Note 9. Segment Information

The Company has four reportable operating segments, which include the Asphalt Group, the Aggregate and Mining Group, the Mobile Asphalt Paving Group and the Underground Group. The business units in the Asphalt Group design, manufacture and market a complete line of asphalt plants and related components, heating and heat transfer processing equipment and storage tanks for the asphalt paving and other non-related industries. The business units in the Aggregate and Mining Group design, manufacture and market equipment for the aggregate, metallic mining and recycling industries. The business units in the Mobile Asphalt Paving Group design, manufacture and market asphalt pavers, material transfer vehicles, milling machines and screeds. The business units in the Underground Group design, manufacture and market a complete line of trenching equipment and directional drills for the underground construction market. The Company also has one other category that contains the business units that do not meet the requirements for separate disclosure as an operating segment. The business units in the Other category include Astec Insurance Company and Astec Industries, Inc., the parent company.

These forward-looking statements are based largely on management's expectations which are subject to a number of known and unknown risks, uncertainties and other factors discussed in this Report and in other documents filed by the Company with the Securities and Exchange Commission, which may cause actual results, financial or otherwise, to be materially different from those anticipated, expressed or implied by the forward-looking statements. All forward-looking statements included in this document are based on information available to the Company on the date hereof, and the Company assumes no obligation to update any such forward-looking statements to reflect future events or circumstances.

In addition to the risks and uncertainties identified elsewhere herein and in other documents filed by the Company with the Securities and Exchange Commission, most recently in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2005, the risk factors described in the section under the caption "Risk Factors" should be carefully considered when evaluating the Company's business and future prospects.

The Company is a leading manufacturer and marketer of construction equipment. The Company's businesses:

• design, engineer, manufacture and market equipment that is used in road building, from quarrying and crushing the aggregate, to preparing and paving the road surface;
• manufacture certain equipment and components unrelated to road construction, including trenching, auger boring, directional drilling, industrial heat transfer; and
• manufacture and sell replacement parts for equipment in each of its product lines.

The Company has four reportable operating segments, which include the Asphalt Group, the Aggregate and Mining Group, the Mobile Asphalt Paving Group and the Underground Group. The business units in the Asphalt Group design, manufacture and market a complete line of asphalt plants and related components, heating and heat transfer processing equipment and storage tanks for the asphalt paving and other non-related industries. The business units in the Aggregate and Mining Group design, manufacture and market equipment for the aggregate, metallic mining and recycling industries. The business units in the Mobile Asphalt Paving Group design, manufacture and market asphalt pavers, material transfer vehicles, milling machines and screeds. The business units in the Underground Group design, manufacture and market a complete line of trenching equipment and directional drills and auger boring machines for the underground construction market. The Company also has one other category that contains the business units that do not meet the requirements for separate disclosure as an operating segment. The business units in the Other category include Astec Insurance Company and Astec Industries, Inc., the parent company.

The Company's financial performance is affected by a number of factors, including the cyclical nature and varying conditions of the markets it serves. Demand in these markets fluctuates in response to overall economic conditions and is particularly sensitive to the amount of public sector spending on infrastructure development, privately funded infrastructure development, changes in the price of crude oil (fuel costs and liquid asphalt) and changes in the price of steel.

Public sector spending at the federal, state and local levels has been driven in large part by federal spending under the six-year federal-aid highway program, the Transportation Equity Act for the 21^st Century ("TEA-21"), enacted in June 1998. TEA-21 authorized the appropriation of $217 billion in federal aid for road, highway and bridge construction, repair and improvement and other federal highway and transit projects for federal fiscal years October 1, 1998 through September 30, 2004. In August 2005, President Bush signed into law the Safe, Accountable, Flexible and Efficient Transportation Equity Act - A Legacy for Users ("SAFETEA-LU"), which authorizes appropriation of $286.5 billion in guaranteed federal funding for road, highway and bridge construction, repair and improvement of the federal highway and transit projects for federal fiscal years October 1, 2004 through September 30, 2009. The Company believes that the federal highway funding significantly influences the purchasing decisions of the Company's customers who are more likely to make purchasing decisions with the six-year legislation in place. The Federal funding provides for approximately 25% of highway, street and roadway construction funding in the United States.

