ** | **Elimi-  nations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|-------------------------------------------------|------------|---------------------|------------|--------------------------------------------------------|------------|
|                                                          |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Net sales                                                     |       | $                                             | —     |                                                 | $          | 176,367                                         |       | $                   | 14,841     |                                                   | $          | — |   | $ | 191,208 |   |
| Cost of sales                                                 |       | —                                        |       | 136,543                                              |       | 9,128                                           |       | —              |       | 145,671                                                |       |
| Gross profit                                                  |       | —                                        |       | 39,824                                               |       | 5,713                                           |       | —              |       | 45,537                                                 |       |
| Selling and administrative expenses                           |       |                                          |       | 17,834                                               |       | 4,364                                           |       | —              |       | 22,198                                                 |       |
| Other operating income (expense), net                         |       | 56                                            |       | (256                                                 | )          | 14                                              |       | —              |       | (186                                                   | )          |
| Total operating income                                        |       | 56                                            |       | 21,734                                               |       | 1,363                                           |       | —              |       | 23,153                                                 |       |
| Non-operating income and (expense):                           |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Interest income                                               |       | —                                        |       | 102                                                  |       | 28                                              |       | —              |       | 130                                                    |       |
| Interest expense                                              |       | —                                        |       | (26                                                  | )          | —                                          |       | —              |       | (26                                                    | )          |
| Intercompany interest (expense) income                        |       | (345                                          | )          | 357                                                  |       | (12                                             | )          | —              |       | —                                                 |       |
| Other (expense) income, net                                   |       | (4                                            | )          | 68                                                   |       | 84                                              |       | —              |       | 148                                                    |       |
|                                                          |       | (349                                          | )          | 501                                                  |       | 100                                             |       | —              |       | 252                                                    |       |
| (Loss) income from continuing operations  before income taxes |       | (293                                          | )          | 22,235                                               |       | 1,463                                           |       | —              |       | 23,405                                                 |       |
| Benefit from (provision for) income taxes                     |       | 103                                           |       | (7,900                                               | )          | (563                                            | )          | —              |       | (8,360                                                 | )          |
| (Loss) income from continuing operations                      |       | (190                                          | )          | 14,335                                               |       | 900                                             |       | —              |       | 15,045                                                 |       |
| Loss from discontinued operations, net of  income tax benefit |       | —                                        |       | (665                                                 | )          | —                                          |       | —              |       | (665                                                   | )          |
| Income from investment in subsidiaries                        |       | 14,570                                        |       | —                                               |       | —                                          |       | (14,570             | )          | —                                                 |       |
| Net income (loss)                                             |       | $                                             | 14,380     |                                                 | $          | 13,670                                          |       | $                   | 900        |                                                   | $          | (14,570 | ) | $ | 14,380 |   |

 

24

----

 

CONDENSED CONSOLIDATING FINANCIAL INFORMATION (UNAUDITED)

 

CONDENSED CONSOLIDATING STATEMENTS OF CASHFLOWS

Six Months Ended June 30, 2005

 
| **(Dollars in thousands)**                                            | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Detroit  Stoker  Company  (Non-  Guarantor)** | ** ** | **Elimi-  nations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |   |
|-----------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|-------------------------------------------------|------------|---------------------|------------|--------------------------------------------------------|------------|--------|
|                                                                  |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| OPERATING ACTIVITIES:                                                 |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Cash flows (used in) provided bycontinuing  operations                |       | $                                             | (6,056     | )                                                    | $          | 26,943                                          |       | $                   | 365        |                                                   | $          | — |   | $ | 21,252 |   |
| Cash flows used in discontinued operations                            |       | —                                        |       | (2,596                                               | )          | —                                          |       | —              |       | (2,596                                                 | )          |
| Net cash provided by (used in) operating  activities                  |       | (6,056                                        | )          | 24,347                                               |       | 365                                             |       | —              |       | 18,656                                                 |       |
| INVESTING ACTIVITIES:                                                 |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Purchase of property and equipment                                    |       | —                                        |       | (12,542                                              | )          | (49                                             | )          | —              |       | (12,591                                                | )          |
| Proceeds from sale of available-for-sale  securities                  |       | 124,626                                       |       | —                                               |       | —                                          |       | —              |       | 124,626                                                |       |
| Investments in marketable equity securities                           |       | (12,684                                       | )          | —                                               |       | —                                          |       |                |       | (12,684                                                | )          |
| Business acquisition, net of cash acquired                            |       | —                                        |       | (9,883                                               | )          | —                                          |       | —              |       | (9,883                                                 | )          |
| Proceeds from sale of property                                        |       | —                                        |       | 7,555                                                |       | —                                          |       | —              |       | 7,555                                                  |       |
| Net cash (used in) provided by investing  activities                  |       | 111,942                                       |       | (14,870                                              | )          | (49                                             | )          | —              |       | 97,023                                                 |       |
| FINANCING ACTIVITIES:                                                 |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Repayment of collateral received from  securities lending transaction |       | (124,619                                      | )          | —                                               |       | —                                          |       | —              |       | (124,619                                               | )          |
| Repayment of long-term debt                                           |       | —                                        |       | (638                                                 | )          | —                                          |       | —              |       | (638                                                   | )          |
| Proceeds from exercise of stock options                               |       | 1,208                                         |       | —                                               |       | —                                          |       | —              |       | 1,208                                                  |       |
| Dividends paid                                                        |       | (2,465                                        | )          | —                                               |       | —                                          |       | —              |       | (2,465                                                 | )          |
| (Increase) decrease in restricted cash                                |       | 25,000                                        |       | 4,046                                                |       | —                                          |       | —              |       | 29,046                                                 |       |
| Purchase of treasury shares                                           |       | (24,978                                       | )          | —                                               |       | —                                          |       | —              |       | (24,978                                                | )          |
| Intercompany                                                          |       | 20,000                                        |       | (20,000                                              | )          | —                                          |       | —              |       | —                                                 |       |
| Net cash (used in) provided by financing  activities                  |       | (105,854                                      | )          | (16,592                                              | )          | —                                          |       | —              |       | (122,446                                               | )          |
| (Decrease) increase in cash and cash  equivalents                     |       | 32                                            |       | (7,115                                               | )          | 316                                             |       | —              |       | (6,767                                                 | )          |
| Cash and cash equivalents at beginning of  year                       |       | 129                                           |       | 72,269                                               |       | 8,281                                           |       | —              |       | 80,679                                                 |       |
| Cash and cash equivalents at end of period                            |       | $                                             | 161        |                                                 | $          | 65,154                                          |       | $                   | 8,597      |                                                   | $          | — |   | $ | 73,912 |   |
|                                                                       |            |                                               |            |                                                      |            |                                                 |            |                     |            |                                                        |            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

25

----

 

CONDENSED CONSOLIDATING FINANCIAL INFORMATION (UNAUDITED)

 

