# ** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.20549**

 

**FORM 10-Q/A**

**Amendment No. 1**

 
| ý    **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|----------------------------------------------------------------------------------------------------------------------------------|

 

**For the quarterly period ended June 30,2003**

 

**OR**

 
| o    **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|------------------------------------------------------------------------------------------------------------------------------|

 

**For the transitionperiodfrom                  to                  **

 

**Commission FileNumber  0-29798**

 

**CompuDyne Corporation**

(Exact name of registrant as specified in itscharter)

 

| **Nevada**                                                                         |   | **23-1408659**                        |
|------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                    |   | (I.R.S. Employer  Identification No.) |
|                                                                               |   |                                  |
| **7249 National Drive, Hanover, Maryland 21076**                                   |
| (Address of principal executive offices)                                           |
|                                                                               |   |                                  |
| Registrant’s telephone number, including  area code:  **(410) 712-0275** |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes   ý                     No   o

 

Indicate by checkmark whether the registrant is an accelerated filer(as defined in rule 12b-2 of the Exchange Act)

 

Yes   ý                     No   o

 

As of August 13, 2003, a total of 7,924,012 shares of CommonStock, $.75 par value, were outstanding.

 

 

----

 

Explanatory Note

 

Subsequent tothe issuance of CompuDyne’s Form 10-Q for the period ended June 30, 2003,CompuDyne determined that the purchase price of its acquisition of Tiburon,Inc. was incorrectly reduced in the quarter ended March 31, 2003 resultingin an understatement of goodwill at June 30, 2003 in the amount of$3,430,000 with a corresponding understatement of additional paid-in-capital.This amended Form 10-Q includes the restated purchase price amounts.  Such restatement had no effect on previouslyreported results of operations or cash flows.

 

Except asdisclosed above, all information contained herein is as originallyreported.  No changes have been made toItems 3 and 4, which have not been reported in this amendment.

 

2

----

 

COMPUDYNE CORPORATION AND SUBSIDIARIES

INDEX

 

 
| Part I.  Financial Information |                                                                                                |
|-------------------------------------|-----------------------------------------------------------------------------------------------------|
|                                |                                                                                                |   |
|                                | Item 1. Financial Statements - Unaudited                                                            |   |
|                                |                                                                                                |   |   |
|                                |                                                                                                | Condensed Consolidated Balance Sheets -  June 30, 2003 (as restated) and December 31, 2002 |   |
|                                |                                                                                                |   |   |
|                                |                                                                                                | Condensed Consolidated Statements of  Operations -  Three Months and Six Months Ended  June 30, 2003 and 2002 |   |
|                                |                                                                                                |   |   |
|                                |                                                                                                | Condensed Consolidated Statement of Changes  in  Shareholders’ Equity (as restated) – Six Months Ended  June 30, 2003 |   |
|                                |                                                                                                |   |   |
|                                |                                                                                                | Condensed Consolidated Statements of Cash  Flows -  Six Months Ended June 30, 2003 and 2002 |   |
|                                |                                                                                                |   |   |
|                                |                                                                                                | Notes to Condensed Consolidated Financial  Statements |   |
|                                |                                                                                                |   |   |
|                                | Item 2. Management’s Discussion and Analysis of Financial Condition  and Results of Operations |   |
|                                |                                                                                                |   |
|                                | Signature  and Certifications                                                                       |   |

 

3

----

 

ITEM 1.FINANCIAL STATEMENTSCOMPUDYNE CORPORATION AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCESHEETS

 (unaudited)

 
|                                                                                                                                                               |   | **June 30,  2003**              |       | **December  31,  2002** |       |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------|------------|-------------------------|------------|
|                                                                                                                                                               |   | **(in  thousands)**             |       |
|                                                                                                                                                               |   | **(as  restated,  see note 9)** |       |                    |       |
|                                                                                                                                                               |   |                            |       |                    |       |
| **ASSETS**                                                                                                                                                         |   |                            |       |                    |       |
|                                                                                                                                                               |   |                            |       |                    |       |
| Current Assets                                                                                                                                                     |   |                            |       |                    |       |
| Cash and cash equivalents                                                                                                                                          |   | $                               | 4,079      |                    | $          | 1,274 |   |
| Accounts receivable, net                                                                                                                                           |   | 43,124                          |       | 45,168                  |       |
| Contract costs in excess of billings                                                                                                                               |   | 15,159                          |       | 18,297                  |       |
| Inventories                                                                                                                                                        |   | 5,637                           |       | 6,401                   |       |
| Deferred tax assets                                                                                                                                                |   | 1,220                           |       | 1,220                   |       |
| Prepaid expenses and other                                                                                                                                         |   | 3,168                           |       | 2,510                   |       |
| Total Current Assets                                                                                                                                               |   | 72,387                          |       | 74,870                  |       |
|                                                                                                                                                               |   |                            |       |                    |       |
| Property, plant and equipment, net                                                                                                                                 |   | 10,836                          |       | 12,171                  |       |
| Goodwill, net                                                                                                                                                      |   | 21,281                          |       | 21,938                  |       |
| Other intangible assets, net                                                                                                                                       |   | 9,915                           |       | 10,171                  |       |
| Deferred tax assets                                                                                                                                                |   | 965                             |       | 987                     |       |
| Other                                                                                                                                                              |   | 746                             |       | 667                     |       |
| Total Assets                                                                                                                                                       |   | $                               | 116,130    |                    | $          | 120,804 |   |
|                                                                                                                                                               |   |                            | ** ** |                    | ** ** |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                      |   |                            | ** ** |                    | ** ** |
|                                                                                                                                                               |   |                            | ** ** |                    | ** ** |
| Current Liabilities                                                                                                                                                |   |                            |       |                    |       |
| Accounts payable and accrued liabilities                                                                                                                           |   | $                               | 24,177     |                    | $          | 22,235 |   |
| Billings in excess of contract costs  incurred                                                                                                                     |   | 13,654                          |       | 13,602                  |       |
| Deferred revenue                                                                                                                                                   |   | 3,793                           |       | 5,812                   |       |
| Current portion of notes payable                                                                                                                                   |   | 2,107                           |       | 2,402                   |       |
| Total Current Liabilities                                                                                                                                          |   | 43,731                          |       | 44,051                  |       |
|                                                                                                                                                               |   |                            |       |                    |       |
| Notes payable                                                                                                                                                      |   | 18,975                          |       | 25,108                  |       |
| Deferred tax liabilities                                                                                                                                           |   | 2,114                           |       | 2,114                   |       |
| Other                                                                                                                                                              |   | 270                             |       | 327                     |       |
| Total Liabilities                                                                                                                                                  |   | 65,090                          |       | 71,600                  |       |
|                                                                                                                                                               |   |                            |       |                    |       |
| Commitments and contingencies                                                                                                                                      |   |                            |       |                    |       |
|                                                                                                                                                               |   |                            |       |                    |       |
| Shareholders’ Equity                                                                                                                                          |   |                            |       |                    |       |
| Preferred stock, 2,000,000 shares  authorized and unissued                                                                                                         |   | —                          |       | —                  |       |
| Common stock, par value $.75 per share:  15,000,000 shares authorized; 8,513,980 and 8,391,522 shares issued at June  30, 2003 and December 31, 2002, respectively |   | 6,385                           |       | 6,294                   |       |
| Additional paid-in-capital                                                                                                                                         |   | 42,406                          |       | 42,508                  |       |
| Retained earnings                                                                                                                                                  |   | 6,497                           |       | 4,518                   |       |
| Accumulated other comprehensive loss                                                                                                                               |   | (162                            | )          | (196                    | )          |
| Treasury stock, at cost; 594,768 shares at  June 30, 2003 and 573,930 shares at December 31, 2002                                                                  |   | (4,086                          | )          | (3,920                  | )          |
| Total Shareholders’ Equity                                                                                                                                    |   | 51,040                          |       | 49,204                  |       |
| Total Liabilities and Shareholders’ Equity                                                                                                                    |   | $                               | 116,130    |                    | $          | 120,804 |   |

 

The accompanying notes are an integral partof these financial statements.

 

4

----

 

COMPUDYNE CORPORATION AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS

(unaudited)

 
|                                                      |   | **Three  Months Ended  June 30,**          |   | **Six Months  Ended  June 30,** |   |
|-----------------------------------------------------------|--------|--------------------------------------------|--------|---------------------------------|--------|
|                                                      |   | **2003**                                   |   | **2002**                        |   | **2003** |   | **2002** |   |
|                                                      |   | **(in  thousands, except per share data)** |   |
|                                                      |   |                                       |   |                            |   |   |   |   |   |
| Net sales                                                 |   | $                                          | 47,538 |                            | $      | 39,416 |   | $ | 94,305 |   | $ | 69,906 |   |
| Cost of goods sold                                        |   | 35,751                                     |   | 29,978                          |   | 70,735 |   | 54,473 |   |
| Gross profit                                              |   | 11,787                                     |   | 9,438                           |   | 23,570 |   | 15,433 |   |
|                                                      |   |                                       |   |                            |   |   |   |   |   |
| Operating expenses                                        |   | 7,696                                      |   | 6,692                           |   | 15,654 |   | 11,184 |   |
| Research and development                                  |   | 2,032                                      |   | 1,289                           |   | 3,913 |   | 1,323 |   |
| Operating income                                          |   | 2,059                                      |   | 1,457                           |   | 4,003 |   | 2,926 |   |
|                                                      |   |                                       |   |                            |   |   |   |   |   |
| Other expense (income)                                    |   |                                       |   |                            |   |   |   |   |   |
| Interest expense                                          |   | 334                                        |   | 346                             |   | 713 |   | 659 |   |
| Other (income) expense                                    |   | (2                                         | )      | (77                             | )      | (9 | ) | (139 | ) |
| Total other expense                                       |   | 332                                        |   | 269                             |   | 704 |   | 520 |   |
|                                                      |   |                                       |   |                            |   |   |   |   |   |
| Income before income taxes                                |   | 1,727                                      |   | 1,188                           |   | 3,299 |   | 2,406 |   |
| Income taxes                                              |   | 690                                        |   | 475                             |   | 1,320 |   | 912 |   |
| Net income                                                |   | $                                          | 1,037  |                            | $      | 713 |   | $ | 1,979 |   | $ | 1,494 |   |
|                                                      |   |                                       |   |                            |   |   |   |   |   |
| Earnings per share:                                       |   |                                       |   |                            |   |   |   |   |   |
| Basic earnings per share                                  |   | $                                          | .13    |                            | $      | .10 |   | $ | .25 |   | $ | .21 |   |
|                                                      |   |                                       |   |                            |   |   |   |   |   |
| Weighted average number of common shares  outstanding     |   | 7,898                                      |   | 7,427                           |   | 7,860 |   | 7,050 |   |
|                                                      |   |                                       |   |                            |   |   |   |   |   |
| Diluted earnings per share                                |   | $                                          | .13    |                            | $      | .09 |   | $ | .24 |   | $ | .20 |   |
|                                                      |   |                                       |   |                            |   |   |   |   |   |
| Weighted average number of common shares  and equivalents |   | 8,139                                      |   | 8,065                           |   | 8,106 |   | 7,656 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

5

----

 

