** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

** **

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

**For the quarterly periodended June 30, 2007**

** **

**OR**

** **

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

**For the transition periodfrom ____________________ to ____________________**

** **

**Commission File Number:**1-4252

** **

**UNITED INDUSTRIAL CORPORATION**

(Exact name of registrantas 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, ifchanged since last report)

Indicate by check mark whether the registrant: (1) has filed allreports required to be filed by Section 13 or 15(d) of the Securities ExchangeAct of 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes x      No o

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

Largeaccelerated filer o         Acceleratedfiler x         Non-acceleratedfiler o

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

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date:  9,956,435shares of common stock as of August 2, 2007.

 

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** **

**UNITED INDUSTRIALCORPORATION**

INDEX
|                                                                                                                        | ** ** | **Page** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| PART  I — FINANCIAL INFORMATION                                                                                   |       |     |       |
|                                                                                                                   |       |     |       |
| Item  1. Financial Statements                                                                                          |       |     |       |
|                                                                                                                   |       |     |       |
| Consolidated Condensed Balance Sheets —  June 30, 2007 (unaudited) and December 31, 2006                          |       | 2        |       |
|                                                                                                                   |       |     |       |
| Consolidated Condensed Statements of Operations  (unaudited) —  Three and Six Months Ended June 30, 2007 and 2006 |       | 3        |       |
|                                                                                                                   |       |     |       |
| Consolidated Condensed Statements of Cash Flows  (unaudited) —  Six Months Ended June 30, 2007 and 2006           |       | 4        |       |
|                                                                                                                   |       |     |       |
| Notes to Consolidated Condensed Financial Statements  (unaudited)                                                      |       | 5        |       |
|                                                                                                                   |       |     |       |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations                    |       | 25       |       |
|                                                                                                                   |       |     |       |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                                    |       | 35       |       |
|                                                                                                                   |       |     |       |
| Item 4. Controls and Procedures                                                                                        |       | 35       |       |
|                                                                                                                   |       |     |       |
| PART  II — OTHER INFORMATION                                                                                      |       |     |       |
|                                                                                                                   |       |     |       |
| Item  1. Legal Proceedings                                                                                             |       | 36       |       |
|                                                                                                                   |       |     |       |
| Item 2. Unregistered Sales of Equity Securities and Use  of Proceeds                                                   |       | 36       |       |
|                                                                                                                   |       |     |       |
| Item 4. Submission of Matters to a Vote of Security  Holders                                                           |       | 36       |       |
|                                                                                                                   |       |     |       |
| Item 6. Exhibits                                                                                                       |       | 37       |       |
|                                                                                                                   |       |     |       |
| SIGNATURES                                                                                                             |       | 38       |       |

 

1

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** **

**PART I — FINANCIALINFORMATION**

**Item 1. — Financial Statements**

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

UNITED INDUSTRIAL CORPORATION AND SUBSIDIARIESCONSOLIDATED CONDENSED BALANCE SHEETS
| ** **                                                                                                                                                                                             | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                             | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| ** **                                                                                                                                                                                             | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| ASSETS                                                                                                                                                                                                 |       |              |       |                  |       |
| Current assets:                                                                                                                                                                                        |       |              |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                             |       | $                 | 1,633      |                  | $          | 39,158 |   |
| Accounts  receivable, net                                                                                                                                                                              |       | 64,020            |       | 71,503                |       |
| Note receivable                                                                                                                                                                                        |       | 833               |       | 833                   |       |
| Inventories                                                                                                                                                                                            |       | 86,948            |       | 73,700                |       |
| Prepaid expenses  and other current assets                                                                                                                                                             |       | 10,963            |       | 10,102                |       |
| Assets of  discontinued operations                                                                                                                                                                     |       | 11,791            |       | 11,996                |       |
| Total current  assets                                                                                                                                                                                  |       | 176,188           |       | 207,292               |       |
| Marketable equity  securities                                                                                                                                                                          |       | 5,474             |       | 11,392                |       |
| Deferred income taxes,  net of valuation allowance                                                                                                                                                     |       | 3,423             |       | 4,073                 |       |
| Note receivable                                                                                                                                                                                        |       | 3,967             |       | 4,167                 |       |
| Intangible assets, net                                                                                                                                                                                 |       | 30,538            |       | 27,894                |       |
| Goodwill                                                                                                                                                                                               |       | 47,060            |       | 51,314                |       |
| Other assets                                                                                                                                                                                           |       | 5,825             |       | 5,466                 |       |
| Property and equipment,  net                                                                                                                                                                           |       | 45,995            |       | 47,042                |       |
| Total assets                                                                                                                                                                                           |       | $                 | 318,470    |                  | $          | 358,640 |   |
|                                                                                                                                                                                                   |       |              |       |                  |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                                                                                                             |       |              |       |                  |       |
| Current liabilities:                                                                                                                                                                                   |       |              |       |                  |       |
| Current portion  of long-term debt                                                                                                                                                                     |       | $                 | 17         |                  | $          | 2,896 |   |
| Accounts payable                                                                                                                                                                                       |       | 43,351            |       | 39,578                |       |
| Accrued employee  compensation and taxes                                                                                                                                                               |       | 18,648            |       | 17,506                |       |
| Customer  advances                                                                                                                                                                                     |       | 22,007            |       | 32,393                |       |
| Borrowings under  revolving credit facility                                                                                                                                                            |       | 25,473            |       | —                |       |
| Post-retirement  benefit obligation other than pension benefit                                                                                                                                         |       | 2,118             |       | 2,118                 |       |
| Other current  liabilities                                                                                                                                                                             |       | 13,010            |       | 13,988                |       |
| Liabilities of  discontinued operations                                                                                                                                                                |       | 12,529            |       | 12,113                |       |
| Total current  liabilities                                                                                                                                                                             |       | 137,153           |       | 120,592               |       |
| Long-term debt                                                                                                                                                                                         |       | 120,022           |       | 120,030               |       |
| Post-retirement benefit  obligation other than pension benefit                                                                                                                                         |       | 13,539            |       | 14,052                |       |
| Unfunded status of  pension liability                                                                                                                                                                  |       | 36,617            |       | 37,830                |       |
| Other liabilities                                                                                                                                                                                      |       | 3,492             |       | 2,837                 |       |
| Total  liabilities                                                                                                                                                                                     |       | 310,823           |       | 295,341               |       |
| Shareholders’ equity:                                                                                                                                                                             |       |              |       |                  |       |
| Preferred stock,  par value $1.00 per share; 1,000,000 shares authorized; none issued and  outstanding                                                                                                 |       | —            |       | —                |       |
| Common stock,  par value $1.00 per share; 30,000,000 shares authorized; 9,954,867 and  11,320,095 shares outstanding at June 30, 2007 and December 31, 2006,  respectively (net of shares in treasury) |       | 14,374            |       | 14,374                |       |
| Additional  capital                                                                                                                                                                                    |       | 87,989            |       | 86,471                |       |
| Retained  earnings                                                                                                                                                                                     |       | 99,662            |       | 82,337                |       |
| Treasury stock,  at cost; 4,419,281 and 3,054,053 shares at June 30, 2007 and December 31,  2006, respectively                                                                                         |       | (156,237          | )          | (78,505               | )          |
| Accumulated  other comprehensive loss, net of income tax                                                                                                                                               |       | (38,141           | )          | (41,378               | )          |
| Total  shareholders’ equity                                                                                                                                                                       |       | 7,647             |       | 63,299                |       |
| Total liabilities and shareholders’ equity                                                                                                                                                        |       | $                 | 318,470    |                  | $          | 358,640 |   |

 

See accompanyingnotes to the consolidated condensed financial statements.

2

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UNITED INDUSTRIAL CORPORATION AND SUBSIDIARIESCONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS(Unaudited)
| ** **                                                                                                                                                                                                                                                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                                                                                                                                                               | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                                                                                                                                                                                                               | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net sales                                                                                                                                                                                                                                                                |       | $                                | 183,170    |                           | $          | 137,400 |   | $ | 344,016 |   | $ | 266,101 |   |
| Operating costs  and expenses                                                                                                                                                                                                                                            |       | 165,527                          |       | 124,360                        |       | 309,627 |   | 239,656 |   |
| Operating income                                                                                                                                                                                                                                                         |       | 17,643                           |       | 13,040                         |       | 34,389 |   | 26,445 |   |
| Non-operating  income and (expense):                                                                                                                                                                                                                                     |       |                             |       |                           |       |   |   |   |   |
| Interest income                                                                                                                                                                                                                                                          |       | 243                              |       | 908                            |       | 785 |   | 1,833 |   |
| Interest expense                                                                                                                                                                                                                                                         |       | (1,646                           | )          | (1,442                         | )          | (3,089 | ) | (2,825 | ) |
| Other income, net                                                                                                                                                                                                                                                        |       | 291                              |       | 753                            |       | 368 |   | 168 |   |
|                                                                                                                                                                                                                                                                     |       | (1,112                           | )          | 219                            |       | (1,936 | ) | (824 | ) |
| Income from  continuing operations before income taxes                                                                                                                                                                                                                   |       | 16,531                           |       | 13,259                         |       | 32,453 |   | 25,621 |   |
| Provision for  income taxes                                                                                                                                                                                                                                              |       | (6,116                           | )          | (4,907                         | )          | (12,013 | ) | (9,617 | ) |
| Income from  continuing operations                                                                                                                                                                                                                                       |       | 10,415                           |       | 8,352                          |       | 20,440 |   | 16,004 |   |
| (Loss) income  from discontinued operations, net of income tax benefit (provision) of $152  and $(1,100) for the three months ended June 30, 2007 and 2006,  respectively and $599 and $(1,623) for the six months ended June 30,  2007 and 2006, respectively |       | (282                             | )          | 1,907                          |       | (1,112 | ) | 2,823 |   |
| Net income                                                                                                                                                                                                                                                               |       | $                                | 10,133     |                           | $          | 10,259 |   | $ | 19,328 |   | $ | 18,827 |   |
|                                                                                                                                                                                                                                                                     |       |                             |       |                           |       |   |   |   |   |
| Basic earnings  per share:                                                                                                                                                                                                                                               |       |                             |       |                           |       |   |   |   |   |
| Income from continuing operations                                                                                                                                                                                                                                        |       | $                                | 1.01       |                           | $          | 0.73 |   | $ | 1.91 |   | $ | 1.41 |   |
| (Loss) income from discontinued operations                                                                                                                                                                                                                               |       | (0.02                            | )          | 0.17                           |       | (0.10 | ) | 0.25 |   |
| Net income                                                                                                                                                                                                                                                               |       | $                                | 0.99       |                           | $          | 0.90 |   | $ | 1.81 |   | $ | 1.66 |   |
| Diluted earnings  per share:                                                                                                                                                                                                                                             |       |                             |       |                           |       |   |   |   |   |
| Income from continuing operations                                                                                                                                                                                                                                        |       | $                                | 0.82       |                           | $          | 0.60 |   | $ | 1.57 |   | $ | 1.20 |   |
| (Loss) income from discontinued operations                                                                                                                                                                                                                               |       | (0.02                            | )          | 0.12                           |       | (0.08 | ) | 0.19 |   |
| Net income                                                                                                                                                                                                                                                               |       | $                                | 0.80       |                           | $          | 0.72 |   | $ | 1.49 |   | $ | 1.39 |   |

 

See accompanying notes tothe consolidated condensed financial statements.