The public sector spending described above is needed to fund road, bridge and mass transit improvements. Unquestionably, the Company believes that increased funding is needed to restore the nation's highways to a quality level required for safety, fuel efficiency and mitigation of congestion. In the Company's opinion, amounts needed are significantly above amounts proposed, and funding mechanisms such as the federal usage fee per gallon of gasoline, which has not been increased in twelve years, should be increased along with other measures to generate the funds needed.

In addition to public sector funding, the economies in the markets the Company serves, the price of oil and its impact on customers' purchase decisions and the price of steel may each affect the Company's financial performance. Economic downturns, like the one experienced from 2001 through 2003, generally result in decreased purchasing by the Company's customers, which, in turn, causes reductions in sales and increased pricing pressure on the Company's products. Rising interest rates also typically have the effect of negatively impacting customers' attitudes toward purchasing equipment. The Company believes interest rates may rise during the year, but it does not expect such increases to have a material impact on the financial results of the Company. In addition, significant portions of the Company's revenues are related to the sale of equipment that produces asphalt mix. A major component of asphalt is oil. A rise in the price of oil increases the cost of providing asphalt, which could likely decrease demand for asphalt, and therefore decrease demand for certain Company products. Steel is a major component in the Company's equipment. As steel prices increased during 2004, the cost of manufactured parts, as well as the costs of purchased parts and components, also increased. Steel prices abated somewhat during 2005 but remain at historically high levels. The Company has instituted price increases in response to rising steel prices, purchased parts and component prices. If the Company is not able to raise the prices of its products enough to cover the increased costs of goods, the Company's financial results will be negatively affected. The Company believes that steel prices will be relatively flat during the remainder of 2006 and into 2007. In addition, although oil prices have recently retreated from record highs experienced earlier this year, the Company expects oil prices to remain volatile during the balance of 2006 and into 2007. The Company's customers appear to be adapting their prices in response to the fluctuating oil prices and the fluctuations do not appear to be significantly impairing the equipment purchases by them at this time. In addition to the factors stated above, many of the Company's markets are highly competitive, and its products compete worldwide with a number of other manufacturers and distributors that produce and sell similar products.

The price of oil could have a significant impact on liquid asphalt prices as well as domestic and foreign economies which could result in increased volatility and a lack of economic visibility. The Company believes that, based on its backlog and customer activity, the economic environment as it impacts the Company will continue to remain strong. The Company also believes that SAFETEA-LU will result in sustained or increased federal availability of highway funds and such funding should have a positive impact on customers' attitudes toward purchasing new equipment. The 2007 federal funding proposals recently approved by the Senate Appropriation Committee and the House each provide for the largest funding level in history. In addition, the Company believes that an improving economy should increase state highway funding revenues and private commercial projects.

For the three months ended September 30, 2006, net sales increased $22,367,000, or 15.0%, to $171,470,000 from $149,103,000 for the three months ended September 30, 2005. Sales are generated primarily from new equipment purchases made by customers for use in construction for privately funded infrastructure development and public sector spending on infrastructure development. For the quarter ended September 30, 2006 compared to the quarter ended September 30, 2005, (1) net sales for the Asphalt Group increased approximately $10,114,000 or 28.9%; (2) net sales for the Aggregate and Mining Group increased approximately $5,821,000 or 9.2%; (3) net sales for the Underground Group increased approximately $5,435,000 or 23.7%; and (4) net sales for the Mobile Asphalt Group increased approximately $997,000 or 3.6%. Parts sales for the quarter ended September 30, 2006 were $40,239,000 compared to $35,642,000 for the quarter ended September 30, 2005, for an increase of $4,597,000 or 12.9%. For the quarter ended September 30, 2006 compared to the same period of 2005, the increase in sales for all business segments related to a significant increase in international sales. Domestic sales accounted for 65.8% and international sales 34.2% of the third quarter revenues of 2006 compared to 80.5% for domestic sales and 19.5% for international sales for the third quarter of 2005.

