-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ETIO05Fube7MeOrZS3H08lutUDqUFKcbxUvkP1amLkjGejuZl2OSccIFEWV/fU/c 5H5WP/fcNcNXz98G80OChw== 0001137403-06-000030.txt : 20060530 0001137403-06-000030.hdr.sgml : 20060529 20060530152257 ACCESSION NUMBER: 0001137403-06-000030 CONFORMED SUBMISSION TYPE: 10KSB/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20051231 FILED AS OF DATE: 20060530 DATE AS OF CHANGE: 20060530 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SENTRY TECHNOLOGY CORP CENTRAL INDEX KEY: 0001030708 STANDARD INDUSTRIAL CLASSIFICATION: COMMUNICATIONS EQUIPMENT, NEC [3669] IRS NUMBER: 113349733 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB/A SEC ACT: 1934 Act SEC FILE NUMBER: 001-12727 FILM NUMBER: 06873754 BUSINESS ADDRESS: STREET 1: 1881 LAKELAND AVENUE CITY: RONKONKOMA STATE: NY ZIP: 11779 BUSINESS PHONE: 6317392000 MAIL ADDRESS: STREET 1: 1881 LAKELAND AVENUE CITY: RONKONKOMA STATE: NY ZIP: 11779 10KSB/A 1 skvy10ksb2005.txt SKVY10KSB 2005-REVISED SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ____________ FORM 10-KSB X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE - --- ACT OF 1934 For the fiscal year ended December 31, 2005 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: 1-12727 _________________ SENTRY TECHNOLOGY CORPORATION (Exact name of the Registrant as specified in its charter) Delaware 96-11-3231714 ---------------------- --------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1881 Lakeland Avenue, Ronkonkoma, NY 11779 ----------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (631) 739-2000 --------------- (Former address, if changed since last report) Securities registered pursuant to Section 12(b) of the Act: None. Securities registered pursuant to Section 12(g) of the Act: Title of each class: -------------------- Common Stock, $.001 par value 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. ____ The issuer's revenues for the latest fiscal year were $13,570,000. At April 12, 2006, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $5,375,000 based upon the closing price of such securities on the OTC Bulletin Board on that date. At April 12, 2006, the Registrant had outstanding 120,728,804 shares of Common Stock. Documents Incorporated by Reference - -------------------------------------- None. ------ PART I ------ Item 1. BUSINESS - ------------------- GENERAL Sentry Technology Corporation ("Sentry") is engaged in the design, sale, installation and servicing of a complete line of Radio Frequency (RF) and Electro-Magnetic (EM) electronic article surveillance (EAS) systems and Closed Circuit Television (CCTV) solutions. The CCTV product line features the proprietary SentryVision SmartTrack patented traveling surveillance system. The Company's products are used by retailers to deter shoplifting and internal theft and by industrial and institutional customers to protect assets and people. Sentry was incorporated in Delaware in 1996. Its corporate predecessors had been in business for more than 38 years. Sentry was formed in connection with the February 1997 merger of Knogo North America Inc., a Delaware corporation, and Video Sentry Corporation, a Minnesota corporation. As a result of the merger, we became the parent corporation of two wholly-owned Delaware subsidiaries: Knogo North America Inc. ("Knogo") and Video Sentry Corporation ("Video"). This series of transactions is referred to herein collectively as the "Initial Merger." Knogo was engaged in the design, manufacture, sale, installation and servicing of a complete line of electronic article surveillance equipment. Knogo was incorporated in Delaware in October 1996. Its corporate predecessors had been in business for more than 30 years. Video designed, manufactured, marketed, installed and serviced a programmable traveling closed circuit television surveillance system that delivers a high quality video picture which is used in a wide variety of applications. Video also acted as a system integrator for conventional CCTV products that it marketed, installed and serviced. Video's predecessor was founded in 1990 and made its first sales in 1992. Video was merged into Knogo as of December 31, 2000. On April 30, 2004, Sentry acquired all the outstanding common stock and Series "A" preference shares of ID Security Systems Canada, Inc., an Ontario corporation, and all the outstanding capital stock of ID Systems USA, Inc., a Pennsylvania corporation, (collectively "ID Systems"). The acquisition expanded our product offering to include proximity Access Control and Radio Frequency Identification (RFID) solutions. Effective January 1, 2005, ID Systems changed the name of ID Security Systems Canada Inc. and ID Systems USA Inc. to Sentry Technology Canada Inc. and Sentry Technology USA Inc., (collectively "Sentry Canada"). On March 22, 2005, Sentry was merged into its subsidiary Knogo pursuant to a plan of merger in which Knogo was the surviving corporation. The merger was effective for accounting purposes on January 1, 2005. Pursuant to the Plan of Merger, Knogo changed its name to Sentry Technology Corporation. RECENT DEVELOPMENTS Over the last several years, our largest shareholder, Dialoc ID Holdings B.V. ("Dialoc") was not able to provide us with additional financial support. On April 19, 2004, Dialoc sold 39,066,927 Sentry common shares (representing approximately 46% of the total issued and outstanding shares of Sentry) to a group of investors. Of the group, Saburah Investments Inc. ("Saburah") acquired 22,758,155 shares, Mr. Robert Furst 14,554,386 shares and Dr. Morton Roseman 1,754,386 shares. Mr. Peter Murdoch, President, CEO and Director of Sentry, is the owner of Saburah. Mr. Furst is a long-standing member of Sentry's Board of Directors. As a result of this transaction, Messers Angel and de Nood, Principals of Dialoc, resigned from Sentry's Board of Directors. In addition to the purchase of Sentry's common shares, Saburah also acquired 100% of ID Security Systems Canada, Inc. and ID Systems USA, Inc. The price paid to Dialoc by Saburah and Murdoch for Sentry and ID Systems shares in cash, debt assumption and other consideration was approximately $3.6 million plus the surrender of Murdoch's 15% interest in Dialoc. Saburah also agreed to make a payment to Dialoc in the future equal to approximately 6% of any payment it received from Checkpoint Systems Inc. ("Checkpoint") resulting from litigation brought by ID Canada against Checkpoint. On April 30, 2004, Sentry purchased from Saburah Investments, Inc., an Ontario corporation, all of the outstanding common shares and Series "A" preference shares of ID Security Systems Canada, Inc., an Ontario corporation, and all of the outstanding capital stock of ID Systems USA, Inc., a Pennsylvania corporation. ID Systems is a Toronto based company engaged in anti-shoplifting technology, security labeling, radio frequency identification (RFID), access control and library security. Sentry acquired ID Systems from Saburah in exchange for 30,000,000 Sentry common shares. The price paid per Sentry share for the securities of ID Systems was valued at approximately $0.11. A special committee of Sentry's Board of Directors received an opinion from Corporate Valuation Services confirming that the price paid for the acquisition of ID Systems was fair from the point of view of Sentry shareholders. As part of the purchase agreement, the proceeds of the ID Systems litigation settlement were distributed to the former ID Systems' shareholders. Sentry's Board of Directors and shareholders owning a majority of Sentry common stock approved the acquisition of ID Systems. Other benefits flowing to Sentry/ID Systems via the purchase of ID Systems are as follows: - - ID Systems and Sentry continue as the exclusive distributor in North and South America for a period of five years for all Dialoc products including Laserfuse radio frequency security labels and all RFID products. - - Dialoc became a distributor in Europe and Asia of labels manufactured by ID Systems' security label manufacturing subsidiary, Custom Security Industries Inc. ("CSI"). - - CSI acquired the right to purchase Laserfuse raw material for processing into finished security labels in its Toronto plant in order to reduce the cost of production. - - CSI acquired the option to purchase a non-exclusive license to manufacture complete Laserfuse security labels for a period of 10 years subject to the payment of $500,000 and a running royalty of $0.001 per label. - - Dialoc will continue to be a dealer for Sentry products in Europe and Asia. On April 30, 2004, Sentry entered into a $2,000,000 secured convertible debenture with Brascan Technology Fund ("Brascan"), an alternative investment fund established by Brascan Asset Management, to invest in early stage, technology-based companies with high growth potential. Effective November 2005, the entities changed their respective names to Brookfield Technology Fund and Brookfield Asset Management, (collectively referred to as, "Brookfield"). Key terms of the transaction are as follows: - - Four year term. - - Interest rate of 8%. - - Redeemable at Sentry's option after 18 months. - - Conversion price equal to the market price, at time of conversion, less a discount of 30% with a maximum conversion price of $0.12 per share. - - Conversion is at the option of Brookfield when market share price is equal to or greater than $0.17 per share or with the approval of Sentry's Board of Directors when the market share price is less than $0.17 per share. - - Sentry will provide most favored pricing to all Brookfield affiliates and expects to be a supplier of security and identification products to the Brookfield affiliates. - - Brookfield was issued warrants for 5,000,000 shares of Sentry common stock, priced at $0.15 per share, exercisable anytime until April 30, 2008. - - Brookfield is entitled to one seat on Sentry's Board of Directors or will participate as an observer. The Debenture is secured by a general security interest over all the assets and properties of Sentry. The amount is subordinate to the existing credit facilities. Sentry acquired ID Systems as a condition of the financing. On August 1, 2004, ID Systems and Checkpoint entered into a settlement agreement effective July 30, 2004, pursuant to which Checkpoint agreed to pay $19.95 million in full and final settlement of claims covered by the antitrust litigation. Payment in full was received on August 5, 2004. As provided when Sentry purchased ID Systems, the proceeds of the settlement were distributed to former shareholders of ID Systems, after payment of litigation fees and expenses. The agreement includes mutual releases between the parties for complaints arising from activities prior to the date of the agreement, except for any contractual obligations and any future claims for patent, copyright or trademark infringement. The agreement is not an acknowledgement of any wrongdoing or liability by either party. A Stipulation of Dismissal has been filed with the Third Circuit Court of Appeals to finally conclude the legal proceedings. During the third quarter of 2004, Sentry and its subsidiaries received $753,000 through the repayment of debt incurred by Dialoc prior to the ID Systems acquisition and reimbursement of litigation expenses. While Sentry did not obtain an interest in the litigation settlement, Saburah and Sentry agreed that Sentry might require Saburah to purchase additional Sentry common shares equal to approximately 4.5% of any amount received (net of legal fees and expenses) from Checkpoint. The price per share was set at 80% of the previous 20 days trading average prior to the announcement of the settlement. Our Board of Directors has exercised this option and based on the settlement amount, Sentry sold to Saburah approximately 4.8 million shares for $641,000 on November 5, 2004. These transactions, totaling $1.4 million, represent the total cash flowing to Sentry directly and indirectly as a result of the Checkpoint lawsuit. Mr. Murdoch, directly or indirectly through his ownership of Saburah, owns or controls 49.5% of the outstanding common stock of Sentry. THE SENTRYVISION SYSTEM SentryVision refers to our family of proprietary traveling CCTV surveillance systems. Over the years, Sentry has developed various generations of traveling CCTV surveillance systems including the H-System, OH-System, the original SentryVision and currently the improved SmartTrack system. All versions of the product consist of a camera carriage unit, a continuous track enclosed with tinted or mirrored glass enclosure and electronic control equipment. The carriage unit moves within the enclosure and carries one or two PTZ CCTV cameras, electronic transmission components and motor drives. The carriage track and enclosure are designed to custom lengths for more complete viewing. The carriage unit transmits video and control signals from the camera(s) through two copper conductors running inside the enclosure to a receiver unit located at one end of the carriage track. The copper conductors also carry power to the camera carriage, eliminating the need for power or communication cables. From the receiver unit, the video signals are relayed to a central monitoring location by wire or fiber optics, where a system operator can position or move the camera carriage to obtain the best vantage point while viewing and recording the continuous, live video pictures. The system design supports conventional peripheral devices, such as analog and digital videocassette recorders, alarm inputs, fixed cameras, PTZ dome cameras, switches/multiplexers, voice intercom systems, panic buttons and remote viewing capability using dedicated phone lines or internet technology. Unlike our previous products, our SentryVision SmartTrack system features one or two state-of-the-art pan, tilt and zoom ("PTZ") domes providing for 360 unobstructed views to eliminate most blind spots. Additionally, SmartTrack utilizes sophisticated software that provides six tours and up to 60 presets per camera carriage to allow programmable viewing and recording with or without an operator. The improvements made to the carriage make the new SmartTrack system the fastest and most reliable traveling CCTV surveillance system in the history of SentryVision product offerings. SmartTrack is our premier product, replacing all previous generations of SentryVision products. SentryVision is designed to provide enhanced loss prevention surveillance in retail stores and distribution centers as well as to provide monitoring and deterrence of illegal and unsafe activities in a variety of other locations such as parking garages, correctional facilities, warehouses, transportation centers and public transit terminals. SentryVision may also be employed in a broad range of operational and process monitoring applications in commercial manufacturing and industrial settings. SentryVision is now installed in four of the top five and six of the top ten Global Retailers. As of December 31, 2005, SentryVision systems had been installed at the following customer locations in North America: Lowe's Home Centers, Target Stores, Mills Fleet Farm, Winn Dixie, Federal Express, Cabellas, Fred Meyer, Symbol Technologies, Menards, UPS, J.C. Penney, Canadian Tire, Reno Depot, Estee Lauder, Kohl's Department Stores and Disney Direct Marketing. In addition, during 2005, the Company's international distributors installed SentryVision systems in customer locations throughout Western and Eastern Europe, Latin America and Asia. Our international customers include ASDA Wal-Mart, Carrefour, Auchan, Cora, Castorama, B & Q, Tesco and Coop. We believe that, by providing expanded surveillance coverage and enhanced flexibility to select the locations watched, SentryVision has enabled customers to significantly reduce inventory shrinkage, increase theft apprehension rates and improve safety and security. Based on the price of its system and the experience of Sentry's customers to date, we believe SentryVision is a cost-effective solution, which can improve the operations of our customers. Sentry sold its first systems in 1992 for installation in parking garage security surveillance applications, but quickly moved its market focus into the retail sector. In this sector, we have identified a number of specific market segments for which SentryVision is well suited for loss prevention surveillance, including home centers, mass merchandise chains, supermarkets, hypermarkets and drug stores, as well as related distribution centers. The key application is inventory loss prevention in the stores, stock rooms and distribution centers. SentryVision is typically installed in large retail stores which use a checkout area at the front of the store and product display configurations and high merchandise shelving which form rows and aisles. Sentry specializes in designing system applications which are customized to fit a customer's specific needs and which integrate the customer's existing surveillance equipment (PTZ dome and fixed-mount cameras) with SentryVision . The flexibility of the system allows the customer to specify target-coverage areas ranging from stock rooms to total store coverage and focus on shoplifting, employee theft or performance evaluation of client personnel. Typically, SentryVision has been installed near the ceiling between the rows of cash registers and the ends of the merchandise aisles. This allows the retailer to easily observe both the cash handling activities of cashiers in the checkout area and customer activities between the merchandise rows, despite the presence of hanging signs and other obstructions. The entire sales floor can be monitored efficiently by focusing up and down the aisles and by moving the carriage horizontally from aisle to aisle, or from cash register to cash register. In addition, with the use of camera pan, tilt and zoom lens features, activities in each area can be monitored in greater detail. Results from Sentry's current installations indicate significant improvements in detecting shoplifting and employee theft. Retailers have also integrated SentryVision with "front end" packages of conventional CCTV cameras, dedicated to monitoring the registers and allowing users to locate the traveling camera track where the maximum coverage of in-store traffic can be monitored. The SentryVision system is today generally sold in conjunction with conventional CCTV applications. Customers using the SentryVision system have reported significant reductions in theft-related inventory shrinkage. Our SentryVision Mobile allows the user to view and control video images from the SmartTrack traveling CCTV system using a mobile hand held computer and wireless communication network. The earlier generation SentryVision Mobile product operated on a wireless Personal Digital Assist (PDA) using Windows CE. The new version now runs on the latest, tablet style wireless computer under Windows XP and is significantly faster than the earlier PDA version. The increased speed and computing power offered by the tablet gives the user real time video viewing. Customers are no longer required to sit in front of a video console to manage the SmartTrack system. The SentryVision Mobile solution is being used to manage operations and security in large distribution centers in the United States. SentryVision Server is an IP addressable digital video server, which gives users the ability to capture, stream, view and store video images using a web browser with the reliability of the Linux OS. The SentryVision Server comes with software that allows multiple users to simultaneously connect to a variety of SentryVision DVMS (Digital Video Management System) via LAN - across TCIP/IP networks. The system uses a Windows-based application for configuration and a browser-based client for remote viewing of live and recorded video for quick and easy investigation of security issues, as well as policies and procedure compliance. Retail Market Applications - ---------------------------- - - Home Centers. Sentry has installed systems in the home center segment of the retail market. This market has by far been the greatest market for the SmartTrack systems. Typical of our customers in this market are Lowe's Home Centers, with more than 1,234 stores in 46 states, and Mills Fleet Farm, a 30 store regional hardware, home supply and discount retail chain. Both companies required systems for total floor coverage. We applied different solutions to this common problem in each case. Lowe's Home Centers chose to integrate track cameras with PTZ dome and fixed-mount cameras, while Mills Fleet Farm chose to use only the track camera system. - - Mass Merchandise Chains. Sentry has installed systems for customers including Sears, Navy Exchange, Walgreens and Target Stores. The targeted coverage varies extensively in these installations from only stock rooms to total store coverage. The equipment package provided in each case varies with the application and location of the need. - - Supermarkets. Sentry has installed systems in supermarket customers including Kroger, Marsh, Cub Foods, Winn-Dixie and Fiesta Mart. The targeted coverage in most of these installations has been the entire retail space. Industrial Market Applications - -------------------------------- - - Distribution Centers. Sentry also provides loss prevention surveillance for distribution centers and warehouses, and has installed systems for retailers including TJ Maxx, Big Lots, Home Depot, Kohl's Department Stores, Target Stores, Ingram Micro, Navarro, Wendy's, Mastronardi Produce, Borders Group, Disney Direct Marketing, Barnes & Noble, Robinsons-May, Ross, Saks, Guess, Tower Records, Big Dog, Food