COMPUDYNE CORPORATION AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTSOF CHANGES IN SHAREHOLDERS’ EQUITY(unaudited)(in thousands)

 
|                                                                        |       | **Common  Stock** |       | **Additional  Paid-in  Capital** |   | **Retained  Earnings** |   | **Accumulated  Other  Comprehensive  Loss** |   | **Treasury  Stock** |   | **Total** |   |
|-----------------------------------------------------------------------------|------------|-------------------|------------|----------------------------------|--------|------------------------|--------|---------------------------------------------|--------|---------------------|--------|-----------|--------|
|                                                                        |       |              |       |                             |   |                   |
|                                                                        |       |              |       |                             |   |                   |
|                                                                        | **Shares** |              | **Amount** |                             |   |                   |   | **Shares**                                  |   | **Amount**          |   |      |
|                                                                        |       |              |       |                             |   |                   |   |                                        |   |                |   |      |   |   |   |   |   |
| December 31, 2002                                                           |       | 8,392             |       | $                                | 6,294  |                   | $      | 42,508                                      |   | $                   | 4,518  |      | $      | (196 | ) | 574 |   | $ | (3,920 | ) | $ | 49,204 |   |
|                                                                        |       |              |       |                             |   |                   |   |                                        |   |                |   |      |   |   |   |   |   |
| Acquisition of Tiburon purchase price  adjustment (As restated, see note 9) |       |              |       |                             |   | (370                   | )      |                                        |   |                |   |      |   |   |   | (370 | ) |
|                                                                        |       |              |       |                             |   |                   |   |                                        |   |                |   |      |   |   |   |   |   |
| Stock options exercised                                                     |       | 74                |       | 55                               |   | 138                    |   |                                        |   |                |   |      |   |   |   | 193 |   |
|                                                                        |       |              |       |                             |   |                   |   |                                        |   |                |   |      |   |   |   |   |   |
| Warrants exercised                                                          |       | 48                |       | 36                               |   | 130                    |   |                                        |   |                |   | 21        |   | (166 | ) | — |   |
|                                                                        |       |              |       |                             |   |                   |   |                                        |   |                |   |      |   |   |   |   |   |
| Net income                                                                  |       |              |       |                             |   |                   |   | 1,979                                       |   |                |   |      |   |   |   | 1,979 |   |
|                                                                        |       |              |       |                             |   |                   |   |                                        |   |                |   |      |   |   |   |   |   |
| Other comprehensive income, net of tax:                                     |       |              |       |                             |   |                   |   |                                        |   |                |   |      |   |   |   |   |   |
| Loss on interest rate swap agreement                                        |       |              |       |                             |   |                   |   |                                        |   | 41                  |   |      |   |   |   | 41 |   |
| Translation adjustment                                                      |       |              |       |                             |   |                   |   |                                        |   | (7                  | )      |      |   |   |   | (7 | ) |
| Balance at June 30, 2003 (As restated, see  note 9)                         |       | 8,514             |       | $                                | 6,385  |                   | $      | 42,406                                      |   | $                   | 6,497  |      | $      | (162 | ) | 595 |   | $ | (4,086 | ) | $ | 51,040 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

6

----

 

COMPUDYNE CORPORATION AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS(unaudited)

 
|                                                                               |   | **Six Months  Ended  June 30,** |   |
|------------------------------------------------------------------------------------|--------|---------------------------------|--------|
|                                                                               |   | **2003**                        |   | **2002** |   |
|                                                                               |   | **(in  thousands)**             |   |
| Cash flows from operating activities:                                              |   |                            |   |   |   |
| Net income                                                                         |   | $                               | 1,979  |   | $ | 1,494 |   |
|                                                                               |   |                            |   |   |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operations: |   |                            |   |   |   |
| Depreciation and amortization                                                      |   | 1,376                           |   | 1,073 |   |
| Equity earnings in affiliated company                                              |   | —                          |   | (23 | ) |
| Loss (Gain) from disposition of property,  plant and equipment                     |   | 1                               |   | (5 | ) |
|                                                                               |   |                            |   |   |   |
| Changes in assets and liabilities:                                                 |   |                            |   |   |   |
| Accounts receivable                                                                |   | 2,044                           |   | (6,560 | ) |
| Contract costs in excess of billings                                               |   | 3,714                           |   | 2,335 |   |
| Inventories                                                                        |   | 764                             |   | 71 |   |
| Prepaid expenses and other current assets                                          |   | (658                            | )      | 786 |   |
| Other assets                                                                       |   | (79                             | )      | (49 | ) |
| Accounts payable and accrued liabilities                                           |   | 2,268                           |   | (1,493 | ) |
| Billings in excess of contract costs  incurred                                     |   | 52                              |   | 2,324 |   |
| Deferred revenue                                                                   |   | (2,019                          | )      | — |   |
| Other liabilities                                                                  |   | (1                              | )      | (4 | ) |
| Net cash flows provided by (used in)  operating activities                         |   | 9,441                           |   | (51 | ) |
|                                                                               |   |                            |   |   |   |
| Cash flows from investing activities:                                              |   |                            |   |   |   |
| Additions to property, plant and equipment                                         |   | (339                            | )      | (2,464 | ) |
| Proceeds from sale of property, plant and  equipment                               |   | 9                               |   | 25 |   |
| Net payment for acquisition                                                        |   | (71                             | )      | (10,374 | ) |
| Net cash flows used in investing activities                                        |   | (401                            | )      | (12,813 | ) |
|                                                                               |   |                            |   |   |   |
| Cash flows from financing activities:                                              |   |                            |   |   |   |
| Issuance of common stock                                                           |   | 193                             |   | 527 |   |
| Warrants exercised                                                                 |   | 166                             |   | 64 |   |
| Purchase of treasury stock                                                         |   | (166                            | )      | (64 | ) |
| Repayment of subordinated notes payable                                            |   | —                          |   | (587 | ) |
| Borrowings of bank notes                                                           |   | —                          |   | 14,500 |   |
| Repayment of bank notes                                                            |   | (6,428                          | )      | (416 | ) |
| Net cash (used in) provided by financing  activities                               |   | (6,235                          | )      | 14,024 |   |
|                                                                               |   |                            |   |   |   |
| Net change in cash and cash equivalents                                            |   | 2,805                           |   | 1,160 |   |
| Cash and cash equivalents at beginning of  period                                  |   | 1,274                           |   | 296 |   |
| Cash and cash equivalents at end of period                                         |   | $                               | 4,079  |   | $ | 1,456 |   |
|                                                                               |   |                            |   |   |   |
| Supplemental disclosures of cash flow information:                                 |   |                            |   |   |   |
| Cash paid during the period for:                                                   |   |                            |   |   |   |
| Interest                                                                           |   | $                               | 587    |   | $ | 604 |   |
| Income taxes                                                                       |   | $                               | 1,220  |   | $ | 696 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

7

----

 

COMPUDYNE CORPORATION AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS(UNAUDITED)

 

1.             BASIS OFPRESENTATION

 

The accompanying unaudited condensed consolidated financial statementsof CompuDyne Corporation and its subsidiaries (the “Company”) have beenprepared pursuant to the rules and regulations of the Securities and ExchangeCommission. The condensed consolidated balance sheet as of December 31,2002 has been derived from the Company’s December 31, 2002 auditedfinancial statements.  Certaininformation and note disclosures included in the annual financial statements,prepared in accordance with accounting principles generally accepted in theUnited States of America, have been condensed or omitted pursuant to thoserules and regulations, although the Company believes that the disclosures madeare adequate to make the information presented not misleading.

 

In the opinion of management, the accompanying unaudited condensedconsolidated financial statements reflect all necessary adjustments andreclassifications (all of which are of a normal, recurring nature) that arenecessary for the fair presentation of the periods presented.  It is suggested that these condensedconsolidated unaudited financial statements be read in conjunction with the consolidatedfinancial statements and the notes thereto included in the Company’s annualreport filed with the Securities and Exchange Commission on Form 10-K for theyear ended December 31, 2002. Operating results for the three and sixmonth periods ended June 30, 2003 and 2002 are not necessarily indicativeof operating results for the entire fiscal year.

 

New Accounting Pronouncements:

 

In May 2003, the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards (“SFAS”) No. 150, “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity.” The Statement establishesstandards for how an issuer classifies and measures in its statement offinancial position certain financial instruments with characteristics of bothliabilities and equity.  It requiresthat an issuer classify a financial instrument that is within its scope as aliability (or an asset in some circumstances) because that financial instrumentembodies an obligation of the issuer. Many of such instruments were previously classified as equity.  The statement is effective for financialinstruments entered into or modified after May 31, 2003, and otherwise iseffective at the beginning of the first interim period beginning afterJune 15, 2003, except for mandatorily redeemable financial instruments ofnonpublic entities.  The Statement is tobe implemented by reporting the cumulative effect of a change in accountingprinciple for financial instruments created before the issuance of the date ofthe Statement and still existing at the beginning of the interim period ofadoption.  Restatement is notpermitted.  Management believes that theadoption of this statement will not have a significant impact on the financialposition, results of operations or cash flows of the Company.

 

In April 2003, the FASB issued SFAS No. 149, “Amendment of SFASNo. 133 on Derivative Instruments and Hedging Activities”. The Statement amendsand clarifies accounting for derivative instruments, including certainderivative instruments embedded in other contracts, and for hedging activitiesunder Statement 133.  The amendments setforth in SFAS 149 improve financial reporting by requiring that contracts withcomparable characteristics be accounted for similarly. In particular, thisStatement clarifies under what circumstances a contract with an initial netinvestment meets the characteristic of a derivative as discussed in Statement133. In addition, it clarifies when a derivative contains a financing componentthat warrants special reporting in the statement of cash flows. Statement 149amends certain other existing pronouncements. Those changes will result in moreconsistent reporting of contracts that are derivatives in their entirety orthat contain embedded derivatives that warrant separate accounting.  This Statement is effective for contractsentered into or modified after June 30, 2003 and for hedging relationshipsdesignated after June 30, 2003. The Company does not expect that adoptionof this pronouncement will have a material effect on its financial position,results of operations or cash flows.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting forStock-Based Compensation —Transition and 

 

8

----

 

Disclosure, an amendment of FASB Statement No. 123” which amends SFASNo. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation” and thereporting provisions of APB Opinion No. 30, “Interim Financial Reporting.”  SFAS 148 provides alternative methods oftransition for a voluntary change to the fair value based method of accountingfor stock-based employee compensation and requires prominent disclosures inboth annual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method used on reportedresults.  Adoption of this statement wasrequired at the beginning of fiscal year 2003. The adoption of this pronouncement did not have a material effect on thefinancial position, results of operations or cash flows of CompuDyne.

 

In July 2002, the FASBissued SFAS No. 146, “Accounting for Costs Associated with Exit or DisposalActivities”. The Statement is effective for fiscal years beginning afterDecember 31, 2002.  SFAS No. 146 requirescompanies to recognize costs associated with exit or disposal activities whenthey are incurred, rather than at the date of a commitment to an exit ordisposal plan. The adoption of this standard did not have a material effect onthe financial position,  results ofoperations or cash flows of CompuDyne.

 

In April 2002, the FASB issued SFAS No. 145, “Rescission of FASBStatements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections.”  This statement iseffective for fiscal years beginning after May 15, 2002.  SFAS 145 requires, among other things,eliminating reporting debt extinguishments as an extraordinary item in theincome statement.  The adoption of thisstandard did not have a material effect on the financial position, results ofoperations or cash flows of CompuDyne.

 

In January 2003, the FASBissued Interpretation No. 46, “Consolidation of Variable InterestEntities.”  The Interpretation clarifiesthe application of Accounting Research Bulletin No. 51, “Consolidated FinancialStatements,” to certain entities in which the equity investors do not have thecharacteristics of a controlling financial interest or do not have sufficientequity at risk for the entity to finance its activities without additionalsubordinated financial support from other parties.  The Interpretation applies immediately to variable interestentities created after January 31, 2003, or in which the Company obtainsan interest after that date.  TheInterpretation is effective July 1, 2003 to variable interest entities inwhich the Company holds a variable interest acquired before February 1,2003.  The Company has assessed theimpact of adopting this Interpretation. The adoption of this standard did nothave a material effect on the financial position, results of operations or cashflows of CompuDyne.

