10KSB 1 doc1.txt SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ____________ FORM 10-KSB ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003 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 96-11-3349733 ---------------------- --------------- (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 --------------- 350 WIRELESS BOULEVARD, HAUPPAUGE, NY 11788 ------------------------------------------- (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-K 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 $13,009,000. At March 12, 2004, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $6,786,000 based upon the closing price of such securities on the OTC Bulletin Board on that date. At March 12, 2004, the Registrant had outstanding 85,755,610 shares of Common Stock. Documents Incorporated by Reference -------------------------------------- None. ------ PART I ------ ITEM 1. BUSINESS ------------------- GENERAL Sentry Technology Corporation ("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 "Merger." Knogo is 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 designs, manufactures, markets, installs and services 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 acts as a system integrator for conventional CCTV products that it markets, installs and services. Video's predecessor was founded in 1990 and made its first sales in 1992. Video was merged into Knogo as of December 31, 2000. RECENT DEVELOPMENTS Our strategy following the Merger in 1997 was to use Knogo's engineering staff and excess manufacturing capacity resulting from a 1994 restructuring for the reengineering and production of its proprietary and patented SentryVision programmable traveling closed circuit television surveillance ("CCTV") systems. With the reengineering completed, management believed that sales of SentryVision , which had fallen in the final year that Video was a separate corporation, would rebound. While the engineering staff was able to resolve substantially the design and manufacturing problems associated with SentryVision , the sales of the system did not achieve the levels anticipated by the Company. Furthermore, while still profitable, sales of Knogo's Electronic Article Surveillance ("EAS") systems have continued to erode due to the attention we gave to the reengineering and marketing of SentryVision as well as competition from lower-priced, "off-the-shelf" systems and competition from larger, better-financed competitors such as Sensormatic Electronics Corporation and Checkpoint Systems Inc. In addition, due to a non-compete provision entered into by Knogo in 1994, we were not permitted to market our EAS products outside of the United States and Canada. The non-compete provision expired at the end of 1999. We recognized that, because of our continuing operating losses and the depletion of our tangible assets to fund ongoing operations, our ability to continue to market our existing SentryVision and EAS products and to develop new products and product extensions to allow us to remain competitive would require additional investment. On January 8, 2001, Dialoc ID Holdings, B.V. ("Dialoc ID"), formerly known as Dutch A&A Holding, B.V., acquired 23,050,452 shares of the Company's common stock for $3.0 million, $1.0 million of which was paid in January 2001, and the remaining balance was paid in equal $1.0 million installments on April 30, 2001 and August 31, 2001. Dialoc ID is a Netherlands company which, through its subsidiaries, is in the business of development, manufacture, sale and distribution of various kinds of RFID, access control and anti-theft electronic article surveillance products and accessories. Concurrent with the share purchase agreement, the Company entered into a distribution agreement with Dialoc ID allowing the Company access to new products of Dialoc ID and allowing Dialoc ID access to the Company's products for an initial period of not less than two years. As a result of the issuance of shares in settlement of past due debt obligations, Dialoc ID currently owns 49.1% of the Company's common stock outstanding. As of January 8, 2001, Dialoc ID owned 37.5 percent of the outstanding common stock of the Company. Under the share purchase agreement, at any time prior to January 8, 2002, Dialoc ID had the right to increase its ownership of the Company's common stock to a total of 51% of the shares of common stock then outstanding. If the average market value of the Company's common stock, measured over any 10-day trading period during the one year period following January 8, 2001, was at least $15.0 million, the purchase price for the additional shares was to be determined by multiplying the actual number of shares to be purchased by $.001. In November 2001, this market capitalization threshold was met. At that time, our Board of Directors agreed to extend Dialoc ID's purchase right until January 8, 2003 in exchange for an extension of the distribution agreement for one year. On May 14, 2002, Dialoc ID exercised their right to purchase 14,500,000 additional common stock shares at a price of $.001 per share, increasing its percentage of our outstanding common stock to 48.1% of the Company's common stock. On January 7, 2003, Dialoc exercised its right to purchase 4,516,475 additional shares of our common stock at a price of $.001 per share, increasing its percentage of our outstanding common stock to 51% and it total common stock ownership to 42,066,927 shares. In addition to the election of three nominees of Dialoc ID to the Board of Directors, other matters which were approved at the December 8, 2000 Special Meeting of Stockholders, and became effective as of January 8, 2001, were proposals to amend the Company's certificate of incorporation to: (i) permit the payment of a dividend of additional shares of Class A Preferred Stock at the rate of 0.075 shares of Class A Preferred Stock for each share of Class A Preferred Stock held; (ii) to reclassify Class A Preferred Stock into shares of common stock on a ratio of five shares of common stock for each share of Class A Preferred Stock outstanding; and (iii) to increase the number of the Company's authorized shares of common stock to 140,000,000. As a result of the dividend and reclassification, 28,666,660 common shares were issued to former Class A Preferred Stockholders. We have incurred reduced revenue levels, decreased financial position and recurring operating losses over the past several years. As a result, the Board of Directors approved a restructuring plan for 2003 to strengthen the Company's operating efficiencies and to better align its operations with current economic and market conditions. To date, we have made significant progress under our revised business plan including the downsizing of operations, the settlement of past due trade vendors, the relocation to smaller facilities and the outsourcing of all non-essential manufacturing and assembly operations to qualified subcontractors. The successful implementation of this restructuring has resulted in substantial gross margin improvements and reductions in operating expenses beginning in the second half of 2003. However, our Company has been operating in a cash flow deficit and has borrowed the maximum amounts available under our credit line. We have supplemented our cash requirements through the use of purchase order financing, at significantly higher costs than conventional borrowing. Dialoc ID is not able to provide us with additional financial support. We continue to pursue additional debt or equity financing through our financial advisors and on February 26, 2004, Sentry signed a term sheet to raise $2,000,000 in secured convertible debt with a venture fund ("the VC Fund") managed by a multibillion-dollar North American company. 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 the VC Fund 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 VC Fund affiliates and expects to be a supplier of security and identification products to the affiliates of the VC Fund. - The VC Fund will be issued warrants for 5,000,000 shares of Sentry common stock, priced at $0.15 per share, exercisable anytime within the next four years. - The VC Fund will be entitled to one seat on Sentry's Board of Directors. - As a condition of the financing, Sentry will be required to acquire ID Security Systems Canada Inc. ("ID Canada") and ID Systems USA Inc., Collectively referred to as "ID Systems." Sentry's Board of Directors and shareholders owning a majority of Sentry common stock have approved the proposed transaction with the VC Fund and the acquisition of ID Systems, both of which are subject to customary due diligence and expected to close during the next 45 days. In a related transaction, Dialoc ID Holdings B.V. ("Dialoc") has agreed to sell 39,066,927 Sentry common shares (representing approximately 46% of the total issued and outstanding shares of Sentry) and all of the stock of ID Systems, to Saburah Investments Inc. ("Saburah"). ID Systems is a Toronto based company engaged in anti-shoplifting technology, security labeling, radio frequency identification (RFID), access control and library security. Peter L. Murdoch, President and CEO of Sentry and President of ID Systems, is the owner of Saburah. The price to be paid to Dialoc by Saburah and Murdoch for Sentry and ID Systems shares in cash, debt assumption and other consideration is approximately $3.6 million plus the surrender of Murdoch's 15% interest in Dialoc. Saburah has also agreed to make a payment to Dialoc in the future equal to approximately 6% of any payment it receives from Checkpoint Systems Inc. resulting from litigation brought by ID Canada against Checkpoint. ID Canada is appealing the reduction of the original jury award of $79.2 million. The appeal is scheduled to be heard during the last week of March. As a condition of the VC Fund financing, Sentry has agreed to purchase ID Systems from Saburah in exchange for 30,000,000 Sentry common shares. The price to be paid per Sentry share will be approximately $0.12. An opinion has been provided to a special committee of Sentry's Board of Directors by Corporate Valuation Services confirming that both the price paid for the acquisition of ID Systems and the agreed conversion price of the proposed VC Fund debt are fair from the point of view of Sentry shareholders. Although Sentry will not obtain an interest in the Checkpoint Systems litigation, Saburah and Sentry have agreed that Sentry may require Saburah to purchase additional Sentry shares equal to approximately 4.5% of any amount received by Saburah from the Checkpoint litigation, to a maximum of $1,000,000. The price per share will be determined by market conditions if and when the call is made. This transaction represents the maximum future benefit that may flow to Sentry and ID Systems as a result of the Checkpoint lawsuit. 