Lion, Roundy's, the Gap, Bealls and J.C. Penney. Traveling through a facility from an overhead position, the SentryVision system can monitor activities occurring between the stacked rows of cartons or lines of hanging garments. The system can also move a surveillance camera into position to monitor shipping and receiving docks and parked delivery trucks. To achieve surveillance capabilities equivalent to those of the SentryVision system, a conventional PTZ dome system or fixed-mount CCTV camera would have to be installed at every desired vantage point, requiring numerous cameras, additional equipment and wiring and increased installation and operating costs. - - Manufacturing and Transportation Facilities. So far SentryVision use in factories has been limited, but the benefits of continuous tracking of industrial operations and processes indicate future growth potential. Continued expansion of the SentryVision dealer program is expected to generate increased installations in factories manufacturing electronics, pharmaceuticals, computers and other high value products and in various wholesale distribution and transportation facilities. Express package and other high throughput distribution facilities are also good prospects for a continuous tracking CCTV system for theft prevention. Installations include Watkins Motor Lines, Symbol Technologies, AT&T Wireless, Federal Express, UPS, Wyeth-Ayerst Labs, USF Logistics and Thompson Electronics. In Cape Town, South Africa, The Metro Rail Network has installed 10 tracks at several terminal stations to monitor passengers at the junction of bus, railway and taxi services. Smart Track is an integral part of an overall crime prevention and deterrence program including central management of all video devices over a network. - - Internet Data Centers. Sentry markets SentryVision systems to Internet data centers (IDC's). Most IDC's are full service business internet providers with state-of-the-art systems that host, monitor and maintain mission-critical web-sites, e-commerce platforms and business applications for small to medium sized businesses. SentryVision systems are used to heighten security through remote video monitoring. Installations include Dallas Exchange, TIAA-CREF, Savvis and The Discovery Channel. Institutional Market Applications - ----------------------------------- - - Corrections and Government Institutions. SentryVision has been installed in correctional facilities in Michigan, New Mexico and Illinois, with reported safety benefits of continuous coverage in dormitory, recreation and visitation areas. SentryVision installations have also been completed in various government agencies including the Federal Reserve Bank, U.S. Postal Service, Central Intelligence Agency and U.S. Immigration Service. CONVENTIONAL CCTV SYSTEMS Conventional CCTV is cost effective in many applications and is the most widely used loss prevention system in North America. Conventional CCTV uses all the basic components of the video surveillance industry including fixed and dome cameras, digital video recorders, VCR's, monitors, switchers, multiplexers and controllers. As all of this equipment is manufactured for Sentry by outside vendors, we can provide our customers with state-of-the-art equipment for specific applications at favorable costs. We believe that, while less profitable than SentryVision and traditional EAS products, the CCTV products complement our other surveillance systems and provide retailers with further protection against internal theft and external shoplifting activities. CCTV systems can also be electronically connected to EAS systems, causing a video record to be generated when a theft alarm is triggered. While we believe that conventional CCTV and SentryVision are complementary security solutions, many companies have traditionally viewed them as competing solutions and have selected between conventional CCTV systems and SentryVision systems for their security solutions. Remote video transmission and digital recording are continuing growth areas for Sentry. These systems allow customers to monitor remote sites using existing communication lines and a PC-based system. Video camera images are stored and manipulated digitally, substituting the PC for the VCR and multiplexer, and eliminating the videotape. Sentry markets digital video recording and a remote video transmission unit developed by third-party vendors including GE Security and TeleWatch. We continue to expand conventional CCTV installations in industrial and institutional facilities. Significant installations have been made for express package companies, including Federal Express, United Parcel Service, Emery Air Freight and Airborne Express. The use of CCTV surveillance also continues to grow in both new and existing correctional facilities and Sentry now has CCTV installations in both state and county facilities. The school market is another CCTV segment. Successful installations were completed with reported benefits including decreased vandalism and improved safety. In schools, conventional CCTV is an extremely cost effective security option with Digital Recording and Remote Video Transmission becoming attractive options for large school districts. Our largest single school CCTV installation was at the Norristown (PA) High School with 111 cameras, using digital recording and fiber optic cabling. It is an advanced, cost effective system with video from all cameras instantly accessible on their network. EAS SYSTEMS EAS systems consist of detection devices that are triggered when articles or persons tagged with reusable tags or disposable labels, (referred to as tags), pass through the detection device. The EAS systems that Sentry manufactures are based upon three distinct technologies. One, the Radio Frequency ("Knoscape RF") System, uses medium radio frequency transmissions in the two to nine megahertz range. Second, the "Ranger " system uses ultra-high frequency radio signals in the 902 megahertz and 928 megahertz bands. Third, the Electromagnetic ("Knoscape MM ") system uses very low frequency electromagnetic signals in the range of 218 hertz to nine kilohertz. The principal application of Sentry's products is to detect and deter shoplifting and employee theft in supermarket, department, discount, specialty and various other types of retail stores including bookstores, video, liquor, drug, shoe, sporting goods and other stores. The use of these products reduces inventory shrinkage by deterring shoplifting, increases sales potential by permitting the more open display of greater quantities of merchandise, reduces surveillance responsibilities of sales and other store personnel and, as a result, increases profitability for the retailer. In addition, Sentry's EAS systems are used in non-retail establishments to detect and deter theft, in office buildings to control the loss of office equipment and other assets, in nursing homes and hospitals for both asset and patient protection, and in a variety of other applications. The North and South American market for retail EAS systems and tags is estimated by industry sources in excess of $500 million and is growing at an estimated rate of 8 percent per year. At December 31, 2005, the approximate number of EAS Systems sold or leased by Sentry and its predecessors exceeded 26,400. Radio Frequency and Ranger Detection Systems Sentry manufactures and distributes the Knoscape RF system, the principal application of which is to detect and deter shoplifting and employee theft of clothing and hard goods in retail establishments. Sentry also manufactures and distributes the Ranger system, which the Company believes is a particularly useful and cost efficient EAS system for high fashion retail stores with wide mall-type exit areas that ordinarily would require multiple Knoscape RF systems for adequate protection. The Knoscape RF and Ranger systems consist of radio signal transmission and monitoring equipment installed at exits of protected areas, such as doorways, elevator entrances and escalator ramps. The devices are generally located in panels or pedestals anchored to the floor for a vertical arrangement or mounted in or suspended from the ceiling (Silver Cloud) and mounted in or on the floor in a horizontal arrangement. The panels or pedestals are designed to harmonize with the decor of the store. The monitoring equipment is activated by tags containing electronic circuitry, attached to merchandise transported through the monitored zone. The circuitry in the tag interferes with the radio signals transmitted through the monitoring system, thereby triggering alarms, flashing lights or indicators at a central control point, or triggering the transmission of an alarm directly to the security authorities. By means of multiple installations of horizontal Knoscape RF systems or installation of one or more Ranger systems, the Company's products have the ability to protect any size entrance or exit. Non-deactivatable reusable tags are manufactured in a variety of sizes and types and are attached directly to the articles to be protected by means of specially designed fastener assemblies. A clerk at the checkout desk removes a reusable tag from the protected article by use of a decoupling device specially designed to facilitate the removal of the fastener assemblies with a minimum of effort. Removal of the tag without a decoupler is very difficult and unauthorized removal will usually damage the protected article and thereby reduce its value to a shoplifter. Optional reminder stations automatically remind the store clerk, by means of audiovisual indicators, to remove the tag when the article is placed on the cashier's desk. Disposable labels can be applied to products either by placing them directly on the outside packaging of the item or hidden within the product by the manufacturer. These labels can be deactivated, at the checkout desk, through the use of a deactivation device. Knoscape RF and Ranger systems generally have an economic useful life of six years (although many of Sentry's systems have been operating for longer periods), have a negligible false alarm rate and are adaptable to meet the diversified article surveillance needs of individual retailers. Electromagnetic Detection Systems The primary application of Knoscape MM systems is to detect and deter theft in "hard goods" applications such as supermarkets, bookstores and in other specialty stores such as video, drug, liquor, shoe, record and sporting goods. Knoscape MM systems use detection monitors that are activated by electromagnetically sensitized strips. The MM targets are typically attached to the articles to be protected and are easily camouflaged on a wide array of products. The detection monitors used by the Knoscape MM systems are installed at three to five foot intervals at the exits of protected areas. The magnetic targets can be supplied in many forms and are attractively priced, making them suitable for a variety of retail applications. In addition, the MM targets can be manufactured to be activated and deactivated repeatedly while attached to the articles to be protected. Accurate deactivation is also very important when the item to be protected is a personal accessory that will be carried by its owner from place to place, such as pocket books, pens, lipstick, shoes, camera film and cameras. The Knoscape MM system offers retailers several features not available in Knoscape RF and Ranger systems. Since the target is very small, relatively inexpensive and may be inserted at the point of manufacture or packaging, it provides retailers with a great deal of flexibility and is practical for permanent attachment to a wide variety of hard goods, especially low profit-margin products. The target can be automatically deactivated at check-out, eliminating the risk of triggering alarms when merchandise leaves the store and saving sales personnel valuable time. Since the targets can be incorporated directly into a price tag or the article itself, they are convenient to use. PATRON SELF CHECK BOOK BORROWING SYSTEMS Libraries worldwide are struggling to reduce operating costs by applying cost effective technology solutions. The Sentry QuickCheck patron self check book borrowing system offers an ideal solution to gain an increasing share of the estimated $100 million library security market in North America. The QuickCheck system is RFID ready and provides for user access to circulation software, automatic security strip deactivation, automatic return ticket printing, user access to book renewals, multi-lingual software interface and on-screen user instructions. QuickCheck systems have been installed in Omaha Public Library, Supreme Court of Canada, Harris County Public Library, Burlington Public Library, Vancouver Public Library, Ottawa Public Library, McGill University Library and Calgary Public Library. RADIO FREQUENCY IDENTIFICATION (RFID) RFID is a wireless electronic data collection system that uses radio frequency signals to identify and track objects using readers and tiny integrated circuits in label format. Applications include library management, warehousing, parcel tracking, inventory control, asset protection and supply chain management. We are in the initial stages of introducing ISO standard, RFID labels, tags and readers for library management and upgrades to its access control systems. PRODUCT AUTHENTICATION Product Authentication is a specific use technology, identifying fraudulent documentation and/or "knock-off" products. With our patented, application specific electromagnetic label imbedded in an object, an EM reader will quickly determine the authenticity of the item. We anticipate introducing products to address this need. DIALOC ID SECURITY PRODUCTS Under a five-year license agreement, ending in March 2009, we also distribute EAS systems manufactured by Dialoc ID. The 9000-P 8.2 MHz system, which is housed in slender, self-contained Plexiglas panels, provides retailers with clear lines of sight at the front end along with the durability of solid Plexiglas. The panels can be custom printed with the retailer's logo for enhanced image and trade name awareness. The system's electronics, which are built-in to the base of the Plexiglas antenna, provide detection of 8.2 MHz labels and hard tags in aisles up to six feet wide. The 9000 PL system is offered in both single and dual aisle configurations and is compatible with all existing 8.2 MHz tags and checkout accessories. In addition, through Sentry, Dialoc ID anticipates it may introduce LaserFuse, a new RF label technology, which will be compatible with, and an alternative to, the labels offered by Checkpoint Systems, Inc. BOOKINGS Of Sentry's bookings for the year ended December 31, 2005, approximately 31 percent were attributable to SentryVision , 14 percent to CCTV and 55 percent to EAS. Of Sentry's bookings for the year ended December 31, 2004, approximately 32 percent were attributable to SentryVision , 26 percent to CCTV and 42 percent to EAS. For the year ended December 31, 2003, approximately 52 percent were attributable to SentryVision, 30 percent to CCTV, 18 percent to EAS. MAJOR CUSTOMERS Although the composition of our largest customers has changed from year to year, a significant portion of our revenues has been attributable to a limited number of major customers. In 2005, Goody's Family Clothing accounted for 10% of total revenues. In 2004 and 2003, Lowe's Home Centers accounted for 30% and 44%, respectively, of total revenues. In January 2005, Lowe's Home Centers notified us that they would not be renewing their annual maintenance contract, which represented $0.9 million of our revenues in 2004. The maintenance contract also contributed towards the selection of vendors for replacement and add-on CCTV business in new and existing Lowe's locations. As a result of this decision, Revenues from Lowe's Home Centers decreased from $5.0 million in 2004 to $1.0 million in 2005. We anticipate that future revenues from Lowe's will continue to decline on a comparable basis. While we believe that one or more major customers could account for a significant portion of our sales for at least the next two years, we anticipate that our customer base will continue to expand and that in the future we will be less dependent on major customers. PRODUCTION SentryVision and CCTV Products - --------------------------------- By the end of 2005, Sentry had outsourced substantially all of its manufacturing operations. Although we are not dependent upon any particular supplier, Sentry has made an investment in material and training with selected sub-contractors to supply major portions of our SmartTrack system. Most system parts are "off-the-shelf" components, and other materials and system components are designed by Sentry and manufactured to Sentry's specifications. Some minimal final assembly operations are conducted at the Company's facilities in Ronkonkoma, New York. System components and parts include cameras, circuit boards, electric motors and a variety of machined parts. Each finished assembly undergoes a quality assurance check by Sentry prior to its shipment to an installation site. All SentryVision carriage assemblies are tested and burned in for 24 hours, resulting in approximately 3,000 travel and PTZ cycles prior to quality assurance sign off. Sentry is not required under any state or federal environmental law or regulations to obtain related licenses or permits in connection with its manufacturing and assembly operations. EAS Products - ------------- Sentry produces at our facilities in Ronkonkoma, New York, or purchases through suppliers, its RF, Ranger, and MM systems, or their components. Production consists of final assembly operations of electronic and mechanical components that Sentry purchases from various suppliers. Independent contractors using existing molds and tooling produce plastic cases and antenna coils for the tags to Sentry's specifications. Sentry is not dependent on any one supplier or group of suppliers of components for its systems. Our policy is to maintain our inventory at a level that is sufficient to meet projected demand for its products. We do not anticipate any difficulties in continuing to obtain suitable components for our products at competitive prices in sufficient quantities as and when needed. Security Labels - ---------------- As a result of the acquisition of ID Systems in 2004, we obtained a 51% interest in Custom Securities Industries Inc. ("CSI"), an Ontario company. Since it's founding in 1988, CSI has established a worldwide reputation for innovation and excellence in the Electronic Article Surveillance (EAS) Industry. Extensive experience and know how in the leading EAS technologies, combined with expertise in converting, in house development of proprietary products and the use of specially designed converting equipment, enables CSI to offer custom tailored solutions with a rapid turn around time. Over the years, CSI has acquired a wide range of knowledge and developed its own trade secrets and manufacturing procedures to ensure competitive pricing, a broad range of high quality products, and the ability to supply products in both small and large volumes. CSI offers EAS products compatible with Radio Frequency (RF), Electromagnetic (EM), and Accousto-Magnetic (AM) technologies. Whatever the particular application, from standard EM pressure sensitive labels to sequentially printed barcode labels, products are available. Recently CSI has also introduced Source Tagging Solutions for the Radio Frequency and Accousto-Magnetic technologies. These products are successfully meeting the needs of retailers in the hardware, auto aftermarket, food and general merchandise categories. CSI specializes in custom solutions for hard to tag items. Long term associations with leading suppliers of EAS sensor materials, films and papers, pressure sensitive materials and adhesives enables CSI to handle the most demanding of label product needs with either standard or custom solutions. CSI offers a wide selection of labels and fashion tags. Our products are made with high performance materials, such as extremely low coercivity amorphous alloys and ultra stable deactivation ribbon. CSI's manufacturing equipment incorporates computer and control technology, including PLC's, Motion Controllers, Servo Motors, many different types of position and movement sensors, along with a very large inventory of specialized tooling and dies. Besides providing security labels to Sentry and ID Systems, CSI's customers include Tyco, Checkpoint, Dialoc ID, KMA and Retailers Advantage. MARKETING We market our SentryVision and conventional CCTV Systems through the direct efforts of salespersons located in select metropolitan areas across the United States and Canada, as well as through dealers/system integrators. In 2005, we increased the number of direct salespersons from four to 11, whose efforts were supplemented through six in-house sales support staff and independent sales representatives. We have centralized our sales management in our Toronto office. We also market our EAS products to smaller local and regional retailers through selected dealers and distributors. Sales are made into the library market on both a direct basis as well as through catalogs and dealers. We market our products primarily through participation in trade shows, placement of ads in trade publications, direct mailings and through telemarketing. In addition, these efforts are augmented through our Website, which provides enhanced product and market oriented information. Internationally, we market SentryVision through large system integrators and distributors including Honeywell, ADT, Chubb, Intrepid