UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                            ------------------------

                                    FORM 10-Q


             [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934
                  For the quarterly period ended June 30, 2006

                                       OR

            [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934
           For the transition period from             to
                                          -----------    -----------


                         Commission File Number 0-29798


                              CompuDyne Corporation
             (Exact name of registrant as specified in its charter)

                Nevada                                23-1408659
    (State or other jurisdiction of               (I.R.S. Employer
     incorporation or organization)              Identification No.)

              2530 Riva Road, Suite 201, Annapolis, Maryland 21401
                    (Address of principal executive offices)

       Registrant's telephone number, including area code: (410) 224-4415

   Indicate by check mark if the registrant is a well-known seasoned issuer,
                 as defined in Rule 405 of the Securities Act.
                        Yes [ ]                 NO [X]

    Indicate by check mark if the registrant is not required to file reports
              pursuant to Section 13 or Section 15(d) of the Act.
                        Yes [ ]                 NO [X]

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
  the preceding 12 months (or for such shorter period that the registrant was
    required to file such reports), and (2) has been subject to such filing
                       requirements for the past 90 days.
                        Yes [X]                 NO [ ]

 Indicate by check mark whether the registrant is a large accelerated filer, an
  accelerated filer, or a non-accelerated filer. See definition of accelerated
      filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
                                  (Check one):
Large accelerated filer [ ]    Accelerated filer [ ]   Non-accelerated filer [X]

 Indicate by checkmark whether the registrant is a shell company (as defined in
                        Rule 12b-2 of the Exchange Act)
                        Yes [ ]                 NO [X]

  As of August 2, 2006, a total of 8,427,024 shares of Common Stock, $.75 par
                            value, were outstanding.

                                       1
<PAGE>
                     COMPUDYNE CORPORATION AND SUBSIDIARIES
                                      INDEX


                                                                      Page No.
                                                                      --------

Part I.  Financial Information

   Item 1.  Financial Statements - Unaudited

      Consolidated Balance Sheets - June 30, 2006
      and December 31, 2005                                           3

      Consolidated Statements of Operations -
      Three Months and Six Months Ended June 30, 2006 and 2005        4

      Consolidated Statement of Changes in Shareholders' Equity -
      Six Months Ended June 30, 2006                                  5

      Consolidated Statements of Cash Flows -
      Six Months Ended June 30, 2006 and 2005                         6

      Notes to Consolidated Financial Statements                      7-16

    Item 2.  Management's Discussion and Analysis of
      Financial Condition and Results of Operations                   17-31

    Item 3.  Quantitative and Qualitative Disclosures
      About Market Risk                                               32

    Item 4.  Controls and Procedures                                  33

Part II.  Other Information                                           34

      Signature                                                       35


                                       2
<PAGE>

                          ITEM 1. FINANCIAL STATEMENTS

                     COMPUDYNE CORPORATION AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                                   (unaudited)
<TABLE>
<CAPTION>

                                                                   June 30,       December 31,
                                     ASSETS                          2006             2005
                                                                 -------------    -------------
                                                                     (dollars in thousands)
<S>                                                              <C>              <C>
Current Assets
     Cash and cash equivalents                                   $      7,529     $      6,938
     Marketable securities                                              7,238           11,429
     Cash and marketable securities - pledged                             440                -
     Accounts receivable, net                                          30,496           39,625
     Contract costs in excess of billings                              11,053           13,764
     Inventories                                                        5,831            6,195
     Prepaid expenses and other                                         2,642            2,809
                                                                 -------------    -------------
        Total Current Assets                                           65,229           80,760

Cash and marketable securities - pledged                                6,677                -
Property, plant and equipment, net                                      9,696            9,962
Goodwill                                                               26,846           26,846
Other intangible assets, net                                            8,090            8,221
Other                                                                     779              903
                                                                 -------------    -------------
        Total Assets                                             $    117,317     $    126,692
                                                                 =============    =============

                             LIABILITIES AND SHAREHOLDERS' EQUITY

Current Liabilities
     Accounts payable and accrued liabilities                    $     15,533     $     23,030
     Billings in excess of contract costs incurred                     12,309           13,847
     Deferred revenue                                                   6,664            8,094
     Current portion of notes payable                                     440              440
                                                                 -------------    -------------
        Total Current Liabilities                                      34,946           45,411

Notes payable                                                           2,825            3,125
Convertible subordinated notes payable, net                            39,399           39,305
Deferred tax liabilities                                                2,060            2,060
Other                                                                     289              369
                                                                 -------------    -------------
        Total Liabilities                                              79,519           90,270
                                                                 -------------    -------------

Commitments and Contingencies

Shareholders' Equity
     Preferred stock, 2,000,000 shares authorized and unissued              -                -
     Common stock, par value $.75 per share:  50,000,000 shares
      authorized at June 30, 2006 and December 31, 2005;
      8,951,181 and 8,950,356 shares issued at June 30, 2006 and
      December 31, 2005, respectively                                   6,713            6,712
     Additional paid-in-capital                                        44,969           44,388
     Accumulated deficit                                               (7,851)          (8,963)
     Accumulated other comprehensive (loss)                              (357)             (39)
     Treasury stock, at cost; 831,777 shares at June 30, 2006
      and December 31, 2005                                            (5,676)          (5,676)
                                                                 -------------    -------------
        Total Shareholders' Equity                                     37,798           36,422
                                                                 -------------    -------------
        Total Liabilities and Shareholders' Equity               $    117,317     $    126,692
                                                                 =============    =============
</TABLE>

   The accompanying notes are an integral part of these financial statements.

                                       3
<PAGE>

                     COMPUDYNE CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (unaudited)

<TABLE>
<CAPTION>

                                           Three Months Ended June 30,      Six Months Ended June 30,
                                               2006           2005             2006           2005
                                           ------------    -----------      -----------    -----------
                                                      (in thousands, except per share data)
<S>                                        <C>            <C>               <C>            <C>
Revenues:
 Contract revenues earned                  $    20,000     $   20,293       $   40,826     $   43,759
 Other revenues                                 18,394         10,811           38,038         23,651
                                           ------------    -----------      -----------    -----------
   Total revenues                               38,394         31,104           78,864         67,410

Cost of sales                                   26,258         20,677           54,219         44,600
                                           ------------    -----------      -----------    -----------

Gross profit                                    12,136         10,427           24,645         22,810

Selling, general & administrative expenses       9,342         10,295           19,078         20,322
Research and development                         1,934          2,242            3,701          4,353
                                           ------------    -----------      -----------    -----------
Income (loss) from operations                      860         (2,110)           1,866         (1,865)
                                           ------------    -----------      -----------    -----------

Other expense (income)
 Interest expense                                  842            750            1,657          1,553
 Interest income                                  (290)          (210)            (568)          (438)
 Other income                                       (4)           (11)            (158)           (22)
                                           ------------    -----------      -----------    -----------
   Total other expense                             548            529              931          1,093
                                           ------------    -----------      -----------    -----------

Income (loss) before taxes on income               312         (2,639)             935         (2,958)
Income tax expense (benefit)                         7              -             (177)             -
                                           ------------    -----------      -----------    -----------
Net income (loss)                          $       305     $   (2,639)      $    1,112     $   (2,958)
                                           ============    ===========      ===========    ===========

Income (loss) per share:
------------------------------------------
Basic income (loss) per common share       $       .04     $     (.33)      $      .14     $     (.36)
                                           ============    ===========      ===========    ===========

Weighted average number of common
shares outstanding                               8,119          8,118            8,119          8,141
                                           ============    ===========      ===========    ===========

Diluted income (loss) per common share     $       .04     $     (.33)      $      .14     $     (.36)
                                           ============    ===========      ===========    ===========

Weighted average number of common
shares and equivalents                           8,164          8,118            8,161          8,141
                                           ============    ===========      ===========    ===========

</TABLE>
   The accompanying notes are an integral part of these financial statements.

                                       4
<PAGE>

                     COMPUDYNE CORPORATION AND SUBSIDIARIES
            CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
                                   (unaudited)
                                 (in thousands)

<TABLE>
<CAPTION>

                                                                               Accumulated
                                                     Additional                   Other
                                     Common Stock     Paid-in    Accumulated  Comprehensive   Treasury Stock
                                   Shares   Amount    Capital      Deficit    Income (Loss)  Shares    Amount    Total
                                   ----------------  ----------  -----------  -------------  -----------------  --------

<S>                                 <C>     <C>      <C>         <C>          <C>               <C>   <C>       <C>
Balance at January 1, 2006          8,950   $6,712   $  44,388   $   (8,963)  $        (39)     832   $(5,676)  $36,422
Stock options exercised                 1        1           3                                                        4
Stock-based compensation                                   578                                                      578
                                   -------------------------------------------------------------------------------------
  Subtotal                          8,951    6,713      44,969       (8,963)           (39)     832    (5,676)   37,004
Comprehensive income:
  Net income                                                          1,112                                       1,112
Other comprehensive
 loss, net of tax:
Unrealized loss on available for
 sale marketable securities                                                           (318)                        (318)
                                                                                                                --------
Comprehensive income                                                                                                794
                                   -------------------------------------------------------------------------------------
Balance at June 30, 2006            8,951   $6,713   $  44,969   $   (7,851)  $       (357)     832   $(5,676)  $37,798
                                   =======  =======  ==========  ===========  =============  =======  ========  ========

</TABLE>

   The accompanying notes are an integral part of these financial statements.

                                       5
<PAGE>


                     COMPUDYNE CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (unaudited)
<TABLE>
<CAPTION>

                                                              Six Months Ended June 30,
                                                                 2006          2005
                                                              ------------  -----------
                                                                   (in thousands)
<S>                                                           <C>            <C>
Cash flows from operating activities:
  Net income (loss)                                           $     1,112    $  (2,958)

Adjustments to reconcile net income (loss) to
 net cash provided (used) by operations:
  Depreciation and amortization                                     1,545        1,725
  Amortization of debt discount and financing fees                    164          134
  (Accretion of premium) Amortization of discount on
   marketable securities, net                                           -           (7)
  Stock-based compensation expense                                    578            -
  Unrealized gain on interest rate swap                                 -           18

Changes in assets and liabilities:
  Accounts receivable                                               9,129        2,923
  Contract costs in excess of billings                              2,711        1,519
  Inventories                                                         364         (611)
  Prepaid expenses and other current assets                           141         (599)
  Other assets                                                         54           (3)
  Accounts payable and accrued liabilities                         (7,496)      (3,517)
  Billings in excess of contract costs incurred                    (1,538)      (2,292)
  Deferred revenue                                                 (1,430)        (888)
  Other liabilities                                                   (80)         (98)
                                                              ------------  -----------
Net cash flows provided by (used in) operating activities           5,254       (4,654)
                                                              ------------  -----------

Cash flows from investing activities:
  Purchase of marketable securities                                (6,957)      (7,721)
  Redemption of marketable securities                               4,310       13,237
  Additions to property, plant and equipment                       (1,148)        (615)
  Net payment for prior year acquisition                                -          (27)
                                                              ------------  -----------
Net cash flows (used in) provided by investing activities          (3,795)       4,874
                                                              ------------  -----------

Cash flows from financing activities:
  Stock options exercised                                               3            4
  Purchase of treasury shares                                           -         (690)
  Restricted cash                                                    (571)           -
  Repayment of notes payable                                         (300)        (300)
                                                              ------------  -----------
Net cash used in financing activities                                (868)        (986)
                                                              ------------  -----------

Net change in cash and cash equivalents                               591         (766)
Cash and cash equivalents at beginning of period                    6,938        5,198
                                                              ------------  -----------
Cash and cash equivalents at end of period                    $     7,529    $   4,432
                                                              ============  ===========
</TABLE>

   The accompanying notes are an integral part of these financial statements.

                                       6
<PAGE>
                     COMPUDYNE CORPORATION AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)


1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation:
The  accompanying  unaudited  consolidated  financial  statements  of  CompuDyne
Corporation and its subsidiaries  (the "Company") have been prepared pursuant to
the rules  and  regulations  of the  Securities  and  Exchange  Commission.  The
consolidated  balance  sheet as of December  31, 2005 has been  derived from the
Company's December 31, 2005 audited financial  statements.  Certain  information
and note disclosures  included in the annual financial  statements,  prepared in
accordance with accounting principles generally accepted in the United States of
America, have been condensed or omitted pursuant to those rules and regulations,
although the Company  believes that the  disclosures  made in this Form 10-Q are
adequate to make the information presented not misleading.

In the opinion of the Company, the accompanying unaudited consolidated financial
statements reflect all necessary adjustments and reclassifications (all of which
are  of a  normal,  recurring  nature,  unless  otherwise  disclosed)  that  are
necessary for the fair  presentation of the periods  presented.  It is suggested
that these consolidated  unaudited  financial  statements be read in conjunction
with the consolidated financial statements and the notes thereto included in the
Company's  annual report filed with the  Securities  and Exchange  Commission on
Form 10-K for the year ended December 31, 2005.  Operating results for the three
and six  month  periods  ended  June  30,  2006  and  2005  are not  necessarily
indicative of operating results for the entire fiscal year.

Comprehensive Income (Loss)
The following table shows the components of comprehensive  income (loss), net of
income taxes, for the six months ended June 30, 2006 and 2005, in thousands:

                                                            For the Six Months
                                                              Ended June 30,
                                                             2006        2005
                                                          ----------  ----------

Net income (loss)                                         $   1,112   $  (2,958)
Unrealized (loss) gain on available-for-sale securities        (318)         13
                                                          ----------  ----------
Comprehensive income (loss)                               $     794   $  (2,945)
                                                          ==========  ==========


Stock-Based Compensation
In December  2004,  the FASB issued SFAS No. 123R  (revised  2004)  "Share-Based
Payment."  This statement  replaces SFAS No. 123,  "Accounting  for  Stock-Based
Compensation,"  and supersedes  Accounting  Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees." This statement requires that the
cost resulting from all  share-based  payment  transactions be recognized in the
financial  statements.  Pro forma  disclosure is no longer an alternative.  This
statement  establishes fair value as the measurement objective in accounting for
share-based   payment   arrangements  and  requires  all  entities  to  apply  a
fair-value-based  measurement  method  in  accounting  for  share-based  payment
transactions  with  employees.  This statement uses the terms  compensation  and
payment in their broadest senses to refer to the consideration paid for goods or
services, regardless of whether the supplier is an employee.

The Company  adopted SFAS No. 123R effective  January 1, 2006 and is recognizing
the cost of stock-based  compensation,  consisting of stock  options,  using the
modified  prospective  application  method  whereby  the cost of new  awards and
awards modified,  repurchased or cancelled after January 1, 2006 and the portion
of awards  for which  the  requisite  service  has not been  rendered  (unvested
awards) that are outstanding as of January 1, 2006, as the requisite  service is
rendered on or after the  effective  date,  January 1, 2006.  This standard will
have a material impact on its financial statements.

Income Taxes
The Company follows  Statement of Financial  Accounting  Standards  ("SFAS") No.
109,  "Accounting  for Income Taxes." Under SFAS 109,  deferred income taxes are
recognized for the future tax  consequences of differences  between tax bases of
assets and liabilities and financial  reporting amounts,  based upon enacted tax
laws and statutory tax rates  applicable to the periods in which the differences
are  expected  to affect  taxable  income.  The Company has decided to provide a
valuation  allowance  against its deferred tax assets, as it has determined that
due to the Company's  recent operating losses there is uncertainty as to whether
it is more likely than not that these assets will be realized.