3

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UNITED INDUSTRIAL CORPORATION AND SUBSIDIARIESCONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS(Unaudited)
| ** **                                                                         | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                      | ** ** | **2006** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                                         |       |                                          |       |   |   |
| Net income                                                                         |       | $                                             | 19,328     |   | $ | 18,827 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                          |       |   |   |
| Loss (income) from discontinued operations, net of  income tax benefit (provision) |       | 1,112                                         |       | (2,823 | ) |
| Amortization of debt issuance costs and deferred  financing costs                  |       | 610                                           |       | 644 |   |
| Depreciation and amortization                                                      |       | 7,427                                         |       | 5,354 |   |
| Stock-based compensation                                                           |       | 1,634                                         |       | 1,144 |   |
| Deferred income tax benefit                                                        |       | (329                                          | )          | (573 | ) |
| Excess tax benefit from stock-based compensation                                   |       | (169                                          | )          | (1,059 | ) |
| Other, net                                                                         |       | (159                                          | )          | 133 |   |
| Changes in operating assets and liabilities:                                       |       |                                          |       |   |   |
| Decrease (increase) in accounts receivable                                         |       | 7,483                                         |       | (29,104 | ) |
| Increase in inventories                                                            |       | (13,055                                       | )          | (8,908 | ) |
| (Increase) decrease in prepaid expenses and other  current assets                  |       | (515                                          | )          | 255 |   |
| Increase in accounts payable, accruals and other  current liabilities              |       | 4,193                                         |       | 26,978 |   |
| (Decrease) increase in customer advances                                           |       | (10,386                                       | )          | 1,735 |   |
| Increase in long-term liabilities                                                  |       | 679                                           |       | 3,983 |   |
| Net cash  provided by operating activities from continuing operations              |       | 17,853                                        |       | 16,586 |   |
| Net cash (used  in) provided by operating activities from discontinued operations  |       | (491                                          | )          | 1,730 |   |
| Net cash  provided by operating activities                                         |       | 17,362                                        |       | 18,316 |   |
| ** **                                                                         | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                         |       |                                          |       |   |   |
| Purchases of  property and equipment                                               |       | (4,346                                        | )          | (3,484 | ) |
| Proceeds from  sale of marketable equity securities                                |       | 6,651                                         |       | — |   |
| Collections of  note receivable                                                    |       | 200                                           |       | — |   |
| Business  acquisition, net of cash received                                        |       | —                                        |       | (6,556 | ) |
| Net cash  provided by (used in) investing activities from continuing operations    |       | 2,505                                         |       | (10,040 | ) |
| Net cash used in  investing activities from discontinued operations                |       | —                                        |       | (42 | ) |
| Net cash  provided by (used in) investing activities                               |       | 2,505                                         |       | (10,082 | ) |
| ** **                                                                         | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                         |       |                                          |       |   |   |
| Borrowings under  revolving credit facility                                        |       | 25,473                                        |       | — |   |
| Repayment of  long-term debt                                                       |       | (2,887                                        | )          | (642 | ) |
| Decrease in  deposits and restricted cash                                          |       | —                                        |       | 4,810 |   |
| Proceeds from  exercise of stock options                                           |       | 960                                           |       | 2,414 |   |
| Excess tax  benefit from stock-based compensation                                  |       | 169                                           |       | 1,059 |   |
| Dividends paid                                                                     |       | (2,130                                        | )          | (2,270 | ) |
| Purchase of  treasury shares                                                       |       | (78,977                                       | )          | — |   |
| Net cash (used  in) provided by financing activities                               |       | (57,392                                       | )          | 5,371 |   |
| (Decrease) increase  in cash and cash equivalents                                  |       | (37,525                                       | )          | 13,605 |   |
| Cash and cash  equivalents at beginning of year                                    |       | 39,158                                        |       | 77,496 | (1) |
| Cash and cash  equivalents at end of period                                        |       | $                                             | 1,633      |   | $ | 91,101 | (2) |

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

(2)             Includescash reported in assets held for sale of $17,460 at June 30, 2006.

See accompanying notes to the consolidated condensed financialstatements.

4

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

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

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

The company’s transportationoperation and former energy operation are accounted for as discontinuedoperations. United Industrial divested its energy segment (operated throughDetroit Stoker Company) on December 29, 2006 as part of its ongoingstrategy to focus the company on its core aerospace and defense business. Thehistorical results of operations of the discontinued energy operation have beenreported in the accompanying consolidated statements of operations and cashflows for the three and six months ended June 30, 2006. (See Notes J and K foradditional information.)

The accompanying Consolidated CondensedFinancial Statements of the company have been prepared in accordance withaccounting principles generally accepted in the United States of America (“GAAP”)for interim financial information and with the instructions to Form 10-Q andRule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notesrequired by GAAP for complete financial statements.  In the opinion of management, all adjustments(consisting of normal recurring items) considered necessary for a fairpresentation have been included. Operating results for the three and six month periods ended June 30,2007 are not necessarily indicative of the results that may be expected for theyear ending December 31, 2007.  Theseunaudited Consolidated Condensed Financial Statements should be read inconjunction with the Consolidated Financial Statements and notes theretoincluded in the company’s Annual Report on Form 10-K for the year endedDecember 31, 2006.

On November 28, 2006, AAICorporation acquired Symtx.  On November 14,2006, the company acquired McTurbine.  OnJune 19, 2006, the company acquired Aerosonde. The operating results of these entities have been included in theconsolidated financial statements of the company since their respectiveacquisition dates.

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

5

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The following table summarizes thecompany’s sales by product line for the three and six months ended June 30,2007 and 2006:

|                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **             | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **             | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Unmanned Systems       |       | $                                | 110,653    |                           | $          | 92,013 |   | $ | 203,988 |   | $ | 183,603 |   |
| Services and Logistics |       | 43,045                           |       | 25,584                         |       | 82,147 |   | 45,383 |   |
| Test Systems           |       | 20,527                           |       | 10,192                         |       | 41,730 |   | 19,121 |   |
| Training Systems       |       | 1,271                            |       | 4,080                          |       | 3,665 |   | 7,712 |   |
| Advanced Programs      |       | 4,448                            |       | 5,195                          |       | 8,644 |   | 9,152 |   |
| Other                  |       | 3,226                            |       | 336                            |       | 3,842 |   | 1,130 |   |
|                   |       | $                                | 183,170    |                           | $          | 137,400 |   | $ | 344,016 |   | $ | 266,101 |   |

 

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

**Note B -****New AccountingPronouncement**

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

**Note C-Earnings Per Share**

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

Options topurchase 50,962 shares and 122,058 shares of the company’s Common Stock for thethree and six months ended June 30, 2007, respectively, and options to purchase37,500 shares and 128,500 shares of the company’s Common Stock for the threeand six months ended June 30, 2006, respectively, were not included in thecomputation of diluted earnings per share because their impact would beanti-dilutive.

6

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Basic and diluted earnings per share amounts werecomputed as follows:
| ** **                         | ** ** | **Three Months Ended June 30,** | ** ** |
|------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                         | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| ** **                         | ** ** | **Earnings**                                        | ** ** | **Shares** | ** ** | **Per  Share** | ** ** | **Earnings** | ** ** | **Shares** | ** ** | **Per  Share** | ** ** |
|                               |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Basic earnings  per share:         |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Income from continuing operations  |       | $                                                   | 10,415     |   | 10,278,225 |   | $ | 1.01 |   | $ | 8,352 |   | 11,400,448 |   | $ | 0.73 |   |
|                               |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Effect of  dilutive securities:    |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Stock options                      |       | —                                              |       | 399,728 |   |   |   | — |   | 399,259 |   |   |   |
| 3.75% Convertible Senior Notes     |       | 863                                                 |       | 3,058,356 |   |   |   | 492 |   | 3,058,356 |   |   |   |
| Diluted earnings  per share:       |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Income from  continuing operations |       | $                                                   | 11,278     |   | 13,736,309 |   | $ | 0.82 |   | $ | 8,844 |   | 14,858,063 |   | $ | 0.60 |   |

 
| ** **                         | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------|------------|---------------------------------------------------|------------|
| ** **                         | ** ** | **2007**                                          | ** ** | **2006** | ** ** |
| ** **                         | ** ** | **Earnings**                                      | ** ** | **Shares** | ** ** | **Per  Share** | ** ** | **Earnings** | ** ** | **Shares** | ** ** | **Per  Share** | ** ** |
|                               |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Basic earnings  per share:         |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Income from continuing operations  |       | $                                                 | 20,440     |   | 10,683,366 |   | $ | 1.91 |   | $ | 16,004 |   | 11,345,420 |   | $ | 1.41 |   |
|                               |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Effect of  dilutive securities:    |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Stock options                      |       | —                                            |       | 392,076 |   |   |   | — |   | 416,578 |   |   |   |
| 3.75% Convertible Senior Notes     |       | 1,740                                             |       | 3,058,356 |   |   |   | 1,802 |   | 3,058,356 |   |   |   |
| Diluted earnings  per share:       |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Income from  continuing operations |       | $                                                 | 22,180     |   | 14,133,798 |   | $ | 1.57 |   | $ | 17,806 |   | 14,820,354 |   | $ | 1.20 |   |

 

**Note D -Stock-Based Compensation**

Stock-basedcompensation expense of  $836 and $782for the three months ended June 30, 2007 and 2006, respectively and $1,634 and$1,144 for the six months ended June 30, 2007 and 2006, respectively, wasrecorded in operating costs and expenses included in operating income.Additional compensation cost will be recognized as new options are awarded. Asof June 30, 2007, there was $5,230 of total unrecognized compensation costrelated to unvested share-based compensation arrangements granted under thecompany’s equity compensation plan. That cost is expected to be recognized overa three-year period.

7

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A summary of stock option activity during the six months ended June 30,2007 under the company’s equity compensation plan is as follows:

|                                 | ** ** | **Number of   Shares  (in thousands)** | ** ** |
|---------------------------------|------------|-------------------------------------------------------|------------|
| Number of shares under option:  |       |                                                  |       |
| Outstanding at January  1, 2007 |       | 1,020                                                 |       |
| Granted                         |       | 161                                                   |       |
| Exercised                       |       | (40                                                   | )          |
| Cancelled                       |       | (8                                                    | )          |
| Outstanding at June 30,  2007   |       | 1,133                                                 |       |
|                            |       |                                                  |       |
| Exercisable at June 30,  2007   |       | 745                                                   |       |
| Unexercisable at June  30, 2007 |       | 388                                                   |       |
|                            |       |                                                  |       |
| Available for future grants     |       | 609                                                   |       |

 

##### **NoteE - Marketable Equity Securities**

The company’s investment inmarketable equity securities consists of the common stock of one company in theAerospace and Defense industry.  In June2007, the company sold 369,287 shares for $6,651, at an average price of$18.01, resulting in a realized gain of $37. The company’s remaining cost basis is $5,988 and the carrying value(fair market value) was $5,474 at June 30, 2007.

Unrealized holding gains andlosses deemed temporary on available-for-sale securities are excluded fromearnings and are reported as a separate component of other comprehensive incomeuntil realized. If an unrealized holding loss is deemed to be other-than-temporary,such unrealized loss is charged to earnings when identified.

In June 2006, theinvestee company disclosed the indictment of the investee company and itschairman and suspension of certain of its plants from receiving U.S. Governmentcontracts, and possible delisting of its common stock.  In October 2006, the investee companyannounced that the suspension of certain of its plants from receiving U.S.Government contracts had been lifted.  OnJune 27, 2007, the investee company announced that two of its eightmanufacturing facilities had been suspended from receiving new U.S. Governmentcontract awards pending completion of a full investigation of certaindeliveries by the investee company. Management continues to evaluate the financial stability of the investeecompany in relation to the severity and duration of the unrealized loss. Basedon that evaluation and the company’s ability and intent to hold the investmentfor a reasonable period of time sufficient for a forecasted recovery of fairvalue, the company does not consider this investment to beother-than-temporarily impaired at June 30, 2007. At June 30, 2007, thecumulative net unrealized loss recorded in accumulated other comprehensive losswas $514.

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

Inventories consisted of the following components forthe periods specified:

|                         | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **              | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| Work-in-process         |       | $                 | 69,675     |                  | $          | 60,194 |   |
| Materials and  supplies |       | 17,273            |       | 13,506                |       |
| Total inventories       |       | $                 | 86,948     |                  | $          | 73,700 |   |

 

Cash paid for Federal income taxes during the sixmonths ended June 30, 2007 and 2006 was $14,300 and $8,010, respectively.  Cash paid for interest during the six monthsended June 30, 2007 and 2006 was $2,257 and $2,332, respectively.

8

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** **

**Note G - Goodwill and Intangibles**

On November 14, 2006, the company acquiredMcTurbine Inc.  The purchase price wasallocated to the estimated fair value of net tangible and intangible assetsacquired, with any excess recorded to goodwill. Thecompany is in the process of obtaining valuations of certain assets and recently obtained apreliminary valuation of McTurbine’s assets that increased intangible assets by$4,887 and decreased goodwill by the same amount.  The increase in intangible assets anddecrease in goodwill has been recorded in the Consolidated Balance Sheet as ofJune 30, 2007.

**Note H - Pension and OtherPost-Retirement Benefits**

On December29, 2006, United Industrial completed the sale of its wholly ownedsubsidiary, Detroit Stoker Company (“Detroit Stoker”). Detroit Stokermaintained its own tax-qualified defined benefit plan for union employees andunfunded post-retirement benefit plans for eligible employees.  The assets and liabilities of these planswere transferred with Detroit Stoker to the new owner as part of the saletransaction. In addition, the company agreed to transfer the portion of theassets and liabilities in the company’s tax-qualified defined benefit planattributable to the frozen accrued pension benefits of active Detroit Stokernon-union employees, determined as of the closing date of the merger, to thenew pension plan established by Detroit Stoker. The assets of $2,199 weretransferred on April 30, 2007. All amounts in the tables below for the three andsix months ended June 30, 2006 have been adjusted to reflect the transfer ofthese assets and liabilities of the Detroit Stoker plans with the exception ofthe transferred portion attributable to the frozen accrued pension benefits ofactive Detroit Stoker non-union employees. Pension expense related to DetroitStoker has been reported in income from discontinued operations for the threeand six months ended June 30, 2006.

