** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

** **

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

 

                       For the quarterly periodended March 31, 2006

 

or

 

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

 

**           **For the transitionperiod from                             to                             

 

Commission File Number: 1-4252* *

 

**UNITED INDUSTRIAL CORPORATION**

(Exact name of registrant as specified in its charter)

 
| **Delaware**                                                    | ** ** | **95-2081809**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                            |       |                                  |
| **124  Industry Lane, Hunt Valley, Maryland**                   | ** ** | **21030**                             |
| (Address of  principal executive offices)                       |       | (Zip Code)                            |

 

**(410) 628-3500**

(Registrant’s telephonenumber, including area code)

 

**NotApplicable**

(Former name, former address and former fiscalyear, if changed 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 SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing 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 ExchangeAct. (Check one):

                Large accelerated filer o                    Accelerated filer x                             Non-acceleratedfiler o

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of 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: 11,380,377 shares of common stock as of April 24,2006.

 

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# **UNITEDINDUSTRIAL CORPORATION**

INDEX
|                                                                                                     | ** ** | **Page** |
|-----------------------------------------------------------------------------------------------------|------------|----------|
| PART I  - FINANCIAL INFORMATION                                                                |       |     |
|                                                                                                |       |     |
| Item  1. Financial Statements                                                                       |       |     |
|                                                                                                |       |     |
| Consolidated Condensed Balance Sheets -                                                             |       |     |
| March 31,  2006 and December 31, 2005                                                     |       |     |
|                                                                                                |       |     |
| Consolidated Condensed Statements of Operations -                                                   |       |     |
| Three Months  Ended March 31, 2006 and 2005                                                    |       |     |
|                                                                                                |       |     |
| Consolidated Condensed Statements of Cash Flows -                                                   |       |     |
| Three Months  Ended March 31, 2006 and 2005                                                    |       |     |
|                                                                                                |       |     |
| Notes to Consolidated Condensed Financial Statements                                                |       |     |
|                                                                                                |       |     |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations |       |     |
|                                                                                                |       |     |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                 |       |     |
|                                                                                                |       |     |
| Item  4. Controls and Procedures                                                                    |       |     |
|                                                                                                |       |     |
| PART II - OTHER INFORMATION                                                                    |       |     |
|                                                                                                |       |     |
| Item  1. Legal Proceedings                                                                          |       |     |
|                                                                                                |       |     |
| Item 6.  Exhibits                                                                                   |       |     |
|                                                                                                |       |     |
| SIGNATURES                                                                                          |       |     |

 

1

----

**PART I- FINANCIAL INFORMATION**

**Item 1. - Financial Statements**

UNITED INDUSTRIALCORPORATION AND SUBSIDIARIESCONSOLIDATED CONDENSED BALANCE SHEETS*(Dollarsin thousands)*
| ** **                                                                | ** ** | **March 31** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| ** **                                                                | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| ASSETS                                                                    |       |              |       |                  |       |
| Current assets:                                                           |       |              |       |                  |       |
| Cash and cash equivalents                                                 |       | $                 | 86,713     |                  | $          | 77,496 |   |
| Marketable equity securities                                              |       | 14,692            |       | 11,617                |       |
| Deposits and restricted cash                                              |       | 2,515             |       | 4,810                 |       |
| Trade receivables, net                                                    |       | 71,659            |       | 69,284                |       |
| Inventories                                                               |       | 33,611            |       | 23,603                |       |
| Prepaid expenses and other current assets                                 |       | 8,533             |       | 9,244                 |       |
| Assets of discontinued operations                                         |       | 12,496            |       | 12,428                |       |
| Total current assets                                                      |       | 230,219           |       | 208,482               |       |
| Deferred income  taxes                                                    |       | 12,771            |       | 12,835                |       |
| Intangible  assets, net                                                   |       | 7,824             |       | 7,946                 |       |
| Goodwill                                                                  |       | 3,646             |       | 3,607                 |       |
| Other assets                                                              |       | 6,223             |       | 6,602                 |       |
| Insurance  receivable — asbestos litigation                          |       | 20,186            |       | 20,186                |       |
| Property and  equipment — net                                        |       | 43,317            |       | 44,743                |       |
| Total assets                                                              |       | $                 | 324,186    |                  | $          | 304,401 |   |
|                                                                      |       |              |       |                  |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                |       |              |       |                  |       |
| Current liabilities:                                                      |       |              |       |                  |       |
| Current portion of long-term debt                                         |       | $                 | 988        |                  | $          | 964 |   |
| Accounts payable                                                          |       | 29,940            |       | 25,787                |       |
| Accrued employee compensation and taxes                                   |       | 16,675            |       | 17,290                |       |
| Other current liabilities                                                 |       | 22,636            |       | 20,147                |       |
| Liabilities of discontinued operations                                    |       | 13,136            |       | 13,287                |       |
| Total current liabilities                                                 |       | 83,375            |       | 77,475                |       |
| Long-term debt                                                            |       | 120,378           |       | 120,723               |       |
| Post-retirement  benefit obligation other than pension                    |       | 19,121            |       | 19,409                |       |
| Minimum pension  liability                                                |       | 30,437            |       | 28,448                |       |
| Accrual for  asbestos obligations                                         |       | 31,450            |       | 31,450                |       |
| Other  liabilities                                                        |       | 2,011             |       | 1,374                 |       |
| Total liabilities                                                         |       | 286,772           |       | 278,879               |       |
| Shareholders’ equity:                                                |       |              |       |                  |       |
| Preferred stock,  par value $1.00 per share; 1,000,000 shares authorized; |       |              |       |                  |       |
| none issued and outstanding                                               |       | —            |       | —                |       |
| Common stock,  par value $1.00 per share; 30,000,000 shares authorized;   |       |              |       |                  |       |
| 11,355,543 and  11,279,379 shares outstanding at March 31, 2006      |       |              |       |                  |       |
| and December 31, 2005, respectively (net of  shares in treasury)     |       | 14,374            |       | 14,374                |       |
| Additional capital                                                        |       | 84,255            |       | 83,799                |       |
| Retained earnings                                                         |       | 47,163            |       | 39,724                |       |
| Treasury stock,  at cost; 3,018,605 and 3,094,769 shares at               |       |              |       |                  |       |
| March 31, 2006 and December 31, 2005,  respectively             |       | (74,976           | )          | (76,868               | )          |
| Accumulated other comprehensive loss, net of tax                          |       | (33,402           | )          | (35,507               | )          |
| Total shareholders’ equity                                           |       | 37,414            |       | 25,522                |       |
| Total liabilities and  shareholders’ equity                          |       | $                 | 324,186    |                  | $          | 304,401 |   |

 

See accompanyingnotes to the consolidated condensed financial statements.

2

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UNITED INDUSTRIALCORPORATION AND SUBSIDIARIESCONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS*(Dollars in thousands, except per share amounts)*(Unaudited)
| ** **                                        | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                        | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Net sales                                         |       | $                                                | 137,619    |   | $ | 107,548 |   |
| Operating costs  and expenses                     |       | 122,507                                          |       | 95,310 |   |
| Operating income                                  |       | 15,112                                           |       | 12,238 |   |
| Non-operating income  and (expense):              |       |                                             |       |   |   |
| Gain on sale of property                          |       | —                                           |       | 7,152 |   |
| Interest income                                   |       | 1,089                                            |       | 1,051 |   |
| Interest expense                                  |       | (1,383                                           | )          | (1,828 | ) |
| Other income (expense), net                       |       | (575                                             | )          | 636 |   |
|                                              |       | (869                                             | )          | 7,011 |   |
| Income from continuing  operations                |       |                                             |       |   |   |
| before income taxes                               |       | 14,243                                           |       | 19,249 |   |
| Provision for  income taxes                       |       | 5,388                                            |       | 6,625 |   |
| Income from  continuing operations                |       | 8,855                                            |       | 12,624 |   |
| (Loss) income from  discontinued operations,      |       |                                             |       |   |   |
| net of income  tax benefit of $155 and income tax |       |                                             |       |   |   |
| provision of  $529 for the three months ended     |       |                                             |       |   |   |
| March 31, 2006 and 2005, respectively        |       | (287                                             | )          | 48 |   |
| Net income                                        |       | $                                                | 8,568      |   | $ | 12,672 |   |
|                                              |       |                                             |       |   |   |
| Basic earnings per  share:                        |       |                                             |       |   |   |
| Income from continuing operations                 |       | $                                                | 0.78       |   | $ | 1.03 |   |
| Loss from discontinued operations                 |       | (0.02                                            | )          | — |   |
| Net income                                        |       | $                                                | 0.76       |   | $ | 1.03 |   |
| Diluted earnings per  share:                      |       |                                             |       |   |   |
| Income from continuing operations                 |       | $                                                | 0.69       |   | $ | 0.84 |   |
| Loss from discontinued operations                 |       | (0.02                                            | )          | — |   |
| Net income                                        |       | $                                                | 0.67       |   | $ | 0.84 |   |

 

See accompanying notes tothe consolidated condensed financial statements.

3

----

UNITED INDUSTRIAL CORPORATION AND SUBSIDIARIESCONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS*(Dollars in thousands)*(Unaudited)
| ** **                                                                         | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                         |       |                                             |       |   |   |
| Net income                                                                         |       | $                                                | 8,568      |   | $ | 12,672 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                             |       |   |   |
| Loss (income) from discontinued operations, net of  taxes                          |       | 287                                              |       | (48 | ) |
| Amortization of debt issuance costs and deferred  financing costs                  |       | 309                                              |       | 244 |   |
| Depreciation and amortization                                                      |       | 2,814                                            |       | 1,944 |   |
| Stock based compensation                                                           |       | 362                                              |       | — |   |
| Gain on sale of property                                                           |       | —                                           |       | (7,152 | ) |
| Deferred income taxes                                                              |       | (131                                             | )          | 2,833 |   |
| Income from equity investment in joint venture                                     |       | (45                                              | )          | (14 | ) |
| Excess tax benefit from stock based compensation                                   |       | (764                                             | )          | — |   |
| Other — net                                                                   |       | 40                                               |       | (276 | ) |
| Changes in  operating assets and liabilities:                                      |       |                                             |       |   |   |
| Increase in trade receivables                                                      |       | (2,375                                           | )          | (3,839 | ) |
| (Increase) decrease in inventories                                                 |       | (9,758                                           | )          | 9,623 |   |
| (Increase) decrease in prepaid expenses and other  current assets                  |       | (43                                              | )          | 3,278 |   |
| Increase (decrease) in accounts payable, accruals  and other current liabilities   |       | 6,755                                            |       | (3,294 | ) |
| Increase in long-term liabilities                                                  |       | 2,337                                            |       | 555 |   |
| Net cash  provided by operating activities from continuing operations              |       | 8,356                                            |       | 16,526 |   |
| Net cash used in  operating activities by discontinued operations                  |       | (506                                             | )          | (2,738 | ) |
| Net cash  provided by operating activities                                         |       | 7,850                                            |       | 13,788 |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES:**                                         |       |                                             |       |   |   |
| Purchases of  property and equipment                                               |       | (1,466                                           | )          | (7,994 | ) |
| Proceeds from  sale of available-for-sale securities                               |       | —                                           |       | 124,619 |   |
| Proceeds from  sale of property                                                    |       | —                                           |       | 7,555 |   |
| Net cash (used  in) provided by investing activities                               |       | (1,466                                           | )          | 124,180 |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                         |       |                                             |       |   |   |
| Repayment of  long-term debt                                                       |       | (321                                             | )          | (334 | ) |
| Repayment of  collateral received from securities lending transaction              |       | —                                           |       | (124,619 | ) |
| Decrease in  deposits and restricted cash                                          |       | 2,295                                            |       | 29,047 |   |
| Proceeds from  exercise of stock options                                           |       | 1,222                                            |       | 344 |   |
| Excess tax  benefit from stock based compensation                                  |       | 764                                              |       | — |   |
| Dividends paid                                                                     |       | (1,127                                           | )          | (1,233 | ) |
| Net cash  provided by (used in) financing activities                               |       | 2,833                                            |       | (96,795 | ) |
| Increase in cash  and cash equivalents                                             |       | 9,217                                            |       | 41,173 |   |
| Cash and cash  equivalents at beginning of year                                    |       | 77,496                                           |       | 80,679 |   |
| Cash and cash  equivalents at end of period                                        |       | $                                                | 86,713     |   | $ | 121,852 |   |

 

See accompanyingnotes to the consolidated condensed financial statements.

4

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UNITED INDUSTRIALCORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

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

Theaccompanying Consolidated Condensed Financial Statements of United IndustrialCorporation (“United Industrial”) and its subsidiaries (collectively, the “Company”)have been prepared in accordance with accounting principles generally acceptedin the United States for interim financial information and with theinstructions to Form 10-Q and Rule 10-01 of RegulationS-X. Accordingly, they do not include all of the information and notes requiredby accounting principles generally accepted in the United States of America(GAAP) for complete financial statements. In the opinion of management, alladjustments (consisting of normal recurring items) considered necessary for afair presentation have been included. Operating results for the three monthperiod ended March 31, 2006 are not necessarily indicative of the resultsthat may be expected for the year ending December 31, 2006. 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 yearended December 31, 2005.

OnApril 4, 2005, the Company acquired ESL Defence Limited (“ESL”), anelectronic warfare systems company based in the United Kingdom. The operatingresults of ESL have been included in the consolidated financial statements ofthe Company since April 4, 2005.

The Company conducts asignificant amount of business with the U.S. Government. No single customerother than the U.S. Government accounted for ten percent or more ofconsolidated net sales in any year.

Thepreparation of financial statements in conformity with GAAP requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements as well as reported amounts of revenues andexpenses during the reporting period. Actual results could differ from theseestimates and those differences could be material. Certain prior year amountshave been reclassified to conform with current year presentation. Specifically,general and administrative expenses have been included in operating costs andexpenses.

**Note B- New Accounting Pronouncements**

Effective January 1, 2006, theCompany adopted Statement of Financial Accounting Standards No. 123(revised 2004), Share-Based Payment (“SFAS 123R”), which requires the Companyto recognize in the income statement the grant-date fair value of  share options and other equity basedcompensation issued to employees and non-employees. The cost of employeeservices is recognized as compensation cost over the period that an employeeprovides service in exchange for the award. See Note E - Stock BasedCompensation for information regarding the Company’s adoption of SFAS 123R.