Other Recently Issued Accounting Pronouncements
In  May  2005,  the  FASB  issued  SFAS  154,   "Accounting  Changes  and  Error
Corrections" (SFAS 154) which replaces APB Opinion No. 20, "Accounting  Changes"
and SFAS 3, "Reporting  Accounting  Changes in Interim  Financial  Statements-An

                                       7
<PAGE>
Amendment of APB Opinion No. 28." SFAS 154 provides  guidance on the  accounting
for and reporting of accounting  changes and error  corrections.  It establishes
retrospective  application,  or the latest  practicable  date,  as the  required
method for  reporting a change in  accounting  principle  and the reporting of a
correction  of an  error.  SFAS 154 is  effective  for  accounting  changes  and
corrections  of errors made in fiscal years  beginning  after December 15, 2005.
The  adoption  of SFAS 154 did not have a  material  impact on our  consolidated
financial position, results of operations or cash flows.

Reclassifications - Certain prior year amounts have been reclassified to conform
with the current year's presentation.

2.  EARNINGS PER SHARE

Earnings per share are presented in accordance with SFAS No. 128,  "Earnings Per
Share." This Statement  requires dual presentation of basic and diluted earnings
per share on the face of the statement of  operations.  Basic earnings per share
is computed using the weighted average number of shares  outstanding  during the
period and excludes any dilutive  effects of options,  warrants,  or convertible
securities.  Diluted  earnings per share is computed using the weighted  average
number of common and  common  stock  equivalent  shares  outstanding  during the
period;  common stock  equivalent  shares are excluded from the  computation  if
their effect is antidilutive.

Stock options and warrants to purchase  1,424,297  and 1,557,333  shares for the
three  month  periods  ended  June 30,  2006 and  2005,  respectively,  were not
dilutive  and,  therefore,  were not  included  in the  computation  of  diluted
earnings per common  share.  Additionally,  the 2,897,768  shares  issuable upon
conversion of the 6.25% Convertible Subordinated Notes due January 15, 2011 (the
"2011  Notes") are excluded for the three month  periods ended June 30, 2006 and
2005 as the effect is antidilutive.

Stock options and warrants to purchase  1,464,733  and 1,550,233  shares for the
six month periods ended June 30, 2006 and 2005, respectively,  were not dilutive
and,  therefore,  were not included in the  computation of diluted  earnings per
common share. Additionally, the 2,897,768 shares issuable upon conversion of the
6.25% Convertible Subordinated Notes due January 15, 2011 (the "2011 Notes") are
excluded for the six month periods ended June 30, 2006 and 2005 as the effect is
antidilutive.

The  computations of the Company's  basic and diluted  earnings per common share
amounts were as follows:
<TABLE>
<CAPTION>

                                                   Three Months Ended      Six Months Ended
                                                        June 30,               June 30,
                                                    2006       2005        2006       2005
                                                  ---------  ---------   ---------  ---------
                                                     (in thousands, except per share data)
<S>                                               <C>        <C>         <C>        <C>
Net income (loss)                                 $    305   $ (2,639)   $  1,112   $ (2,958)
                                                  =========  =========   =========  =========

Weighted average common shares outstanding           8,119      8,118       8,119      8,141
Effect of dilutive stock options and warrants           45          -          42          -
                                                  ---------  ---------   ---------  ---------
Diluted weighted average number of common shares
 outstanding                                         8,164      8,118       8,161      8,141
                                                  =========  =========   =========  =========

Net income (loss) per common share
Basic                                             $    .04   $   (.33)   $    .14   $   (.36)
Diluted                                           $    .04   $   (.33)   $    .14   $   (.36)

</TABLE>

In March 2004, the EITF reached a final consensus on Issue 03-6,  "Participating
Securities and the Two-Class  Method under FASB Statement No. 128,  Earnings Per
Share" ("Issue 03-6"),  effective June 30, 2004.  Issue 03-6 requires the use of
the  two-class  method to compute  earnings  per share for  companies  that have
issued securities other than common stock that contractually  entitle the holder
to participate in dividends and earnings of the Company ("participation rights")
when, and if, it declares dividends on its common stock.

The 2011 Notes contain contingent participation rights. The participation rights
are contingent  upon the ability,  based on the  undistributed  earnings for the
period, of the Company to declare and distribute dividends per share equal to or
in  excess  of the per share  fair  value of the  Company's  common  stock.  The
contingency  was not met for the three or six month  periods ended June 30, 2006
and June 30, 2005. Accordingly, no undistributed earnings have been allocated to
the 2011 Notes.  At each  reporting  period,  the Company  assesses  whether the
contingency  criteria have been met and consequently if  undistributed  earnings
should be allocated to participating securities.

                                       8
<PAGE>

3.  STOCK-BASED COMPENSATION

Effective  January 1, 2006, we adopted SFAS No. 123(R),  "Share-Based  Payment."
This  statement  requires  us to  expense  the fair  value of grants of  various
stock-based  compensation  programs  over the vesting  period of the awards.  We
elected to adopt the "Modified Prospective  Application" transition method which
does not require the  restatement  of previously  issued  financial  statements.
Compensation expense is measured and recognized beginning in 2006 as follows:

Awards granted after December 31, 2005 - Awards are measured at their fair value
at date of grant.  The  resulting  compensation  expense  is  recognized  in the
consolidated  statement of  operations  ratably  over the vesting  period of the
award.

Awards  granted  prior to December 31, 2005 - Awards were measured at their fair
value at the date of original grant.  Compensation  expense  associated with the
unvested  portion  of these  options at  January  1, 2006 is  recognized  in the
consolidated statement of operations ratably over the remaining vesting period.

For all  grants  issued  after  December  31,  2005  the  amount  of  recognized
compensation  expense is adjusted based upon an estimated  forfeiture rate which
is derived from historical data.

The following table shows total stock-based compensation expense included in the
Consolidated Statement of Operations:
<TABLE>
<CAPTION>

                                            For the Three Months   For the Six Months
                                            Ended June 30, 2006    Ended June 30, 2006
                                            --------------------   -------------------
                                                          (in thousands)
<S>                                              <C>                   <C>
     Cost of sales                               $       21            $       39
     Selling, general and administrative                279                   493
     Research and development                            23                    46
                                                 -----------           -----------

     Effect on net income                        $      323            $      578
                                                 ===========           ===========
</TABLE>

No similar  expense was charged  against  income in the prior  periods as we had
elected to apply the  provisions  of APB No. 25 to those periods as permitted by
SFAS No. 123.

SFAS No.  123(R) also requires that the tax benefit from the exercise of options
be  reflected  in the  statement  of cash flows as a cash inflow from  financing
activities.  Prior to the adoption of SFAS No.  123(R),  these tax benefits were
reflected  as a cash  inflow  from  operations.  Because we elected to adopt the
"Modified Prospective  Application" transition method, the prior year statements
of cash flows have not been  restated.  The tax  benefit  from the  exercise  of
options was $0 for each of the three and six months ended June 30, 2006 and June
30, 2005.

Stock Option Plans
------------------

2005 Stock Incentive Compensation Plan for Employees.  Stock options are granted
with an  exercise  price  equal to the market  price of the stock at the date of
grant.  Substantially  all of the options granted are exercisable  pursuant to a
five-year vesting  schedule.  The fair value of these options is estimated using
the Black-Scholes  option pricing model which incorporates the assumptions noted
in  the  table  below.   Expected  volatilities  are  based  on  the  historical
performance of our stock. We also use historical data to estimate the timing and
amount of option  exercises  and  forfeitures  within the valuation  model.  The
expected  term of the options is derived  from the output of the option  pricing
model and  represents  the period of time that  options  are  expected to remain
unexercised. The risk-free interest rate for periods within the contractual life
of the option is based on the U.S.  Treasury  bond rate in effect at the time of
grant.

2005 Stock Option Plan for  Non-Employee  Directors.  Stock  options are granted
with an  exercise  price  equal to the market  price of the stock at the date of
grant.  Substantially  all of the options granted are exercisable  pursuant to a
three-year vesting schedule.  The fair value of these options is estimated using
the Black-Scholes  option pricing model which incorporates the assumptions noted
in  the  table  below.   Expected  volatilities  are  based  on  the  historical
performance of our stock. We also use historical data to estimate the timing and
amount of option  exercises  and  forfeitures  within the valuation  model.  The
expected  term of the options is derived  from the output of the option  pricing
model and  represents  the period of time that  options  are  expected to remain
unexercised. The risk-free interest rate for periods within the contractual life
of the option is based on the U.S.  Treasury  bond rate in effect at the time of
grant.

The 1996 Stock  Incentive  Plan for Employees and the 1996 Stock Option Plan for
Non-Employee  Directors,  collectively  referred to as the "Prior  Plans,"  have
expired in  accordance  with their  terms and no further  stock  options  may be
granted under these plans.

The fair values of grants in the stated period were computed using the following
range of assumptions for our various stock option plans:

                                       9
<PAGE>

                                     For the Three       For the Six
                                     Months Ended       Months Ended
                                     June 30, 2006      June 30, 2006
                                     -------------      -------------
Risk-free interest rates                   5.0%               4.9%
Dividend yield                                -                  -
Expected volatility                       77.7%              78.0%
Expected lives                             6.5 years          6.5 years
Annual forfeiture rate                     4.4%               4.4%

The following is a summary of all option  activity for the six months ended June
30, 2006:
<TABLE>
<CAPTION>

                                                               Weighted-     Aggregate
                                                                Average      Intrinsic
                                                Number of      Exercise      Value at
                                                 Shares         Price      June 30, 2006
                                                ----------    ----------   --------------
                <S>                                 <C>            <C>            <C>
Outstanding at December 31, 2005                1,453,358     $  8.7550
Granted                                           399,000     $  6.8637
Exercised                                             825     $  4.3100
Forfeited                                          65,200     $  7.3704
Expired                                            70,350     $  9.1070
                                                ----------    ----------
Outstanding at June 30, 2006                    1,715,983     $  8.3556    $     231,630
                                                ==========    ==========   ==============

Exercisable at June 30, 2006                      857,883     $  9.5468    $     163,529
                                                ==========    ==========   ==============
</TABLE>

A summary of our stock options outstanding at June 30, 2006 follows:
<TABLE>
<CAPTION>

                                         Options outstanding                            Options exercisable
                                -----------------------------------------            -------------------------
                                              Weighted-         Weighted-                           Weighted-
                                               Average           Average                             Average
                                              Remaining         Exercise                             Exercise
 Range of Exercise Price        Shares       Life (yrs)            Price             Shares           Price
 -----------------------       -------       ----------         ---------           -------         ----------
              <S>                 <C>            <C>               <C>                 <C>             <C>
     $  1.625 - $  6.250       182,350          6.49            $  5.2562            62,350         $   3.9087
     $  6.315 - $  6.855       194,336          8.86            $  6.7463            20,936         $   6.6788
     $  6.860 - $  6.950       246,800          9.67            $  6.9248             6,800         $   6.8750
     $  7.000 - $  7.640       265,500          7.84            $  7.4194            83,500         $   7.4212
     $  7.719 - $  8.195       175,000          5.53            $  8.0597           126,400         $   8.0630
     $  8.215 - $  9.410       175,197          6.59            $  8.6657           106,097         $   8.6532
     $  9.495 - $ 10.460       199,300          5.71            $ 10.1942           174,300         $   10.754
     $ 11.165 - $ 12.210       173,000          6.68            $ 11.6267           173,000         $  11.6267
     $ 13.290 - $ 16.330       103,500          5.80            $ 13.5380           103,500         $  13.5380
     $ 16.630 - $ 16.630         1,000          5.24            $ 16.6300             1,000         $  16.6300
------------------------------------------------------------------------------------------------------------------

     $  1.625 - $ 16.630     1,715,983          7.22            $  8.3556           857,883         $   9.5468
                             =========                                              =======
</TABLE>

In the first two quarters of 2006, the weighted-average grant-date fair value of
an option granted was $4.83. The total intrinsic  value, the difference  between
the exercise price and the market price on the date of exercise,  of all options
exercised  during  the  period  was  approximately  $1,600.  Total  unrecognized
compensation  expense from stock  options was $3.7 million  excluding  estimated
forfeitures,  which is expected to be recognized over a weighted-average  period
of 2.96 years as follows, in thousands:

                                                                 Compensation
                                                              Expense Excluding
                                Year                       Estimated Forfeitures
                                ----                       ---------------------
                                2006 (remaining)           $         536
                                2007                               1,040
                                2008                                 877
                                2009                                 690
                                2010                                 410
                                2011                                 152
                                                           -------------
                                     Total                 $       3,705
                                                           =============

                                       10
<PAGE>



For the three and six months ended June 30, 2005, we applied the intrinsic value
based  method  of  accounting  for  stock  options  prescribed  by APB  No.  25.
Accordingly,  no  compensation  expense was  recognized  for these stock options
since all options  granted  have an exercise  price equal to the market value of
the  underlying  stock on the  grant  date.  If  compensation  expense  had been
recognized  based on the  estimate of the fair value of each  option  granted in
accordance  with the  provisions of SFAS No. 123 as amended by SFAS No. 148, our
results of operations would have been reduced to the following pro forma amounts
as follows, in thousands:
<TABLE>
<CAPTION>

                                                                            Three Months Ended      Six Months Ended
                                                                              June 30, 2005          June 30, 2005
                                                                              -------------          -------------
                                   <S>                                             <C>                   <C>
                          Net loss as reported                                $    (2,639)           $    (2,958)
                          Deduct:  pro forma stock based employee
                             compensation expense, net of tax                        (290)                  (566)
                                                                              ------------           -------------
                          Pro forma net loss                                  $    (2,929)           $    (3,524)
                                                                              ============           =============
                          Earnings per common share:
                              Basic - as reported                             $     (0.33)           $     (0.36)
                              Basic - pro forma                               $     (0.36)           $     (0.43)

                              Diluted - as reported                           $     (0.33)           $     (0.36)
                              Diluted - pro forma                             $     (0.36)           $     (0.43)
</TABLE>

Pro forma  compensation  expense recognized under SFAS No. 123 does not consider
potential forfeitures.

4.     INVESTMENTS IN MARKETABLE SECURITIES

The  Company's  marketable  securities  are  categorized  as  available-for-sale
securities,  as defined by SFAS No. 115,  "Accounting for Certain Investments in
Debt and Equity  Securities."  At June 30, 2006 and December 31, 2005 all of the
Company's    investments   in   marketable   securities   were   classified   as
available-for-sale,  and as a result,  were  reported at fair value.  Unrealized
gains and losses are reported as a component of accumulated other  comprehensive
income/(loss) in shareholders'  equity.  The cost for marketable  securities was
determined using the specific  identification  method and adjusted for accretion
of discounts or  amortization of premiums from the date of purchase to maturity.
The accretion and amortization is included in interest  income.  The fair values
of  marketable  securities  are  estimated  based on the quoted market price for
these securities.

At June 30, 2006, $7.1 million of cash and marketable securities, at fair value,
were pledged to the Company's  bank to serve as collateral  for a portion of its
$14.2 million of letters of credit.  Of the $7.1 million of cash and  marketable
securities, $440 thousand was classified as a current asset, with the balance of
$6.7 million classified as a long-term asset.