For the nine months ended September 30, 2006, net sales increased $66,904,000, or 13.9%, to $548,455,000 from $481,551,000 for the nine months ended September 30, 2005. For the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005, (1) net sales for the Asphalt Group increased approximately $12,740,000 or 9.3%; (2) net sales of the Aggregate and Mining Group increased approximately $31,665,000 or 17.0%; (3) net sales for the Underground Group increased approximately $10,684,000 or 15.8%; and (4) net sales for the Mobile Asphalt Group increased approximately $11,815,000 or 12.9%. For the nine months ended September 30, 2006 compared to the same period of 2005, the increase in the sales for all business segments related primarily to an increase in international sales. Domestic sales accounted for 73.2% and international sales 26.8% of revenues during the nine months ended September 30, 2006 compared to 81.2% for domestic sales and 18.8% for international sales during the nine months ended September 30, 2005.

International sales for the quarter ended September 30, 2006 compared to the same period of 2005 increased $29,617,000, or 102.1%. International sales were $58,619,000 for the quarter ended September 30, 2006 compared to $29,002,000 for the quarter ended September 30, 2005. For the quarters ended September 30, 2006 and 2005, international sales accounted for approximately 34.2% and 19.5% of net sales, respectively. International sales increased for the third quarter of 2006 compared to the same period in 2005, in Canada, Europe, Africa, South America, China, Japan, Korea and the Middle East while for the comparable periods international sales decreased in Australia, Central America and the West Indies. The Company believes the overall increased level of international sales relates to improving economic conditions in certain foreign economies, continued weakness of the U.S. dollar compared to certain foreign currencies and increased sales efforts by the Company in foreign markets.

International sales for the nine months ended September 30, 2006 compared to the same period of 2005 increased $56,265,000, or 62.1%. International sales were $146,836,000 for the nine months ended September 30, 2006 compared to $90,571,000 for the nine months ended September 30, 2005. For the nine months ended September 30, 2006 and 2005, international sales accounted for approximately 26.8% and 18.8% of net sales, respectively. International sales increased for the nine months ended September 30, 2006 compared to the same period in 2005, in Canada, Europe, South America, Australia, the Middle East and Africa while for the comparable periods international sales decreased in the West Indies, China, Japan, Korea and Central America. The Company believes the overall increased level of international sales relates to improving economic conditions in certain foreign economies, continued weakness of the U.S. dollar compared to certain foreign currencies, and increased sales effort by the Company in foreign markets.

Gross profit for the three months ended September 30, 2006 increased $7,825,000 or 23.6%, to $41,017,000 from $33,192,000 for the three months ended September 30, 2005. Gross profit as a percentage of sales for the three months ended September 30, 2006 and 2005 was 23.9% and 22.3%, respectively, or an increase of 160 basis points. For the quarter ended September 30, 2006 compared to the same period in 2005, gross profit for the Asphalt Group increased from approximately $7,749,000 to approximately $11,160,000 or an increase of approximately $3,411,000 or 44.0%. This resulted in an increase in gross profit as a percentage of sales from 22.2% to 24.8% or 260 basis points for the same periods for the Asphalt Group. For the quarter ended September 30, 2006 compared to the same period in 2005, gross profit for the Aggregate and Mining Group increased from approximately $15,278,000 to approximately $16,688,000 or an increase of approximately $1,410,000 or 9.2%. Gross profit as a percentage of sales remained consistent at 24.2% for the third quarters of 2006 and 2005 for the Aggregate and Mining Group. For the quarter ended September 30, 2006 compared to the same period in 2005, gross profit for the Mobile Asphalt Paving Group decreased from approximately $6,380,000 to approximately $5,989,000 or a decrease of approximately $391,000 or 6.1%. This resulted in a decrease in gross profit as a percentage of sales from 22.8% to 20.7% or 210 basis points for the same periods for the Mobile Asphalt Paving Group. The decrease in margins for the Mobile Asphalt Paving Group was primarily caused by product mix variations and production inefficiencies encountered during a plant expansion and related relocation of manufacturing equipment. For the quarter ended September 30, 2006 compared to the same period in 2005, gross profit for the Underground Group increased from approximately $3,809,000 to approximately $7,200,000 or an increase of approximately $3,391,000 or 89.0%. This resulted in an increase in gross profit as a percentage of sales from 16.6% to 25.4% or 880 basis points for the same periods for the Underground Group. The gross profit percentage increase for the quarter ended September 30, 2006 compared to the same period of 2005 was primarily due to a favorable mix of products, including increased parts sales, increased international sales, price increases, more efficient utilization of the Company's manufacturing capacity and the impact of the Company's cost and design initiative programs.