CONDENSED CONSOLIDATING STATEMENTS OF CASHFLOWS

Six Months Ended June 30, 2004

 
| **(Dollars in thousands)**                              | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Detroit  Stoker  Company  (Non-  Guarantor)** | ** ** | **Elimi-  nations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |   |
|---------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|-------------------------------------------------|------------|---------------------|------------|--------------------------------------------------------|------------|--------|
|                                                    |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| OPERATING ACTIVITIES:                                   |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Cash flows (used in) provided by continuing  operations |       | $                                             | (3,936     | )                                                    | $          | 18,219                                          |       | $                   | 1,325      |                                                   | $          | — |   | $ | 15,608 |   |
| Cash flows used in discontinued operations              |       | —                                        |       | (1,219                                               | )          | —                                          |       | —              |       | (1,219                                                 | )          |
| Net cash (used in) provided by operating  activities    |       | (3,936                                        | )          | 17,000                                               |       | 1,325                                           |       | —              |       | 14,389                                                 |       |
| INVESTING ACTIVITIES:                                   |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Purchase of property and equipment                      |       | —                                        |       | (3,397                                               | )          | (85                                             | )          | —              |       | (3,482                                                 | )          |
| Net cash used in investing activities                   |       | —                                        |       | (3,397                                               | )          | (85                                             | )          | —              |       | (3,482                                                 | )          |
| FINANCING ACTIVITIES:                                   |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Proceeds from exercise of stock options                 |       | 2,862                                         |       | —                                               |       | —                                          |       | —              |       | 2,862                                                  |       |
| Dividends paid                                          |       | (2,609                                        | )          | —                                               |       | —                                          |       | —              |       | (2,609                                                 | )          |
| Purchase of treasury shares                             |       | (10,486                                       | )          | —                                               |       | —                                          |       | —              |       | (10,486                                                | )          |
| Intercompany                                            |       | 13,923                                        |       | (13,923                                              | )          | —                                          |       | —              |       | —                                                 |       |
| Net cash provided by (used in) financing  activities    |       | 3,690                                         |       | (13,923                                              | )          | —                                          |       | —              |       | (10,233                                                | )          |
| (Decrease) increase in cash and cash  equivalents       |       | (246                                          | )          | (320                                                 | )          | 1,240                                           |       | —              |       | 674                                                    |       |
| Cash and cash equivalents at beginning of  year         |       | 648                                           |       | 17,482                                               |       | 6,008                                           |       | —              |       | 24,138                                                 |       |
| Cash and cash equivalents at end of period              |       | $                                             | 402        |                                                 | $          | 17,162                                          |       | $                   | 7,248      |                                                   | $          | — |   | $ | 24,812 |   |
|                                                         |            |                                               |            |                                                      |            |                                                 |            |                     |            |                                                        |            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

26

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**Note R – Subsequent Event**

 

On July 18, 2005, the Company’s wholly-owned subsidiary AAIentered into a $100,000,000 four-year revolving credit facility with asyndicate of six banks, consisting of SunTrust Bank, as administrative agentand issuing bank, Citibank, F.S.B., Key Bank, PNC Bank, Commerce Bank andProvident Bank (the “Credit Facility”). The Credit Facility consists of a $100,000,000 Senior Secured RevolvingCredit Facility with a $100,000,000 Letter of Credit sub-facility.

 

Pursuant to the terms of the Credit Facility, the Company hasguaranteed AAI’s obligations.  Theproceeds of the Credit Facility will be used to fund future acquisitions,finance capital expenditures, provide working capital, fund letters of credit,and for other general corporate purposes. The Credit Agreement contains affirmative, negative and financialcovenants customary for facilities of this type, including, among other things,maintenance of certain leverage and fixed charge coverage ratios, as well asminimum consolidated tangible net worth ratios, limits on the incurrence ofdebt and preferred equity, limits on the incurrence of liens, a limit on themaking of dividends or distributions, limits on sales of assets and a limit oncapital expenditures.

 

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**Item2. - Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

###### **Forward-LookingInformation**

 

This Quarterly Report on Form 10-Q contains “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995.  Such forward-looking statementsare based on management’s expectations, estimates, projections andassumptions.  Words such as “expects,” “anticipates,”“intends,” “plans,” “believes,” “estimates,” and variations of such words andsimilar expressions are intended to identify such forward-looking statementswhich include, but are not limited to, projections of revenues, earnings,segment performance, cash flows and contract awards.  These forward-looking statements are subjectto risks and uncertainties, which could cause the actual results or performanceof United Industrial Corporation (“United Industrial”) and its subsidiaries(collectively, the “Company”) to differ materially from those expressed orimplied in such statements.  These risksand uncertainties include, but are not limited to, the following:

 

•                  the Company’ssuccessful execution of internal performance plans;

•                  performanceissues with key suppliers, subcontractors and business partners;

•                  the abilityto negotiate financing arrangements with lenders;

•                  the outcomeof current and future litigation, proceedings and investigations;

•                  the accuracyof the Company’s analysis of its potential asbestos-related exposure andinsurance coverage;

•                  productdemand and market acceptance risks;

•                  the effectof economic conditions;

•                  the impactof competitive products and pricing;

•                  productdevelopment, commercialization and technological difficulties;

•                  capacity andsupply constraints or difficulties;

•                  legislativeor regulatory actions impacting the Company’s Defense segment, Energy segmentand discontinued transportation operation;

•                  changingpriorities or reductions in the U.S. Government’s defense budget;

•                  contractcontinuation and future contract awards; and

•                  U.S. andforeign military budget constraints and determinations.

 

The Company intends that all forward-looking statements it makes willbe subject to the safe harbor protection of the Federal securities laws foundin Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended.

 

These statements 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 7 of the Company’s Annual Report on Form 10-K for the year ended December 31,2004, for important factors that could cause the Company’s actual results todiffer materially from those suggested by the Company’s forward-lookingstatements contained in this Quarterly Report on Form 10-Q.

 

###### **Management Overview**

 

United Industrial Corporation (“United Industrial”) and itssubsidiaries (collectively, the “Company”) design, develop, manufacture andsupport defense systems and training and test systems.  The Company is committed to creatinginnovative solutions, disciplined program management and continuous operationalimprovements.  Its products and servicesinclude unmanned aerial vehicle (“UAV”) systems, training and simulation systems,automated aircraft test and maintenance equipment, armament systems, logisticaland engineering services, and other leading-edge technology solutions fordefense needs.  The Company alsomanufactures combustion equipment for biomass and refuse fuels.

 

Thecontinuing operations of the Company consist of two business segments: Defenseand Energy.  Costs related to thecontinuing operations that are not identified with the two business segmentsprimarily relate to financing costs and are grouped under the headingOther.  The operations of the Defense andEnergy segments are conducted principally through two wholly-ownedsubsidiaries, AAI Corporation and its subsidiaries (“AAI”) and Detroit StokerCompany (“Detroit Stoker”), respectively. The following information primarily relates to the continuing operationsof the Company and its consolidated subsidiaries.  The Company has a transportation operationthat is accounted for as discontinued operations, and is discussed separatelyin the 

 

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information that follows.