 

In November 2002, the FASBissued Interpretation No. 45, “Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers” (“FIN 45”). FIN 45 requires the recognition of liabilities forguarantees that are issued or modified subsequent to December 31, 2002.The liabilities should reflect the fair value, at inception, of the guarantors’obligations to stand ready to perform, in the event that the specifiedtriggering events or conditions occur. The adoption of this standard did nothave a material effect on the financial position, results of operations or cashflows of CompuDyne.

 

Reclassifications:

 

Certain prior period amounts have been reclassified to conform to thecurrent period’s presentation.

 

2.                                       OPERATINGSEGMENT INFORMATION

 

The following is the operating segment information for the three monthsended June 30, 2002 and 2003.

 

9

----

 

 
|                           |   | **Revenues**                           |   | **Gross Profit** |   | **Pre-tax  Income/(Loss)** |   |
|--------------------------------|--------|----------------------------------------|--------|------------------|--------|----------------------------|--------|
|                           |   | **(Three  Months ended June 30)** |   |
|                           |   | **(in  thousands)**                    |   |
|                           |   | **2003**                               |   | **2002**         |   | **2003**                   |   | **2002** |   | **2003** |   | **2002** |   |
| Institutional Security Systems |   | $                                      | 25,692 |             | $      | 21,981                     |   | $ | 3,240 |   | $ | 3,539 |   | $ | 835 |   | $ | 1,040 |   |
| Attack Protection              |   | 6,533                                  |   | 5,598            |   | 1,380                      |   | 795 |   | (52 | ) | (696 | ) |
| Federal Security Systems       |   | 4,261                                  |   | 3,893            |   | 603                        |   | 689 |   | 296 |   | 252 |   |
| Public Safety and Justice      |   | 11,052                                 |   | 7,944            |   | 6,564                      |   | 4,415 |   | 482 |   | 491 |   |
| CompuDyne Corporate            |   | —                                 |   | —           |   | —                     |   | — |   | 166 |   | 101 |   |
|                           |   | $                                      | 47,538 |             | $      | 39,416                     |   | $ | 11,787 |   | $ | 9,438 |   | $ | 1,727 |   | $ | 1,188 |   |

 

The following is the operating segment information for the six monthsended June 30, 2002 and 2003.

 
|                           |   | **Revenues**                         |   | **Gross  Profit** |   | **Pre-tax  Income/(Loss)** |   |
|--------------------------------|--------|--------------------------------------|--------|-------------------|--------|----------------------------|--------|
|                           |   | **(Six  Months ended June 30)** |   |
|                           |   | **(in  thousands)**                  |   |
|                           |   | **2003**                             |   | **2002**          |   | **2003**                   |   | **2002** |   | **2003** |   | **2002** |   |
| Institutional Security Systems |   | $                                    | 49,140 |              | $      | 42,201                     |   | $ | 6,517 |   | $ | 7,230 |   | $ | 1,572 |   | $ | 2,178 |   |
| Attack Protection              |   | 14,876                               |   | 11,772            |   | 3,355                      |   | 2,122 |   | 510 |   | (689 | ) |
| Federal Security Systems       |   | 7,750                                |   | 6,861             |   | 1,125                      |   | 1,140 |   | 503 |   | 301 |   |
| Public Safety and Justice      |   | 22,539                               |   | 9,072             |   | 12,573                     |   | 4,941 |   | 550 |   | 493 |   |
| CompuDyne Corporate            |   | —                               |   | —            |   | —                     |   | — |   | 164 |   | 123 |   |
|                           |   | $                                    | 94,305 |              | $      | 69,906                     |   | $ | 23,570 |   | $ | 15,433 |   | $ | 3,299 |   | $ | 2,406 |   |

 

3.             EARNINGS PER SHARE

 

Earnings per share are presented in accordance with SFAS No. 128,“Earnings Per Share.”  This Statementrequires dual presentation of basic and diluted earnings per share on the faceof the statement of operations.  Basicearnings per share excludes dilution and is computed by dividing net income bythe weighted-average number of common shares outstanding during theperiod.  Diluted earnings per share alsoreflects the potential dilution that could occur if securities or othercontracts to issue common stock were exercised or converted into commonstock.  Stock options and warrants topurchase 814,520 shares and 25,500 shares for the three month periods endedJune 30, 2003 and 2002 respectively, were not dilutive and, therefore,were not included in the computation of diluted earnings per common share.  Stock options and warrants to purchase1,044,020 shares and 45,500 shares for the six month periods endedJune 30, 2003 and 2002 respectively, were not dilutive and, therefore,were not included in the computation of diluted earnings per common share.

 

The computations of the Company’s basic and diluted earnings per shareamounts for the Company’s operations were as follows:

 
|                                                |   | **Three  Months Ended  June 30,**     |   | **Six Months  Ended  June 30,** |   |
|-----------------------------------------------------|--------|--------------------------------------------|--------|--------------------------------------|--------|
|                                                |   | **2003**                                   |   | **2002**                             |   | **2003** |   | **2002** |   |
|                                                |   | **(in  thousands, except per share data)** |   |
|                                                |   |                                       |   |                                 |   |   |   |   |   |
| Net income                                          |   | $                                          | 1,037  |                                 | $      | 713 |   | $ | 1,979 |   | $ | 1,494 |   |
|                                                |   |                                       |   |                                 |   |   |   |   |   |
| Weighted average common shares outstanding          |   | 7,898                                      |   | 7,427                                |   | 7,860 |   | 7,050 |   |
| Effect of dilutive stock options and  warrants      |   | 241                                        |   | 638                                  |   | 246 |   | 606 |   |
| Diluted weighted average common shares  outstanding |   | 8,139                                      |   | 8,065                                |   | 8,106 |   | 7,656 |   |
|                                                |   |                                       |   |                                 |   |   |   |   |   |
| Net income per common share                         |   |                                       |   |                                 |   |   |   |   |   |
| Basic                                               |   | $                                          | .13    |                                 | $      | .10 |   | $ | .25 |   | $ | .21 |   |
| Diluted                                             |   | $                                          | .13    |                                 | $      | .09 |   | $ | .24 |   | $ | .20 |   |

 

10

----

 

4.             INVENTORIES

 

Inventories consist of the following:

 
|             |   | **June 30,  2003** |   | **December 31,  2002** |   |
|------------------|--------|-------------------------|--------|-----------------------------|--------|
|             |   | **(in  thousands)**     |   |
| Raw materials    |   | $                       | 3,702  |                        | $      | 3,937 |   |
| Work in progress |   | 1,541                   |   | 2,197                       |   |
| Finished goods   |   | 394                     |   | 267                         |   |
|             |   | $                       | 5,637  |                        | $      | 6,401 |   |

 

5.             GOODWILL ANDINTANGIBLE ASSETS

 

Intangible assets include the trade name, customer relationships andbacklog from the acquisition of Tiburon, Inc. Other intangibles includeDepartment of State Certifications, Underwriters Laboratories, Inc. listings,and patents related to the acquisition of Norment and Norshield.  Except for goodwill and trade names, whichhave indefinite lives, intangibles are being amortized using the straight-linemethod.

 

Goodwill and intangible assets consist of the following:

 
|                           |   | **June 30,  2003** |   | **December 31,  2002** |   | **Amortizable  Lives** |   |
|--------------------------------|--------|-------------------------|--------|-----------------------------|--------|------------------------|--------|
|                           |   | **(in  thousands)**     |   | **(in years)**              |   |
| Goodwill                       |   | $                       | 21,386 |                        | $      | 22,043                 |   | Indefinite |   |
| Trade name                     |   | 6,913                   |   | 6,913                       |   | Indefinite             |   |
| Customer relationships         |   | 2,500                   |   | 2,500                       |   | 14                     |   |
| Backlog                        |   | 300                     |   | 300                         |   | 2                      |   |
| Other                          |   | 1,220                   |   | 1,220                       |   | 2 - 20                 |   |
|                           |   | 32,319                  |   | 32,976                      |   |                   |   |
| Less: accumulated amortization |   | (1,123                  | )      | (867                        | )      |                   |   |
|                           |   | $                       | 31,196 |                        | $      | 32,109                 |   |   |   |

 

Goodwill consisted of $19.8 million and $20.5 million for the PublicSafety and Justice segment at June 30, 2003 and December 2002,respectively, and $0.8 million for the Institutional Security Systems segmentand $0.8 million for the Attack Protection segment for both June 30, 2003and December 31, 2002.

 

Amortization expense for the three and six months period endedJune 30, 2003 was $128 thousand and $256 thousand, respectively.  The following schedule lists theexpected amortization expense for each of the years ending December 31:

 
| **Year** |   | **Expense**         |   |
|----------|--------|---------------------|--------|
|     |   | **(in  thousands)** |   |
| 2003     |   | $                   | 386    |   |
| 2004     |   | 350                 |   |
| 2005     |   | 270                 |   |
| 2006     |   | 225                 |   |
| 2007     |   | 225                 |   |
| Total    |   | $                   | 1,456  |   |

 

6.             ACQUISITION OFTIBURON, INC.

 

On January 25, 2002, the Company and Tiburon, Inc. (“Tiburon”)entered into a First Amendment Agreement whereby upon the satisfaction ofcertain conditions, the Company agreed to purchase all of the issued andoutstanding common

 

11

----

 

shares and other common stock equivalents it did not already own for acombination of cash and stock.  Allrequisite conditions were met and the Company completed the purchase ofTiburon, Inc. (“Tiburon”) on May 2, 2002. CompuDyne distributed approximately 1.1 million shares of CompuDynecommon stock and approximately 91,000 warrants to purchase shares of theCompany’s stock, valued collectively at $14.3 million and approximately $10.4million, net in cash to acquire the portion of Tiburon that the Company did notpreviously own.  Including the Company’sinitial investment of $6.0 million in Tiburon and transaction costs resulted inthe Company recording $33.4 million as the value of the consideration paid forthis acquisition.  To fund the cashportion of the Tiburon acquisition, the Company negotiated a $10.0 millionincrease in its borrowing facility from its banks.  The remainder of the cash consideration paid was funded from theCompany’s working capital.

 

Tiburon provides a fully integrated suite of products includingcomputer-assisted dispatch, records management and court and probation softwaresystems for the law enforcement, fire and rescue, corrections and justiceenvironments. Tiburon is a worldwide market leader in the development,implementation and support of public safety and justice automation systems.

 

In the first quarter of 2003 the Company reduced the purchase price ofTiburon by $370,000.  The Companycompleted the valuation of fair value of the plant and equipment acquired inthe second quarter of 2003.  Thisvaluation resulted in a $545 thousand increase in goodwill.  In addition, other final adjustments to thepurchase price of Tiburon amounted to $887 thousand and were recorded as adecrease in goodwill in April 2003.