and BSC. SentryVision and CCTV Products - --------------------------------- To date, most SentryVision and conventional CCTV Systems have been sold on a direct sale basis. Typical billing arrangements for SentryVision systems involve invoicing 50% of total sale upon shipment of the product and 50% on the completion of the installation. While most of the current SentryVision and conventional CCTV sales have been made to home centers, retail chains and distribution centers, our marketing plan for Sentry also emphasized a dealer program for institutional, industrial and international prospects. We also market SentryVision through qualified security dealers and integrators. Much of the industrial and institutional SentryVision / CCTV prospects are serviced by local security companies who design and install integrated CCTV, access control and alarm systems. By working with these companies, we expected to be able to reach a far larger number of SentryVision prospects and penetrate the market more rapidly. The program has generated interest through trade advertising, direct mail and trade show participation. In 2005, our largest domestic dealer was Tyco's ADT Security division. Domestic dealers did not generate significant SentryVision installations in industrial and institutional facilities in 2004. Prior sales were made through ADT, STG, Siemans, Mosler and Security Link. In addition, we market SentryVision internationally using independent distributors on both an exclusive and nonexclusive basis. We sell our products to independent distributors at prices below those charged to end-users because distributors typically make volume purchases and assume marketing, customer training, installation, servicing and financing responsibilities. As of December 31, 2005, we have distributors in Canada, UK, France, Mexico, Belgium, Holland, Italy, Poland, Singapore, Russia, Spain, Brazil, Argentina, Hungary, Romania, Taiwan, Lebanon, Australia, Japan, South Africa, South Korea, Israel and the United Arab Emirates. During 2005, Sentry placed in service 150 SentryVision systems and 1,180 CCTV cameras, as compared to 229 SentryVision systems and 2,626 CCTV cameras in 2004, and 197 SentryVision systems and 2,996 CCTV cameras in 2003. EAS Products - ------------- Sentry EAS systems are principally marketed on a direct sales basis. In the case of the Knoscape MM systems, detection targets, which are sold to the customer, are permanently attached to the item to be protected. Therefore, as the customer replenishes its inventory, additional targets will be required for those items to be protected. We also market a more expensive, removable, reusable detection tag for use with the Knoscape MM systems on certain products such as clothing and other soft goods. RF and Ranger systems continue to be used by apparel and department stores that have wide exit areas and a desire for deterrence based on reusable hard tags. Both the Silver Cloud and Knoscape RF systems are universal in that they can detect both 2 MHz hard tags and 8 MHz labels. Knogo also markets an 8MHz P-2000 RF system designed for both hard and soft good customers. The P-2000 system is economical and self-installable by the customer. Supermarkets, bookstores, video stores and specialty stores remain good prospects for MM systems due to the small size and low cost of Micro-Magnetic strips. Knoscape MM Systems feature updated digital electronics. Knoscape MM Systems detect virtually all manufacturers' magnetic strips and can universally replace older magnetic strip systems manufactured by various EAS vendors. The library market continues to be a substantial market for magnetic technology. We were subject to an agreement not to compete against 3M for sales and service of EAS Systems in the library market, which expired in March 2004. During the years ended December 31, 2005 and 2004, Sentry placed in service 450 and 202 EAS systems, respectively. In addition in 2005, we sold 23 QuickCheck patron self check systems to libraries. BACKLOG Our backlog of orders was approximately $1.2 million at December 31, 2005, as compared to approximately $2.2 million at December 31, 2004 and approximately $3.2 million at December 31, 2003. We have experienced a trend, particularly with our major customers, of receiving fewer long-term blanket orders than in the past. We anticipate that substantially all of the backlog present as of December 31, 2005 will be delivered within 12 months. SEASONAL ASPECTS OF THE BUSINESS Our current customers are primarily dependent on retail sales, which are seasonal and subject to significant fluctuations and are difficult to predict. SERVICE Installation services are performed by our personnel and by carefully screened and supervised subcontractors as well as authorized dealers and distributors. Repair and maintenance services are performed primarily by our personnel. All products sold are covered by a warranty period, generally, one year. After the warranty period, we offer our customers the option of entering into a maintenance contract with the Company or paying for service on a per call basis. Installations of SentryVision systems typically take from three days to several weeks and involve mounting the enclosures, installing the controller unit, installing the carriage assembly, and connecting control and transmission cables to the central monitoring location. Items such as high voltage power termination wiring are typically the responsibility of the end user. The use of subcontractors supervised by Company employees proved cost effective with no apparent sacrifice in quality. A network of qualified contractors was established. The loss of the Lowe's maintenance contract in the beginning of 2005, lead to a reduction of technician headcount to 14. In 2005, we released 9 employees and retained only our most technically skilled employees. Our technical staff now focuses on EAS, SentryVision and CCTV service and maintenance and we rely on our well-established partner network for installation work. The model remains cost-effective and allows us to scale our efforts up or down as business requires without the risk of a fixed cost structure. This strategy has resulted in significant cost savings. In addition, we retain our reputation for technical expertise within the industry. We anticipate that this level of coverage will be adequate, coupled with our maturing Service Partner Network, to service our customer base. Our Design Center personnel continued to screen all service requests over the telephone, avoiding costly service calls. In addition, careful screening allowed us to ship replacement parts in advance of the technician's arrival increasing our ability to complete calls in a single visit. COMPETITION We operate in a highly competitive market with many companies engaged in the business of furnishing security services designed to protect against shoplifting and theft. In addition to EAS systems using the concept of tagged merchandise, such security services use, among other things, conventional PTZ dome and fixed mount CCTV systems, traveling CCTV systems, mirrors, guards, private detectives and combinations of the foregoing. We compete principally on the basis of the nature and quality of its products and services and the adaptability of these products to meet specific customer needs and price requirements. To our knowledge, there are several other companies that market, directly or through distributors, conventional closed circuit video systems and/or EAS equipment to retail stores, of which Sensormatic (acquired by Tyco/ADT), Checkpoint Systems, Inc., GE Security, Pelco Manufacturing, Inc., Panasonic, Inc. and Honeywell are the Company's principal competitors. Outside the U.S., we are aware of other companies that market other types of traveling CCTV systems including Lextar Technologies, Ltd. in Australia, T.E.B., Sensormatic and DETI in France and Moving Cameras Ltd. in the UK. Some of our competitors have far greater financial resources, more experienced marketing organizations and a greater number of employees than the Company. PATENTS AND OTHER INTELLECTUAL PROPERTY Although patent protection is advantageous to Sentry, we do not consider any single patent or patent license we own or hold to be material to our operations. We believe that our competitive position ultimately will depend on our experience, know-how and proprietary data, engineering, marketing and service capabilities and business reputation, all of which are outside the scope of patent protection. SentryVision - ------------ Sentry has a United States patent covering the cable-free transmission of a video signal to and from the carriage. This technology prevents degradation of the video signal, which can result from the movement of and prolonged friction caused by the carriage. Three additional U.S. patents were received for improvements made to the original technology, which has been incorporated into the SmartTrack product. Sentry also has received a corresponding European patent and eleven foreign country patents. We intend to seek patent protection on specific aspects of the SentryVision system, as well as for certain aspects of new systems which may be developed for Sentry. There can be no assurance that any patents applied for will be issued, or that the patents currently held, or new patents, if issued, will be valid if contested or will provide any significant competitive advantage to Sentry. We are not aware of any infringement of patents or intellectual property held by third parties. However, if Sentry is determined to have infringed on the rights of others, Sentry may be required to obtain licenses from such other parties. There can be no assurance that the persons or organizations holding desired technology would grant licenses at all or, if licenses were available, that the terms of such licenses would be acceptable to the Company. In addition, we could be required to expend significant resources to develop non-infringing technology. Sentry has also relied on the registration of trademarks and trade names, as well as on trade secret laws and confidentiality agreements with its employees. While we intend to continue to seek to protect Sentry's proprietary technology and developments through patents, trademark registration and confidentiality agreements, we do not rely on such protection to establish and maintain Sentry's position in the marketplace. Management believes that improvement of Sentry's existing products, reliance upon trade secrets and on unpatented proprietary know-how, and the development of new products will be as important as patent protection in establishing and maintaining a competitive advantage. EAS Products - ------------- Sentry has 21 United States and Canadian patents and one patent application relating to (i) the method and apparatus for the detection of movement of articles and persons and accessory equipment employed by Sentry in its Knoscape RF, Ranger and Knoscape MM systems, (ii) various specific improvements used in the Knoscape RF, Ranger and Knoscape MM systems and (iii) various electrical theft detection methods, apparatus and improvements not presently used in any of Sentry's EAS systems. Product Authentication - ----------------------- Sentry's Custom Security Industry subsidiary has two United States patents related to a product authentication. One patent is for a system that measures certain magnetic properties of a marker with an electronic reader utilizing an electromagnetic search field and the second patent is for a unique reader suitable for this system. RESEARCH AND DEVELOPMENT As of December 31, 2005, Sentry Technology Corporation had 8 full time employees engaged in research, engineering, product development and design. In addition, the Company may retain consultants to assist in specific areas related to research, engineering and product development. For the years ended December 31, 2005, 2004 and 2003, approximately $0.9 million, $0.8 million and $0.7 million, respectively, was expended on Company-sponsored research. The SmartTrack System continued to benefit from product improvement efforts focused on adding features and reducing the cost of manufactured products. Continued software developments during 2005 resulted in improved user interfaces, additional support for industry protocols, and allowed the use of a wider range of camera options. Also in 2005, we commenced work with a design firm for the development of the next generation SmartTrack system. Additional projects included revisions to EAS products. EM product offerings were enhanced through development of a new antenna panel called WAM, which was released in 2005. The design incorporates a contemporary furniture style that compliments a wide variety of environments. Technological advances in the design simplify the installation process and result in a more reliable system. In addition, internal development in RF Systems focused on cost reductions in the swept RF wrap desk and improvements to our customer installable systems. REGULATION Because Sentry's EAS and CCTV systems use radio transmission and electromagnetic wave principles, such systems are subject to regulation by the Federal Communications Commission ("FCC") under the Communications Act of 1934. In those instances where it has been required, certification of such products by the FCC has been obtained. As we develop new products, application will be made to the FCC for certification or licensing when required. No assurance can be given that such certification or licensing will be obtained or that current rules and regulations of the FCC will not be changed in an adverse manner. Our business plan calls for the sale and use of Sentry's products in domestic markets and, where consistent with contractual obligations, in international markets. Sentry's products may be subject to regulation by governmental authorities in various countries having jurisdiction over electronic and communication use. We intend to apply for certification of our products to comply with the requirements under the regulations of the countries in which we plan to market our products. No assurance can be given that such certification will be obtained or that current rules and regulations in such countries will not be changed in a manner adverse to Sentry. We believe we are in material compliance with applicable United States, state and local laws and regulations relating to the protection of the environment. EMPLOYEES At December 31, 2005, the Company and its subsidiaries employed 83 full-time employees, of whom 17 were employed in administrative and clerical capacities, 8 in engineering, research and development, 25 in production and manufacturing support, 16 in sales and marketing and 17 in customer service and support. None of our employees are employed pursuant to collective bargaining agreements. Item 2. PROPERTIES - -------------------- Our principal executive, administrative offices, research and development and distribution facilities are located in Ronkonkoma, New York, in a 20,000 square foot facility leased by the Company. In addition, we maintain a sales, administrative and distribution office in a leased 7,400 square foot facility in Toronto, Ontario. Our CSI subsidiary leases facilities for manufacturing and distribution totaling 7,000 square feet located in Thornhill, Ontario. Item 3. LEGAL PROCEEDINGS - ---------------------------- In August 2004, Bi-County Park Associates, Inc. d/b/a Ashlind Properties brought an action against us in the Supreme Court of New York, County of Suffolk, for the recovery of a real estate brokerage commission in the amount of $250,000 relating to the termination of its lease on its former Hauppauge facility. We are still in the discovery stages related to this action. We believe there is no merit to this claim and we are actively defending such action. Although we are involved in ordinary, routine litigation incidental to our business, we are not presently a party to any other legal proceeding, the adverse determination of which, either individually or in the aggregate, would be expected to have a material adverse affect on the Company's business or financial condition. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - --------------------------------------------------------------------- During the fourth quarter of fiscal year ended December 31, 2005, there were no matters submitted to a vote of the Company's security holders through the solicitation of proxies or otherwise. PART II ------- Item 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER - ------------------------------------------------------------------------------ MATTERS - ------- (a) Price Range of Common Stock. The following table sets forth, for the periods indicated, the high and low sales prices per share of common stock: High Low ---- --- 2004 First Quarter $ 0.25 $ 0.12 Second Quarter 0.29 0.14 Third Quarter 0.18 0.10 Fourth Quarter 0.19 0.09 2005 First Quarter $ 0.24 $ 0.15 Second Quarter 0.16 0.10 Third Quarter 0.13 0.09 Fourth Quarter 0.15 0.09 2006 First Quarter $ 0.15 $ 0.08 Second Quarter (through April 12, 2006) $ 0.12 $ 0.11 The Company's Common Stock is quoted on the OTC Bulletin Board ("OTCBB") under the symbol SKVY. (b) Holders of Common Stock. As of April 12, 2006, the Company had 120,728,804 shares of Common Stock issued and outstanding, which were held by approximately 359 holders of record. (c) Dividends. The payment of future dividends will be a business decision to be made by the Board of Directors of Sentry from time-to-time based upon the results of operations and financial condition of Sentry and such other factors as the Board of Directors considers relevant. Sentry has not paid, and does not presently intend to pay or consider the payment of, any cash dividends on the Common Stock. In addition, covenants in the Company's credit agreements prohibit the Company from paying cash dividends without the consent of the lenders. (d) Securities Authorized for Issuance Under Equity Compensation Plans. For a description of the Company's equity securities authorized for issuance as described in Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," see Notes to our Financial Statements, Note 1.o. "Significant Accounting Policies, Stock-Based Compensation," and Note 9, "Common Shareholders' Equity." Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - -------- ----------------------------------------------------------------- AND RESULTS OF OPERATIONS ---------------------------- Critical Accounting Policies Management's discussion and analysis of its financial position and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Actual results could differ from those estimates. Management believes that the critical accounting policies and areas that require the most significant judgments and estimates to be used in the preparation of the consolidated financial statements are allowance for doubtful accounts, inventory obsolescence and accrued warranty. Allowance for Doubtful Accounts -- We maintain an allowance for doubtful trade accounts receivable for estimated losses resulting from the inability of our customers to make required payments. In determining collectibility, we review available customer financial statement information, credit rating reports as well as other external documents and public filings. When it is deemed probable that a specific customer account is uncollectible, that balance is included in the reserve calculation. Actual results could differ from these estimates under different assumptions. Inventory Obsolescence --We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual future demand or market conditions are less favorable than those we project, additional inventory write-downs may be required. Impairment of long-lived assets -- We review our long-lived assets, property and equipment, intangible assets, goodwill and other assets for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be fully recoverable. Impairment is measured at fair value. If impairment indicators exist, we determine whether the projected undiscounted cash flows will be sufficient to cover the carrying value of such assets. This requires us to make significant judgments about the expected future cash flows of the asset group. The future cash flows are dependent on general and economic conditions and are subject to change. Accrued Warranty -- We provide for the estimated cost of product warranty at the time revenue is recognized. We calculate the reserve utilizing historical product failure rates and service repair costs by product family. These rates are reviewed and adjusted periodically. We utilize judgment for estimating these costs and adjust our estimates as actual results become available. Revenue Recognition -- We offer our security devices for sale or lease. We recognize revenue when installation is complete or other post-shipment obligations have been satisfied. For those products not requiring installation, or if installation costs are not material, the Company recognizes revenues upon shipment. Service revenues are recognized when earned and maintenance revenues are recognized ratably over the service contract period. Related Party Transactions -- Details of related party transactions are included in Item 12 and in Notes 2 and 12 of the Financial Statements of this Form 10-KSB. Selected Financial Data - ------------------------- The table below sets forth selected consolidated historical financial data of the Company for the years ended December 31, 2001, 2002, 2003, 2004 and 2005. The selected consolidated historical financial data should be read in conjunction with the Consolidated Financial Statements of the Company included in Item 7.