The following table provides thecomponents of net periodic pension benefit cost for the three and six monthsended June 30, 2007 and 2006:
| ** **                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                          | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Service cost                        |       | $                                               | 1,245      |                                          | $          | 1,175 |   | $ | 2,454 |   | $ | 2,350 |   |
| Interest cost                       |       | 2,842                                           |       | 2,500                                         |       | 5,625 |   | 5,000 |   |
| Expected return on  plan assets     |       | (3,206                                          | )          | (3,100                                        | )          | (6,435 | ) | (6,200 | ) |
| Amortization of  prior service cost |       | 167                                             |       | 175                                           |       | 333 |   | 350 |   |
| Amortization of  actuarial loss     |       | 1,202                                           |       | 1,225                                         |       | 2,278 |   | 2,450 |   |
| Net periodic  pension benefit cost  |       | $                                               | 2,250      |                                          | $          | 1,975 |   | $ | 4,255 |   | $ | 3,950 |   |

 

The following table provides thecomponents of post-retirement benefit obligation cost other than pensionbenefit for the three and six months ended June 30, 2007 and 2006:
| ** **                                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                       | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Service cost                                     |       | $                                               | 17         |                                          | $          | 23 |   | $ | 34 |   | $ | 46 |   |
| Interest cost                                    |       | 223                                             |       | 226                                           |       | 446 |   | 452 |   |
| Amortization of  prior service cost              |       | 3                                               |       | 3                                             |       | 6 |   | 6 |   |
| Amortization of  actuarial loss                  |       | 37                                              |       | 33                                            |       | 74 |   | 66 |   |
| Net periodic  other post-retirement benefit cost |       | $                                               | 280        |                                          | $          | 285 |   | $ | 560 |   | $ | 570 |   |

 

9

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The followingtable provides the company’s contributions to and benefits paid under pension,and post-retirement benefit plans other than pension benefit for the six monthsended June 30, 2007 and 2006:
| ** **                                                                 | ** ** | **Pension Benefits  Six Months Ended  June 30,** | ** ** | **Post-retirement Benefit  Obligation Other Than  Pension Benefit  Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2007**                                                             | ** ** | **2006**                                                                                                                           | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                       |       |                                                                 |       |                                                                                                                               |       |   |   |   |   |
| Expected fiscal  year contributions reported at the end of the prior year: |       |                                                                 |       |                                                                                                                               |       |   |   |   |   |
| Employer                                                                   |       | $                                                                    | 5,200      |                                                                                                                               | —     |   | $ | 2,118 |   | $ | 2,236 |   |
| Employee                                                                   |       | —                                                               |       | —                                                                                                                             |       | — |   | — |   |
| Total expected  contributions at end of prior year                         |       | 5,200                                                                |       | —                                                                                                                             |       | 2,118 |   | 2,236 |   |
|                                                                       |       |                                                                 |       |                                                                                                                               |       |   |   |   |   |
| Actual  contributions made in the current year                             |       | 1,405                                                                |       | —                                                                                                                             |       | 993 |   | 1,006 |   |
| Remaining  contributions expected to be made in the current year           |       | 2,905                                                                |       | —                                                                                                                             |       | 891 |   | 963 |   |
| Total expected  current year contributions                                 |       | 4,310                                                                |       | —                                                                                                                             |       | 1,884 |   | 1,969 |   |
| Difference from  expectations at end of the prior year                     |       | $                                                                    | (890       | )                                                                                                                                  | —     |   | $ | (234 | ) | $ | (267 | ) |

#####  

##### **Note I - Comprehensive Income**

The following table sets forth the components of othercomprehensive income and total comprehensive income for the periods specified:
| ** **                                                            | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30** | ** ** |
|-----------------------------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                            | ** ** | **2007**                                        | ** ** | **2006**                                     | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                            | ** ** | ** **                                      | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                            |       | $                                               | 10,133     |                                         | $          | 10,259 |   | $ | 19,328 |   | $ | 18,827 |   |
|                                                                  |       |                                            |       |                                         |       |   |   |   |   |
| Other  comprehensive income:                                          |       |                                            |       |                                         |       |   |   |   |   |
| Recognition of prior service cost and actuarial  loss, net of tax     |       | 917                                             |       | —                                       |       | 1,750 |   | — |   |
| Adjustment for sale of marketable securities                          |       | 845                                             |       | —                                       |       | 845 |   | — |   |
| Unrealized gain (loss) on marketable securities, net  of income taxes |       | 251                                             |       | (6,074                                       | )          | (150 | ) | (4,075 | ) |
| Gain on foreign currency translation                                  |       | 655                                             |       | 388                                          |       | 792 |   | 494 |   |
| Total  comprehensive income                                           |       | $                                               | 12,801     |                                         | $          | 4,573 |   | $ | 22,565 |   | $ | 15,246 |   |

 

The company did not record the amortization of prior service cost andactuarial gains through other comprehensive income in the first quarter of2007.  The company does not believe thatthe $833 of amortization related to prior service cost and actuarial gains inthe first quarter of 2007 had a material impact.

##### **Note J - Income Tax**

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

 

10

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** **

The company adopted the provisions of FIN 48 on January 1, 2007. As aresult of the implementation of FIN 48, the company recognized no materialadjustment in the liability for unrecognized income tax benefits. At theadoption date of January 1, 2007, the company had $4,829 of unrecognized taxbenefits, all of which would favorably impact the company’s effective tax rate,if recognized. At June 30, 2007, the company had $5,471 of unrecognized taxbenefits.

The company recognizes interest and penalties related to uncertain taxpositions in income tax expense. As of June 30, 2007, the company hadapproximately $2,442 of accrued interest related to uncertain tax positions.

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

##### **Note K - Discontinued Operations**

**Discontinued Energy Operation**

*Sale of Energy Segment*

United Industrial divested its energy segment (operated through DetroitStoker Company) on December 29, 2006. For additional information, pleasesee Note 19 to the Consolidated Financial Statements included in Part II, Item8 of the company’s Annual Report on Form 10-K for the year ended December 31,2006.

The results of operations of the discontinued energy operation havebeen reported in the accompanying consolidated statement of operations for thethree and six months ended June 30, 2006 and cash flows for the six monthsended June 30, 2006.

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

|                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                    | ** ** | **June 30, 2006**      | ** ** | **June 30, 2006**    | ** ** |
| Net sales                     |       | $                                | 11,815     |                           | $          | 20,733 |   |
| Operating costs and  expenses |       | 8,530                            |       | 15,741                         |       |
| Operating income              |       | 3,285                            |       | 4,992                          |       |
| Other income, net             |       | 204                              |       | 378                            |       |
| Income before income  taxes   |       | 3,489                            |       | 5,370                          |       |
| Provision for income  taxes   |       | 1,268                            |       | 1,946                          |       |
| Net income                    |       | $                                | 2,221      |                           | $          | 3,424 |   |

 

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

|                                                                                                                | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                     | ** ** | **June 30, 2006**    | ** ** |
| Net income                                                                                                     |       | $                              | 3,424      |   |
| Changes in operating  assets and liabilities                                                                   |       | (285                           | )          |
| Net cash provided by  operating activities from discontinued energy operation                                  |       | 3,139                          |       |
| Net cash used in  investing activities from discontinued energy operation, purchase of property  and equipment |       | (42                            | )          |
| Net increase in cash and cash equivalents from discontinued energy  operation                                  |       | $                              | 3,097      |   |

 

11

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There were no cash flowsfrom financing activities from the discontinued energy operation for the sixmonths ended June 30, 2006.

**Discontinued TransportationOperation**

In December 2001,United Industrial’s Board of Directors decided to discontinue thetransportation business.  The companyceased to accept new transportation business at that time and decided to sellall or part of the transportation business and “runoff” the operations for anyremaining contractual obligations. As of June 30, 2007, the company’sdiscontinued transportation operation consists primarily of its investment inElectric Transit, Inc. (“ETI”).  ETI isowned 35% by AAI Corporation and 65% by Skoda, a Czech company.  AAI Corporation’s last commitment to ETIexpired in April 2006.  (See Note L foradditional information.)

The companyhas determined that ETI is a variable interest entity, for which the company isthe primary beneficiary, in accordance with the FASB issued InterpretationNo. 46 (revised December 2003), Consolidation of Variable InterestEntities, an Interpretation of Accounting Research Bulletin No. 51** (“FIN 46R”), whichbecame effective for years beginning after December 31, 2002. Thefinancial statements for ETI have been consolidated for all periods presented.The company accounts for its remaining transportation operation as adiscontinued operation, including the consolidation of ETI as a variableinterest entity.

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

|                                                                             | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                  | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Sales                                                                       |       | $                                               | 270        |                                          | $          | 446 |   | $ | 642 |   | $ | 839 |   |
| Cost of sales                                                               |       | (178                                            | )          | 109                                           |       | (500 | ) | (146 | ) |
| General and  administrative expenses                                        |       | (506                                            | )          | (1,023                                        | )          | (1,813 | ) | (1,584 | ) |
| Other expense                                                               |       | (20                                             | )          | (14                                           | )          | (40 | ) | (33 | ) |
| Loss before income  taxes                                                   |       | (434                                            | )          | (482                                          | )          | (1,711 | ) | (924 | ) |
| Benefit from income  taxes                                                  |       | 152                                             |       | 168                                           |       | 599 |   | 323 |   |
| Loss from discontinued transportation operation, net of income tax  benefit |       | $                                               | (282       | )                                             | $          | (314 | ) | $ | (1,112 | ) | $ | (601 | ) |

 

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

|                                                                                   | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                        | ** ** | **2007**                                      | ** ** | **2006** | ** ** |
| Net loss                                                                          |       | $                                             | (1,112     | ) | $ | (601 | ) |
| Changes in operating  assets and liabilities                                      |       | 621                                           |       | (906 | ) |
| Deferred income taxes                                                             |       | —                                        |       | 98 |   |
| Net cash used in operating activities from discontinued  transportation operation |       | $                                             | (491       | ) | $ | (1,409 | ) |

** **

**Therewere no cash flows from financing or investing activities from the discontinuedtransportation operation for the six months ended June 30, 2007 or 2006.**

**Assetsand liabilities of the discontinued transportation operation, which have beenreported and summarized in the accompanying Consolidated Balance Sheets asAssets and Liabilities of discontinued operations, respectively, were as follows:**

12

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** **

|                                            | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| Current Assets:                            |       |              |       |                  |       |
| Cash                                       |       | $                 | 224        |                  | $          | 387 |   |
| Accounts  receivable                       |       | 109               |       | 206                   |       |
| Prepaid expenses  and other current assets |       | 153               |       | 98                    |       |
| Deferred income  taxes                     |       | 11,305            |       | 11,305                |       |
|                                       |       | $                 | 11,791     |                  | $          | 11,996 |   |
| Current Liabilities:                       |       |              |       |                  |       |
| Accounts payable                           |       | $                 | 547        |                  | $          | 61 |   |
| Accrued employee  compensation and taxes   |       | 173               |       | 150                   |       |
| Other current  liabilities                 |       | 11,761            |       | 11,779                |       |
| Accrual for  contract losses               |       | 48                |       | 123                   |       |
|                                       |       | $                 | 12,529     |                  | $          | 12,113 |   |

 

**Note L - Commitments and Contingencies**

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

**ASBESTOS**

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

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

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

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

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

13

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

**OTHER LEGAL MATTERS**

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

Thecompany has in place international and domestic compliance policies andprocedures, including training of employees. From time to time, the company receives allegations of improper conductrelating to its operations, including operations subject to the U.S. ForeignCorrupt Practices Act, export control and licensing regulations and other U.S.domestic and international laws. When the company receives any suchallegations, it conducts internal (and if necessary, external) investigationsto determine whether there is support for any such allegations, and takescorrective action when warranted. 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 United Industrial’s Board of Directors to determineif there is support for any such allegations, and to review the company’scompliance policies and procedures, and the company is cooperating fully withcounsel. In addition, appropriate government agencies have been advised of thisinvestigation. The company is cooperating with their requests for information.The investigation by external counsel, which is continuing, has thus far notrevealed any prior involvement or knowledge regarding the allegations by any officeror director of United Industrial. At the current stage of this investigation,any ultimate liability is not presently determinable.