 

The purchase price was recorded as follows (in thousands):

 
| Goodwill                     |   | $       | 19,813 |   |
|------------------------------|--------|---------|--------|--------|
| Current assets               |   | 20,215  |   |
| Property plant and equipment |   | 3,653   |   |
| Other long term assets       |   | 8,917   |   |
| Liabilities assumed          |   | (19,168 | )      |
| Purchase price               |   | $       | 33,430 |   |

 

The following are the Company’s unaudited pro forma results assumingthe acquisition of Tiburon had occurred on January 1, 2002:

 
|                |   | **Three  Months Ended  June 30,**     |   | **Six Months  Ended  June 30,** |   |
|---------------------|--------|--------------------------------------------|--------|--------------------------------------|--------|
|                |   | **2003**                                   |   | **2002**                             |   | **2003** |   | **2002** |   |
|                |   | **(in  thousands, except per share data)** |   |
|                |   |                                       |   |
| Revenue             |   | $                                          | 47,538 |                                 | $      | 42,739 |   | $ | 94,305 |   | $ | 83,654 |   |
| Net income          |   | $                                          | 1,037  |                                 | $      | 824 |   | $ | 1,979 |   | $ | 1,757 |   |
| Earnings per share: |   |                                       |   |                                 |   |   |   |   |   |
| Basic               |   | $                                          | .13    |                                 | $      | .10 |   | $ | .25 |   | $ | .22 |   |
| Diluted             |   | $                                          | .13    |                                 | $      | .10 |   | $ | .24 |   | $ | .21 |   |

 

These unaudited pro forma results have been prepared for comparativepurposes only and do not purport to be indicative of the results of operationswhich would have actually resulted had the combination been effective onJanuary 1, 2002, or of future results of operations.

 

7.             STOCK-BASEDCOMPENSATION

 

As of June 30, 2003, the Company continues to account for itsstock-based compensation plans, which are described more fully in the Company’s2002 Annual Report, using the intrinsic value method and in accordance with therecognition and measurement principles of APB Opinion No. 25, “Accounting forStock Issued to Employees,” and

 

12

----

 

related Interpretations.  Nostock-based employee compensation cost is reflected in net income, as all optionsgranted had an exercise price equal to fair market value of the underlyingcommon stock on the date of grant.  Thefollowing table illustrates, in accordance with the provisions of SFAS No. 148,“Accounting for Stock-Based Compensation – Transition and Disclosure,” theeffect on net income and earnings per share if the Company had applied the fairvalue recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” to stock-based employee compensation.

 
|                                                                                                                                               |   | **For the  Three Months  Ended June 30,** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------|--------|
|                                                                                                                                               |   | **2003**                                       |   | **2002** |   |
|                                                                                                                                               |   | **(in  thousands, except per share data)**     |   |
| Net income, as reported                                                                                                                            |   | $                                              | 1,037  |   | $ | 713 |   |
| Deduct:   Total stock-based employee compensation expense determined under fair  value based method for all awards net of related tax effects |   | (469                                           | )      | (392 | ) |
| Pro forma net income                                                                                                                               |   | $                                              | 568    |   | $ | 321 |   |
|                                                                                                                                               |   |                                           |   |   |   |
| Earnings per share:                                                                                                                                |   |                                           |   |   |   |
|                                                                                                                                               |   |                                           |   |   |   |
| Basic – as reported                                                                                                                           |   | $                                              | .13    |   | $ | .10 |   |
| Basic – pro forma                                                                                                                             |   | $                                              | .07    |   | $ | .04 |   |
|                                                                                                                                               |   |                                           |   |   |   |
| Diluted – as reported                                                                                                                         |   | $                                              | .13    |   | $ | .09 |   |
| Diluted – pro forma                                                                                                                           |   | $                                              | .07    |   | $ | .04 |   |

 
|                                                                                                                                               |   | **For the  Six Months  Ended June 30,** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------|--------|
|                                                                                                                                               |   | **2003**                                     |   | **2002** |   |
|                                                                                                                                               |   | **(in  thousands, except per share data)**   |   |
| Net income, as reported                                                                                                                            |   | $                                            | 1,979  |   | $ | 1,494 |   |
| Deduct:   Total stock-based employee compensation expense determined under fair  value based method for all awards net of related tax effects |   | (964                                         | )      | (702 | ) |
| Pro forma net income                                                                                                                               |   | $                                            | 1,015  |   | $ | 792 |   |
|                                                                                                                                               |   |                                         |   |   |   |
| Earnings per share:                                                                                                                                |   |                                         |   |   |   |
|                                                                                                                                               |   |                                         |   |   |   |
| Basic – as reported                                                                                                                           |   | $                                            | .25    |   | $ | .21 |   |
| Basic – pro forma                                                                                                                             |   | $                                            | .13    |   | $ | .11 |   |
|                                                                                                                                               |   |                                         |   |   |   |
| Diluted – as reported                                                                                                                         |   | $                                            | .24    |   | $ | .20 |   |
| Diluted – pro forma                                                                                                                           |   | $                                            | .12    |   | $ | .10 |   |

 

The fair value of the Company’s stock-based option awards to employeeswas estimated using the Black-Scholes model assuming no expected dividends andthe following weighted-average assumptions:

 
|                    |   | **For The  Three Months Ended  June 30** |   | **For The  Six Months Ended  June 30** |   |
|-------------------------|--------|-----------------------------------------------|--------|---------------------------------------------|--------|
|                    |   | **2003**                                      |   | **2002**                                    |   | **2003** |   | **2002** |   |
| Expected volatility     |   | 79.6                                          | %      | 74.0                                        | %      | 80.0 | % | 74.0 | % |
| Risk-free interest rate |   | 2.6                                           | %      | 5.0                                         | %      | 2.8 | % | 5.0 | % |
| Expected life in years  |   | 6.7                                           |   | 7.5                                         |   | 6.9 |   | 7.5 |   |

 

13

----

 

8.             PRODUCT WARRANTIES

 

Accruals forestimated expenses related to warranties are made at the time products are soldor services are rendered. These accruals are established using historicalinformation on the nature, frequency, and average cost of warranty claims. TheCompany warrants numerous products, the terms of which vary widely. In general,the Company warrants its products against defect and specific non- performance.As of June 30, 2003, the Company had a product warranty accrual in the amountof $475 thousand.

 
|                                      |   | **Product Warranty Liabilities** |   |
|-------------------------------------------|--------|----------------------------------|--------|
|                                      |   | **(in thousands)**               |   |
| Beginning balance at January 1, 2003 |   | $                                | 482    |   |
| Minus accruals for product                |   | (7                               | )      |
| Ending balance at June 30, 2003      |   | $                                | 475    |   |

 

9.             AMENDMENT TOQUARTERLY FINANCIAL STATEMENTS

 

Subsequent to the issuance of the Company’s condensed consolidatedfinancial statements for the three and six month periods ended June 30,2003, the Company determined that the purchase price of Tiburon was incorrectlyreduced in the quarter ended March 31, 2003 resulting in an understatementof goodwill in the amount of $3,430,000 with a corresponding understatement ofadditional paid-in-capital.  Theaccompanying condensed consolidated balance sheet as of June 30, 2003includes the restated purchase price amounts. Such restatement had no effect on previously reported results ofoperations or cash flows.

 

14

----

 

ITEM 2COMPUDYNE CORPORATION AND SUBSIDIARIESMANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS

 

# **Overview**

CompuDyne Corporation(“CompuDyne” or the “Company”) was reincorporated in Nevada in 1996, and is aleading provider of products and services to the public security market. TheCompany operates in four (4) distinct segments in this marketplace:Institutional Security Systems (formerly known as Corrections), AttackProtection, Federal Security Systems, and Public Safety and Justice.

 

The Institutional Security Systems segment is headquartered inMontgomery, Alabama and is known to the trade as Norment Security Group(“Norment”).  This segment providesphysical and electronic security products and services to the correctionsindustry (prisons and jails) and to the courthouse, municipal and commercialmarkets.  Norment serves as acontractor, responsible for most installation work on larger projects.  Installations involve hard-line (steelsecurity doors, frames, locking devices, etc.) and sophisticated electronicsecurity systems, including software, electronics, touch-screens, closedcircuit TV, perimeter alarm devices and other security monitoringcontrols.  Norment also developed aproduct called MaxWall.  MaxWall is amodular steel, concrete filled prefabricated jail cell. It allows forconstruction projects to use considerably less space and can save the projectowner significant amounts of money. Norment, through a network of regional offices provides field leveldesign, installation and maintenance of both physical and electronic securityproducts.

 

Included in the Institutional Security Systems segment is the TrenTechline which designs, manufactures and integrates electronic securitysystems.  TrenTech integrates generallyavailable products and software as well as designing its own proprietarysystems. TrenTech has developed a sophisticated proprietary video badgingsystem, which has become the virtual standard for the United States Air Forceand has been installed at over 200 United States Air Force facilitiesthroughout the world.

 

The Institutional Security Systems segment also manufactures a completeline of locks and locking devices under the brand name Airteq.  Airteq is an industry leader in pneumaticand electro-mechanical sliding devices used in the corrections industry.

 

The Attack Protection segment is the country’s largest originalequipment manufacturer (OEM) of bullet, blast and attack resistant windows anddoors designed for high security applications such as embassies, courthouses,Federal buildings, banks, corporate headquarters and other facilities that insiston having the highest level of protection currently available.  CompuDyne is a premier provider of Level 8security products, the highest rating level of commercial security products.The product manufactured is an integrated and structurally secure product wherethe rated protection comes not only from the glass but also from the frame andencasement, which are specifically designed to become integral parts of thestructure into which they are to be installed. Existing product installations number in the thousands and range fromthe Middle East to the White House. Working under contracts from the United States Department of State, thesegment’s largest customer, Attack Protection is the largest supplier of bulletand blast resistant windows and doors to United States embassies throughout theworld.   Products are also sold to drugstores, convenience stores, and banks to secure drive through facilities.  Other commercial applications include guardbooths, tollbooths, cash drawers and other similar items.  Additionally, this segment designs andinstalls both fixed and pop-up bollards and barrier security systems.

 

The Attack Protection segment also manufactures a highly sophisticatedfiber optic sensor system, known as Fiber SenSys, used to detect physicalintrusion.  This application is designedto protect large perimeters including such applications as Federal facilities,oil fields, airport tarmacs, public utilities, nuclear reactors and watersystems.  In addition, it has beeninstalled to protect the perimeters of numerous private estates and othersimilar properties.  A related productis SecurLan, which protects data lines from physical intrusion using a fiberoptic technology similar to the Fiber SenSys technology.

 

15

----

 

The Federal Security Systems segment is known as Quanta SystemsCorporation.  This segment has beenserving the Federal government’s security needs since 1952.  Its customer base includes military,governmental agencies, and state and local governmental units.  Federal Security Systems provides turnkeysystems integration of public security and safety systems.  This segment is a classic securityintegrator and specializes in a wide range of customized access control andbadging, intrusion detection, surveillance and assessment, communications,command and control, fire and life safety, and asset tracking systems.  Federal Security Systems provides centralstation oversight and control of multiple and separate facilities as well assecurity and public life safety systems and equipment.

 

The Public Safety and Justice segment consists of two subsidiariesknown to the industry as CorrLogic, Inc., (“CorrLogic”) and Tiburon, Inc.(“Tiburon”).  CorrLogic is a leadingdeveloper of inmate management and institutional medical software systems.CorrLogic specializes in the development, implementation and support ofcomplex, integrated inmate management software systems, including inmatemedical management that improves the efficiency and accuracy of correctionalfacility operations.  CorrLogic’s focusis entirely on information solutions for the corrections industry.

 

CompuDyne expanded its offerings in the Public Safety and Justicesector through the completion of its acquisition of Tiburon, on May 2,2002. Tiburon provides a fully integrated suite of products includingcomputer-assisted dispatch, records management, court and probation softwaresystems for the law enforcement, fire and rescue, corrections and justiceenvironments.  Tiburon is a worldwidemarket leader in the development, implementation and support of public safetyand justice automation systems.   Inbusiness since 1980, with more than 450 systems supporting over 700 agencies,Tiburon is a leader in public safety and justice solutions.

 

The Company has restated the three and six month periods endedJune 30, 2003 as discussed in footnote 9 to the condensed consolidatedfinancial statements.  Management’sDiscussion and Analysis reflects the effects of this restatement.