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 becomes the exclusive distributor in Europe and Asia of labels manufactured by ID Systems' security label manufacturing subsidiary, Custom Security Industries Inc. ("CSI"). - CSI acquires 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 acquires 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 distributor for Sentry products in Europe and Asia. ID Systems' management including Dr. Morton Roseman, President of CSI, and Peter Murdoch will invest $100,000 each to complete the proposed transaction between Saburah and Dialoc. Furst Capital Partners LLC and associates will invest $900,000 of equity in the combined transaction. Mr. Robert Furst is a long-standing member of Sentry's Board of Directors. On completion of these transactions and prior to the VC Fund conversion of the proposed $2,000,000 debt transaction, Peter Murdoch, directly or indirectly through his ownership of Saburah, will own or control 47.4% of the outstanding common stock of Sentry. There can be no assurance, however, that changes in our plans or other events affecting our operations will not result in accelerated or unexpected cash requirements, or that we will be successful in achieving positive cash flow from operations or that the proposed convertible debt transaction with the VC Fund or other equity financing will be available on terms that are satisfactory to Sentry, or that any such debt or equity financing will be sufficient to provide the full amount of funding necessary. Our future cash requirements are expected to depend on numerous factors, including, but not limited to: (i) the ability to generate positive cash flow from operations, and the extent thereof, (ii) the ability to raise additional capital or obtain additional financing, and (iii) economic conditions. Sentry 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. If we are not able to raise additional debt or equity financing, we could be forced into a bankruptcy or be required to liquidate our assets. In this scenario, most likely, our secured lender would receive the bulk of any proceeds. THE SENTRYVISION SYSTEM SentryVision refers to our family of traveling CCTV surveillance systems. Over the years, Video has developed various generations of traveling CCTV surveillance systems including the H-System, OH-System, the original SentryVision and currently the new and 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 recently developed 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. Sentry's proprietary CCTV system, called 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. As of December 31, 2003, 1,401 SentryVision systems had been installed in customer locations in North America. Current customers include 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, Disney Direct Marketing and Duke University. In addition, during 2003, the Company's international distributors installed 98 SentryVision systems in customer locations throughout Western and Eastern Europe, Latin America and Asia. Our international customers include ASDA Wal-Mart, Carrefour, Auchon, 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. Video 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 Video'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. Recently, we have introduced SmartTrack Mobile, which 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 SmartTrack Mobile product released in 2002, 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. RETAIL MARKET APPLICATIONS ---------------------------- - Home Centers. Video has installed 911 systems in more than 379 store locations for 9 customers in the home center segment of the retail market. Typical of our customers in this market are Lowe's Home Centers, with more than 950 stores in 45 states, and Mills Fleet Farm, a 24 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. Video has installed 222 systems for customers in this segment, including Sears, Navy Exchange 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. Video has installed 39 systems in 38 store locations for 9 supermarket customers. The targeted coverage in most of these installations has been the entire retail space. Supermarket chains using SentryVision include Kroger, Marsh, Cub Foods, Winn-Dixie and Fiesta Mart. INDUSTRIAL MARKET APPLICATIONS -------------------------------- - Distribution Centers. Video also provides loss prevention surveillance for distribution centers and warehouses, and has installed 115 systems in distribution centers for 42 different retailers including Big Lots, Home Depot, Kohl's Department Stores, Target Stores, Borders Group, Disney Direct Marketing, Barnes & Noble, Robinsons-May, Ross, Saks, Guess, Tower Records, Big Dog, Food Lion, 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. - Internet Data Centers. Video 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 FirstWorld Communications, Inc., 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 Video 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 Video. 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. Video markets digital video recording and a remote video transmission unit developed by third-party vendors including GE Interlogix 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 Magnetic ("Knoscape MM ") system uses very low frequency electromagnetic signals in the range of 218 hertz to nine kilohertz. Previously, Sentry was an authorized distributor of the library security systems and related products of Minnesota Mining and Manufacturing Company ("3M"). We cancelled our distribution agreement with 3M effective December 31, 2002. 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 U.S. market for retail EAS systems and tags is estimated by industry sources at $570 million and is growing at an estimated rate of 8 percent per year. At December 31, 2003, the approximate number of EAS Systems sold or leased by Sentry and its predecessors exceeded 25,725. 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 which 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 reusable tag is removed from the protected article, usually by a clerk at the checkout desk, 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 Knogo'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. MAGNETIC 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 which 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. BOOKINGS Of Sentry's bookings for the year ended December 31, 2003, approximately 52 percent were attributable to SentryVision , 30 percent to CCTV, 17 percent to EAS and 1% to Access Control. Of Sentry's bookings for the year ended December 31, 2002, approximately 32 percent were attributable to SentryVision , 45 percent to CCTV, 20 percent to EAS and 3 percent to 3M library security systems. For the year ended December 31, 2001, approximately 23 percent were attributable to SentryVision , 40 percent to CCTV, 31 percent to EAS, and 6 percent to 3M library security systems. 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 2003, 2002 and 2001, Lowe's Home Centers accounted for 44%, 40% and 22%, respectively, of total revenues. In 2001, Goody's Family Clothing accounted for 11% of total revenues. 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 --------------------------------- Sentry's manufacturing operations continued the shift to out-sourcing in 2003. 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 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 system component and finished assembly undergoes a quality assurance check by Sentry prior to its shipment to an installation site. All SentryVision electronic circuit board enclosures are tested and burned in for 72 hours. Upon completion, the finished product is tested and run for an additional 24 hours resulting in approximately 3,000 travel and PTZ cycles prior to quality assurance sign off. Sentry is not subject to any state or federal environmental laws, regulations or obligations 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 Knoscape RF, Ranger, Knoscape MM and KnoGlo, 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. Through product redesign efforts, final assembly machines were modified to reduce production complexities. As a result, increased production run rates of this product have been realized, simultaneously increasing production quality and reducing manpower. 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 EAS products at competitive prices in sufficient quantities as and when needed. MARKETING We marketed our products 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 2003, as part of our restructuring plan, we have reduced the number of direct salespersons to four, whose efforts are now supplemented through six in-house sales support staff and independent sales representatives. We market our products primarily through participation in trade shows 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, Chubb, Cegelec, 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 Video also emphasized a dealer program for institutional, industrial and international prospects. Beginning in mid-1998, we began a program to 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. Domestic dealers did not generate significant SentryVision installations in industrial and institutional facilities in 2003. Prior sales were made through ADT, STG, Siemans, Mosler and Security Link. In addition, we market SentryVision internationally using independent distributors. The agreements require the distributor to purchase a minimum dollar amount of the Company's product during the term of the agreement to retain distributor status. 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, 2003, we have distributors in Canada, UK, France, Mexico, Belgium, Holland, Italy, Poland, Singapore, Russia, Spain, Brazil, Argentina, Hungary, Romania, Taiwan and the United Arab Emirates. During 2003, Video placed in service 227 SentryVision systems and 2,996 CCTV cameras, as compared to 186 SentryVision systems and 4,449 CCTV cameras in 2002 and 97 SentryVision systems and 4,257 CCTV cameras in 2001. EAS PRODUCTS ------------- Sentry EAS systems are marketed on both a direct sales and lease basis, with direct sales representing the majority of the business. The terms of the standard leases are generally from one to five years. The sales prices and lease rates vary based upon the type of system purchased or leased, number and types of targets included, the sophistication of the system employed and, in the case of a lease, its term. In the case of the Knoscape MM systems, detection targets which are permanently attached to the item to be protected are sold to the customer even when the system is leased. Therefore, in the case of either a sale or lease of a Knoscape MM system, 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. During the years ended December 31, 2003 and 2002 Sentry placed in service 226 and 590 Knoscape RF, Ranger, and Knoscape MM systems. RF and Ranger systems continue to be used by apparel and department stores which 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. In March 1996, 3M and Sentry entered into a strategic alliance to provide universal asset protection to libraries across North America. The agreement permitted Sentry to act as a distributor of all of 3M's library products and other 3M library materials flow management products and accessories to public, academic and government libraries. Under the agreement, 3M provided service and installation for all new and existing Sentry library customers throughout North America. In exchange for these agreements, we agreed not to compete against 3M for sales and service of EAS Systems in the library market until March 2004. Sales of 3M library products declined in 2002 and 2001 due to 3M's direct sales practices in competition with Sentry making it uneconomical to sell these products. As a result, we have discontinued our distribution agreement with 3M effective December 31, 2002. DIALOC ID SECURITY PRODUCTS 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. The Plexiglas RF system is one of the products being brought to market by the Company as a result of a distribution agreement with Dialoc ID. In addition, through Sentry, Dialoc ID anticipates it will introduce LaserFuse, a new RF label technology, which will be compatible with, and an alternative to, the labels offered by Checkpoint Systems, Inc. In the future, we will also sell Dialoc ID products in the RFID markets. We also sell products manufactured by ID Systems including proximity access control, time and attendance and security labeling. BACKLOG Our backlog of orders was approximately $3.2 million at December 31, 2003, as compared to approximately $5.2 million at December 31, 2002 and approximately $6.0 million at December 31, 2001. We have noticed 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, 2003 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 which 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 the Company's personnel. All products sold or leased 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 sacrifice in quality. A network of qualified contractors was established. As part of our restructuring plan in 2003, we released 17 installation employees and retained only our most technically skilled employees. We intend to continue to focus on EAS, SentryVision and CCTV technical service and maintenance and continue to expand our contractor network for installation work. This strategy has resulted in significant cost savings. In addition, we retain our reputation of technical expertise within the industry and management efforts can be focused on increased electronics training for our employees, distributors and sub-contractors. We currently have a network of 63 Service Partners and installation contractors throughout the United States to augment service provided by Company employees. Many of these partners are factory trained and have contractual commitments to provide prompt, quality service at our direction. The field service management structure was also modified so that two of our most experienced managers will focus exclusively on quality control with our service partners. In addition, our Call Center was reorganized. Technical support functions were transferred to our Design Center personnel and all service requests are now screened extensively via telephone. Initial results have been highly successful in lowering the number of on-site visits required to resolve service issues. Technician headcount was reduced to 23 in 2003 as we continued to develop expertise among our service and installation partner companies. Company employees now perform only technical service and our well-established partner network performs all installations. 