**PERFORMANCE GUARANTIES**

Inconnection with certain contracts, United Industrial’s operating subsidiarieshave committed to certain performance guaranties existing at June 30, 2007.Some of these performance guaranties are supported by surety bonds, whichtotaled $6,723 at June 30, 2007.  Theability to perform under these guaranties may, in part, be dependent on theperformance of other parties, including partners and subcontractors. If UnitedIndustrial’s operating subsidiaries are unable to meet these performanceobligations, the performance guaranties could have a material adverse effect onprofit margins and the company’s results of operations, liquidity or financialposition. United Industrial’s operating subsidiaries monitor the progress oftheir partners and subcontractors, and United Industrial and its operatingsubsidiaries do not believe that the performance of these partners andsubcontractors will adversely affect these contracts. No assurances can begiven, however, as to the liability of United Industrial’s operatingsubsidiaries if partners or subcontractors are unable to perform theirobligations.

**LABOR AND MATERIALS BOND CLAIM**

AAICorporation’s discontinued transportation operation consists of a 35% interestin ETI held by AAI Corporation.  Skoda, aCzech company, owns the remaining 65% of ETI. One of ETI’s contracts involvedthe design and manufacture of 273 electric trolley buses for the San FranciscoMunicipal Railway (“MUNI”). In executing its contract with MUNI, ETI 

14

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entered into subcontracts with AAI Corporation, certainSkoda operating affiliates and others. All remaining ETI and AAI Corporation contractual performanceobligations to MUNI concluded on April 22, 2007.

Asoriginally required by MUNI, ETI obtained a surety bond to guaranty payment toall those providing labor and materials to ETI in furtherance of itsperformance under the MUNI contract. AAI Corporation agreed to indemnify thesurety, if necessary, for up to $14,800 on this labor and materials bond,representing 35% of the original face value of the bond (in proportion to AAICorporation’s equity interest in ETI). On November 18, 2003, AAICorporation made a claim against the labor and materials bond for unpaidreceivables in connection with AAI Corporation’s MUNI subcontract from ETI,totaling in excess of $47,000, the maximum penal sum of the labor and materialsbond. AAI Corporation’s payment rights under the labor and materials bond(among other claims) are currently at issue in a case before the United StatesDistrict Court for the Northern District of California. Prior to finaladjudication of this case, there can be no assurances as to the amount ortiming of a recovery by AAI Corporation, if any, on its claim on the labor andmaterials bond. To date, no amount of recovery has been recorded.

##### **Note M - Dividends**

During each quarter of thesix months ended June 30, 2007 and 2006, United Industrial’s Board of Directorsdeclared and paid a dividend of $0.10 per share on its Common Stock.

| Quarter ended | ** ** | **Total amount dividends paid** | ** ** | **Date dividends were paid** | ** ** |
|--------------------|------------|------------------------------------------------|------------|---------------------------------------------|------------|
|               |       |                                           |       |                                        |       |
| March 31, 2007     |       | $1,100                                         |       | March  26, 2007                             |       |
| June 30, 2007      |       | $1,030                                         |       | May  30, 2007                               |       |
| March 31, 2006     |       | $1,127                                         |       | March  27, 2006                             |       |
| June 30, 2006      |       | $1,139                                         |       | May 25, 2006                                |       |

 

**Note N - Treasury Stock**

On May 11, 2007, United Industrial’s Board ofDirectors authorized a stock purchase plan for up to $50,000. The Board also authorizedan additional $50,000 of stock purchases for a total of $100,000, contingent onthe company executing an amended or new credit facility of at least $200,000 incapacity.  An amendment and restatementof the existing credit facility was completed on May 31, 2007, increasing thecapacity of the facility to $200,000. During the second quarter, United Industrial purchased 577,544 shares ofCommon Stock at an average market price of $59.39.  At June 30, 2007, $65,699 remained availableunder the stock purchase plan.

On November 17, 2006, United Industrial’s Boardof Directors authorized a stock purchase plan for up to $50,000. At December31, 2006, $44,719 remained available under the stock purchase plan.  During the three months ended March 31, 2007,United Industrial purchased 827,438 shares at an average market price of$54.04, utilizing all remaining funds available under that plan.

**NoteO - Long Term Debt and Credit Arrangements**

On May 31, 2007, United Industrial and its whollyowned subsidiary, AAI Corporation, (the “Borrowers”) entered into an Amendedand Restated Revolving Credit Agreement (the “Credit Agreement”), with asyndicate of nine financial institutions, consisting of SunTrust Bank asadministrative agent, Citibank N.A. and JPMorgan Chase Bank as co-syndicationagents, Key Bank and PNC Bank as co-documentation agents, and M&T Bank,General Electric Capital Corporation, BB&T Bank, and Wachovia Bank.  The Credit Agreement supersedes the revolvingcredit agreement established in July 2005. The Credit Agreement provides for a revolving credit facility (inclusiveof a swingline subfacility and a letter of credit subfacility) in an aggregatecommitted amount of $200,000. The proceeds of the senior secured, revolvingcredit facility will be used to provide working capital to finance capitalexpenditures, potential acquisitions, letters of credit, and sharerepurchases  and for other generalcorporate purposes.  The revolving creditfacility expires on May 31, 2012.

15

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Revolving loans under the Credit Agreement will bear interest at amargin rate of 0.00% to 0.25% above a certain base rate, or 0.75% to 1.25%above the London Interbank Offering Rate (“LIBOR”), subject to UIC’s leverageratio.  Swingline loans under the CreditAgreement will bear interest at the rate as offered by the swingline lender andaccepted by UIC.

The Credit Agreement contains affirmative, negative and financialcovenants customary for facilities of this type, including, among otherrequirements, maintenance of certain leverage and fixed charge coverage ratios.The company was in compliance with all of the covenants in the Credit Agreementat June 30, 2007.

Each of the direct and indirect domestic materialsubsidiaries of the Borrowers (other than AAI) (the “Subsidiary Loan Parties”)has, on a joint and several basis, unconditionally guaranteed all obligationsof the Borrowers under the Credit Agreement and the related credit documents.

Each of the credit facilities is secured (i) by substantially all thepersonal property of the Borrowers and the Subsidiary Loan Parties, and (ii) apledge of all equity interests of the domestic subsidiaries and non-votingequity interests of the foreign subsidiaries, and not more than 65% of thevoting equity interests of any foreign subsidiary of the Borrowers or theSubsidiary Loan Parties.

As of June 30, 2007, the company had $18,000 outstanding under therevolving credit facility and $7,473 outstanding under the swinglinesubfacility each incurring interest at an annualized rate of 6.07%, and $1,820outstanding under the letter of credit subfacility.  At June 30, 2007 $172,707 was available underthe revolving credit facility.

The 3.75% Convertible Senior Notes are convertible into shares of thecompany’s Common Stock prior to stated maturity at an initial conversion rate,subject to adjustment, of 25.4863 shares per $1 principal amount of the 3.75%Convertible Senior Notes (equal to an initial conversion price of approximately$39.24 per share) under certain circumstances.The holders of the 3.75% Convertible SeniorNotes can convert their Senior Notes into shares of Common Stock during thecalendar quarter from July 1, 2007 through September 30, 2007.  This event was triggered by United Industrial’sstock price remaining above $47.09 (120% of the initial conversion price) forat least 20 consecutive trading days during the last 30 trading days of thequarter ended June 30, 2007.

**NoteP - Derivative Instruments**

In June 2007, the company entered into forward contracts with anotional value totaling $10,384 in order to hedge British pound exposuresrelated to the purchase of unmanned aircraft engines.  These contracts expire from November 2007through January 2009.  The company marksthese forward contracts to market value each period and records the gain orloss in operating income in the Consolidated Statement of Operations.  The gains and losses on these instrumentsoffset losses and gains on the underlying purchase commitments.  The company recognized a gain of $96 for thethree and six months ended June 30, 2007 as a result of the change in fairvalue of the forward contracts.

**NoteQ - Supplemental Guarantor Information**

In September 2004,United Industrial issued and sold $120,000 aggregate principal amount of 3.75%Convertible Senior Notes, which are fully and unconditionally guaranteed byAAI. The following condensed consolidating financial information sets forthsupplemental information for United Industrial, the parent company, AAI, theguarantor subsidiary, and Detroit Stoker, the non-guarantor subsidiary (priorto its sale), as of June 30, 2007 and December 31, 2006, and for the three andsix months ended June 30, 2007 and 2006.

 

16

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** **

CONDENSEDCONSOLIDATING FINANCIAL INFORMATION

CONDENSED CONSOLIDATING BALANCE SHEETSAs of June 30, 2007  (Unaudited)
| ** **                                      | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|-------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
|                                            |       |                                          |       |                                                 |       |             |       |                                                   |       |
| ASSETS                                          |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Current Assets                                  |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Cash and cash  equivalents                      |       | $                                             | —     |                                                 | $          | 1,633            |       | $                                                      | —     |   | $ | 1,633 |   |
| Accounts  receivable, net                       |       | 679                                           |       | 63,341                                               |       | —           |       | 64,020                                                 |       |
| Note receivable                                 |       | 833                                           |       | —                                               |       | —           |       | 833                                                    |       |
| Inventories                                     |       | —                                        |       | 86,948                                               |       | —           |       | 86,948                                                 |       |
| Other current  assets                           |       | 4,151                                         |       | 7,346                                                |       | (534             | )          | 10,963                                                 |       |
| Assets of  discontinued operations              |       | —                                        |       | 11,791                                               |       | —           |       | 11,791                                                 |       |
| Total current  assets                           |       | 5,663                                         |       | 171,059                                              |       | (534             | )          | 176,188                                                |       |
| Property and equipment,  net                    |       | —                                        |       | 45,995                                               |       | —           |       | 45,995                                                 |       |
| Other assets                                    |       | 12,787                                        |       | 106,145                                              |       | (22,645          | )          | 96,287                                                 |       |
| Investment in  consolidated subsidiaries        |       | 173,411                                       |       | —                                               |       | (173,411         | )          | —                                                 |       |
| Total assets                                    |       | $                                             | 191,861    |                                                 | $          | 323,199          |       | $                                                      | (196,590   | ) | $ | 318,470 |   |
|                                            |       |                                          |       |                                                 |       |             |       |                                                   |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY      |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Current portion of  long-term debt              |       | $                                             | —     |                                                 | $          | 17               |       | $                                                      | —     |   | $ | 17 |   |
| Other current  liabilities                      |       | 6,465                                         |       | 171,109                                              |       | (52,967          | )          | 124,607                                                |       |
| Liabilities of  discontinued operations         |       | —                                        |       | 12,529                                               |       | —           |       | 12,529                                                 |       |
| Total current  liabilities                      |       | 6,465                                         |       | 183,655                                              |       | (52,967          | )          | 137,153                                                |       |
| Long-term debt                                  |       | 120,000                                       |       | 22                                                   |       | —           |       | 120,022                                                |       |
| Other long-term  liabilities                    |       | 7,457                                         |       | 69,370                                               |       | (23,179          | )          | 53,648                                                 |       |
| Intercompany payables  (receivables)            |       | 50,292                                        |       | (103,259                                             | )          | 52,967           |       | —                                                 |       |
| Shareholders’ (deficit)  equity            |       | 7,647                                         |       | 173,411                                              |       | (173,411         | )          | 7,647                                                  |       |
| Total liabilities and shareholders’ equity |       | $                                             | 191,861    |                                                 | $          | 323,199          |       | $                                                      | (196,590   | ) | $ | 318,470 |   |

 