 

**RESULTS OF OPERATIONS**

 

Three months ended June 30, 2003 and 2002

 

*Revenues*.  The Company had revenues of $47.5 millionand $39.4 million for the three months ended June 30, 2003 andJune 30, 2002, respectively.  Therevenues for the three months ended June 30, 2003 increased by $8.1million or 20.6% over the comparable period for 2002.

 

Revenues from the Institutional Security Systems segment increased from$22.0 million in the second quarter of 2002 to $25.7 million in the secondquarter of 2003.  This was an increase of16.9%.  The Institutional SecuritySystems segment is largely a construction driven business.  Much of its revenue is obtained by workingon new and retrofit construction projects in the corrections industry, asopposed to from sources of recurring revenue. As such, the increase in revenue experienced by this segment is largelyattributable to its ability to win and work on more projects than it did in thecomparable quarter of the previous year. One of the reasons it was able to dothis was because its backlog had grown from $92.3 million at December 31,2001 to $99.5 million at December 31, 2002, thus providing it with theability to engage in more work in the second quarter of 2003 than it did in thesecond quarter of 2002.  AtJune 30, 2003, the backlog for the Institutional Security System’s segmenthad declined to $81.9 million.  Thefirst half of 2003 was a slow bidding period, which the Company attributes tothe seasonal nature of the bidding process and due in general to the state andlocal government budget deficits which are causing these governmental units torethink and delay many of their pending corrections projects.

 

Revenues from the Attack Protection segment increased from $5.6 millionduring the quarter ended June 30, 2002 to $6.5 million in the quarterended June 30, 2003.  This was anincrease of 16.7%.  The AttackProtection segment was largely capacity constrained during 2001.  As a result, the Company purchased anexisting 75,000 square foot factory on 20 acres of land in close proximity toits existing factory in Montgomery, Alabama. This expansion provides the segment with the necessary capacity togenerate incremental revenue of approximately $10 million per year.  Of the $0.9 million of increased revenuegenerated by the Attack Protection segment, $1.2 million of the increaseresulted

 

16

----

 

from the Norshield product line while its Fiber SenSys product line sawa decrease in revenue of $0.3 million. The Norshield product line encompasses the segment’s bullet and blastresistant windows and doors, guard booths, bollards, barriers and other relatedproducts.  During the second quarter of2003, the Attack Protection segment experienced an increased demand for itsproducts, as the slow down in the government building process experiencedduring 2002 appeared to end. Now it appears that projects are being releasedfor construction, and thus the Attack Protection segment is experiencing anincreased demand for its products.  Thesegment’s Fiber SenSys product line consists primarily of fiber optic perimeterprotection products.  These productsexperienced significant growth in 2002 as revenues from this product line grewfrom $1.5 million in 2001 to $4.9 million in 2002, of which $1.4 million occurredin the second quarter of 2002.  Ordersreceived for the Fiber SenSys line tend to be large dollar orders.  Although fewer orders were received andshipped for these products during the second quarter of 2003 as compared to thesecond quarter of 2002, the Company continues to see heightened interest forthese products and expects sales for these items to continue to experiencesignificant growth in 2003.

 

Revenues from the FederalSecurity Systems segment increased from $3.9 million during the second quarterof 2002 to $4.3 million during the second quarter of 2003.  This was an increase of 9.5%.  At December 31, 2001 the FederalSecurity Systems segment backlog was a relatively small $380 thousand.  Substantially all of this segment’s revenueis backlog driven.  Its backlog istherefore a precursor to future revenues. The Federal Security Systemssegment’s failure to have any meaningful backlog at December 31, 2001resulted in substantially all of its 2002 revenue being driven by contractawards it received during 2002.  Thisinherently caused the segment’s revenue to be low during that period.  The Federal Security Segment ended 2002 witha significantly improved backlog level of $11.4 million. As such it entered thefirst quarter of 2003 with a much greater book of business from which togenerate its increased revenue in the first and second quarter of 2003.

 

Revenues from the Public Safetyand Justice segment increased $3.1 million from $7.9 million during the secondquarter of 2002 to $11.0 million during the second quarter of 2003, an increaseof 39.2%.  On May 2, 2002 theCompany completed its acquisition of Tiburon, Inc.  Prior thereto, the Company controlled approximately 20% ofTiburon and recorded its investment in Tiburon under the equity method ofaccounting.  Subsequent to May 2,2002, Tiburon became a wholly owned subsidiary of the Company and thus itsoperating results are now consolidated with those of the Company.  Tiburon’s revenues for the three monthsended June 30, 2003 amounted to $10.0 million, whereas only two (2) monthsof Tiburon’s revenues were included in the Company’s June 30, 2002results.  This inclusion of anadditional one (1) month’s revenue accounts for substantially all of theincrease in revenue experienced by this segment during the second quarter of2003 compared to the second quarter of 2002.

 

*Expenses*.  Cost of goods sold increased from $30.0million during the second quarter of 2002 to $35.8 million during the secondquarter of 2003.  This increase waslargely a result of increased costs of goods sold of $4.0 million in theInstitutional Security Systems segment, $0.3 million at the Attack Protectionsegment and $0.5 million at the Federal Security Systems segment, all largelyattributable to the increased sales levels attained by these segments.  In addition the acquisition of Tiburon onMay 2, 2002, added $1.0 million of cost of goods sold.  The smaller percentage increase in cost ofgoods sold as compared to the percentage increase in sales resulted in anincreased gross profit percentage of 24.8% in the second quarter of 2003 ascompared to 23.9% during the second quarter of 2002.

 

Cost of goods sold in the Institutional Security Systems segmentincreased from $18.4 million in the second quarter of 2002 to $22.5 million inthe second quarter of 2003.  This was anincrease of $4.0 million or 21.7%. This increase was larger than the relatedsales increase of this segment of 16.9% resulting in a decline in the grossprofit percentage from 16.0% in the second quarter of 2002 to 12.6% in thesecond quarter of 2003.  During 2002,the West Coast operations of the Institutional Security Systems segmentexperienced significant cost overruns on many of its projects.  These cost overruns were incurred andrecorded during the third and fourth quarters of 2002 and amounted toapproximately $1.8 million.  As aresult, as these projects are brought to completion, many in the first andsecond quarter of 2003, the revenues generated by them resulted in littlemargin or in some cases losses.  Inaddition, the Company recorded approximately $1.0 million of additionalwrite-downs on several additional projects that were nearing completion in thesecond quarter of 2003.  This was theprimary reason for the decrease in the gross profit percentage by theInstitutional Security Systems segment. To address this situation, the Company implemented more centralizedcontrols and replaced certain personnel at its West Coast operations.

 

17

----

 

Cost of goods sold in the Attack Protection segment increased from $4.8million in the second quarter of 2002 to $5.2 million in the second quarter of2003.  This was an increase of $350thousand or 7.3%. This increase was smaller than the related sales increase ofthis segment of 16.7%, resulting in an increase in the gross profit percentagefrom 14.2% in the second quarter of 2002 to 21.1% in the second quarter of2003.  During 2002 the Attack Protectionsegment experienced lower-than-expected volume in its bullet and blastresistant windows and doors product line which was exacerbated by excess plantcapacity which resulted from the addition of its new 75,000 square foot factorythat was placed in service during the spring of 2002.  As a result of the terrorist attacks of September 11, 2001,the Company had geared up in anticipation of increased demand for thissegment’s products, which is only now beginning to materialize.  This new factory was provisioned and staffed,using new equipment and hires as well as by the movement of equipment and stafffrom the Company’s existing factory. This resulted in the Company running both of its factories at levelssignificantly below optimum capacity in 2002, resulting in operational inefficiencies.As a result, the Company experienced incremental expenses in excess of thecommensurate sales volume increase resulting in the lower gross profitpercentage during 2002.

 

Cost of goods sold in the Federal Security Systems segment increasedfrom $3.2 million in the second quarter of 2002 to $3.7 million in the secondquarter of 2003.  This was an increaseof $454 thousand or 14.2%.  Thisincrease was greater than the related sales increase of this segment of 9.5%,resulting in a decrease in the gross profit percentage from 17.7% in the secondquarter of 2002 to 14.2% in the second quarter of 2003.  Substantially all of the projects awarded inthis segment are discrete projects.

 

Cost of goods sold in thePublic Safety and Justice segment increased from $3.5 million in the secondquarter of 2002 to $4.5 million in the second quarter of 2003.  This was an increase of $1.0 million or28.6%.  Substantially all of thisincrease was a result of the Company’s May 2, 2002 acquisition of Tiburonand by lower margins experienced by CorrLogic on a major new project.

 

Operating expenses increasedfrom $6.7 million in the second quarter of 2002 to $7.7 million in the secondquarter of 2003.  This was an increaseof $1.0 million.  Substantially all ofthe change in operating expenses was a result of the Company’s May 2, 2002acquisition of Tiburon.

 

*Amortization ofIntangible Assets and Capitalized Software Acquired in the Tiburon Acquisition*    In conjunction with the acquisition onMay 2, 2002, of Tiburon, Inc. and in compliance with Statement of FinancialAccounting Standards No. 141 (SFAS 141) Business Combinations, the Companydetermined the fair value of the following identifiable assets and assigned theindicated lives thereto for purposes of amortization and depreciation.

 
|                   |   | **Amount**          |       | **Life**       |       |
|------------------------|--------|---------------------|------------|----------------|------------|
|                   |   | **(in  thousands)** |       | **(in years)** |       |
|                   |   |                | ** ** |           | ** ** |
| Trade name             |   | $                   | 5,340      |           | Indefinite |   |
| Customer relationships |   | $                   | 2,500      |           | 14         |   |
| Software               |   | $                   | 3,000      |           | 5          |   |
| Backlog                |   | $                   | 300        |           | 2          |   |
| Other                  |   | $                   | 135        |           | 3          |   |

 

The amortization of the above intangibles for the three months endedJune 30, 2003 resulted in the Company recording amortization expenserelated to intangibles and software included in property, plant and equipmentof $243 thousand, which is included in operating expenses.

 

Research and Developmentexpenses increased from $1.3 million in the second quarter of 2002 to $2.0million in the second quarter of 2003. Historically, the Company did not expend significant monies on researchand development. With the acquisition of Tiburon, the Company’s Public Safetyand Justice segment expends significantly more dollars

 

18

----

 

on software development.  Being a technology driven enterprise, theCompany’s Public Safety and Justice segment is required to continually updateand enhance its software offerings thus causing it to incur significantresearch and development costs.

 

Interest expense decreased from$346 thousand in the second quarter of 2002 to $334 thousand in the secondquarter of 2003. The decrease in the Company’s interest expense during thesecond quarter of 2003 is a result of the Company having a lower averageinterest rate and a smaller average level of borrowings in the second quarterof 2003 as compared to the second quarter of 2002.

 

The following table compares the weighted average of the Company’ssecond quarter of 2003 and the second quarter of 2002 interest bearingborrowings and the related interest rates charged thereon.

 
|                                             |   | **Average  second quarter of 2003** |   | **Average  second quarter of 2002** |   |
|--------------------------------------------------|--------|-------------------------------------|--------|-------------------------------------|--------|
| **(in thousands)**                               |   | **Amount**                          |   | **Rate**                            |   | **Amount** |   | **Rate** |   |
| Bank borrowings                                  |   | $                                   | 21,081 |                                | 5.6    | % | $ | 22,162 |   | 6.7 | % |
| Subordinated borrowings                          |   | $                                   | — |                                | — |   | $ | 1,232 |   | 6.6 | % |
| Amortization and write-off of financing  charges |   | $                                   | 51     |                                |   |   | $ | 37 |   |   |   |
|                                                  |        |                                     |        |                                     |        |  |  |  |  |  |  |  |

* *

*Taxes on Income.*  The effective tax rate in the second quarterof 2003 and 2002 was 40.0%.