Gross profit for the nine months ended September 30, 2006 increased $26,042,000 or 24.2%, to $133,559,000 from $107,517,000 for the nine months ended September 30, 2005. Gross profit as a percentage of sales for the nine months ended September 30, 2006 and 2005 was 24.4% and 22.3%, respectively, or an increase of 210 basis points. For the nine months ended September 30, 2006 compared to the same period in 2005, gross profit for the Asphalt Group increased from approximately $29,592,000 to approximately $37,981,000 or an increase of approximately $8,389,000 or 28.3%. This resulted in an increase in gross profit as a percentage of sales from 21.7% to 25.5% or 380 basis points for the same periods for the Asphalt Group. For the nine months ended September 30, 2006 compared to the same period in 2005, gross profit for the Aggregate and Mining Group increased from approximately $44,952,000 to approximately $53,292,000 or an increase of approximately $8,340,000 or 18.6%. This resulted in an increase in gross profit as a percentage of sales from 24.1% to 24.5% or 40 basis points for the same periods for the Aggregate and Mining Group. For the nine months ended September 30, 2006 compared to the same period in 2005, gross profit for the Mobile Asphalt Paving Group increased from approximately $21,062,000 to approximately $24,641,000 or an increase of approximately $3,579,000 or 17.0%. This resulted in an increase in gross profit as a percentage of sales from 23.0% to 23.9% or 90 basis points for the same periods for the Mobile Asphalt Paving Group. For the nine months ended September 30, 2006 compared to the same period in 2005, gross profit for the Underground Group increased from approximately $11,974,000 to approximately $17,687,000 or an increase of approximately $5,713,000 or 47.7%. This resulted in an increase in gross profit as a percentage of sales from 17.7% to 22.6% or 490 basis points for the same periods for the Underground Group. The gross profit percentage increase for the nine months ended September 30, 2006 compared to the same period of 2005 was primarily due to a favorable mix of products, including increased parts sales, increased international sales, price increases and the impact of the Company's cost and design initiative program implemented in 2005 that continues in 2006.

Selling, general, administrative and engineering expenses for the quarter ended September 30, 2006 were $25,295,000, or 14.8% of net sales, compared to $23,400,000, or 15.7% of net sales for the quarter ended September 30, 2005, an increase of $1,895,000 or 8.1%. The increase in selling, general, administrative and engineering expenses for the three months ended September 30, 2006 compared to the same period of 2005 related primarily to an increase in personnel expenses of approximately $1,072,000 due to increased staffing in order to support increased sales volume. Group health insurance expense increased approximately $1,553,000 due to an increase in the utilization rate as compared to the prior year and an increase in staffing. Sales commissions increased approximately $370,000 due to increased sales volumes while travel expense, including airline tickets, rental cars, lodging and meals increased approximately $410,000 due to increased selling efforts by the Company and cost increases by vendors in these services. These increases were offset by a reversal of expense of approximately $1,708,000 related to the Company's SERP. In addition, the Company was able to offset franchise tax expense with approximately $450,000 of jobs tax credits granted by the state of Tennessee during the third quarter. The Company also recorded certain legal expenses in the third quarter of 2005 of approximately $1,052,000 that did not reoccur in the third quarter of 2006.

Selling, general, administrative and engineering expenses for the nine months ended September 30, 2006 were $80,307,000, or 14.6% of net sales, compared to $69,020,000, or 14.3% of net sales for the nine months ended September 30, 2005, an increase of $11,287,000 or 16.4%. The increase in selling, general, administrative and engineering expenses for the nine months ended September 30, 2006 compared to the same period of 2005 related primarily to an increase in personnel expenses of approximately $8,472,000 due to increased staffing in order to support increased sales volume. Group health insurance expense increased approximately $2,781,000 due to an increase in the utilization rate as compared to the prior year and an increase in staffing. Profit-sharing expense increased approximately $1,239,000 and is a formula-driven amount based on the performance of the Company's subsidiaries. Sales commissions increased approximately $1,327,000 due to increased sales volumes. Expenses related to advertising and exhibits increased approximately $815,000 and stock option expense related to the adoption of SFAS 123R was approximately $470,000. Travel expense, including airline tickets, rental cars, lodging and meals, increased approximately $1,395,000 due to increased selling efforts and cost increases in these services.