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. Our Design Center personnel continued to screen all service requests and were able to close almost 720 calls 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. Customer service is a priority and we are focused on continued improvements in 2004. We anticipate that increased installation and service work can be supported by the existing headcount and infrastructure. 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 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 Interlogix, 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, trade secret laws 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 applications 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. RESEARCH AND DEVELOPMENT As of December 31, 2003, 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, 2003, 2002 and 2001, approximately $0.7 million, $0.5 million and $0.7 million, respectively, was expended on Company-sponsored research. Continued product improvement efforts focused most engineering tasks in 2003 on adding features to the SmartTrack System and towards reducing the cost of manufactured products. Enhancements were made to the electro-mechanical, electronic, software, and optical portions of the SmartTrack System. Mechanical reliability and extended service life was accomplished through various improvements in material and the application of new assembly techniques. Extensive development in software during 2003 resulted in improved user interfaces, additional support for industry protocols, and allowed the use of a wider range of camera options. Additional projects included revisions to EAS products. RF systems have been enhanced through improvements in the electronics resulting in shorter installation times and greater system stability. Introducing acrylic antenna panels for a more modern look enhanced visual aesthetics of the Knoscape RF product. The Ranger system has been upgraded to use recently available integrated circuits resulting in greater system stability. 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 new products are developed by the Company, 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. Sentry's 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. Sentry intends to apply for certification of its products to comply with the requirements under the regulations of the countries in which it plans to market its 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. Industry Canada, the department of the Canadian federal government that regulates and licenses the radio frequency spectrum in Canada, has brought to our attention that several hundred of the units of the earlier generation of Ranger 1 and 2 EAS devices sold to retailers in Canada do not comply with the relevant Industry Canada technical standards, and may cause interference to other users of the radio spectrum. Industry Canada has written to the customers concerned to apprise them of the situation, and to demand that the non-compliant devices be removed or replaced with compliant ones. The Company worked with Industry Canada officials and the retailers concerned to put in place a replacement program and a schedule that will satisfy both the retailers and Industry Canada. All identified retailers have subsequently upgraded to compliant EAS devices. Under the Radiocommunication Act (Canada) (the "Act") which it administers, Industry Canada has extensive powers to, among other measures, confiscate radio equipment that is non-compliant, and to initiate prosecutions for alleged violations of the regulatory provisions in the Act. However, Industry Canada's normal practice is to use cooperative approaches to problems of technical non-compliance or radio interference, and to work with the parties concerned to resolve such problems within a reasonable time frame. As a result of our continuing efforts in cooperating with Industry Canada, we believe that all remaining issues relating to the Ranger 1 and 2 problems have been resolved. EMPLOYEES As part of our restructuring plan, our headcount was reduced by approximately 47% on March 7, 2003. At December 31, 2003, the Company and its subsidiaries employed 64 full-time employees, of whom 15 were employed in administrative and clerical capacities, 8 in engineering, research and development, 8 in manufacturing support, 4 in sales and 29 in customer service and support. None of our employees are employed pursuant to collective bargaining agreements. ITEM 2. PROPERTIES -------------------- The Company's principal executive, sales and 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. ITEM 3. LEGAL PROCEEDINGS ---------------------------- 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 fiscal year ended December 31, 2003, 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 ----- ----- 2002 First Quarter. . . . . . . . . . . . . . . . $0.22 $0.12 Second Quarter . . . . . . . . . . . . . . . 0.21 0.08 Third Quarter. . . . . . . . . . . . . . . . 0.10 0.05 Fourth Quarter . . . . . . . . . . . . . . . 0.07 0.01 2003 First Quarter. . . . . . . . . . . . . . . . $0.03 $0.01 Second Quarter . . . . . . . . . . . . . . . 0.08 0.01 Third Quarter. . . . . . . . . . . . . . . . 0.14 0.02 Fourth Quarter . . . . . . . . . . . . . . . 0.21 0.09 2004 First Quarter . .(through March 15, 2004) . $0.25 $0.13
The Company's Common Stock is quoted on the OTC Bulletin Board ("OTCBB") using the symbol SKVY. (b) Holders of Common Stock. The Common Stock began trading on the American Stock Exchange on February 13, 1997 under the symbol "SKV." Prior to such date, no public market for the Common Stock existed. As of March 12, 2004, the Company had 85,755,610 shares of Common Stock issued and outstanding, which were held by 293 holders of record and approximately 2,900 beneficial owners. (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 agreement prohibit the Company from paying cash dividends without the consent of the lender. 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. 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. 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 13 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, 1999, 2000, 2001, 2002 and 2003. The selected consolidated historical financial data should be read in conjunction with the audited Consolidated Financial Statements of the Company included in Item 7.
(AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE DATA) Years Ended December 31,. . . . . . . . . . . . . . . . . . . . . 1999 2000 2001 2002 2003 --------- --------- -------- -------- -------- SELECTED STATEMENT OF OPERATIONS DATA: Total revenues. . . . . . . . . . . . . . . . . . . . . . . . . . $ 22,281 $ 19,865 $17,299 $14,536 $13,009 Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . 14,339 11,120 8,879 7,382 5,179 Customer service expenses . . . . . . . . . . . . . . . . . . . . 5,457 4,464 4,361 4,240 3,977 Selling, general and administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . 9,169 7,576 5,773 5,119 3,575 Restructuring and impairment charges . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,026 2,981 - - - Gain on sale of assets. . . . . . . . . . . . . . . . . . . . . . 503 - - - - Loss before income taxes. . . . . . . . . . . . . . . . . . . . . (11,034) (7,821) (2,911) (3,356) (1,049) Extraordinary item - Gain on extinguishment of debt . . . . . . . - - - - 738 Cumulative effect of change in accounting principal . . . . . . . - 301 - - - Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . (11,034) (8,122) (2,911) (3,356) 181 Preferred stock dividends . . . . . . . . . . . . . . . . . . . . 1,326 1,337 25 - - Return to common shareholders from redemption of preferred stock. - - 27,198 - - Net income (loss) available to common shareholders. . . . . . . . . . . . . . . . . . . . . . (12,360) (9,459) 24,262 (3,356) 181 Net income (loss) per common share: Basic. . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1.27) (0.97) 0.40 (0.05) 0.00 Diluted. . . . . . . . . . . . . . . . . . . . . . . . . . . . (1.27) (0.97) 0.39 (0.05) 0.00 As of December 31, SELECTED BALANCE SHEET DATA:. . . . . . . . . . . . . . . . . . . 1999 2000 2001 2002 2003 --------- --------- -------- -------- -------- Working capital . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,290 $ 2,173 $ 2,235 $ (768) $ (285) Total assets. . . . . . . . . . . . . . . . . . . . . . . . . . . 22,007 13,845 11,561 7,992 4,093 Property, plant and equipment, net. . . . . . . . . . . . . . . . 3,934 3,324 2,962 2,563 209 Obligations under capital leases. . . . . . . . . . . . . . . . . 3,058 2,892 2,751 2,652 18 Redeemable cumulative preferred stock . . . . . . . . . . . . . . 27,843 29,180 - - - Total common shareholders' equity (deficit) . . . . . . . . . . . (16,335) (25,794) 2,891 (451) (125)
RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2003 COMPARED WITH YEAR ENDED DECEMBER 31, 2002 Consolidated revenues were 11% lower in the year ended December 31, 2003 than in the year ended December 31, 2002. As part of the Company's restructuring plan for 2003, we reduced the direct sales force from ten to four. The backlog of orders, which we expect to deliver within twelve months, decreased to $3.2 million at December 31, 2003 as compared to $5.2 million at December 31, 2002. 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: 2003 2002 Change ---- ---- ------ (in thousands) EAS $ 1,817 $ 2,530 (28%) CCTV 3,601 4,578 (21%) SentryVision 3,049 2,368 29% 3M library products 45 256 (82%) ------- -------- Total sales 8,512 9,732 (13%) Service, installation and other 4,497 4,804 (6%) ------- ----- Total revenues $ 13,009 $ 14,536 (11%) ======== ========= ==== Direct sales of EAS products were lower in 2003 as compared to 2002 as a result of lower sales to our Mexican Distributor and to smaller boutique customers. Overall sales of conventional CCTV systems in 2003 have weakened with several of our existing customers compared to the prior year while sales of our proprietary SentryVision Smart Track system continued to strengthen. We continue to see a growing trend for product acceptance and increased market opportunities for traveling camera systems both domestically and internationally. We terminated our distribution agreement with 3M for library products as of the end of 2002, however, the final installations were completed in first quarter of 2003. Service revenues decreased primarily as a result of lower maintenance contract renewals in 2003 than in 2002. 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. Cost of sales were 61% in 2003 compared to 76% in 2002. In the second quarter of 2003, we began to outsource all significant manufacturing operations. The decrease in the cost of sales percentage in 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. In addition, we made a concerted effort to sell inventory from stock in 2003, of which some of the inventory values had been previously written down. Customer service expenses, as a percentage of service revenues, remained the same in 2003 as compared to 2002. Through a combination of a decrease in the number of customer service employees and increased use of outside service contractor costs, we were able to lower total net customer service costs to compensate for the lower revenue levels 2003. Selling, general and administrative expenses were 30% lower in 2003 when compared to 2002 primarily as a result of lower payroll costs and commissions partly as a result of the headcount reduction as of March 7, 2003. We anticipate that selling, general and administrative costs will continue to decline on a comparative basis during 2004, particularly after our relocation to a smaller, less costly facility as of October 1, 2003. Research and development costs were higher in 2003 when compared to 2002 due to a reorganization and transfer of employees into the engineering group as part of our restructuring. Total interest and financing costs increased by $68,000 in 2003 as compared to 2002. Bank interest expense declined by $63,000 in 2003 due to lower average borrowings and lower interest rates under our revolving credit and term loan facility. Interest under capital leases decreased by $159,000 as a result of the cancellation of the sale and leaseback agreement on our former headquarters facility. However, total interest and financing costs in 2003 were higher than in 2002 because we were required to supplement our financing needs through increased use of purchase order financing with EPK Financial, which carries substantially higher financing fees than the revolving credit line. Interest under this facility was $290,000 higher in 2003 than in 2002. We expect that PO financing would be eliminated and interest costs would significantly decrease if we were successful in raising equity or debt financing in the future. 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 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 the third quarter of 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 $492,000 income tax provision recognized on the extraordinary gains was offset by equivalent income tax benefits generated from the current year's loss from operations and the utilization of net operating loss carryforwards. Due to net operating losses, we have not provided for income taxes in 2002. As a result of the foregoing, we had a net profit of $181,000 in the year ended December 31, 2003 as compared to a net loss of $3.4 million in the year ended December 31, 2002. LIQUIDITY AND CAPITAL RESOURCES We have incurred reduced revenue levels, decreased financial position and recurring operating losses over the past several years. As a result, the Board of Directors approved a restructuring plan for 2003 to strengthen the Company's operating efficiencies and to better align its operations with current economic and market conditions. To date, we have made significant progress under our revised business plan including the following: - Significantly downsized our operations including the elimination of approximately 55 of 117 positions as of March 7, 2003. - Negotiated a settlement with past due trade vendors which has resulted in an $877,000 gain. - Negotiated with the previous landlord to move out of its Hauppauge corporate facility. The lease termination resulted in a $353,000 gain. - Relocated our corporate offices to a smaller and less costly facility. - Dedicated a substantial portion of our remaining resources towards maintaining and improving our relationships with our 30 largest customers. - Outsourced all non-essential manufacturing and assembly operations to qualified subcontractors. - Further expanded our Service Partner program to augment service and installations performed by our employees. On January 7, 2003, Sentry initiated its restructuring plan. Due to the size of the layoff, we were required to give the terminated employees a 60-day notice period. The costs associated with these restructuring activities were expensed as incurred. The successful implementation of this restructuring has resulted in substantial gross margin improvements and reductions in operating expenses beginning in the second half of 2003. As of December 31, 2003, we had borrowings of approximately $1.5 million with CIT, the maximum amount available under the revolving credit and term loan facility. Most of our trade vendors require cash in advance or COD payments for purchases. Therefore, we continue to supplement our borrowings under the CIT credit facility with purchase order financing through EPK Financial Corporation. During 2003, we funded $2.4 million of inventory purchases under this facility as compared to $0.6 million in 2002. As of December 31, 2003, we owed approximately $291,000 to EPK Financial. 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 $1.1 million. 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, 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. To date, approximately 82% of past due trade debts have been settled. The first note payment due January 15, 2004 has been delayed pending the proposed funding transaction described below. 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 then current 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. The note also obligates Sentry to prepay an amount of $100,000 against the note in the event of an equity financing, as defined. 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 the third quarter of 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 of October 1, 2003, Sentry moved its corporate offices and distribution center to a smaller and less costly 20,000 square foot facility in Ronkonkoma, New York. The Company entered into a three-year lease with annual rents of $140,000, $144,200 and $148,600, respectively. It is anticipated that the move will result in excess of $250,000 in savings on an annualized basis. Dialoc ID is not able to provide us with additional financial support. We continue to pursue additional debt or equity financing through our financial advisors and on February 26, 2004, Sentry signed a term sheet to raise $2,000,000 in secured convertible debt with a venture fund ("the VC Fund") managed by a multibillion-dollar North American company. 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 the VC Fund 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 VC Fund affiliates and expects to be a supplier of security and identification products to the affiliates of the VC Fund. - The VC Fund will be issued warrants for 5,000,000 shares of Sentry common stock, priced at $0.15 per share, exercisable anytime within the next four years. - The VC Fund will be entitled to one seat on Sentry's Board of Directors. - As a condition of the financing, Sentry will be required to acquire ID Security Systems Canada Inc. ("ID Canada") and ID Systems USA Inc., collectively referred to as "ID Systems." Sentry's Board of Directors and shareholders owning a majority of Sentry common stock have approved the proposed transaction with the VC Fund and the acquisition of ID Systems, both of which are subject to customary due diligence and expected to close during the next 45 days. In a related transaction, Dialoc ID Holdings B.V. ("Dialoc") has agreed to sell 39,066,927 Sentry common shares (representing approximately 46% of the total issued and outstanding shares of Sentry) and all of the stock of ID Systems, to Saburah Investments Inc. ("Saburah"). ID Systems is a Toronto based company engaged in anti-shoplifting technology, security labeling, radio frequency identification (RFID), access control and library security. Peter L. Murdoch, President and CEO of Sentry and President of ID Systems, is the owner of Saburah. The price to be paid to Dialoc by Saburah and Murdoch for Sentry and ID Systems shares in cash, debt assumption and other consideration is approximately $3.6 million plus the surrender of Murdoch's 15% interest in Dialoc. Saburah has also agreed to make a payment to Dialoc in the future equal to approximately 6% of any payment it receives from Checkpoint Systems Inc. resulting from litigation brought by ID Canada against Checkpoint. ID Canada is appealing the reduction of the original jury award of $79.2 million. The appeal is scheduled to be heard during the last week of March. As a condition of the VC Fund financing, Sentry has agreed to purchase ID Systems from Saburah in exchange for 30,000,000 Sentry common shares. The price to be paid per Sentry share will be approximately $0.12. An opinion has been provided to a special committee of Sentry's Board of Directors by Corporate Valuation Services confirming that both the price paid for the acquisition of ID Systems and the agreed conversion price of the proposed VC Fund debt are fair from the point of view of Sentry shareholders. Although Sentry will not obtain an interest in the Checkpoint Systems litigation, Saburah and Sentry have agreed that Sentry may require Saburah to purchase additional Sentry shares equal to approximately 4.5% of any amount received by Saburah from the Checkpoint litigation, to a maximum of $1,000,000. The price per share will be determined by market conditions if and when the call is made. This transaction represents the maximum future benefit that may flow to Sentry and ID Systems as a result of the Checkpoint lawsuit. 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 becomes the exclusive distributor in Europe and Asia of labels manufactured by ID Systems' security label manufacturing subsidiary, Custom Security Industries Inc. ("CSI"). - CSI acquires 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 acquires 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. ID Systems' management including Dr. Morton Roseman, President of CSI, and Peter Murdoch will invest $100,000 each to complete the proposed transaction between Saburah and Dialoc. Furst Capital Partners LLC and associates will invest $900,000 of equity in the combined transaction. Mr. Robert Furst is a long-standing member of Sentry's Board of Directors. On completion of these transactions and prior to the VC Fund conversion of the proposed $2,000,000 debt transaction, Peter Murdoch, directly or indirectly through his ownership of Saburah, will own or control 47.4% of the outstanding common stock of Sentry. There can be no assurance, however, that changes in our plans or other events affecting our operations will not result in accelerated or unexpected cash requirements, or that we will be successful in achieving positive cash flow from operations or that the proposed convertible debt transaction with the VC Fund or other equity financing will be available on terms that are satisfactory to Sentry, or that any such debt or equity financing will be sufficient to provide the full amount of funding necessary. Our future cash requirements are expected to depend on numerous factors, including, but not limited to: (i) the ability to generate positive cash flow from operations, and the extent thereof, (ii) the ability to raise additional capital or obtain additional financing, and (iii) economic conditions. Sentry 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. If we are not able to raise additional debt or equity financing, we could be forced into a bankruptcy or be required to liquidate our assets. In this scenario, most likely, our secured lender would receive the bulk of any proceeds. The table below summarizes aggregate maturities of future minimum lease payments under noncancelable operating and capital leases as of December 31, 2003.