 

The Company’s net sales increased to $119,928,000 in the second quarterof 2005 from $109,560,000 in the second quarter of 2004.  In addition, the Company continued to focuson its core Defense segment, which accounted for approximately 93.1% and 92.7%of total consolidated net sales from continuing operations during the secondquarter of 2005 and 2004, respectively. In the second quarter of 2005, the Defense segment reported a 9.9%increase in net sales compared to the second quarter of 2004 primarily due togreater logistical support related to an increasing number of fielded Shadow®200 Tactical Unmanned Aerial Vehicle (“TUAV”) Systems in 2005.  In addition, growth in the volume of theAdvanced Boresight Equipment (“ABE”) Systems, the addition of the BiologicalDetection Systems program awarded in the third quarter of 2004, and sales ofESL Defence (“ESL”), a company acquired in the second quarter of 2005,  contributed to the higher sales in 2005.

 

**Revolving Credit Facility**

 

On July 18, 2005, the Company’s wholly-owned subsidiary AAIentered into a $100,000,000 four-year revolving credit facility with asyndicate of six banks, consisting of SunTrust Bank, as administrative agentand issuing bank, Citibank, F.S.B., Key Bank, PNC Bank, Commerce Bank andProvident Bank, (the “Credit Facility”). The Credit Facility consists of a $100,000,000 Senior Secured RevolvingCredit Facility with a $100,000,000 Letter of Credit sub-facility.

 

Pursuant to the terms of the Credit Facility, the Company hasguaranteed AAI’s obligations.  Theproceeds of the Credit Facility will be used to fund future acquisitions,finance capital expenditures, provide working capital, fund letters of credit,and for other general corporate purposes.

 

**Gain on Sale of Property**

 

InJanuary 2005, the Company sold approximately 26 acres of undevelopedproperty adjacent to its Hunt Valley, Maryland facility for $8,105,000, whichyielded proceeds of $7,555,000, net of selling expenses and closing costs.  The Company recognized a pre-tax gain on thesale of this property in the first quarter of 2005 of approximately$7,152,000.  On March 4, the Companypurchased a new facility for $5,085,000 in South Carolina for AAI ServicesCorporation (“AAI Services”), a wholly-owned subsidiary of AAI, to support thegrowth in their operations. Substantially all the remaining net proceeds were disbursed from anaccount through July 11, 2005, owned by a qualified intermediary and wereused for improvements to the facility. As a result, the Company expects that it will be able to defer payingsubstantially all of the income tax obligation incurred in connection with thegain on the sale of the property in Hunt Valley, in accordance with Section 1031(b) ofthe Internal Revenue Code.

 

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**Restructuring Activities**

 

During the fourth quarter of 2004, the managements of both AAI andDetroit Stoker developed plans to maximize efficiencies by streamlining certainof their operations, in accordance with the Company’s previously disclosedstrategic initiatives.

 

AAI began reorganizing the operations of its fluid test systems productarea in the Defense segment in order to realize certain operatingefficiencies.  These activities areexpected to result in total cash charges of approximately $2,700,000, of whichapproximately $600,000 was expensed and $200,000 was paid in 2004.  In the second quarter of 2005, an additional$1,559,000 was expensed and $1,406,000 was paid or otherwise settled.  For the six months ended June 30, 2005$1,889,000 was expensed and $2,043,000 was paid or otherwise settled.  The remaining expenses of approximately$200,000 and cash charges of approximately $500,000 are expected to berecognized in, and paid by, the Defense segment’s operations during theremainder of 2005 as the obligations are incurred and paid, respectively.

 

Additionally, as a result of the planned reduction in its work force,Detroit Stoker recognized a curtailment charge of approximately $1,959,000 toaccelerate the amortization of prior service cost and recognize enhancedbenefits for one of its pension benefit plans in the fourth quarter of2004.  In the first quarter of 2005,Detroit Stoker reduced its employee base as contemplated under this plan.  Most of the manufacturing operationspreviously performed at Detroit Stoker’s facilities are expected to beoutsourced to lower-cost producers.  As aresult of the reduction in Detroit Stoker’s workforce, the Company recognizedseverance charges in the Energy segment of approximately $17,000 in the secondquarter of 2005.  The Company alsorecognized $70,000 in facility relocation cost and other restructuringactivities in the second quarter of 2005. For the six months ended June 30,2005, the Energy segment recognized severance charges of $61,000 and facilityrelocation cost and facility closure cost of $107,000.  Additional costs associated with DetroitStoker’s restructuring plan will be paid and charged to operations in 2005 asthe liabilities are incurred, which are estimated to be approximately $123,000.

 

**Acquisition of ESL**

 

On April 4, 2005,the Company acquired ESL Defence Limited (“ESL”), an electronic warfare (“EW”)systems company based in the United Kingdom. The purchase price was $10,515,000 in cash.  ESL is a designer and producer of electrooptical (“EO”) test and simulation products for use on flight lines and inaircraft maintenance facilities.  Thesimulators are used to assess the operational readiness of sophisticatedmissile warning and countermeasures self-protection systems used on militaryaircraft.  ESL’s EO simulators are alsoused at military test, evaluation, and training ranges to evaluate theeffectiveness of new self- protection systems and to train pilots for combatreadiness.  In addition, ESL specializesin EW related research, study, and in-service support activity for U.K.government agencies and prime contractors both in the United Kingdom and theUnited States.

 

**Results of Operations**

 

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 June 30,2005, and the discussion included in its Annual Report on Form 10-K forthe year ended December 31, 2004.

 

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**Overview of Consolidated Results**

 

#### ***Threeand Six Months Ended June 30, 2005 Compared to the Three and Six MonthsEnded June 30, 2004***

 
| ** **                                              | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase  (Decrease)** | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------|------------|--------------------------|------------|-------------------------------------|------------|--------------------------|------------|
| **(Dollars in thousands)**                              | ** ** | **2005**                              | ** ** | **2004**                 | ** ** | **$**                               | ** ** | **%**                    | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                                                    |       |                                  |       |                     |       |                                |       |                     |       |   |   |   |   |   |   |   |   |
| Net sales                                               |       | $                                     | 119,928    |                     | $          | 109,560                             |       | $                        | 10,368     |   | 9.5 | % | $ | 227,476 |   | $ | 191,208 |   | $ | 36,268 |   | 19.0 | % |
| Gross profit                                            |       | 30,285                                |       | 28,050                   |       | 2,235                               |       | 8.0                      | %          | 56,328 |   | 45,537 |   | 10,791 |   | 23.7 | % |
| Selling and administrative expenses                     |       | 17,315                                |       | 11,970                   |       | 5,345                               |       | 44.7                     | %          | 30,950 |   | 22,198 |   | 8,752 |   | 39.4 | % |
| Operating income                                        |       | 12,616                                |       | 15,990                   |       | (3,374                              | )          | (21.1                    | )%         | 24,854 |   | 23,153 |   | 1,701 |   | 7.3 | % |
| Non-operating income (expense)                          |       | (439                                  | )          | 67                       |       | (506                                | )          | (755.2                   | )%         | 6,572 |   | 252 |   | 6,320 |   | 2507.9 | % |
| Income from continuing operations, net of  income taxes |       | 8,301                                 |       | 10,323                   |       | (2,022                              | )          | (19.6                    | )%         | 20,925 |   | 15,045 |   | 5,880 |   | 39.1 | % |
|                                                         |            |                                       |            |                          |            |                                     |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Defense Segment***