 

*Net Income.*  The Company reported net income of $1.0million and $713 thousand in the second quarters of 2003 and 2002,respectively.  Fully diluted earningsper share increased to $.13 in the second quarter of 2003 from $.09 in the secondquarter of 2002.  The weighted averagenumber of common shares and equivalents outstanding was 8.1 million in thesecond quarter of 2002 and in the second quarter of 2003.

 

**RESULTS OF OPERATIONS**

 

Six months ended June 30, 2003 and 2002

 

*Revenues*.  The Company had revenues of $94.3 millionand $69.9 million for the six month period ended June 30, 2003 andJune 30, 2002, respectively.  Thiswas an increase of $24.4 million or 34.9%.

 

Revenues from the InstitutionalSecurity Systems segment increased from $42.2 million in the first six monthsof 2002 to $49.1 million in the first six months of 2003.  This was an increase of 16.4%.  The Institutional Security Systems segmentis largely a construction driven business. Much of its revenue is obtained by working on new and retrofitconstruction projects in the corrections industry, as opposed to from sourcesof recurring revenue.  As such, theincrease in revenue experienced by this segment is largely attributable to itsability to win and work on more projects than it did in the comparable periodof the previous year. One of the reasons it was able to do this was because itsbacklog had grown from $92.3 million at December 31, 2001 to $99.5 millionat December 31, 2002 thus providing it with the ability to engage in morework in the first six months of 2003 than it did in the first six months of2002.  At June 30, 2003, thebacklog for the Institutional Security System’s segment had declined to $81.9million.  The first half of 2003 was aslow bidding period, which the Company attributes to the seasonal nature of thebidding process and due to the general state and local governmental budgetdeficits which is causing theses governmental units to rethink and delay manyof the pending corrections projects.

 

Revenues from the Attack Protection segment increased from $11.8million during the six months ended June 30, 2002 to $14.9 million duringthe six months ended June 30, 2003. This was an increase of 26.4%. The Attack Protection segment was largely capacity constrained during2001.  As a result, the Companypurchased an existing 75,000 square foot factory on 20 acres of land in closeproximity to its existing factory in Montgomery, Alabama.  This expansion

 

19

----

 

provides the segment with the necessary capacity to generateincremental revenue of approximately $10 million per year.  Of the $3.1 million of increased revenuegenerated by the Attack Protection segment, $3.8 million of the increase camefrom its Norshield product line while its Fiber SenSys product line saw adecrease in revenue of $0.7 million. The Norshield product line encompasses the segment’s bullet and blastresistant windows and doors, guard booths, bollards, barriers and other relatedproducts.  During the first six monthsof 2003, the Attack Protection segment experienced an increased demand for itsproducts, as the slow down in the government building process experiencedduring 2002 appeared to end. Now it appears that projects are being released forconstruction, and thus the Attack Protection segment is experiencing anincreased demand for its products.  TheSegment’s Fiber SenSys product line consists primarily of fiber optic perimeterprotection products.  These productsexperienced significant growth in 2002 as revenues from this product line grewfrom $1.5 million in 2001 to $4.9 million in 2002, of which $3.1 millionoccurred in the first six months of 2002. Orders received for the Fiber SenSys line tend to be large dollarorders.  Although fewer orders werereceived and shipped for these products during the first six months of 2003 ascompared to the first six months of 2002, the Company continues to seeheightened interest for these products and expects sales for these items tocontinue to experience significant growth in 2003.

 

Revenues from the FederalSecurity Systems segment increased from $6.9 million during the first sixmonths of 2002 to $7.8 million during the first six months of 2003.  This was an increase of 13.0%.  At December 31, 2001 the FederalSecurity Systems segment backlog was a relatively small $380 thousand.  Substantially all of this segment’s revenueis backlog driven.  Its backlog istherefore a precursor to future revenues. The Federal Security Systemssegment’s failure to have any meaningful backlog at December 31, 2001resulted in substantially all of its 2002 revenue being driven by contractawards it received during 2002.  Thisinherently caused the segment’s revenue to be low during that period.  The Federal Security Systems Segment ended2002 with a significantly improved backlog level of $11.4 million.  As such it entered 2003 with a much greaterbook of business from which to generate its increased revenue during the first sixmonths of 2003.

 

Revenues from the Public Safetyand Justice segment increased $13.5 million from $9.1 million during the firstsix months of 2002 to $22.5 million during the first six months of 2003.  On May 2, 2002 the Company completedits acquisition of Tiburon, Inc.  Priorthereto, the Company controlled approximately 20% of Tiburon and recorded itsinvestment in Tiburon under the equity method of accounting.  Subsequent to May 2, 2002, Tiburonbecame a wholly owned subsidiary of the Company and thus its operating resultsare now consolidated with those of the Company.  Tiburon’s revenues for the six months ended June 30, 2003amounted to $20.4 million as compared to $7.0 million for the two month periodTiburon was owned by CompuDyne during the first six months of 2002.  This accounts for substantially all of theincrease in revenue experienced by this segment during the first six months of2003 compared to the first six months of 2002.

 

*Expenses*.  Cost of goods sold increased from $54.5million during the first six months of 2002 to $70.7 million during the firstsix months of 2003.  This increase waslargely a result of the acquisition of Tiburon on May 2, 2002, which added$5.1 million of cost of goods sold to the results of the Company, as well asincreased costs of goods sold of $7.6 million at the Institutional SecuritySystems segment, $1.9 million at the Attack Protection segment and $0.9 millionat Federal Security Systems, all largely attributable to the increased saleslevels attained by these segments.

 

The smaller percentage increasein cost of goods sold as compared to the percentage increase in sales resultedin an increased gross profit percentage of 25.0% in 2003 as compared to 22.1%during the first six months of 2002.

 

Cost of goods sold in the Institutional Security Systems segmentincreased from $35.0 million in the first six months of 2002 to $42.6 millionin the first six months of 2003.  Thiswas an increase of $7.7 million or 21.9%. This increase was larger than therelated sales increase of this segment of 16.4% resulting in a decline in thegross profit percentage from 17.1% in the first six months of 2002 to 13.3% inthe first six months of 2003.  During2002, the West Coast operations of the Institutional Security Systems segmentexperienced significant cost overruns on many of its projects.  These cost overruns were incurred andrecorded during the third and fourth quarters of 2002 and amounted toapproximately $1.8 million.  As a result,as these projects are brought to completion, many in the first and second quartersof 2003, the revenues generated by them resulted in little margin or in somecases losses.  In addition, the Companyrecorded approximately $1.0 million of additional write-downs on severaladditional projects that were nearing completion in the

 

20

----

 

second quarter of 2003.  Thiswas the primary reason for the decrease in the gross profit percentage byInstitutional Security Systems.  Toaddress this situation, the Company implemented more centralized controls andreplaced certain personnel at its West Coast operations.

 

Cost of goods sold in the Attack Protection segment increased from $9.7million in the first six months of 2002 to $11.5 million in the first sixmonths of 2003.  This was an increase of$1.9 million or 19.4%. This increase was smaller than the related salesincrease of this segment of 26.4%, resulting in an increase in the gross profitpercentage from 18.0% in the first six months of 2002 to 22.6% in the first sixmonths of 2003.  During the first halfof 2002 the Attack Protection segment experienced lower-than-expected volume inits bullet and blast resistant windows and doors product line which wasexacerbated by excess plant capacity which resulted from the addition of itsnew 75,000 square foot factory that was placed in service during the spring of2002.  As a result of the terroristattacks of September 11, 2001, the Company had geared up in anticipationof increased demand for this segment’s products, which is only now beginning tomaterialize.  This new factory wasprovisioned and staffed, via new equipment and hires as well as by the movementof equipment and staff from its existing factory.  This resulted in the Company running both of its factories atlevels significantly below optimum capacity in 2002, resulting in operationalinefficiencies. As a result, the Company experienced incremental expenses inexcess of the commensurate sales volume increase resulting in the lower grossprofit percentage during 2002.

 

Cost of goods sold in the Federal Security Systems segment increasedfrom $5.7 million in the first six months of 2002 to $6.6 million in the firstsix months of 2003.  This was anincrease of $0.9 million or 15.8%.  Thisincrease was consistent with the related sales increase of this segment of13.0%.  The Federal Security Systemssegment gross profit percentage was 14.5% and 16.6% during the first six monthsof 2002 and 2003 respectively.  Substantiallyall of the projects awarded in this segment are discrete projects.

 

Cost of goods sold in thePublic Safety and Justice segment increased from $4.1 million in the first sixmonths of 2002 to $10.0 million in the first six months of 2003.  This was an increase of $5.9 million.  Substantially all of this increase was aresult of the Company’s May 2, 2002 acquisition of Tiburon.

 

Operating expenses increased from $11.1 million in the first six monthsof 2002 to $15.7 million in the first six months of 2003.  This was an increase of $4.6 million.  Substantially all of the change in operatingexpenses was a result of the Company’s May 2, 2002 acquisition of Tiburon.

 

*Amortization ofIntangible Assets and Capitalized Software Acquired in the Tiburon Acquisition*    In conjunction with the acquisition onMay 2, 2002, of Tiburon, Inc. and in compliance with Statement ofFinancial Accounting Standards No. 141 (SFAS 141) Business Combinations, theCompany determined the fair value of the following identifiable assets andassigned the indicated lives thereto for purposes of amortization anddepreciation.

 
|                   |   | **Amount**          |       | **Life**       |       |
|------------------------|--------|---------------------|------------|----------------|------------|
|                   |   | **(in  thousands)** |       | **(in years)** |       |
|                   |   |                | ** ** |           | ** ** |
| Trade name             |   | $                   | 5,340      |           | Indefinite |   |
| Customer relationships |   | $                   | 2,500      |           | 14         |   |
| Software               |   | $                   | 3,000      |           | 5          |   |
| Backlog                |   | $                   | 300        |           | 2          |   |
| Other                  |   | $                   | 135        |           | 3          |   |

 

The amortization of the above intangibles for the six months endedJune 30, 2003 resulted in the Company recording amortization expenserelated to intangibles and software included in property, plant and equipmentof $486 thousand, which is included in operating expenses.

 

Research and Developmentexpenses increased from $1.3 million in the first six months of 2002 to $3.9million in the first six months of 2003. Historically, the Company did not expend significant monies on researchand development.

 

21

----

 

With the acquisition ofTiburon, the Company’s Public Safety and Justice segment expends significantlymore dollars on software development. Being a technology driven enterprise, the Company’s Public Safety andJustice segment is required to continually update and enhance its softwareofferings thus causing it to incur significant research and development costs.

 

Interest expense increased from$659 thousand in the first six months of 2002 to $713 thousand in the first sixmonths of 2003. The increase in the Company’s interest expense during the firstsix months of 2003 is a result of the Company having a greater average level ofborrowings in the first six months of 2003 as compared to the first six monthsof 2002 offset by a lower average borrowing rate.  The increased borrowings in 2003 reflect borrowings made in thesecond quarter of 2002 to fund the cash portion of the Tiburon purchase price.