InNovember 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendmentof ARB No. 43, Chapter 4, which becomes effective for inventory costsincurred by the Company during this quarter. The adoption of SFAS No.151 didnot have a material effect on the Company’s results of operations, financialconditions or cash flows.

**Note C -Segment Information - Continuing Operations**

The Company consists of two reportable segments:Defense and Energy. The operations of the Defense and Energy segments areconducted principally through two wholly owned subsidiaries, AAI Corporation andits subsidiaries (“AAI”) and Detroit Stoker Company (“Detroit Stoker”),respectively. The Company measures its segment performance based on income(loss) before income taxes. Costs related to the continuing operations that arenot identified with the two business segments primarily relate to financingcosts and are grouped under the heading Other. The Company has a transportationoperation that is accounted for as discontinued operations in the accompanyingConsolidated Condensed Financial Statements.

5

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| **(Dollars in thousands)**                          | ** ** | **Defense** | ** ** | **Energy** | ** ** | **Other** | ** ** | **Totals** | ** ** |
|---------------------------------------------------------------|------------|-------------|------------|------------|------------|-----------|------------|------------|------------|
| Three Months Ended  March 31, 2006                       |       |        |       |       |       |      |       |       |       |
| Net sales                                                     |       | $           | 128,701    |       | $          | 8,918     |       | $          | —     |   | $ | 137,619 |   |
| Operating costs  and expenses                                 |       | 115,046     |       | 7,211      |       | 250       |       | 122,507    |       |
| Operating income  (loss)                                      |       | 13,655      |       | 1,707      |       | (250      | )          | 15,112     |       |
| Income from  equity investment in joint venture               |       | 45          |       | —     |       | —    |       | 45         |       |
| Interest income  (expense), net                               |       | 300         |       | 164        |       | (758      | )          | (294       | )          |
| Depreciation and  amortization expense                        |       | 2,767       |       | 47         |       | —    |       | 2,814      |       |
| Income (loss) from  continuing operations before income taxes |       | 14,015      |       | 1,866      |       | (1,638    | )          | 14,243     |       |
|                                                               |            |             |            |            |            |           |            |            |            |  |  |  |  |

 
| **(Dollars in thousands)**                          | ** ** | **Defense** | ** ** | **Energy** | ** ** | **Other** | ** ** | **Totals** | ** ** |
|---------------------------------------------------------------|------------|-------------|------------|------------|------------|-----------|------------|------------|------------|
| Three Months Ended  March 31, 2005                       |       |        |       |       |       |      |       |       |       |
| Net sales                                                     |       | $           | 100,157    |       | $          | 7,391     |       | $          | —     |   | $ | 107,548 |   |
| Operating costs  and expenses                                 |       | 88,039      |       | 7,287      |       | (16       | )          | 95,310     |       |
| Operating income                                              |       | 12,118      |       | 104        |       | 16        |       | 12,238     |       |
| Income from  equity investment in joint venture               |       | 14          |       | —     |       | —    |       | 14         |       |
| Interest income  (expense), net                               |       | 7           |       | 39         |       | (823      | )          | (777       | )          |
| Depreciation and  amortization expense                        |       | 1,869       |       | 75         |       | —    |       | 1,944      |       |
| Income (loss) from  continuing operations before income taxes |       | 19,447      |       | 175        |       | (373      | )          | 19,249     |       |
|                                                               |            |             |            |            |            |           |            |            |            |  |  |  |  |

 

##### **Note D - Earnings Per Share**

Basic earnings per sharefor all periods presented was computed by dividing net earnings for therespective period by the weighted average number of shares of the Company’s commonstock outstanding during the period. Diluted earnings per share was computed bydividing (i) net earnings during the period, adjusted to add back theafter-tax interest and other  chargesincurred on the Company’s $120,000,000 aggregate principal amount of 3.75%Convertible Senior Notes due September 15, 2024, by (ii) the weightedaverage number of shares of Common Stock outstanding during the period,adjusted to add the weighted average number of potential dilutive common sharesthat would have been outstanding upon the assumed exercise of stock optionsusing the treasury stock method and conversion of the 3.75% Convertible SeniorNotes for Common Stock.

Options to purchase21,727 shares of the Company’s Common Stock for the three months ended March 31,2006 and options to purchase 144,000 shares of the Company’s Common Stock forthe three months ended March 31, 2005 were not included in the computationof diluted earnings per share because their impact would be anti-dilutive.

Basic and dilutedearnings per share amounts were computed as follows:
| ** **                                                                      | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                      | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| **(Dollars in thousands, except per share data)** | ** ** | **Earnings**                                         | ** ** | **Shares** | ** ** | **Per Share** | ** ** | **Earnings** | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| Basic Earnings Per  Share                                                       |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
|                                                                            |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Income from continuing operations                                          |       | $                                                    | 8,855      |   | 11,289,402 |   | $ | 0.78 |   | $ | 12,624 |   | 12,316,153 |   | $ | 1.03 |   |
|                                                                            |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Effect of Dilutive  Securities                                                  |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
|                                                                            |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Stock Options                                                                   |       | —                                               |       | 429,694 |   |   |   | — |   | 443,849 |   |   |   |
| 3.75% Convertible Senior Notes                                                  |       | 1,310                                                |       | 3,058,356 |   |   |   | 606 |   | 3,058,356 |   |   |   |
| Diluted Earnings Per  Share                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Income from  continuing operations                                         |       | $                                                    | 10,165     |   | 14,777,452 |   | $ | 0.69 |   | $ | 13,230 |   | 15,818,358 |   | $ | 0.84 |   |

 

6

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**Note E - Stock Based Compensation**

TheCompany adopted the provisions of SFAS 123R on January 1, 2006, using themodified prospective method. Under that transition method, compensation cost isrecognized for all awards granted after the effective date, and to all awardsmodified, repurchased, or cancelled after that date. In addition, compensationcost is recognized on or after the effective date for the portion ofoutstanding awards for which the requisite service has not yet been rendered,based on the grant date fair value of those awards previously calculated andreported in the pro forma disclosures under Statement of Accounting Standards No. 123Accounting for Stock Based Compensation (SFAS No. 123). Net income for thethree months ended March 31, 2006 includes $362,000 net of tax, or $.02per diluted share, of stock based compensation expense. Stock basedcompensation expense was recorded in selling and administrative expensesincluded in operating income. In accordance with the modified prospectiveadoption method of SFAS 123R, financial results for the prior periods have notbeen restated. Based on the number of unvested outstanding awards at March 31,2006, the pretax effect of adopting SFAS No. 123R is expected to increasecompensation cost for the year ended December 31, 2006, by approximately$2,034,000, before tax. Additional compensation cost will be recognized as newoptions are awarded. The Company has not made any material modifications to itsstock-based compensation plans as the result of the issuance of SFAS No. 123R.

Prior to January 1, 2006, theCompany accounted for its stock-based compensation plans in accordance withAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees” (“APB No. 25”), and its related implementation guidance,whereby compensation cost for stock options was recognized in earnings based onthe excess, if any, of the quoted market price of the stock at the grant dateof the award or other measurement date over the amount an employee must pay toacquire the stock. Had compensation cost been determined consistent with thefair value method set forth under SFAS No. 123, for all awards under theplans, income and earnings per share from continuing operations would havedecreased to the pro forma amount indicated below for the three months ended March 31,2005:

|                                                                                                                         | ** ** | **March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|
| **(Dollars in thousands, except per share data)**                                         | ** ** | **2005**           | ** ** |
|                                                                                                                    |       |               |       |
| Income from  continuing operations:                                                                                     |       |               |       |
|                                                                                                                    |       |               |       |
| As reported                                                                                                             |       | $                  | 12,624     |   |
| Deduct: Total employee stock-based compensation  expense determined under fair value method for all awards,  net of tax |       | (208               | )          |
|                                                                                                                    |       |               |       |
| Pro forma income from continuing operations  determined under the fair value based method, net of tax                   |       | $                  | 12,416     |   |
|                                                                                                                    |       |               |       |
| Earnings per  share from continuing operations:                                                                         |       |               |       |
|                                                                                                                    |       |               |       |
| As reported:                                                                                                            |       |               |       |
| Basic                                                                                                                   |       | $                  | 1.03       |   |
| Diluted                                                                                                                 |       | 0.84               |       |
| Pro forma:                                                                                                              |       |               |       |
| Basic                                                                                                                   |       | $                  | 1.01       |   |
| Diluted                                                                                                                 |       | 0.79               |       |

 

InJune 2004, the shareholders approved the 2004 Stock Option Plan (the “2004Plan”). The 2004 Plan provides for the granting of options to key employeeswith respect to an aggregate of up to 600,000 shares of Common Stock. On March 10,2004, the Company’s 1994 Stock Option Plan, as amended (the “1994 Plan”),expired and no additional options may be granted under the 1994 Plan. Optionspreviously granted under the 1994 Plan and granted pursuant to the 2004 Planmay be either “incentive stock options”, within the meaning of Section 422(b) ofthe Internal Revenue Code, or non-

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qualifiedoptions. Shares of Common Stock subject to options may be either authorized andunissued shares, or previously issued shares acquired or to be acquired by theCompany and held in its treasury.

Underthe 2004 Plan and the 1994 Plan (collectively, the “Employee Option Plans”),the exercise price for each share subject to an option granted previously andin the future (in the case of the 2004 plan) may not be less than 100% of themarket value of the Common Stock on the date the option is granted. Optionsgranted are exercisable over a period determined by the Board of Directors, butno longer than ten years after the date they are granted under the 1994 Planand five years for the 2004 Plan. Options granted under the Employee OptionPlans generally vest in three equal installments on the first, second and thirdanniversaries of the date of grant.

InMay 1997, the shareholders approved the 1996 Stock Option Plan forNon-Employee Directors, as amended (the “1996 Plan”), which provides for thegranting of options with respect to an aggregate of up to 300,000 shares ofCommon Stock and expires on July 21, 2006. Options may be exercised up toone-third as of the grant date of an option, and up to an additional one-thirdmay be exercised as of the date of each subsequent annual meeting ofshareholders. Options granted pursuant to the 1996 Plan prior to April 8,2004 expire and are no longer exercisable after ten years from the date ofgrant, and, as the result of an amendment to the 1996 Plan during 2004, optionsgranted after April 8, 2004 expire after five years from the date of grant.The exercise price for each share subject to an option granted may not be lessthan 100% of the market value of the Common Stock on the date the option isgranted.

Inconnection with the adoption by the Board of Directors in March 2006 ofthe 2006 Long Term Incentive Plan, subject to the approval of such plan by theshareholders of the Company at the Annual Meeting of Shareholders to be held May 18,2006, the Board of Directors amended the 1996 Plan to provide for a final awardunder the 1996 Plan of a fully exercisable stock option to purchase 5,000shares to two directors (if re-elected to office) who otherwise would havereceived automatic grants for 15,000 shares exercisable under the old formuladescribed above.

Asummary of stock option activity under all plans is as follows:
| **(Shares and dollars in thousands)** | ** ** | **Number of  Shares** | ** ** | **Aggregate  Intrinsic  Value** | ** ** | **Remaining  Contractual  Term (Yrs)** | ** ** | **Weighted -  Average  Exercise Price** | ** ** |
|-----------------------------------------------------------|------------|----------------------------|------------|---------------------------------|------------|---------------------------------------------|------------|---------------------------------------------------|------------|
|                                                      |       |                       |       |                            |       |                                        |       |                                              |       |
| Balance at  December 31, 2005                        |       | 945                        |       | —                          |       | —                                      |       | $                                                 | 20.73      |   |
| Granted                                                   |       | 143                        |       | —                          |       | —                                      |       | $                                                 | 53.73      |   |
| Exercised                                                 |       | (76                        | )          | —                          |       | —                                      |       | $                                                 | 16.04      |   |
| Cancelled                                                 |       | (7                         | )          | —                          |       | —                                      |       | $                                                 | 19.14      |   |
| Balance at  March 31, 2006                           |       | 1,005                      |       | $                               | 35,318     |                                        | 5.41       |                                              | $          | 25.80 |   |
|                                                      |       |                       |       |                            |       |                                        |       |                                              |       |
| Exercisable at  March 31, 2006                       |       | 613                        |       | $                               | 26,522     |                                        | 5.75       |                                              | $          | 17.69 |   |
| Unexercisable at  March 31, 2006                     |       | 392                        |       | $                               | 8,796      |                                        | 4.88       |                                              | $          | 38.49 |   |
| Available for future  grants                              |       | 278                        |       |                            |       |                                        |       |                                              |       |

 

Asummary of nonvested stock option activity under all plans is as follows:
| **(Shares and dollars in thousands)** | ** ** | **Number of  Shares** | ** ** | **Weighted -  Average Grant  Date  Fair Value** | ** ** |
|-----------------------------------------------------------|------------|----------------------------|------------|----------------------------------------------------------------|------------|
|                                                      |       |                       |       |                                                           |       |
| Nonvested at  1/1/2006                                    |       | 366                        |       | $                                                              | 9.29       |   |
| Granted                                                   |       | 143                        |       | $                                                              | 18.60      |   |
| Vested                                                    |       | (115                       | )          | $                                                              | 8.21       |   |
| Cancelled                                                 |       | (2                         | )          | $                                                              | 7.68       |   |
| Nonvested at  March 31, 2006                         |       | 392                        |       | $                                                              | 13.01      |   |
|                                                      |       |                       |       |                                                           |       |

 

8

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As of March 31, 2006, there was$4,646,000 of total unrecognized compensation cost related to nonvested share-basedcompensation arrangements granted under the plans. That cost is expected to berecognized over a three year period.