17

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CONDENSED CONSOLIDATING FINANCIALINFORMATION

**CONDENSEDCONSOLIDATING BALANCE SHEETSAs of December 31, 2006**
| ** **                                       | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
| ASSETS                                           |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Current assets:                                  |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Cash and cash equivalents                        |       | $                                             | 40,068     |                                                 | $          | (910             | )          | $                                                      | —     |   | $ | 39,158 |   |
| Accounts receivable, net                         |       | 1,715                                         |       | 69,706                                               |       | 82               |       | 71,503                                                 |       |
| Note receivable                                  |       | 833                                           |       | —                                               |       | —           |       | 833                                                    |       |
| Inventories                                      |       | —                                        |       | 73,700                                               |       | —           |       | 73,700                                                 |       |
| Other current assets                             |       | 4,479                                         |       | 5,623                                                |       | —           |       | 10,102                                                 |       |
| Assets of discontinued operations                |       | —                                        |       | 11,996                                               |       | —           |       | 11,996                                                 |       |
| Total current assets                             |       | 47,095                                        |       | 160,115                                              |       | 82               |       | 207,292                                                |       |
| Property and  equipment, net                     |       | —                                        |       | 47,042                                               |       | —           |       | 47,042                                                 |       |
| Other assets                                     |       | 19,893                                        |       | 107,502                                              |       | (23,089          | )          | 104,306                                                |       |
| Investment in  consolidated subsidiaries         |       | 148,459                                       |       | —                                               |       | (148,459         | )          | —                                                 |       |
| Total assets                                     |       | $                                             | 215,447    |                                                 | $          | 314,659          |       | $                                                      | (171,466   | ) | $ | 358,640 |   |
|                                             |       |                                          |       |                                                 |       |             |       |                                                   |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY       |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Current  liabilities:                            |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Current portion of long-term debt                |       | $                                             | —     |                                                 | $          | 2,896            |       | $                                                      | —     |   | $ | 2,896 |   |
| Other current liabilities                        |       | 9,884                                         |       | 135,739                                              |       | (40,040          | )          | 105,583                                                |       |
| Liabilities of discontinued operations           |       | —                                        |       | 12,113                                               |       | —           |       | 12,113                                                 |       |
| Total current liabilities                        |       | 9,884                                         |       | 150,748                                              |       | (40,040          | )          | 120,592                                                |       |
| Long-term debt                                   |       | 120,000                                       |       | 30                                                   |       | —           |       | 120,030                                                |       |
| Other long-term  liabilities                     |       | 7,855                                         |       | 69,953                                               |       | (23,089          | )          | 54,719                                                 |       |
| Intercompany  payables (receivables)             |       | 14,409                                        |       | (54,531                                              | )          | 40,122           |       | —                                                 |       |
| Shareholders’  equity                       |       | 63,299                                        |       | 148,459                                              |       | (148,459         | )          | 63,299                                                 |       |
| Total liabilities and  shareholders’ equity |       | $                                             | 215,447    |                                                 | $          | 314,659          |       | $                                                      | (171,466   | ) | $ | 358,640 |   |

** **

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CONDENSED CONSOLIDATINGFINANCIAL INFORMATION - CONTINUED

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONSThree Months Ended June 30, 2007  (Unaudited)
| ** **                                                    | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
|                                                          |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Net sales                                                     |       | $                                             | —     |                                                 | $          | 183,170          |       | $                                                      | —     |   | $ | 183,170 |   |
| Operating costs  and expenses                                 |       | (721                                          | )          | (164,806                                             | )          | —           |       | (165,527                                               | )          |
| Operating (loss)  income                                      |       | (721                                          | )          | 18,364                                               |       | —           |       | 17,643                                                 |       |
| Non-operating  income and (expense):                          |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Interest income                                               |       | 143                                           |       | 100                                                  |       | —           |       | 243                                                    |       |
| Interest expense                                              |       | (1,370                                        | )          | (276                                                 | )          | —           |       | (1,646                                                 | )          |
| Other income, net                                             |       | 132                                           |       | 159                                                  |       | —           |       | 291                                                    |       |
|                                                          |       | (1,095                                        | )          | (17                                                  | )          | —           |       | (1,112                                                 | )          |
| (Loss) income  from continuing operations before income taxes |       | (1,816                                        | )          | 18,347                                               |       | —           |       | 16,531                                                 |       |
| Benefit from  (provision for) income taxes                    |       | 338                                           |       | (6,454                                               | )          | —           |       | (6,116                                                 | )          |
| (Loss) income  from continuing operations                     |       | (1,478                                        | )          | 11,893                                               |       | —           |       | 10,415                                                 |       |
| Loss from  discontinued operations, net of income tax benefit |       | —                                        |       | (282                                                 | )          | —           |       | (282                                                   | )          |
| Income from  investment in subsidiaries                       |       | 11,611                                        |       | —                                               |       | (11,611          | )          | —                                                 |       |
| Net income                                                    |       | $                                             | 10,133     |                                                 | $          | 11,611           |       | $                                                      | (11,611    | ) | $ | 10,133 |   |

 

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CONDENSED CONSOLIDATINGFINANCIAL INFORMATION - CONTINUED

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONSThree Months Ended June 30, 2006  (Unaudited) 
| ** **                                                                         | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Detroit  Stoker  Company  (Non-Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
| Net sales                                                                          |       | $                                             | —     |                                                 | $          | 137,400                                       |       | $                | —     |                                                   | $          | — |   | $ | 137,400 |   |
| Operating costs  and expenses                                                      |       | (447                                          | )          | (123,913                                             | )          | —                                        |       | —           |       | (124,360                                               | )          |
| Operating (loss)  income                                                           |       | (447                                          | )          | 13,487                                               |       | —                                        |       | —           |       | 13,040                                                 |       |
| Non-operating  income and (expense):                                               |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| Interest income                                                                    |       | 644                                           |       | 264                                                  |       | —                                        |       | —           |       | 908                                                    |       |
| Interest expense                                                                   |       | (1,370                                        | )          | (72                                                  | )          | —                                        |       | —           |       | (1,442                                                 | )          |
| Intercompany interest income                                                       |       | 10                                            |       | —                                               |       | —                                        |       | (10              | )          | —                                                 |       |
| Other income, net                                                                  |       | 615                                           |       | 138                                                  |       | —                                        |       | —           |       | 753                                                    |       |
|                                                                               |       | (101                                          | )          | 330                                                  |       | —                                        |       | (10              | )          | 219                                                    |       |
| (Loss) income  from continuing operations before income taxes                      |       | (548                                          | )          | 13,817                                               |       | —                                        |       | (10              | )          | 13,259                                                 |       |
| Benefit from  (provision for) income taxes                                         |       | 27                                            |       | (4,934                                               | )          | —                                        |       | —           |       | (4,907                                                 | )          |
| (Loss) income  from continuing operations                                          |       | (521                                          | )          | 8,883                                                |       | —                                        |       | (10              | )          | 8,352                                                  |       |
| (Loss) income  from discontinued operations, net of income tax benefit (provision) |       | —                                        |       | (314                                                 | )          | 2,211                                         |       | 10               |       | 1,907                                                  |       |
| Income from  investment in subsidiaries                                            |       | 10,780                                        |       | —                                               |       | —                                        |       | (10,780          | )          | —                                                 |       |
| Net income                                                                         |       | $                                             | 10,259     |                                                 | $          | 8,569                                         |       | $                | 2,211      |                                                   | $          | (10,780 | ) | $ | 10,259 |   |

 

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** **

**CONDENSED CONSOLIDATING FINANCIAL INFORMATION -CONTINUED**

**CONDENSED CONSOLIDATINGSTATEMENTS OF OPERATIONSSix Months Ended June 30, 2007(Unaudited)**
| ** **                                                      | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
|                                                            |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Net sales                                                       |       | $                                             | —     |                                                 | $          | 344,016          |       | $                                                      | —     |   | $ | 344,016 |   |
| Operating costs and  expenses                                   |       | (1,591                                        | )          | (308,036                                             | )          | —           |       | (309,627                                               | )          |
| Operating (loss) income                                         |       | (1,591                                        | )          | 35,980                                               |       | —           |       | 34,389                                                 |       |
| Non-operating income  and (expense):                            |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Interest income                                                 |       | 433                                           |       | 352                                                  |       | —           |       | 785                                                    |       |
| Interest expense                                                |       | (2,743                                        | )          | (346                                                 | )          | —           |       | (3,089                                                 | )          |
| Other income,  net                                              |       | 50                                            |       | 318                                                  |       |             |       | 368                                                    |       |
|                                                            |       | (2,260                                        | )          | 324                                                  |       | —           |       | (1,936                                                 | )          |
| (Loss) income from  continuing operations before income taxes   |       | (3,851                                        | )          | 36,304                                               |       |             |       | 32,453                                                 |       |
| Benefit from (provision  for) income taxes                      |       | 722                                           |       | (12,735                                              | )          | —           |       | (12,013                                                | )          |
| (Loss) income from  continuing operations                       |       | (3,129                                        | )          | 23,569                                               |       |             |       | 20,440                                                 |       |
| (Loss) from  discontinued operations, net of income tax benefit |       | —                                        |       | (1,112                                               | )          |             |       | (1,112                                                 | )          |
| Income from investment  in subsidiaries                         |       | 22,457                                        |       | —                                               |       | (22,457          | )          | —                                                 |       |
| Net income                                                      |       | $                                             | 19,328     |                                                 | $          | 22,457           |       | $                                                      | (22,457    | ) | $ | 19,328 |   |

 

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** **

**CONDENSED CONSOLIDATING FINANCIAL INFORMATION -CONTINUED**

**CONDENSED CONSOLIDATINGSTATEMENTS OF OPERATIONSSix Months Ended June 30, 2006(Unaudited)**
| ** **                                                                         | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Detroit Stoker  Company  (Non-Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
|                                                                               |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| Net sales                                                                          |       | $                                             | —     |                                                 | $          | 266,101                                           |       | $                | —     |                                                   | $          | — |   | $ | 266,101 |   |
| Operating costs  and expenses                                                      |       | (697                                          | )          | (238,959                                             | )          | —                                            |       | —           |       | (239,656                                               | )          |
| Operating (loss)  income                                                           |       | (697                                          | )          | 27,142                                               |       | —                                            |       | —           |       | 26,445                                                 |       |
| Non-operating  income and (expense):                                               |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| Interest income                                                                    |       | 1,256                                         |       | 577                                                  |       | —                                            |       | —           |       | 1,833                                                  |       |
| Interest expense                                                                   |       | (2,740                                        | )          | (85                                                  | )          | —                                            |       | —           |       | (2,825                                                 | )          |
| Intercompany interest income (expense)                                             |       | 25                                            |       | —                                               |       | —                                            |       | (25              | )          | —                                                 |       |
| Other (expense) income, net                                                        |       | (30                                           | )          | 198                                                  |       | —                                            |       | —           |       | 168                                                    |       |
|                                                                               |       | (1,489                                        | )          | 690                                                  |       | —                                            |       | (25              | )          | (824                                                   | )          |
| (Loss) income  from continuing operations before income taxes                      |       | (2,186                                        | )          | 27,832                                               |       | —                                            |       | (25              | )          | 25,621                                                 |       |
| Benefit from  (provision for) income taxes                                         |       | 340                                           |       | (9,957                                               | )          | —                                            |       | —           |       | (9,617                                                 | )          |
| (Loss) income  from continuing operations                                          |       | (1,846                                        | )          | 17,875                                               |       | —                                            |       | (25              | )          | 16,004                                                 |       |
| (Loss) income  from discontinued operations, net of income tax (provision) benefit |       | —                                        |       | (601                                                 | )          | 3,399                                             |       | 25               |       | 2,823                                                  |       |
| Income from  investment in subsidiaries                                            |       | 20,673                                        |       | —                                               |       | —                                            |       | (20,673          | )          | —                                                 |       |
| Net income                                                                         |       | $                                             | 18,827     |                                                 | $          | 17,274                                            |       | $                | 3,399      |                                                   | $          | (20,673 | ) | $ | 18,827 |   |

 

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** **

**CONDENSED CONSOLIDATING FINANCIAL INFORMATION -CONTINUED**

**CONDENSED CONSOLIDATINGSTATEMENTS OF CASH FLOWS**Six Months Ended June 30, 2007(Unaudited)
| ** **                                                            | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
|                                                                  |       |                                          |       |                                                 |       |             |       |                                                   |       |
| OPERATING  ACTIVITIES:                                                |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Cash flows  provided by (used in) continuing operations               |       | $                                             | 33,059     |                                                 | $          | (15,206          | )          | $                                                      | —     |   | $ | 17,853 |   |
| Cash flows used  in operating activities from discontinued operations |       | —                                        |       | (491                                                 | )          | —           |       | (491                                                   | )          |
|                                                                  |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Net cash provided by (used in) operating activities                   |       | 33,059                                        |       | (15,697                                              | )          | —           |       | 17,362                                                 |       |
|                                                                  |       |                                          |       |                                                 |       |             |       |                                                   |       |
| INVESTING  ACTIVITIES:                                                |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Purchase of  property and equipment                                   |       | —                                        |       | (4,346                                               | )          | —           |       | (4,346                                                 | )          |
| Proceeds from  sale of marketable equity securities                   |       | 6,651                                         |       | —                                               |       | —           |       | 6,651                                                  |       |
| Repayment of  note receivable                                         |       | 200                                           |       | —                                               |       | —           |       | 200                                                    |       |
|                                                                  |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Net cash provided by (used in) investing activities                   |       | 6,851                                         |       | (4,346                                               | )          | —           |       | 2,505                                                  |       |
|                                                                  |       |                                          |       |                                                 |       |             |       |                                                   |       |
| FINANCING  ACTIVITIES:                                                |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Borrowings under  revolving credit facility                           |       | —                                        |       | 25,473                                               |       | —           |       | 25,473                                                 |       |
| Repayment of  long-term debt                                          |       | —                                        |       | (2,887                                               | )          | —           |       | (2,887                                                 | )          |
| Proceeds from  exercise of stock options                              |       | 960                                           |       | —                                               |       | —           |       | 960                                                    |       |
| Excess tax  benefit from stock-based compensation                     |       | 169                                           |       | —                                               |       | —           |       | 169                                                    |       |
| Dividends paid                                                        |       | (2,130                                        | )          | —                                               |       | —           |       | (2,130                                                 | )          |
| Purchases of  treasury shares                                         |       | (78,977                                       | )          | —                                               |       | —           |       | (78,977                                                | )          |
|                                                                  |       |                                          |       |                                                 |       |             |       |                                                   |       |
| Net cash (used in) provided by financing activities                   |       | (79,978                                       | )          | 22,586                                               |       | —           |       | (57,392                                                | )          |
| (Decrease)  increase in cash and cash equivalents                     |       | (40,068                                       | )          | 2,543                                                |       | —           |       | (37,525                                                | )          |
| Cash and cash  equivalents at beginning of year                       |       | 40,068                                        |       | (910                                                 | )          | —           |       | 39,158                                                 |       |
| Cash and cash  equivalents at end of period                           |       | $                                             | —     |                                                 | $          | 1,633            |       | $                                                      | —     |   | $ | 1,633 |   |