 

The following table compares the weighted average of the Company’sinterest bearing borrowings and the related interest rates charged thereon forthe first six months of 2003 and the first six months of 2002.

 
|                                             |   | **Average  first six months of 2003** |   | **Average  first six months of 2002** |   |
|--------------------------------------------------|--------|---------------------------------------|--------|---------------------------------------|--------|
| **(in thousands)**                               |   | **Amount**                            |   | **Rate**                              |   | **Amount** |   | **Rate** |   |
| Bank borrowings                                  |   | $                                     | 23,085 |                                  | 5.1    | % | $ | 19,399 |   | 5.8 | % |
| Subordinated borrowings                          |   | $                                     | — |                                  | — |   | $ | 1,497 |   | 6.0 | % |
| Amortization and write-off of financing  charges |   | $                                     | 101    |                                  |   |   | $ | 75 |   |   |   |
|                                                  |        |                                       |        |                                       |        |  |  |  |  |  |  |  |

 

*Taxes on Income*    The effective tax rate in the first sixmonths of 2003 was 40.0% as compared to 37.9% in the first six months of 2002.The primary reason for this change in effective tax rates is due to a change inthe mix in the states in which the Company’s earnings occur.

 

*Net Income.*  The Company reported net income of $2.0million and $1.5 million in the first six months of 2003 and 2002,respectively.  Fully diluted earningsper share increased to $.24 in the first six months of 2003 from $.20 in thefirst six months of 2002.  The weightedaverage number of common shares outstanding and equivalents increased from 7.7million in the first six months of 2002 to 8.1 million in the first six monthsof 2003.

 

**Liquidity and Capital Resources**

 

The Company funds itsoperations through cash flows generated from its operations, bank financing,and the sale of its common stock.  TheCompany’s liquidity requirements arise from cash necessary to carry itsinventories and billed and unbilled receivables, for capital expenditures, torepurchase shares of its common stock under its share repurchase program, forpayments of principal and interest on outstanding indebtedness and foracquisitions. The ultimate customers of the Company are primarily Federal,State and local governmental units.  Inthe event the funding of these governmental units is reduced for any reason,including budgetary reductions due to economic conditions, there is a risk thatthe demand for the Company’s goods and services would decrease which wouldreduce the availability of funds to the Company.

 

As of June 30, 2003, theCompany had working capital of $29 million compared with $31 million as ofDecember 31, 2002. The most significant changes in working capital weredecreases in accounts receivable, contract costs in excess of billings anddeferred revenue and an increase in accounts payable and accrued expenses.

 

Net cash provided by operatingactivities was $9.4 million in the first six months of 2003 versus $51 thousandused in operating activities in the first six months of 2002.

 

Net cash used for investingactivities was $401 thousand in the first six months of 2003 compared to $12.8million in the first six months of 2002. Capital expenditures of $2.5 million were made in 2002 for theacquisition and provisioning of the Attack Protection segment’s new 75,000 squarefoot factory in Montgomery, Alabama to increase

 

22

----

 

capacity of the AttackProtection segment.  Net payments forthe acquisition of Tiburon, Inc. during the first six months of 2002 were $10.4million.

 

Net cash used in financingactivities amounted to $6.2 million in the first six months of 2003 comparedwith $14.0 million provided by financing in 2002. The $10.0 million borrowingfrom banks in 2002 were used to finance the acquisition of Tiburon onMay 2, 2002.  The decrease in cashprovided by financing activities is primarily a result of repayments under theCompany’s bank credit facilities.

 

The following table summarizes the contractual obligations of theCompany as of June 30, 2003 and the payments due by period.

 
|              |   | **Payments  Due by Period** |   |
|-------------------|--------|-----------------------------|--------|
|              |   | **(in  thousands)**         |   |
|              |   | **Long-Term  Debt**         |   | **Operating  Leases** |   |
| December 31: |   |                        |   |   |   |
| 2003              |   | $                           | 974    |   | $ | 1,426 |   |
| 2004              |   | 16,103                      |   | 2,620 |   |
| 2005              |   | 440                         |   | 1,840 |   |
| 2006              |   | 440                         |   | 777 |   |
| 2007              |   | 440                         |   | 556 |   |
| Thereafter        |   | 2,685                       |   | 380 |   |
| Totals            |   | $                           | 21,082 |   | $ | 7,599 |   |

 

*The Company’s total outstandingborrowings at June 30, 2003 amounted to $21.1 million.  These borrowings were at variable rates.*

 

*The Company had two borrowings frombanks, both made under a Credit Agreement that provides for both termborrowings and a line of credit.*

 

The first borrowing is a 3-yearterm loan due in quarterly installments through November 2004.  This borrowing of $5.0 million was enteredinto on November 16, 2001.  Theamount outstanding as of June 30, 2003 was $2.5 million.  The interest rate is variable and can rangefrom LIBOR +1.75% to 3.5% or prime +0.5% to 2.25%.  The rate charged the Company is based on the Company’s leverageratio at the end of each quarter.  Theleverage ratio is defined as the ratio of consolidated indebtedness for borrowedmoney, capital leases, guaranties of borrowed money and reimbursementobligations in respect of letters of credit divided by the Company’s earningsbefore interest, taxes, depreciation, and amortization (EBITDA).  The rate was 3.54% as of June 30, 2003.

 

The second borrowing availablefrom banks under the Credit Agreement is a $25.0 million line of credit, dueNovember 16, 2004.  Borrowingsoutstanding under this line of credit as of June 30, 2003 were $14.0million.  Its interest rate is variableand can range from LIBOR plus 1.50% to 3.25% or the prime rate plus 0.25% to2.0%.  The rate charged the Company isbased on the Company’s leverage ratio at the end of each quarter as definedabove.  The rate ranged from 3.54% to5.00% as of June 30, 2003.

 

The Company also had twoindustrial revenue bonds outstanding as of June 30, 2003 in the amounts of$1.7 million and $2.9 million.  Theseborrowings bear interest at variable rates between 1.1% and 1.9% for the firstsix months of 2003 based on weekly market conditions.   These bonds are fully collateralized by bank letters of creditissued under the Credit Agreement.  TheCompany’s banks consider letters of credit as outstanding borrowings whenconsidering the amount of availability the Company has remaining under its lineof credit.

 

Other than the Company’s $5.0 million of letters of credit, $4.0million of which was entered into in April, 2002, primarily to secure anIndustrial Revenue Bond borrowing on the Company’s new Attack Protectionfacility, the Company has no other material off balance sheet liabilities.

 

The Company had $7.7 million of unused availability under its line ofcredit at June 30, 2003.

 

23

----

 

As a result of the variablenature of the interest rate on the Company’s bank borrowings, any increase inthe amount of outstanding borrowings and/or decreases in the Company’s EBITDA(an increase in the “leverage ratio”) will result in the Company’s interestrate increasing and thus the amount of interest expense incurred alsoincreasing.

 

The Company anticipates thatcash generated from operations and borrowings under the working capital line ofcredit will enable the Company to meet its liquidity, working capital andcapital expenditure requirements during the next 12 months.  The Company, however, may require additionalfinancing to pursue its strategy of growth through acquisitions.  If such financing is required, there are noassurances that it will be available, or if available, that it can be obtainedon terms favorable to the Company.  TheCompany presently has no binding commitment or binding agreement with respectto any acquisition or strategic investment. However, from time to time, theCompany may be party to one or more non-binding letters of intent regardingmaterial acquisitions, which, if consummated, may be paid for with cash orthrough the issuance of a significant number of shares of the Company’s commonstock.  On May 2, 2002, the Companycompleted the acquisition of Tiburon, Inc. CompuDyne distributed approximately 1.1 million shares of CompuDynecommon stock and approximately 91,000 warrants to purchase shares of theCompany’s stock, valued collectively at $14.3 million and approximately $10.4million, net in cash to acquire the portion of Tiburon that the Company did notpreviously own.  Including the Company’sinitial investment of $6.0 million in Tiburon and transaction costs resulted inthe Company recording $33.4 million as the value of the consideration paid forthis acquisition.    To fund the cashportion of the Tiburon acquisition, the Company negotiated an increase in itsbank line of credit of $10.0 million effective May 2, 2002.  Borrowings made by the Company under thisincreased facility may result in increased interest rates charged to theCompany, to the extent its leverage ratio changes resulting in increasedinterest charges. As a result of the approval of this borrowing, the Companyhad adequate cash available to complete this transaction.

 

On March 21, 2003, theCompany and its banks amended the Company’s loan agreements, which included awaiver of compliance with a variety of its loan covenants as ofDecember 31, 2002.  In conjunctionwith the amendment, the Company agreed to raise $7.0 million of new equity orborrowings, or a combination thereof, subordinate to its existing bankborrowings, by June 30, 2003.  OnJune 30, 2003, the Company replaced one of the banks in its banksyndicate.  As a result of thisreplacement, the requirement that the Company raise $7 million of capital,subordinate to its senior banking facility, which was required by the replacedsyndicated member, was eliminated.

 

Additional Considerations

 

**Cost Containment**

 

Due to current economicconditions, and in light of a very strong competitive environment, the Companyrecognizes that its ability to increase the prices it charges its customers islimited.  As a result, in order toenhance its profitability, the Company recognizes the need to continue to seek waysto reduce its costs.

 

**Office Closures and Consolidations**

 

In January 2003, theCompany closed its Midwest Regional Office, located in Wauwatusa, Wisconsin,and consolidated its operations into its Montgomery, Alabama office.  The Company does not believe this office closurewill have a negative impact on its ability to generate sales in the Midwestregion.  The costs to close this officewere minimal. The Company anticipates that closure of this office will resultin annual overhead savings of approximately $100 thousand.

 

In June 2003, the Companymoved its Airteq Systems manufacturing facility from leased space in Tualatin,Oregon to its new plant in Montgomery, Alabama, which was purchased in 2002 forits Attack Protection business.  Themove is expected to result in manufacturing efficiencies, labor reductions,better sharing of engineering and other overhead resources, and will absorbexcess capacity in the Montgomery plant. In conjunction with the Airteq move the Company’s Fiber SenSys business,which manufactures fiber optic based perimeter sensors for intrusion detection,will move from its current leased space in Beaverton, Oregon to the largerAirteq facility, which will result in a 10,000 square foot expansion for FiberSenSys.  These moves will result incharges totaling about $400 thousand during the second and third quarters of2003 and should result in annual savings of $250 thousand in addition toproviding the added capacity for Fiber SenSys. As of June 30, 2003, charges totaling $6 thousand were incurred bythe Company in 

 

24

----

 

conjunction with this move.

 

**Pension Plan**

 

Prior to this year the Company maintained a money purchase pensionplan, which covers employees at one of its divisions. Salaried employees atthis division were eligible to participate in this plan after one year ofservice.  Annual contributions ofbetween 3% and 5% of annual compensation were made by the Company depending onthe employees’ years of service.  Theexpense related to funding the plan was $253 thousand during the first sixmonths of 2002.  EffectiveDecember 31, 2002, the Company ceased contributions to this plan.  The balances in this plan will be 100%vested and rolled into the CompuDyne 401K plan in 2003.

 

# **CompuDyne’s Total Backlog**

# ** **

CompuDyne’s total backlog amounted to $182 million at June 30,2003.  The break down of the Company’sbacklog by business segment is as follows:

 
|                           |   | **June 30,  2003** |    | **December,  31,  2002** |   |
|--------------------------------|--------|-------------------------|---------|--------------------------|--------|
|                           |   | **(in  thousands)**     |    | **(in  thousands)**      |   |
| Institutional Security Systems |   | $                       | 81,916  |                     | $      | 99,527 |   |
| Attack Protection              |   | 16,552                  |    | 18,478                   |   |
| Federal Security Systems       |   | 10,643                  |    | 11,440                   |   |
| Public Safety and Justice      |   | 72,621                  |    | 74,867                   |   |
| Totals                         |   | $                       | 181,732 |                     | $      | 204,312 |   |

 

Included in the backlog of thePublic Safety and Justice segment at June 30, 2003 is $17.2 millionrepresenting awards received by the segment, for which the customers have notyet entered into signed contracts. These awards are expected to result in signed contracts over the nexttwelve (12) months.