On September 27, 2005, the Company closed on the sale of the vacated Grapevine, Texas facility for $13,200,000. The disposed assets had previously been classified on the consolidated balance sheet as assets held for sale with a book value of $4,886,000. As a result, the Company recorded a pretax gain, net of closing costs, on the disposal of the Grapevine, Texas facility of $7,714,000. In addition, during the third quarter of 2005, as a result of the Company's periodic review of its operations, the Company determined that certain idle real estate on the consolidated balance sheet included in property and equipment-net was impaired. The gain on the sale of the Grapevine, Texas facility of $7,714,000, net of the real estate impairment charge of $1,183,000, resulted in a net gain of $6,531,000, which is shown on the consolidated statement of income for the periods ending September 30, 2005 as "gain on sale of real estate, net of real estate impairment charge".

Effective January 1, 2006, the Company adopted SFAS 123R, using the modified prospective method. The fair value of each option grant was estimated based on the date of grant using the Black-Scholes option pricing model. SFAS 123R requires the recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements and is measured based on the grant date calculated fair value of the award. SFAS 123R also requires the stock option compensation expense to be recognized over the period during which an employee is required to provide service in exchange for the award (the vesting period). Prior to the adoption SFAS 123R on January 1, 2006, the Company accounted for stock-based compensation plans in accordance with the provisions of APB No. 25 and applied the disclosure only provision of SFAS 123. Under APB 25, generally no compensation expense was recorded when the terms of the award were fixed and the exercise price of the employee stock option equaled or exceeded the market value of the underlying stock on the date of grant. The Company did not record compensation expense for option awards in periods prior to January 1, 2006.

For the three months ended September 30, 2006, the Company recorded no compensation expense related to stock options.

For the nine months ended September 30, 2006, the Company recorded compensation expense related to stock options that reduced income from operations by $381,000, decreased the provision for income taxes by $83,000, decreased net income by $298,000 and decreased basic and diluted net income per share by $.01 each. Cash received from options exercised during the nine months ended September 30, 2006 totaled $8,938,000 and is included in the accompanying condensed consolidated statement of cash flows as a financing activity. The excess tax benefit realized from the exercise of these options totaled $2,639,000. The stock option compensation expense was included in selling, general and administrative expenses in the accompanying condensed consolidated statement of income. As of September 30, 2006, no unrecognized compensation costs related to stock options remained to be expensed.

In August 2006, the Compensation Committee of the Board of Directors approved a five-year plan to award key members of management restricted stock units each year. The plan allows up to 511,000 shares to be granted to employees over the next five years. Units granted each year will be determined based upon individual subsidiaries and consolidated annual financial performance. Each award will vest at the end of five years from the date of grant, or at the time a recipient reaches age 65, if earlier. No awards have been granted to date, but based upon current estimated performance for 2006, management estimates that 62,500 will be granted in March, 2007. Compensation expense of $89,000 has been recorded in the third quarter of 2006 to reflect the fair value of the 62,500 shares amortized over the vesting period. The fair value of the restricted stock units was $25.25 per share at September 30, 2006.

The Company adopted SFAS 123R using the modified prospective method and, consequently, the statement of operations for the quarter and nine months ended September 30, 2005 have not been restated to reflect the impact of applying the provisions of SFAS 123R. Had the Company accounted for stock-based compensation according to SFAS 123R during the quarter ended September 30, 2005, net income would have been increased by approximately $83,000 resulting in no effect on basic earnings per share and an increase of $0.01 in diluted earnings per share. Had the Company accounted for stock based compensation according to SFAS 123R during the nine months ended September 30, 2005, net income would have been reduced by approximately $336,000 resulting in a $0.01 reduction in basic and diluted earnings per share.

For the quarter ended September 30, 2006 compared to the quarter ended September 30, 2005, interest expense decreased $932,000, or 68.9%, to $421,000 from $1,353,000. Interest expense as a percentage of net sales was 0.25% and 0.91% for the quarters ended September 30, 2006 and 2005, respectively. The decrease in interest expense for the three months ended September 30, 2006 compared to the same period of 2005 related primarily to the elimination of the Company's outstanding debt during late 2005 and the corresponding write-off of approximately $520,000 of previously deferred financing fees along with no borrowings being made against the Company's line of credit in 2006. Interest expense for the three months ended September 30, 2006 related primarily to the amortization of prepaid loan fees and the payment of other monthly fees related to the GECC credit agreement which provides availability through May 2007.