 

The fair value of each option grant is estimated on the date of grantusing the Black-Scholes option pricing model to estimate the fair value ofemployee stock options based on the exercise price of the option, the expectedterm of the option, the current price of the underlying share, the expectedvolatility of the price of the underlying share over the expected life of theoption, the expected dividends on the underlying share and the risk-freeinterest rate for the expected term of the option as of the date of grant usingthe following assumptions:

 
| ** **               | ** ** | **2006 Grants** | ** ** | **2005 Grants** | ** ** |
|--------------------------|------------|----------------------|------------|----------------------|------------|
| Risk-free  interest rate |       | 4.70%                |       | 3.99%                |       |
| Expected  dividend yield |       | 0.75%                |       | 1.19%                |       |
| Expected  volatility     |       | 38.52%               |       | 36.86%               |       |
| Expected life            |       | 4.0  years           |       | 5.0  years           |       |

 

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##### **NoteF - Marketable Equity Securities**

##### Available-for-salesecurities are recorded at fair value. Unrealized holding gains and losses, netof the related tax effect, on available-for-sale securities are excluded fromearnings and are reported as a separate component of other comprehensive incomeuntil realized. Realized gains and losses from the sale of available-for-salesecurities are determined on a specific-identification basis. Marketable equitysecurities at March 31, 2006, represent common stock of one entity. Managementexpects that these securities will be sold within one year. An unrealized gainof $1,999,000, net of tax, was recorded in other comprehensive income at March 31,2006.

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

Inventories consisted of the following components:
| ** **                           | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(Dollars in thousands)** | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| Finished goods  and work-in-process  |       | $                  | 31,793     |                  | $          | 21,601 |   |
| Materials and  supplies              |       | 1,818              |       | 2,002                 |       |
| Total inventories                    |       | $                  | 33,611     |                  | $          | 23,603 |   |

 

Intangible assetsconsisted of the following components: 
| ** **                                | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(Dollars in thousands)**      | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| Customer  relationships                   |       | $                  | 1,994      |                  | $          | 2,054 |   |
| Internally developed  technology          |       | 2,260              |       | 2,329                 |       |
| Intangible  pension asset                 |       | 3,288              |       | 3,288                 |       |
| Patents and  other intangible assets, net |       | 282                |       | 275                   |       |
| Total intangible assets                   |       | $                  | 7,824      |                  | $          | 7,946 |   |

 

Customer relationships andinternally developed technology represents assets acquired in connection withthe purchase of ESL in April 2005, and are being amortized on astraight-line basis through 2012. Patents and other intangible assets representassets acquired in connection with the purchase of ACL Technologies Inc., anindirect, wholly owned subsidiary of the Company, and are being amortizedprimarily on a straight-line basis through 2007. Amortization expense for the three monthsended March 31, 2006 was $184,000.

Goodwill
| ** **                           | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(Dollars in thousands)** | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| Goodwill at  acquisition             |       | $                  | 3,831      |                  | $          | 3,831 |   |
| Foreign currency  translation        |       | (185               | )          | (224                  | )          |
| Total                                |       | $                  | 3,646      |                  | $          | 3,607 |   |

 

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The Company recorded goodwillrelated to the acquisition on April 4, 2005 of ESL. The purchase price ofthis business was allocated to the estimated fair value of net tangible andintangible assets acquired, with the excess of $3,831,000 recorded as goodwill.Goodwill will be tested annually for impairment, or on an interim basiswhenever events or changes in circumstances indicate that the fair value isbelow the carrying value.

Otherassets consisted of the following components:
| ** **                           | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(Dollars in thousands)** | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| Investment in  affiliate             |       | $                  | 1,857      |                  | $          | 1,812 |   |
| Debt issuance  costs, net            |       | 3,393              |       | 3,639                 |       |
| Other                                |       | 973                |       | 1,151                 |       |
| Total                                |       | $                  | 6,223      |                  | $          | 6,602 |   |

 

Other current liabilities consisted of the followingcomponents:
| **(Dollars in thousands)** | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Customer  advances                   |       | $                        | 9,779      |                        | $          | 9,936 |   |
| Reserve for  contract losses         |       | 910                      |       | 1,379                       |       |
| Accrued interest  expense            |       | 224                      |       | 1,349                       |       |
| Federal income  tax payable          |       | 6,749                    |       | 2,296                       |       |
| Other accrued  costs                 |       | 4,974                    |       | 5,187                       |       |
| Total other  current liabilities     |       | $                        | 22,636     |                        | $          | 20,147 |   |

 

Nocash was paid for Federal income taxes during the three months ended March 31,2006 and 2005. Cash paid for interest during the three months ended March 31,2006 and 2005 was $2,260,000 and $2,268,000, respectively.

##### **NoteH - Revolving Credit Facility**

On July 18, 2005,the Company and AAI Corporation, a wholly owned subsidiary of the Company  (“AAI”), entered into a $100,000,000four-year revolving credit agreement (the “Credit Agreement”) with a syndicateof six banks, consisting of SunTrust Bank, as administrative agent and issuingbank, Citibank, F.S.B., Key Bank, PNC Bank, Commerce Bank and Provident Bank. TheCredit Agreement provides for a credit facility (the “Credit Facility”)consisting of a $100,000,000 Senior Secured Revolving Credit Facility with a$5,000,000 Swing Line and a $100,000,000 Letter of Credit sub-facility. Theinterest rate for loans made under this facility is thirty-day London InterbankOffered Rate (“LIBOR”) plus an applicable margin between 1.25% and 2.00% basedupon AAI’s leverage ratio. As of March 31, 2006, the Company had $800,527outstanding under the Letter of Credit sub-facility.

Pursuant to the terms ofthe Credit Agreement and the parent guaranty agreement dated as of July 18,2005 (the “Parent Guaranty”), the Company has guarantied AAI’s obligations. Inaddition, certain of AAI’s subsidiaries entered into a subsidiary guarantyagreement, dated as of July 18, 2005, whereby they guarantied the paymentof AAI’s obligation under the Credit Agreement (the “Subsidiary Guaranty”). Theproceeds of the Credit Facility will be used to fund future acquisitions,finance capital expenditures, provide working capital, fund letters of credit,and for other general corporate purposes. The Credit Agreement containsaffirmative, negative and financial covenants customary for facilities of thistype, including, among other things, maintenance of certain leverage and fixedcharge coverage ratios, as well as minimum consolidated tangible net worthratios, limits on the incurrence of debt and preferred equity, limits on theincurrence of liens, a limit on the making of dividends or distributions,limits on sales of assets and a limit on capital expenditures.

In connection with theCredit Agreement, United Industrial, AAI and certain of AAI’s subsidiariesentered into a security agreement, dated as of July 18, 2005, whereby theygranted the lenders under the Credit Agreement, a first priority securityinterest in all of their assets. The security interest was granted, withrespect to AAI, to secure its obligations under the

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Credit Agreement andother loan documents to which it is a party, with respect to United Industrial,to secure its obligations under the Parent Guaranty and other loan documents towhich it is a party, and with respect to AAI’s subsidiaries, to secure theirobligations under the Subsidiary Guaranty and other loan documents to whichthey are a party.

In connection with theCredit Agreement, United Industrial entered into a parent pledge agreement,dated as of July 18, 2005, pursuant to which it pledged the capital stockof AAI to secure its obligations under the Parent Guaranty, the CreditAgreement, and other loan documents to which it is a party. In addition, AAIand certain of its subsidiaries entered into a borrower pledge agreement, datedas of July 18, 2005, pursuant to which they pledged the capital stock oftheir subsidiaries, with respect to AAI, to secure its obligations under theCredit Agreement and other loan documents to which it is a party, and withrespect to its subsidiaries, to secure their obligations under the SubsidiaryGuaranty and other loan documents to which they are a party.

In connection with theCredit Agreement, AAI and certain of its subsidiaries entered into an environmentalindemnity agreement, dated as of July 18, 2005, pursuant to which theyagreed to indemnify the lenders under the Credit Agreement with respect tocertain hazardous materials or environmental conditions that may affect certainproperty that the lenders encumbered in connection with the Credit Agreement.

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**Note I - Pension and OtherPost-retirement Benefits**

The following table provides thecomponents of net periodic pension benefit cost for the three months ended March 31,2006 and 2005:
| ** **                           | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------|------------|--------------------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
|                                 |       |                                             |       |   |   |
| Service cost                         |       | $                                                | 1,195      |   | $ | 809 |   |
| Interest cost                        |       | 2,610                                            |       | 2,579 |   |
| Expected return  on plan assets      |       | (3,208                                           | )          | (3,209 | ) |
| Net amortization and  deferral:      |       |                                             |       |   |   |
| Amortization of prior service cost   |       | 183                                              |       | 69 |   |
| Amortization of actuarial loss       |       | 1,260                                            |       | 1,054 |   |
|                                 |       |                                             |       |   |   |
| Net periodic  pension benefit cost   |       | $                                                | 2,040      |   | $ | 1,302 |   |

 

The following table provides thecomponents of post-retirement benefit obligation cost other than pension forthe three months ended March 31, 2006 and 2005:
| ** **                           | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------|------------|--------------------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
|                                 |       |                                             |       |   |   |
| Service cost                         |       | $                                                | 48         |   | $ | 48 |   |
| Interest cost                        |       | 314                                              |       | 297 |   |
| Net amortization and  deferral:      |       |                                             |       |   |   |
| Amortization of prior service cost   |       | (3                                               | )          | (5 | ) |
| Amortization of actuarial loss       |       | 46                                               |       | 3 |   |
|                                 |       |                                             |       |   |   |
| Other  post-retirement benefit cost  |       | $                                                | 405        |   | $ | 343 |   |

 

The following tableprovides the Company’s contributions to and benefits paid under pension andpost-retirement benefit plans:
| ** **                                                                 | ** ** | **Pension Benefits  Three Months Ended  March 31,** | ** ** | **Post-retirement Benefit  Obligation Other  Than Pension  Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------|------------|
| **(Dollars in thousands)**                                       | ** ** | **2006**                                                                | ** ** | **2005**                                                                                                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                       |       |                                                                    |       |                                                                                                                     |       |   |   |   |   |
| Expected fiscal year  contributions reported at the end of the prior year: |       |                                                                    |       |                                                                                                                     |       |   |   |   |   |
| Employer                                                                   |       | $                                                                       | 935        |                                                                                                                     | $          | 244 |   | $ | 2,689 |   | $ | 3,007 |   |
| Employee                                                                   |       | —                                                                  |       | —                                                                                                                   |       | — |   | — |   |
|                                                                       |       | 935                                                                     |       | 244                                                                                                                      |       | 2,689 |   | 3,007 |   |
|                                                                       |       |                                                                    |       |                                                                                                                     |       |   |   |   |   |
| Actual  contributions made in the current year                             |       | 51                                                                      |       | 37                                                                                                                       |       | 693 |   | 838 |   |
| Remaining  contributions expected to be made in the current year           |       | 884                                                                     |       | 207                                                                                                                      |       | 1,930 |   | 2,255 |   |
| Total expected  current year contributions                                 |       | 935                                                                     |       | 244                                                                                                                      |       | 2,623 |   | 3,093 |   |
| Difference from  expectations at end of the prior year                     |       | $                                                                       | —     |                                                                                                                     | $          | — |   | $ | (66 | ) | $ | 86 |   |

 

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

The following table sets forth the components of othercomprehensive income and total comprehensive income:
| ** **                                           | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(Dollars in thousands)**                 | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Net income                                           |       | $                                                | 8,568      |   | $ | 12,672 |   |
|                                                 |       |                                             |       |   |   |
| Other comprehensive  income:                         |       |                                             |       |   |   |
| Unrealized gain on marketable securities, net of tax |       | 1,999                                            |       | 4 |   |
| Gain on foreign currency translation                 |       | 106                                              |       | — |   |
| Total  comprehensive income                          |       | $                                                | 10,673     |   | $ | 12,676 |   |

 

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

InDecember 2001, a decision was made to discontinue the transportationbusiness. Further, the Company ceased to accept new transportation business atthat time. It was decided that AAI would sell all or part of the transportationbusiness and “runoff” the operations for any remaining contractual obligations.  In July 2002, AAI sold twotransportation overhaul contracts with the New Jersey Transit Corporation andthe Maryland Transit Administration and related assets and liabilities toALSTOM Transportation, Inc. After the sale of the two transportationoverhaul contracts, the Company’s transportation operations consisted primarilyof one remaining production contract between Electric Transit, Inc. (“ETI”)and San Francisco Municipal Railway (“MUNI”). AAI owns a 35% interest in theshares of ETI, with the remaining 65% owned by a Czech company, Skoda. AAIcontinued to perform its obligations under its subcontract with ETI on the MUNIproject, and continues to provide ETI with personnel and other financialsupport in order to enable ETI to satisfy certain of its remaining commitmentsto MUNI.

Following Skoda’s bankruptcy declaration in 2001 in theCzech Republic, effective as of 2002, AAI began recording 100%, instead of 35%,of ETI’s losses and income in accordance with the equity method of accountingapplicable to minority shareholders. The Company has determined that ETI is avariable interest entity, for which the Company is the primary beneficiary, inaccordance with FIN 46R, which became effective for years beginning after December 31,2002. The financial statements for ETI have been consolidated for the yearended December 31, 2005 and the three months ended March 31, 2006 and2005. Prior to the filing of the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2005, the Company accounted for itsinvestment in ETIunder the equity method. The Company accounts forits remaining transportation operation as discontinued operations, includingthe consolidation of ETI as a variable interest entity.

Summary results of thediscontinued transportation operation, which have been reported separately as(loss) income from discontinued operations in the accompanying ConsolidatedStatements of Operations, were as follows:
| ** **                                                       | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(Dollars in thousands)**                             | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Sales                                                            |       | $                                                | 393        |   | $ | 1,012 |   |
| Cost of sales                                                    |       | (255                                             | )          | 488 |   |
| General and  administrative expenses                             |       | (561                                             | )          | (889 | ) |
| Other expense                                                    |       | (19                                              | )          | (34 | ) |
| (Loss) income  before income taxes                               |       | (442                                             | )          | 577 |   |
| Benefit  (provision for) from income taxes                       |       | 155                                              |       | (529 | ) |
| (Loss) income  from discontinued operations, net of income taxes |       | $                                                | (287       | ) | $ | 48 |   |

 

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During2005, ETI was able to favorably resolve certain operational risks associatedwith the execution of its last remaining program. ETI reported net income forthe three months ended March 31, 2006 and 2005 of approximately $2,000 and$533,000, respectively. Offsetting this income in 2006 was $289,000, net oftax, of general and administrative expenses incurred by the Company’sdiscontinued transportation operation to wind down its operation. Partiallyoffsetting this income in 2005 was approximately $485,000, net of tax, ofgeneral and administrative expenses consisting primarily of professional feesrelated to a certain litigation matter involving a recovery claim initiated bythe Company.