 

**Critical Accounting Policies**

 

A complete description of theCompany’s significant accounting policies appears in the Company’s AnnualReport to its stockholders and is incorporated by reference in its AnnualReport on Form 10-K for the year ended December 31, 2002.

 

Percentage of Completion Accounting

 

Approximately 85% of theCompany’s revenues are derived from long term contracts where revenue isrecognized under the percentage of completion method of accounting.  The Company’s software related contractsutilize labor hours incurred to date on a project, divided by the totalexpected project hours to determine the completion percentage. The Company’smanufacturing and construction contracts utilize costs incurred to date on aproject, divided by the total expected project costs to determine the completionpercentage.  Both of these methodsrequire considerable judgment and as such, the estimates derived at any pointin time could differ significantly from actual results.  These estimates effect many of the balancesheet and statement of operations accounts including net sales, cost of goodssold, accounts receivable, contract costs in excess of billings and billings inexcess of contract costs incurred.

 

Provisions for estimated losseson uncompleted contracts are recognized in the period such losses aredetermined.

 

Goodwill and Intangible Assets

 

The Company reviews the carrying value of goodwill and intangibleassets annually as of September 30 or whenever events or changes incircumstances indicate that the carrying value may not be recoverable,utilizing a discounted cash flow model. Changes in estimates of future cash flows caused by items such asunforeseen events or changes in market conditions could negatively affect thereporting unit’s fair value and result in an impairment charge.  The Company cannot predict the occurrence ofevents that might adversely affect the reported value of goodwill andintangible assets that totaled $21.4 million and $9.9 million, respectively asof June 30, 2003.

 

25

----

 

**Economic Conditions and the After Effect ofthe September 11, 2001 Terrorist Attacks**

 

Much of the work CompuDyneperforms is for state and local governmental units.  These entities have been particularly hard hit by recent economicconditions and the resultant contraction of the tax bases of these governmentalunits.  This has caused thesegovernmental units to carefully evaluate their budgets and defer expenses andprojects where possible.  Much of thework of the Company’s Public Safety and Justice and Institutional SecuritySystems segments is contracted with these state and local governmentalunits.  As a result, these segments,although building a strong backlog, have seen delays in new work available tobe bid and worked on.  In addition, evenwork that has been contracted for, where possible is being deferred by thecustomer into the future, presumably when the economy will experience morerobust times.

 

After the occurrence of thetragic events of the September 11, 2001 terrorist attacks, there was ageneral perception that CompuDyne’s Federal Security Systems and AttackProtection segments would see a significant increase in order flow.  To the contrary, in the months subsequent tothe terrorist attacks these segments actually saw a slowing in new workopportunities as the various Federal agencies and other customers that are theusual source of business for the Company slowed their procurement processeswaiting for definitive direction as to how to proceed in the postSeptember 11 world. Now further complicated by the military action inIraq, the Company’s customers are reevaluating priorities and budgets and arefunding only their most pressing demands while also making key decisions as towhich projects can be deferred.

 

Over time the Company believesthese units will start to see a significant increase in business, which hasonly recently begun.

 

As a result of the above factors, the Company is experiencing a morechallenging marketplace than it has experienced in several years.

 

**Impact of Inflation**

 

Inflation did not have a significant effect on CompuDyne’s operationsduring the six months ended June 30, 2003.

 

**MarketRisk**

 

The Company is exposed to market risk related to changes in interestrates.  At June 30, 2003, theCompany had a total of $21.1 million of notes payable outstanding. Theseborrowings were all at variable rates. The Company entered into an interestrate swap agreement on June 26, 2001 in the initial amount of $11.5million.  The amount of this swapagreement declines by $676 thousand on a quarterly basis until it becomes $0 onOctober 1, 2005.  At June 30,2003 the amount of the swap agreement had declined to $6.8 million at a fixedrate of 4.9%.  As such, approximately$14.3 million of the Company’s variable rate borrowings were not hedged with aninterest rate swap agreement.  Theeffects of a 100 basis point change in interest rates would not be material tothe results of operations of the Company.

 

###### **Recent Accounting Pronouncements**

 

In May 2003, the Financial Accounting Standards Board (“FASB”)issued Statement of Financial Accounting Standards (“SFAS”) No. 150,“Accounting for Certain Financial Instruments with Characteristics of bothLiabilities and Equity.” The Statement establishes standards for how an issuerclassifies and measures in its statement of financial position certainfinancial instruments with characteristics of both liabilities and equity.  It requires that an issuer classify afinancial instrument that is within its scope as a liability (or an asset insome circumstances) because that financial instrument embodies an obligation ofthe issuer.  Many of such instrumentswere previously classified as equity. The statement is effective for financial instruments entered into ormodified after May 31, 2003, and otherwise is effective at the beginningof the first interim period beginning after June 15, 2003, except formandatorily redeemable financial instruments of nonpublic entities.  The Statement is to be implemented byreporting the cumulative effect of a change in accounting principle forfinancial instruments created before the issuance of the date of the Statementand still existing at the beginning of the interim period of adoption.  Restatement is not permitted.  Management believes that the adoption ofthis statement will not have a significant impact on the financial position,results of operations or cash flows

 

26

----

 

of the Company.

 

In April 2003, the FASB issued SFAS No. 149, “Amendment of SFASNo. 133 on Derivative Instruments and Hedging Activities”.  The Statement amends and clarifiesaccounting for derivative instruments, including certain derivative instrumentsembedded in other contracts, and for hedging activities under Statement133.  The amendments set forth in SFAS149 improve financial reporting by requiring that contracts with comparablecharacteristics be accounted for similarly. In particular, this Statementclarifies under what circumstances a contract with an initial net investmentmeets the characteristic of a derivative as discussed in Statement 133. Inaddition, it clarifies when a derivative contains a financing component thatwarrants special reporting in the statement of cash flows. Statement 149 amendscertain other existing pronouncements. Those changes will result in moreconsistent reporting of contracts that are derivatives in their entirety orthat contain embedded derivatives that warrant separate accounting.  This Statement is effective for contractsentered into or modified after June 30, 2003 and for hedging relationshipsdesignated after June 30, 2003. Management does not expect that adoptionof this pronouncement will have a material effect on the financial position,results of operations or cash flows of CompuDyne.

 

In December 2002, the FASB issued SFAS No. 148 “Accounting forStock-Based Compensation —Transition and Disclosure, an amendment of FASBStatement No. 123” which amends SFAS No. 123 (“SFAS 123”), “Accounting forStock-Based Compensation” and the reporting provisions of APB Opinion No. 30,“Interim Financial Reporting.”  SFAS 148provides alternative methods of transition for a voluntary change to the fairvalue based method of accounting for stock-based employee compensation andrequire prominent disclosures in both annual and interim financial statementsabout the method of accounting for stock-based employee compensation and theeffect of the method used on reported results. Adoption of this statement was required at the beginning of fiscal year2003.  The adoption of thispronouncement did not have a material effect on the financial position, resultsof operations or cash flows of CompuDyne.

 

In July 2002, the FASB issued SFAS No. 146, “Accounting for CostsAssociated with Exit or Disposal Activities”. The statement is effective forfiscal years beginning after December 31, 2002.  SFAS No. 146 requires companies to recognize costs associatedwith exit or disposal activities when they are incurred rather than at the dateof a commitment to an exit or disposal plan. The adoption of this standard didnot have a material effect on the financial position, results of operations orcash flows of CompuDyne.

 

In April 2002, the FASB issued SFAS No. 145, “Rescission of FASBStatements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections.”  This Statement iseffective for fiscal years beginning after May 15, 2002.  SFAS 145 requires, among other things,eliminating reporting debt extinguishments as an extraordinary item in theincome statement.  The adoption of thisstandard did not have a material effect on the financial position, results ofoperations or cash flows of CompuDyne.

 

In January 2003, the FASBissued FASB Interpretation No. 46, “Consolidation of Variable InterestEntities.”  The Interpretation clarifiesthe application of Accounting Research Bulletin No. 51, “Consolidated FinancialStatements,” to certain entities in which the equity investors do not have thecharacteristics of a controlling financial interest or do not have sufficientequity at risk for the entity to finance its activities without additionalsubordinated financial support from other parties.  The Interpretation applies immediately to variable interestentities created after January 31, 2003, or in which the Company obtains aninterest after that date.  TheInterpretation is effective July 1, 2003 to variable interest entities inwhich the Company holds a variable interest acquired before February 1,2003. The Company has assessed the impact of adopting this Interpretation. Theadoption of this standard did not have a material effect on the financialposition, results of operations or cash flows of CompuDyne.

 

In November 2002, the FASB issued Interpretation No. 45,“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others” (“FIN 45”). FIN 45 requires therecognition of liabilities for guarantees that are issued or modifiedsubsequent to December 31, 2002. The liabilities should reflect the fairvalue, at inception, of the guarantors’ obligations to stand ready to perform,in the event that the specified triggering events or conditions occur. Theadoption of this standard did not have a material effect on the financialcondition, results of operations or cash flows of CompuDyne.

 

27

----

 

**Safe Harbor StatementUnder the Private Securities Litigation Reform Act of 1995**

Certain statements made in thisForm 10-Q/A with regard to the Company’s expectations as to future revenues,expenses, financial position and industry conditions, the Company’s ability tosecure new contracts, its goals for future operations, implementation ofbusiness strategy and other future events constitute “forward-lookingstatements” within the meaning of the federal securities laws.  When used in this Form 10-Q/A, words such as“anticipate,” “believe,” “estimate,” “expect,” “intend” and similarexpressions, as they relate to management, identify forward-looking statements.  Although the Company makes such statementsbased on current information and assumptions it believes to be reasonable,there can be no assurance that actual results will not differ materially fromthose expressed or implied by such forward-looking statements.  Actual results could differ materially fromthose contemplated by the forward-looking statements as a result of certainimportant factors, including but not limited to, demand for the Company’sproducts, competitive factors and pricing pressures, changes in legal andregulatory requirements, government budget problems, the ability to remain incompliance with its bank covenants and its amended bank covenants, delays ingovernment procurement processes, ability to obtain bid, payment andperformance bonds on various of the Company’s projects, technological change ordifficulties, the ability to refinance debt when it becomes due, productdevelopment risks, commercialization difficulties, adverse results inlitigation and general economic conditions. Risks inherent in the Company’s business and with respect to futureuncertainties are further described in our other filings with the Securitiesand Exchange Commission.

 

28

----

 

PART II - OTHER INFORMATION

 

Item 6: Exhibits

(a)          Exhibits –

31.1 Certification by Mr. Martin Roenigk,Chief Executive Officer pursuant to Rule 13a-14(a), filed herewith.

31.2 Certification by Mr. Geoffrey F.Feidelberg, Chief Financial Officer pursuant to Rule 13a-14(a), filed herewith.

32.1 Certification Pursuant To Section 906Of The Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, for Mr. MartinRoenigk, Chief Executive Officer, filed herewith.

32.2 Certification Pursuant ToSection 906 Of The Sarbanes-Oxley Act of 2002, 18 U.S.C.Section 1350, for Mr. Geoffrey F. Feidelberg, Chief Financial Officer,filed herewith.

 

29

----

 

SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

COMPUDYNECORPORATION

 

 
| Date: November 24, 2003 | /s/ Geoffrey F. Feidelberg                      |   |
|------------------------------|-------------------------------------------------|--------|
|                         | Geoffrey F. Feidelberg  Chief Financial Officer |

 

30

----