 

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** **

**CONDENSED CONSOLIDATING FINANCIAL INFORMATION -CONTINUED**

**CONDENSED CONSOLIDATINGSTATEMENTS OF CASH FLOWS**Six Months Ended June 30, 2006(Unaudited)
| ** **                                                                          | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Detroit Stoker  Company  (Non-Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|-------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
| ** **                                                                          | ** ** | ** **                                    | ** ** | ** **                                           | ** ** | ** **                                        | ** ** | ** **       | ** ** | ** **                                             | ** ** |
| OPERATING  ACTIVITIES:                                                              |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| Cash flows  provided by continuing operations                                       |       | $                                             | 3,369      |                                                 | $          | 13,217                                            |       | $                | —     |                                                   | $          | — |   | $ | 16,586 |   |
| Cash flows (used  in) provided by operating activities from discontinued operations |       | —                                        |       | (1,409                                               | )          | 3,139                                             |       | —           |       | 1,730                                                  |       |
| Net cash provided by operating activities                                           |       | 3,369                                         |       | 11,808                                               |       | 3,139                                             |       | —           |       | 18,316                                                 |       |
|                                                                                |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| INVESTING  ACTIVITIES:                                                              |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| Purchase of  property and equipment                                                 |       | —                                        |       | (3,484                                               | )          | —                                            |       | —           |       | (3,484                                                 | )          |
| Business acquisition,  net of cash received                                         |       | —                                        |       | (6,556                                               | )          | —                                            |       | —           |       | (6,556                                                 | )          |
| Net cash used in  investing activities from continuing operations                   |       | —                                        |       | (10,040                                              | )          | —                                            |       | —           |       | (10,040                                                | )          |
| Net cash used in  investing activities from discontinued operations                 |       | —                                        |       | —                                               |       | (42                                               | )          | —           |       | (42                                                    | )          |
| Net cash used in  investing activities                                              |       | —                                        |       | (10,040                                              | )          | (42                                               | )          | —           |       | (10,082                                                | )          |
|                                                                                |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| FINANCING  ACTIVITIES:                                                              |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| Repayment of  long-term debt                                                        |       | —                                        |       | (642                                                 | )          | —                                            |       | —           |       | (642                                                   | )          |
| Decrease in  deposits and restricted cash                                           |       | —                                        |       | 4,810                                                |       | —                                            |       | —           |       | 4,810                                                  |       |
| Proceeds from  exercise of stock options                                            |       | 2,414                                         |       | —                                               |       | —                                            |       | —           |       | 2,414                                                  |       |
| Excess tax  benefit from stock-based compensation                                   |       | 1,059                                         |       | —                                               |       | —                                            |       | —           |       | 1,059                                                  |       |
| Dividends paid                                                                      |       | (2,270                                        | )          | —                                               |       | —                                            |       | —           |       | (2,270                                                 | )          |
| Net cash  provided by financing activities                                          |       | 1,203                                         |       | 4,168                                                |       | —                                            |       | —           |       | 5,371                                                  |       |
| Increase in cash  and cash equivalents                                              |       | 4,572                                         |       | 5,936                                                |       | 3,097                                             |       | —           |       | 13,605                                                 |       |
| Cash and cash  equivalents at beginning of year                                     |       | 54,365                                        |       | 8,768                                                |       | 14,363                                            | (1)        | —           |       | 77,496                                                 |       |
| Cash and cash  equivalents at end of period                                         |       | $                                             | 58,937     |                                                 | $          | 14,704                                            |       | $                | 17,460     | (2)                                                    | $          | — |   | $ | 91,101 |   |

----

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

(2)             Reportedin assets held for sale at June 30, 2006.

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** **

**Item 2. - Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**(Dollars inthousands, except per share amounts or unless otherwise noted)

**Forward-Looking Information**

This Quarterly Report on Form 10-Qcontains “forward-looking statements” within the meaning of the PrivateSecurities Litigation Reform Act of 1995. Such forward-looking statements arebased on management’s expectations, estimates, projections and assumptions.Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates”and variations of such words and similar expressions are intended to identifysuch forward-looking statements, which include, but are not limited to, growthand business strategies to be implemented and projections of revenues,earnings, performance, cash flows and contract awards. These forward-lookingstatements are subject to risks and uncertainties, which could cause the actualresults or performance of the company to differ materially from those expressedor implied in such statements. These risks and uncertainties include, but arenot limited to, the following:

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

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

·       performance issues with key suppliers, subcontractors and businesspartners;

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

·       the ability to negotiate financing arrangements with lenders;

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

·       demand for and market acceptance of, the company’s products;

·       the effect of economic conditions;

·       the impact of competitive products and pricing;

·       product development, commercialization and technological difficulties;

·       capacity and supply constraints or difficulties;

·       the integration of acquisitions;

·       legislative or regulatory actions impacting defense operations;

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

·       contract continuation and future contract awards.

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

These statements speak onlyas to the date when they are made.  Thecompany makes no commitment to update any forward-looking statement or todisclose any facts, events or circumstances after the date of this QuarterlyReport on Form 10-Q that may affect the accuracy of any forward-lookingstatements.  See “Risk Factors” underItem 1A of the company’s Annual Report on Form 10-K for the year endedDecember 31, 2006, for important factors that could cause the company’sactual results to differ materially from those suggested by the company’sforward-looking statements contained in this Quarterly Report on Form 10-Q.

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***ManagementOverview***

**Introduction**

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

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

Thefollowing discussion should be read in conjunction with the company’sConsolidated Financial Statements and related notes thereto contained in thisQuarterly Report on Form 10-Q for the quarterly period ended June 30, 2007, andthe discussion included in its Annual Report on Form 10-K for the year endedDecember 31, 2006.

**Defense Industry Considerations**

TheU.S. Government, principally the U.S. Department of Defense (“DoD”), is thecompany’s largest customer, and the company expects that direct and indirectsales to the DoD will be its primary source of revenue for the foreseeablefuture.  The company’s largest productarea includes the development, manufacture and support of Unmanned AircraftSystems (“UAS”), including the Shadow® 200 Tactical Unmanned Aircraft System (“TUAS”),which is the tactical UAS platform for the U.S. Army and Marine Corps.  AAI is one of a limited number of companiesto have entered full-rate production and successfully fielded operational UASfor the DoD.

**Company Strategy**

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

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

**Acquisitions and Dispositions**

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

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OnNovember 28, 2006, AAI acquired Symtx, Inc. for a cash purchase priceof $34,300 (exclusive of acquisition costs), with the potential for anadditional payment of up to $5,000 based upon the achievement of a certainfinancial target in 2007.  Symtxcontributed net sales of $10,609 and $22,972 in the three and six months endedJune 30, 2007, respectively.

OnNovember 14, 2006, the company acquired McTurbine Inc. for a cash purchaseprice of $31,000 (exclusive of acquisition costs) subject to adjustment basedupon the closing net worth of McTurbine. On July 5, 2007 the company paid an additional $1,239 in purchaseprice.  McTurbine contributed net salesof $6,829 and $12,830 in the three and six months ended June 30, 2007,respectively.

OnJune 19, 2006, the company acquired Aerosonde Pty Ltd. and Aerosonde NorthAmerica, Incorporated in stock purchase transactions for an aggregate cashpurchase price of $6,338 (exclusive of acquisition costs), with additionalconsideration payable upon the achievement of certain milestones. One of thesemilestones was achieved and resulted in a $500 payment by the company inFebruary 2007.  Aerosonde contributed netsales of $639 and $777 in the three and six months ended June 30, 2007,respectively.

**Other Business Considerations**

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

Salesto the U.S. Government may be affected by changes in procurement policies,budget considerations, changing defense requirements and politicaldevelopments. The influence of these factors, which are largely beyond thecompany’s control, could impact the company’s financial position or results ofoperations.

Inaddition, the company’s programs typically involve the development, applicationand manufacturing of advanced defense and technology systems and products aimedat achieving challenging goals. New technologies may be untested or unproven.In some instances, product requirements or specifications may be modified. As aresult, the company may experience technological and other performance difficulties,which may result in delays, setbacks, cost overruns and product failures inconnection with its programs.

Asa U.S. Government contractor, the company is subject to specific import andexport, procurement and other regulations and requirements. Failure to complywith these regulations and requirements could result in reduced contractualvalue, contract modifications or termination, and the assessment of penaltiesand fines, and could lead to suspension or debarment, for cause, fromgovernment contracting or subcontracting for a period of time. Potentialgrounds for debarment include violations of various statutes, including thoserelated to procurement integrity, export control, government securityregulations, employment practices, the protection of the environment, theaccuracy of records and the recording of costs. Under many governmentcontracts, the company is required to maintain facility and personnel securityclearances complying with DoD requirements.

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

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*** ***

***Results of Operations***

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

The following informationrelates to the continuing operations of the company and its consolidatedsubsidiaries, except where references are made to discontinued operations. Thetransportation operation and the former energy operation are accounted for asdiscontinued operations in the company’s consolidated financial statements forthe three and six months ended June 30, 2007 and 2006 and for the year endedDecember 31, 2006.

**Consolidated Results of Operations**

***Continuing Operations***

The following discussion provides an overview of thecompany’s consolidated results of operations from continuing operations for thethree and six months ended June 30, 2007 and 2006.

Certain reclassifications were made to prior periodsto conform to the current period presentation.

***Summary for the Three and Six MonthsEnded June 30, 2007 Compared to the Three and Six Months Ended June 30, 2006***

Summary financial resultsfor the three and six months ended June 30, 2007 and 2006 are as follows:
| ** **                                                                         | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase  (Decrease)** | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|--------------------------|------------|-----------------------------------------------|------------|--------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                        | ** ** | **2006**                 | ** ** | **$**                                         | ** ** | **%**                    | ** ** | **2007** | ** ** | **2006** | ** ** | **$** | ** ** | **%** | ** ** |
| Net sales                                                                          |       | $                                               | 183,170    |                     | $          | 137,400                                       |       | $                        | 45,770     |   | 33.3 | % | $ | 344,016 |   | $ | 266,101 |   | $ | 77,915 |   | 29.3 | % |
| Operating costs  and expenses                                                      |       | 165,527                                         |       | 124,360                  |       | 41,167                                        |       | 33.1                     |       | 309,627 |   | 239,656 |   | 69,971 |   | 29.2 |   |
| Operating income                                                                   |       | 17,643                                          |       | 13,040                   |       | 4,603                                         |       | 35.3                     |       | 34,389 |   | 26,445 |   | 7,944 |   | 30.0 |   |
| Operating margin                                                                   |       | 9.6                                             | %          | 9.5                      | %          | —                                        |       | —                   |       | 10.0 | % | 9.9 | % | — |   | — |   |
| Non-operating  (expense) income, net                                               |       | (1,112                                          | )          | 219                      |       | (1,331                                        | )          | (607.8                   | )          | (1,936 | ) | (824 | ) | (1,112 | ) | (135.0 | ) |
| Income from  continuing operations, net of income taxes                            |       | 10,415                                          |       | 8,352                    |       | 2,063                                         |       | 24.7                     |       | 20,440 |   | 16,004 |   | 4,436 |   | 27.7 |   |
| (Loss) income  from discontinued operations, net of income tax benefit (provision) |       | (282                                            | )          | 1,907                    |       | (2,189                                        | )          | (114.8                   | )          | (1,112 | ) | 2,823 |   | (3,935 | ) | (139.4 | ) |
| Net income                                                                         |       | 10,133                                          |       | 10,259                   |       | (126                                          | )          | (1.2                     | )          | 19,328 |   | 18,827 |   | 501 |   | 2.7 |   |
|                                                                                    |            |                                                 |            |                          |            |                                               |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Three Months Ended June 30, 2007 Compared to the Three MonthsEnded June 30, 2006***

Net sales for thesecond quarter of 2007 increased 33.3% to $183,170, from $137,400 during thesame period in 2006. Thegrowth in net sales includes $18,024 related to acquisitions made by thecompany in 2006, $8,614 of increased sales for the UAS One System® ground control station including greaterdevelopmental efforts supporting the Extended Range Multi-Purpose UAS programand production of  One System RemoteVideo Terminals, an increase of $5,740 in logistical support for an increasingnumber of fielded Shadow 200 TUAS, $5,557 increased volume on aircraftMaintenance

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Training Device (“MTD”)programs, a $2,064increase in engineering activities primarily related to new UAS initiatives, a$1,541 increase in the Shadow 200 TUAS production program, and other increasesof $4,230.