 
| ** **                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase  (Decrease)** | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|-------------------------------------|------------|---------------------------------------|------------|--------------------------|------------|-------------------------------------|------------|--------------------------|------------|
| **(Dollars in thousands)**          | ** ** | **2005**                              | ** ** | **2004**                 | ** ** | **$**                               | ** ** | **%**                    | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                                |       |                                  |       |                     |       |                                |       |                     |       |   |   |   |   |   |   |   |   |
| Net sales                           |       | $                                     | 111,614    |                     | $          | 101,561                             |       | $                        | 10,053     |   | 9.9 | % | $ | 211,771 |   | $ | 176,367 |   | $ | 35,404 |   | 20.1 | % |
| Gross profit                        |       | 27,176                                |       | 24,999                   |       | 2,177                               |       | 8.7                      | %          | 50,737 |   | 39,824 |   | 10,913 |   | 27.4 | % |
| Selling and administrative expenses |       | 15,215                                |       | 9,846                    |       | 5,369                               |       | 54.5                     | %          | 26,561 |   | 17,834 |   | 8,727 |   | 48.9 | % |
| Operating income                    |       | 11,701                                |       | 15,026                   |       | (3,325                              | )          | (22.1                    | )%         | 23,819 |   | 21,734 |   | 2,085 |   | 9.6 | % |
| Income before income taxes          |       | 12,212                                |       | 15,046                   |       | (2,834                              | )          | (18.8                    | )%         | 31,659 |   | 22,235 |   | 9,424 |   | 42.4 | % |
|                                     |            |                                       |            |                          |            |                                     |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Energy Segment***

 
| ** **                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase  (Decrease)** | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|-------------------------------------|------------|---------------------------------------|------------|--------------------------|------------|-------------------------------------|------------|--------------------------|------------|
| **(Dollars in thousands)**          | ** ** | **2005**                              | ** ** | **2004**                 | ** ** | **$**                               | ** ** | **%**                    | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
|                                |       |                                  |       |                     |       |                                |       |                     |       |   |   |   |   |   |   |   |   |
| Net sales                           |       | $                                     | 8,314      |                     | $          | 7,999                               |       | $                        | 315        |   | 3.9 | % | $ | 15,705 |   | $ | 14,841 |   | $ | 864 |   | 5.8 | % |
| Gross profit                        |       | 3,109                                 |       | 3,051                    |       | 58                                  |       | 1.9                      | %          | 5,591 |   | 5,713 |   | (122 | ) | (2.1 | )% |
| Selling and administrative expenses |       | 2,100                                 |       | 2,044                    |       | 56                                  |       | 2.7                      | %          | 4,389 |   | 4,364 |   | 25 |   | 0.6 | % |
| Income before income taxes          |       | 915                                   |       | 1,059                    |       | (144                                | )          | (13.6                    | )%         | 1,090 |   | 1,463 |   | (373 | ) | (25.5 | )% |
|                                     |            |                                       |            |                          |            |                                     |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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***Three Months Ended June 30,2005 compared to the Three Months Ended June 30, 2004***

 

The Company’s net sales increased 9.5% for the three months ended June 30,2005 compared to the three months ended June 30, 2004, including  $10,053,000 and $315,000 higher net sales forthe Defense and Energy segments, respectively. Net sales for the Defensesegment in the second quarter of 2005 increased 9.9% to $111,614,000 from$101,561,000 for the second quarter of 2004. The increase was primarily due to greater logistical support related toan increasing number of fielded Shadow 200 TUAV Systems in 2005, growth in thevolume of ABE Systems, the addition of the Biological Detection Systems programawarded in the third quarter of 2004 and the acquisition of ESL in the secondquarter of 2005.

 

The gross margin percentage for continuing operations decreased to25.3% in the second quarter of 2005 from 25.6% during the second quarter of2004. The Defense segment’s gross margin percentage was 24.3% in the secondquarter 2005 compared to 24.6% in the second quarter of 2004.  This decrease is mainly due to a product mixthat included a higher volume of support/services type contracts in the 2005second quarter, which generally contribute a lower gross margin than productiontype contracts.

 

Selling and administrative expense increased to $17,315,000, or 14.4 %of sales, in the second quarter of 2005 compared to $11,970,000, or 10.9% ofsales, in the second quarter of 2004. Selling and administrative expense in the Defense segment increased to$15,215,000, or 13.6 % of sales, in the second quarter of 2005 from $9,846,000,or 9.7% of sales, in the second quarter of 2004. The $5,369,000 increase wasprimarily due to $1,570,000 higher research and development expense and bid andproposal costs, $1,559,000 for restructuring charges for facility closure costsand severance related to the reorganization of the Defense segment’s fluid testsystems product area, $900,000 of increased legal expenses, $696,000 of generaland administrative fees incurred by the recently acquired ESL, and other netexpenses of $600,000 associated with the general volume increase in the Defensesegment’s business.

 

Operating income decreased to $12,616,000 or 10.5% of sales in thesecond quarter of 2005 from $15,990,000, or 14.6% of sales, in second quarterof 2004.  During the second quarter 2004,the Company’s UAV Systems realized the favorable resolution of technical risksand production efficiencies, which positively impacted 2004 operating income byapproximately $4,400,000.  Excluding thisfavorable impact, operating income in the second quarter 2004 would have been$11,590,000, or 10.6% of sales.  Pursuantto U.S. Government procurement standards, costs accumulated under long-termdevelopment and production contracts include costs of product and servicerevenue, and general and administrative expenses.  Accordingly, the Company believes operatingincome provides a meaningful measure of performance.

 

Netinterest expense increased $745,000 to $692,000 during the second quarter of 2005from net interest income of $53,000 in the same period in 2004 primarily as aresult of the Company’s issuance of $120,000,000 3.75% Convertible Senior Notes in September 2004.

 

Incomefrom continuing operations net of income taxes, in the second quarter of 2005decreased to $8,301,000, or $0.60 per diluted share, compared to $10,323,000,or $0.78 per diluted share, in the second quarter of 2004.

 

Netincome in the second quarter of 2005 decreased to $8,446,000, or $0.61 perdiluted share, compared to $10,133,000, or $0.77 per diluted share, in thesecond quarter of 2004.