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 operating activities by discontinued operationsin the accompanying Consolidated Statements of Cash Flows:
| ** **                                                        | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(Dollars in thousands)**                              | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Net (loss)  income                                                |       | $                                                | (287       | ) | $ | 48 |   |
| Changes in  operating assets and liabilities                      |       | (266                                             | )          | (4,039 | ) |
| Deferred income  taxes                                            |       | 47                                               |       | 1,253 |   |
| Net cash used in  operating activities by discontinued operations |       | $                                                | (506       | ) | $ | (2,738 | ) |

 

Therewere no financing or investing activities in the three months ended March 31,2006 or 2005.

Assets and liabilities of thediscontinued transportation operation, which have been reported and summarizedin the accompanying Consolidated Balance Sheets as Assets and Liabilities ofdiscontinued operations, respectively, were as follows:
| ** **                                | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(Dollars in thousands)**      | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| Current Assets:                           |       |               |       |                  |       |
| Cash                                      |       | $                  | 751        |                  | $          | 606 |   |
| Trade receivables                         |       | 73                 |       | 103                   |       |
| Prepaid expenses and other current assets |       | 150                |       | 150                   |       |
| Deferred income taxes                     |       | 11,522             |       | 11,569                |       |
|                                      |       | $                  | 12,496     |                  | $          | 12,428 |   |
|                                      |       |               |       |                  |       |
| Current  Liabilities:                     |       |               |       |                  |       |
| Accounts payable                          |       | 338                |       | 256                   |       |
| Accrued employee compensation and taxes   |       | 106                |       | 159                   |       |
| Other current liabilities                 |       | 11,562             |       | 11,270                |       |
| Accrual for contract losses               |       | 1,130              |       | 1,602                 |       |
|                                      |       | $                  | 13,136     |                  | $          | 13,287 |   |

 

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**Note L - Commitments and Contingencies**

In the normal course of its continuing anddiscontinued business, various lawsuits, claims and legal proceedings have beenor may be instituted or asserted against or by the Company. Based on currentlyavailable facts, the Company believes, except as otherwise set forth below,that the disposition of matters pending or asserted against the Company willnot have a material adverse effect on the Company’s financial position, resultsof operations or liquidity.

ASBESTOS

History

United Industrial and Detroit Stoker have been named asdefendants in asbestos-related personal injury litigation. Neither UnitedIndustrial nor Detroit Stoker fabricated, milled, mined, manufactured ormarketed asbestos, and neither United Industrial nor Detroit Stoker made orsold insulation products or other construction materials that have beenidentified as the primary cause of asbestos-related disease in the vastmajority of claimants. Rather, United Industrial and Detroit Stoker made severalproducts, 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.

Cases involving United Industrial and Detroit Stoker typicallyname 80 to 100 defendants. As of this date, United Industrial and DetroitStoker have not gone to trial with respect to any asbestos-related personalinjury claims, although there is no assurance that trials may not occur in thefuture. Accordingly, as of this date, neither United Industrial nor DetroitStoker have been required to pay any punitive damage awards, although there canbe no assurance this might not occur in the future. In addition, as of thisdate, some previously pending claims have been settled or dismissed (with orwithout prejudice). There is no assurance, however, that dismissals andsettlements will occur at the same rate, if at all, or that claims that havebeen dismissed without prejudice will not be re-filed.

Defenses

Management continues to believe that a majority of theclaimants in pending cases will not be able to demonstrate that they have beenexposed to United Industrial’s or Detroit Stoker’s asbestos-containing productsor suffered any compensable loss as a result of any such exposure. This beliefis based in large part on two factors: the limited number ofasbestos-containing products and betterments sold by United Industrial andDetroit Stoker and United Industrial’s and Detroit Stoker’s access to sales,service, and other historical business records going back over 100 years, whichallow United Industrial and Detroit Stoker to determine to whom products weresold, the date of sale, the installation site and, in some instances, the dateproducts were removed from service. In addition, because of the limited andrestricted placement of the asbestos-containing products, even at sites where aclaimant can verify his or her presence during the same period those productswere installed, liability cannot be presumed because, even if an individualcontracted an asbestos-related disease, not everyone who was employed at a sitewas exposed to United Industrial’s or Detroit Stoker’s asbestos-containingproducts.

These factors have allowed United Industrial and DetroitStoker to effectively manage their asbestos-related claims.

Settlements

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

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Insurance Coverage

The insurance coverage potentially available to UnitedIndustrial and Detroit Stoker is substantial. Following the institution ofasbestos litigation, an effort was made to identify all of United Industrial’sand Detroit Stoker’s primary and excess insurance carriers from 1940 through1990. There were approximately 40 such carriers, all of which were put onnotice of the litigation. In November of 1999, a Participation Agreementwas entered into among United Industrial, Detroit Stoker and three of theirprimary insurance carriers. The Participation Agreement is an advanceunderstanding that supplements all of the contracts of insurance, withoutaltering the coverage of those contracts, which creates an administrative frameworkwithin which the insurers and United Industrial and Detroit Stoker can moreefficiently and effectively manage the large quantity of on-going litigation.

Any party may terminate the Participation Agreement, withoutcause, by giving the other parties 60 days prior written notice. Termination ofthe Participation Agreement does not affect any rights or obligations of theparties that have accrued under the Participation Agreement on or before theeffective date of the termination, nor does it affect any rights outside of theParticipation Agreement.

Although the carriers can opt out of the ParticipationAgreement on 60 days notice, management does not believe that this will occurin the immediate or near term. For example, unless a carrier professes to havemet the limits of its liability, it would have to consider the potentiallygreater costs of permitting United Industrial and Detroit Stoker to handletheir own cases. Further, opting out of the Participation Agreement does notexculpate liability on the part of the carrier.

United Industrial’s counsel retained a consulting firm withexpertise in the field of evaluating insurance coverage and the likelihood ofrecovery for claims, such as costs incurred in connection with asbestos-relatedinjury claims. In 2002 and 2003, that firm worked with United Industrial toproject the insurance coverage of United Industrial and Detroit Stoker forasbestos-related claims. In 2005, United Industrial engaged the same firm toupdate its insurance analysis and projection. In each case, the insuranceconsultant’s conclusions were based primarily on a review of United Industrial’sand Detroit Stoker’s coverage history, application of reasonable assumptions tothe allocation of coverage consistent with industry standards, an assessment ofthe creditworthiness of the insurance carriers, and the knowledge andexperience of the consulting firm in the field of insurance coverage analysis.The insurance consultant also considered the Participation Agreement.

Based on the assumptions employed by and the report preparedby the insurance consultant, other variables, and the report prepared by theasbestos liability consultant, which is discussed below, the Company recordedan estimated insurance recovery as of December 31, 2005, of $20,186,000reflecting the estimate determined to be probable of being available tomitigate United Industrial’s and Detroit Stoker’s potential asbestos liabilitythrough 2015, and as of December 31, 2002, of $20,343,000, reflecting theestimate determined to be probable of being available to mitigate UnitedIndustrial’s and Detroit Stoker’s potential asbestos liability through 2012. TheCompany continuously evaluates this insurance receivable and believes it isappropriately valued at March 31, 2006.

Quantitative Claims Information

As of March 31, 2006, United Industrial and/or DetroitStoker were named in asbestos litigation pending in Arkansas, California,Louisiana, Michigan, Minnesota, Mississippi, New Jersey, New York, North Dakotaand Rhode Island. As of March 31, 2006, there were approximately 10,159total pending claims asserted in law suits, compared to approximately 11,059pending claims asserted in lawsuits as of December 31, 2005 andapproximately 19,447 pending claims as of March 31, 2005. The decrease inclaims was primarily attributable to dismissal of cases initially brought inMississippi in 2002-2003. In 2004, Detroit Stoker was named as adefendant in two cases in Arkansas alleging personal injuries to one andapproximately 199 plaintiffs (subsequently reduced to 42), respectively, as aresult of silica and/or refractory ceramic fiber exposure, in addition toasbestos exposure. The pleadings in these two cases name approximately 32 and68 defendants,

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respectively. Because claims are often filed and disposed ofby dismissal or settlement in large numbers, the amount and timing ofsettlements and the number of open claims during a particular period canfluctuate from period to period and may not be indicative of the trend infuture claims, settlements or dismissals. In addition, most of these lawsuitsdo not include specific dollar claims for damages, and many include a number ofplaintiffs and multiple defendants. Therefore, the Company cannot provide anymeaningful disclosure about the total amount of the damages sought. Inaddition, the direct asbestos-related expenses of United Industrial and DetroitStoker for defense and indemnity for the past five years were not material.

A significant increase in the volume of asbestos-relatedbodily injury cases arose in Mississippi beginning in 2002 and extended throughmid-year 2003. Management believes this peak in the volume of claims inMississippi was due to the passage of tort reform legislation (applicable toasbestos-related injuries), which became effective at the end of 2002 and whichresulted in a large number of claims being filed in Mississippi by plaintiffsseeking to ensure their claims would be governed by the law in effect prior tothe passage of tort reform.

In 2002, United Industrial’s counsel engaged a consultingfirm with expertise in the field of evaluating asbestos bodily-injury claims toassist United Industrial in projecting the future asbestos-related liabilitiesand defense costs of United Industrial and Detroit Stoker. In 2005, UnitedIndustrial’s counsel engaged the same consulting firm to update the report itissued in 2003. In each case, the methodology used by the asbestos liabilityconsultant to project future asbestos-related costs is based primarily onestimates of the labor force exposed to asbestos in United Industrial’s andDetroit Stoker’s products, epidemiological modeling of asbestos-related diseasemanifestation, and estimates of claim filings and settlement and defense coststhat may occur in the future. Using this information, in each case the asbestosliability consultant estimated the number of future claims that would be filed,as well as the related costs that would be incurred in resolving those claims.United Industrial’s and Detroit Stoker’s claims history prior to 2002 was not asignificant variable in developing the estimates because such history wasdetermined by the consulting firm not to be significant as compared to thenumber of claims filed in 2002.

Projecting future asbestos costs is subject to numerousvariables that are extremely difficult to predict. In addition to thesignificant uncertainties surrounding the number of claims that might bereceived, other variables include the type and severity of the disease allegedby each claimant, the long latency period associated with asbestos exposure,dismissal rates, costs of medical treatment, the impact of bankruptcies ofother companies that are co-defendants in claims, uncertainties surrounding thelitigation process from jurisdiction to jurisdiction and from case to case, andthe impact of potential changes in legislative or judicial standards.Furthermore, any predictions with respect to these variables are subject toeven greater uncertainty as the projection period lengthens. In light of theseinherent uncertainties, United Industrial’s and Detroit Stoker’s limited claimshistory and consultation with the asbestos and insurance consultants, theCompany believes that ten years is the most reasonable period for recognizing areserve for future costs, and that costs that might be incurred after thatperiod were not reasonably estimable. As a result, the Company also believesthat its ultimate net asbestos-related contingent liability (i.e. its indemnityor other claim disposition costs plus related legal fees less insurancerecoveries) cannot be estimated with certainty.

Based on the assumptions and results reflected in the 2005and 2003 reports, prepared by the asbestos liability consultant and othervariables, the Company recorded an undiscounted liability for its best estimateof liabilities for asbestos-related matters in the amount of $31,450,000 as of March 31,2006 and $ 31,852,000as of March 31, 2005, respectively, including damagesand defense costs, and its insurance receivables for asbestos-relatedliabilities were $20,186,000 and $20,343,000 at March 31, 2006 and 2005,respectively. These figures reflect the Company’s policy of maintaining aten-year estimate of future liability, the period in which such costs aredeemed to be reasonably estimable.

Given the inherent uncertainty in making futureprojections, and the fact that United Industrial and Detroit Stokerperiodically receive potentially material new information from claimants andtheir counsel that relates to the factual basis of their asserted andunasserted claims, United Industrial and Detroit Stoker will periodically,either (1) validate the key assumptions used in projecting the futureasbestos-related liabilities and defense costs of United Industrial and DetroitStoker or; (2) re-examine and if necessary update the projections ofcurrent and future asbestos claims, based on experience and other relevantfactors, such as changes in the tort system and the resolution of bankruptciesof various asbestos defendants.

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No assurances can be given as to the actual amount of UnitedIndustrial’s and Detroit Stoker’s liability for such present and future claimsor the amount of insurance recoveries (including any recoveries fromliquidating excess insurance carriers), and the differences from estimatedamounts could be material.

FederalAsbestos Legislation

The outlook for federal legislation to provide a nationalasbestos litigation trust fund continues to be uncertain. Also uncertain iswhether, and to what extent, United Industrial and Detroit Stoker would berequired to make contributions to any prospective national asbestos trust. Noassurances can be given that a proposed trust or any other asbestos legislationwill ultimately become law, or when such action might occur.

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

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

In1996, United Industrial entered into a consentdecree with ADEQ. Pursuant to the consent decree, United Industrial is requiredto complete a Remedial Investigation/Feasibility Study (“RI/FS”), pay $125,000for past response costs, pay quarterly Arizona oversight costs (averaging lessthan $13,000 annually) and pay $125,000 for future response costs plus agraduated percentage of the cleanup costs for the site if those costs are inexcess of $10,000,000 but less than $40,000,000. United Industrial’s liabilityfor future response costs under the consent decree is capped at $1,780,000 inaddition to the $125,000 that United Industrial has already paid. In connectionwith the RI/FS, United Industrial has retained and is paying for anenvironmental consultant. The Remedial Investigation was submitted to ADEQ forapproval on March 31, 2004 and was approved by ADEQ on August 9, 2004.In March 2005, ADEQ issued its Proposed Remedial Objectives Report forpublic comment. ADEQ received no substantive comments regarding the report, andin May 2005, ADEQ issued its final Remedial Objectives Report. UnitedIndustrial is required to submit to ADEQ a Feasibility Study and ProposedRemedies to meet ADEQ’s May 2005 Remedial Objectives.  Management believes it will likely reachclosure 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 actual extent to which United Industrial may bedetermined to have further liability, if at all. Management believes it isappropriately accrued for this matter.