Operating margin for the second quarter of 2007 was9.6%, 0.1 of a percentage point greater than during the second quarter of2006.  This increase includes favorableperformance on fixed price production contracts and lower non-cash pensionexpense, partially offset by higher intangible asset amortization resultingfrom acquisitions made during the second half of 2006, and a cost overrun of$1,284 (largely due to penalties for late delivery) on a particular Trainingsystem fixed price contract nearing completion.

Net income from continuing operations for the second quarter of 2007increased 24.7% to $10,415, or $0.82 per diluted share, from $8,352, or $0.60per diluted share, during the same period in 2006.

Net income, including results of both continuing and discontinuedoperations, for the second quarter of 2007 decreased 1.2% to $10,133, or $0.80per diluted share, from $10,259, or $0.72 per diluted share, during the sameperiod in 2006.

***Six Months Ended June 30, 2007 Compared to the Six MonthsEnded June 30, 2006***

Net sales for thesix months ended June 30, 2007 increased 29.3% to $344,016 from $266,101 duringthe same period in 2006. Thegrowth in net sales includes $36,526 related to acquisitions made by thecompany in 2006, $16,149 of increased sales for the UAS One System groundcontrol station including greater developmental efforts supporting the ExtendedRange Multi-Purpose UAS program and production of One System Remote VideoTerminals, a $15,491 increase due to increased volume on aircraft MTD programs,a $10,674 increase in logistical support for an increasing number of fieldedShadow 200 TUAS, a $4,145 increase in UAS engineering activities, and $8,089 inother increases.  These increaseswere partially offset by a decrease of$13,159 in the Shadow 200 TUAS production program, primarily due to the timingof material requirements in the first quarter of 2007.

Operating margin for the first six months of 2007 was10.0%, 0.1 of a percentage point greater than during the first six months of2006.  This increase includes favorableperformance on fixed price production contracts and lower non-cash pensionexpense, partially offset by higher intangible asset amortization resultingfrom acquisitions made during the second half of 2006, a cost overrun of $1,284(largely due to penalties for late deliveries) on a particular Training systemfixed price contract nearing completion, higher non-cash long-term incentivecompensation, and lower award fee income due to the timing of recognizing suchaward fees for the Biological Detection Systems (“BDS”) program.

Net income from continuing operations for the six months ended June 30,2007 increased 27.7% to $20,440, or $1.57 per diluted share, from $16,004, or$1.20 per diluted share, during the same period in 2006.

Net income, including results of both continuing and discontinuedoperations, for the six months ended June 30, 2007 increased 2.7% to $19,328,or $1.49 per diluted share, from $18,827, or $1.39 per diluted share, duringthe same period in 2006.

**Discontinued Operations**

***Energy Operation***

On December 29, 2006,United Industrial completed the sale of its wholly owned subsidiary, DetroitStoker Company, which constituted the energy operation. The company’s discontinued energy operationreported income of $2,221 and $3,424, net of income tax for the three and sixmonths ended June 30, 2006, respectively. For additional information regarding the discontinued energy operation,see Note K to the Consolidated Condensed Financial Statements included in thisQuarterly Report on Form 10-Q.

***Transportation Operation***

***Three and Six Months EndedJune 30, 2007 Compared to Three and Six Months Ended June 30, 2006***

The company’s discontinued transportation operation reported a loss of$282, net of income tax benefit, for the three months ended June 30, 2007,compared to a loss of $314, net of income tax benefit, for the same period in2006, and

29

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reporteda loss of $1,112, net of income tax benefit, for the six months ended June 30,2007, compared to a loss of $601, net of income tax benefit, for the sameperiod in 2006.

The company’s discontinued transportation operation incurred $413 and$1,529 of pretax general and administrative expenses attributable to on-going litigationinvolving AAI Corporation’s claims under a labor and materials bond and a lossof $21 and $182 reported by ETI for the three and six months ended June 30,2007, respectively.

The company’s discontinued transportation operation incurred $822 and $1,266of pretax general and administrative expenses to wind down its operationsincluding litigation costs associated with AAI Corporation’s bond claim notedabove, partially offset by net income of $340 and $342 reported by ETI, for thethree and six months ended June 30, 2006, respectively.

For additional information regarding the discontinued transportationoperation, see Note K to the Consolidated Condensed Financial Statementsincluded in this Quarterly Report on Form 10-Q.

**FundedBacklog**

The company’s funded backlog represents the estimated remaining salesvalue of work to be performed under contracts for which funds have beenappropriated or purchase orders received. Backlog at June 30, 2007 and December31, 2006 was as follows:

|                                                                                                                                                                                                                                                                                                        | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **Increase** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|--------------|------------|
| ** **                                                                                                                                                                                                                                                                                             | ** ** | **2007**          | ** ** | **2006**              | ** ** | **$**        | ** ** | **%** | ** ** |
|                                                   |       | $                 | 678,468    |                  | $          | 662,244      |       | $ | 16,224 |   | 2.5 | % |
|                                                                                                                                                                                                                                                                                                        |            |                   |            |                       |            |              |            |  |  |  |  |  |

 

The increase in funded backlog at June 30, 2007 compared toDecember 31, 2006 was generally due to an increase in U.S. Army orders forcontinued logistical support services for delivered Shadow 200 TUAS systems,including systems deployed in Operation Iraqi Freedom, and new Shadow 200 TUASproduction.

The companyreceived $144,547 of funded new orders for products and services during thesecond quarter of 2007, a decrease of $107,644, or 42.7 %, compared to $252,191for the same period in 2006.

The companyreceived $360,240 of funded new orders for products and services during the sixmonths ended June 30, 2007, a decrease of $59,029, or 14.1%, compared to$419,269 for the same period in 2006.

The decrease infunded new orders in 2007 compared to 2006 primarily reflects the timing of neworders for Shadow 200 TUAS production and logistical support for fielded Shadow200 TUAS. The company does not expect this decrease to represent a trend forfuture funded new orders.

**Liquidity and Capital Resources**

**Overview**

The company’s principal sources of liquidity are cash on hand, cashgenerated from operations and a revolving credit facility. On May 31, 2007,United Industrial and its wholly owned subsidiary, AAI Corporation, (the “Borrowers”)entered into an Amended and Restated Revolving Credit Agreement (the “CreditAgreement”).  For additional informationregarding the Credit Agreement see Note O to the Consolidated CondensedFinancial Statements included in this Quarterly Report on Form 10-Q.

As of June 30, 2007, the company had $18,000 outstanding under therevolving credit facility and $7,473 outstanding under the swinglinesubfacility each incurring interest at an annualized rate of 6.07%, and $1,820outstanding under the letter of credit subfacility.  At June 30, 2007 $172,707 was available underthe revolving credit facility.

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The proceeds of the Credit Facility may be used to fund futureacquisitions, to support future purchases of the company’s Common Stock,finance capital expenditures, provide working capital, fund letters of creditand for other general corporate purposes. Based on cash on hand, future cash expectedto be generated from operations and the Credit Facility, the company expects tohave sufficient cash to meet its requirements for at least the next twelvemonths.

The company seeks to complement its growth strategy through selectacquisitions that broaden its product and service offerings, deepen itscapabilities and allow entry into new markets. Acquisition candidates mayinclude public and private companies and divisions, subsidiaries and productlines of such companies. In accordance with this initiative, the companyacquired ESL on April 4, 2005, Aerosonde on June 19, 2006, McTurbineon November 14, 2006 and Symtx on November 28, 2006.

Further acquisitions depend, in part, on the availability of financialresources at an acceptable cost of capital. The company expects to utilize cashon hand and generated by operations, as well as cash available under the CreditFacility, and may involve negotiation of a new credit facility or therenegotiation of credit limits to finance future acquisitions as well aspurchases of the company’s Common Stock and for other general corporatepurposes.  Other sources of capital couldinclude the issuance of common and/or preferred stock, and the placement ofdebt. The company periodically evaluates capital markets and may access suchmarkets when circumstances appear favorable. The company believes thatsufficient capital resources will be available from one or several of thesesources to finance future acquisitions. However, no assurances can be made thatacceptable financing will be available, or that acceptable acquisitioncandidates will be identified, or that any such acquisitions will be accretiveto earnings.

The company conducts a significant amount of business with the U.S.Government. There are currently no indications of a significant change in thestatus of government funding for any of the company’s programs. However, shoulda change in government funding occur, the company’s results of operations,financial position and liquidity could be materially and adversely affected.Such a change could have a significant, adverse impact on the company’sprofitability and stock price.

**Sources and Uses of Cash**

The following is a discussion of thecompany’s major operating, investing and financing activities for the sixmonths ended June 30, 2007 and June 30, 2006. The financial information presented in the table below is summarizedfrom the company’s Consolidated Condensed Statements of Cash Flows for theperiods presented.
| ** **                                                                        | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                        | ** ** | **2007**                                      | ** ** | **2006** | ** ** |
| Operating  activities:                                                            |       |                                          |       |   |   |
| Net cash provided by continuing operations                                        |       | $                                             | 17,853     |   | $ | 16,586 |   |
| Net cash (used in) provided by operating activities  from discontinued operations |       | (491                                          | )          | 1,730 |   |
| Net cash  provided by operating activities                                        |       | 17,362                                        |       | 18,316 |   |
| Net cash  provided by (used in) investing activities by continuing operations     |       | 2,505                                         |       | (10,040 | ) |
| Net cash used in  investing activities from discontinued operations               |       | —                                        |       | (42 | ) |
| Net cash (used  in) provided by financing activities by continuing operations     |       | (57,392                                       | )          | 5,371 |   |
| (Decrease)  increase in cash and cash equivalents                                 |       | $                                             | (37,525    | ) | $ | 13,605 |   |

 

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** **

## ***Operating Activities***

Netcash provided by continuing operations in the six months ended June 30, 2007increased $1,267 to $17,853 compared to the six months ended June 30,2006.  This increase was generally due tothe timing of cash receipts related to milestone billings, offset by inventorypurchases and an increase in accounts payable.

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

Netcash used by the discontinued Transportation operation in the six months endedJune 30, 2007 primarily related to expenses attributable to ongoing litigationinvolving AAI’s claims under a labor and materials bond, as discussed in Note17 to the Consolidated Financial Statements included in Part II, Item 8 of thecompany’s Annual Report on Form 10-K for the year ended December 31, 2006 andNote L to the Consolidated Condensed Financial Statements included in part I,Item 1 of this Quarterly Report on Form 10-Q.

## ***Investing Activities***

Forthe six months ended June 30, 2007 and June 30, 2006, investing activitiesincluded the purchases of property and equipment of $4,346 and $3,484,respectively.  In June 2007, the companysold a portion of its marketable equity securities and received cash of$6,651.  On June 19, 2006, the Companypurchased Aerosonde Pty Ltd and Aerosonde North America for $6,556, net of cashacquired.

## ***Financing Activities***

The company’s financingactivities in the six months ended June 30, 2007 included the use of $78,977for the purchase of the company’s Common Stock, $2,887 for the repayment oflong-term debt and $2,130 for dividends paid, offset by proceeds fromborrowings under the Credit Facility of $25,473 and proceeds from the exerciseof stock options of $960.

The company’s financingactivities in the six months ended June 30, 2006 provided $5,371 of cash,including a decrease in restricted cash of $4,810, proceeds from the exerciseof stock options of $2,414, excess tax benefits from stock-based paymentarrangements of $1,059, offset by dividends paid of $2,270 and repayment oflong-term debt of $642.

**Debt and Related Covenants**

OnSeptember 15, 2004, United Industrial issued and sold $120,000 aggregateprincipal amount of 3.75% Convertible Senior Notes. Under specificcircumstances, United Industrial may have to pay, in cash or a combination ofcash and Common Stock, amounts in addition to the 3.75% fixed interest rate.Such payments, which are defined in the Indenture governing the 3.75%Convertible Senior Notes, include Contingent Interest, Additional Interest, aMake-Whole Interest Payment and a Repurchase Event Make-Whole Premium. See Note7 to the Consolidated Financial Statements included in Part II, Item 8 ofthe company’s Annual Report on Form 10-K for the year ended December 31, 2006for a more detailed discussion of the amounts of these contingent payments andthe circumstances that would trigger such additional payments.