For the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005, interest expense decreased $2,250,000, or 64.0%, to $1,268,000 from $3,518,000. Interest expense as a percentage of net sales was 0.23% and 0.73% for the nine month periods ended September 30, 2006 and 2005, respectively. The decrease in interest expense for the nine months ended September 30, 2006 compared to the same period of 2005 related primarily to the elimination of the Company's outstanding debt during late 2005 and no borrowings being made against the Company's line of credit in 2006. Interest expense for the nine months ended September 30, 2006 related primarily to the amortization of prepaid loan fees and the payment of other monthly fees related to the GECC credit agreement which provides availability through May 2007.

Other income, net was $570,000 for the quarter ended September 30, 2006 compared to other income, net of $56,000 for the quarter ended September 30, 2005, for an increase of $514,000. Other income, net for the quarters ended September 30, 2005 and 2006 consisted primarily of interest income earned on the Company's available cash balances.

Other income, net was $1,052,000 for the nine months ended September 30, 2006 compared to other income, net of $191,000 for the nine months ended September 30, 2005, for an increase of $861,000. Other income, net for the nine months ended September 30, 2005 and 2006 consisted primarily of interest income earned on the Company's available cash balances, offset by foreign currency exchange losses.

For the three months ended September 30, 2006, the Company recorded income tax expense of $5,807,000, compared to income tax expense of $4,938,000 for the three months ended September 30, 2005. This resulted in effective tax rates for the quarters ended September 30, 2006 and 2005 of 36.6% and 32.9%, respectively. The increase in the effective tax rate for the three months ended September 30, 2006 compared to the same period in 2005 is primarily due to the application of research and development credits from 2004 and prior years to the 2005 taxable income combined with an absence of research and development credits in the calculation of income tax expense in 2006. Although the Company has not claimed research and development credits in 2006 due to the lack of Congressional approval of such tax credits thus far, the Company fully expects to benefit from such credits during 2006 once Congress approves them. In addition, the meals and entertainment exclusion increased significantly relative to the same period last year.

For the nine months ended September 30, 2006, the Company recorded income tax expense of $19,666,000, compared to income tax expense of $14,541,000 for the nine months ended September 30, 2005. This resulted in effective tax rates for the nine months ended September 30, 2006 and 2005 of 37.1% and 34.9%, respectively. The increase in the effective tax rate for the nine months ended September 30, 2006 compared to the same period in 2005 is primarily due to the application of research and development credits from 2004 and prior years to the 2005 taxable income combined with an absence of research and development credits in the calculation of income tax expense in 2006. Although the Company has not claimed research and development credits in 2006 due to the lack of Congressional approval of such tax credits thus far, the Company fully expects to benefit from such credits during 2006 once Congress approves them. In addition, the meals and entertainment exclusion increased significantly relative to the same period last year.

  For the three months ended September 30, 2006, the Company had net income of $10,026,000 compared to net income of $10,059,000 for the three months ended September 30, 2005 for a decrease of $33,000 or 0.3%. Earnings per diluted share for the three months ended September 30, 2006 were $0.46 compared to earnings per diluted share for the quarter ended September 30, 2005 of $0.47 for a decrease of $0.01 or 2.1%. Diluted shares outstanding for the three months ended September 30, 2006 and 2005 were 21,927,051 and 21,239,420, respectively. The increase in shares outstanding is primarily due to the exercise of stock options by employees of the Company.

 For the nine months ended September 30, 2006, the Company had net income of $33,288,000 compared to net income of $27,072,000 for the nine months ended September 30, 2005 for an increase of $6,216,000 or 23.0%. Earnings per diluted share for the nine months ended September 30, 2006 were $1.52 compared to earnings per diluted share for the nine months ended September 30, 2005 of $1.30 for an increase of $0.22 or 16.9%. Diluted shares outstanding for the nine months ended September 30, 2006 and 2005 were 21,960,133 and 20,799,050, respectively. The increase in shares outstanding is primarily due to the exercise of stock options by employees of the Company.