MICHIGANDEPARTMENT OF NATURAL RESOURCES

Detroit Stoker was notified in March 1992by the Michigan Department of Natural Resources (“MDNR”) that it is apotentially responsible party in connection with the cleanup of a formerindustrial landfill located in Port of Monroe, Michigan. MDNR is treating thePort of Monroe landfill site as a contaminated facility within the meaning ofthe Michigan Environmental Response Act (“MERA”). Under MERA, if a release orpotential release of a discarded hazardous substance is or may be injurious tothe environment or to the public health, safety or welfare, MDNR is empoweredto undertake or compel investigation and response activities in order toalleviate any contamination threat. Management believes Detroit Stoker would beconsidered a de minimus potentially responsible party and does not believe thatthe resolution of this matter will have a materially adverse effect on UnitedIndustrial’s or Detroit Stoker’s financial condition or results of operations.No assurances can be given, however, as to the actual extent to which DetroitStoker may be determined to be liable, if at all.

OTHER LEGAL MATTERS

Departments and agencies of the U.S. Government have theauthority at many levels to investigate transactions and operations of theCompany, and the results of such investigations may lead to administrative,civil, or criminal proceedings, the ultimate outcome of which could be fines,penalties, repayments or compensatory or treble damages. Agencies that overseecontract performance include: the Defense Contract Audit Agency, the Departmentof Defense Inspector General,

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the General Accounting Office, the Department of Justice,the Department of State, and Congressional Committees. U.S. Governmentregulations provide that certain findings against a contractor may lead tosuspension or debarment from future U.S. Government contracts or the loss ofexport privileges for a company or an operating division or subdivision.

The Company has in place international and domesticcompliance policies and procedures, including training of employees. From timeto time, the Company receives allegations of improper conduct relating to itsoperations, including operations subject to the U.S. Foreign Corrupt PracticesAct, export control and licensing regulations and other U.S. domestic andinternational laws. When the Company receives any such allegations, it conductsinternal (and if necessary, external) investigations to determine whether thereis support for any such allegations, and takes corrective action when warranted.An investigation is ongoing in response to allegations provided to Companymanagement of improper payments to foreign government officials and improperinvoicing. External counsel has been retained by the Audit Committee of theCompany’s Board of Directors to determine if there is support for any suchallegations, and to review the Company’s compliance policies and procedures,and the Company is cooperating fully with counsel. In addition, appropriategovernment agencies have been advised of this investigation. The Company iscooperating with their requests for information. The investigation by externalcounsel, which is continuing, has thus far not revealed any prior involvementor knowledge regarding the allegations by any officer or director of UnitedIndustrial. At the current stage of this investigation, any ultimate liabilityis not presently determinable.

PERFORMANCE GUARANTIES

In connection with certain contracts, United Industrial’soperating subsidiaries have committed to certain performance guarantiesexisting at March 31, 2006. The ability to perform under these guarantiesmay, in part, be dependent on the performance of other parties, includingpartners and subcontractors. If United Industrial’s operating subsidiaries areunable to meet these performance obligations, the performance guaranties couldhave a material adverse effect on profit margins and the Company’s results ofoperations, liquidity or financial position. United Industrial’s operatingsubsidiaries monitor the progress of their partners and subcontractors, andUnited Industrial and its operating subsidiaries do not believe that theperformance of these partners and subcontractors will adversely affect thesecontracts. No assurances can be given, however, as to the liability of UnitedIndustrial’s operating subsidiaries if partners or subcontractors are unable toperform their obligations.

DISCONTINUED TRANSPORTATION OPERATION

## MUNI Contract

In connection with the discontinued Transportationoperations, AAI owns 35% of ETI. Skoda a.s. (“Skoda”), a Czech company, ownsthe remaining 65% of ETI. ETI’s one remaining production contract with MUNIinvolves the design and manufacture of 273 electric trolley buses (“ETBs”). Inexecuting its contract with MUNI, ETI entered into subcontracts with AAI,certain Skoda operating affiliates and others. AAI and the Skoda operatingaffiliates have completed performance of their respective scopes of work tosupport the delivery of the ETBs to MUNI and the Skoda operating affiliates arenow subject to warranty requirements. Skoda’s operating affiliates havecontinued to deliver products and services under their subcontracts with ETIthrough March 2006.

As of April 22, 2004, ETI and MUNI finalized anagreement to modify the original MUNI contract (“Modification No. 6”)under which ETI assigned its remaining subcontractor obligations to MUNI andMUNI relieved ETI of its warranty, performance and certain related bondingobligations, as well as other obligations under its ETB contract with MUNI,except for the performance of a defined scope of work related to modifications ofETB hardware, which have been completed.

In conjunction with Modification No. 6, AAI executed aguaranty agreement with MUNI as of April 22, 2004 (the “Guaranty Agreement”)that assures performance of certain of ETI’s obligations under Modification No. 6.In conjunction with the Guaranty Agreement, AAI obtained a release from allfurther obligations under its subcontract with ETI, including its subcontractorwarranty obligations, in exchange for a cash payment to MUNI of $500,000 andother consideration. AAI’s sole remaining obligation under the GuarantyAgreement, which has been satisfied, was to provide the services of threeengineers and one purchasing expediter through April 2006.

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As required by MUNI, ETI obtained a surety bond to guarantypayment to all those providing labor and materials to ETI in furtherance of itsperformance under the MUNI contract. AAI agreed to indemnify the surety, ifnecessary, for up to $14,800,000 on this labor and materials bond, representing35% of the original face value of the bond (in proportion to AAI’s equityinterest in ETI). On November 18, 2003, AAI made a claim against the laborand materials bond for unpaid receivables in connection with AAI’s MUNIsubcontract from ETI, totaling in excess of $47,000,000, the maximum penal sumof the labor and materials bond. AAI’s payment rights under the labor andmaterials bond (among other claims) are currently at issue in a case before theUnited States District Court for the Northern District of California. Prior tofinal adjudication of this case, there can be no assurances as to the amount ortiming of a recovery by AAI, if any, on its claim on the labor and materialsbond. To date no amount of recovery has been recorded.

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

TheCompany’s Board of Directors declared a dividend of $0.10 per share on itscommon stock for each quarter for the three months ended March 31, 2006and 2005.

| For the quarter ended | ** ** | **Total amount dividends paid** | ** ** | **Date dividends were paid** | ** ** |
|--------------------------------------|------------|------------------------------------------------|------------|---------------------------------------------|------------|
| March 31, 2006                  |       | $1,127,212                                     |       | March 27,  2006                        |       |
| March 31,  2005                 |       | $1,230,089                                     |       | March 31, 2005                         |       |

 

**Note N - TreasuryStock**

OnMarch 10, 2005, the Company’s Board of Directors of the Company authorizeda stock purchase plan for up to $25,000,000. During the first six months of2005, a total of 735,345 shares were repurchased under the plan, at an averageprice of $33.97 per share, utilizing all funds available under the March 10,2005 stock purchase plan.

OnSeptember 7, 2005, the Board of Directors of the Company authorized astock purchase plan for up to $15,000,000. The Company repurchased a total of425,627 shares at an average price of $35.20 during the remainder of 2005utilizing all funds available under the plan.

Duringthe first quarter of 2006, there were no repurchases of stock.

** Note O -Supplemental Guarantor Information**

In September 2004, United Industrialissued and sold $120,000,000 aggregate principal amount of 3.75% ConvertibleSenior Notes, which are fully and unconditionally guarantied by AAI, theCompany’s wholly owned subsidiary that constitutes the Defense segment. The3.75% Convertible Senior Notes are not guarantied by Detroit Stoker, theCompany’s wholly owned subsidiary that constitutes the Energy segment. Thefollowing condensed consolidating financial information sets forth supplementalinformation for United Industrial, the parent company, AAI, the guarantorsubsidiary, and Detroit Stoker, the non-guarantor subsidiary, as of March 31,2006 and December 31, 2005, and for the three month period ended March 31,2006 and 2005.

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CONDENSEDCONSOLIDATING FINANCIAL INFORMATION

CONDENSED CONSOLIDATING BALANCE SHEETSAsof March 31, 2006(Dollars in thousands)(Unaudited)
| ** **                                             | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Detroit  Stoker  Company  (Non-Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
| ASSETS                                                 |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| Current Assets                                         |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| Cash and cash equivalents                              |       | $                                             | 54,828     |                                                 | $          | 15,332                                        |       | $                | 16,553     |                                                   | $          | — |   | $ | 86,713 |   |
| Marketable equity securities                           |       | 14,692                                        |       | —                                               |       | —                                        |       | —           |       | 14,692                                                 |       |
| Deposits and restricted cash                           |       | —                                        |       | 2,515                                                |       | —                                        |       | —           |       | 2,515                                                  |       |
| Trade receivables, net                                 |       | 323                                           |       | 67,626                                               |       | 3,710                                         |       | —           |       | 71,659                                                 |       |
| Inventories                                            |       | —                                        |       | 30,790                                               |       | 2,821                                         |       | —           |       | 33,611                                                 |       |
| Other current assets                                   |       | 98                                            |       | 8,285                                                |       | 805                                           |       | (655             | )          | 8,533                                                  |       |
| Assets of discontinued operations                      |       | —                                        |       | 12,496                                               |       | —                                        |       | —           |       | 12,496                                                 |       |
| Total current assets                                   |       | 69,941                                        |       | 137,044                                              |       | 23,889                                        |       | (655             | )          | 230,219                                                |       |
| Insurance  receivable — asbestos litigation  |       | —                                        |       | —                                               |       | 20,186                                        |       | —           |       | 20,186                                                 |       |
| Property and  equipment, net                           |       | —                                        |       | 41,736                                               |       | 1,581                                         |       | —           |       | 43,317                                                 |       |
| Other assets                                           |       | 9,063                                         |       | 34,081                                               |       | 4,846                                         |       | (17,526          | )          | 30,464                                                 |       |
| Intercompany  receivables                              |       | —                                        |       | 589                                                  |       | —                                        |       | (589             | )          | —                                                 |       |
| Investment in  consolidated subsidiaries          |       | 118,968                                       |       | —                                               |       | —                                        |       | (118,968         | )          | —                                                 |       |
|                                                   |       | $                                             | 197,972    |                                                 | $          | 213,450                                       |       | $                | 50,502     |                                                   | $          | (137,738 | ) | $ | 324,186 |   |
|                                                   |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY             |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| Current portion  of long-term debt                     |       | $                                             | —     |                                                 | $          | 988                                           |       | $                | —     |                                                   | $          | — |   | $ | 988 |   |
| Other current  liabilities                             |       | 8,296                                         |       | 80,911                                               |       | 7,067                                         |       | (27,023          | )          | 69,251                                                 |       |
| Liabilities of  discontinued operations                |       | —                                        |       | 13,136                                               |       | —                                        |       | —           |       | 13,136                                                 |       |
| Total current liabilities                              |       | 8,296                                         |       | 95,035                                               |       | 7,067                                         |       | (27,023          | )          | 83,375                                                 |       |
| Long-term debt                                         |       | 120,000                                       |       | 378                                                  |       | —                                        |       | —           |       | 120,378                                                |       |
| Accrual for  asbestos obligation                       |       | —                                        |       | —                                               |       | 31,450                                        |       | —           |       | 31,450                                                 |       |
| Other long-term  liabilities                           |       | 4,667                                         |       | 53,200                                               |       | 11,816                                        |       | (18,114          | )          | 51,569                                                 |       |
| Intercompany  (receivables) payables                   |       | 37,292                                        |       | (64,333                                              | )          | 649                                           |       | 26,392           |       | —                                                 |       |
| Shareholders’  equity (deficit)                   |       | 27,717                                        |       | 129,170                                              |       | (480                                          | )          | (118,993         | )          | 37,414                                                 |       |
|                                                   |       | $                                             | 197,972    |                                                 | $          | 213,450                                       |       | $                | 50,502     |                                                   | $          | (137,738 | ) | $ | 324,186 |   |

 

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CONDENSED CONSOLIDATING FINANCIALINFORMATION

CONDENSED CONSOLIDATING BALANCE SHEETSAs of December 31, 2005
| **(Dollars in thousands)**                   | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Detroit  Stoker  Company  (Non-Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
|                                                   |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| ASSETS                                                 |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| Current assets:                                        |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| Cash and cash equivalents                              |       | $                                             | 54,365     |                                                 | $          | 8,768                                         |       | $                | 14,363     |                                                   | $          | — |   | $ | 77,496 |   |
| Marketable equity securities                           |       | 11,617                                        |       | —                                               |       | —                                        |       | —           |       | 11,617                                                 |       |
| Securities pledged to creditors                        |       | —                                        |       | —                                               |       | —                                        |       | —           |       | —                                                 |       |
| Deposits and restricted cash                           |       | —                                        |       | 4,810                                                |       | —                                        |       | —           |       | 4,810                                                  |       |
| Trade receivables, net                                 |       | 311                                           |       | 64,487                                               |       | 4,486                                         |       | —           |       | 69,284                                                 |       |
| Inventories                                            |       | —                                        |       | 21,186                                               |       | 2,417                                         |       | —           |       | 23,603                                                 |       |
| Other current assets                                   |       | 1,151                                         |       | 7,330                                                |       | 828                                           |       | (65              | )          | 9,244                                                  |       |
| Assets of discontinued operations                      |       | —                                        |       | 12,428                                               |       | —                                        |       | —           |       | 12,428                                                 |       |
| Total current assets                                   |       | 67,444                                        |       | 119,009                                              |       | 22,094                                        |       | (65              | )          | 208,482                                                |       |
| Insurance  receivable — asbestos litigation  |       | —                                        |       | —                                               |       | 20,186                                        |       | —           |       | 20,186                                                 |       |
| Property and  equipment, net                           |       | —                                        |       | 43,128                                               |       | 1,615                                         |       | —           |       | 44,743                                                 |       |
| Other assets                                           |       | 9,309                                         |       | 34,952                                               |       | 4,852                                         |       | (18,123          | )          | 30,990                                                 |       |
| Intercompany  receivables                              |       | —                                        |       | 508                                                  |       | —                                        |       | (508             | )          | —                                                 |       |
| Investment in  consolidated subsidiaries          |       | 118,968                                       |       | —                                               |       | —                                        |       | (118,968         | )          | —                                                 |       |
|                                                   |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
|                                                   |       | $                                             | 195,721    |                                                 | $          | 197,597                                       |       | $                | 48,747     |                                                   | $          | (137,664 | ) | $ | 304,401 |   |
|                                                   |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY             |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| Current liabilities:                                   |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| Current portion of long-term debt                      |       | $                                             | —     |                                                 | $          | 964                                           |       | $                | —     |                                                   | $          | — |   | $ | 964 |   |
| Other current liabilities                              |       | 5,020                                         |       | 72,582                                               |       | 6,564                                         |       | (20,942          | )          | 63,224                                                 |       |
| Liabilities of discontinued operations            |       |                                          |       | 13,287                                               |       | —                                        |       | —           |       | 13,287                                                 |       |
| Total current liabilities                              |       | 5,020                                         |       | 86,833                                               |       | 6,564                                         |       | (20,942          | )          | 77,475                                                 |       |
| Long-term debt                                         |       | 120,000                                       |       | 723                                                  |       |                                          |       |             |       | 120,723                                                |       |
| Accrual for  asbestos obligation                       |       | —                                        |       | —                                               |       | 31,450                                        |       | —           |       | 31,450                                                 |       |
| Other long-term  liabilities                           |       | 3,260                                         |       | 52,305                                               |       | 11,789                                        |       | (18,123          | )          | 49,231                                                 |       |
| Intercompany  (receivables) payables                   |       | 41,617                                        |       | (62,622                                              | )          | 612                                           |       | 20,393           |       | —                                                 |       |
| Shareholders’  equity (deficit)                   |       | 25,824                                        |       | 120,358                                              |       | (1,668                                        | )          | (118,992         | )          | 25,522                                                 |       |
|                                                   |       | $                                             | 195,721    |                                                 | $          | 197,597                                       |       | $                | 48,747     |                                                   | $          | (137,664 | ) | $ | 304,401 |   |