OnMay 31, 2007, United Industrial and its wholly owned subsidiary, AAICorporation, entered into an Amended and Restated Revolving Credit Agreementwith a syndicate of nine financial institutions.  The Credit Agreement supersedes the revolvingcredit agreement established in July, 2005. The Credit Agreement provides for a revolving credit facility (inclusiveof a swingline subfacility and a letter of credit subfacility) in an aggregatecommitted amount of $200,000. The proceeds of the senior secured, revolving creditfacility will be used to provide working capital; to finance capitalexpenditures, potential acquisitions, letters of credit, and share repurchases;and for other general corporate purposes. The revolving credit facility expires on May 31, 2012.  The company was in compliance with all of thecovenants in the Credit Agreement at June 30, 2007.

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** **

**Cash Requirements**

***Capital Expenditures***

Capitalexpenditures in 2007 are expected to be primarily in support of UAS, facilitiesand information technology projects. The company expects 2007 capitalexpenditures to approximate 2006 capital expenditures.

***Other Cash Requirements***

OnMay 11, 2007, United Industrial’s Board of Directors authorized a stockpurchase plan for up to $50,000. The Board also authorized an additional$50,000 of stock purchases for a total of $100,000, contingent on the companyexecuting an amended or new credit facility of at least $200,000 incapacity.  An amendment and restatementof the existing credit facility was completed on May 31, 2007, increasing thecapacity of the facility to $200,000. During the second quarter, UnitedIndustrial purchased 577,544 shares of Common Stock at an average market priceof $59.39. At June 30, 2007, $65,699 remained available under the stockpurchase plan.

OnNovember 17, 2006, United Industrial’s Board of Directors authorized astock purchase plan for up to $50,000. As of March 31, 2007, United Industrial had purchased a total of 933,174shares at an average market price of $53.58, utilizing all funds availableunder the plan.

During the six monthsended June 30, 2007, the company paid two quarterly cash dividends of $0.10 pershare for an aggregate amount of $2,130. Thepayment of any future dividends will be at the discretion of the Board ofDirectors and will depend upon, among other things, the company’s corporatestrategy, future earnings, operations, capital requirements and the company’sfinancial condition and general business conditions.  Should the companydistribute a cash dividend in any quarterly period in excess of $0.10 pershare, the conversion rate provided for in the Indenture governing the 3.75%Convertible Senior Notes would be adjusted.  In addition, thecompany’s Credit Facility imposes certain restrictions on the payment ofdividends.

The company does notexpect significant additional cash requirements to exit the discontinuedTransportation operation subsequent to June 30, 2007, except for legal fees tobe incurred related to claims made by AAI Corporation in pursuit of paymentunder a surety bond. (See Note L to the Consolidated Condensed FinancialStatements included in this Quarterly Report on Form 10-Q for a discussion ofAAI Corporation’s claims.)

For additionalinformation regarding the company’s contingencies, please see the discussionunder the heading “*Contingent Matters*”below.

During 2007 the companyexpects to contribute $4,310 to the UIC Retirement Plan, of which $1,405 waspaid during the six months ended June 30, 2007. Further, the company expects to pay other post-retirement benefits ofapproximately $1,884 in 2007, of which $993 was paid during the six monthsended June 30, 2007.

**ContingentMatters**

**Off-Balance Sheet Arrangements**

Inconnection with certain contracts, the company has committed to certainperformance guarantees. Some of theseperformance guaranties are supported by surety bonds, which totaled $6,723 atJune 30, 2007.  The ability toperform under these guarantees may, in part, be dependent on the performance ofother parties, including partners and subcontractors. If the company is unableto meet these performance obligations, the performance guarantees could have amaterial adverse effect on product margins and the company’s results ofoperations, liquidity or financial position. The company monitors the progressof its partners and subcontractors, and as of June 30, 2007 does not believethat the performance of these partners and subcontractors will adversely affectthese contracts. No assurances can be given, however, as to the liability ofthe company if partners or subcontractors are unable to perform theirobligations.

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** **

**Other Contingent Matters**

Thecompany is involved in various lawsuits and claims. There have been nomaterial changes in any legal proceedings since the company filed its AnnualReport on Form 10-K for the year ended December 31, 2006.  Forfurther information, refer to the Consolidated Financial Statements and Notesthereto included in the company’s Annual Report on Form 10-K for the year endedDecember 31, 2006 and see Note L to the Consolidated Financial Statementsincluded in Part I,  Item 1 of thisQuarterly Report on Form 10-Q.

##### **MarketableEquity Securities**

Thecompany’s investment in marketable equity securities consists of the commonstock of one company in the Aerospace and Defense industry. In June 2007, thecompany sold 369,287 shares for $6,651, at an average price of $18.01,resulting in a realized gain of $37.  Thecompany’s remaining cost basis is $5,988 and the carrying value (fair marketvalue) was $5,474 at June 30, 2007.

Unrealizedholding gains and losses deemed temporary on available-for-sale securities areexcluded from earnings and are reported as a separate component of othercomprehensive income until realized. If an unrealized holding loss is deemed tobe other-than-temporary, such unrealized loss is charged to earnings whenidentified.

InJune 2006, the investee company disclosed the indictment of the investeecompany and its chairman and suspension of certain of its plants from receivingU.S. Government contracts, and possible delisting of its common stock. InOctober 2006, the investee company announced that the suspension ofcertain of its plants from receiving U.S. Government contracts had beenlifted.  On June 27, 2007, the investeecompany announced that two of its eight manufacturing facilities had beensuspended from receiving new U.S. Government contract awards pending completionof a full investigation of certain deliveries by the investee company.  Management continues to evaluate thefinancial stability of the investee company in relation to the severity andduration of the unrealized loss. Based on that evaluation and the company’sability and intent to hold the investment for a reasonable period of timesufficient for a forecasted recovery of fair value, the company does notconsider this investment to be other-than-temporarily impaired at June 30,2007. At June 30, 2007 the cumulative net unrealized loss for this investmentrecorded in accumulated other comprehensive loss was $514.

**Critical Accounting Policies**

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions.  These estimates andassumptions affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements, as well as reported amounts of revenues and expenses during thereporting period.  Judgments andassessments of uncertainties are required in applying the company’s accountingpolicies in many areas.  Actual resultscould differ from these estimates.

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

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** **

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

**InterestRate**

OnSeptember 15, 2004, the company issued and sold $120,000 of 3.75% ConvertibleSenior Notes.  Several features containedin the indenture governing the 3.75% Convertible Senior Notes are consideredembedded derivative instruments and are being accounted for as derivativeinstruments separate from the host contract (i.e., the 3.75% Convertible SeniorNotes). The company will record gains or losses in its Consolidated CondensedStatements of Operations for changes in the fair value of these embeddedderivatives.  The aggregate fair valueassigned to these embedded derivatives at June 30, 2007 was approximately $339and at December 31, 2006 was approximately $403.  Accordingly, the company recognized a gain of$64 for the six months ended June 30, 2007 as the result of the change in fairvalue of the embedded derivatives.

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

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

**Foreign Currency**

In June 2007, thecompany entered into forward contracts with a notional value totaling $10,384in order to hedge British pounds exposures related to the purchase of unmannedaircraft engines.  The company recognizeda gain of $96 in operating income for the six months ended June 30, 2007 as aresult of the change in fair value of the forward contracts.

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

**Marketable Equity Securities**

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

**Item4. - Controls and Procedures**

Thecompany’s management, under the supervision and with the participation of theChief Executive Officer and the Chief Financial Officer, evaluated theeffectiveness of the design and operation of the company’s disclosure controlsand procedures (as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”)) as of June30, 2007. Based on this evaluation, the Chief Executive Officer and ChiefFinancial Officer concluded that, as of June 30, 2007, the company’s disclosurecontrols and procedures were effective to ensure that information required tobe disclosed by the company in the reports that the company files or submitsunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in the Securities and Exchange Commission’s rulesand forms, and that such information is accumulated and communicated to thecompany’s management (including the Chief Executive Officer and Chief FinancialOfficer) to allow timely decisions regarding required disclosures. Based onsuch evaluation, the Chief Executive Officer and Chief Financial Officer haveconcluded that the company is in compliance with Rule 13a-15(e) of theExchange Act.

There has been nochange in the company’s internal control over financial reporting (as definedin Rules 13a-15(f) and 15d-15(f) under the Exchange Act) in the quarter endedJune 30, 2007, that materially affected, or is reasonably likely to materiallyaffect, the company’s internal control over financial reporting.

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       **PARTII - OTHER INFORMATION**

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

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

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

ISSUERPURCHASES OF EQUITY SECURITIES
| **Period(1)**         | ** ** | **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** | ** ** |
|-----------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------|------------|
| 4/1/07 — 4/30/07 |       | —                                             |       | $                                                  | —     |                                                                                                                                           | —     |                                                                                                                                       | $          | — |   |
| 5/1/07 — 5/31/07 |       | 491,207                                            |       | $                                                  | 59.30      |                                                                                                                                           | 491,207    |                                                                                                                                       | $          | 70,873 |   |
| 6/1/07 — 6/30/07 |       | 86,337                                             |       | $                                                  | 59.94      |                                                                                                                                           | 86,337     |                                                                                                                                       | $          | 65,699 |   |

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(1) On May 11, 2007 the company announced that itsBoard of Directors authorized a $50,000 stock purchase plan.  The Board alsoauthorized an additional $50,000 of stock purchases for a total of $100,000,contingent on the company executing an amended or new credit facility of atleast $200,000 in capacity.  An amendmentand restatement of the existing credit facility was completed on May 31, 2007,increasing the capacity of the facility to $200,000.

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

(a)  The Company held its 2007 Annual Meeting ofShareholders on May 18, 2007.

(b)  The following matters were voted upon at themeeting:

(i)                         Thefirst item considered was the election of six directors of the company to serveuntil the 2008 annual meeting of shareholders, and the results of such votingwere as follows:

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| Nominees                     | ** ** | **Votes For** | ** ** | **Withheld** | ** ** |
|------------------------------|------------|--------------------|------------|--------------|------------|
| Thomas A.  Corcoran          |       | 9,871,801          |       | 141,304      |       |
| Glen M. Kassan               |       | 9,885,930          |       | 127,176      |       |
| Warren G.  Lichtenstein      |       | 9,866,686          |       | 146,420      |       |
| Robert F. Mehmel             |       | 9,900,769          |       | 112,336      |       |
| Gen. Richard I.  Neal (Ret.) |       | 9,896,038          |       | 117,068      |       |
| Frederick M. Strader         |       | 9,906,272          |       | 106,883      |       |

 

(ii)                      Thesecond item considered was a proposal to ratify KPMG LLP as the company’sindependent auditor for the year ended December 31, 2007, which was approvedwith 9,859,526 shares voted in favor of such proposal, 127,812 shares votedagainst such proposal, and holders of 25,766 shares abstained.

**Item6. - Exhibits**

| 31.1   |   | Rule 13a-14(a)/15d-14(a) Certification by the Chief  Executive Officer of the Company. |
|--------|--------|----------------------------------------------------------------------------------------|
|   |   |                                                                                   |
| 31.2   |   | Rule 13a-14(a)/15d-14(a) Certification by the Chief  Financial Officer of the Company. |
|   |   |                                                                                   |
| 32.1   |   | Section 1350 Certification by the Chief Executive  Officer of the Company.             |
|   |   |                                                                                   |
| 32.2   |   | Section 1350 Certification 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 9,  2007 |   | By:                           |   | /s/ James H. Perry |
|                  |   |                          |   | James H. Perry |
|                  |   |                          |   | Vice President, Chief Financial Officer, |
|                  |   |                          |   | and Controller |
|                  |   |                          |   | (as duly authorized officer and principal accounting  officer) |

 

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INDEX OF EXHIBITSFILED HEREWITH

**Exhibit No.**

| 31.1   |   | Rule 13a-14(a)/15d-14(a) Certification by the Chief  Executive Officer of the Company. |
|--------|--------|----------------------------------------------------------------------------------------|
|   |   |                                                                                   |
| 31.2   |   | Rule 13a-14(a)/15d-14(a) Certification of the Chief  Financial Officer of the Company. |
|   |   |                                                                                   |
| 32.1   |   | Section 1350 Certification of the Chief Executive  Officer of the Company.             |
|   |   |                                                                                   |
| 32.2   |   | Section 1350 Certification of the Chief Financial  Officer of the Company.             |

 

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