Marketable securities are summarized, in thousands, as follows:
<TABLE>

                                                      June 30,                                    December 31,
                                                        2006                                         2005
                                       -----------------------------------------   ------------------------------------------
                                                   Gross Unrealized       Fair                 Gross Unrealized       Fair
                                         Cost      Gains      Losses      Value     Cost       Gains      Losses      Value
                                       -------     -----      ------     --------  -------     ------    --------    ----------
           <S>                           <C>         <C>         <C>        <C>      <C>         <C>        <C>          <C>
Collateralized mortgage
 obligations (CMO's) consisting
 of securities issued by
 Fannie Mae and Freddie Mac            $ 14,140    $   -      $  356     $ 13,784  $11,494      $   -     $    65     $   11,429
</TABLE>

The cost and estimated fair value of current  marketable  securities at June 30,
2006, by contractual maturity,  are shown below. Expected maturities will differ
from contractual maturities because the issuers of the securities have the right
to repay obligations without prepayment penalties. It is the Company's policy to
classify  available-for-sale  securities  that are  available for use in current
operations as a current asset.

                                                                      Estimated
(in thousands)                                           Cost         Fair Value
                                                       --------       ----------
Due after one year and beyond                          $ 14,140       $  13,784
                                                       --------       ----------
Total debt securities                                  $ 14,140       $  13,784
                                                       ========       ==========

5.     INVENTORIES

Inventories consist of the following, in thousands:


                                       11
<PAGE>


                                                      June 30,      December 31,
                                                       2006            2005
                                                      --------      ------------
Raw materials                                         $ 3,795       $     3,984
Work in progress                                        2,747             3,342
Finished goods                                            436               240
                                                      --------      ------------
Total inventory                                         6,978             7,566
Reserve for excess and obsolete inventory              (1,147)           (1,371)
                                                      ---------     ------------
Inventories, net                                      $ 5,831       $     6,195
                                                      =========     ============

6.     GOODWILL

The Company  reviews the carrying value of goodwill  annually  during the fourth
quarter of the year or whenever events or changes in circumstances 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 as
unforeseen  events or changes in market  conditions could negatively  affect the
reporting  unit's  fair value and result in an  impairment  charge.  The Company
cannot predict the occurrence of events that might adversely affect the reported
value of goodwill of approximately $26.8 million at June 30, 2006.

Goodwill, by segment, consists of the following, in thousands:

                                                  Public
                                  Attack          Safety &
                                Protection        Justice            Total
                                ----------        ---------         --------

     December 31, 2005          $      728        $  26,118         $ 26,846
                                ==========        =========         ========
     June 30, 2006              $      728        $  26,118         $ 26,846
                                ==========        =========         ========

7.     INTANGIBLE ASSETS

Intangible  assets include the trade name,  customer  relationships  and backlog
from the  acquisition  of  CompuDyne  Public  Safety & Justice,  Inc.  (formerly
Tiburon,  Inc.) in 2002. Other  intangibles  include trade names,  Department of
State  Certifications,  Underwriters  Laboratories,  Inc. listings,  and patents
related to the acquisition of Norment in 1998 and its other recent acquisitions.
With the exception of the Norment and Tiburon trade names, which have indefinite
lives, the intangible assets are being amortized using the straight-line method.

Intangible assets consist of the following, in thousands:
<TABLE>
<CAPTION>

                                                June 30,        December 31,     Amortizable
                                                  2006              2005            Lives
                                                ---------       ------------    ---------------
      Cost                                                                        (in years)
               <S>                                 <C>               <C>               <C>
        Trade names                             $  5,692        $     5,692     15 - Indefinite
        Customer relationships                     2,500              2,500             14
        Other                                      1,195              1,195            1-20
                                                ---------       ------------
                                                   9,387              9,387
                                                ---------       ------------
      Accumulated amortization
        Trade names                                   (6)                (4)
        Customer relationships                      (744)              (655)
        Other                                       (547)              (507)
                                                ---------          ---------
                                                  (1,297)            (1,166)
                                                ---------          ---------
      Net cost                                  $  8,090           $  8,221
                                                =========          =========
</TABLE>

Amortization  expense for the Company's  intangible assets for the three and six
month   periods  ended  June  30,  2006  was  $66  thousand  and  $130  thousand
respectively. The following schedule lists the expected amortization expense for
each of the next five years ending December 31, in thousands:


                                       12
<PAGE>



 Year
 ----
 2006 (remaining)          $    131
 2007                           255
 2008                           243
 2009                           243
 2010                           229
 Thereafter                   1,357
                           --------
 Total                     $  2,458
                           ========

8.     NOTES PAYABLE AND LINE OF CREDIT
<TABLE>
<CAPTION>
                                                                                     June 30,         December 31,
                                                                                      2006               2005
                                                                                    -----------       ------------
                                                                                            (in thousands)
                           <S>                                                        <C>                <C>
Industrial revenue bond, interest payable monthly at a variable rate
of 3.14% to 4.19% (4.19% at June 30, 2006) principal payable
in quarterly installments of $35,000.  The bond is fully collateralized
by a $1.3 million letter of credit and a bond guarantee agreement.                  $  1,260          $   1,260

Industrial revenue bond, interest payable monthly at a variable rate
of 3.07% to 4.11% (4.09% at June 30, 2006) principal payable
in annual installments of $300,000 until 2013 when the annual
installments become $100,000.  The bond is fully collateralized by
a $2.0 million letter of credit and a bond guarantee agreement.                        2,005              2,305

6.25% Convertible Subordinated Notes due January 15, 2011.
The notes bear interest at a rate of 6.25% per annum, payable
semi-annually, and are convertible into shares of common
stock at a conversion price of $13.89 per share.  These notes
are subordinated to all other liabilities of the Company.                             40,250             40,250
                                                                                    -----------       ------------

Total notes payable                                                                   43,515             43,815
Less convertible subordinated notes discount                                             851                945
                                                                                    -----------       ------------
Subtotal                                                                              42,664             42,870
Less amount due within one year
                                                                                         440                440
                                                                                    -----------       ------------
                                                                                    $ 42,224          $  42,430
                                                                                    ===========       ============
</TABLE>


Maturities of notes payable are as follows, in thousands:

                                 Year Ending December 31,                Amount
                                 ------------------------               --------
                                 2006 (remaining)                   $       140
                                 2007                                       440
                                 2008                                       440
                                 2009                                       440
                                 2010                                       440
                                 Thereafter                              41,615
                                                                    ------------
                                                                    $    43,515
                                                                    ============

On January 22,  2004,  the  Company  completed  an  offering  of $40.25  million
principal  amount of the 2011 Notes.  The 2011 Notes bear  interest at a rate of
6.25% per annum,  payable  semi-annually,  and are  convertible  into  shares of
common stock at a conversion price of $13.89 per share,  subject to adjustments.
The 2011 Notes are  subordinated  to all other  liabilities of the Company.  The
June 30, 2006 carrying value is listed below, in thousands.

Face value                          $  40,250
Underwriters discounts, net               851
                                    ---------
                                    $  39,399
                                    =========


                                       13
<PAGE>


The 2011 Notes can be converted into the Company's common stock at the option of
the holder at any time at a  conversion  price of $13.89  per share,  subject to
adjustments for stock splits, stock dividends, the issuance of certain rights or
warrants to the existing  holders of the Company's common stock and common stock
cash dividends in excess of a stated threshold.

The 2011 Notes are  redeemable  at the option of the Company  after  January 15,
2009, at a premium of two percent of the face value plus accrued interest unless
a change in control event,  as defined in the indenture  dated as of January 15,
2004 between the Company and U.S. Bank,  relating to the 2011 Notes,  occurs. If
such an event does occur,  the Company may redeem the 2011 Notes at a premium in
whole  but not in part at face.  If a change in  control  event  occurs  and the
Company  does not elect to redeem the 2011  Notes,  the  holders can require the
Company to repurchase the 2011 Notes at face value plus accrued interest.

The debt issuance  costs for the 2011 Notes are recorded as  non-current  assets
and are amortized on a straight-line  basis to interest expense over the term of
the 2011 Notes. In addition,  underwriters'  discounts  totaled $1.3 million and
are amortized on a straight-line  basis to interest expense over the term of the
2011  Notes.  Interest  expense  recorded  for the  total of the  deferred  debt
issuance  costs  and  underwriters'  discounts  on the 2011  Notes  totaled  $63
thousand and $63 thousand for the three month  periods  ended March 31, 2006 and
2005, respectively, and $126 thousand and $126 thousand for the six months ended
June 30, 2006 and 2005, respectively.

On December 19, 2005, the Company and its bank entered into a Second Amended and
Restated  Revolving  Credit and Security  Agreement (the "Second Restated Credit
Agreement").  The Second  Restated  Credit  Agreement  amended and  restated the
Company's Amended and Restated Credit Agreement dated March 31, 2004.

In connection with the execution of the Second Restated  Credit  Agreement,  the
Company  provided  the bank  with  collateral  that  includes  all  receivables,
equipment,  general intangibles,  inventory,  investment property, real property
and a  security  interest  in  subsidiary  stock.  The  Second  Restated  Credit
Agreement allows the Company to obtain revolving  advances in a principal amount
of up to $20,000,000. Revolving advances are limited by a borrowing base formula
based upon the value of the Company's receivables, inventory, fixed assets, real
property and issued and  outstanding  letters of credit.  The maximum  aggregate
face  amount of letters of credit  that may be drawn  under the Second  Restated
Credit Agreement is limited to $18,000,000. The Second Restated Credit Agreement
matures on December 18, 2008.

Revolving advances under the Second Restated Credit Agreement bear interest,  at
the  election of the Company,  at a variable  rate equal to the  alternate  base
rate, a prime interest based rate, or the Eurodollar  rate plus two and one half
percent.  For letters of credit, the Company pays an amount equal to the average
daily face amount of each outstanding letter of credit multiplied by two and one
half  percent  per annum,  and a fronting  fee of one quarter of one percent per
annum, together with other administrative fees and charges. The Company paid its
bank a closing fee of $50,000 in  connection  with the  execution  of the Second
Restated  Credit  Agreement.  The  Company is also  required  to pay the bank an
unused  fee equal to  three-eighths  of one  percent  per annum of the amount by
which  $20,000,000  exceeds the average  daily unpaid  balance of the  revolving
advances and undrawn amount of any outstanding  letters of credit.  In addition,
the Company is required to pay a collateral  monitoring  fee equal to $1,000 per
month and a collateral evaluation fee as required.

The Second Restated Credit Agreement  contains various  affirmative and negative
covenants including financial covenants.  The Company is required to maintain an
unrestricted  undrawn  borrowing  base  availability  of  at  least  $5,000,000.
Commencing  with the fiscal quarter ended June 30, 2006, the Company is required
to  maintain  a fixed  charge  coverage  ratio  of at  least  1.1 to  1.0.  This
requirement was met at June 30, 2006.

9.     PRODUCT WARRANTIES

Included in accounts  payable and accrued  liabilities  are  estimated  expenses
related  to  warranties  made at the  time  products  are sold or  services  are
rendered.  These accruals are established  using  historical  information on the
nature,  frequency,  and average cost of warranty  claims.  The Company warrants
numerous  products,  the terms of which vary  widely.  In  general,  the Company
warrants its products against defect and specific  non-performance.  The changes
in the product  warranty  liability  are displayed in the  following  table,  in
thousands:

  Beginning balance at January 1, 2006               $ 388
  Plus:  accruals for product warranties               296
  Less:  warranty charges/claims                      (162)
                                                     ------
  Ending balance at June 30, 2006                    $ 522
                                                     ======


                                       14
<PAGE>


10.    OPERATING SEGMENT INFORMATION

The following is the operating  segment  information  for the three months ended
June 30, 2006 and 2005, in thousands:
<TABLE>
<CAPTION>

                                              Revenues                    Pre-tax income (loss)
                                       ----------------------             ---------------------
                                         2006          2005                2006         2005
                                       --------      --------            --------     ---------
           <S>                            <C>           <C>                 <C>           <C>
Institutional Security Systems         $ 13,220      $ 11,728            $  (386)     $   (532)
Attack Protection                        11,333         6,065              1,548          (840)
Integrated Electronic Systems             2,983         1,888                161            16
Public Safety and Justice                10,858        11,423               (529)          400
CompuDyne Corporate                           -             -               (482)       (1,683)
                                       --------      --------            --------     ---------
                                       $ 38,394      $ 31,104            $   312      $ (2,639)
                                       ========      ========            ========     =========
</TABLE>

The following is the operating segment information for the six months ended June
30, 2006 and 2005, in thousands:
<TABLE>
<CAPTION>

                                              Revenues                    Pre-tax income (loss)
                                       ----------------------             ---------------------
                                         2006          2005                2006         2005
                                       --------      --------            --------     ---------
            <S>                           <C>           <C>                 <C>           <C>
Institutional Security Systems         $ 26,575      $ 27,460            $  (250)       $  698
Attack Protection                        23,017        12,963              2,753          (341)
Integrated Electronic Systems             6,570         3,907                345             8
Public Safety and Justice                22,702        23,080               (522)          (82)
CompuDyne Corporate                           -             -             (1,391)       (3,241)
                                       --------      --------            --------      --------
                                       $ 78,864      $ 67,410            $   935       $(2,958)
                                       ========      ========            ========      ========
</TABLE>


11.      CONTINGENCIES

Legal  Matters.  The Company is party to certain legal actions and inquiries for
environmental  and other matters  resulting  from the normal course of business.
Some of the  businesses,  especially  Institutional  Security  Systems,  involve
working as a subcontractor to a prime contractor.  From time to time the Company
makes claims against the prime contractor,  or the prime contractor makes claims
against the Company.  At any point in time the Company is engaged in a number of
claim  disputes  with prime  contractors,  some of which may have a  significant
negative outcome.  Although the total amount of potential liability with respect
to  these  matters  can not be  ascertained  given  the  nature  of the  related
allegations,  the Company presently  believes that any resulting  liability will
not  have a  material  effect  on its  financial  position,  results  of  future
operations or cash flows.

In addition to claims with prime  contractors,  the Company may also make claims
against customers and customers may make claims against the Company.

The Company has learned  that the National  Association  of  Securities  Dealers
("NASD") and other regulatory bodies are seeking sanctions against purchasers of
the  Company's  common  stock in its 2001 PIPE  transaction.  In  addition,  the
Company has learned that the placement agent for this  transaction is also being
investigated  by the SEC,  NASD and other  regulatory  bodies.  The  Company  is
investigating  these matters,  has filed lawsuits against certain purchasers and
is evaluating its other options for recovery.

The Company  has been named in  lawsuits  involving  asbestos  related  personal
injury and death claims in which CompuDyne  Corporation,  individually and as an
alleged successor, is a defendant.  The Company has been named as a defendant in
cases  related  to  claims  for  asbestos  exposure  allegedly  due to  asbestos
contained in certain of its predecessor's  products. The Company has advised its
insurers  of each of these  cases,  and the  insurers  are  providing  a defense
pursuant to agreement with the Company,  subject to reservation of rights by the
insurers.  The insurers have advised that claims in such litigation for punitive
damages,  exemplary  damages,  malicious  and  willful and wanton  behavior  and
intentional  conduct are not covered.  One of the carriers has given notice that
asbestos  related  claims  are  excluded  from  certain of these  policies.  The
insurers have additional coverage defenses,  which are reserved,  including that
claims may fall outside of a particular  policy  period of coverage.  Litigation
costs  to date  have  not  been  significant  and the  Company  has not paid any
settlements from its own funds.