 

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CONDENSED CONSOLIDATINGFINANCIAL INFORMATION - CONTINUED

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONSThreeMonths Ended March 31, 2006(Dollars in thousands)(Unaudited)
| ** **                                                            | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Detroit Stoker  Company  (Non-Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
| Net sales                                                             |       | $                                             | —     |                                                 | $          | 128,701                                           |       | $                | 8,918      |                                                   | $          | — |   | $ | 137,619 |   |
| Operating costs  and expenses                                         |       | 250                                           |       | 115,046                                              |       | 7,211                                             |       | —           |       | 122,507                                                |       |
| Total operating  income                                               |       | (250                                          | )          | 13,655                                               |       | 1,707                                             |       | —           |       | 15,112                                                 |       |
|                                                                  |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| Non-operating income  and (expense):                                  |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |
| Interest income                                                       |       | 612                                           |       | 313                                                  |       | 164                                               |       | —           |       | 1,089                                                  |       |
| Interest expense                                                      |       | (1,370                                        | )          | (13                                                  | )          | —                                            |       | —           |       | (1,383                                                 | )          |
| Intercompany interest income (expense)                                |       | 15                                            |       | —                                               |       | (15                                               | )          | —           |       | —                                                 |       |
| Other income (expense) — net                                     |       | (645                                          | )          | 60                                                   |       | 10                                                |       | —           |       | (575                                                   | )          |
|                                                                  |       | (1,388                                        | )          | 360                                                  |       | 159                                               |       | —           |       | (869                                                   | )          |
| (Loss) income  from continuing operations before income taxes         |       | (1,638                                        | )          | 14,015                                               |       | 1,866                                             |       | —           |       | 14,243                                                 |       |
| Benefit from  (provision for) income taxes                            |       | 313                                           |       | (5,023                                               | )          | (678                                              | )          | —           |       | (5,388                                                 | )          |
| (Loss) income  from continuing operations                             |       | (1,325                                        | )          | 8,992                                                |       | 1,188                                             |       | —           |       | 8,855                                                  |       |
| Income from  discontinued operations — net of income tax benefit |       | —                                        |       | (287                                                 | )          | —                                            |       | —           |       | (287                                                   | )          |
| Income from  investment in subsidiaries                               |       | 9,893                                         |       | —                                               |       | —                                            |       | (9,893           | )          | —                                                 |       |
| Net income  (loss)                                                    |       | $                                             | 8,568      |                                                 | $          | 8,705                                             |       | $                | 1,188      |                                                   | $          | (9,893 | ) | $ | 8,568 |   |
|                                                                  |       |                                          |       |                                                 |       |                                              |       |             |       |                                                   |       |

 

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CONDENSED CONSOLIDATINGFINANCIAL INFORMATION - CONTINUED

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONSThreeMonths Ended March 31, 2005(Dollars in thousands)(Unaudited)
| ** **                                                          | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Detroit  Stoker  Company  (Non-Guarantor)** | ** ** | **Eliminations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------|------------|------------------|------------|--------------------------------------------------------|------------|
| Net sales                                                           |       | $                                             | —     |                                                 | $          | 100,157                                       |       | $                | 7,391      |                                                   | $          | — |   | $ | 107,548 |   |
| Operating costs  and expenses                                       |       | (16                                           | )          | 88,040                                               |       | 7,286                                         |       | —           |       | 95,310                                                 |       |
| Total operating  income                                             |       | 16                                            |       | 12,117                                               |       | 105                                           |       | —           |       | 12,238                                                 |       |
|                                                                |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| Non-operating  income and (expense):                                |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| Interest income                                                     |       | 915                                           |       | 98                                                   |       | 38                                            |       | —           |       | 1,051                                                  |       |
| Interest expense                                                    |       | (1,736                                        | )          | (92                                                  | )          | —                                        |       | —           |       | (1,828                                                 | )          |
| Intercompany interest income (expense)                              |       | (1                                            | )          | —                                               |       | 1                                             |       | —           |       | —                                                 |       |
| Other income — net                                             |       | 432                                           |       | 7,324                                                |       | 32                                            |       | —           |       | 7,788                                                  |       |
|                                                                |       | (390                                          | )          | 7,330                                                |       | 71                                            |       | —           |       | 7,011                                                  |       |
| (Loss) income  from continuing operations before income taxes       |       | (374                                          | )          | 19,447                                               |       | 176                                           |       | —           |       | 19,249                                                 |       |
| Benefit from  (provision for) income taxes                          |       | 131                                           |       | (6,688                                               | )          | (68                                           | )          | —           |       | (6,625                                                 | )          |
| (Loss) income  from continuing operations                           |       | (243                                          | )          | 12,759                                               |       | 108                                           |       | —           |       | 12,624                                                 |       |
| Loss from discontinued  operations — net of income tax benefit |       | —                                        |       | 48                                                   |       | —                                        |       | —           |       | 48                                                     |       |
| Income from  investment in subsidiaries                             |       | 12,915                                        |       | —                                               |       | —                                        |       | (12,915          | )          | —                                                 |       |
| Net income  (loss)                                                  |       | $                                             | 12,672     |                                                 | $          | 12,807                                        |       | $                | 108        |                                                   | $          | (12,915 | ) | $ | 12,672 |   |

 

25

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CONDENSED CONSOLIDATINGFINANCIAL INFORMATION - CONTINUED

CONDENSEDCONSOLIDATING STATEMENTS OF CASH FLOWSThreeMonths Ended March 31, 2006(Dollars in thousands)(Unaudited)
| ** **                                                          | ** ** | **United  Industrial  Corporation  (Parent)** | ** ** | **AAI  Corporation  and  Subsidiaries  (Guarantor)** | ** ** | **Detroit  Stoker  Company  (Non-  Guarantor)** | ** ** | **Elimi-  nations** | ** ** | **United  Industrial  Corporation  and  Subsidiaries** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|-------------------------------------------------|------------|---------------------|------------|--------------------------------------------------------|------------|
| OPERATING ACTIVITIES:                                               |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Cash flows (used  in) provided by continuing operations        |       | $                                             | (2,838     | )                                                    | $          | 8,991                                           |       | $                   | 2,203      |                                                   | $          | — |   | $ | 8,356 |   |
| Cash flows used  in operating activities by discontinued operations |       | —                                        |       | (506                                                 | )          | —                                          |       | —              |       | (506                                                   | )          |
| Net cash (used in) provided by operating activities                 |       | (2,838                                        | )          | 8,485                                                |       | 2,203                                           |       | —              |       | 7,850                                                  |       |
|                                                                |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| INVESTING ACTIVITIES:                                               |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Purchase of  property and equipment                                 |       | —                                        |       | (1,453                                               | )          | (13                                             | )          | —              |       | (1,466                                                 | )          |
| Net cash (used in) investing activities                             |       | —                                        |       | (1,453                                               | )          | (13                                             | )          | —              |       | (1,466                                                 | )          |
|                                                                |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| FINANCING ACTIVITIES:                                               |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Repayment of  long-term debt                                        |       | —                                        |       | (321                                                 | )          | —                                          |       | —              |       | (321                                                   | )          |
| Proceeds from  exercise of stock options                            |       | 1,222                                         |       | —                                               |       | —                                          |       | —              |       | 1,222                                                  |       |
| Excess benefit  from stock based compensation                       |       | 764                                           |       | —                                               |       | —                                          |       | —              |       | 764                                                    |       |
| Dividends paid                                                      |       | (1,127                                        | )          | —                                               |       | —                                          |       | —              |       | (1,127                                                 | )          |
| Decrease in  deposits and restricted cash                           |       | —                                        |       | 2,295                                                |       | —                                          |       | —              |       | 2,295                                                  |       |
| Intercompany  activities                                            |       | 2,442                                         |       | (2,442                                               | )          | —                                          |       | —              |       | —                                                 |       |
| Net cash provided by (used in) financing activities                 |       | 3,301                                         |       | (468                                                 | )          | —                                          |       | —              |       | 2,833                                                  |       |
| Increase in cash  and cash equivalents                              |       | 463                                           |       | 6,564                                                |       | 2,190                                           |       | —              |       | 9,217                                                  |       |
|                                                                |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Cash and cash  equivalents at beginning of year                     |       | 54,365                                        |       | 8,768                                                |       | 14,363                                          |       | —              |       | 77,496                                                 |       |
|                                                                |       |                                          |       |                                                 |       |                                            |       |                |       |                                                   |       |
| Cash and cash  equivalents at end of period                         |       | $                                             | 54,828     |                                                 | $          | 15,332                                          |       | $                   | 16,553     |                                                   | $          | — |   | $ | 86,713 |   |

 

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CONDENSED CONSOLIDATINGFINANCIAL INFORMATION - CONTINUED

CONDENSEDCONSOLIDATING STATEMENTS OF CASH FLOWSThreeMonths Ended March 31, 2005(Dollars in the thousands)(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 (used in) continuing operations               |       | $                                             | 1,127      |                                                 | $          | 15,690                                        |       | $                | (291       | )                                                      | $          | — |   | $ | 16,526 |   |
| Cash flows used  in operating activities by discontinued operations   |       | —                                        |       | (2,738                                               | )          | —                                        |       | —           |       | (2,738                                                 | )          |
|                                                                  |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| Net cash provided by (used in) operating activities                   |       | 1,127                                         |       | 12,952                                               |       | (291                                          | )          | —           |       | 13,788                                                 |       |
|                                                                  |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| INVESTING ACTIVITIES:                                                 |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| Purchase of  property and equipment                                   |       | —                                        |       | (7,971                                               | )          | (23                                           | )          | —           |       | (7,994                                                 | )          |
| Proceeds from  sale of available for sale securities                  |       | 124,619                                       |       | —                                               |       | —                                        |       | —           |       | 124,619                                                |       |
| Proceeds from  sale of property                                       |       | —                                        |       | 7,555                                                |       | —                                        |       | —           |       | 7,555                                                  |       |
|                                                                  |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| Net cash provided by (used in) investing activities                   |       | 124,619                                       |       | (416                                                 | )          | (23                                           | )          | —           |       | 124,180                                                |       |
|                                                                  |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| FINANCING ACTIVITIES:                                                 |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| Repayment of  collateral received from securities lending transaction |       | (124,619                                      | )          | —                                               |       | —                                        |       | —           |       | (124,619                                               | )          |
| Repayment of  long-term debt                                          |       | —                                        |       | (334                                                 | )          | —                                        |       | —           |       | (334                                                   | )          |
| Proceeds from  exercise of stock options                         |       | 344                                           |       | —                                               |       | —                                        |       | —           |       | 344                                                    |       |
| Dividends paid                                                        |       | (1,233                                        | )          | —                                               |       | —                                        |       | —           |       | (1,233                                                 | )          |
| Decrease in  deposits and restricted cash                             |       | 25,000                                        |       | 4,047                                                |       | —                                        |       | —           |       | 29,047                                                 |       |
| Intercompany  activities                                              |       | (25,000                                       | )          | 25,000                                               |       | —                                        |       | —           |       | —                                                 |       |
|                                                                  |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| Net cash (used in) provided by financing activities                   |       | (125,508                                      | )          | 28,713                                               |       | —                                        |       | —           |       | (96,795                                                | )          |
|                                                                  |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| Increase  (decrease) in cash and cash equivalents                     |       | 238                                           |       | 41,249                                               |       | (314                                          | )          | —           |       | 41,173                                                 |       |
|                                                                  |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| Cash and cash  equivalents at beginning of year                       |       | 129                                           |       | 72,269                                               |       | 8,281                                         |       | —           |       | 80,679                                                 |       |
|                                                                  |       |                                          |       |                                                 |       |                                          |       |             |       |                                                   |       |
| Cash and cash  equivalents at end of period                           |       | $                                             | 367        |                                                 | $          | 113,518                                       |       | $                | 7,967      |                                                   | $          | — |   | $ | 121,852 |   |

 

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**Item 2.- Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

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

ThisQuarterly Report on Form 10-Q contains “forward-looking statements”within the meaning of the Private Securities Litigation Reform Act of 1995. Suchforward-looking statements are based on management’s expectations, estimates,projections and assumptions. Words such as “expects,” “anticipates,” “intends,”“plans,” “believes,” “estimates,” and variations of such words and similar expressionsare intended to identify such forward-looking statements which include, but arenot limited to, projections of revenues, earnings, segment performance, cashflows and contract awards. These forward-looking statements are subject torisks and uncertainties, which could cause the actual results or performance ofUnited Industrial Corporation and its subsidiaries (collectively, the “Company”)to differ materially from those expressed or implied in such statements. Theserisks and uncertainties include, but are not limited to, the following:

·                  the Company’ssuccessful execution of internal performance plans;

·                  performanceissues with key suppliers, subcontractors and business partners;

·                  the abilityto negotiate financing arrangements with lenders;

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

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

·                  productdemand and market acceptance risks;

·                  the effectof economic conditions;

·                  the impactof competitive products and pricing;

·                  productdevelopment, commercialization and technological difficulties;

·                  capacity andsupply constraints or difficulties;

·                  theintegration of acquisitions;

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

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

·                  contractcontinuation and future contract awards; and

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

TheCompany intends that all forward-looking statements it makes will be subject tothe safe harbor protection of the Federal securities laws found in Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended.