(Amounts in thousands except for per share data) Years Ended December 31, 2001 2002 2003 2004 2005 -------- -------- -------- ------- -------- Selected Statement of Operations Data: - ------------------------------------- Total revenues $17,299 $14,704 $13,243 $16,863 $13,570 Cost of sales 8,879 7,382 5,179 6,351 5,960 Customer service expenses 4,361 4,240 3,977 4,175 2,654 Selling, general and administrative expenses 5,773 5,287 3,809 4,840 5,348 Restructuring and impairment charges - - - - - Income (loss) before income taxes (2,911) (3,356) (1,049) 253 (1,581) Extraordinary item - Gain on extinguishment of debt - - 738 - - Cumulative effect of change in accounting principal - - - - - Net income (loss) (2,911) (3,356) 181 31 (1,690) Preferred stock dividends 25 - - - - Return to common shareholders from redemption of preferred stock . 27,198 - - - - Net income (loss) available to common shareholders 24,262 (3,356) 181 31 (1,690) Net income (loss) per common share: Basic 0.40 (0.05) 0.00 0.00 (0.01) Diluted 0.39 (0.05) 0.00 0.00 (0.01) As of December 31, Selected Balance Sheet Data: 2001 2002 2003 2004 2005 -------- -------- -------- ------- -------- Working capital . $ 2,235 $ (768) $ (285) $ 4,545 $ 3,037 Total assets . 11,561 7,992 4,093 12,247 9,395 Property, plant and equipment, net . 2,962 2,563 209 689 637 Obligations under capital leases . 2,751 2,652 18 13 7 Convertible debentures - - - 1,862 1,904 Minority interest - - - 1,045 1,140 Total common shareholders' equity (deficit) 2,891 (451) (125) 4,345 2,698
Results of Operations Year Ended December 31, 2005 Compared with Year Ended December 31, 2004 On April 30, 2004, Sentry purchased from Saburah Investments, Inc. all of the outstanding common shares and Series "A" preference shares of ID Security Systems Canada, Inc., and all of the outstanding capital stock of ID Systems USA, Inc. (collectively, "ID Systems"). ID Systems is a Toronto based company engaged in anti-shoplifting technology, security labeling, radio frequency identification (RFID), access control and library security. Our consolidated statements of operations include the revenues and expenses of ID Systems from May 1, 2004. Effective January 1, 2005, ID Systems changed the name of ID Security Systems Canada Inc. and ID Systems USA Inc. to Sentry Technology Canada Inc. and Sentry Technology USA Inc., (collectively "Sentry Canada"). Consolidated revenues were 20% lower in the year ended December 31, 2005 than in the year ended December 31, 2004. Sentry Canada's revenues for the twelve months ended December 31, 2005 represented $5.6 million of total revenues compared with $4.1 million of total revenues for the eight month period included in the year ended December 31, 2004. Our backlog of orders was approximately $1.2 million at December 31, 2005, as compared to approximately $2.2 million at December 31, 2004. We have experienced a trend, particularly with our major customers, of receiving fewer long-term blanket orders than in the past. We anticipate that substantially all of the backlog present as of December 31, 2005 will be delivered within 12 months. Total revenues for the periods presented are broken out as follows: % 2005 2004 Change ---- ---- ------ (in thousands) EAS $ 6,490 $ 5,358 21 CCTV 1,670 3,272 (49) SentryVision 2,971 3,852 (23) ----- ----- ---- Total sales 11,131 12,482 (11) Service, installation and other 2,439 4,381 (44) ----- ----- ---- Total revenues $ 13,570 $ 16,863 (20) ======== ======== ==== The increase in EAS sales is primarily attributable to Sentry Canada's sales, which represented $5.3 million of EAS sales in 2005 compared to $3.8 million in 2004. In January 2005, we were notified by Lowe's Home Center, historically our largest customer, that they would not be renewing their maintenance contract for 2005. While the annual value of the maintenance contract was approximately $0.9 million, it contributed towards the selection of vendors for replacement and add-on CCTV business in new and existing Lowe's locations. As a result, revenues from Lowe's decreased from $5.0 million in 2004 to $1.0 million in 2005. As Lowe's purchased both CCTV and SentryVision products this reduction affected the reported sales in both categories. We anticipate that this decision will continue to result in a decrease in future revenues from Lowe's on a comparative basis. We have added new sales representatives and new customers that have somewhat offset the loss of Lowe's sales in 2005. As a result, we anticipate that our business will be more balanced and will be less reliant on a single large customer for future success. Sales to our international dealers and distributors represented $1.3 million of total SentryVision sales in 2005 as compared to $1.6 million in 2004. Our sales of SentryVision products to our international dealers and distributors are denominated in U.S. dollars, therefore the strengthening of the U.S. dollar against the Euro in 2005 had no significant impact on reported revenues. Both service and installation revenues were significantly lower in the 2005 periods, as compared to the same periods of 2004, due to lower domestic sales of CCTV and SentryVision systems. Even though EAS sales increased, the installation revenues associated with EAS systems are lower than for CCTV and SentryVision sales. Maintenance revenues were also lower primarily as a result of cancellation of the Lowe's maintenance contract. Sales reps and international distributors have been added to the sales group plus new print ads and trade show attendance will assist in improving our sales results. In addition, our flagship SmartTrack traveling camera system and proprietary library security and information systems require little maintenance, which has helped both to reduce service costs and allow our sales reps to develop new business as a result of strong references from many satisfied national and international customers. In January 2006, we received orders from J.C. Penney and Target for installation of SentryVision SmartTrack traveling camera systems in five distribution centers. Both customers are among the 10 largest retailers in America and are repeat users of our flagship products with budgets allocated for the acquisition of additional SmartTrack systems in 2006. Cost of sales was 54% of sales in 2005 compared to 51% in 2004. We continue to see strong domestic margin improvements in 2005 on the SmartTrack product lines as a result of our outsourcing of manufacturing. However, our comparative margins on international SmartTrack sales have been reduced in 2005, due to competitive pressures. Sentry Canada's sales increased as a percentage of total sales in 2005, compared to 2004. As a percentage of sales, Sentry Canada's cost of sales are higher than Sentry's historical costs as a portion of its sales are made through dealers and distributors that carry lower margins than sales made direct to end users. In addition, lower production volume at our 51% owned labeling subsidiary resulted in higher overhead and a higher cost of sales percentage in first half of 2005. The decrease in customer service expenses in 2005, as compared 2004, is primarily a result of a decrease in the number of customer service employees and increased use of outside service contractors in order to better manage our total net customer service costs during fluctuations in activity levels between periods. Selling, general and administrative expenses were 10% higher in 2005 as compared to 2004. The increase in such expenses, on a comparable basis, is principally a result of higher sales and marketing expenses and higher foreign exchange losses. The increase in such expenses 2005 is principally a result of twelve full months of Sentry Canada expenses in 2005, compared to eight months in the 2004 period. Included in selling, general and administrative expenses were foreign exchange losses (gains) of $133,000 in 2005, compared to $79,000 in 2004. The change in the foreign currency exposure is a result of the global credit facility entered into in the second quarter of 2005, which is denominated in Canadian dollars. We are currently working with our lender to develop the most efficient hedging strategies to mitigate this exposure. We have made certain administrative expense reductions to help compensate for the reduction in Lowe's business. In October 2005, we consolidated our accounting and distribution functions from our Toronto, Ontario facility to Ronkonkoma, NY resulting in the elimination of duplicate functions while further streamlining operations. At the same time, we have increased funding of sales and marketing programs, which we expect will continue to increase our business with new and existing customers. Four new sales persons were hired in 2005 with substantial industry experience. In addition, we recently hired a new VP of Sales and Marketing, with prior experience with our industry's largest competitor, to lead the growing team of sales professionals and to focus on establishing the Sentry brand name as a market leader. Many new sales opportunities are being developed that we anticipate will have a positive impact on future revenues. New programs include a marketing campaign to promote SentryVision to Homeland Security and the appointment of a new distributor for the Brazilian market to sell EAS products to the library market and SentryVision systems to all customers. Research and development costs increased 3% in 2005, compared to 2004, principally as a result of the inclusion of twelve months of research efforts of Sentry Canada in 2005, compared to eight months in 2004. Total interest and financing costs were lower in 2005, compared to 2004, as a result of lower average bank debt and lower interest rates under the new credit agreement as well as a result of the elimination of costly financing associated with purchase order financing included in the first half of 2004. The income tax provision of $ 49,000 in 2005, and $140,000 in 2004, principally results from taxable income of our ID Systems subsidiaries, which cannot be offset by Sentry's net operating loss carryforwards. As a result of the foregoing, we had net loss of $1,690,000 in the year ended December 31, 2005, as compared to net income of $31,000 in the year ended December 31, 2004. Year Ended December 31, 2004 Compared with Year Ended December 31, 2003 Our consolidated statements of operations include the revenues and expenses of Sentry Canada from May 1, 2004. Consolidated revenues were 27% higher in the year ended December 31, 2004 than in the year ended December 31, 2003 Sentry Canada's revenues for the eight months period ended December 31, 2004 represented $4.1 million of total revenues. The backlog of orders, which we expect to deliver within twelve months, decreased to $2.2 million at December 31, 2004 as compared to $3.2 million at December 31, 2003. We believe this is due in part to a trend, particularly from our major customers, of awarding fewer long-term blanket orders than in the past. Total revenues for the periods presented are broken out as follows: % 2004 2003 Change ---- ---- ------ (in thousands) EAS $ 5,358 $ 1,914 180 CCTV 3,272 3,699 (12) SentryVision 3,852 3,133 23 ----- ----- -- Total sales 12,482 8,746 43 Service, installation and other 4,381 4,497 (3) ----- ----- -- Total revenues $ 16,863 $ 13,243 27 ========= ======== == The increase in sales of EAS products in 2004 was attributable to Sentry Canada's sales, which represented $3.8 million of the total. Sentry's historical comparative sales of EAS systems and tags decreased in 2004. The decrease in CCTV revenues is primarily a result of lower sales to two customers. We had sales of $0.6 million in 2003 to Home Depot, which did not repeat in 2004 and we lost $0.5 million in revenues in 2004 from a significant customer that decided to source their purchases from the CCTV manufacturer. SentryVision sales increased both domestically and internationally. Sales to our international dealers and distributors represented $1.6 million of total SentryVision sales in 2004 as compared to $1.2 million in 2003. Our sales of SentryVision products to our international dealers and distributors are denominated in U.S. dollars, therefore the strengthening of the Euro against the U.S. dollar had no significant impact on revenues. Service, installation and other revenues decreased 2004 primarily as a result of lower CCTV installations than in 2003. Even though EAS sales increased substantially, the installation revenues associated with EAS systems are significantly lower than those for CCTV and SentryVision sales. In addition, Lowe's negotiated a lower rate per store for the maintenance contract in 2004 than in 2003. Total revenues from Lowe's Home Centers represented $5.0 million in 2004 as compared to $5.8 million in 2003. Of the $0.8 million decrease, $0.6 million was a reduction in SentryVision sales and $0.2 million was a reduction in service and installation income. Cost of sales was 51% of sales in 2004, compared to 59% in 2003. We continue to see margin improvements as a result of the outsourcing of all significant manufacturing operations, which we began in the second quarter of 2003. The decrease in the cost of sales percentage in 2004 as compared to 2003 is primarily the result of the elimination of the charge to cost of sales of under absorbed fixed overhead costs due to the termination of in-house manufacturing and the move to a smaller facility. As a percentage of sales, the costs associated with Sentry Canada's sales were slightly higher than Sentry's historical costs as a higher portion of their sales are made through dealer and distributors which carry lower margins than sales made direct to end users. Our customer service expenses increased by 5% in 2004, as compared to 2003. Of the increase 4% was due to the Sentry Canada acquisition. In 2004, we decreased the number of customer service employees and increased the use of outside service contractors in order to manage our total net customer service costs during fluctuations in activity levels between periods. However, our efforts were hampered somewhat by our inability to maintain a proper level of service parts during the first six months of 2004, due to inadequate trade credit and financial resources, which resulted in inefficiencies. Selling, general and administrative expenses were 27% higher in 2004 when compared to 2003. While our historical costs decreased as a result of our restructuring in 2003, our acquisition of Sentry Canada added $1.1 million in selling, general and administrative expenses during the eight months they were included in the 2004 results. The increase in research and development costs in 2004, when compared to 2003, is also primarily a result of the Sentry Canada acquisition. As a result of the restructuring of operations, the increase in sales activity levels and the acquisition of Sentry Canada, we were able to show operating income of $0.7 million in 2004 as compared to an operating loss of $0.4 million in 2003. Total interest and financing costs decreased by $259,000 in 2004, as compared to 2003. Bank interest expense increased by $39,000 in 2004, due to higher average borrowings and slightly higher interest rates under our revolving credit and term loan facility with CIT and the Sentry Canada credit facility with Bank of Montreal. Interest under capital leases decreased by $156,000, as a result of the cancellation of the sale and leaseback agreement on our former headquarters facility. While interest and financing costs related to the Brookfield Technology financing added $151,000 in 2004, we were able to eliminate, in the second half of 2004, the costly financing costs associated with purchase order financing, resulting in a savings of $293,000 for the entire year. During 2003, we entered into settlements with certain vendors for past due obligations which resulted in a gain of approximately $526,000 (net of $351,000 income taxes), which represents the difference between the amounts due before the settlement and the total amount payable, including the value of the common stock, as a result of the settlement. In addition, on July 9, 2003, we entered into a settlement agreement with our former landlord regarding the termination of its long-term capital and operating leases for our facility in Hauppauge, New York. We recognized an extraordinary gain of $212,000 (net of $141,000 income taxes) in 2003, representing the difference between the carrying amounts of outstanding obligations to the landlord less the net book value of the property on the date of the settlement. The income tax provision of $140,000 in 2004 principally results from taxable income of our Sentry Canada subsidiaries, which cannot be offset by Sentry's net operating loss carryforwards. The $492,000 income tax provision recognized on the extraordinary gains in 2003 was offset by equivalent income tax benefits generated from the 2003 loss from operations and the utilization of net operating loss carryforwards. As a result of the foregoing, we had net income of $31,000 in the year ended December 31, 2004 as compared to $181,000 in the year ended December 31, 2003. Liquidity and Capital Resources At December 31, 2005, we had cash of $0.8 million, working capital of $3.0 million, total assets of $9.4 million and shareholders' equity of $2.7 million. While we had a loss of $1.7 million in 2005, our net cash used in operating activities was only $242,000. This was a result of lower amounts of accounts receivable partially as a result of better collections efforts as well as lower sales volume. We have also eliminated the use of expensive purchase order financing to fund inventory purchases and we are continuing to reestablish credit with new and existing vendors. We utilized $0.8 million in financing activities through a pay down of balances under our previous credit facilities. Availability under the credit facilities is principally based on the level of our receivables and inventory, which declined in 2005. Net reductions in our credit facilities were funded through the use of existing cash. On May 13, 2005, the Company and certain of its subsidiaries entered into a new secured credit facility with Royal Bank of Canada ("RBC") for maximum borrowings of up to Canadian $4.5 million (U.S. $3.9 million), which are subject to certain limitations based on a percentage of eligible accounts receivable and inventories as defined in the agreement. Interest is payable at a rate of RBC prime rate (5.0% at December 31, 2005), plus 1.25% per annum. Borrowings under this facility are secured by substantially all of the Company's assets. This new facility replaced the Company's former revolving credit agreement in the United States and its overdraft lending and term loan agreement in Canada. The consolidation of our credit facilities is another step in our efforts to improve operating efficiencies and to further reduce our costs of financing. The new facility also provides for limited financing of certain foreign receivables, which may provide additional future availability over the previous facilities. As of December 31, 2005, we had borrowings of approximately $2.0 million with RBC and had excess borrowing capacity of $0.5 million. As of the end of the third and fourth quarters of 2005, the Company failed to meet one of its financial covenants under the Royal Bank agreement. Subsequent to year end, the Company received from RBC a tolerance of default and waiver of the covenant as of those dates. In addition, on January 23, 2006, the agreement was amended with regard to certain financial and reporting covenants and the interest rate increased to RBC prime rate plus 1.75%. We will require liquidity and working capital to finance increases in receivables and inventory associated with sales growth, payments to past due vendors and, to a lesser extent, for capital expenditures. We had no material capital expenditure or purchase commitments, other than the Dialoc distribution agreement, as of December 31, 2005. Sentry's revenues declined and we incurred an operating loss in 2005. This trend continued through the first quarter of 2006 and substantially reduced the Company's available cash reserves and limited our ability to secure additional bank financing. The Company has instituted certain plans to increase its revenue base as well as preserve its cash, including cost cutting measures and inventory reduction initiatives. We are presently in the final stages of negotiations with RBC, our lender, to amend our credit agreement by further modifying certain financial covenants and by extending the term of the agreement through April 2007. Mr. Murdoch, Sentry's CEO and Director and Mr. Furst, a Sentry Director, have agreed to provide a personal guarantee to RBC in the amount of Canadian $1 million (U.S. $860,000) in exchange for the bank providing increased availability under its credit facility to the Company by the same amount. In consideration of these guarantees, Mr. Murdoch and Mr. Furst will receive a fee of $43,000, to be shared between them, paid in 12 equal monthly installments. As additional consideration, they will receive fully vested, two year warrants to purchase between 2.9 million and 3.8 million shares of the Company's common stock, at an exercise price ranging between $0.075 and $0.10 per share, dependent upon certain stock market conditions. The fair value of these warrants will be recorded in accordance with SFAS No. 123R "Share-Based Payment" in the second quarter of 2006 and will be written off over the period of the guarantee. After conversations with RBC, management believes that these amendments will be approved in the near future. Based upon the achievement of its plans, as well as the additional borrowing availability as a result of the Directors guaranties, the Company believes that it will have sufficient cash to meet its anticipated operating costs, capital expenditures and debt service requirements for at least the next twelve months. On March 28, 2005, our Board of Directors and a majority of the outstanding shareholders approved an increase in the authorized number of Sentry's common shares from 140,000,000 to 160,000,000, principally in order to meet the requirements of the Brookfield Technology Fund investment. The table below summarizes aggregate maturities contractual obligations as of December 31, 2005. Less Contractual than 1-3 4-5 After 5 Obligations Total 1 Year Years Years Years - ----------- ----- ------ ----- ----- ------- (In Thousands) Operating leases $ 1,009 $ 285 $ 533 $ 191 $ - Capital leases 8 7 1 - - Notes payable & term loans 91 91 - - - Convertible debentures 2,000 - 2,000 - - ------- ----- ------ ----- -------- Total $ 3,108 $ 383 $2,534 $ 191 $ - ======= ===== ====== ===== ======== Recent Accounting Pronouncements In November 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 151, "Inventory Costs, an amendment of ARB No. 43, Chapter 4". This statement amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing" to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). SFAS No. 151 requires that those items be recognized as current period charges. In addition, this statement requires that allocation of fixed production overheads to costs of conversion be based upon the normal capacity of the production facilities. The provisions of SFAS No. 151 are effective for inventory costs incurred in fiscal years beginning after June 15, 2005. The Company is currently evaluating the impact of SFAS No. 151 on its consolidated financial statements. In December 2004, the FASB issued SFAS No. 153, "Exchanges of Non-monetary Assets, an amendment of APB Opinion No. 29". SFAS No. 153 replaces the exception from fair value measurement in APB Opinion No. 29 for non-monetary exchanges of similar productive assets with a general exception from fair value measurement for exchanges of non-monetary assets that do not have commercial substance. A non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is to be applied