 

***Six Months Ended June 30,2005 compared to the Six Months Ended June 30, 2004***

 

Net sales from continuing operations for the six months ended June 30,2005 increased 19.0% to $227,476,000 compared to $191,208,000 for the sixmonths ended June 30, 2004.  Netsales for the Defense segment for the six months ended June 30, 2005increased 20.1% to $211,771,000 from $176,367,000 for the six months ended June 30,2004.  The increase was primarily due tohigher production and logistics support in UAV Systems, increased demand forABE System, and the Biological Detection System Program that was awarded in thethird quarter to 2004.

 

The gross margin percentage for continuing operations increased to24.8% in the six months ended June 30, 2005 from 23.8% in the six monthsended June 30, 2004.   The grossmargin percentage for the Defense segment increased to 24.0% in the six monthsended June 30, 2005 from 22.6% in the six months ended June 30, 2004.The increase in gross margin percentage is primarily due to increasedefficiencies from the UAV, and Test and Training Systems product lines as wellas the ESL acquisition during the first half of 2005.

 

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Selling and administrative expenses in the six months ended June 30,2005 increased to $30,950,000, or 13.6% of sales from $22,198,000, or 11.6 % ofsales when compared to the six months ended June 30, 2004.  Selling and administrative expenses in the Defensesegment in the six months ended June 30, 2005 increased to $26,561,000, or12.5% of sales, from $17,834,000, or 10.1% of sales when compared to the sixmonths ended June 30, 2004.  The$8,727,000 increase was primarily due to $3,197,000 for higher research anddevelopment expenses and bid and proposal costs to support the Defense segment’sgrowth, $1,889,000 of restructuring charges to reorganize the Defense segment’sfluid test systems product area, $900,000 of increased legal expenses, $696,000of general and administrative expenses incurred by the recently acquired ESL,and other expenses associated with the general volume increase in the Defensesegment’s business.

 

Operating income increased to $24,854,000, or 10.9% of sales, in thesix months ended June 30, 2005 from $23,153,000, or 12.1% of sales, forthe first six months of 2004.  During thesecond quarter 2004, the Company’s UAV Systems realized the favorableresolution of technical risks and production efficiencies which positivelyimpacted 2004 operating profit by approximately $4,400,000.  Excluding this favorable impact, operatingincome in the first six months in 2004 would have been $18,753,000, or 9.8% ofsales.

 

Net interest expense increased $1,599,000 to $1,469,000 for the sixmonths ended June 30, 2005 from $130,000 net interest income for the sixmonths ended June 30, 2004 primarily as a result of the Company’s issuanceof  $120,000,000 3.75% Convertible SeniorNotes in September 2004.  Includedin the interest expense is approximately $2,743,000 related to the $120,000,0003.75% Convertible Senior Notes issued in September 2004.

 

Income from continuing operations before income taxes in the six monthsended June 30, 2005 increased 34.3% to $31,426,000 from $23,405,000 in thesix months ended June 30, 2004. This increase included a $7,152,000 gain from the sale of undevelopedproperty recorded during the first quarter of 2005.

 

Income from continuing operations, net of taxes in the six months endedJune 30, 2005 increased $5,880,000 to $20,925,000, or $1.44 per dilutedshare, compared to $15,045,000, or $1.13 per diluted share, in the six monthsended June 30, 2004.

 

Netincome in the six months ended June 30, 2005 increased to $21,118,000, or$1.45 per diluted share, compared to $14,380,000, or $1.08 per diluted share,in the six months ended June 30, 2004.

 

**Discontinued Transportation Operations**

 

Income from the Company’s discontinued transportation operations forthe second quarter of 2005 was $145,000, or $0.01 per diluted share, comparedto a loss of ($190,000), or ($0.01) per diluted share in the second quarter of2004.  Income from the Company’sdiscontinued transportation operations for the six months ended June 30,2005 was $193,000, or $0.01 per diluted share as compared to a loss of($665,000) or ($0.05) per diluted share for the same period in the prior year.

 

Electric Transit, Inc. (“ETI”), an entity owned 35% by AAI and 65%by Skoda a.s. (“Skoda”), a Czech company, sold its remaining inventory of spareparts and continued to favorably resolve certain operational challengesassociated with its last remaining program during the six months ended June 30,2005, which accounts for the favorable results from the discontinuedtransportation operations in 2005.

 

Foradditional information regarding the discontinued transportation operations,see Note L to the Consolidated Condensed Financial Statements included in thisQuarterly Report on Form 10-Q.

 

**Funded Backlog**

** **
| **(Dollars in thousands)** | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Defense segment            |       | $                       | 472,389    |                        | $          | 380,622 |   |
| Energy segment             |       | 10,404                  |       | 7,296                       |       |
| Total                      |       | $                       | 482,793    |                        | $          | 387,918 |   |

 

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The Company’s funded backlog for continuing operations, defined asorders placed for which funds have been appropriated or purchase ordersreceived, was $482,793,000 at June 30, 2005, an increase of $94,875, or24.5 %, from December 31, 2004.

 

The Company received $224,559,000 of new orders and/or funding forproducts and services during the second quarter of 2005, an increase of$127,508,000, or 131.3 %, compared to the second quarter of 2004. Included inthe second quarter 2005 were $215,286,000 of bookings in the Defense segmentand $9,273,000 in the Energy segment.

 

For the six months ended June 30, 2005, the Company received$320,393,000 in new orders and funding compared to $172,554,000 for the sixmonths ended June 30, 2004, an increase of $147,839,000, or 85.7%.   The bookings for the six months ended June 30,2005 included $300,851,000 of bookings in the Defense segment and $19,542,000of bookings in the Energy segment.

 

The increase in the funded backlog for the Defense segment includedadditional funding for existing contracts and funding for new contracts, fornew TUAV systems, logistical support for fielded Shadow TUAV systems anddevelopment of ground control stations. Further, we received additional funding for the Biological DetectionSystems program.

 

Theincrease in the Energy segment’s funded backlog was primarily due to anincrease in orders received during the second quarter of 2005.

 

**Liquidity and Capital Resources**

 

**Overview**

 

The Company’s principal source of liquidity is cash on hand and cashgenerated from operations.  On June 30,2005, the Company had cash and cash equivalents of $73,912,000.  Effective December 23, 2004, the Companyterminated its Loan and Security Agreement dated June 28, 2001, asamended, with Bank of America Business Capital (formerly Fleet CapitalCorporation).  On July 18, 2005, theCompany’s wholly-owned subsidiary, AAI, entered into a $100,000,000 four-yearrevolving credit facility with a syndicate of six banks, consisting of SunTrustBank, as administrative agent and issuing bank, Citibank, F.S.B., Key Bank, PNCBank, Commerce Bank and Provident Bank, (the “Credit Facility”).  The Credit Facility consists of a$100,000,000 Senior Secured Revolving Credit Facility with a $100,000,000Letter of Credit sub-facility. Pursuant to the terms of the Credit Facility,the Company has guaranteed AAI’s obligations. The proceeds of the Credit Facility will be used to fund futureacquisitions, finance capital expenditures, provide working capital, fundletters of credit, and for other general corporate purposes. Based on cash onhand, future cash expected to be generated from operations, and the new CreditFacility, the Company expects to have sufficient cash to meet its requirementsduring the next twelve months.