The Company  cannot  ascertain  the total  amount of  potential  liability  with
respect to these legal  matters,  but does not believe  that any such  potential
liability  should  have a  material  effect on its  financial  position,  future
operations or future cash flows.

The Company,  as a government  contractor,  is from time to time subject to U.S.
Government  investigations  relating to its operations.  Government  contractors
that are found to have  violated  the  False  Claims  Act,  or are  indicted  or
convicted for  violations of other  federal  laws, or are  considered  not to be
responsible   contractors,   may  be  suspended  or  debarred  from   government
contracting  for some  period of time.  Such  convictions  could also  result in
fines.  Suspension  or  debarment  could have a material  adverse  effect on the
Company. No such violations or conditions of debarment exist at this time.


                                       15
<PAGE>


12.      SUBSEQUENT EVENT - ACQUISITION OF THE ASSETS OF SIGNAMI, LLC

During  July 2006,  the  Company  acquired  substantially  all of the assets and
certain liabilities of Signami, LLC, a producer of software and hardware systems
for signals intelligence gathering.


                                       16
<PAGE>



                 ITEM 2. COMPUDYNE CORPORATION AND SUBSIDIARIES
                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

Overview of CompuDyne Corporation

CompuDyne  Corporation was  reincorporated in Nevada in 1996. We were originally
incorporated in 1952. We believe that we are a leading  provider of products and
services to the public security markets.  We operate in four distinct  segments:
Institutional  Security Systems ("ISS");  Attack Protection  ("AP");  Integrated
Electronic Systems ("IES"); and Public Safety and Justice ("PS&J").

The  Institutional  Security  Systems  segment is  headquartered  in Montgomery,
Alabama and operates under the trade name Norment  Security  Group  ("Norment").
This segment provides physical and electronic  security products and services to
the corrections  industry  (prisons and jails) and to the courthouse,  municipal
and commercial markets. ISS typically serves as a subcontractor, responsible for
their portion of the installation work on larger projects. Installations involve
hard-line   (steel  security  doors,   frames,   locking   devices,   etc.)  and
sophisticated  electronic  security systems,  including  software,  electronics,
touch-screens,  closed  circuit TV,  perimeter  alarm devices and other security
monitoring controls.  ISS also developed a product called MaxWall.  MaxWall is a
modular  steel,   concrete  filled   prefabricated  jail  cell.  It  allows  for
construction  projects to use  considerably  less space and can save the project
owner   significant   amounts  of  money.   ISS  provides  field  level  design,
installation and maintenance of both physical and electronic security products.

Included in the  Institutional  Security  Systems  segment is the TrenTech  line
which  manufactures  and  integrates   electronic  security  systems.   TrenTech
integrates  generally  available products and software as well as developing its
own  proprietary  systems.  TrenTech has developed a  sophisticated  proprietary
video badging system,  with  approximately 250 systems installed at more than 70
facilities, most of which are military installations.

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

The Attack Protection  segment is one of the country's largest  manufacturers of
bullet,  blast and attack resistant windows and doors designed for high security
applications such as embassies, courthouses, Federal buildings, banks, corporate
headquarters  and other  facilities  that insist on having the highest  level of
protection  currently  available.  We believe that we are a premier  provider of
Underwriters  Laboratory  ballistic standard UL-752 Level 8 security windows and
doors,  the highest rating level of commercial  ballistic  security  windows and
doors.  Our attack  resistant  windows and doors are integrated and structurally
secure  products with  specifically  designed  frames and  encasements  that are
integral  parts of the structure in which they are installed.  Existing  product
installations  number in the  thousands  and range from the  Middle  East to the
White House. AP is a significant  supplier of bullet and blast resistant windows
and doors to United  States  embassies  throughout  the world.  AP usually works
under contracts from prime contractors who have direct contracts with the United
States  Department of State,  the segment's  largest client.  Attack  Protection
products  are also sold to drug stores and  convenience  stores to secure  drive
through  facilities.   Other  commercial   applications  include  guard  booths,
tollbooths,  cash drawers and other similar  items.  Additionally,  this segment
designs and installs both fixed and pop-up  bollards and wedge barrier  security
systems.

The Attack  Protection  segment also  manufactures a  sophisticated  fiber optic
sensor system,  known as Fiber SenSys, used to detect physical  intrusion.  This
application is designed to protect large perimeters  including such applications
as Federal  facilities,  military  deployments  and bases,  oil fields,  airport
tarmacs,  public utilities,  nuclear reactors and water systems. In addition, it
has been  installed  to protect  the  perimeters  of private  estates  and other
similar properties.

The  Integrated  Electronic  Systems  segment  consists of  CompuDyne-Integrated
Electronics Division, LLC. Its customer base includes the military, governmental
agencies,  and state and local  governmental  units. IES provides turnkey system
integration of public security and safety systems. This segment specializes in a
wide range of  customized  access  control  and  badging,  intrusion  detection,
surveillance and assessment,  communications, command and control, fire and life
safety,  and asset tracking systems.  IES provides central station oversight and
control of multiple and separate  facilities as well as security and public life
safety  systems and  equipment.  This  segment  also  designs  and  manufactures
advanced digital signal  processing  products used in  reconnaissance of foreign
telecommunications  signals  designed for the United States  Government  and its
foreign  allies.  In July 2006,  the  Company  acquired  the assets and  certain
liabilities  of Signami,  LLC, a producer of software and  hardware  systems for
signals intelligence gathering.


                                       17
<PAGE>


The Public  Safety and Justice  segment  consists of  CompuDyne-Public  Safety &
Justice,  Inc. (formerly Tiburon,  Inc.),  CorrLogic,  LLC, Xanalys  Corporation
("Xanalys"),  and the acquired  assets of 90 Degrees,  Inc.  ("90  Degrees") and
Copperfire Software Solutions, Inc. ("Copperfire").  PS&J's software systems are
used in a wide  range of  applications  within the  public  safety and  criminal
justice  sectors of governmental  units,  including  police,  fire and emergency
medical  services  computer-aided  dispatch  systems,  and police,  fire,  jail,
prosecution,   probation,  court  records  and  institutional  medical  software
management  systems.  We also specialize in the development,  implementation and
support of complex,  integrated  inmate management  software systems,  including
inmate  medical  management  systems that improve the efficiency and accuracy of
correctional facility operations.

During the second half of 2004,  we expanded our  offerings in the Public Safety
and Justice  segment by acquiring  the assets of 90 Degrees and  Copperfire.  90
Degrees  provides a  web-based  fire  records  management  system.  90  Degrees'
enterprise-wide  records management  solutions assist fire and Emergency Medical
Service agencies in managing  responses to emergency  situations.  We anticipate
that 90 Degrees' open web-based  technology  product  offerings will advance our
current fire and rescue product offerings. Copperfire provides customized report
writing and forms generation  software  designed  specifically for public safety
and justice  agencies.  The  software  automates  an agency's  current  business
practices,  turning hard copy forms into digital  images,  to create a paperless
report writing  system.  Xanalys was acquired  during the third quarter of 2005.
Xanalys provides a suite of investigative management and analysis solutions that
enable investigators to collect, analyze and share information to solve cases.

Cautionary Statement Regarding Forward-Looking Information
----------------------------------------------------------

Certain  statements  made  in  this  Form  10-Q  with  regard  to the  Company's
expectations as to future revenues,  expenses,  financial  position and industry
conditions, the Company's ability to secure new contracts, the ability to secure
payment and performance bonds, its goals for future  operations,  implementation
of  business  strategy  and  other  future  events  constitute  "forward-looking
statements" within the meaning of the federal securities laws. When used in this
Form 10-Q, words such as "anticipate," "believe," "estimate," "expect," "intend"
and  similar  expressions  identify  forward-looking  statements.  Although  the
Company makes such  statements  based on current  information and assumptions it
believes to be  reasonable,  there can be no assurance  that actual results will
not differ  materially from those  expressed or implied by such  forward-looking
statements.  Actual results could differ  materially from those  contemplated by
the  forward-looking  statements  as a  result  of  certain  important  factors,
including but not limited to, capital  spending  patterns of the security market
and the demand for the  Company's  products,  competitive  factors  and  pricing
pressures,  changes in legislation,  regulatory requirements,  government budget
problems,  the Company's ability to secure new contracts,  the ability to remain
in  compliance  with  its  bank  covenants,  delays  in  government  procurement
processes,  inability to obtain bid, payment and performance bonds on various of
the Company's  projects,  technological  change or difficulties,  the ability to
refinance debt when it becomes due, product development risks, commercialization
difficulties,  adverse results in litigation,  the level of product returns, the
amount  of  remedial  work  needed to be  performed,  costs of  compliance  with
Sarbanes-Oxley  requirements  and the impact of the  failure to comply with such
requirements,  risks associated with internal control  weaknesses  identified in
complying with Section 404 of  Sarbanes-Oxley,  the Company's ability to realize
anticipated  cost savings,  the Company's  ability to simplify its structure and
modify its strategic objectives, and general economic conditions. Risks inherent
in the Company's  business and with respect to future  uncertainties are further
described in our other filings with the Securities and Exchange Commission.

Management Outlook

We continue to find  ourselves in very  challenging  times.  We have three major
areas of focus:

o        The first is increasing the amount of our backlog.
o        The second is migrating to a business model with a more predictable
         revenue stream.
o        The third is to improve our cost structure (including evaluating our
         strategy to determine if we would benefit from focusing on fewer
         segments), quality, and customer and employee satisfaction.

Our backlog is a key indicator of what our future  revenues will look like.  Our
backlog  peaked at December 31, 2002,  at which time it exceeded  $204  million.
Backlog  was  approximately  $111.5  million at June 30,  2006,  as shown in the
following table:


                                       18
<PAGE>

<TABLE>
<CAPTION>

                                 Institutional                      Integrated          Public
                                   Security          Attack         Electronic        Safety and        Backlog
          (in thousands)           Systems         Protection         Systems           Justice           Total
                                 -------------------------------------------------------------------------------

       <S>                          <C>               <C>              <C>               <C>               <C>
December 31, 2002                $ 99,527          $ 18,478         $ 11,440          $ 74,867          $204,312
December 31, 2003                $ 57,258          $ 10,043         $  8,326          $ 63,727          $139,354
December 31, 2004                $ 49,324          $ 20,803         $  8,299          $ 48,434          $126,860
March 31, 2005                   $ 42,700          $ 20,139         $  8,395          $ 44,488          $115,722
June 30, 2005                    $ 56,492          $ 19,466         $  9,105          $ 46,045          $131,108
September 30, 2005               $ 52,557          $ 16,210         $  8,146          $ 58,270          $135,183
December 31, 2005                $ 58,128          $ 28,802         $  7,503          $ 53,705          $148,138
March 31, 2006                   $ 57,030          $ 20,961         $  6,590          $ 43,874          $128,455
June 30, 2006                    $ 51,173          $ 13,593         $  7,393          $ 39,351          $111,510
</TABLE>

The  decline in backlog  during the first half of 2006 could lead to a potential
decline in future quarterly revenues.

Historically,  approximately  93% of our revenues  were  generated  from sources
where the ultimate client is a federal,  state or local government unit.  During
the last few  years,  due to the  general  economic  slowdown,  state  and local
budgets, which we are dependent on for approximately 69% of our revenue sources,
have  come  under  intense  pressure.  Most  states  were  running  in a deficit
situation, as were many local governments. This caused many of them to delay and
in some cases cancel  certain  infrastructure  projects until such time as their
economic  fortunes rebound.  In recent months,  tax revenues have been improving
resulting  in  increased  activity  preparatory  to the  issuance  of  bids  and
ultimately  the awarding of new  projects.  In addition,  we have  increased our
sales and  marketing  efforts  with a specific  objective  of  marketing  to the
commercial  sector  which  inherently   offers  faster  project   implementation
schedules.

Our second area of focus is the  reengineering  of our business model so that it
contains  a  greater  percentage  of  recurring  revenue.  As  indicated  in the
following table,  approximately 14.4% of our revenue during the first six months
of 2006 was generated  from recurring  revenue  sources  (primarily  maintenance
revenues),  and the majority of these revenues occurred in our Public Safety and
Justice  segment.  We define  one-time  revenue as revenue derived from discrete
projects,  from which we do not expect to generate  incremental revenue upon the
completion  of the project.  We define  recurring  revenue as sources of revenue
from which we  anticipate  receiving  revenue in the current,  as well as future
periods, for example annual renewable maintenance contracts.
<TABLE>
<CAPTION>

                                                                       Six Months Ended June 30, 2006
                                                   --------------------------------------------------------------------
          (in thousands)                           One-time Revenue       %          Recurring Revenue         %       Total
                                                   ----------------      ----        -----------------       ----      --------
            <S>                                          <C>             <C>                <C>               <C>        <C>
Institutional Security Systems                     $         24,195      30.7        $           2,380        3.0      $ 26,575
Attack Protection                                            23,017      29.2                        -          -        23,017
Integrated Electronic Systems                                 6,570       8.3                        -          -         6,570
Public Safety and Justice                                    13,765      17.4                    8,937       11.4        22,702
                                                   ----------------      ----        -----------------       ----      ---------
     Total                                         $         67,547      85.6        $          11,317       14.4      $ 78,864
                                                   ================      ====        =================       ====      =========
</TABLE>


Since the majority of our revenues are one-time revenues and are  non-recurring,
we must reinvent our book of business on a continual  basis.  This makes it very
difficult  for us to project  our future  revenue  stream and thus makes it very
difficult for us to project our earnings as well as our business  outlook.  Over
the next five  years,  we hope to modify  our  business  model to rely less upon
one-time sources of revenue and more on recurring sources of revenue.

Our third focus area is to improve our cost structure,  quality,  and client and
employee satisfaction.  Our Institutional Security Systems and Attack Protection
business  segments  are  undergoing   significant   organizational  and  expense
restructuring,  including a partial consolidation of regional office efforts and
an increased focus on centralized  performance of the most complicated  security
projects. This initiative began by ensuring our organization is properly aligned
with our  clients'  needs.  Many  changes  have  been made and  initial  results
indicate  that  our  cost,  our  quality,  our  clients  and our  employees  are
responding  favorably to the changes implemented thus far. We have much room for
improvement  as  we  move  toward  a  more  client-oriented  organization.   The
organization  re-alignment is critical to strengthening  our future as it allows
us to deploy the Six Sigma and Lean Manufacturing  methodologies  across all our
business segments more efficiently.  The Six Sigma methodology focuses on defect
elimination,  which will have a direct impact on our cost,  quality,  and client
satisfaction.  Lean  Manufacturing  also  focuses  on  reduction  of  costs  and
elimination of waste. In addition,  in light of the escalating selling,  general
and  administrative  costs  associated  with the current  heightened  regulatory
environment, we are evaluating our structure and strategy to determine if a less
decentralized,  or other organizational structure would result in lower selling,
general and administrative costs and we are evaluating our strategy to determine
if we would benefit from focusing on fewer segments.


                                       19
<PAGE>


We believe that if we address and implement  successfully  the above three areas
of focus, we will significantly enhance our future growth opportunities and will
provide for more predictable financial results.