Contractual Less than 1-3 4-5 After 5 Obligations Total 1 Year Years Years Years --------------- ----- --------- ----- ----- ----- (In Thousands) Operating Leases $ 398 $ 141 $ 257 $ - $- Capital Leases 22 7 15 - - ------ ------ ------ --- --- Total $ 420 $ 148 $ 272 $ - $- ====== ====== ====== === ===
RECENT ACCOUNTING PRONOUNCEMENTS In April 2003, FASB issued Statement of Financial Accounting Standards No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities ("SFAS 149"). SFAS 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS 133. SFAS 149 is effective for contracts and hedging relationships entered into or modified after June 30, 2003. We adopted the provisions of SFAS 149 effective June 30, 2003 and such adoption did not have a material impact on our consolidated financial statements since we have not entered into any derivative or hedging transactions. In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" ("FAS 150"). This statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, financial instruments that embody obligations for the issuer are required to be classified as liabilities. FAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We adopted the provisions of SFAS 150 effective June 30, 2003 and such adoption did not have a material impact on our consolidated financial statements. 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 two 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 due to its current financial condition; (vi) the risk that the borrowing availability under the new credit facility 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 ---------------- REPORT ON AUDITS OF ------------------- CONSOLIDATED FINANCIAL STATEMENTS --------------------------------- YEARS ENDED DECEMBER 31, 2003 AND 2002 -------------------------------------- CONTENTS -------- Page ---- CONSOLIDATED FINANCIAL STATEMENTS: Independent auditors' report 24 Balance sheets 25 Statements of operations 26 Statements of shareholders' equity 27 Statements of cash flows 28 Notes to financial statements 29 - 43 ------ Independent Auditors' Report ---------------------------- To the Board of Directors and Stockholders of Sentry Technology Corporation Ronkonkoma, New York We have audited the accompanying consolidated balance sheets of Sentry Technology Corporation and subsidiaries (the "Company") as of December 31, 2003 and 2002, and the related consolidated statements of operations, shareholders' equity (deficit) and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the consolidated financial statements. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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, 2003 and 2002, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 4 to the consolidated financial statements, the Company's recurring losses from operations and negative cash flow position raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 4. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ Holtz Rubenstein & Co., LLP Melville, New York February 27, 2004 SENTRY TECHNOLOGY CORPORATION ----------------------------- AND SUBSIDIARIES ---------------- CONSOLIDATED BALANCE SHEETS --------------------------- (IN THOUSANDS, EXCEPT PAR VALUE AMOUNTS)
December 31, 2003 2002 -------------- --------- ASSETS ---------------------------------------------------------------------- Current Assets: Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . $ 210 $ 266 Accounts receivable, less allowance for doubtful accounts of $304 and $303, respectively . . . . . . . . . . . . . . . . . . 1,482 1,472 Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,855 3,145 Prepaid expenses and other current assets. . . . . . . . . . . . . . 126 237 -------------- --------- Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . 3,673 5,120 PROPERTY, PLANT AND EQUIPMENT, net . . . . . . . . . . . . . . . . . . 209 2,563 PATENTS, less accumulated amortization of $260 and $338, respectively. 133 207 OTHER ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78 102 -------------- --------- $ 4,093 $ 7,992 ============== ========= LIABILITIES AND SHAREHOLDERS' EQUITY ---------------------------------------------------------------------- Current Liabilities: Revolving line of credit and term loan . . . . . . . . . . . . . . . $ 1,515 $ 2,067 Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . 566 1,807 Accrued liabilities. . . . . . . . . . . . . . . . . . . . . . . . . 1,601 1,523 Obligations under capital leases - current portion . . . . . . . . . 5 97 Deferred income. . . . . . . . . . . . . . . . . . . . . . . . . . . 271 394 -------------- --------- Total current liabilities. . . . . . . . . . . . . . . . . . . . . . . 3,958 5,888 NOTES PAYABLE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247 - OBLIGATIONS UNDER CAPITAL LEASES, noncurrent portion . . . . . . . . . 13 2,555 -------------- --------- Total liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . 4,218 8,443 COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY (DEFICIT): Common stock, $0.001 par value; authorized 140,000 shares, issued and outstanding 85,756 and 78,044 shares, respectively. . . 86 78 Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . 44,658 44,521 Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . . (44,749) (44,930) Note receivable from shareholder . . . . . . . . . . . . . . . . . . (120) (120) -------------- --------- Total shareholders' equity (deficit) . . . . . . . . . . . . . . . . . (125) (451) -------------- --------- $ 4,093 $ 7,992 ============== =========
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, -------------------------- 2003 2002 -------- -------- REVENUES: Sales. . . . . . . . . . . . . . . . . . . . . . . . $ 8,512 $ 9,732 Service revenues and other . . . . . . . . . . . . . 4,497 4,804 ----------- -------- 13,009 14,536 ----------- -------- COST AND EXPENSES: Cost of sales. . . . . . . . . . . . . . . . . . . . 5,179 7,382 Customer service expenses. . . . . . . . . . . . . . 3,977 4,240 Selling, general and administrative expenses . . . . 3,575 5,119 Research and development . . . . . . . . . . . . . . 656 548 ----------- -------- 13,387 17,289 ----------- -------- OPERATING LOSS. . . . . . . . . . . . . . . . . . . . (378) (2,753) INTEREST AND FINANCING EXPENSE, net . . . . . . . . . 671 603 ----------- -------- LOSS BEFORE INCOME TAXES AND EXTRAORDINARY ITEM . . . . . . . . . . . . . . . . . (1,049) (3,356) INCOME TAX BENEFIT. . . . . . . . . . . . . . . . . . (492) - ----------- -------- LOSS BEFORE EXTRAORDINARY ITEM. . . . . . . . . . . . (557) (3,356) EXTRAORDINARY ITEM - Gain on extinguishment of debt, net of $492 income taxes . . . . . . . . . . . . . . 738 - ----------- -------- NET INCOME (LOSS) . . . . . . . . . . . . . . . . . . $ 181 $(3,356) =========== ======== BASIC INCOME (LOSS) PER COMMON SHARE: Income (loss) before extraordinary item. . . . . . . $ (0.01) $ (0.05) Extraordinary item . . . . . . . . . . . . . . . . . 0.01 0.00 ----------- -------- Net income (loss). . . . . . . . . . . . . . . . . . $ 0.00 $ (0.05) =========== ======== WEIGHTED AVERAGE BASIC COMMON SHARES. . . . . . . . . 84,153 72,193 =========== ========
See notes to consolidated financial statements SENTRY TECHNOLOGY CORPORATION ----------------------------- AND SUBSIDIARIES ---------------- CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY ----------------------------------------------- (IN THOUSANDS) YEARS ENDED DECEMBER 31, 2003 AND 2002 --------------------------------------
Total Note Common Additional Receivable Shareholders' Common Stock Paid-in Accumulated from Equity Shares Amount Capital Deficit Shareholder (Deficit) BALANCE, January 1, 2002 . . . . . . . . . . . . . 61,543 $ 62 $ 44,403 $ (41,574) $ - $ 2,891 Net loss and comprehensive loss. . . . . . . . . . - - - (3,356) - (3,356) Net proceeds from common stock issued to Dialoc ID 14,500 14 - - - 14 Exercise of stock options. . . . . . . . . . . . . 2001 2 118 - (120) - --------- --------- ----------- ---------- ---------- --------- BALANCE, December 31, 2002 . . . . . . . . . . . . 78,044 78 44,521 (44,930) (120) (451) Net income and comprehensive income. . . . . . . . - - - 181 - 181 Settlement of debt and lease obligations . . . . . 3,193 3 137 - - 140 Net proceeds from common stock issued to Dialoc ID 4,517 5 - - - 5 Exercise of stock options. . . . . . . . . . . . . 2 - - - - - ---------- --------- ----------- ---------- ---------- --------- BALANCE, December 31, 2003 . . . . . . . . . . . . 85,756 $ 86 $ 44,658 $ (44,749) $ (120) $ (125) ========== ========= =========== ========== ========== =========
See notes to consolidated financial statements SENTRY TECHNOLOGY CORPORATION ----------------------------- AND SUBSIDIARIES ---------------- CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------- (IN THOUSANDS)
Years Ended December 31, --------------------------- 2003 2002 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 181 $ (3,356) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization. . . . . . . . . . . . . . . . . . . . . . . 262 474 Amortization of intangibles and other assets . . . . . . . . . . . . . . . 90 42 Provision for bad debts. . . . . . . . . . . . . . . . . . . . . . . . . . (16) (226) Extraordinary gain on extinguishments of debt. . . . . . . . . . . . . . . (1,230) - Changes in operating assets and liabilities: Accounts receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 1,467 Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,290 1,595 Prepaid expenses and other assets. . . . . . . . . . . . . . . . . . . . . 118 142 Accounts payable and accrued liabilities . . . . . . . . . . . . . . . . . 65 313 Deferred income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (123) 91 -------- -------- Net cash provided by operating activities. . . . . . . . . . . . . . . . . . 643 542 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property, plant and equipment. . . . . . . . . . . . . . . . . . (81) (41) Intangibles. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (16) (15) -------- -------- Net cash used in investing activities. . . . . . . . . . . . . . . . . . . . (97) (56) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net payments on the revolving line of credit . . . . . . . . . . . . . . . . (1,339) (566) Proceeds of term loan. . . . . . . . . . . . . . . . . . . . . . . . . . . . 845 100 Repayment of term loan . . . . . . . . . . . . . . . . . . . . . . . . . . . (58) (67) Repayment of obligations under capital leases. . . . . . . . . . . . . . . . (55) (124) Proceeds of sale of stock, net . . . . . . . . . . . . . . . . . . . . . . . 5 14 -------- -------- Net cash used in financing activities. . . . . . . . . . . . . . . . . . . . (602) (643) -------- -------- DECREASE IN CASH AND CASH EQUIVALENTS . . . . . . . . . . . . . . . . . . . . (56) (157) CASH AND CASH EQUIVALENTS, beginning of year. . . . . . . . . . . . . . . . . 266 423 -------- -------- CASH AND CASH EQUIVALENTS, end of year. . . . . . . . . . . . . . . . . . . . $ 210 $ 266 ======== ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for: Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 676 $ 633 ======== ======== Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ - $ - ======== ======== During 2003 the Company issued 3,193,263 shares of its common stock, with a value approximating $138,000, to certain vendors and its former landlord in connection with the settlement of certain obligations.