Thesestatements speak only as to the date when they are made. The Company makes nocommitment to update any forward-looking statement or to disclose any facts,events, or circumstances after the date hereof that may affect the accuracy ofany forward-looking statements. See “Risk Factors” under Item 1A of the Company’sAnnual Report on Form 10-K for the year ended December 31,2005, for important factors that could cause the Company’s actual results todiffer materially from those suggested by the Company’s forward-lookingstatements contained in this Quarterly Report on Form 10-Q.

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

The Companydesigns, produces and supports defense systems. Its products and servicesinclude unmanned aircraft systems, training and simulation systems, automatedaircraft test and maintenance equipment, armament systems, logistical andengineering services, and other leading-edge technology solutions for defenseneeds. The Company also manufactures combustion equipment for biomass andrefuse fuels.

Thecontinuing operations of the Company consist of two business segments: Defenseand Energy. Costs related to the continuing operations that are not identifiedwith the two business segments primarily relate to financing costs and aregrouped under the heading Other. The operations of the Defense and Energysegments are conducted principally through its two wholly owned subsidiaries,AAI and Detroit Stoker, respectively. The following information primarilyrelates to the continuing operations of the Company and its consolidatedsubsidiaries. The Company has a transportation operation that is accounted foras a discontinued operation, and is discussed separately in the informationthat follows.

The Company’s netsales increased to $137,619,000 in the first quarter of 2006 from $107,548,000during the same period in 2005. In addition, the Company continued to focus onits core Defense segment, which accounted for approximately

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93.5% and 93.1% oftotal consolidated net sales from continuing operations during the firstquarter of 2006 and 2005, respectively. In the first quarter of 2006, theDefense segment reported a 28.5% increase in net sales compared to the sameperiod of 2005 primarily due to greater logistical support related to anincreasing number of fielded Shadow® 200 Tactical Unmanned Aerial VehicleSystems (“TUAS”). Sales by ESL also contributed to the higher sales in 2006.

**Revolving Credit Facility**

On July 18, 2005,the Company and AAI entered into a $100,000,000 four year revolving creditagreement (the “Credit Agreement”) with a syndicate of six banks, consisting ofSunTrust Bank, as administrative agent and issuing bank, Citibank, F.S.B., KeyBank, PNC Bank, Commerce Bank and Provident Bank. The Credit Agreement providesfor a credit facility (the “Credit Facility”) consisting of a $100,000,000Senior Secured Revolving Credit Facility with a $5,000,000 Swing Line and a$100,000,000 Letter of Credit sub-facility.

Pursuant to theterms of the Credit Agreement and the parent guaranty agreement dated as of July 18,2005 (the “Parent Guaranty”), the Company has guarantied AAI’s obligations. Theproceeds of the Credit Facility will be used to fund future acquisitions,finance capital expenditures, provide working capital, fund letters of credit,and for other general corporate purposes.

**Gain on Sale of Property**

InJanuary 2005, the Company sold approximately 26 acres of undevelopedproperty adjacent to its Hunt Valley, Maryland facility for $8,105,000, whichyielded proceeds of $7,555,000, net of selling expenses and closing costs. TheCompany recognized a pre-tax gain on the sale of this property in the firstquarter of 2005 of approximately $7,152,000. On March 4, 2005, the Companypurchased a new facility for $5,085,000 in South Carolina for AAI ServicesCorporation (“AAI Services”), a wholly owned subsidiary of AAI, to support thegrowth in their operations. Substantially all the remaining net proceeds weredisbursed from a qualified intermediary account by July 11, 2005, and wereused for improvements to the facility. As a result, the Company will deferpaying substantially all of the income tax obligation incurred in connectionwith the gain on the sale of the property in Hunt Valley, in accordance with Section 1031(b) ofthe Internal Revenue Code.

**RestructuringActivities**

During the fourthquarter of 2004, the managements of both AAI and Detroit Stoker developed plansto maximize efficiencies by streamlining certain of their operations, inaccordance with the Company’s previously disclosed strategic initiatives.

During the firstquarter of 2005, Detroit Stoker reduced its employee base as contemplated underthis plan. Most of the manufacturing operations previously performed at DetroitStoker’s facilities have been outsourced to lower-cost producers. As a resultof the reduction in Detroit Stoker’s workforce, the Company recognizedseverance charges in the Energy Segment of approximately $44,000 and alsorecognized $37,000 in facility relocation cost in the first quarter of 2005.  Detroit Stoker’s restructuring plan wascompleted in 2005, and accordingly, Detroit Stoker did not recognize anyadditional restructuring charges in the first quarter of 2006.

AAI reorganized theoperations of its fluid test systems product area in the Defense segment inorder to realize certain operating efficiencies. In the first quarter of 2005,$330,000 of restructuring costs were expensed. These activities were completedin 2005 and the Company did not recognize any additional restructuring chargesin the first quarter of 2006 related to the fluid system product line.

**Acquisitionof ESL**

On April 4, 2005,the Company acquired ESL Defence Limited (“ESL”), an electronic warfare (“EW”)systems company based in the United Kingdom. The net purchase price was$10,363,000 in cash. ESL is a designer and producer of electro optical (“EO”)test and simulation products for use on flight lines and in aircraftmaintenance facilities. The simulators are used to assess the operationalreadiness of sophisticated missile warning and countermeasures self-protectionsystems used on military aircraft. ESL’s EO simulators are also used atmilitary test, evaluation, and training ranges to evaluate the

29

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effectiveness of newself- protection systems and to train pilots for combat readiness. In addition,ESL specializes in EW related research, study, and in-service support activityfor U.K. government agencies and prime contractors both in the United Kingdomand the United States. For the three months ended March 31, 2006, ESLcontributed net sales of $2,883,000.

**Results of Operations**

Thefollowing discussion should be read in conjunction with the Company’sConsolidated Financial Statements and related notes thereto contained in thisQuarterly Report on Form 10-Q for the quarterly period ended March 31,2006, and the discussion included in its Annual Report on Form 10-Kfor the year ended December 31, 2005.

30

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**Overviewof Consolidated Results**

#### ***ThreeMonths Ended March 31, 2006 Compared to theThree Months Ended March 31,2005***

| **(Dollars in thousands)**                    | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase  (Decrease)** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------|------------|
| ** **                                              | ** ** | **2006**                                         | ** ** | **2005**                 | ** ** | **$** | ** ** | **%** | ** ** |
|                                                    |       |                                             |       |                     |       |   |   |   |   |
| Net sales                                               |       | $                                                | 137,619    |                     | $          | 107,548 |   | $ | 30,071 |   | 28.0 | % |
| Operating costs  and expenses                           |       | 122,507                                          |       | 95,310                   |       | 27,197 |   | 28.5 | % |
| Operating income                                        |       | 15,112                                           |       | 12,238                   |       | 2,874 |   | 23.5 | % |
| Operating income  as a percentage of sales              |       | 11.0%                                            |       | 11.4%                    |       | — |   | — |   |
| Non-operating  income (expense)                         |       | (869                                             | )          | 7,011                    |       | (7,880 | ) | (112.4 | %) |
| Income from continuing  operations, net of income taxes |       | 8,855                                            |       | 12,624                   |       | (3,769 | ) | (29.9 | %) |
|                                                         |            |                                                  |            |                          |            |  |  |  |  |  |  |  |

 

***Defense Segment***
| **(Dollars in thousands)**       | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase  (Decrease)** | ** ** |
|--------------------------------------------|------------|--------------------------------------------------|------------|--------------------------|------------|
| ** **                                 | ** ** | **2006**                                         | ** ** | **2005**                 | ** ** | **$** | ** ** | **%** | ** ** |
|                                       |       |                                             |       |                     |       |   |   |   |   |
| Net sales                                  |       | $                                                | 128,701    |                     | $          | 100,157 |   | $ | 28,544 |   | 28.5 | % |
| Operating costs  and expenses              |       | 115,046                                          |       | 88,039                   |       | 27,007 |   | 30.7 | % |
| Operating income                           |       | 13,655                                           |       | 12,118                   |       | 1,537 |   | 12.7 | % |
| Operating income  as a percentage of sales |       | 10.6%                                            |       | 12.1%                    |       | — |   | — |   |
| Income before income  taxes                |       | 14,015                                           |       | 19,447                   |       | (5,432 | ) | (27.9 | %) |
|                                            |            |                                                  |            |                          |            |  |  |  |  |  |  |  |

 

***Energy Segment***
| **(Dollars in thousands)**       | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase  (Decrease)** | ** ** |
|--------------------------------------------|------------|--------------------------------------------------|------------|--------------------------|------------|
| ** **                                 | ** ** | **2006**                                         | ** ** | **2005**                 | ** ** | **$** | ** ** | **%** | ** ** |
|                                       |       |                                             |       |                     |       |   |   |   |   |
| Net sales                                  |       | $                                                | 8,918      |                     | $          | 7,391 |   | $ | 1,527 |   | 20.7 | % |
| Operating costs  and expenses              |       | 7,211                                            |       | 7,287                    |       | (76 | ) | (1.0 | %) |
| Operating income                           |       | 1,707                                            |       | 104                      |       | 1,603 |   | 1541.4 | % |
| Operating income  as a percentage of sales |       | 19.1%                                            |       | 1.4%                     |       | — |   | — |   |
| Income before income  taxes                |       | 1,866                                            |       | 175                      |       | 1,691 |   | 966.3 | % |
|                                            |            |                                                  |            |                          |            |  |  |  |  |  |  |  |

 

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***Three Months Ended March 31, 2006 compared to the ThreeMonths Ended March 31, 2005***

Netsales from continuing operations increased ­­28.0% to $137,619,000 from$107,548,000 during the same period in 2005.

Operatingincome from continuing operations increased 23.5% to $15,112,000, or 11.0% ofsales, from $12,238,000, or 11.4% of sales, during the same period in 2005. Sellingand administrative expenses were 12.9% and 12.7% of sales in 2006 and 2005,respectively.

Netincome from continuing operations decreased 29.9% to $8,855,000, or $0.69 perdiluted share, from $12,624,000, or $0.84 per diluted share, during the sameperiod in 2005. The first quarter of 2005 included a gain on sale ofundeveloped property of $4,649,000, net of tax, or $0.29 per diluted share. Inthe first quarter of 2006, net income included the effect of expensing stockoption compensation of $362,000 net of tax, or $0.02 per diluted share. Inaddition, other expense included a $419,000, net of tax, increase in the fairvalue of an embedded derivative related to the $120,000,000 3.75% ConvertibleNotes issued in September 2004, which had no impact on earnings perdiluted share.

Netincome (including results of both continuing and discontinued operations)decreased 32.4% to $8,568,000, or $0.67 per diluted share, from $12,672,000, or$0.84 per diluted share, during the same period in 2005.

Netsales from the Defense segment increased 28.5% to $128,701,000 from $100,157,000during the same period in 2005. The growth was primarily due to $14,500,000greater logistical support for an increasing number of fielded Shadow 200Tactical Unmanned Aircraft Systems (“TUAS”), a $10,145,000 increase inproduction of these systems, and $2,883,000 generated by ESL Defence Limited,an electronic warfare systems company based in the United Kingdom, acquired in April 2005.

Operatingincome from the Defense segment increased 12.7% to $13,655,000, or 10.6% ofsales, from $12,118,000, or 12.1% of sales, during the same period in 2005. Thedecrease in the operating margin was largely due to an increase in the level ofservices based sales, that generally earn lower margins, resulting primarilyfrom higher logistical support for fielded Shadow 200 TUAS. Further, the firstquarter of 2005 experienced higher margins due to production efficienciesrealized on the initial full rate production contract for the Shadow 200 TUASand the favorable Joint Service Electronic Combat Systems Tester (“JSECST”) productionprogram. These contracts were completed in 2005. Also a contributing to thelower margin in 2006 was higher pension expense of $735,000, due generally togreater employment and lower discount rate.

Net sales from the Energy segment increased 20.7%to $8,918,000 from $7,391,000 in the first quarter of 2005. The increase wasprimarily driven by higher demand for its alternative fuel products, such ascoal and wood burning stokers, in response to recent high and volatile pricesfor oil and natural gas. The Energy segment’s operating income increased to$1,707,000 from $104,000 during the same period in 2005. The increase inoperating income was due to increased sales and profit margins in 2006. Theimproved margins were a result of the restructuring activities in 2005.

**Discontinued TransportationOperations**

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

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**Funded Backlog**

| (Dollars in thousands) | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Defense segment                  |       | $                        | 525,743    |                        | $          | 487,366 |   |
| Energy segment                   |       | 15,705                   |       | 8,499                       |       |
| Total                            |       | $                        | 541,448    |                        | $          | 495,865 |   |

 

TheCompany’s funded backlog for continuing operations, defined as orders placedfor which funds have been appropriated or purchase orders received, was$541,448,000 at March 31, 2006, an increase of $45,583,000, or 9.2%, from December 31,2005.

The Company received$183,222,000 of funded new orders for products and services during the firstquarter of 2006, an increase of $87,390,000 or 91.2%, compared to $95,832,000for the quarter ending March 31, 2005. Included in the first quarter 2006were funded new orders of $167,078,000 in the Defense segment and $16,144,000in the Energy segment.