 

On December 29, 2004,the Company invested $124,619,000 in U.S. treasury bills maturing on February 24,2005.  The U.S. treasury bills wereconcurrently loaned to the Company’s broker-dealer in a securities lendingtransaction in exchange for cash collateral in an amount equal to 100% of thefair value of the securities lent.  Thesecurities lending transaction terminated on February 23, 2005, at whichtime the Company redeemed the U.S. treasury bills and received approximately$373,000 of interest thereon, repaid the cash collateral to its broker-dealertogether with $444,000 of related interest charges, and collected the$25,000,000 deposit plus $86,000 of accrued interest thereon.

 

As discussed under the subheading “*Gainon Sale of Property*” in the “*ManagementOverview*” section above, in January 2005, the Company soldapproximately 26 acres of undeveloped property adjacent to its Hunt Valley,Maryland facility for $8,105,000, which yielded proceeds of $7,555,000, net ofselling expenses and closing costs.  TheCompany reinvested approximately $5,085,000 of the net proceeds from this salein a new facility in South Carolina for AAI Services to support the growth intheir operations.  The remaining netproceeds were disbursed from an account through July 11, 2005, owned by aqualified intermediary and were used primarily for improvements to thefacility.  As a result, the Companyexpects that it will be able to defer paying substantially all of the incometax obligation incurred in connection with the gain on the sale of the propertyin Hunt Valley, in accordance with Section 1031 (b) of the InternalRevenue Code.

 

Inaccordance with its strategic initiatives to enhance shareholder value, theCompany is continuing to focus its efforts on the profitability and growth ofits core Defense product areas, seeking to maximize operating efficiencies, andexploring the sale of non-core assets.

 

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TheCompany intends to complement its growth strategy for its Defense segmentthrough select acquisitions that broaden its product and service offerings,deepen its capabilities, and allow entry into new markets.  Acquisition candidates may include public andprivate companies and divisions, subsidiaries and product lines of suchcompanies.  On April 4, 2005, theCompany acquired ESL Defence Limited, an Electronic Warfare systems companybased in the United Kingdom, as more fully discussed in the “ManagementOverview” section above.

 

Duringthe fourth quarter of 2003, as part of the Company’s strategy to explore thesale of non-core assets, the Company engaged Imperial Capital, LLC, an investment-bankingfirm, to act as exclusive financial advisor to assist in exploring strategicalternatives for Detroit Stoker, including a possible sale (the “Transaction”).  The Company and Imperial Capital arecontinuing to explore potential Transactions involving Detroit Stoker.  From time to time, the Company and potentialbuyers may (i) have discussions regarding a potential Transaction, (ii) negotiatethe preliminary terms of a potential Transaction, and (iii) enter intocustomary non-binding agreements in order to facilitate any such discussionsand negotiations.  No assurances can begiven regarding whether a Transaction involving Detroit Stoker will occur orthe timing or proceeds from any such Transaction.

 

**Sources and Uses of Cash**

 

Thefollowing is a discussion of the Company’s major operating, investing, andfinancing activities for each of the six-month periods ended June 30, 2005and 2004.  The financial informationpresented in the table below is summarized from the Company’s ConsolidatedCondensed Statements of Cash Flows.

 
| ** **                                           | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------|------------|
| **(Dollars in thousands)**                           | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| Operating activities:                                |       |                                |       |   |   |
| Net cash provided by continuing operations           |       | $                                   | 21,252     |   | $ | 15,608 |   |
| Net cash used in discontinued operations             |       | (2,596                              | )          | (1,219 | ) |
| Net cash provided by operating activities            |       | 18,656                              |       | 14,389 |   |
| Net cash provided by (used in) investing  activities |       | 97,023                              |       | (3,482 | ) |
| Net cash used in financing activities                |       | (122,446                            | )          | (10,233 | ) |
| (Decrease) increase in cash and cash  equivalents    |       | $                                   | (6,767     | ) | $ | 674 |   |

 

## ***Operating Activities***

##  

Net cash provided by continuing operations in the sixmonths ended June 30, 2005 increased $5,644,000 compared to the six monthsended June 30, 2004 primarily due to higher income from continuingoperations before non-cash depreciation and other charges.  Favorable changes in operating assets andliabilities in the six months ended June 30, 2005 of $1,810,000 included adecrease in inventory, and prepaid expenses and other current assets of$12,362,000 and $2,846,000 respectively, offset by an increase in accountsreceivable of $12,670,000, due to the timing of milestone invoicing andpayments, and other net unfavorable changes in operating assets and liabilitiesof $4,348,000.  Inventory was lower andaccounts receivable higher at June 30, 2005 than at June 30, 2004primarily due to the achievement of certain billing milestones that had beendelayed in the Defense segment.

 

Netcash used by the discontinued transportation operations in the six months endedJune 30, 2005 primarily related to unreimbursed services rendered to, andother financial support to ETI in connection with the MUNI contract guarantyagreement as discussed in Note M.

 

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***Investing Activities***

 

On December 29, 2004, the Company invested $124,619,000 of cash inU.S. treasury bills, which matured on February 24, 2005.  The U.S. treasury bills were concurrentlyloaned to the Company’s broker-dealer in a securities lending transaction,which is discussed in the “*LiquidityOverview*” section above.

 

During the six months ended June 30, 2005, the Company invested$12,684,000 in marketable common stock securities of one entity that areavailable for sale.

 

Cash used for the purchase of property and equipment was $12,591,000, including$6,707,000 for the purchase and improvement of a building in South Carolina,$2,097,000 for implementation of AAI’s new Enterprise Resource Planning (“ERP”)system,  $2,747,000 for Defense facilityimprovements including $1,323,000 for enhancements to the UAV ProductionFacilities for the six months ended June 30, 2005.  Capital expenditures were $3,482,000 for thesame period of the prior year and was the only investing activity for the sixmonths ended June 30, 2004.   See “*Capital Expenditures*” below.

 

On April 4, 2005, the Company purchased ESL Defence Limited, anelectronic warfare systems company, for $9,883,000, net of cash acquired.

 

Net cash provided by investing activities in 2005 included proceeds of$7,555,000 from the sale of certain undeveloped property at the Company’s HuntValley, MD corporate headquarters.