See notes to consolidated statements SENTRY TECHNOLOGY CORPORATION ----------------------------- AND SUBSIDIARIES ---------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------ YEARS ENDED DECEMBER 31, 2003 AND 2002 -------------------------------------- 1. BASIS OF PRESENTATION: ----------------------- Sentry Technology Corporation ("Sentry") a publicly traded Delaware Corporation, was established to effect the merger of Knogo North America Inc. ("Knogo N.A.") and Video Sentry Corporation ("Video Sentry") which was consummated on February 12, 1997. The merger resulted in Knogo N.A. and Video Sentry becoming wholly owned subsidiaries of Sentry. The term "Company" refers to Sentry as of and subsequent to February 12, 1997 and to Knogo N.A. prior to such date. Prior to the merger, Video Sentry was engaged in the design, development and marketing of a traveling closed circuit television security surveillance system throughout the United States. 2. INVESTMENT BY DIALOC ID: -------------------------- On January 8, 2001, Dialoc ID, formerly known as Dutch A&A Holding, B.V., acquired 23,050,452 shares of Sentry common stock for $3 million. Dialoc ID is a Netherlands company which, through its subsidiaries, is in the business of development, manufacture, sale and distribution of various kinds of identification, access control and anti-theft electronic article surveillance systems and accessories. Concurrent with the share purchase agreement, the Company entered into a distribution agreement with Dialoc ID allowing the Company access to new products of Dialoc ID and allowing Dialoc ID access to the Company's products for an initial period of not less than two years. As of January 8, 2001, Dialoc ID owned 37.5% of the Company's outstanding common stock. Under the share purchase agreement, at any time prior to January 8, 2002, Dialoc ID had the right to increase its ownership of the Company's common stock to a total of 51% of the shares of common stock then outstanding. If the average market value of the Company's common stock, measured over any 10-day trading period during the one year period following January 8, 2001, was at least $15.0 million, the purchase price for the additional shares shall be determined by multiplying the actual number of shares to be purchased by $.001. In November 2001, this market capitalization threshold was met. At that time, the Board of Directors agreed to extend Dialoc ID's purchase right until January 8, 2003 in exchange for an extension of the distribution agreement for one year. On May 14, 2002, Dialoc ID exercised its right to purchase 14,500,000 additional common shares at a price of $.001 per share. On January 7, 2003, they brought their ownership to 51% through the exercise of 4,516,475 additional shares of newly issued common stock at an exercise price of $0.001 per share. As of December 31, 2003, Dialoc ID owned 42,066,927 shares. As a result of the issuance of shares in settlement of past due debt obligations, Dialoc ID currently owns 49.1% of the Company's common stock outstanding. In addition to the election of three nominees of Dialoc ID to the Board of Directors, other matters which were approved at the December 8, 2001 Special Meeting of Stockholders and became effective on January 8, 2001 were amendments to the Company's certificate of incorporation to: (i) permit the payment of a dividend of additional shares of Class A Preferred Stock at the rate of 0.075 shares of Class A Preferred Stock for each share of Class A Preferred Stock held; (ii) to reclassify Class A Preferred Stock into shares of common stock on a ratio of five shares of common stock for each share of Class A Preferred Stock outstanding; and (iii) to increase the number of the Company's authorized shares of common stock to 140,000,000. As a result of the dividend and reclassification, 28,666,660 common shares were issued to former Class A Preferred shareholders. 3. SIGNIFICANT ACCOUNTING POLICIES: --------------------------------- a. Business -------- The Company is engaged in the design, manufacture, distribution, installation and service of systems designed to be used by retailers to deter shoplifting and employee theft and by commercial, manufacturing and governmental customers to protect people and assets. 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, 2003 and 2002, leases of security devices were not material. The Company recognizes revenue when installation is complete or other post-shipment obligations have been satisfied. Service revenues are recognized when earned and maintenance revenues are recognized ratably over the service contract period. Included in accounts receivable at December 31, 2003 and 2002 are unbilled accounts receivable of $41,000 and $21,000, 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. 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 accounts. 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, plant 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 ------- 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. Estimated annual amortization expense for the next five succeeding fiscal years will range from $15,000 to $20,000. j. Impairment of long-lived assets ---------------------------------- The Company reviews its long-lived assets, property and equipment, intangible assets 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. k. 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, 2003 and 2002 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. l. Deferred income ---------------- Deferred income consists of rentals related to operating leases and maintenance contracts billed or paid in advance. m. 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. The Company and its subsidiaries file consolidated tax returns. n. 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 fiscal 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 2003 or 2002. The weighted average fair value of the options granted for the year ended December 31, 2001 is estimated at $0.05, using the Black-Scholes option pricing model with the following weighted average assumptions: expected life of five years; stock volatility, 147% in 2001; risk free interest rates, 4.8% in 2001, 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 of the post 1995 awards 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:
2003 2002 ----------- ---------- (In Thousands, Except Per Share Amounts) Net income (loss): As reported. . . . . . . . $ 181 $ (3,356) Pro forma. . . . . . . . . 107 (3,554) Net income (loss) per share: As reported. . . . . . . . $ - $ (0.05) Pro forma. . . . . . . . . $ - $ (0.05)
o. Foreign currency translation ------------------------------ The functional currency of the Company's foreign entity is the U.S. dollar. Unrealized foreign exchange transaction gains (losses) are included in selling, general and administrative expenses and amounted to approximately $12,000 and ($16,000) for the years ended December 31, 2003 and 2002, respectively. p. Shipping and handling costs ------------------------------ The Company includes shipping and handling costs in cost of goods sold. q. 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. r. Reclassifications ----------------- Certain prior year balances have been reclassified to conform with current year classifications. s. Recent accounting pronouncements ---------------------------------- In April 2003, FASB issued Statement of Financial Accounting Standards No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities ("SFAS 149"). SFAS 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS 133. SFAS 149 is effective for contracts and hedging relationships entered into or modified after June 30, 2003. We adopted the provisions of SFAS 149 effective June 30, 2003 and such adoption did not have a material impact on our consolidated financial statements since we have not entered into any derivative or hedging transactions. In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" ("FAS 150"). This statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, financial instruments that embody obligations for the issuer are required to be classified as liabilities. FAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company adopted the provisions of SFAS 150 effective June 30, 2003 and such adoption did not have a material impact on our consolidated financial statements. 4. FINANCIAL CONDITION AND LIQUIDITY: ------------------------------------ The Company has incurred reduced revenue levels, decreased financial position and recurring operating losses over the past several years. As a result, the Board of Directors approved a restructuring plan for 2003 to strengthen the Company's operating efficiencies and to better align its operations with current economic and market conditions. Our progress under the revised business plan is as follows: - Significantly downsized our operations including the elimination of approximately 55 of 117 positions as of March 7, 2003. - Negotiated a settlement with past due trade vendors which has resulted in an $877,000 gain. - Negotiated with the previous landlord to move out of its Hauppauge corporate facility. The lease termination has resulted in a gain of $353,000. - Relocated its corporate offices to a smaller and less costly facility. - Dedicated a substantial portion of our remaining resources towards maintaining and improving our relationships with our 30 largest customers. - Outsourced all non-essential manufacturing and assembly operations to qualified subcontractors. - Further expanded our Service Partner program to augment service and installations performed by our employees. On January 7, 2003, Sentry initiated its restructuring plan. Due to the size of the layoff, Sentry was required to give the terminated employees a 60-day notice period. The costs associated with these restructuring activities are being expensed as they are incurred. The successful implementation of this restructuring has resulted in substantial gross margin improvements and reductions in operating expenses beginning in the second half of 2003. In October 2002, the Company entered into a purchase order financing facility with EPK Financial Corporation ("EPK"). Funding entails EPK providing funds directly to vendors to allow the Company to secure the inventory needed to fulfill customer orders. Sentry's costs for each financing transaction will be equal to 2.75% of Sentry's selling price, plus 1.85% on the maximum outstanding funded amount each ten calendar days or portion thereof, until EPK is paid in full, plus expenses. In connection with this facility, an Intercreditor Agreement was entered into between EPK, the CIT Group/Business Credit, Inc. ("CIT"), with whom the Company has a revolving line of credit (see Note 9), and Sentry. Under this agreement, CIT subordinated its rights and interests in the collateral related to each transaction to EPK. Currently, under the terms of the Intercreditors Agreement, the maximum amount subordinated to EPK at any time is limited to $650,000. Sentry uses the funds provided by EPK to fund vendor purchases to complete orders currently in backlog. At December 31, 2003, the amount owed to EPK was approximately $291,000. Dialoc ID is not able to provide us with additional financial support. We continue to pursue additional debt or equity financing through our financial advisors and on February 26, 2004, Sentry signed a term sheet to raise $2,000,000 in secured convertible debt with a venture fund ("the VC Fund") managed by a multibillion-dollar North American company. 