On May 2, 2005, we filed a Form 8-K disclosing that the we failed to timely file
an amendment to our Annual  Report on Form 10-K for the year ended  December 31,
2004 to provide management's report on internal control over financial reporting
as of December  31, 2004 and the related  report of our  independent  registered
public  accounting  firm on  management's  assessment  of the  effectiveness  of
internal control over financial reporting (together,  the "404 Report") required
by Section 404 of the Sarbanes-Oxley Act of 2002.

On May 4, 2005, we received a notice from the Listing Qualifications  Department
of The Nasdaq  Stock  Market  stating that due to our failure to timely file the
404 Report, we were no longer in compliance with the requirements of Marketplace
Rule 4310(c)(14). The Rule requires us to file with Nasdaq copies of all reports
required to be filed with the  Securities  and Exchange  Commission on or before
the date they are required to be filed with the SEC.

On June 27, 2005,  the Company filed its Form 10-K/A with the SEC containing the
404 Report.  On June 30, 2005, the Nasdaq Listing  Qualifications  Panel advised
CompuDyne  that  CompuDyne had remedied its filing  delinquency  and was in full
compliance with Nasdaq Market Place Rules.

On December 21, 2005 the Securities and Exchange  Commission  issued Release No.
33-8644 "Revisions to Accelerated Filer Definition and Accelerated Deadlines For
Filing Periodic Reports" (the "Release").  The Release revised the definition of
"accelerated filer" to make it simpler for accelerated filers whose public float
falls below the $50 million threshold on the measurement date of June 30 to exit
accelerated  filer status.  Under the new rules,  an accelerated  filer that has
voting and non-voting  equity held by non-affiliates of less than $50 million at
the end of its second  fiscal  quarter is  permitted to exit  accelerated  filer
status at the end of that year and to file its  annual  report for that year and
subsequent periodic reports on a non-accelerated basis. Accelerated filer status
affects an issuer's  deadlines for filing its periodic  reports with the SEC and
complying  with the  requirements  of Section 404 of the  Sarbanes-Oxley  Act of
2002. A  non-accelerated  filer must begin to comply with the  internal  control
over financial  reporting  requirements  including the  attestation  report of a
registered  public  accounting firm for its first fiscal year ending on or after
July 15, 2007.

The aggregate worldwide market value of CompuDyne  Corporation's  equity held by
non-affiliates as of June 30, 2005, the last business day of CompuDyne's  second
fiscal quarter, was less than $50 million. As a result, as of December 31, 2005,
CompuDyne exited accelerated filer status.

Prior to the issuance of the Release CompuDyne was classified as an "accelerated
filer" and was  required to comply with the  requirements  of Section 404 of the
Sarbanes-Oxley  Act  of  2002.  In  light  of  the  Release,   CompuDyne,  as  a
non-accelerated  filer as of December 31, 2005,  was not required to comply with
Section 404 for the year ended December 31, 2005. The Company's worldwide market
value  held by  non-affiliates  on June 30,  2006 was less than $50  million  so
CompuDyne will also not be classified as an accelerated filer for the year ended
December 31, 2006.

Results of Operations

THREE MONTHS ENDED JUNE 30, 2006 and 2005

Revenues.  The Company had revenues of $38.4  million and $31.1  million for the
three months ended June 30, 2006 and June 30, 2005,  respectively,  representing
an increase of $7.3 million or 23.4%. As discussed below, the increase  occurred
primarily due to higher revenues in our ISS, IES and AP segments, offset in part
by a decrease in revenues from our PS&J segment.

Revenues from the Institutional  Security Systems segment were $13.2 million for
the three  months ended June 30, 2006,  an increase  from $11.7  million for the
three  months  ended June 30, 2005  representing  an increase of $1.5 million or
12.7%.  The  Institutional  Security  Systems  segment is largely a construction
driven business.  Much of its revenue is obtained by working on new and retrofit
construction  projects  in the  corrections  industry,  as opposed to sources of
recurring revenue.  As such, the increase in revenue experienced by this segment
is  largely  attributable  to our  working on more  projects  than we did in the
previous year.  Backlog was $51.2 million and $56.5 million at June 30, 2006 and
June 30, 2005,  respectively.  The years 2003 and 2004 were slow bidding periods
for the  Company.  Although  the gross  amount of  construction  spending in the
corrections  area remained  relatively  flat between 2003 and 2004, the types of
projects  that the  Company  solicits,  namely  large-scale  medium  to  maximum
security installations,  declined significantly in 2003 and 2004. This situation
was  further  compounded  by the  general  state and local  governmental  budget
deficits  which  caused  these  governmental  units to rethink and delay many of
their pending corrections projects.  Since 2005, ISS has seen heightened bidding
activity,  particularly in the market space it serves, namely large-scale medium
to maximum security prisons.


                                       20
<PAGE>


Revenues  from the Attack  Protection  segment were $11.3  million for the three
months ended June 30, 2006, an increase from $6.1 million for the same period of
2005  representing  an  increase of $5.3  million or 86.9%.  In 2002 the Company
purchased  an  existing  75,000  square foot  factory for the Attack  Protection
segment  on 20 acres of land in  close  proximity  to its  existing  factory  in
Montgomery,  Alabama. This capacity increase was largely driven by the Company's
expectation that the demands for its products,  principally its bullet and blast
resistant windows and doors would accelerate significantly in the post September
11, 2001 world.  Throughout 2002,  2003, and 2004 this  anticipated  increase in
demand did not materialize leaving the segment with significant excess capacity.
This segment is composed of two chief product offerings, namely Norshield, which
encompasses bullet and blast resistant windows and doors and ancillary products,
and Fiber SenSys, which encompasses fiber optic intrusion detection systems. For
the three months ended June 30, 2006 the  Norshield  line  experienced  a 121.6%
increase  in  revenues as  compared  to the three  months  ended June 30,  2005,
whereas the Fiber SenSys line  experienced a 18.9%  decrease in revenues for the
comparable period. The increase in revenue of $5.6 million in the Norshield line
is a direct result of the  execution on an award of a major  contract won in the
fourth quarter of 2005. Execution on this contract began immediately upon award.
Fiber SenSys'  revenue decline is a result of the rollout of its next generation
product, which until its testing was completed and accepted, which did not occur
until the end of the  second  quarter  of 2006,  negatively  impacted  revenues.
During  2003,  the Company  furnished  bids to supply its products for eight new
embassy  projects.  At the time, this was the largest number of embassy projects
bid in a single calendar year for this segment.  The Company was awarded four of
these embassy  projects,  for a total CompuDyne  contract value of $7.0 million,
and lost the remaining four embassy project bids to competitors. During 2004, we
bid on fifteen new  embassy  projects.  The  Company was awarded  seven of these
embassy  projects for a total  contract  value of $9.9  million,  and lost eight
embassy  project  bids to  competitors.  In 2005,  we bid on  seventeen  embassy
projects.  The Company was awarded five of these projects,  for a total of $20.4
million,  and lost four  projects  and one bulk bid embassy  project  comprising
eight embassies to competitors.  In 2006, sixteen embassy projects were planned,
none of which have been awarded yet. We believe that this increased level of new
embassy construction will continue for the next several years.

Revenues  from  Integrated  Electronic  Systems  were $3.0 million for the three
months ended June 30, 2006, an increase from $1.9 million for the same period of
2005  representing an increase of $1.1 million or 58.0%.  The first half of 2005
was a difficult  time for IES,  with a downturn in  revenues  and gross  profit,
ensuing  from:  a delay  in a  large-scale  installation  contract  pending  the
government's  completion  of the  building  to house the  system's  Command  and
Control  Center;  a reduction in an ongoing  governmental  integration  program,
resulting from the  Department of Defense's  base  relocation and closure (BRAC)
program;  delays  in  several  significant  awards,  because  funding  had  been
redirected  to the war  efforts  in Iraq  and  Afghanistan;  and a delay  in the
start-up of a 5-year, $25 million security contract with the Bureau of Engraving
& Printing ("BEP"), due to an award protest by the predecessor  contractor.  IES
is currently performing work under the BEP contract although the protest remains
unresolved.  During the second quarter of 2006 IES saw its revenues  return to a
more normal level.

Revenues from the Public  Safety and Justice  segment were $10.9 million for the
three months ended June 30,  2006,  a decrease  from $11.4  million for the same
period of 2005  representing  a decrease of $0.6 million or 4.9%.  PS&J has been
experiencing  lower  backlogs and has increased its focus on developing its next
generation  products.  Beginning  in the fourth  quarter of 2005 and  continuing
through the second quarter of 2006,  PS&J  redeployed a portion of its technical
staff,  typically  deployed in the research  and  development  area,  to work on
projects.  It should be noted that although we made three  acquisitions  in this
segment,  two in  2004  (90  Degrees  and  Copperfire)  and one in  August  2005
(Xanalys),  these  acquisitions had little impact on Public Safety and Justice's
revenues due to their relatively small size.

Expenses.  Cost of sales of $26.3  million for the three  months  ended June 30,
2006 were up $5.6 million or 27.0% from $20.7 million  during the same period of
2005.  The smaller  percentage  increase in sales as compared to the  percentage
increase in cost of goods sold resulted in a decreased  gross profit  percentage
of 31.6% for the three  months  ended June 30, 2006 as compared to 33.5% for the
three months ended June 30, 2005.

Cost of  goods  sold in the  Institutional  Security  Systems  segment  of $11.4
million for the three  months  ended June 30, 2006 were up $1.2 million or 12.0%
from $10.1 million  during the same period of 2005.  This increase was less than
the  related  sales  increase  of this  segment of 12.7 %,  resulting  in a 0.5%
increase in the gross profit percentage to 14.0% from 13.5% for the three months
ended June 30, 2005. In 2002  Institutional  Security Systems' senior management
determined  that the costs to complete  certain of its West Coast  projects were
going to be significantly higher than was previously projected. This resulted in
significant cost overruns on many of these projects. As the work on the projects
progressed,  the Institutional  Security Systems segment  identified  additional


                                       21
<PAGE>



cost  overruns  which caused the costs to complete  these  projects to increase.
Although the projects  identified in 2002 are  substantially  all complete,  the
problems in the ISS West Coast  operations  continued into 2003, 2004, and 2005.
The West Coast  office  continues  to be  affected by one final  contract  which
requires ISS to install a  proprietary  duress  system which has been  validated
through an independent  consultant and the  manufacturer  of the equipment,  but
will not function as required by the contract  specifications.  ISS has incurred
significant costs trying to make the equipment function as desired. The customer
is  working  with ISS to  develop  a level of  acceptance,  and both ISS and the
customer  are  cooperating  to close out the project in an amicable  manner.  We
believe that all future costs on these projects to the extent ascertainable have
been  adequately  accounted for through June 30, 2006. The West Coast office has
been  downsized to a sales and support  office,  consolidating  the  estimating,
electronics   engineering  and  electronics   fabrication   functions  into  the
Montgomery home office. The West Coast office realized positive gross margins on
its projects in 2005 and 2006.  Despite these positive  gross margins,  the West
Coast office  experienced  high legal and overhead costs closing out many of the
old  projects.  While  this  resulted  in an  overall  loss  at the  West  Coast
operation, the office was also able to significantly reduce aged receivables and
filed multiple claims for possible future upside recovery.


The West Coast  project  overruns  resulted  in pre-tax  losses  recorded in the
following periods, in thousands:

                Second Half of 2002                                    $  2,698
                Full Year 2003                                            4,087
                Full Year 2004                                            6,092
                First Quarter of 2005                                       740
                Second Quarter of 2005                                      472
                Third Quarter of 2005                                       399
                Fourth Quarter of 2005                                      417
                First Quarter of 2006                                        30
                Second Quarter of 2006                                      254
                                                                       ---------
                        Total                                          $ 15,189
                                                                       =========

To address this situation, the Company has implemented more centralized controls
and has reorganized the function of the West Coast office.

Cost of goods sold in the Attack  Protection  segment  of $7.5  million  for the
three  months  ended June 30,  2006  increased  $2.8  million or 59.5% from $4.7
million during the same period of 2005. This increase was less than the relative
sales increase,  resulting in a 11.3% increase in the gross profit percentage to
34.1% from 22.8%  during the three months  ended June 30,  2005.  The  principal
reason for the increase in the gross profit percentage during the second quarter
of 2006 as compared to the second  quarter of 2005 was  significantly  increased
utilization  of our  Norshield  factories.  The  increase in gross profit due to
utilization  was offset in part by a decrease in gross  margin due to the mix of
products sold.  The bullet and blast  resistant  windows and doors  component of
this segment  experienced  significant  growth  while the fiber optic  component
experienced a revenue decline. The windows and doors component of the segment is
a lower margin business than is the high margin fiber optic business.

Cost of goods sold in the Integrated  Electronic Systems segment of $2.5 million
for the three  months ended June 30, 2006  increased  $0.9 million or 60.8% from
$1.5 million during the same period of 2005.  This increase was consistent  with
the  related  sales  increase  of this  segment  of 58.0%,  resulting  in a 1.4%
decrease in the gross profit  percentage to 16.6% from 18.0% in the three months
ended June 30, 2005.  Substantially  all of the projects awarded in this segment
are discrete projects.

Cost of goods sold in the Public Safety and Justice  segment of $4.9 million for
the three  months  ended  June 30,  2006 was up $0.6  million or 14.7% from $4.3
million  during 2005.  This increase  coupled with the related sales decrease of
this  segment  of  4.9%,  resulting  in a  7.8%  decrease  in the  gross  profit
percentage to 54.6% from 62.4% in the period ended June 30, 2005.

Selling,  general and  administrative  expenses  were $9.3 million for the three
months  ended  June 30,  2006,  a  decrease  of $0.9  million or 9.2% from $10.3
million  for the same  period  of 2005.  Much of this  decrease  is  related  to
additional  costs incurred by the Company during 2005 related to compliance with
Section 404 of the  Sarbanes-Oxley  Act ("SOX").  The Company exited accelerated
filer  status as of December  31, 2005 and is  currently  not required to comply
with Section 404 of SOX until December 31, 2007.

In conjunction  with the  acquisition of the assets of 90 Degrees and Copperfire
and  the  stock  of  Xanalys  and in  compliance  with  Statement  of  Financial
Accounting  Standards  No. 141 (SFAS 141)  Business  Combinations,  the  Company
determined the fair value of the following  identifiable assets and assigned the
indicated lives for the purposes of amortization and depreciation.


                                       22
<PAGE>


                                                  Amount              Life
                                              (in thousands)       (in years)
                                              --------------       ----------
     Software                                 $    2,434               5
     Non Compete Agreements                          130               3
     Tradename                                        60               15
                                              ----------
                                              $    2,624
                                              ==========

The  amortization  of  the  above  assets  resulted  in  the  Company  recording
amortization  expense related to these assets of $134 thousand and $134 thousand
for the  three  months  ended  June 30,  2006 and 2005,  respectively,  which is
included in operating expenses.

Research and  development  expenses were $1.9 million for the three months ended
June 30,  2006,  a decrease of $0.3  million or 13.7% from $2.2  million for the
same period of 2005.  This decrease was largely a result of reduced  engineering
labor costs. Being a technology-driven  enterprise,  the Company's Public Safety
and Justice  segment  continually  updates and enhances its software  offerings,
thus incurring  significant  research and development costs.  During 2005 Public
Safety and Justice started investing in its Next Generation products. During the
second  quarter of 2006 and 2005 this  segment  expended  $0.6  million and $0.5
million, respectively, for this project.