prospectively, and is effective for non-monetary asset exchanges occurring in fiscal periods after the December 2004 issuance of SFAS No. 153. The Company does not believe the adoption of SFAS No. 153 will be significant to the overall results of operations or financial position. In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123R"). SFAS No. 123R requires the Company to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost of the employee services is recognized as compensation cost over the period that an employee provides service in exchange for the award. Beginning with the Company's first quarter of fiscal year 2006, it will be required to adopt SFAS 123(R), and will recognize share-based compensation costs in its results of operations. The Company currently provides pro forma disclosures under SFAS 123 reflecting the effects of share-based compensation costs on its results of operations in Note 8 to consolidated financial statements. Although such pro forma effects of applying SFAS 123 may be indicative of the effects of adopting SFAS 123(R), the provisions of these two statements differ in some important respects. The actual effects of adopting SFAS 123(R) will be dependent on numerous factors including, but not limited to, levels of share-based payments granted in the future and the timing thereof; the valuation model chosen by the Company to value stock-based awards; the assumed award forfeiture rate; the accounting policies adopted concerning the method of recognizing the fair value of awards over the service period; and the transition method chosen for adopting SFAS 123(R), which permits public companies to adopt its requirements using various methods, including the "modified prospective application method" and the "modified retrospective application method." The Company plans to adopt SFAS 123(R) using the modified prospective application method. The Company expects that the adoption of SFAS 123(R) may have a material impact on its results of operations subsequent to adoption. SFAS No. 123R will be effective January 1, 2006 for the Company and may be adopted using a modified prospective method or a modified retrospective method. Although the Company has not yet completed an analysis to quantify the exact impact the new standard will have on its future financial performance, the disclosures in Note 8 provide detail as to the Company's financial performance as if the Company had applied the fair value-based method and recognition provisions of SFAS No. 123R to stock-based employee compensation to the current reporting periods. In March 2005, the FASB issued FASB Staff Position ("FSP") No. 46(R)-5, "Implicit Variable Interests under FASB Interpretation No. ("FIN") 46 (revised December 2003), Consolidation of Variable Interest Entities" ("FSP FIN 46R-5"). FSP FIN 46R-5 provides guidance for a reporting enterprise on whether it holds an implicit variable interest in Variable Interest Entities ("VIEs") or potential VIEs when specific conditions exist. This FSP is effective in the first period beginning after March 3, 2005 in accordance with the transition provisions of FIN 46 (revised December 2003), "Consolidation of Variable Interest Entities - an Interpretation of Accounting Research Bulletin No. 51" ("FIN 46R"). The Company has determined that the adoption of FSP FIN 46R-5 will not have an impact on its results of operations and financial position. In March 2005, the FASB issued Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations" ("FIN 47"), which will result in (1) more consistent recognition of liabilities relating to asset retirement obligations, (2) more information about expected future cash outflows associated with those obligations, and (3) more information about investments in long-lived assets because additional asset retirement costs will be recognized as part of the carrying amounts of the assets. FIN 47 clarifies that the term "conditional asset retirement obligation" as used in SFAS No. 143, "Accounting for Asset Retirement Obligations", refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/or method of settlement. Uncertainty about the timing and/or method of settlement of a conditional asset retirement obligation should be factored into the measurement of the liability when sufficient information exists. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. The adoption of FIN 47 in 2005 did not have a material impact on the financial position or results of operations of the Company. In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections", which replaces APB Opinion No. 20, "Accounting Changes", and SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements - An Amendment of APB Opinion No. 28". SFAS No. 154 provides guidance on the accounting for and reporting of changes in accounting principles and error corrections. SFAS No. 154 requires retrospective application to prior period financial statements of voluntary changes in accounting principle and changes required by new accounting standards when the standard does not include specific transition provisions, unless it is impracticable to do so. SFAS No. 154 also requires certain disclosures for restatements due to correction of an error. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, and is required to be adopted by the Company as of January 1, 2006. The impact that the adoption of SFAS No. 154 will have on the Company's results of operations and financial condition will depend on the nature of future accounting changes adopted by the Company and the nature of transitional guidance provided in future accounting pronouncements. Inflation The Company does not consider inflation to have a material impact on the results of operations. Cautionary Statement Regarding Forward-Looking Statements The "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other sections of this Annual Report on Form 10-KSB contain "forward-looking statements" (as defined in the Private Securities Litigation Reform Act of 1995 or the "PSLRA") that are based on current expectations, estimates and projections about the industry in which the Company operates, as well as management's beliefs and assumptions. Words such as "expects," "anticipates" and "believes" and variations of such words and similar expressions generally indicate that a statement is forward-looking. The Company wishes to take advantage of the "safe harbor" provisions of the PSLRA by cautioning readers that many important factors discussed herein, among others, may cause the Company's results of operations to differ from those expressed in the forward-looking statements. These factors include: (i) the risk that any delay or cancellation of orders from one or more of Sentry's major customers may have a material adverse effect on the Company's financial condition; (ii) the risk that anticipated growth in the demand for the Company's products in the retail, commercial and industrial sectors will not develop as expected, whether due to competitive pressures in these markets or to any other failure to gain market acceptance of the Company's products; (iii) the risk that anticipated revenue growth through the domestic and international dealers programs does not develop as expected; (iv) the risk that the Company may not find sufficient qualified Service Partners to provide future installation services; (v) the risk that the Company will not be able to retain key personnel; (vi) the risk that the borrowing availability under our credit facilities will not be adequate to meet the Company's growth requirements; and (vii) the risk arising from the large market position and greater financial and other resources of Sentry's principal competitors, as described under "Item 1. Business-Competition." Item 7. FINANCIAL STATEMENTS - -------- --------------------- SENTRY TECHNOLOGY CORPORATION ----------------------------- AND SUBSIDIARIES ---------------- CONSOLIDATED FINANCIAL STATEMENTS --------------------------------- YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 -------------------------------------------- CONTENTS -------- Page ---- Reports of Independent Registered Public Accounting Firms 28 - 29 CONSOLIDATED FINANCIAL STATEMENTS: Balance sheets 30 Statements of operations 31 Statements of shareholders' equity 32 Statements of cash flows 33 Notes to financial statements 34 - 48 ------ Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Sentry Technology Corporation We have audited the accompanying consolidated balance sheet of Sentry Technology Corporation as at December 31, 2005 and the related consolidated statements of operations, shareholders' equity and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). These standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe our audit provides a reasonable basis for our opinion. In our opinion, such consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sentry Technology Corporation as at December 31, 2005 and the results of its consolidated operations, shareholders' equity and cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. The consolidated financial statements of Sentry Technology Corporation as of December 31, 2004 and 2003, were audited by other auditors whose report dated March 29, 2005, expressed an unqualified opinion on those statements. /s/ SF Partnership, LLP CHARTERED ACCOUNTANTS TORONTO, CANADA March 16, 2006 Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Sentry Technology Corporation Ronkonkoma, New York We have audited the accompanying consolidated balance sheet of Sentry Technology Corporation and subsidiaries (the "Company") as of December 31, 2004 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the two years in the period ended December 31, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Sentry Technology Corporation and subsidiaries as of December 31, 2004 and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2004 in conformity with U.S. generally accepted accounting principles. /s/ Holtz Rubenstein Reminick LLP Melville, New York March 29, 2005 SENTRY TECHNOLOGY CORPORATION ----------------------------- AND SUBSIDIARIES ---------------- CONSOLIDATED BALANCE SHEETS --------------------------- (In Thousands, Except Par Value Amounts)
December 31, ---------------------------- 2005 2004 -------------- ------------ ASSETS - ------------------------------------------------------------------ -------------- ------------ Current Assets: Cash and cash equivalents $ 842 $ 1,965 Accounts receivable, less allowance for doubtful accounts of $141 and $338, respectively 2,762 3,500 Inventories 2,709 3,314 Prepaid expenses and other current assets 318 525 -------------- ------------ Total current assets 6,631 9,304 PROPERTY AND EQUIPMENT, net 637 689 GOODWILL 1,564 1,564 OTHER ASSETS 563 690 -------------- ------------ $ 9,395 $ 12,247 ============== ============ LIABILITIES AND SHAREHOLDERS' EQUITY - ------------------------------------------------------------------ Current Liabilities: Revolving line of credit and term loan $ 2,039 $ 2,640 Accounts payable 489 799 Accrued liabilities 925 1,146 Obligations under capital leases - current portion 6 5 Deferred income 135 169 -------------- ------------ Total current liabilities 3,594 4,759 NOTES PAYABLE --- 189 OBLIGATIONS UNDER CAPITAL LEASES, less current portion 1 8 DEFERRED TAX LIABILITY 58 39 CONVERTIBLE DEBENTURES 1,904 1,862 MINORITY INTEREST 1,140 1,045 -------------- ------------ Total liabilities 6,697 7,902 COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY: Common stock, $0.001 par value; authorized 160,000 and 140,000 shares, respectively; issued and outstanding 120,629 and 120,549 shares, respectively 121 121 Additional paid-in capital 48,783 48,779 Accumulated deficit (46,408) (44,718) Equity adjustment from foreign currency conversion 202 163 -------------- ------------ Total shareholders' equity 2,698 4,345 -------------- ------------ $ 9,395 $ 12,247 ============== ============
See notes to consolidated financial statements SENTRY TECHNOLOGY CORPORATION ----------------------------- AND SUBSIDIARIES ---------------- CONSOLIDATED STATEMENTS OF OPERATIONS ------------------------------------- (In Thousands, Except Per Share Amounts)
Years Ended December 31, ------------------------------------------------------ 2005 2004 2003 ------------------------------------------------------ REVENUES: Sales $ 11,131 $ 12,482 $ 8,746 Service, installation and other revenues 2,439 4,381 4,497 -------------------------- ------------ ------------ 13,570 16,863 13,243 -------------------------- ------------ ------------ COST AND EXPENSES: Cost of sales 5,960 6,351 5,179 Customer service expenses 2,654 4,175 3,977 Selling, general and administrative expenses 5,348 4,840 3,809 Research and development 856 832 656 -------------------------- ------------ ------------ 14,818 16,198 13,621 -------------------------- ------------ ------------ OPERATING INCOME (LOSS) (1,248) 665 (378) INTEREST AND FINANCING EXPENSE, net 333 412 671 -------------------------- ------------ ------------ INCOME (LOSS) BEFORE INCOME TAXES, MINORITY INTEREST AND EXTRAORDINARY ITEM (1,581) 253 (1,049) INCOME TAX EXPENSE (BENEFIT) 49 140 (492) -------------------------- ------------ ------------ INCOME (LOSS) BEFORE MINORITY INTEREST AND EXTRAORDINARY ITEM (1,630) 113 (557) MINORITY INTEREST (60) (82) --- -------------------------- ------------ ------------ INCOME (LOSS) BEFORE EXTRAORDINARY ITEM (1,690) 31 (557) EXTRAORDINARY ITEM - Gain on extinguishment of debt, net of $492 income taxes --- --- 738 -------------------------- ------------ ------------ NET INCOME (LOSS) $ (1,690) $ 31 $ 181 ========================== ============ ============ BASIC INCOME (LOSS) PER COMMON SHARE: Income (loss) before extraordinary item $ (0.01) $ 0.00 $ (0.01) Extraordinary item 0.00 0.00 0.01 -------------------------- ------------ ------------ Net income (loss) $ (0.01) $ 0.00 $ 0.00 ========================== ============ ============ WEIGHTED AVERAGE BASIC COMMON SHARES 120,594 106,532 84,153 ========================== ============ ============
See notes to consolidated financial statements SENTRY TECHNOLOGY CORPORATION ----------------------------- AND SUBSIDIARIES ---------------- CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY ----------------------------------------------- (In Thousands) YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 --------------------------------------------
Note Additional Receivable Common Stock Paid-in Accumulated from Shares Amount Capital Deficit Shareholder ------------- -------- ------------ --------- --------------- BALANCE, January 1, 2003 78,044 $ 78 $ 44,521 $(44,930) $ (120) Net income - - - 181 - Settlement of debt and lease obligations 3,193 3 137 - - Net proceeds from common stock issued to Dialoc 4,517 5 - - - Exercise of stock options 2 - - - - ------------- -------- ------------ --------- --------------- BALANCE, December 31, 2003 85,756 86 44,658 (44,749) (120) Net income - - - 31 - Repayment of note receivable from shareholder - - - - 120 Issuance of warrants - - 215 - - Acquisition of ID Systems 30,000 30 3,270 - - Net proceeds from common stock sold to Saburah 4,795 5 636 - - Retired stock (5) - - - - Exercise of stock options 3 - - - - Equity adjustment from foreign currency translation - - - - - Comprehensive income - - - - - ------------- -------- ------------ --------- --------------- BALANCE, December 31, 2004 120,549 121 48,779 (44,718) - Net loss - - - (1,690) - Exercise of stock options 80 - 4 - - Equity adjustment from foreign currency translation - - - - - Comprehensive loss - - - - - ------------- -------- ------------ --------- --------------- BALANCE, December 31, 2005 120,629 $ 121 $ 48,783 $(46,408) $ - ============= ======== ============ ========= =============== Accumulated Total Other Shareholders' Comprehensive Comprehensive Equity Income Income (Deficit) (Loss) ------------- --------------- --------------- BALANCE, January 1, 2003 $ - $ (451) Net income - 181 $ 181 =============== Settlement of debt and lease obligations - 140 Net proceeds from common stock issued to Dialoc - 5 Exercise of stock options - - ------------- --------------- BALANCE, December 31, 2003 - (125) Net income - 31 $ 31 Repayment of note receivable from shareholder - 120 Issuance of warrants - 215 Acquisition of ID Systems - 3,300 Net proceeds from common stock sold to Saburah - 641 Retired stock - - Exercise of stock options - - Equity adjustment from foreign currency translation 163 163 163 --------------- Comprehensive income - - $ 194 ------------- --------------- =============== BALANCE, December 31, 2004 163 4,345 Net loss - (1,690) $ (1,690) Exercise of stock options - 4 Equity adjustment from foreign currency translation 39 39 39 --------------- Comprehensive loss - - $ (1,651) ------------- --------------- =============== BALANCE, December 31, 2005 $ 202 $ 2,698 ============= ===============
See notes to consolidated financial statements SENTRY TECHNOLOGY CORPORATION ----------------------------- AND SUBSIDIARIES ---------------- CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------- (In Thousands)
Years Ended December 31, ------------------------ 2005 2004 2003 ---------- ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (1,690) $ 31 $ 181 Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities: Depreciation 154 183 262 Amortization of intangibles and other assets 135 179 90 Provision for bad debts 1 (14) (16) Deferred income taxes 19 39 --- Non-cash consideration 59 63 --- Minority interest in net income of consolidated subsidiary 95 208 --- Extraordinary gain on extinguishments of debt --- --- (1,230) Changes in operating assets and liabilities: Accounts receivable 737 (823) 6 Inventories 605 (196) 1,290 Prepaid expenses and other assets 207 143 (129) Accounts payable and accrued liabilities (530) (557) 65 Deferred income (34) (102) (123) ---------- ------------ ------------ Net cash (used in) provided by operating activities (242) (846) 396 ---------- ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (102) (205) (81) Intangibles (25) (92) (16) Net cash provided by the acquisition of ID Systems --- 31 --- ---------- ------------ ------------ Net cash used in investing activities (127) (266) (97) ---------- ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowing (payments) on the revolving line of credit 220 329 (1,372) Proceeds of notes payable --- --- 247 Repayment of notes payable (189) (58) --- Proceeds of term loan --- --- 845 Repayment of term loan (821) (203) (25) Proceeds of bridge loan --- 100 --- Repayment of bridge loan --- (100) --- Proceeds of convertible debenture and warrants --- 2,000 --- Repayment of obligations under capital leases (7) (5) (55) Proceeds of sale of stock, net 4 641 5 ---------- ------------ ------------ Net cash provided by (used in) financing activities (793) 2,704 (355) ---------- ------------ ------------ EFFECT OF EXCHANGE RATE CHANGES 39 163 --- ---------- ------------ ------------ INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,123) 1,755 (56) CASH AND CASH EQUIVALENTS, beginning of year 1,965 210 266 ---------- ------------ ------------ CASH AND CASH EQUIVALENTS, end of year $ 842 $ 1,965 $ 210 ========== ============ ============ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 302 $ 341 $ 676 ========== ============ ============ Income taxes $ 83 $ 72 $ --- ========== ============ ============
See notes to consolidated statements SENTRY TECHNOLOGY CORPORATION ----------------------------- AND SUBSIDIARIES ---------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------ YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 ---------------------------------------------- 1. SIGNIFICANT ACCOUNTING POLICIES: --------------------------------- a. Business -------- Sentry Technology Corporation ("Sentry" or the "Company"), a publicly traded Delaware Corporation, was established on February 12, 1997. Its corporate predecessors had been in business for more than 39 years. The Company is engaged in the design, manufacture, distribution, installation and service of systems designed to be used by retailers to deter shoplifting and internal theft and by industrial and institutional customers to protect assets and people. b. Principles of consolidation ----------------------------- The consolidated financial statements include the accounts of the Company and its wholly owned and majority owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. c. Revenue recognition -------------------- The Company offers its security devices for sale or lease. For the years ended December 31, 2005, 2004 and 2003, leases of security devices were not material. The Company recognizes revenue when installation is complete or other post-shipment obligations have been satisfied. For those products not requiring installation or if installation costs are not material, the Company recognizes revenues upon shipment. Service revenues are recognized when earned and maintenance revenues are recognized ratably over the service contract period. Included in accounts receivable at December 31, 2005 and 2004 are unbilled accounts receivable of $36,000 and $129,000, respectively. d. Cash and cash equivalents ---------------------------- The Company considers all highly liquid temporary investments with original maturities of less than ninety days to be cash equivalents. Temporary cash investments are placed with high credit quality financial institutions. At times, the Company's cash deposits with any one financial institution may exceed federally insured limits. e. Allowance for doubtful accounts ---------------------------------- Losses from uncollectible accounts are provided for by utilizing the allowance for doubtful accounts method based upon management's estimate of uncollectible amounts. Management specifically analyzed accounts receivable and analyzes potential bad debts, customer concentrations, credit worthiness, current economic trends and changes in customer payment terms when evaluating the allowance for doubtful accounts. f. Inventories ----------- Inventories are stated at the lower of cost (first-in, first-out method) or market. g. Product warranty ----------------- Provisions for estimated expenses related to product warranties are made at the time products are sold. These estimates are established using historical information on the nature, frequency, and average cost of warranty claims. h. Depreciation and amortization ------------------------------- Depreciation of security devices on lease and property and equipment is provided for using the straight-line method over their related estimated useful lives. Security devices on lease generally have estimated useful lives of six years, except the cost of security devices related to operating leases with purchase options are depreciated over the life of the lease. i. Patents and other intangibles -------------------------------- Cost and expenses incurred in obtaining patents are amortized over the remaining life of the patents, not exceeding 17 years, on a straight-line basis. Costs assigned to other intangibles, including trade secrets, distribution agreements and customer relationships, are being amortized on a straight line basis over their estimated useful lives of 5 to 15 years. Estimated annual amortization expense for the next five succeeding fiscal years will range from $76,000 in 2006 to $9,000 in 2010. j. Goodwill -------- Goodwill represents the excess of acquisition cost over the fair value of net assets acquired in business combinations. In accordance with Statement of Financial Accounting Standards (SFAS) No. 142, goodwill is not amortized but reviewed annually for impairment. k. Impairment of long-lived assets ---------------------------------- The Company reviews its long-lived assets, property and equipment, intangible assets, goodwill and other assets for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be fully recoverable. To determine recoverability of its long-lived assets, the Company evaluates the probability that future undiscounted net cash flows, without interest charges, will be less than the carrying amount of the assets. Impairment is measured at fair value. The Company completed its annual review of impairment and determined that long-lived assets were not impaired. l. Fair value of financial instruments --------------------------------------- It is management's belief that the carrying amounts of the Company's financial instruments (cash and cash equivalents, accounts receivable, revolving line of credit, accounts payable and obligations under capital leases) approximate their fair value at December 31, 2005 and 2004 due to the short maturity of these instruments or due to the terms of such instruments approximating instruments with similar terms currently available to the Company. m. Deferred income ---------------- Deferred income consists of rentals related to operating leases and maintenance contracts billed or paid in advance. n. Income taxes ------------- The Company accounts for income taxes under SFAS No. 109, Accounting for Income Taxes, which requires an asset and liability approach to financial accounting and reporting for income taxes. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. o. Stock-based compensation ------------------------- The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS No. 123, Accounting for Stock-Based Compensation, requires the disclosure of pro forma net income and earnings per share had the Company adopted the fair value method as of the beginning of 1995. Under SFAS No. 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock options awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. No options were granted in 2004 or 2003. The weighted average fair value of the options granted for the year ended December 31, 2005 is estimated at $0.08, using the Black-Scholes option pricing model with the following weighted average assumptions: expected life of 4.7 years; stock volatility, 123%; risk free interest rates, 4.0%, and no dividends during the expected term. The Company's calculations are based on a multiple option valuation approach and forfeitures are recognized as they occur. If the computed fair values had been amortized to expense over the vesting period of the awards, pro forma net income attributed to common shareholders would have been as follows: 2005 2004 2003 ------- ------ ------ (In thousands, except per share data) Net income (loss): As reported $ (1,690) $ 31 $ 181 Less stock based compensation expense determined under the fair value method for all awards, net of related tax effects (27) (12) (74) ----------- --------- ---------- Pro forma $ (1,717) $ 19 $ 107 Net income (loss) per share: As reported $ (0.01) $ 0.00 $ 0.00 Pro forma (0.01) 0.00 0.00 p. Foreign currency translation ------------------------------ The functional currency of the Company's foreign entities is the local currency. The translation of foreign currencies into U.S. dollars is performed for balance sheet accounts using the exchange rates in effect at the balance sheet dates and for revenue and expense accounts using a weighted average exchange rate during the year. The gains or losses resulting from the translation are included in Accumulated Other Comprehensive Income in the Consolidated Statement of Shareholders' Equity and are excluded from net income. Foreign exchange transaction gains (losses) are included in selling, general and administrative expenses and amounted to approximately $(133,000), $(79,000) and $12,000 for the years ended December 31, 2005, 2004 and 2003, respectively. q. Shipping and handling costs ------------------------------ Shipping and handling costs are included in selling, general and administrative expenses and approximated $233,000, $251,000 and $215,000 in 2005, 2004 and 2003, respectively. r. Use of estimates ------------------ The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. s. Reclassifications ----------------- Certain prior year balances have been reclassified to conform to current year classifications. t. Recent accounting pronouncements ---------------------------------- In November 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 151, "Inventory Costs, an amendment of ARB No. 43, Chapter 4". This statement amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing" to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). SFAS No. 151 requires that those items be recognized as current period charges. In addition, this statement requires that allocation of fixed production overheads to costs of conversion be based upon the normal capacity of the production facilities. The provisions of SFAS No. 151 are effective for inventory costs incurred in fiscal years beginning after June 15, 2005. The Company is currently evaluating the impact of SFAS No. 151 on its consolidated financial statements. In December 2004, the FASB issued SFAS No. 153, "Exchanges of Non-monetary Assets, an amendment of APB Opinion No. 29". SFAS No. 153 replaces the exception from fair value measurement in APB Opinion No. 29 for non-monetary exchanges of similar productive assets with a general exception from fair value measurement for exchanges of non-monetary assets that do not have commercial substance. A non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is to be applied prospectively, and is effective for non-monetary asset exchanges occurring in fiscal periods after the December 2004 issuance of SFAS No. 153. The Company does not believe the adoption of SFAS No. 153 will be significant to the overall results of operations or financial position. In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123R"). SFAS No. 123R requires the Company to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost of the employee services is recognized as compensation cost over the period that an employee provides service in exchange for the award. Beginning with the Company's first quarter of fiscal year 2006, it will be required to adopt SFAS 123(R), and will recognize share-based compensation costs in its results of operations. The Company currently provides pro forma disclosures under SFAS 123 reflecting the effects of share-based compensation costs on its results of operations in Note 8 to consolidated financial statements. Although such pro forma effects of applying SFAS 123 may be indicative of the effects of adopting SFAS 123(R), the provisions of these two statements differ in some important respects. The actual effects of adopting SFAS 123(R) will be dependent on numerous factors including, but not limited to, levels of share-based payments granted in the future and the timing thereof; the valuation model chosen by the Company to value stock-based awards; the assumed award forfeiture rate; the accounting policies adopted concerning the method of recognizing the fair value of awards over the service period; and the transition method chosen for adopting SFAS 123(R), which permits public companies to adopt its requirements using various methods, including the "modified prospective application method" and the "modified retrospective application method." The Company plans to adopt SFAS 123(R) using the modified prospective application method. The Company expects that the adoption of SFAS 123(R) may have a material impact on its results of operations subsequent to adoption. In March 2005, the FASB issued FASB Staff Position ("FSP") No. 46(R)-5, "Implicit Variable Interests under FASB Interpretation No. ("FIN") 46 (revised December 2003), Consolidation of Variable Interest Entities" ("FSP FIN 46R-5"). FSP FIN 46R-5 provides guidance for a reporting enterprise on whether it holds an implicit variable interest in Variable Interest Entities ("VIEs") or potential VIEs when specific conditions exist. This FSP is effective in the first period beginning after March 3, 2005 in accordance with the transition provisions of FIN 46 (revised December 2003), "Consolidation of Variable Interest Entities - an Interpretation of Accounting Research Bulletin No. 51" ("FIN 46R"). The Company has determined that the adoption of FSP FIN 46R-5 will not have an impact on its results of operations and financial position. In March 2005, the FASB issued Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations" ("FIN 47"), which will result in (1) more consistent recognition of liabilities relating to asset retirement obligations, (2) more information about expected future cash outflows associated with those obligations, and (3) more information about investments in long-lived assets because additional asset retirement costs will be recognized as part of the carrying amounts of the assets. FIN 47 clarifies that the term "conditional asset retirement obligation" as used in SFAS No. 143, "Accounting for Asset Retirement Obligations", refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/or method of settlement. Uncertainty about the timing and/or method of settlement of a conditional asset retirement obligation should be factored into the measurement of the liability when sufficient information exists. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. The adoption of FIN 47 in 2005 did not have a material impact on the financial position or results of operations of the Company. In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections", which replaces APB Opinion No. 20, "Accounting Changes", and SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements - An Amendment of APB Opinion No. 28". SFAS No. 154 provides guidance on the accounting for and reporting of changes in accounting principles and error corrections. SFAS No. 154 requires retrospective application to prior period financial statements of voluntary changes in accounting principle and changes required by new accounting standards when the standard does not include specific transition provisions, unless it is impracticable to do so. SFAS No. 154 also requires certain disclosures for restatements due to correction of an error. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, and is required to be adopted by the Company as of January 1, 2006. The impact that the adoption of SFAS No. 154 will have on the Company's results of operations and financial condition will depend on the nature of future accounting changes adopted by the Company and the nature of transitional guidance provided in future accounting pronouncements. 2. CAPITAL TRANSACTIONS AND ID SYSTEMS ACQUISITION: ----------------------------------------------------- Our largest shareholder had been Dialoc ID Holdings B.V. ("Dialoc"). On April 19, 2004, Dialoc sold 39,066,927 Sentry common shares (representing approximately 46% of the total issued and outstanding common shares of Sentry) to a group of investors. Of the group, Saburah Investments Inc. ("Saburah") acquired 22,758,155 shares, Mr. Robert Furst 14,554,386 shares and Dr. Morton Roseman 1,754,386 shares. Mr. Peter Murdoch, President, CEO and Director of Sentry, is the owner of Saburah. Mr. Furst is a long-standing member of Sentry's Board of Directors. As a result of this transaction, Messers Angel and de Nood, Principals of Dialoc, resigned from Sentry's Board of Directors. In addition to the purchase of Sentry's common shares, Saburah also acquired 100% of ID Security Systems Canada, Inc. and ID Systems USA Inc. ("ID Systems"). The price paid to Dialoc by Saburah and Murdoch for Sentry and ID Systems shares in cash, debt assumption and other consideration was approximately $3.6 million plus the surrender of Murdoch's 15% interest in Dialoc. Saburah also agreed to make a payment to Dialoc in the future equal to approximately 6% of any payment it receives from Checkpoint Systems Inc. ("Checkpoint") resulting from litigation brought by ID Canada against Checkpoint. On April 30, 2004, Sentry purchased from Saburah Investments, Inc., an Ontario corporation, all of the outstanding common shares and Series "A" preference shares of ID Security Systems Canada Inc., an Ontario corporation, and all of the outstanding capital stock of ID Systems USA, Inc., a Pennsylvania corporation (collectively, "ID Systems"). Effective January 1, 2005, the names of the acquired subsidiaries were changed to Sentry Technology Canada Inc. and Sentry Technology USA Inc. ID Systems is a Toronto based company engaged in anti-shoplifting technology, security labeling, radio frequency identification ("RFID"), access control and library security. Sentry acquired ID Systems from Saburah in exchange for 30,000,000 Sentry common shares. The price paid per Sentry share for the securities of ID Systems was valued at approximately $0.11. A special committee of Sentry's Board of Directors received an opinion from Corporate Valuation Services confirming that the price paid for the acquisition of ID Systems was fair from the point of view of Sentry shareholders. As part of the purchase agreement, the proceeds of the ID Systems litigation settlement will be distributed to the former ID Systems' shareholders. However Saburah and Sentry have agreed that Sentry may require Saburah to purchase additional Sentry common shares under certain circumstances. Sentry's Board of Directors and shareholders owning a majority of Sentry common stock approved the acquisition of ID Systems. Other benefits flowing to Sentry/ID Systems via the purchase of ID Systems are as follows: - - ID Systems and Sentry continue as the exclusive distributor in North and South America for a period of five years for all Dialoc products including Laserfuse radio frequency security labels and all RFID products. - - Dialoc became a distributor in Europe and Asia of labels manufactured by ID Systems' security label manufacturing subsidiary, Custom Security Industries Inc. ("CSI"). - - CSI acquired the right to purchase Laserfuse raw material for processing into finished security labels in its Toronto plant in order to reduce the cost of production. - - CSI acquired the option to purchase a non-exclusive license to manufacture complete Laserfuse security labels for a period of 10 years subject to the payment of $500,000 and a running royalty of $0.001 per label. - - Dialoc will continue to be a dealer for Sentry products in Europe and Asia. The purchase price of the ID Systems acquisition was as follows: (in thousands) Value of Sentry Technology Corporation common stock $ 3,300 Transaction costs 88 ------------ Total purchase price $ 3,388 ============ Under the purchase method of accounting, the total purchase price as detailed above was allocated to ID System's net tangible assets and intangible assets based on their fair values as of April 30, 2004, which were as follows: (in thousands) Cash $ 119 Accounts receivable 1,181 Inventories 1,263 Prepaid expenses and other current assets 754 Property and equipment 458 Deferred charges 69 Bank debt (998) Accounts payable and accrued liabilities (449) Other liabilities (843) ---------- Net tangible assets 1,554 Goodwill and other intangibles 1,834 ---------- Total purchase price $ 3,388 ========== Other intangible assets acquired ($270,000) included trade secrets ($150,000 - 10 year life), patents ($60,000 - 15 year life) and customer relationships ($60,000 - 5 year life). On an ongoing basis, Sentry will evaluate the carrying value versus the discounted cash benefit expected to be realized from the performance of the underlying operations and adjust for any impairment in value. Based on the Company's annual review, there was no impairment as of December 31, 2005. The accompanying consolidated statements of operations include the revenues and expenses of ID Systems from May 1, 2004. The following supplemental pro forma information illustrates the effects of the acquisition on the historical operating results for the years ended December 31, 2004 and 2003, as if the acquisition had occurred at the beginning of each respective period: 2004 2003 ---- ---- (In thousands, except per share data) ------------------------------------- Revenues $ 18,128 $ 19,566 Income (loss) before extraordinary item $ (92) $ (130) * Net income (loss) $ (92) $ 608 * Net income (loss) per share $ (0.00) $ 0.01 * The income (loss) before extraordinary item in the year ended December 31, 2003 includes an income tax benefit of $492,000 resulting from the utilization of net operating loss carryforwards. Net income in 2003 includes both the income tax benefit and the extraordinary gains of $738,000 from the extinguishment of debt. 3. CONVERTIBLE DEBENTURE: ---------------------- On April 30, 2004, Sentry entered into a $2,000,000 secured convertible debenture with Brascan Technology Fund ("Brascan"), an alternative investment fund established by Brascan Asset Management, to invest in early stage, technology-based companies with high growth potential. Effective November 2005, the entities changed their respective names to Brookfield Technology Fund and Brookfield Asset Management, (collectively referred to as, "Brookfield"). Key terms of the transaction are as follows: - - Four-year term. - - Interest rate of 8%. - - Redeemable at Sentry's option after 18 months. - - Conversion price equal to the market price, at time of conversion, less a discount of 30% with a maximum conversion price of $0.12 per share. - - Conversion is at the option of Brookfield when market share price is equal to or greater than $0.17 per share or with the approval of Sentry's Board of Directors when the market share price is less than $0.17 per share. - - Sentry will provide most favored pricing to all Brookfield affiliates and expects to be a supplier of security and identification products to the Brookfield affiliates. - - Brookfield was issued warrants for 5,000,000 shares of Sentry common stock, priced at $0.15 per share, exercisable anytime within the next four years. - - Brookfield is entitled to one seat on Sentry's Board of Directors or will participate as an observer. The Debenture is secured by a general security interest over all the assets and properties of Sentry. The amount is subordinate to the existing Royal Bank of Canada credit facilities. The proceeds of the financing, to be used primarily for working capital, were initially allocated between the debenture ($1,835,000) and the warrants ($165,000) based on their respective fair values in accordance with EITF 00-27 ("Application of Issue 98-5 to Certain Convertible Instruments"). The difference between the face value of the debenture and the allocated value is being charged to interest and financing expenses over the term of the debenture. Certain other warrants to purchase 425,000 shares of Sentry common stock at exercise prices ranging from $0.18 to $0.20 per share were issued in conjunction with the convertible debenture. The warrants are exercisable over one to three years. The fair value of these warrants ($49,000) is being charged to operations over the life of the warrants. As a condition of the financing, Sentry also acquired ID Systems. Sentry's Board of Directors and shareholders owning a majority of Sentry common stock approved the transaction with Brookfield. 4. INVENTORY: ---------
Inventories consist of the following: December 31, 2005 2004 ---------------------------- (In thousands) ---------------------------- Raw materials $ 1,101 $ 1,206 Work-in-process 279 292 Finished goods 1,329 1,816 --------------- ------ $ 2,709 $3,314 =============== ======
The components of inventory shown are net of reserves for excess and obsolete inventory totaling $1,261,000 and $1,528,000 as of December 31, 2004 and 2003, respectively. 5. PROPERTY AND EQUIPMENT: ------------------------ Property and equipment are stated at cost and are summarized as follows:
Estimated Useful Lives December 31, Years 2005 2004 ----------------------- (In thousands) ----------------------- Machinery and equipment 3 - 10 $ 2,362 $ 2,270 Furniture, fixtures and office equipment 3 - 10 2,360 2,349 Leasehold improvements 3 - 10 92 89 ----------- ---------- 4,814 4,708 Less accumulated depreciation 4,177 4,019 ----------- ---------- $ 637 $ 689 =========== ==========
Net property and equipment located in Canada approximated $578,000 and $585,000 in 2005 and 2004. Depreciation expense on property and equipment in 2005, 2004 and 2003 totaled $154,000, $139,000 and $261,000, respectively. 6. ACCRUED LIABILITIES: --------------------
December 31, Accrued liabilities consist of the following: 2005 2004 ------------------------ (In thousands) ------------------------ Accrued salaries, employee benefits and payroll taxes $ 260 $ 333 Other accrued liabilities 665 813 ----------- --------- $ 925 $ 1,146 =========== =========
7. CREDIT FACILITIES: ------------------
Balances under credit facilities December 31, consist of the following: ======================= 2005 2004 ----------------------- (In thousands) ----------------------- Royal Bank of Canada $ 2,039 $ --- The CIT Group/Business Credit Inc. revolving credit --- 1,769 Bank of Montreal overdraft lending --- 734 Bank of Montreal non-revolving demand --- 137 --------- ------- $ 2,039 $ 2,640 ========= =======
On May 13, 2005, the Company and certain of its subsidiaries entered into a new secured credit facility with Royal Bank of Canada ("RBC") for maximum borrowings of up to Canadian $4.5 million (U.S. $3.9 million), which are subject to certain limitations based on a percentage of eligible accounts receivable and inventories as defined in the agreement. Interest is payable at a rate of Royal Bank of Canada prime rate (5.0% at December 31, 2005), plus 1.25% per annum. Borrowings under this facility are secured by substantially all of the Company's assets. This new facility replaced the Company's former revolving credit agreement in the United States and its overdraft lending and term loan agreement in Canada. As of December 31, 2005, the Company had excess borrowing capacity of approximately $0.5 million. As of the end of the third and fourth quarters of 2005, the Company failed to meet one of its financial covenants under the RBC agreement. Subsequent to year end, the Company received from RBC a tolerance of default and waiver of the covenant as of those dates. In addition, on January 23, 2006, the agreement was amended with regard to certain financial and reporting covenants and the interest rate increased to RBC prime rate plus 1.75%. The Company is presently in the final stages of negotiations with RBC to amend the credit agreement by further modifying certain financial covenants and by extending the term of the agreement through April 2007. In addition, while the maximum borrowing under the facility would remain the same, the Company has requested that RBC increase the borrowing availability to the Company by Canadian $1.0 million (U.S. $860,000) in exchange for additional security provided by two of the Company's directors. After conversations with RBC, management believes that these amendments will be approved in the near future. 8. OBLIGATIONS UNDER CAPITAL AND OPERATING LEASES: ---------------------------------------------- a. Capital leases --------------- The Company currently leases office equipment under non-cancelable capital leases with minimum annual rental commitments of $7,000 in 2006 and $1,000 in 2007. b. Operating leases ----------------- The Company leases certain administrative and manufacturing facilities and equipment under non-cancelable operating leases that expire at various dates through 2009. Rent expense related to operating leases for 2005, 2004 and 2003 was $283,000, $234,000 and 103,000 per year, respectively. Minimum annual rental commitments are $285,000 in 2006, $283,000 in 2007, $250,000 in 2008 and $190,000 in 2009. 9. COMMON SHAREHOLDERS' EQUITY: ----------------------------- a. Earnings Per Share ("EPS") ----------------------------- Basic EPS is determined by using the weighted average number of common shares outstanding during each period. Diluted EPS further assumes the issuance of common shares for all dilutive potential common shares outstanding. Options to purchase 2,431,524, 1,275,316 and 1,581,924 shares of common stock were outstanding at the end of 2005, 2004 and 2003, respectively, but were not included in the computation of diluted net loss per share because their effect would be antidilutive or immaterial. b. Stock options -------------- In February 1997, the Company adopted the 1997 Stock Incentive Plan of Sentry Technology Corporation (the "1997 Plan"). The 1997 Plan initially provided for grants up to 2,250,000 options to purchase the Company's common stock. Under the antidilution provisions of the 1997 Plan, as a result of the preferred stock redemption in January 2001, the shares available for grant were increased by 1,719,365 shares. In March 2001, the Board of Directors approved an additional increase of 3,600,000. In April 2004, in order to meet certain criteria for the Brookfield financing, the Board of Directors reduced the number of shares available for grant by 5,200,000. In August 2005, as a result of the increase in total authorized shares, the Board of Directors increased the number of shares available for grant by 4,000,000. The stock option committee may grant awards to eligible employees in the form of stock options, restricted stock awards, phantom stock awards or stock appreciation rights. Stock options may be granted as incentive stock options or nonqualified stock options. Such options normally become exercisable at a rate of 20% per year over a five-year period and expire ten years from the date of grant. However, the Saburah investment constituted a change in control under the 1997 Plan, resulting in the immediate vesting of all shares issued prior to May 1, 2004. All outstanding stock options are issued at not less than the fair value of the related common stock at the date of grant. At December 31, 2005, 2,431,524 common shares were reserved for issuance in connection with the exercise of stock options. Stock option transactions for the years ended December 31, 2005, 2004 and 2003 are as follows:
Weighted Average Number Exercise of Shares Price Balance, January 1, 2003 3,341,292 $ 0.69 Granted - - Exercised (2,000) 0.05 Canceled (1,757,368) 0.79 ----------- --------- Balance, December 31, 2003 1,581,924 0.57 Granted - - Exercised (3,000) 0.05 Canceled (303,608) 0.35 ----------- --------- Balance, December 31, 2004 1,275,316 0.63 Granted 1,525,000 0.10 Exercised (80,000) 0.05 Canceled (288,792) 0.34 ----------- --------- Balance, December 31, 2005 2,431,524 $ 0.35 ----------- ---------
Significant option groups outstanding at December 31, 2005 and related option price and life information were as follows:
Weighted Average Remaining Range of Number Contractual Number Exercise Price Outstanding Life Exercisable - --------------- ------------ ----------- ----------- 0.05 - 0.15 1,907,500 8.24 682,500 0.31 - 0.62 127,500 3.06 127,500 1.05 - 3.00 396,524 0.61 396,524 ---------- ------ ---------- 2,431,524 6.73 1,206,524
At December 31, 2005, options to purchase an aggregate of 1,206,524 common shares were vested and currently exercisable at a weighted average exercise price of $0.61 expiring through 2015. At December 31, 2005, options for 3,341,214 common shares were available for future grants. As discussed in Note 1, the Company accounts for its stock-based awards using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, ("Accounting for Stock Issued to Employees and its related interpretations"). Accordingly, as all options have been granted at exercise prices equal to fair market value on the date of grant, no compensation expense has been recognized in the financial statements for employee stock arrangements. c. Warrants -------- Sentry currently has outstanding warrants for 6,725,000 common shares issued in connection with various financing arrangements. The warrants have exercise prices ranging from $0.15 to $0.20 and expire from April 29, 2007 through January 21, 2009. 10. INCOME TAXES: ------------- The reconciliation between total tax expense and the expected U.S. Federal income tax is as follows:
2005 2004 2003 --------------------------------- (In thousands) --------------------------------- Expected tax provision (benefit) at 34% $ (537) $ 86 $ (357) Add: Nondeductible expenses 13 16 16 U.S. losses producing no tax benefit 524 6 - Use of net operating loss carry forwards to offset tax on extraordinary item - - (151) Foreign tax provision 49 32 - ------- ------ ------- $ 49 $ 140 $ (492)
As of December 31, 2005, the Company had net operating loss carryforwards of approximately $34 million, which expire through the year 2025. The utilization of these net operating loss carryforwards will likely be subject to substantial annual limitations imposed by the Internal Revenue Code Section 382. Significant components of deferred tax assets (liabilities) at December 31, 2005 and 2004 are comprised of:
Deferred Tax Assets (Liabilities) 2005 2004 ------------- --------------- (In thousands) --------------------------------- Assets: Accounts receivable $ 52 $ 112 Inventories 514 639 Accrued liabilities 100 98 Property and equipment 425 353 Net operating loss carryforwards 13,876 13,078 ----------- -------- Gross deferred tax assets 14,967 14,280 Less valuation allowance 14,936 14,268 ----------- -------- Deferred tax assets 31 12 Liabilities: Property and equipment (83) (51) Other (19) -- ----------- -------- Gross deferred tax liabilities (102) (51) Less valuation allowance 13 -- ----------- -------- Deferred tax liabilities (89) (51) ----------- -------- Net deferred tax liability $ (58) $ (39) ----------- --------
The increase in the valuation allowance for the years ended December 31, 2005, and 2004, was primarily attributable to the increase in net operating loss carryforwards. A valuation allowance has been recorded against the net deferred tax assets, because it is more likely than not that such asset will not be realized in the foreseeable future. The $49,000 and $142,000 income tax provisions for 2005, and 2004, respectively, is principally attributable to foreign taxes on Canadian operations. The $492,000 income tax benefit for 2003 represents the utilization of that period's loss from operations against the tax provision on the extraordinary gain from debt extinguishment. 11. EXTRAORDINARY ITEM - GAIN ON THE EXTINGUISHMENT OF DEBT: --------------------------------------------------------------- During 2003, the Company entered into a settlement with certain of its vendors for past due obligations. Under the terms of the settlement, each participating vendor received a note for approximately 10% of their balance due and two shares of Sentry common stock for each dollar owed in full satisfaction of their outstanding balances, which approximated $1,092,000. The notes, approximating $112,000, are non-interest bearing and are payable in three equal installments on January 15, 2004, 2005, and 2006. The 2,193,263 shares issued in connection with this settlement were valued at approximately $105,000, based on the market value of the stock at the time of the settlement. As a result of this transaction, the Company realized an extraordinary gain of $877,000 in 2003, representing the difference between the amounts due before the settlement and the total amount payable, including the value of the common stock, as a result of the settlement. The Company made the first and second annual note payments. The third payment due January 2006 is currently on hold. On July 9, 2003, Sentry entered into a settlement agreement with its landlord regarding the termination of its long-term capital and operating leases for its facility in Hauppauge, New York. Under terms of the settlement, Sentry was released from its current and future liabilities under the leases in exchange for a $250,000, 8% note, payable in 36 equal monthly installments of $7,834, including interest, commencing November 1, 2003. In addition, Sentry issued the landlord 1,000,000 shares of common stock, for which the fair value of the stock ($33,000) was determined using the closing price as of July 9, 2003. Sentry was also obligated to pay rent of $16,000 per month until it vacated the premises on September 30, 2003. The Company recognized a gain of $353,000 in 2003, representing the difference between the carrying amounts of outstanding obligations to the landlord less the net book value of the property on the date of the settlement. As a result of the Brookfield financing, Sentry was obligated to prepay an amount of $50,000 against the note in May 2004, which resulted in a reduction in the remaining monthly payments to $5,932. As of October 1, 2003, Sentry moved its corporate offices and distribution center to a 20,000 square foot facility in Ronkonkoma, New York. The Company entered into a three-year lease with an option to renew for an additional three year period. The current annual rent is $148,600. Sentry presently expects to exercise the renewal option as of October 1, 2006, at which time the annual rent for the next three years will increase to $160,000, 165,000 and $170,000, respectively. The $492,000 income tax provision recognized in 2003 on the extraordinary gains was offset by an equivalent income tax benefit generated from that periods' loss from operations and the utilization of net operating loss carryforwards. 12. RELATED PARTY TRANSACTIONS: ---------------------------- On January 22, 2004, Robert Furst, a Sentry Director, made a bridge loan to the Company in the amount of $100,000. The interest rate on the loan was 15% per annum and the loan was due on or before April 30, 2004. As additional consideration for the loan, Mr. Furst received a warrant to purchase 300,000 shares of Sentry common stock at a price of $0.17 per share, which was the market price on the date of grant (valued at $3,000 and charged to interest and financing expenses). The warrant expires January 21, 2009. The note was repaid in full on April 30, 2004. On August 1, 2004, ID Systems and Checkpoint Systems Inc. entered into a settlement agreement effective July 30, 2004, pursuant to which Checkpoint agreed to pay $19.95 million in full and final settlement of claims covered by an antitrust litigation. Payment in full was received on August 5, 2004. As provided when Sentry purchased ID Systems, the proceeds of the settlement were distributed to former shareholders of ID Systems, after payment of litigation fees and expenses. The agreement includes mutual releases between the parties for complaints arising from activities prior to the date of the agreement, except for any contractual obligations and any future claims for patent, copyright or trademark infringement. The agreement is not an acknowledgement of any wrongdoing or liability by either party. A Stipulation of Dismissal was filed with the Third Circuit Court of Appeals to finally conclude the legal proceedings. During the third quarter of 2004, Sentry and its subsidiaries received $753,000 through the repayment of debt incurred by Dialoc prior to the ID Systems acquisition and reimbursement of litigation expenses. While Sentry did not obtain an interest in the litigation settlement, Saburah and Sentry agreed that Sentry might require Saburah to purchase additional Sentry common shares equal to approximately 4.5% of any amount received (net of legal fees and expenses) from Checkpoint. The price per share was set at 80% of the previous 20 days trading average prior to the announcement of the settlement. Our Board of Directors has exercised this option and based on the settlement amount, Sentry sold to Saburah approximately 4.8 million shares for $641,000 on November 5, 2004. These transactions, totaling $1.4 million, represent the total cash flowing to Sentry directly and indirectly as a result of the Checkpoint lawsuit. In April 2006, Mr. Murdoch, Sentry's CEO and Director and Mr. Furst, a Sentry Director, agreed to provide a personal guarantee to RBC, the Company's lender, in the amount of Canadian $1 million (U.S. $860,000) in exchange for the bank providing increased availability under its credit facility to the Company by the same amount. In consideration of these guarantees, Mr. Murdoch and Mr. Furst will receive a fee of $43,000, to be shared between them, paid in 12 equal monthly installments. As additional consideration, they will receive fully vested, two year warrants to purchase between 2.9 million and 3.8 million shares of the Company's common stock, at an exercise price ranging between $0.075 and $0.10 per share, dependent upon certain stock market conditions. The fair value of these warrants will be recorded in accordance with SFAS No. 123R "Share-Based Payment" in the second quarter of 2006 and will be written off over the period of the guarantee. 13. COMMITMENTS AND CONTINGENCIES: ------------------------------- a. 401(k) Plan ------------ In January 1997, the Company adopted the Sentry Technology Corporation Retirement Savings 401(k) Plan (the "Plan"). The Plan permits eligible employees to make voluntary contributions to a trust, up to a maximum of 35% of compensation, subject to certain limitations. The Company may elect to contribute a matching contribution equal to a designated percentage of the eligible employee's deferral election. The Company may also make discretionary contributions, subject to certain conditions, as defined in the Plan. No Company contributions were made in 2005, 2004 or 2003. b. Employment agreements ---------------------- The Company and several key executives entered into employment agreements with remaining terms of one year for which the Company will have a minimum commitment of $423,000. Also, the president of the Company's 51% owned subsidiary, Custom Security Industries Inc., is entitled to receive 10% of its pretax profits. c. Litigation ---------- In August 2004, Bi-County Park Associates, Inc. d/b/a Ashlind Properties brought an action against the Company for the recovery of a real estate brokerage commission in the amount of $250,000 relating to the termination of its lease on its former Hauppauge facility. Management believes there is no merit to this claim and is actively defending such action. The Company is a party to litigation matters and claims, which are normal in the course of its operations. While the results of such litigation and claims cannot be predicted with certainty, management believes that the final outcome of such matters will not have a materially adverse effect on the Company's consolidated financial position, results of operations and cash flows. d. Distribution Agreements ------------------------ On March 31, 2004, the Company entered into a five-year distribution agreement with Dialoc under which the Company must purchase a minimum of $1.1 million of Dialoc's products each year. 14. MAJOR CUSTOMERS AND CREDIT CONCENTRATIONS: --------------------------------------------- The Company grants credit to customers who are principally in the retail industry and libraries. During 2005, revenues from Goody's represented approximately 10% of total revenues. During 2004 and 2003, revenues from Lowe's Home Center represented approximately 30% and 44% of total revenues, respectively. No other customer accounted for more than 10% of total revenues in 2005, 2004 and 2003. In January 2005, Lowe's Home Centers notified the Company that they would not be renewing their annual maintenance contract, which represented $850,000 of revenues in 2004. The annual maintenance contract had an impact on the selection of vendors for replacement and add-on CCTV business in existing Lowe's locations. The Company anticipates that this decision will result in a substantial decrease in future revenues from Lowe's on a comparative basis. Canadian revenues approximated $2,756,000, $2,322,000 and $247,000 in 2005, 2004 and 2003, respectively. 15. REVENUE BY PRODUCT LINE: --------------------------
Revenues by product line are as follows: 2005 2004 2003 ---------- --------- ---------- (In thousands) ----------------------------------- EAS $ 6,490 $ 5,358 $ 1,914 CCTV 1,670 3,272 3,699 Sentry Vision 2,971 3,852 3,133 Service, installation and other revenues 2,439 4,381 4,497 --------- -------- -------- Total revenues $ 13,570 $16,863 $13,243 ========= ======== ========
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - -------- ------------------------------------------------------------------- FINANCIAL DISCLOSURE --------------------- None. ITEM 8A. CONTROLS AND PROCEDURES - --------------------------------- As of the end of the period covered by this report, our Company conducted an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) of the Exchange Act). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. There was no change in our internal controls, which are included within disclosure controls and procedures, during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls. PART III -------- ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. - -------- --------------------------------------------------------- DIRECTORS The following sets forth information regarding the persons serving as Directors of Sentry: PETER L. MURDOCH, age 52, has been the President and Chief Executive Officer, Director and Chairman of the Board since January 8, 2001. Mr. Murdoch has extensive experience in the retail security industry as well as in the sales of technology-based products. He was Managing Director and President of ID Security Systems Canada, Inc. since its inception in 1987 until its acquisition by Sentry. From 1997 through 2004, he served as member of the management committee of Dialoc ID. Prior to joining ID Security Systems Canada, Inc., Mr. Murdoch was Vice President of Sales for Catalyst International Business Systems. He is an economics graduate from the University of Western Ontario. Mr. Murdoch's term as a Director expires at the next Annual Meeting. ROBERT D. FURST, JR., age 53, has been a Director of Sentry Technology since its inception. Prior thereto he was a Director of Video Sentry Corporation, our predecessor, from January 1993 until February 1997. He was Chairman of the Board of Video Sentry from July 1996 and Chief Executive Officer from August 1996 until February 1997. Mr. Furst was one of the original shareholders of Video Sentry. He is also a founder and managing principal of Alternative Strategy Advisers LLC, an alternative investment management firm. Mr. Furst is a member of the Chicago Board of Trade and has been a securities and commodities trader since 1980. Mr. Furst is a continuing director on the Board of Directors after the completion of the Dialoc ID Investment. Mr. Furst's term as a Director expires at the next Annual Meeting. JONATHAN G. GRANOFF, age 55, has been a Director of Sentry Technology since January 8, 2001. Mr. Granoff was appointed to the Board of Directors when it was expanded from five to seven members. Mr. Granoff is the President of the Global Security Institute and United Nations representative for Lawyers Alliance for World Security. He is also Chairman of the American Bar Association Committee on Arms Control and Disarmament. Mr. Granoff has been in the practice of law since 1979. Formerly Mr. Granoff served at Nutri Systems Inc. as an attorney and Director of Franchising. Mr. Granoff's term as a Director expires at the next Annual Meeting. EXECUTIVE OFFICERS The following sets forth information regarding the persons serving as executive officers of the Company: NAME AGE OFFICE - ---- --- ------ Peter L. Murdoch 52 President and Chief Executive Officer Our President and Chief Executive Officer since January 8, 2001. Mr. Murdoch has extensive experience in the retail security industry as well as in the sales of technology-based products. He was Managing Director of ID Security Systems Canada, Inc. since its inception in 1987. Beginning in 1997 he has served as member of the management committee of Dialoc ID. Prior to joining ID Security Systems Canada, Inc., Mr. Murdoch was Vice President of Sales for Catalyst International Business Systems. He is an economics graduate from the University of Western Ontario. NAME AGE OFFICE - ---- --- ------ Peter J. Mundy 49 Vice President-Finance and Chief Financial Officer Our Vice President-Finance and Chief Financial Officer. Mr. Mundy also serves as our Secretary and Treasurer. Mr. Mundy was Vice President - Finance, Chief Financial Officer, Secretary and Treasurer of Knogo North America Inc. from December 1994. Prior thereto, Mr. Mundy served as an officer of Knogo Corporation where he was Vice President - Corporate Controller from May 1994 and, prior to such time, Corporate Controller and Controller since 1982. Mr. Mundy is a Certified Public Accountant. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934 (the "Exchange Act") requires the Company's officers, Directors and persons who own more than 10% of a registered class of the Company's equity securities to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Officers, Directors and greater than ten-percent Stockholders are required by Securities and Exchange Commission regulations to furnish the Company with copies of all such reports they file. Based solely on a review of the copies of reports furnished to the Company, or written representations that no Forms 5 were required, the Company believes that during the fiscal year ended December 31, 2005, all Section 16(a) filing requirements applicable to its officers, Directors and greater than ten-percent beneficial owners were complied with, except the following. Robert D. Furst, Jr., a member of the Board, filed a late report on Form 4 on January 28, 2005 with the SEC, for the sale of 400,000 shares of the Company's common stock at prices ranging from $0.225 per share to $0.26 per share, which sales occurred on January 25, 2005. AUDIT COMMITTEE FINANCIAL EXPERT We do not have a separate audit committee and therefore the Board of Directors in its entirety functions as the audit committee. We have at least one audit committee financial expert serving on our Board of Directors, Mr. Robert Furst. CODE OF ETHICS We have adopted a written Code of Ethics that applies to all of our directors, officers and employees. A copy of our Code of Ethics is available on our website at www.sentrytechnology.com and print copies are available to any shareholder that requests a copy. Any amendment to the Code of Ethics or any waiver of the Code of Ethics will be disclosed on our website at www.sentrytechnology.com promptly following the date of such amendment or waiver. ITEM 10. EXECUTIVE COMPENSATION. - ---------------------------------- SUMMARY COMPENSATION TABLE The following table summarizes the compensation for our fiscal years ended December 31, 2005 of our Chief Executive Officer and Chief Financial Officer:
LONG-TERM ALL OTHER ANNUAL COMPENSATION COMPENSATION COMPENSATION -------------------- ------------- ---------------- NAME AND SECURITIES UNDERLYING PRINCIPAL POSITION YEAR SALARY BONUS OPTIONS (#) - ----------------------- ---- -------------------- --------------------- ---------------- Peter L. Murdoch 2005 $178,275 - - - President and CEO 2004 237,962 (1) - - - 2003 50,000 - - - Peter J. Mundy 2005 136,013 - - - Vice President - CFO, 2004 131,160 - - - Secretary and Treasurer 2003 131,160 - - -
(1) Includes amounts paid by ID Systems in 2004 and $62,500 of Sentry salary deferred from 2002. As to various items of personal benefits, we have concluded that the aggregate amount of such benefits with respect to each individual does not exceed the lesser of $50,000 or 10% of the annual salary and bonus reported in the table for such individual. OPTIONS GRANTED IN LAST FISCAL YEAR No options were granted to executive officers in 2005. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES The following table sets forth for each of the persons named in the Summary Compensation Table the number of options exercised during 2005 and the amount realized by each such officer. In addition, the table shows the number of options that the named executive officer held as of December 31, 2004, both exercisable (E) and unexercisable (U), and the value of such options as of that date.