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 the VC Fund 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 VC Fund affiliates and expects to be a supplier of security and identification products to the affiliates of the VC Fund. - The VC Fund will be issued warrants for 5,000,000 shares of Sentry common stock, priced at $0.15 per share, exercisable anytime within the next four years. - The VC Fund will be entitled to one seat on Sentry's Board of Directors. As a condition of the financing, Sentry will be required to acquire ID Security Systems Canada Inc. ("ID Canada") and ID Systems USA Inc., collectively referred to as "ID Systems." Sentry's Board of Directors and shareholders owning a majority of Sentry common stock have approved the proposed transaction with the VC Fund and the acquisition of ID Systems, both of which are subject to customary due diligence and expected to close during the next 45 days. In a related transaction, Dialoc ID Holdings B.V. ("Dialoc") has agreed to sell 39,066,927 Sentry common shares (representing approximately 46% of the total issued and outstanding shares of Sentry) and all of the stock of ID Systems, to Saburah Investments Inc. ("Saburah"). ID Systems is a Toronto based company engaged in anti-shoplifting technology, security labeling, radio frequency identification (RFID), access control and library security. Peter L. Murdoch, President and CEO of Sentry and President of ID Systems, is the owner of Saburah. The price to be paid to Dialoc by Saburah and Murdoch for Sentry and ID Systems shares in cash, debt assumption and other consideration is approximately $3.6 million plus the surrender of Murdoch's 15% interest in Dialoc. Saburah has also agreed to make a payment to Dialoc in the future equal to approximately 6% of any payment it receives from Checkpoint Systems Inc. resulting from litigation brought by ID Canada against Checkpoint. ID Canada is appealing the reduction of the original jury award of $79.2 million. The appeal is scheduled to be heard during the last week of March. As a condition of the VC Fund financing, Sentry has agreed to purchase ID Systems from Saburah in exchange for 30,000,000 Sentry common shares. The price to be paid per Sentry share will be approximately $0.12. An opinion has been provided to a special committee of Sentry's Board of Directors by Corporate Valuation Services confirming that both the price paid for the acquisition of ID Systems and the agreed conversion price of the proposed VC Fund debt are fair from the point of view of Sentry shareholders. Although Sentry will not obtain an interest in the Checkpoint Systems litigation, Saburah and Sentry have agreed that Sentry may require Saburah to purchase additional Sentry shares equal to approximately 4.5% of any amount received by Saburah from the Checkpoint litigation, to a maximum of $1,000,000. The price per share will be determined by market conditions if and when the call is made. This transaction represents the maximum future benefit that may flow to Sentry and ID Systems as a result of the Checkpoint lawsuit. 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 becomes the exclusive distributor in Europe and Asia of labels manufactured by ID Systems' security label manufacturing subsidiary, Custom Security Industries Inc. ("CSI"). - CSI acquires 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 acquires 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. ID Systems' management including Dr. Morton Roseman, President of CSI, and Peter Murdoch will invest $100,000 each to complete the proposed transaction between Saburah and Dialoc. Furst Capital Partners LLC and associates will invest $900,000 of equity in the combined transaction. Mr. Robert Furst is a long-standing member of Sentry's Board of Directors. On completion of these transactions and prior to the VC Fund conversion of the proposed $2,000,000 debt transaction, Peter Murdoch, directly or indirectly through his ownership of Saburah, will own or control 47.4% of the outstanding common stock of Sentry. There can be no assurance, however, that changes in our plans or other events affecting our operations will not result in accelerated or unexpected cash requirements, or that we will be successful in achieving positive cash flow from operations or that proposed convertible debt transaction with the VC Fund or other equity financing will be available on terms that are satisfactory to Sentry, or that any such debt or equity financing will be sufficient to provide the full amount of funding necessary. Our future cash requirements are expected to depend on numerous factors, including, but not limited to: (i) the ability to generate positive cash flow from operations, and the extent thereof, (ii) the ability to raise additional capital or obtain additional financing, and (iii) economic conditions. Sentry 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. If we are not able to raise additional debt or equity financing, we could be forced into a bankruptcy or be required to liquidate our assets. In this scenario, most likely, our secured lender would receive the bulk of any proceeds. 5. 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, 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 first payment due on the notes as of January 15, 2004 has been delayed due to the pending transaction with the VC Fund. 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. The note also obligates Sentry to prepay an amount of $100,000 against the note in the event of an equity financing, as defined. 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 the third quarter of 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 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 annual rents of $140,000, $144,200 and $148,600, respectively. The $492,000 income tax provision recognized in 2003 on the extraordinary gains was offset by an equivalent income tax benefit generated from the current periods' loss from operations and the utilization of net operating loss carryforwards. 6. INVENTORIES ----------- Inventories consist of the following:
December 31, 2003 2002 -------- -------- (In Thousands) ----------------- Raw materials. . . $ 449 $ 513 Work-in-process. . 283 618 Finished goods . . 1,123 2,014 -------- -------- $ 1,855 $ 3,145
The components of inventory shown are net of reserves for excess and obsolete inventory totaling $2,148,000 and $3,610,000 as of December 31, 2003 and 2002, respectively. 7. PROPERTY, PLANT AND EQUIPMENT: -------------------------------- Property, plant and equipment are stated at cost and are summarized as follows:
Estimated Useful Lives December 31, (Years) 2003 2002 ---------- --------- -------- (In Thousands) -------------------- Building. . . . . . . . . . . . . . . . . 20 $ - $ 3,033 Machinery and equipment . . . . . . . . . 3 - 10 826 2,076 Furniture, fixtures and office equipment. 3 - 10 2,148 3,700 Leasehold improvements. . . . . . . . . . 3 - 10 66 312 3,040 9,121 -------- --------- Less allowance for depreciation . . . . . 2,831 6,558 -------- --------- $ 209 $ 2,563 ======= =========
The reduction in values of the building and leasehold improvements is related to the termination of the capital lease of the Hauppauge facility. Depreciation expense on property, plant and equipment in 2003 and 2002 totaled $261,000 and $466,000, respectively. 8. ACCRUED LIABILITIES: -------------------- Accrued liabilities consist of the following:
December 31, 2003 2002 ------ ------ (In Thousands) --------------- Accrued salaries, employee benefits and payroll taxes. $ 417 $ 522 Purchase order financing . . . . . . . . . . . . . . . 291 7 Accrued warranty . . . . . . . . . . . . . . . . . . . 227 268 Other accrued liabilities. . . . . . . . . . . . . . . 666 726 ------ ------- $1,601 $1,523 ====== =======
9. REVOLVING LINE OF CREDIT: --------------------------- On March 22, 2002, the Company entered into a three-year revolving line of credit and term loan with CIT for maximum borrowings of $8 million, which are subject to certain limitations based on a percentage of eligible accounts receivable and inventories as defined in the agreement. Interest on the revolving line of credit is payable monthly at the JPMorgan Chase Bank prime rate (4% at December 31, 2003), plus 2% per annum. The Company is required to pay a commitment fee of 0.375% per annum on any unused portion of the credit facility. Borrowings under the line are secured by substantially all of the Company's assets. The terms of the agreement, among other matters, places restrictions on capital expenditures and prohibits the payment of dividends. In addition, the Company entered into a $100,000 term loan with CIT. The principal was repaid to CIT in twelve equal monthly installments of $8,333, which began May 1, 2002 and was paid in full on April 1, 2003. Interest on the term note was at the JPMorgan Chase Bank prime plus 2.25%. During 2003, CIT also provided the Company with an additional $300,000 over-advance facility. On December 8, 2003, the Company entered into a Forbearance Agreement with CIT through December 8, 2004. CIT agreed to forbear from (i) establishing additional availability reserves related to the inventory advance percentage and (ii) demanding immediate payment of the overadvance. To induce CIT not to take the forbearance actions, it was mutually agreed that the maximum borrowings would be reduced from $8 million to $3 million and would exclude eligible inventory from the borrowing base; the existing eligible inventory loan of $845,000 would be converted into a term loan with payments of $25,000 due in December 2003 and $10,000 per month thereafter; certain limitations on eligible accounts receivable from a major customer would be established and certain financial covenants would be established after June 2004. The Company had borrowings on the line of credit totaling $690,000 and $2,034,000 as of December 31, 2003 and 2002, respectively. The balance on the term loan was $825,000 at December 31, 2003. 