Interest  expense was $0.8  million for the three months ended June 30, 2006 and
June 30,  2005.  The  following  table  compares  the  weighted  average  of the
Company's three months ended June 30, 2006 and 2005 interest bearing borrowings,
in  thousands,  which  includes  bank letters of credit fees for the  industrial
revenue bonds, and the related rates charged thereon:
<TABLE>
<CAPTION>

                                                        Monthly Weighted                  Monthly Weighted
                                                         Average - 2006                    Average - 2005
                                                        Amount      Rate                  Amount       Rate
                                                        ------      ----                  ------       ----
               <S>                                         <C>       <C>                     <C>        <C>
      Industrial revenue bonds                         $   3,265     6.8%                 $ 3,705       3.8%
      Subordinated borrowings                          $  40,250     6.3%                 $40,250       6.3%
      Swap hedge agreement                             $       -       -                  $ 1,353       1.9%
</TABLE>


The Company also incurred letter of credit fees, in addition to those related to
the  industrial  revenue  bonds,  of $60  thousand and $3 thousand for the three
months ended June 30, 2006 and 2005, respectively.

In addition the Company recorded the following  non-cash  interest  expense,  in
thousands:
<TABLE>
<CAPTION>
                 <S>                                     <C>                                  <C>
      Amortization and write-off
        of deferred financing charges                   $     82                          $    67
</TABLE>


Taxes on Income. The effective tax rate was 2.5% for the three months ended June
30, 2006 and the  effective tax rate was zero percent for the three months ended
June 30, 2005. The Company has decided to provide a valuation  allowance against
its deferred tax assets, as it has determined that due to the Company's 2004 and
2005 operating  losses there is uncertainty as to whether it is more likely than
not that the  assets  will be  realized.  The  Company  had net  operating  loss
carryforwards  for  financial  accounting  purposes of $8.9  million at June 30,
2006.

Net Income (Loss). The Company reported net income of $0.3 million for the three
months  ended June 30, 2006 and a net loss of $2.6  million for the three months
ended June 30,  2005.  Diluted  income per share was $0.04 for the three  months
ended  June 30,  2006 and a loss of $0.33 for the three  months  ended  June 30,
2005. The weighted  average number of common shares  outstanding and equivalents
used in  computing  earnings  per share was 8.2 million for both the three month
periods ended June 30, 2006 and 2005.

SIX MONTHS ENDED JUNE 30, 2006 and 2005

Revenues.  The Company had revenues of $78.9  million and $67.4  million for the
six months ended June 30, 2006 and June 30, 2005, respectively,  representing an
increase of $11.5 million or 17.0%. As discussed  below,  the increase  occurred
primarily due to higher revenues in our IES and AP segments, offset in part by a
decrease in revenues from our ISS and PS&J segments.

Revenues from the Institutional  Security Systems segment were $26.6 million for
the six months ended June 30, 2006,  a decrease  from $27.5  million for the six
months ended June 30, 2005  representing a decrease of $0.9 million or 3.2%. The
Institutional   Security  Systems  segment  is  largely  a  construction  driven


                                       23
<PAGE>


business.  Much of its  revenue  is  obtained  by  working  on new and  retrofit
construction  projects  in the  corrections  industry,  as opposed to sources of
recurring revenue.  As such, the decrease in revenue experienced by this segment
is largely  attributable  to our  working on fewer  projects  than we did in the
previous  year and the delay in the start of some  projects.  Backlog  was $51.2
million  and $56.5  million  at June 30,  2006 and June 30,  2005  respectively.
Several of ISS' recently won awards were delayed  and/or not yet available to be
worked on by us.  The years  2003 and 2004 were  slow  bidding  periods  for the
Company.  Although the gross amount of construction  spending in the corrections
area remained  relatively flat between 2003 and 2004, the types of projects that
the  Company   solicits,   namely   large-scale   medium  to  maximum   security
installations,  declined  significantly  in 2003 and 2004.  This  situation  was
further compounded by the general state and local  governmental  budget deficits
which caused these governmental units to rethink and delay many of their pending
corrections  projects.  Since 2005, ISS has seen  heightened  bidding  activity,
particularly in the market space it serves, namely large-scale medium to maximum
security prisons.

Revenues  from the Attack  Protection  segment  were $23.0  million  for the six
months ended June 30, 2006,  an increase  from $13.0 million for the same period
of 2005  representing an increase of $10.1 million or 77.6%. In 2002 the Company
purchased  an  existing  75,000  square foot  factory for the Attack  Protection
segment  on 20 acres of land in  close  proximity  to its  existing  factory  in
Montgomery,  Alabama. This capacity increase was largely driven by the Company's
expectation that the demands for its products,  principally its bullet and blast
resistant windows and doors would accelerate significantly in the post September
11, 2001 world.  Throughout 2002,  2003, and 2004 this  anticipated  increase in
demand did not materialize leaving the segment with significant excess capacity.
This segment is composed of two chief product offerings, namely Norshield, which
encompasses bullet and blast resistant windows and doors and ancillary products,
and Fiber SenSys, which encompasses fiber optic intrusion detection systems. For
the six months  ended June 30,  2006 the  Norshield  line  experienced  a 149.3%
increase in revenues as compared to the six months ended June 30, 2005,  whereas
the  Fiber  SenSys  line  experienced  a  55.6%  decrease  in  revenues  for the
comparable  period.  The increase in revenue of $12.6  million in the  Norshield
line is a direct result of the execution on an award of a major  contract won in
the fourth quarter of 2005.  Execution on this contract began  immediately  upon
award.  Fiber  SenSys'  revenue  decline is a result of the  rollout of its next
generation  product,  which until its testing was completed and accepted,  which
did not occur until the end of the second quarter of 2006,  negatively  impacted
revenues.  During 2003,  the Company  furnished  bids to supply its products for
eight new embassy projects.  At the time, this was the largest number of embassy
projects bid in a single calendar year for this segment. The Company was awarded
four of these embassy  projects,  for a total  CompuDyne  contract value of $7.0
million, and lost the remaining four embassy project bids to competitors. During
2004, we bid on fifteen new embassy  projects.  The Company was awarded seven of
these embassy  projects for a total  contract  value of $9.9  million,  and lost
eight embassy project bids to competitors.  In 2005, we bid on seventeen embassy
projects.  The Company was awarded five of these projects,  for a total of $20.4
million,  and lost four  projects  and one bulk bid embassy  project  comprising
eight embassies to competitors.  In 2006, sixteen embassy projects were planned,
none of which have been awarded yet. We believe that this increased level of new
embassy construction will continue for the next several years.

Revenues from Integrated Electronic Systems were $6.6 million for the six months
ended June 30, 2006,  an increase  from $3.9 million for the same period of 2005
representing  an increase of $2.7 million or 68.2%. The first half of 2005 was a
difficult  time for IES, with a downturn in revenues and gross  profit,  ensuing
from: a delay in a large-scale  installation  contract  pending the government's
completion of the building to house the system's  Command and Control Center;  a
reduction in an ongoing  governmental  integration  program,  resulting from the
Department of Defense's base  relocation and closure (BRAC)  program;  delays in
several  significant  awards,  because  funding had been  redirected  to the war
efforts in Iraq and  Afghanistan;  and a delay in the start-up of a 5-year,  $25
million security contract with the Bureau of Engraving & Printing  ("BEP"),  due
to an award protest by the predecessor  contractor.  IES is currently performing
work under the BEP contract although the protest remains unresolved.  During the
first half of 2006 IES saw its revenues return to a more normal level.

Revenues from the Public  Safety and Justice  segment were $22.7 million for the
six months  ended June 30,  2006,  a decrease  from $23.1  million  for the same
period of 2005  representing  a decrease of $0.4 million or 1.6%.  PS&J has been
experiencing  lower  backlogs and has increased its focus on developing its next
generation  products.  Beginning  in the fourth  quarter of 2005 and  continuing
through  the first half of 2006,  PS&J  redeployed  a portion  of its  technical
staff,  typically  deployed in the research  and  development  area,  to work on
projects.  It should be noted that although we made three  acquisitions  in this
segment,  two in  2004  (90  Degrees  and  Copperfire)  and one in  August  2005
(Xanalys),  these  acquisitions had little impact on Public Safety and Justice's
revenues due to their relatively small size.

Expenses.  Cost of sales of $54.2 million for the six months ended June 30, 2006
were up $9.6 million or 21.6% from $44.6 million during the same period of 2005.
The smaller percentage  increase in sales as compared to the percentage increase
in cost of goods sold resulted in a decreased  gross profit  percentage of 31.3%
for the six months  ended June 30,  2006 as compared to 33.8% for the six months
ended June 30, 2005.


                                       24
<PAGE>


Cost of  goods  sold in the  Institutional  Security  Systems  segment  of $22.5
million for the six months ended June 30, 2006 were up $0.2 million or 1.1% from
$22.3 million  during the same period of 2005.  This  increase  coupled with the
related sales decrease of this segment of 3.2%,  resulting in a 3.6% decrease in
the gross  profit  percentage  to 15.1% from 18.7% for the six months ended June
30, 2005.  The decrease in the gross  profit  percentage  is largely a result of
ISS' fixed costs now being  absorbed by a smaller  revenue base during the first
half of 2006.  In  addition,  during  the  first  quarter  of 2005,  one of this
segment's  customers  terminated its contract for convenience,  resulting in the
recognition  of $1.3 million in gross  margin.  In 2002  Institutional  Security
Systems' senior management  determined that the costs to complete certain of its
West Coast  projects were going to be  significantly  higher than was previously
projected. This resulted in significant cost overruns on many of these projects.
As the work on the  projects  progressed,  the  Institutional  Security  Systems
segment  identified  additional cost overruns which caused the costs to complete
these  projects  to  increase.  Although  the  projects  identified  in 2002 are
substantially  all  complete,  the  problems  in the ISS West  Coast  operations
continued  into 2003,  2004,  and 2005.  The West Coast  office  continues to be
affected  by one final  contract  which  requires  ISS to install a  proprietary
duress system which has been validated through an independent consultant and the
manufacturer of the equipment, but will not function as required by the contract
specifications.  ISS has incurred significant costs trying to make the equipment
function as  desired.  The  customer  is working  with ISS to develop a level of
acceptance,  and both ISS and the  customer  are  cooperating  to close  out the
project  in an  amicable  manner.  We  believe  that all  future  costs on these
projects  have been  adequately  accounted  for through June 30, 2006.  The West
Coast office has been downsized to a sales and support office, consolidating the
estimating,  electronics  engineering and electronics fabrication functions into
the  Montgomery  home office.  The West Coast  office  realized  positive  gross
margins on its projects in 2005 and 2006.  Despite these positive gross margins,
the West Coast office experienced high legal and overhead costs closing out many
of the old  projects.  While this  resulted in an overall loss at the West Coast
operation, the office was also able to significantly reduce aged receivables and
filed multiple claims for possible future upside recovery.

The West Coast  project  overruns  resulted  in pre-tax  losses  recorded in the
following periods, in thousands:

                Second Half of 2002                                    $  2,698
                Full Year 2003                                            4,087
                Full Year 2004                                            6,092
                First Quarter of 2005                                       740
                Second Quarter of 2005                                      472
                Third Quarter of 2005                                       399
                Fourth Quarter of 2005                                      417
                First Quarter of 2006                                        30
                Second Quarter of 2006                                      254
                                                                       ---------
                        Total                                          $ 15,189
                                                                       =========

To address this situation, the Company has implemented more centralized controls
and has reorganized the function of the West Coast office.

Cost of goods sold in the Attack Protection segment of $15.9 million for the six
months  ended June 30, 2006  increased  $6.7  million or 72.2% from $9.2 million
during the same period of 2005.  This increase was less than the relative  sales
increase,  resulting in a 2.2% increase in the gross profit  percentage to 31.1%
from 28.9% during the six months ended June 30, 2005.  The principal  reason for
the  increase in the gross  profit  percentage  during the first half of 2006 as
compared  to the first half of 2005 was a shift in product  mix.  The bullet and
blast  resistant  windows  and  doors  component  of  this  segment  experienced
significant  growth  while  the  fiber  optic  component  experienced  a revenue
decline.  The  windows  and doors  component  of the  segment is a lower  margin
business  than is the high margin fiber optic  business,  resulting in the small
overall margin  increase  during the first half of 2006 as compared to the first
half of 2005.  New senior  management  hired in January 2005 continues to reduce
manufacturing and overhead costs. In addition,  one of this segment's  customers
terminated  its  contracts  for  convenience  during  the first  quarter of 2005
resulting  in the  recognition  of $0.2  million in gross margin due to contract
closeout activities.

Cost of goods sold in the Integrated  Electronic Systems segment of $5.6 million
for the six months ended June 30, 2006 increased $2.3 million or 69.6% from $3.3
million during the same period of 2005.  This increase was  consistent  with the
related sales increase of this segment of 68.2%, resulting in a 0.7% decrease in
the gross profit percentage to 15.2% from 15.9% in the six months ended June 30,
2005.  Substantially  all of the  projects  awarded in this segment are discrete
projects.

Cost of goods sold in the Public Safety and Justice segment of $10.2 million for
the six months ended June 30, 2006 was up $0.4 million or 4.6% from $9.8 million
during  2005.  This  increase  coupled with the related  sales  decrease of this
segment of 1.6%,  resulting in a 2.7% decrease in the gross profit percentage to
54.9% from 57.6% in the period ended June 30, 2005.


                                       25
<PAGE>


Selling,  general and  administrative  expenses  were $19.1  million for the six
months  ended  June 30,  2006,  a  decrease  of $1.2  million or 6.1% from $20.3
million  for the same  period  of 2005.  Much of this  decrease  is  related  to
additional  costs incurred by the Company during 2005 related to compliance with
Section 404 of the  Sarbanes-Oxley  Act ("SOX").  The Company exited accelerated
filer  status as of December  31, 2005 and is  currently  not required to comply
with  Section 404 of SOX until  December 31, 2007.  In addition,  AP's  selling,
general and  administrative  expenses  increased by $0.6 million or 21.1% during
the six months  ended June 30, 2006 as compared to the six months ended June 30,
2005. This increase was largely the result of increased  legal costs  associated
with ongoing claims resolutions in actions both as plaintiff and defendant,  and
for increased  selling and training costs as the segment is trying to expand its
presence into new marketplaces.

In conjunction  with the  acquisition of the assets of 90 Degrees and Copperfire
and  the  stock  of  Xanalys  and in  compliance  with  Statement  of  Financial
Accounting  Standards  No. 141 (SFAS 141)  Business  Combinations,  the  Company
determined the fair value of the following  identifiable assets and assigned the
indicated lives for the purposes of amortization and depreciation.

                                                  Amount              Life
                                              (in thousands)       (in years)
                                              --------------       ----------
     Software                                    $ 2,434               5
     Non Compete Agreements                          130               3
     Tradename                                        60               15
                                                 -------
                                                 $ 2,624
                                                 =======

The  amortization  of  the  above  assets  resulted  in  the  Company  recording
amortization  expense related to these assets of $268 thousand and $268 thousand
for the six months ended June 30, 2006 and 2005, respectively, which is included
in operating expenses.