 

***Financing Activities***

 

The Company’s financing activities for the six months ended June 30,2005 used $122,446,000 of cash, including approximately $124,619,000 for therepayment of collateral received from a securities lending transaction of U.S.treasury bills that were sold concurrently. In connection with this securities lending transaction, which isdiscussed more fully in the “*LiquidityOverview*” section above, the Company also received the$25,000,000 refundable deposit from its broker-dealer. This deposit, togetherwith a decrease of $4,046,000 in collateral theCompany was required to post in connection with outstanding letters of creditand a cash management security arrangement with Bank of America BusinessCapital, is presented as a $29,046,000 decrease in restricted cash in theaccompanying Consolidated Statements of Cash Flows for the period ending June 30,2005.  Financing activities in 2005 alsoincluded $24,978,000 for the purchase of the Company’s common stock, $2,465,000of cash used for the payment of dividends, $1,208,000 of cash receipts from theexercise of stock options, and $638,000 used for the repayment of long-termdebt, primarily related to the financing of the ERP System.  The Company’s financing activities for thesix months ended June 30, 2004 used $10,486,000 for the purchase of theCompany’s common stock, $2,609,000 of cash for the payment of dividends and$2,862,000 receipts from the exercise of stock options.

 

**Debt and Related Covenants**

 

The Credit Facility entered into on July 18, 2005 by the Company’swholly-owned subsidiary AAI, contains affirmative, negative and financialcovenants customary for facilities of this type, including, among other things,maintenance of certain leverage and fixed charge coverage ratios, as well asminimum consolidated tangible net worth ratios, limits on the incurrence ofdebt and preferred equity, limits on the incurrence of liens, a limit on themaking of dividends or distributions, limits on sales of assets and a limit oncapital expenditures.

 

For a complete description of the Company’s long-term debt, includingthe terms and conditions of each debt instrument, please see Note 6 to theConsolidated Financial Statements included in Part II, Item 8 of theCompany’s Annual Report on Form 10-K for the year ended December 31,2004 and Note R to the Consolidated Condensed Financial Statements included inpart I, Item 1 of this Quarterly Report on Form 10-Q.  There are no covenant violations as of June 30,2005.

 

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**Cash Requirements**

 

***Capital Expenditures***

 

The Company expects that capital expendituresin 2005 will be significantly higher than in 2004 primarily due to (i) thepurchase of the $5,085,000 new facility in South Carolina, and approximately$3,500,000 of improvements to be made to that facility, (ii) approximately$3,200,000 of enhancements to the Company’s UAV production facilities,including the purchase of new manufacturing equipment to increase productionoutput and efficiency and, (iii) $4,800,000 related to the continuingimplementation of the Company’s ERP System.

 

As of June 30, 2005, the Company had nosignificant commitments for capital expenditures except for the continuingimplementation of its new ERP System and improvements to be made to therecently acquired facility in South Carolina.  In addition to the capital assets to be acquired, the Company expects toincur approximately $2,000,000 related to the implementation of its ERP System,which exclude ongoing annual maintenance fees of approximately $400,000 peryear.  As of June 30, 2005, theCompany had capitalized a total of approximately $5,401,000 related to theimplementation of the ERP System, $1,600,000 for improvements to the newfacility in South Carolina and $1,300,000 for enhancements to the Company’s UAVproduction facilities.

 

***Other CashRequirements***

 

OnMarch 10, 2005, the Company’s Board of Directors authorized a new stockpurchase plan for up to $25,000,000.  Asof June 30, 2005, the Company had purchased a total of 735,345 shares foran aggregate amount of $25,000,000, or an average price of $33.97 per share,utilizing all funds available under the March 10, 2005 stock purchaseplan.

 

On April 4, 2005, the Company purchased ESL Defence Limited, anelectronic warfare systems company, for $10,515,000 in cash.

 

For the six months ended June 30, 2005, the Company paid cashdividends of $0.10 per share on March 31, 2005 and on May 30, 2005,for an aggregate amount of $2,465,000.  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 financialcondition and general business conditions. Should the Company distribute a cash dividend inany quarterly period in excess of $0.10 per share, the conversion rate providedfor in the Indenture governing the 3.75% Convertible Senior Notes would beadjusted.  In addition, the Company’s lenders may imposerestrictions on the payment of dividends.

 

As discussed more fully under “*ManagementOverview*” above, during the remainder of 2005 the Company’smanagement will continue to implement its restructuring plans to reduce costsand streamline operations in the Defense segment’sfluid test systems product area and at Detroit Stoker.  The Company expects that it will continue toincur and pay costs during the remainder of 2005 as these plans are fullyimplemented, which will primarily be charged to earnings as the relatedobligations are incurred.  For thereorganization activities in the Defense segment’s fluidtest systems product line, the Company estimates that it will incur total cash chargesof approximately $2,700,000, of which approximately $600,000 was expensed and$200,000 was paid in 2004.  For the sixmonths ended June 30, 2005, an additional $1,889,000 was expensed and$2,043,000 was paid or otherwise settled. The remaining expenses of approximately $200,000 are expected to becharged to the Defense segment’s operations, and paid during the remainder of2005 as the obligations are incurred. The Energy segment recognized expense of $168,000 for restructuringactivities during 2005.  The Companyestimates Detroit Stoker will recognize additional expense of approximately$123,000 for the restructuring activities for the remainder of 2005.

 

The cash required to completely exit the discontinuedtransportation operation subsequent to June 30, 2005, is expected to beapproximately $3,400,000 through 2006, of which $2,500,000 is expected to bepaid during the remainder of 2005.  Theseamounts exclude legal fees expected to be incurred related to claims made byAAI in pursuit of payment under a

 

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surety bond (see Note M to the Consolidated CondensedFinancial Statements included in this Quarterly Report on Form 10-Q for adiscussion of AAI’s claims).

 

For additional information regarding the Company’s contingencies,please see the discussion under the heading “*ContingentMatters*” below.

 

The Company does not anticipate having to contribute cash to the UICRetirement Pension Plan, but does  expectto contribute $244,000 to the union pension plan in the Energy segment during2005 of which $88,000 was funded in the second quarter of 2005.  Further, the Company expects to pay otherpostretirement benefits of approximately $3,348,000 in 2005 of which $1,844,000was funded during the six months ended June 30, 2005.

 

**Contingent Matters**

 

**Off-Balance Sheet Arrangements**

 

In connection with certain contracts, United Industrial’s operatingsubsidiaries have committed to certain performance guarantees. The ability toperform under these guarantees may, in part, be dependent on the performance ofother parties, including partners and subcontractors. If United Industrial’soperating subsidiaries are unable to meet these performance obligations, theperformance guarantees could have a material adverse effect on product marginsand the Company’s results of operations, liquidity or financial position.United Industrial’s operating subsidiaries monitor the progress of theirpartners and subcontractors, and United Industrial does not believe that theperformance of these partners and subcontractors will adversely affect thesecontracts as of June 30, 2005. No assurances can be given, however, as tothe liability of United Industrial’s operating subsidiaries if partners orsubcontractors are unable to perform their obligations.