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED IN OPTIONS AT YEAR-END THE MONEY OPTIONS AT (#) YEAR END ($) SHARES ACQUIRED ON VALUE EXERCISABLE/ EXERCISABLE/ NAME EXERCISE (#) REALIZED ($) UNEXERCISABLE UNEXERCISABLE - ---------------- ------------ ------------ ---------------------- ----------------------- Peter L. Murdoch - - E - E - U - U - Peter J. Mundy - - E 444,632 E $3,900 U - U -
COMPENSATION OF DIRECTORS Directors who are also our full-time employees receive no additional compensation for their services as Directors. Each Director and Brookfield Technology Fund, in its capacity as an Observer, received an annual retainer of $5,000 for 2005. In addition, each non-employee Director is eligible to participate in our 1997 Stock Incentive Plan. In March 2005, Mr. Furst, Mr. Granoff and the Brookfield Technology Fund each received options to purchase 50,000 shares of our common stock at an exercise price of $0.15 per share, which was the market price on the date of grant. The options were exercisable immediately and expire after 10 years. No options were awarded to Directors during 2004 and 2003. EMPLOYMENT AGREEMENTS AND COMPENSATION OF EXECUTIVE OFFICERS; CHANGE OF CONTROL ARRANGEMENTS The Board set Peter L. Murdoch's compensation, in the capacity of President, at an annual salary of approximately $178,000, in 2005, $175,000 in 2004 and $50,000 in 2003. Our Board of Directors approves the compensation paid to our other executive officers, approving or disapproving the recommendation of the Chief Executive Officer. The Board of Directors also determines the amount of shares and exercise prices for any stock option grants under our 1997 Stock Incentive Plan, and the amount of our matching contribution percentage under our Retirement Savings 401(k) Plan, respectively. Currently, Mr. Mundy is compensated pursuant to a written employment agreement providing for his base salary. This agreement provides for annual salary increases intended to maintain his base salary against increases in the cost of living as measured by the United States Department of Labor. Mr. Mundy waived these increases for the years 2003 and 2004. The employment agreement for Mr. Mundy renews automatically on May 1 for one-year terms. His annual salary for 2006 is presently $140,664. The employment agreement for Mr. Mundy also provides that in the event of a change in control, the term of his employment will be automatically extended for a period of one year, following the date of such change in control. Following such change in control, Mr. Mundy will have the right to terminate his employment for good reason, as defined, while continuing to receive the salary and bonus otherwise payable thereunder for the remainder of the employment term. Additionally, the employment agreement provides that in the event of a change in control all options held by Mr. Mundy, whether or not then vested, would fully vest. If the change in control was not approved by a majority of the Existing Directors (as defined in our Certificate of Incorporation), he would be entitled to receive, for each option for which the exercise price is less than the market price of our common stock, cash in cancellation of such options in an amount equal to such difference. [GRAPHIC OMITED]
PERFORMANCE CHART ----------------- 12/31/01 12/31/02 12/31/03 12/31/04 12/31/05 ------------------------------------------------------------- Sentry Technology Corporation $ 100 $ 13 $ 90 $ 123 $ 61 S&P 600 Small Cap Index $ 100 $ 85 $ 116 $ 142 $ 151 S&P Elec. Equip. Index $ 100 $ 48 $ 81 $ 75 $ 75
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ---------------------------------------------------------------------- The following table sets forth the beneficial ownership of our common stock at April 12, 2006, as to each (i) beneficial owner of five percent or more of the common stock, (ii) Sentry Director, (iii) executive officer of Sentry, and (iv) all Directors and executive officers as a group. On April 12, 2006, 120,728,804 shares of common stock were outstanding .
NAME AND ADDRESS OF BENEFICIAL OWNERS - -------------------------------------------------- SHARES OF PERCENT DIRECTORS AND EXECUTIVE OFFICERS COMMON STOCK OF CLASS (1) - -------------------------------------------------- ------------ ------------ Peter L. Murdoch (5) 59,715,096 (2) 49.5% c/o Saburah Investments Inc. 37 Voyager Court North Toronto, Ontario M9W 4Y2 Robert D. Furst, Jr. 16,368,714 (3) 13.5% c/o Alternative Strategies Advisors LLC 601 Carlson Parkway, Suite 610 Minnetonka, MN 55305 Peter J. Mundy 449,069 (4) * Jonathan G. Granoff 140,000 (5) * All Sentry Directors and executive officers as a group (4 persons) 76,664,776 (6) 63.1%
___________________ * Less than one percent 1) Based on 120,728,804 shares of common stock outstanding as of April 12, 2006. Each figure showing the percentage of outstanding shares beneficially owned has been calculated by treating as outstanding and owned the shares of common stock that could be purchased by the indicated person within 60 days upon the exercise of stock options. 2) Includes 57,553,596 shares of common stock held by Saburah Investments Inc. of which Mr. Murdoch is the 100% owner. 3) Includes 404,000 shares of common stock issuable upon the exercise of stock options or warrants exercisable within 60 days of the date hereof. Mr. Furst also holds a warrant to purchase 2,500,000 common shares from Saburah investments Inc., which are excluded from the shares owned. Shares subject to this warrant will be issued from shares currently owned by Saburah. 4) Includes 245,000 shares of common stock issuable upon the exercise of stock options exercisable within 60 days from the date hereof. 5) Includes 80,000 shares of common stock exercisable upon the exercise of stock options exercisable within 60 days from the date hereof. 6) Includes 729,000 shares of common stock issuable upon the exercise of stock options and warrants exercisable within 60 days from the date hereof. - ------ ITEM 12.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - ----------------------------------------------------------- On January 22, 2004, Robert Furst, a Sentry Director, made a bridge loan to the Company in the amount of $100,000. The interest rate on the loan was 15% per annum and the loan was due on or before April 30, 2004. As additional consideration for the loan, Mr. Furst received a warrant to purchase 300,000 shares of Sentry common stock at a price of $0.17 per share, which was the market price on the date of grant (valued at $3,000 and charged to interest and financing expenses). The warrant expires January 21, 2009. The note was repaid in full on April 30, 2004. On August 1, 2004, ID Systems and Checkpoint Systems Inc. entered into a settlement agreement effective July 30, 2004, pursuant to which Checkpoint agreed to pay $19.95 million in full and final settlement of claims covered by an antitrust litigation. Payment in full was received on August 5, 2004. As provided when Sentry purchased ID Systems, the proceeds of the settlement were distributed to former shareholders of ID Systems, after payment of litigation fees and expenses. The agreement includes mutual releases between the parties for complaints arising from activities prior to the date of the agreement, except for any contractual obligations and any future claims for patent, copyright or trademark infringement. The agreement is not an acknowledgement of any wrongdoing or liability by either party. A Stipulation of Dismissal was filed with the Third Circuit Court of Appeals to finally conclude the legal proceedings. During the third quarter of 2004, Sentry and its subsidiaries received $753,000 through the repayment of debt incurred by Dialoc prior to the ID Systems acquisition and reimbursement of litigation expenses. While Sentry did not obtain an interest in the litigation settlement, Saburah and Sentry agreed that Sentry might require Saburah to purchase additional Sentry common shares equal to approximately 4.5% of any amount received (net of legal fees and expenses) from Checkpoint. The price per share was set at 80% of the previous 20 days trading average prior to the announcement of the settlement. Our Board of Directors has exercised this option and based on the settlement amount, Sentry sold to Saburah approximately 4.8 million shares for $641,000 on November 5, 2004. These transactions, totaling $1.4 million, represent the total cash flowing to Sentry directly and indirectly as a result of the Checkpoint lawsuit. In April 2006, Mr. Murdoch, Sentry's CEO and Director and Mr. Furst, a Sentry Director, agreed to provide personal guarantees to RBC, the Company's lender, in the amount of Canadian $1 million (U.S. $860,000) in exchange for the bank providing increased availability under its credit facility to the Company by the same amount. For these guarantees, Mr. Murdoch and Mr. Furst will receive a fee of $43,000 to be paid in 12 equal monthly installments, and fully vested, two year warrants for between 2.9 million and 3.8 million common shares, dependent upon certain stock market conditions. The fair value of these warrants will be recorded in accordance with SFAS No. 123R "Share-Based Payment" in the second quarter of 2006 and will be written off over the period of the guarantee. ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K - ------------------------------------------------ 2.1 Amended and Restated Agreement and Plan of Reorganization and Merger, dated as of November 27, 1996 among Video Sentry Corporation, Knogo North America Inc., Sentry Technology Corporation, Viking Merger Corp. and Strip Merger Corp., as amended by Amendment No. 1 to Amended and Restated Agreement and Plan of Reorganization and Merger, dated as of January 10, 1997. Incorporated by reference to Exhibit 2.1 to Company's Registration Statement on Form S-4 (No. 333-20135). 2.2 Plan of Merger, merging Sentry Technology Corporation, a Delaware corporation into Knogo North America, Inc., a Delaware corporation, to be effective as of January 1, 2005. 2.3 Certificate of Merger, merging Sentry Technology Corporation, a Delaware corporation into Knogo North America, Inc., a Delaware corporation, effective date January 1, 2005, as filed with the Delaware Secretary of State on April 26, 2005. 2.4 Stock Purchase Agreement, dated April 29, 2004, by and between Sentry Technology Corporation and Saburah Investments, Inc. Incorporated by reference to Exhibit 2.1 to Company's Current Report on Form 8-K dated July 14, 2004. 3.1 Amended and Restated Certificate of Incorporation of Sentry Technology Corporation, as filed with the Delaware Secretary of State on April 26, 2005. 3.2 Certificate of Amendment of Certificate of Incorporation of Sentry Technology Corporation, as filed with the Delaware Secretary of State on May 27, 2005. 3.3 Amended and Restated Bylaws of the Company. 4.1 Convertible Debenture, dated April 30, 2004, issued by Sentry Technology Corporation to Brascan Technology Fund, Inc. Incorporated by reference to Exhibit 2.1 to Company's Current Report on Form 8-K dated July 14, 2004. 4.2 Warrant Certificate, dated April 30, 2004, issued by Sentry Technology Corporation to Brascan Technology Fund, Inc. Incorporated by reference to Exhibit 2.1 to Company's Current Report on Form 8-K dated July 14, 2004. 4.3 Stakeholders Rights Agreement, dated April 30, 2004, by and among Sentry Technology Corporation, Peter Murdoch, Robert Furst, Saburah Investments Inc., and Brascan Technology Fund Inc. Incorporated by reference to Exhibit 2.1 to Company's Current Report on Form 8-K dated July 14, 2004. 10.1 1997 Stock Incentive Plan. Incorporated by reference to Exhibit 10.5 to the Company's Registration Statement on Form S-4 (No. 333-20135). 10.2 Retirement Savings 401(k) Plan. Incorporated by reference to Exhibit 10.6 to the Company's Registration Statement on Form S-4 (No. 333-20135). 10.3 Employment Agreement, dated as of February 12, 1997, between the Company and Peter J. Mundy. Incorporated by reference to Exhibit 10.2 to the Company's Registration Statement on Form S-4 (No. 333-20135). 10.4 Contribution and Divestiture Agreement dated December 29, 1994 between Knogo Corporation and Knogo North America Inc. Incorporated by reference to Exhibit 10.8 to the Company's annual report on Form 10-K for fiscal 1997. 10.5 License Agreement dated December 29, 1994 between Knogo Corporation and Knogo North America Inc. Incorporated by reference to Exhibit 10.9 to the Company's annual report on Form 10-K for fiscal 1997. 10.6 Stipulation of Settlement and Lease Termination dated July 29, 2003 between Knogo North America Inc. and NOG (NY) QRS 12-23, Inc. Incorporated by reference to Exhibit 10.34 to the Company's Quarterly Report on Form 10-Q dated November 4, 2003. 10.7 Distribution Agreement, dated January 8, 2001, between Sentry and Dialoc ID, incorporated by reference to Exhibit B of Exhibit 10.1 to the Company's Current Report on Form 8-K, dated August 10, 2000. 10.8 Lease Agreement dated September 16, 2003 between Sentry Technology Corporation and G & J Lakeland Realty Corp. Incorporated by reference to Exhibit 10.34 to the Company's Quarterly Report on Form 10-QSB dated November 4, 2003. 10.9 Forbearance Agreement between The CIT Group/Business Credit, Inc. and Knogo North America Inc., dated December 8, 2003. Incorporated by reference to Exhibit 10.36 to the Company's annual report on Form 10-KSB for fiscal 2003. 10.10 Amendment to Forbearance Agreement and Financing Agreement between The CIT Group/Business Credit, Inc. and Knogo North America Inc., dated December 30, 2004. Incorporated by reference to Exhibit 10.37 to the Company's annual report on Form 10-KSB for fiscal 2004. 10.11 Credit Facility Letter Agreement between Sentry Technology Canada Inc. and Royal Bank of Canada dated April 19, 2005. Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K, dated May 18, 2005. 10.12 Amendment to Credit Facility Letter Agreement between Sentry Technology Canada Inc. and Royal Bank of Canada dated May 12, 2005. Incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K, dated May 18, 2005. 10.13 Postponement and Subordination Agreement between Brascan Technology Fund, Royal Bank of Canada and Sentry Technology Canada Inc. dated May 12, 2005. Incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K, dated May 18, 2005. 10.14 Amendment to Credit Facility Letter Agreement between Sentry Technology Canada Inc. and Royal Bank of Canada dated January 23, 2006. 14 Code of Ethics. 21 Subsidiaries of the Company. 23.1 Consent of SF Partnership, LLP. 23.2 Consent of Holtz Rubenstein Reminick LLP. 31.1 Certification by the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification by the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification by the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*** 32.2 Certification by the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*** *** In accordance with Item 601(b)(32)(ii) of Regulation S-B, this exhibit shall not be deemed "filed" for the purposes of Section 18 of the Securities and Exchange Act of 1934 or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934. (b) Reports on Form 8-K. There were no Forms 8-K filed by the registrant during the fourth quarter of 2005. - ------ ITEM 14.PRINCIPAL ACCOUNTANTS FEES AND SERVICES - ---------------------------------------------------- The Company's board of directors reviews and approves audit and permissible non-audit services performed by its independent accountants, as well as the fees charged for such services. In its review of non-audit service fees and its appointment of SF Partnership, LLP as the Company's independent accountants, the board of directors considered whether the provision of such services is compatible with maintaining independence. The board of directors approved all of the services provided and fees charged by SF Partnership, LLP in 2005. AUDIT FEES The aggregate fees billed by for professional services for the audit of the annual financial statements of the Company and the reviews of the financial statements included in the Company's quarterly reports on Form 10-QSB in 2005 were $65,000 by SF Partnership, LLP. In 2005, 2004 and 2003 the amounts paid to Holtz Rubenstein Reminick LLP, our predecessor auditors, were $15,000, $104,000 and $58,000, respectively, net of expenses. AUDIT-RELATED FEES There were $2,000 of other fees billed by SF Partnership, LLP in 2005 and $33,000 and $9,000 of other fees billed by Holtz Rubenstein Reminick during 2004 and 2003, respectively, for assurance and related services that were reasonably related to the performance of the audit or review of the Company's financial statements and not reported under "Audit Fees" above. TAX FEES There were no other fees billed by our independent auditors during the last two fiscal years for tax compliance. ALL OTHER FEES There were no other fees billed by our independent auditors during the last two fiscal years for products and services provided. Holtz Rubenstein Reminick LLP had served as the Company's independent public accountants since December 30, 2002. Holtz Rubenstein Reminick LLP 's report on the Company's consolidated financial statements for the fiscal years ended December 31, 2004 and 2003 did not contain an adverse opinion or disclaimer of opinion, nor was such report qualified or modified as to uncertainty, audit scope or accounting principles. During the year ended December 31, 2004, and the interim period ended August 1, 2005, there were no disagreements between the Company and Holtz Rubenstein Reminick LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure which, if not resolved to Holtz Rubenstein Reminick LLP 's satisfaction, would have caused it to make reference to the subject matter in connection with its report on the Company's consolidated financial statements for such year; and there were no reportable events as defined in Item 304(a)(1)(v) of Regulation S-B. During the year ended December 31, 2004, and the interim period ended August 1, 2005, the Company did not consult SF Partnership LLP with respect to either (i) the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on the Company's consolidated financial statements, or (ii) any matter that was either the subject of a disagreement, within the meaning of Item 304(a)(1)(iv) of Regulation S-B, or any "reportable event," as that term is defined in Item 304(a)(1)(v) of Regulation S-B. SIGNATURES: - ----------- Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SENTRY TECHNOLOGY CORPORATION By: /s/ Peter J. Mundy --------------------- Peter J. Mundy Vice President-Finance, Chief Financial Officer, Secretary and Treasurer Dated: May 30, 2006 Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-KSB has been signed below by the following persons in the capacities and on the date indicated. Signature Title - --------- ----- /s/ Peter L. Murdoch Chief Executive Officer and Director - ----------------------- Peter L. Murdoch /s/ Peter J. Mundy Vice President-Finance, - --------------------- Chief Financial and Accounting Officer Peter J. Mundy Secretary and Treasurer /s/ Robert D. Furst, Jr. Director - ---------------------------- Robert D. Furst, Jr. /s/ Jonathan G. Granoff Director - -------------------------- Jonathan G. Granoff Dated: May 30, 2006 EXHIBIT INDEX 2.2 Plan of Merger, merging Sentry Technology Corporation, a Delaware corporation into Knogo North America, Inc., a Delaware corporation, to be effective as of January 1, 2005. 2.3 Certificate of Merger, merging Sentry Technology Corporation, a Delaware corporation into Knogo North America, Inc., a Delaware corporation, effective date January 1, 2005, as filed with the Delaware Secretary of State on April 26, 2005. 3.1 Amended and Restated Certificate of Incorporation of Sentry Technology Corporation, as filed with the Delaware Secretary of State on April 26, 2005. 3.2 Certificate of Amendment of Certificate of Incorporation of Sentry Technology Corporation, as filed with the Delaware Secretary of State on May 27, 2005. 3.3 Amended and Restated Bylaws of the Company. 10.14 Amendment to Credit Facility Letter Agreement between Sentry Technology Canada Inc. and Royal Bank of Canada dated January 23, 2006. 14 Code of Ethics. 21 Subsidiaries of the Company 23.1 Consent of SF Partnership, LLP. 23.2 Consent of Holtz Rubenstein Reminick LLP. 31.1 Certification by the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification by the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification by the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *** 32.2 Certification by the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *** EX-23.2 2 consentofhrr.txt CONSENT OF HOLTZ RUBENSTEIN REMINICK EXHIBIT 23.2 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in Registration Statement No. 333-34929 and 333-34867 of Sentry Technology Corporation on Form S-8 of our report dated March 29, 2005 appearing in this Annual Report on Form 10-KSB/A of Sentry Technology Corporation for the year ended December 31, 2005. /s/ Holtz Rubenstein Reminick LLP Melville, New York May 26, 2006 -----END PRIVACY-ENHANCED MESSAGE-----