Research  and  development  expenses  were $3.7 million for the six months ended
June 30,  2006,  a decrease of $0.7  million or 15.0% from $4.4  million for the
same period of 2005.  This decrease was largely a result of reduced  engineering
labor costs. Being a technology-driven  enterprise,  the Company's Public Safety
and Justice  segment  continually  updates and enhances its software  offerings,
thus incurring  significant  research and development costs.  During 2005 Public
Safety and Justice started investing in its Next Generation products. During the
first half of 2006 and 2005 this segment expended $1.1 million and $0.8 million,
respectively, for this project.

Interest expense was $1.7 million and $1.6 million for the six months ended June
30, 2006 and June 30,  2005,  respectively.  The  following  table  compares the
weighted  average  of the  Company's  six months  ended  June 30,  2006 and 2005
interest bearing borrowings, in thousands, which includes bank letters of credit
fees for the industrial revenue bonds, and the related rates charged thereon:
<TABLE>
<CAPTION>

                                                        Monthly Weighted                  Monthly Weighted
                                                         Average - 2006                    Average - 2005
                                                        Amount      Rate                  Amount       Rate
                                                        ------      ----                  ------       ----
              <S>                                         <C>        <C>                    <C>         <C>
      Industrial revenue bonds                         $   3,415     6.2%                 $ 3,855       3.4%
      Subordinated borrowings                          $  40,250     6.3%                 $40,250       6.3%
      Swap hedge agreement                             $       -       -                  $ 1,691       2.1%
</TABLE>


The Company also incurred letter of credit fees, in addition to those related to
the industrial revenue bonds, of $102 thousand and $6 thousand for the six month
periods ended June 30, 2006 and 2005, respectively.

In addition the Company recorded the following  non-cash  interest  expense,  in
thousands:
<TABLE>
<CAPTION>
                <S>                                       <C>                              <C>
      Amortization and write-off
        of deferred financing charges                  $     164                          $   134
</TABLE>

Other  income  benefited  during the first  quarter  of 2006 by a $161  thousand
positive legal settlement by the Attack Protection segment.

Taxes on  Income.  The  effective  tax rate was a  benefit  of 18.9% for the six
months ended June 30, 2006 and the  effective  tax rate was zero percent for the
six months  ended June 30,  2005.  The tax benefit for the six months ended June
30, 2006 is primarily a result of $200 thousand previously recorded as a reserve
for uncertain tax positions which is no longer needed, partially offset by state
tax expenses.  The Company has decided to provide a valuation  allowance against
its deferred tax assets, as it has determined that due to the Company's 2004 and
2005 operating  losses there is uncertainty as to whether it is more likely than
not  the  assets  will  be  realized.   The  Company  had  net  operating   loss
carryforwards  for  financial  accounting  purposes of $8.9  million at June 30,
2006.


                                       26
<PAGE>


Net Income (Loss).  The Company  reported net income of $1.1 million for the six
months  ended June 30,  2006 and a net loss of $3.0  million  for the six months
ended June 30, 2005. Diluted income per share was $0.14 for the six months ended
June 30, 2006 and a loss of $0.36 for the six months  ended June 30,  2005.  The
weighted  average number of common shares  outstanding and  equivalents  used in
computing  earnings  per share was 8.2 million and 8.1 million for the six month
periods ended June 30, 2006 and 2005, respectively.

Liquidity and Capital Resources

The  Company  funds  its  operations  through  cash  flows  generated  from  its
operations,  bank and public  financings,  and the sale of its common stock. The
Company's  liquidity  requirements  arise  from  cash  necessary  to  carry  its
inventories and billed and unbilled receivables,  for capital  expenditures,  to
repurchase  shares of its common stock under its share repurchase  program,  for
payments  of  principal  and  interest  on  outstanding   indebtedness  and  for
acquisitions.  The ultimate clients of the Company are primarily federal,  state
and local  governmental  units.  In the event the funding of these  governmental
units is reduced for any reason,  including budgetary reductions due to economic
conditions, there is a risk that the demand for the Company's goods and services
would decrease which would reduce the availability of funds to the Company.

As of June 30, 2006, the Company had working  capital of $30.3 million  compared
with $35.3 million as of December 31, 2005.

Net cash provided by operating activities was $5.3 million during the six months
ended June 30, 2006 versus $4.6 million used in operating  activities during the
six months  ended June 30,  2005.  The  largest  component  of cash  provided by
operating  activities  was a decrease in accounts  receivable  of $9.1  million,
which was  partially  offset by a  decrease  in  accounts  payable  and  accrued
liabilities of $7.5 million.

Net cash used in investing  activities was $3.8 million for the six months ended
June 30, 2006  compared to net cash  provided of $4.9  million in the six months
ended  June  30,  2005.  In the six  months  ended  June  30,  2006,  the net of
marketable  securities  bought  and  redeemed  was a  decrease  of  cash of $2.6
million.  In the six months ended June 30, 2005 the net redemption of marketable
securities was $6.4 million.

Net cash used in  financing  activities  amounted  to $0.9  million  for the six
months ended June 30, 2006 compared  with net cash used in financing  activities
of $1.0 million in the six months ended June 30, 2005.

The following table summarizes contractual obligations consisting of total notes
payable and related interest of the Company as of June 30, 2006 and the payments
due by period, in thousands.

                                                          Interest on
                              Notes Payable              Notes Payable
                              -------------              -------------
December 31:
    2006 (remaining)          $      140                 $       1,323
    2007                             440                         2,633
    2008                             440                         2,615
    2009                             440                         2,597
    2010                             440                         2,578
Thereafter                        41,615                           950
                              ----------                 -------------
Totals                        $   43,515                 $      12,696
                              ==========                 =============

In addition,  the Company enters into purchase  obligations to procure equipment
and services,  including  subcontractor  contracts,  in the  performance  of the
day-to-day  operations of its business.  Substantially  all of these obligations
are covered by our existing backlog and the revenues generated by these backlogs
are expected to be sufficient  to meet any payment  obligations  resulting  from
these purchase commitments.

On January 22, 2004, the Company  completed the offering of the 2011 Notes.  The
offering was for $40.25 million principal  amount.  The 2011 Notes bear interest
at the rate of 6.25% per annum, payable semi-annually,  and are convertible into
shares of common stock at a conversion  price of $13.89 per share.  The proceeds
from the  2011  Notes  were  used to repay  substantially  all of the  Company's
outstanding bank borrowings.


                                       27
<PAGE>


On December 19, 2005, the Company and its bank entered into a Second Amended and
Restated  Revolving  Credit and Security  Agreement (the "Second Restated Credit
Agreement").  The Second  Restated  Credit  Agreement  amended and  restated the
Company's Amended and Restated Credit Agreement dated March 31, 2004.

In connection with the execution of the Second Restated  Credit  Agreement,  the
Company  provided  the bank  with  collateral  that  includes  all  receivables,
equipment, general intangibles, inventory, investment property, real property, a
security  interest  in  subsidiary  stock  and  cash and  marketable  securities
specifically  pledged to the bank. The Second Restated Credit  Agreement  allows
the  Company  to  obtain  revolving  advances  in a  principle  amount  of up to
$20,000,000.  Revolving  advances are limited by a borrowing  base formula based
upon the value of the  Company's  receivables,  inventory,  fixed  assets,  real
property,  cash and marketable securities  specifically pledged to the bank, and
issued and outstanding  letters of credit.  The maximum aggregate face amount of
letters of credit that may be drawn under the Second Restated  Credit  Agreement
is limited to  $18,000,000.  The Second  Restated  Credit  Agreement  matures on
December 18, 2008.

Revolving advances under the Second Restated Credit Agreement bear interest,  at
the  election of the Company,  at a variable  rate equal to the  alternate  base
rate, a prime interest based rate, or the Eurodollar  rate plus two and one half
percent.  For letters of credit, the Company pays an amount equal to the average
daily face amount of each outstanding letter of credit multiplied by two and one
half  percent  per annum,  and a fronting  fee of one quarter of one percent per
annum, together with other administrative fees and charges. The Company paid its
bank a closing fee of $50,000 in  connection  with the  execution  of the Second
Restated  Credit  Agreement.  The  Company is also  required  to pay the bank an
unused  fee equal to  three-eighths  of one  percent  per annum of the amount by
which  $20,000,000  exceeds the average  daily unpaid  balance of the  revolving
advances and undrawn amount of any outstanding  letters of credit.  In addition,
the Company is required to pay a collateral  monitoring  fee equal to $1,000 per
month and a collateral evaluation fee as required.

The Second Restated Credit Agreement  contains various  affirmative and negative
covenants including financial covenants.  The Company is required to maintain an
unrestricted  undrawn  borrowing  base  availability  of  at  least  $5,000,000.
Commencing  with the fiscal quarter ended June 30, 2006, the Company is required
to  maintain  a fixed  charge  coverage  ratio  of at  least  1.1 to  1.0.  This
requirement was met at June 30, 2006.

The  Company's  total  outstanding  borrowings  at June  30,  2006  amounted  to
approximately  $43.5  million,  less  broker's  discounts  in the amount of $0.9
million.  The 2011 Notes accounted for $39.4 million, net of broker's discounts,
of  these  borrowings.  The  remaining  amount  of $3.3  million  resulted  from
borrowings  at variable  rates and  consisted of two  industrial  revenue  bonds
outstanding  in the  amounts  of $1.3  million  and $2.0  million.  The  average
interest rate charged to the Company at June 30, 2006 for its industrial revenue
bonds was 4.1%.  The  variable  interest  rate for these  borrowings  fluctuated
between  3.1% and 4.2% during the six months ended June 30, 2006 based on weekly
market  conditions.  These  bonds are fully  collateralized  by bank  letters of
credit issued under the Company's bank  agreement.  The Company's bank considers
letters  of credit as  outstanding  borrowings  when  considering  the amount of
availability the Company has remaining under its line of credit.

Other than the Company's  letters of credit,  which amounted to $14.2 million at
June 30, 2006, the Company has no other material off balance sheet liabilities.

At June 30, 2006 the Company had $5.8 million of unused  availability  under the
Second  Restated  Credit  Agreement,  subject to the  availability of collateral
under its line of credit.

The Company  anticipates  that cash generated from  operations and its currently
available  cash will enable the Company to meet its liquidity,  working  capital
and capital  expenditure  requirements  during the next 12 months.  The Company,
however, may require additional  financing to pursue  acquisitions,  and to meet
its long-term liquidity,  working capital and capital expenditure  requirements.
If  such  financing  is  required,  there  are no  assurances  that  it  will be
available,  or if available,  that it can be obtained on terms  favorable to the
Company.  From time to time, the Company may be party to one or more non-binding
letters of intent regarding material acquisitions, which, if consummated, may be
paid for with cash or through the issuance of a significant  number of shares of
the Company's common stock.

The Company was profitable for the two quarters ended June 30, 2006. The Company
did, however,  record  significant  losses in fiscal 2004 and 2005. We recognize
that  sustaining  profitability  is a critical  objective which the Company must
attain.  The  Company  continues  to  have a  significant  amount  of  cash  and
marketable  securities  on its  balance  sheet at June 30,  2006,  however,  the
Company must sustain its  profitability  prior to depleting its current cash and
marketable securities.


                                       28
<PAGE>


On May 2, 2005, we filed a Form 8-K disclosing  that we failed to timely file an
amendment to our Annual Report on Form 10-K for the year ended December 31, 2004
to provide  management's  report on internal control over financial reporting as
of December 31, 2004 and the related report of our independent registered public
accounting  firm on  management's  assessment of the  effectiveness  of internal
control  over  financial  reporting  (together,  the "404  Report")  required by
Section 404 of the  Sarbanes-Oxley  Act of 2002.  On May 3, 2005,  the Company's
bank  confirmed in writing that there will not be any event of default under the
various credit agreements, by virtue of the Company's failure to file its report
required by Section 404 of Sarbanes-Oxley in a timely manner.

On May 4, 2005, we received a notice from the Listing Qualifications  Department
of The Nasdaq  Stock  Market  stating that due to our failure to timely file the
404 Report, we were no longer in compliance with the requirements of Marketplace
Rule 4310(c)(14). The Rule requires us to file with Nasdaq copies of all reports
required to be filed with the  Securities  and Exchange  Commission on or before
the date they are required to be filed with the SEC.

On June 27, 2005,  the Company filed its Form 10-K/A with the SEC containing the
404 Report.  On June 30, 2005, the Nasdaq Listing  Qualifications  Panel advised
CompuDyne  that  CompuDyne had remedied its filing  delinquency  and was in full
compliance with Nasdaq Market Place Rules.

Another  consequence of not filing the 404 Report timely as noted above includes
our  inability to use a shorter form  registration  document for one year in the
event we were to engage in an offering of our securities. This could have had an
adverse impact on our ability to raise capital and the cost of raising  capital.
This consequence lapsed on June 27, 2006.

Additional Considerations

Bid Bonds  and  Payment  and  Performance  Bonds
Historically,  certain of the Company's projects have required bid bonds at time
of proposal submission and payment and/or performance bonds upon contract award.
The  majority  of these  bonds  have been  needed in the ISS and PS&J  segments.
Recently,  approximately  75% of ISS' work has come from jobs where  payment and
performance  bonds  are  required  and for  PS&J,  19% of its work has  required
payment and performance  bonds.  The Company's losses in 2004 and 2005 have made
it more  challenging  for the  Company to attain the  bonding  needed to procure
certain of its  projects.  As of June 30,  2006,  the  Company  was  required to
provide  collateral for two of its projects which it did by issuing bank letters
of credit as collateral in the amount of approximately $5.5 million in total. In
the  event the  Company  is unable to  obtain  bonds,  or if the  terms,  namely
additional  collateral,  of the bonds are not within the financial  means of the
Company,  the  amount  of work  the  Company  is able to  contract  for  will be
negatively impacted.

Cost  Containment
Due to current economic  conditions,  the Company's losses in 2004 and 2005, and
in light of a very strong competitive  environment,  the Company recognizes that
its  ability to  increase  the  prices it charges  its  clients is  limited.  In
addition,  in light of significant  selling,  general and  administrative  costs
associated with the current heightened regulatory environment, we are evaluating
our strategy to determine if a revised  strategy  would result in lower selling,
general  and  administrative  costs.  As a  result,  in  order  to  enhance  our
profitability, the Company will continue to seek ways to reduce its costs.

Total Backlog
CompuDyne's  backlog  amounted to $111.5  million at June 30,  2006.  This was a
decrease  of 24.7%  from the  Company's  December  31,  2005  backlog  of $148.1
million.  The break down of the Company's  backlog by segment is as follows,  in
thousands:

                                                   June 30,       December 31,
                                                    2006             2005
                                                  ---------       ------------
  Institutional Security Systems                  $  51,173       $     58,128
  Attack Protection                                  13,593             28,802
  Integrated Electronic Systems                       7,393              7,503
  Public Safety and Justice                          39,351             53,705
                                                  ---------       ------------
              Total                               $ 111,510       $    148,138
                                                  =========       ============

The  decline in backlog  during the first half of 2006 could lead to a potential
decline in future quarterly revenues.

Included  in the  backlog of the ISS,  AP and PS&J  segments at June 30, 2006 is
$17.6 million, $0.8 million and $0.6 million, respectively,  representing awards
received by the segment for which the clients  have not yet entered  into signed
contracts. These awards are expected to result in signed contracts over the next
twelve months.