**Liquidity and Capital Resources**

**Overview**

The Company’sprincipal source of liquidity is cash on hand and cash generated fromoperations. On March 31, 2006, the Company had cash and cash equivalentsof $86,713,000. On July 18, 2005, the Company and AAI entered into a$100,000,000 four-year revolving Credit Agreement (“the Credit Agreement”) witha syndicate of six banks, consisting of SunTrust Bank, as administrative agentand issuing bank, Citibank, F.S.B., Key Bank, PNC Bank, Commerce Bank andProvident Bank. The Credit Agreement provides for a credit facility (“theCredit Facility”) consisting of a $100,000,000 Senior Secured Revolving CreditFacility with a $5,000,000 Swing Line and a $100,000,000 Letter of Creditsub-facility. The interest rate for loans made under this facility isthirty-day LIBOR plus an applicable margin between 1.25% and 2.00% based uponAAI’s leverage ratio. As of March 31, 2006, the Company had $800,527outstanding under the Letter of Credit sub-facility. Pursuant to the terms ofthe Credit Agreement and the Parent Guaranty, the Company has guarantied AAI’sobligations. The proceeds of the Credit Facility will be used to fund futureacquisitions, finance capital expenditures, provide working capital, fundletters of credit, and for other general corporate purposes. Based on cash onhand, future cash expected to be generated from operations, and the CreditFacility, the Company expects to have sufficient cash to meet its requirementsfor at least the next twelve months.

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

TheCompany intends to complement its growth strategy for its Defense segmentthrough select acquisitions that broaden its product and service offerings,deepen its capabilities, and allow entry into new markets. Acquisitioncandidates may include public and private companies and divisions, subsidiariesand product lines of such companies. As part of this initiative, the Companyacquired ESL in April 2005.

Asa part of the Company’s strategy to explore the sale of non-core assets, theCompany continues its engagement with Imperial Capital, LLC, aninvestment-banking firm, to act as exclusive financial advisor to assist inexploring strategic alternatives for Detroit Stoker, including a possible sale(the “Transaction”). The Company and Imperial Capital are continuing to explorepotential Transactions involving Detroit Stoker. From time to time, the Companyand potential buyers may (i) have discussions regarding a potentialTransaction, (ii) negotiate the preliminary terms of a potentialTransaction, and (iii) enter into customary non-binding agreements inorder to facilitate any such discussions and negotiations. No assurances can begiven regarding whether a Transaction involving Detroit Stoker will occur orthe timing or proceeds from any such Transaction.

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**Sources and Uses of Cash**

Thefollowing is a discussion of the Company’s major operating, investing, andfinancing activities for of the three month periods ended March 31, 2006and 2005. The financial information presented in the table below is summarizedfrom the Company’s Consolidated Condensed Statements of Cash Flows.
| ** **                                                        | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(Dollars in thousands)**                              | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Operating activities:                                             |       |                                             |       |   |   |
|                                                              |       |                                             |       |   |   |
| Net cash provided by continuing operations                        |       | $                                                | 8,356      |   | $ | 16,526 |   |
|                                                              |       |                                             |       |   |   |
| Net cash used in operating activities by discontinued  operations |       | (506                                             | )          | (2,738 | ) |
|                                                              |       |                                             |       |   |   |
| Net cash  provided by operating activities                        |       | 7,850                                            |       | 13,788 |   |
|                                                              |       |                                             |       |   |   |
| Net cash (used  in) provided by investing activities              |       | (1,466                                           | )          | 124,180 |   |
|                                                              |       |                                             |       |   |   |
| Net cash  provided by (used in) financing activities              |       | 2,833                                            |       | (96,795 | ) |
|                                                              |       |                                             |       |   |   |
| Increase in cash  and cash equivalents                            |       | $                                                | 9,217      |   | $ | 41,173 |   |

 

## ***Operating Activities***

Net cash provided by continuing operations in thethree months ended March 31, 2006 decreased $8,170,000 to $8,356,000compared to $16,526,000 for the three months ended March 31, 2005. Thisdecrease was generally due to a decrease of $10,171,000 in cash for changes inoperating assets and liabilities mainly due to the timing of milestone billingsand payments related to our TUAS program, partially offset by higher incomefrom continuing operations before non-cash charges.

The Company’s cash flowsfrom operations are dependent on the timing of receipts from various governmentpayment offices and, as a result, may differ from period to period and suchdifferences could be significant.

Netcash used by the discontinued transportation operations in the three monthsended March 31, 2006 primarily related to unreimbursed services and otherfinancial support provided to ETI in connection with the MUNI contract guarantyagreement as discussed in Note 17 to the Consolidated Financial Statementsincluded in Part II, Item 8 of the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2005 and Note L to the ConsolidatedCondensed Financial Statements included in part I, Item 1 of this QuarterlyReport on Form 10-Q.

## ***Investing Activities***

Cash used for thepurchase of property and equipment was $1,466,000 in the three months ended March 31,2006. Capital expenditures were $7,994,000, including $5,085,000 for thepurchase of a facility in South Carolina, for the same period of the prior year.The Company anticipates that future requirements will include expendituresincurred during the ordinary course of business. See “*Capital Expenditures*” below.

On December 29, 2004,the Company invested $124,619,000 in U.S. treasury bills maturing on February 24,2005. The U.S. treasury bills were concurrently loaned to the Company’sbroker-dealer in a securities lending transaction in exchange for cashcollateral in an amount equal to 100% of the fair value of the securities lent.The securities lending transaction terminated on February 23, 2005, atwhich time the Company redeemed the U.S. treasury bills and receivedapproximately

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$373,000 of short-termcapital gain thereon, repaid the cash collateral to its broker-dealer togetherwith $444,000 of related interest charges, and collected the $25,000,000deposit plus $86,000 of accrued interest thereon.

Net cash provided byinvesting activities in the three months ended March 31, 2005 includedproceeds of $7,555,000 from the sale of certain undeveloped property at theCompany’s Hunt Valley, MD corporate headquarters.

## ***Financing Activities***

The Company’s financingactivities in the three months ended March 31, 2006 provided $2,833,000 ofcash including, a decrease in restricted cash of $2,295,000, proceeds from theexercise of stock options of $1,222,000, excess tax benefits from stock-basedpayment arrangements of $764,000,  offsetby dividends paid of $1,127,000 and repayment of long-term debt of $321,000.

The Company’s financingactivities in the three months ended March 31, 2005 used $96,795,000 ofcash, including approximately $124,619,000 for the repayment of collateralreceived from a securities lending transaction of U.S. treasury bills that weresold concurrently. In connection with this securities lending transaction, theCompany also received the $25,000,000 refundable deposit from its broker-dealer.This deposit, together with a decrease of $4,047,000 in collateral theCompany was required to post in connection with outstanding letters of creditand a cash management security arrangement with Bank of America BusinessCapital, is presented as a $29,047,000 decrease in deposits and restricted cashin the accompanying Consolidated Statements of Cash Flows for the period endingMarch 31, 2005. Financing activities in 2005 also included $344,000 ofcash receipts from the exercise of stock options, $1,233,000 of cash used forthe payment of dividends, and $334,000 used for the repayment of long-termdebt, primarily related to the financing of AAI’s new Enterprise ResourcePlanning (“ERP”) System.

**Debt and Related Covenants**

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

For a completedescription of the Company’s long-term debt, including the terms and conditionsof each debt instrument, please see Note 17 to the Consolidated FinancialStatements included in Part II, Item 8 of the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2005 and Note H to the ConsolidatedCondensed Financial Statements included in part I, Item 1 of this QuarterlyReport on Form 10-Q. The Company was in compliance with all of itscovenants under the Credit Facility as of March 31, 2006.

**Cash Requirements**

***Capital Expenditures***

TheCompany expects that capital expenditures in 2006 will be significantly lowerthan in 2005.

Capital expenditures in 2005were significantly higher than in 2006 primarily due to the purchase of afacility in Charleston, South Carolina for AAI Services Corporation to supportthe growth in its operations, enhancements to certain of the Company’s UASproduction facilities, including the purchase of new manufacturing equipment toincrease production output and efficiency, and implementation of the Company’sERP System.

Asof March 31, 2006, the Company had no significant commitments for capitalexpenditures.

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***Other Cash Requirements***

For the three monthsended March 31, 2006, the Company paid cash dividends of $0.10 per sharefor an aggregate amount of $1,127,000. The payment of any futuredividends will be at the discretion of the Board of Directors and will dependupon, among other things, the Company’s corporate strategy, future earnings,operations, capital requirements, and the Company’s financial condition andgeneral business conditions. Should the Company distributea cash dividend in any quarterly period in excess of $0.10 per share, theconversion rate provided for in the Indenture governing the 3.75% ConvertibleSenior Notes would be adjusted. In addition, the Company’s lenders may impose restrictionson the payment of dividends.

The cash required to completely exit the discontinuedtransportation operation subsequent to March 31, 2006 is expected to beapproximately $600,000 through 2006. These amounts exclude legal fees expectedto be incurred related to claims made by AAI in pursuit of payment under asurety bond (see Note L to the Consolidated Condensed Financial Statementsincluded in this Quarterly Report on Form 10-Q for a discussion ofAAI’s claims).

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

TheCompany is currently evaluating the need to contribute cash to the UICRetirement Pension Plan, but does expect to contribute $935,000 to the unionpension plan in the Energy segment during 2006, of which $51,000 was funded inthe three months ended March 31, 2006. Further, the Company expects to payother post-retirement benefits of approximately $2,623,000 in 2006, of which$693,000 was funded during the three months ended March 31, 2006.

**ContingentMatters**

**Off-Balance Sheet Arrangements**

Inconnection with certain contracts, United Industrial’s operating subsidiarieshave committed to certain performance guaranties. The ability to perform underthese guaranties may, in part, be dependent on the performance of otherparties, including partners and subcontractors. If United Industrial’soperating subsidiaries are unable to meet these performance obligations, theperformance guaranties could have a material adverse effect on product marginsand the Company’s results of operations, liquidity or financial position.United Industrial’s operating subsidiaries monitor the progress of theirpartners and subcontractors, and United Industrial does not believe that theperformance of these partners and subcontractors will adversely affect thesecontracts as of March 31, 2006. No assurances can be given, however, as tothe liability of United Industrial’s operating subsidiaries if partners orsubcontractors are unable to perform their obligations.

**Other Contingent Matters**

TheCompany is involved in various lawsuits and claims, including asbestos-relatedlitigation and environmental matters. There have been no material changes inany legal proceedings since the Company filed its Annual Report on Form 10-Kfor the year ended December 31, 2005. For further information, refer tothe Consolidated Financial Statements and Notes thereto included in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2005and note L to the Consolidation Condensed Financial Statements included in Part I,Item 1 of this Quarterly Report on Form 10-Q.

**Critical Accounting Policies**

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions. These estimates and assumptionsaffect 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. Judgmentsand assessments of uncertainties are required in applying the Company’saccounting policies in many areas. Actual results could differ from theseestimates.

There have been no revisions to the CriticalAccounting Policies as disclosed in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2005.

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

**InterestRate**

On September 15,2004, the Company issued and sold $120,000,000 of 3.75% Convertible SeniorNotes. Several features contained in the indenture governing the 3.75%Convertible Senior Notes are considered embedded derivative instruments and arebeing accounted for as derivative instruments separate from the host contract(the 3.75% Convertible Senior Notes). The Company will record gains or lossesin its Consolidated Condensed Statements of Operations for changes in the fairvalue of these embedded derivatives. The aggregate fair value assigned to theseembedded derivatives at March 31, 2006 was approximately $1,102,000, andwas approximately $457,000 at December 31, 2005. Accordingly, the Companyrecognized a loss of $645,000 for the three months ended March 31, 2006 asthe result of the change in fair value of the embedded derivatives.

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

Therehas been no material change in the interest rate market risk or contingentpayment features from December 31, 2005 (see Item 7A in the Company’sAnnual Report on Form 10-K for the year ended December 31,2005).

**Foreign Currency**

A portion of the Company’soperations consists of manufacturing and sales activities in foreignjurisdictions, and some of these transactions are denominated in foreigncurrencies. As a result, the Company’s financial results could be affected bychanges in foreign exchange rates. To mitigate the effect of changes in theserates, the Company, from time to time, enters into foreign exchange forwardcontracts. There has been no material change in the firmly committed salesexposures and related derivative contracts from December 31, 2005 (seeItem 7A in the Company’s Annual Report on Form 10-K for the yearended December 31, 2005).

**Item4. - Controls and Procedures**

(a)                The Company maintains disclosure controls andprocedures designed to ensure that it is able to collect the information it isrequired to disclose in the reports it files with the SEC, and to process,summarize and disclose this information within the time periods specified inthe rules of the SEC. The Company’s management evaluated, with theparticipation of the Company’s principal executive and principal financialofficers, the effectiveness of the Company’s disclosure controls and procedures(as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of March 31,2006. Based on their evaluation, the Company’s principal executive andprincipal financial officers concluded that the Company’s disclosure controlsand procedures were effective as of March 31, 2006 to ensure that theCompany is able to collect, process, and disclose the information it isrequired to disclose in the reports it files with the SEC within the requiredtime periods.

(b)               Therehas been no change in the Company’s internal control over financial reporting(as defined in Rules 13a-15(f) and 15d-15(f) underthe Exchange Act) that occurred during the Company’s fiscal quarter ended March 31,2006, that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

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**PART II - OTHERINFORMATION**

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

Referenceis made to the information contained in the section entitled “*Management’s Discussion and Analysis of FinancialCondition and Results of Operations*” set forth above in Item 2 of Part Iand to Note 17 to the Consolidated Condensed Financial Statements included in Part II,Item 8 of the Company’s Annual Report on Form 10-K for the yearended December 31, 2005 and note L to the Consolidation CondensedFinancial Statements included in Part I, Item 1 of this Quarterly Reporton Form 10-Q.

**Item6. - Exhibits**

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

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

32.1           Section 1350 Certification by the Chief ExecutiveOfficer of the Company.

32.2           Section 1350 Certification by the Chief FinancialOfficer of the Company.

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SIGNATURE

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.
|                     |   | UNITED INDUSTRIAL  CORPORATION |
|--------------------------|--------|--------------------------------|
|                     |   |                           |
|                     |   |                           |
|                     |   |                           |
| Date: May 10,  2006 |   | 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 EXHIBITS FILEDHEREWITH

**Exhibit No.**

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

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

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

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

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