 

**Other ContingentMatters**

 

The Company is involved in various lawsuits and claims, includingasbestos-related litigation and environmental matters.  Except as set forth in Note M to theConsolidated Condensed Financial Statements included in this Quarterly Reporton Form 10-Q, there have been no material changes in any legal proceedingssince the Company filed its Annual Report on Form 10-K for the year ended December 31,2004.  For further information, refer tothe Consolidated Financial Statements and Notes thereto included in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2004 andto Note M to the Consolidated Condensed Financial Statements included in thisQuarterly Report on Form 10-Q.

 

**Critical AccountingPolicies**

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions.  Theseestimates and assumptions affect the reported amounts of assets and liabilitiesand disclosure of contingent assets and liabilities at the date of thefinancial statements, as well as reported amounts of revenues and expensesduring the reporting period.  Judgmentsand assessments of uncertainties are required in applying the Company’saccounting policies in many areas. Actual results could differ from these estimates.

 

There have been no revisions to the Critical Accounting Policies asfiled in the Company’s Annual Report on Form 10-K for the year ended December 31,2004.

 

**New Accounting Pronouncements**

 

InMay 2005, the FASB issued SFAS No. 154, Accounting Changes and ErrorCorrections, a replacement of APB opinion No. 20 and FASB Statement No. 3(“SFAS No. 154”).  SFAS No. 154requires retrospective application to prior period financial statements of avoluntary change in accounting principle and is effective in the first quarterof 2006.  The Company does not expect theadoption of SFAS No. 154 to have a material effect on its results ofoperations, financial conditions or cash flows.

 

Forfurther information, refer to the New Accounting Pronouncements as filed in theCompany’s Annual Report on Form 10-K for the year ended December 31,2004.

 

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

 

**Interest Rate**

 

OnSeptember 15, 2004, the Company issued and sold $120,000,000 of 3.75%Convertible Senior Notes.  Severalfeatures contained in the indenture governing the 3.75% Convertible SeniorNotes are considered embedded derivative instruments and are being accountedfor as derivative instruments separate from the host contract (the 3.75%Convertible Senior Notes). The Company will record gains or losses in itsConsolidated Condensed Statements of Operations for changes in the fair valueof these embedded derivatives.  Theaggregate fair value assigned to these embedded derivatives at December 31,2004 was approximately $742,000, and was approximately $440,000 at June 30,2005.  Accordingly, the Companyrecognized a gain of $302,000 for the six months ended June 30, 2005 asthe result of the change in fair value of the embedded derivatives.

 

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

 

Therehas been no material change in the interest rate risk or contingent paymentfeatures from December 31, 2004 (see Item 7A in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2004).

 

**Foreign Currency**

 

Aportion of the Company’s operations consists of manufacturing and salesactivities in foreign jurisdictions, and some of these transactions aredenominated in foreign currencies.  As aresult, the Company’s financial results could be affected by changes in foreignexchange rates.  To mitigate the effectof changes in these rates, the Company, from time to time, enters into foreignexchange forward contracts.  There hasbeen no material change in the firmly committed sales exposures and relatedderivative contracts from December 31, 2004 (see Item 7A in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2004).

 

**Item4. - Controls and Procedures**

 

(a)                The Company’s management evaluated,with the participation of the Company’s principal executive and principalfinancial officers, the effectiveness of the Company’s disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of June 30,2005.  Based on their evaluation, theCompany’s principal executive and principal financial officers concluded thatthe Company’s disclosure controls and procedures were effective as of June 30,2005.

 

(b)               There has been no change in the Company’sinternal control over financial reporting (as defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) that occurred during the Company’sfiscal quarter ended June 30, 2005, that has materially affected, or isreasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

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**PART II- OTHER INFORMATION**

 

##### **Item 1. - Legal Proceedings**

#####  

Referenceis made to the information 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 to Note M to the ConsolidatedCondensed Financial Statements included herein, which information isincorporated herein by reference.

 

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

 

For information regarding the Company’spurchases of its equity securities, please reference Note O to the ConsolidatedCondensed Financial Statements included herein, which information isincorporated herein by reference.

 
| **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** | ** ** |
|-----------------------|------------|---------------------------------------|------------|-----------------------------------|------------|---------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|
| ** **            | ** ** | ** **                            | ** ** | ** **                        | ** ** | ** **                                                                            | ** ** | **(in millions)**                                                                          | ** ** |
| 4/1/05 – 4/30/05 |       | —                                |       | —                            |       | —                                                                                |       | $                                                                                          | 25.0       |   |
|                  |       |                                  |       |                              |       |                                                                                  |       |                                                                                       |       |   |
| 5/1/05 – 5/31/05 |       | 490,964                               |       | $                                 | 33.59      |                                                                                  | 490,964    |                                                                                       | $          | 8.5 |   |
|                  |       |                                  |       |                              |       |                                                                                  |       |                                                                                       |       |   |   |
| 6/1/05 – 6/31/05 |       | 244,381                               |       | $                                 | 34.81      |                                                                                  | 244,381    |                                                                                       | —     |   |

 

**Item 4. - Submission of Matters to a Vote ofSecurity Holders**

 

(a) The Company held its 2005Annual Meeting of Shareholders on May 24, 2005.

 

(b)  The following matters were voted upon at the meeting:

 

(i)  The first item considered was theelection of four directors of the Company to serve until the 2006 annualmeeting of shareholders, and the results of such voting was as follows:

 
| **Nominees**            | ** ** | **Votes For** | ** ** | **Withheld** | ** ** |
|-------------------------|------------|---------------|------------|--------------|------------|
|                    |       |          |       |         |       |
| Glen M. Kassan          |       | 11,276,358    |       | 147,821      |       |
|                    |       |          |       |         |       |
| Warren G. Lichtenstein  |       | 9,224,342     |       | 2,199,837    |       |
|                    |       |          |       |         |       |
| General Richard I. Neal |       | 11,332,423    |       | 91,755       |       |
|                    |       |          |       |         |       |
| Frederick M. Strader    |       | 11,327,564    |       | 96,615       |       |

 

 (ii)   The second item considered was a proposalto ratify KPMG LLP as the Company’s independent auditors for 2005, whichwas approved with 11,152,898 shares voted in favor of such proposal,241,551shares voted against such proposal, holders of 29,729 shares abstainingand no broker non-votes.

 

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**Item6. - Exhibits**

 

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

 

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

 

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

 

32.2                           Section 1350Certification by the 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:  | August 5, 2005           |   | By: |    /s/ James H. Perry |   |
|   |                          | James H. Perry |
|   |                          | Vice President, and |
|   |                          | Chief Financial Officer |
|   |                          | (as duly authorized officer  and principal accounting  officer) |
|        |                               |  |  |  |  |

 

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INDEX OF EXHIBITS FILED HEREWITH

 

**Exhibit No.**

 

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

 

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

 

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

 

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

 

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