                                       29
<PAGE>


Corporate Reorganization
As part of the Company's  efforts to better  manage its costs,  during the first
quarter of 2005 the Company  implemented a corporate  reorganization  whereby it
converted several corporate entities into LLCs (Limited Liability Corporations).
This activity was designed to improve the Company's tax reporting  structure and
should  help  better  manage the  Company's  state  income tax  obligations.  In
conjunction  with this  reorganization,  our  Federal  Security  Systems  group,
formerly   known   as   Quanta   Systems    Corporation,    was   re-formed   as
CompuDyne-Integrated  Electronics  Division,  LLC,  and our  Public  Safety  and
Justice group, formerly known as Tiburon, was renamed  CompuDyne-Public Safety &
Justice, Inc. In addition,  CorrLogic,  Inc. was converted to CorrLogic, LLC and
Fiber  SenSys,  Inc.  was  converted  to Fiber  SenSys,  LLC. The impact of this
reorganization  is not  expected  to have a material  effect on  operations.  In
addition,  in light of  escalating  selling,  general and  administrative  costs
associated with the current heightened regulatory environment, we are evaluating
our structure to determine if another  organizational  structure would result in
lower selling, general and administrative costs.

Critical Accounting Policies and Estimates
A complete description of the Company's significant  accounting policies appears
in the  Company's  Annual  Report on Form 10-K for the year ended  December  31,
2005.

Percentage of Completion Accounting and Revenue Recognition.
Approximately 50% of the Company's revenues are derived from long-term contracts
where  revenue  is  recognized  under the  percentage  of  completion  method of
accounting.  The  Company's  software  related  contracts  utilize  labor  hours
incurred to date on a project,  divided by the total  expected  project hours to
determine  the  completion  percentage.  The  Company's  construction  contracts
utilize  costs  incurred  to date on a project,  divided  by the total  expected
project  costs to determine  the  completion  percentage.  Both of these methods
require  considerable  judgment and, as such, the estimates derived at any point
in time could differ  significantly from actual results.  These estimates affect
many of the balance  sheet and statement of  operations  accounts  including net
sales,  cost of goods sold,  accounts  receivable,  contract  costs in excess of
billings and billings in excess of contract costs incurred.

Revenues for support and  maintenance  contracts  are  deferred  and  recognized
ratably over the life of the contract.  Sales of products  unrelated to contract
revenue are  recognized as revenue when all of the  following  criteria are met:
persuasive evidence of an arrangement exists;  delivery has occurred or services
have been rendered;  the seller's  price to the buyer is fixed or  determinable;
and collectibility is reasonably assured.

Provisions for estimated  losses on uncompleted  contracts are recognized in the
period such losses are determined.

Inventories  are  stated at the  lower of cost or  market,  using the  First-in,
First-out  (FIFO) method.  Costs  included in inventories  consist of materials,
labor,  and  manufacturing  overhead,  which are  related  to the  purchase  and
production of inventories.

Warranty  reserves are  estimated  and recorded at the time products are sold or
services are rendered.  They are established using historical information on the
nature,  frequency  and average cost of warranty  claims.  The Company  warrants
numerous  products,  the terms of which vary  widely.  In  general,  the Company
warrants its products against defect and specific non-performance.

Accounts  receivable are expected to be substantially  collected within one year
except  for a  portion  of the  receivables  recorded  as  retainage.  Retainage
expected to be collected in over one year is reflected as a current  asset as it
will be collected within the operating cycle under the related contract.

Tax valuation  allowances are  established  when the Company  believes it is not
"more  likely than not" that the Company will be able to receive tax benefits in
the future. The federal income tax benefit recorded in the first quarter of 2006
is primarily the result of the reduction of a liability maintained for uncertain
tax positions which was no longer required.

Goodwill and Intangible Assets.
The Company  reviews the carrying  value of goodwill and  intangible  assets not
subject to  amortization  annually during the fourth quarter of the year or when
events or changes in  circumstances  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 as unforeseen events or changes in market
conditions could negatively affect the Company's reporting units' fair value and
result in an impairment  charge.  The carrying  value of goodwill and intangible
assets not subject to amortization totaled  approximately $26.8 million and $5.6
million,  respectively,  and intangible  assets subject to amortization  totaled
approximately  $2.5 million,  net, at June 30, 2006.  The Company cannot predict
the occurrence of events that might adversely affect these values.


                                       30
<PAGE>


Stock Compensation Policy.
Effective  January 1, 2006, we adopted SFAS No. 123(R),  "Share-Based  Payment."
This  statement  requires  us to  expense  the fair  value of grants of  various
stock-based  compensation  programs  over the vesting  period of the awards.  We
elected to adopt the "Modified Prospective  Application" transition method which
does not require the  restatement  of previously  issued  financial  statements.
Compensation expense is measured and recognized beginning in 2006 as follows:

Awards granted after December 31, 2005 - Awards are measured at their fair value
at date of grant.  The  resulting  compensation  expense  is  recognized  in the
consolidated  statement of  operations  ratably  over the vesting  period of the
award.

Awards  granted  prior to December 31, 2005 - Awards were measured at their fair
value at the date of original grant.  Compensation  expense  associated with the
unvested  portion  of these  options at  January  1, 2006 is  recognized  in the
consolidated statement of operations ratably over the remaining vesting period.

For all  grants  issued  after  December  31,  2005  the  amount  of  recognized
compensation  expense is adjusted based upon an estimated  forfeiture rate which
is derived from historical data.

Economic  Conditions  and the After Effect of the September  11, 2001  Terrorist
Attacks
Much of the work CompuDyne performs is for state and local  governmental  units.
These  entities were severely  impacted by recent  economic  conditions  and the
resulting  contraction of the tax bases of these  governmental  units.  This has
caused these  governmental  units to carefully  evaluate their budgets and defer
expenses and projects where possible.  Much of the work of the Company's  Public
Safety and Justice and  Institutional  Security  Systems  segments is contracted
with these state and local governmental units. As a result,  these segments have
seen delays in new work  available  to be bid and worked on. In  addition,  even
work that had been  contracted  for was sometimes  deferred by the customer into
the future. In recent months, it appears the state and local government revenues
have been improving, resulting in increased activity preparatory to the issuance
of requests for new bids and ultimately, the Company expects the awarding of new
projects.  It  appears  to us that we are in the  early  stages  of an  economic
recovery as it relates to the segments of the marketplace we serve.

After the  occurrence of the tragic  events of the September 11, 2001  terrorist
attacks,  there was a general perception that our Integrated  Electronic Systems
and Attack Protection  segments would see a significant  increase in order flow.
To the  contrary,  in the  months  subsequent  to the  terrorist  attacks  these
segments saw a slowing in new work opportunities as the various federal agencies
and other  customers  that are the usual source of their  business  slowed their
procurement  processes waiting for definitive  direction as to how to proceed in
the post September 11 world.  Now further  complicated by the military action in
Iraq,  the Company's  clients are  reevaluating  priorities  and budgets and are
funding only their most  pressing  demands while also making key decisions as to
which projects can be deferred.

As a result of the above  factors,  during  the last few years the  Company  has
experienced a more  challenging  marketplace  than it  experienced  in the years
prior to September 11, 2001.

Market Risk
On January 22,  2004,  the  Company  completed  an  offering  of $40.25  million
principal  amount of the 2011 Notes. The 2011 Notes bear interest at the rate of
6.25% per annum,  payable  semi-annually,  and are  convertible  into  shares of
common  stock at a  conversion  price of $13.89 per share.  The  Company  used a
portion of the proceeds of this note offering to pay down outstanding borrowings
under its variable rate bank notes. Subsequent to the pay-down of its bank notes
the only  variable  rate  borrowing  remaining  outstanding  at June 30, 2006 is
approximately  $3.3 million of industrial  revenue  bonds.  Since this borrowing
bears  interest  at  variable  rates,  in  the  event  interest  rates  increase
dramatically  the increase in interest  expense to the Company could be material
to the results of operations of the Company.

Recent Accounting Pronouncements
In  May  2005,  the  FASB  issued  SFAS  154,   "Accounting  Changes  and  Error
Corrections" (SFAS 154) which replaces APB Opinion No. 20, "Accounting  Changes"
and SFAS 3, "Reporting  Accounting  Changes in Interim  Financial  Statements-An
Amendment of APB Opinion No. 28." SFAS 154 provides  guidance on the  accounting
for and reporting of accounting  changes and error  corrections.  It establishes
retrospective  application,  or the latest  practicable  date,  as the  required
method for  reporting a change in  accounting  principle  and the reporting of a
correction  of an  error.  SFAS 154 is  effective  for  accounting  changes  and
corrections  of errors made in fiscal years  beginning  after December 15, 2005.
The  adoption  of SFAS 154 did not have a  material  impact on our  consolidated
financial position, results of operations or cash flows.


                                       31
<PAGE>



       ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk
CompuDyne  has fixed and variable rate notes  payable.  These  on-balance  sheet
financial instruments expose the Company to interest rate risk, with the primary
interest  rate  exposure  resulting  from  changes  in the bond  market  used to
determine the interest rate  applicable  to the  borrowings  under the Company's
industrial revenue bond borrowings.

The following information  summarizes our sensitivity to market risks associated
with  fluctuations in interest rates as of June 30, 2006. To the extent that the
Company's  financial  instruments expose the Company to interest rate risk, they
are presented in the table below.  The table  presents  principal cash flows and
related  interest rates by year of maturity of the Company's  notes payable with
variable rates of interest in effect at June 30, 2006.

On January 22,  2004,  the  Company  completed  an  offering  of $40.25  million
principal  amount of 6.25%  Convertible  Subordinated  Notes due on January  15,
2011.  The 2011  Notes  bear  interest  at a rate of 6.25%  per  annum,  payable
semi-annually,  and are convertible  into shares of common stock at a conversion
price of $13.89 per share.  The  Company  used a portion of the  proceeds of the
2011  Notes to pay down its  variable  bank notes  payable.  The pay down of its
variable borrowings reduced the Company's interest rate risk.
<TABLE>
<CAPTION>

          Financial Instruments by Expected Maturity Date

               Notes Payable             Variable                                Fixed
                Year Ending              Rate ($)      Average Variable        Rate ($)        Average Fixed
                 December 31          (in thousands)    Interest Rate       (in thousands)     Interest Rate
              ----------------        --------------    -------------       --------------     -------------
                   <S>                   <C>                 <C>                <C>                <C>
              2006 (remaining)        $       140           4.13%           $        -              -
              2007                            440           4.13%                    -              -
              2008                            440           4.13%                    -              -
              2009                            440           4.13%                    -              -
              2010                            440           4.13%                    -               -
              Thereafter                    1,365           4.13%                40,250            6.25%
                                      -----------                           --------------
              Total                   $     3,265           4.13%           $    40,250            6.25%
              Fair Value              $     3,265           4.13%           $    32,854           12.61%
</TABLE>


                                       32
<PAGE>



                         ITEM 4. CONTROLS AND PROCEDURES

Changes in Accelerated Filer Status

On December 21, 2005 the Securities and Exchange  Commission  issued Release No.
33-8644 "Revisions to Accelerated Filer Definition and Accelerated Deadlines For
Filing  Periodic  Reports"  (the  "Release").  Included  in the  Release  was an
amendment to revise the definition of the term "accelerated  filer" to permit an
accelerated  filer that has an  aggregate  worldwide  market value of voting and
non-voting  common equity held by  non-affiliates of less than $50 million as of
the last business day of its second  fiscal  quarter to exit  accelerated  filer
status at the end of the fiscal year in which the  company's  equity falls below
$50 million as of the last business day of its second fiscal quarter and to file
its  annual  report  for  that  year  and  subsequent   periodic  reports  on  a
non-accelerated basis.

The aggregate worldwide market value of CompuDyne  Corporation's  equity held by
non-affiliates as of June 30, 2005, the last business day of CompuDyne's  second
fiscal quarter, was less than $50 million. As a result, as of December 31, 2005,
CompuDyne exited accelerated filer status.

Prior to the Release, CompuDyne was classified as an "accelerated filer" and was
required to comply with the  requirements  of Section 404 of the  Sarbanes-Oxley
Act of 2002. The Company's worldwide market value held by non-affiliates on June
30, 2006 was less than $50 million so  CompuDyne  will not be  classified  as an
accelerated filer for the year ended December 31, 2006.

Disclosure Controls and Procedures

As required by Rule 13a-15 under the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), the Company  conducted an evaluation under the supervision
and with the  participation  of the  Company's  management,  including the Chief
Executive Officer and the Chief Financial  Officer,  of the effectiveness of the
Company's disclosure controls and procedures as of the end of the period covered
by this report.  Based on that evaluation,  the Chief Executive  Officer and the
Chief Financial  Officer  concluded that the disclosure  controls and procedures
are  effective  in ensuring  that all  information  required to be  disclosed in
reports  that the Company  files or submits  under the Exchange Act is recorded,
processed,  summarized  and reported  within the time  periods  specified in the
Securities  and Exchange  Commission  rules and forms.  There was no significant
change in the Company's internal control over financial  reporting that occurred
during the Company's most recent fiscal quarter that has materially affected, or
is reasonably likely to materially  affect,  the Company's internal control over
financial reporting.


                                       33
<PAGE>



PART II - OTHER INFORMATION

Item 4:  Submission of Matters to a Vote of Security Holders.

Proposal #1 - Election of Directors.

At the Annual Meeting of Shareholders on May 24, 2006, the shareholders  elected
Ronald J.  Angelone  Director  for a period of three years to expire at the 2009
Annual Meeting. The votes were cast as follows:

              For - 5,426,393                 Withheld - 37,474

At the Annual Meeting of Shareholders on May 24, 2006, the shareholders  elected
Wade B. Houk  Director  for a period of three years to expire at the 2009 Annual
Meeting. The votes were cast as follows:

              For - 5,375,591                 Withheld - 88,474

Item 6:  Exhibits.

Exhibits -
       10.1 Termination of Employment Agreement between CompuDyne Corporation
               and Mr. Daniel Crawford, herein incorporated by reference
               filed on Form 8-K, July 10, 2006.
       10.2 The Joinder Agreement and the First Amendment to the Second
               Amendment and Restated Revolving Credit and Security Agreement
               both dated July 14, 2006 by and among CompuDyne Corporation,
               subsidiaries of the Company as co-borrowers and PNC Bank,
               National Association, herein incorporated by reference to
               Exhibits 10.1 and 10.2 to Registrants 8-K filed on July 20, 2006
       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 906 Of The Sarbanes-Oxley Act of
               2002, 18 U.S.C. Section 1350, for Mr. Martin Roenigk, Chief
               Executive Officer, filed herewith.
       32.2 Certification Pursuant To Section 906 Of The Sarbanes-Oxley Act of
               2002, 18 U.S.C. Section 1350, for Mr. Geoffrey F. Feidelberg,
               Chief Financial Officer, filed herewith.


                                       34
<PAGE>


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 the
undersigned, thereunto duly authorized.

                                                      COMPUDYNE CORPORATION



Date:  August 4, 2006                                 /s/ Martin Roenigk
                                                      ------------------
                                                      Martin Roenigk
                                                      Chief Executive Officer


                                                      /s/ Geoffrey F. Feidelberg
                                                      --------------------------
                                                      Geoffrey F. Feidelberg
                                                      Chief Financial Officer


                                       35