As shown on the chart below, the third quarter of 2005 earnings included an after tax gain on the sale of the Grapevine, Texas property of $4,736,000, an after tax real estate impairment charge of $726,000 and after tax costs of $319,000 related to the payoff of the term loan. The gain on sale of real estate, net of real estate impairment charges, is presented as a separate line on the statement of income, and the costs related to the loan payoff are included in interest expense set forth therein. Excluding these items, net income for the third quarter of 2005 was $6,368,000, compared to net income for the third quarter of 2006 of $10,026,000, for a 57.4% increase. Diluted EPS in the third quarter of 2005 excluding these items was $0.30 compared to $0.46 in the third quarter of 2006 for a $0.16 per share increase. Excluding these items, net income for the nine months ended September 30, 2005 was $23,381,000, compared to net income for the nine months ended September 30, 2006 of $33,288,000, for a 42.4% increase. Diluted EPS for the nine months ended 2005 excluding these items was $1.12 compared to $1.52 for the nine months ended September 30, 2006 for an increase of $0.40 per share.

Management, with oversight of the Audit Committee of the Board of Directors, has been addressing the material weakness disclosed in the Company's 2005 Form 10-K and is committed to effectively remediating the underlying significant deficiencies in internal controls. Although the Company's remediation efforts are well underway, these significant deficiencies will not be considered remediated until the new internal controls over financial reporting are fully implemented and operational for a period of time, are successfully tested, and management concludes that these controls are operating effectively. The Company's Chief Executive Officer and Chief Financial Officer have therefore concluded that there have been no changes made in the Company's internal controls over financial reporting in connection with its nine-month period ended September 30, 2006 evaluation that would materially affect, or are reasonably likely to affect, its internal control over financial reporting. The current status of the Company's remediation efforts related to the significant deficiencies identified at Astec Underground, Inc. is as follows:

1. Improvements to Steel Inventory Control- (a) The perpetual inventory procedure for the issuance of steel into production has been changed from relieving steel inventory late in the manufacturing process ("back flushing") to now issuing steel into production at the time it is used. This allows for easier and more accurate cycle counts of steel inventory; (b) The Company's prior practice of taking a full physical inventory once a year has been modified to include monthly physical counts of steel plate inventory and test counting of other steel inventory. Further refinements to the perpetual inventory procedures are continuing to be made; (c) Cycle count procedures are being modified to improve accuracy of our perpetual inventory to include using ABC classifications of inventory to obtain a higher dollar value of count coverage and improve the accuracy of the overall inventory valuation; (d) Bills of materials have been and are continuing to be reviewed for accuracy and corrections have been made as needed to improve the accuracy of the relief of inventory usage; (e) A new procedure has been developed whereby all inventory adjustments are reported and reviewed monthly for accuracy; and (f) Further enhancements to the way Underground's ERP (Enterprise Resource Planning) system is utilized, including MRPII (Manufacturing Resource Planning II) and control of finished goods in the Utility product line are being implemented. Additional cycle counts procedures and the use of scanners are also being implemented to improve the overall accuracy of inventory control efforts.

2. Accounting System Access Controls- Underground's management has completed a review of access to the ERP system, including the general ledger module, and has limited the access to only those individuals who are deemed to have a viable need to use a particular function. The documentation of all systems and controls has been completed and the needed refinements to user access has been made.

3. Journal Entry Authorization- Improved procedures are now in place to ensure that all journal entries posted are properly authorized including: (a) documented review of all journal entries entered; (b) comparison of journal entries entered to a revised journal entry checklist; and (c) review of accounting support documents to ensure that all reviews are properly documented and that all required reconciliations have been prepared and properly approved. Additionally, one individual in the accounting department has been assigned the responsibility to ensure that all supporting documents are properly approved and filed.

4. Monitoring Controls- The process of fully documenting controls and the development of the process of monitoring the significant controls has been completed.

During 2005, the Company's Telsmith subsidiary completed the process of installing the general ledger, purchasing, sales, production, product development and customer resource modules of a new ERP computer system as part of a phased implementation schedule. Additional refinements to the modules related to production, product development and customer resource management are scheduled for installation during the fourth quarter of 2006. The new systems installed were subjected to testing prior to and after installation and are functioning to ensure that information required to be disclosed by the Company in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. We have not experienced any significant difficulties to date in connection with the implementation or operations of the new systems.