10. OBLIGATIONS UNDER CAPITAL AND OPERATING LEASES: --------------------------------------------------- In December 1996, the Company completed a sale-leaseback transaction on the Company's former corporate headquarters in Hauppauge, New York. The Company received net proceeds of approximately $4.5 million, which approximated the carrying amount of the land and building. The lease covered a period of 20 years with quarterly payments of $145,000. Because the fair market value of the land on which the principal premises is built was greater than 25 percent of the total fair value of the leased premises at the inception of the lease, the land and building had been considered separately for the purposes of applying the criteria of SFAS No. 13, Accounting for Leases. The land portion of the lease had been classified as an operating lease. Rent expense for 2003 and 2002 was $103,000 and $173,000 per year, respectively. The building portion of the lease had been classified as a capital lease. As a result of the sale-leaseback transaction, a capitalized lease asset and obligation in the amount of $3,033,000 was recorded at the inception of the lease. The building was being amortized on a straight-line basis over the 20-year lease term. The capitalized lease obligation was being amortized under the interest method over the 20-year lease period, utilizing an imputed interest rate of approximately 11%. In July 2003, the Company negotiated a termination of the capital lease with its landlord. The Company had entered into sublease agreements with two parties for portions of its former corporate facility. Rental income under these agreements, included in selling, general and administrative expenses, approximated $217,000 and $370,000 in 2003 and 2002, respectively. As part of its settlement with the Hauppauge landlord, sublease income ended as of June 2003. 11. 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. Since the Company had a loss before extraordinary item for both periods presented, the effect of common stock options and warrants was antidilutive. 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, the shares available for grant were increased by 1,719,365 shares, as a result of the preferred stock redemption in January 2001. In March 2001, the Board of Directors approved an additional increase of 3,600,000 shares available for grant pending ratification by Sentry's shareholders. 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 Dialoc ID investment constituted a change in control under the 1997 Plan, resulting in the immediate vesting of all shares issued prior to January 8, 2001. All outstanding stock options were issued at not less than the fair value of the related common stock at the date of grant. At December 31, 2003, 7,055,738 common shares were reserved for issuance in connection with the exercise of stock options. In January 2001, the Company issued 2,000,000 non-qualified stock options to Mr. Murdoch, its Chief Executive Officer, at the price of $0.06 per share, which was the fair value on the date of the grant. On March 27, 2002, Mr. Murdoch exercised the option through the issuance of a promissory note in the amount of $120,000. The principal of the note is secured by the option shares and is repayable no later than January 8, 2006. Mr. Murdoch will not have any personal liability for the principal of the note if the value of the option shares is not sufficient to repay the note. The note bears interest at prime (currently 4%) less .75%. The note has been reflected as a reduction of shareholders' equity on the consolidated balance sheet. Stock option transactions for the years ended December 31, 2003 and 2002 are as follows:
Weighted Average Number Exercise of Shares Price Balance, January 1, 2002 . 5,821,480 $ 0.49 Granted. . . . . . . . . . - - Exercised. . . . . . . . . (2,001,000) 0.06 Canceled . . . . . . . . . (479,188) 0.87 Balance, December 31, 2002 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
Significant option groups outstanding at December 31, 2003 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 - 0.09 707,500 6.91 493,000 0.31 - 0.62 451,924 2.21 451,924 1.05 - 3.00 422,500 2.62 422,500 ------------ ------- ------------ 1,581,924 4.42 1,367,424 ============ ======= ============
At December 31, 2003, options to purchase an aggregate of 1,367,424 common shares were vested and currently exercisable at a weighted average exercise price of $0.66 and an additional 214,500 options vest at dates extending through the year 2006, expiring through 2011. At December 31, 2003, options for 5,473,814 common shares were available for future grants. As discussed in Note 3, 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 -------- In 1999 the Company issued warrants to purchase 150,000 shares of common stock at an exercise price of $0.13 to its former landlord. Such warrants were cancelled in July 2003 as a result of the lease termination. 12. INCOME TAXES: ------------- The reconciliation between total tax expense and the expected U.S. Federal income tax is as follows: 2003 2002 ---- ---- (In Thousands) -------------- Expected tax benefit at 34% $ (357) $ (1,141) Add: Nondeductible expenses 16 26 U.S. losses producing no tax benefit - 1,115 Use of net operating loss carry forwards to offset tax on extraordinary item (151) - -------- ---------- $ (492) $ - As of December 31, 2003, the Company had net operating loss carryforwards of approximately $32 million, which expire through the year 2023. 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 at December 31, 2003 and 2002 are comprised of: Deferred Tax Assets 2003 2002 --------------------- (In Thousands) -------------- Assets: Accounts receivable $ 121 $ 121 Inventories 859 1,569 Accrued liabilities 91 107 Property, plant and equipment 221 181 Net operating loss carryforwards 12,875 11,993 -------- -------- Gross deferred tax assets 14,167 13,971 Less valuation allowance 14,167 13,971 -------- -------- Net deferred tax asset $ - $ - ======== ======== The increase in the valuation allowance for the years ended December 31, 2003 and 2002 was primarily attributable to the increase in net operating loss carryforwards. A full 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. 13. RELATED PARTY TRANSACTIONS: ---------------------------- As a result of the Dialoc ID investment, Sentry entered into a distribution agreement with Dialoc ID, which contemplates a two-way distribution relationship between the companies. Under the agreement, Sentry has the rights to sell Dialoc ID's EAS, access control and RFID products and accessories and Sentry gives Dialoc ID the rights to sell its EAS and CCTV products and accessories. Pricing for products under the agreements are at the lowest prices charged to affiliates. In addition, Dialoc ID received an annual management fee for product marketing and product engineering management from Sentry in the amount of $50,000 in 2002. Also, Peter Murdoch, a shareholder of Dialoc ID through a trust, receives an annual salary of $50,000 in the capacity of President of Sentry. Purchases from Dialoc ID were $173,000 and $140,000 in 2003 and 2002, respectively. Services and sales to Dialoc ID were $67,000 and $79,000 in 2003 and 2002, respectively. The net amount payable to Dialoc ID as of December 31, 2003 was $129,000. 14. 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. The Company contributed approximately $48,000 to the Plan for the year ended December 31, 2002. No Company contribution was made in 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 $339,000. c. Litigation ---------- 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. 15. MAJOR CUSTOMERS AND CREDIT CONCENTRATIONS: --------------------------------------------- The Company grants credit to customers who are principally in the retail industry and libraries. During 2003 and 2002, revenues from a single customer represented approximately 44% and 40% of total revenues, respectively. No other customer accounted for more than 10% of total revenues for fiscal 2003 and 2002. 16. REVENUE BY PRODUCT LINE: -------------------------- Revenues by product line are as follows: 2003 2002 ---- ---- (In Thousands) -------------- EAS $ 1,817 $ 2,530 CCTV 3,601 4,578 Sentry Vision 3,049 2,368 3 M library products 45 256 Service revenues and other 4,497 4,804 --------- --------- Total revenues $ 13,009 $ 14,536 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 50, has been the President and Chief Executive Officer, Director and Chairman of the Board since January 8, 2001. He is also the President of ID Security Systems Canada Inc. Mr. Murdoch has extensive experience in the retail security industry as well as in the sales of technology-based products. He has been 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. Mr. Murdoch's term as a Director expires at the next Annual Meeting. WILLEM ANGEL, age 71, has been a Director of Sentry Technology since January 8, 2001. Mr. Angel was appointed to the Board of Directors when it was expanded from five to seven members. Mr. Angel is Chairman & C.E.O. of Dialoc ID and has a long history in the EAS and identification business dating to the start of ID Engineering in 1970. In 1977 he co-founded ID Engineering Europe creating an EAS manufacturing and sales organization serving Western Europe. In 1987, his company expanded into Canada, opening ID Security Systems Canada Inc, leading to the creation of Dialoc ID in 1989 and the Dialoc International in 1991 which manufactures and markets EAS, Access Control, and RFID products to dealers and distributors worldwide. Mr. Angel's term as a Director expires at the next Annual Meeting. COR S.A. DE NOOD, age 59, has been a Director of Sentry Technology since January 8, 2001. Mr. De Nood is the Vice President and Chief Technical Officer of Dialoc ID. In 1977, he co-founded the ID Engineering Europe, Dialoc ID in 1989 and Dialoc International B.V. in 1991. As co-founder of ID Engineering, Cor de Nood has more than 30 years of experience developing, designing, and manufacturing EAS and identification systems. In his capacity as Chief Technical Officer of Dialoc ID, Mr. De Nood has developed key ongoing relationships with Philips Electronics, TNO (the Dutch research council) and the University of Eindhoven which greatly assist his companies in developing products and pursuing fundamental research projects. Mr. De Nood's term as a Director expires at the next Annual Meeting. ROBERT D. FURST, JR., age 51, 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 53, 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 50 Our President and Chief Executive Officer since January 8, 2001. He is also President of ID Security Systems Canada, Inc. 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. Peter J. Mundy 47 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, 2003, all Section 16(a) filing requirements applicable to its officers, Directors and greater than ten-percent beneficial owners were complied with. ------ Item 10. Executive Compensation. -------- ----------------------- SUMMARY COMPENSATION TABLE The following table summarizes the compensation for our fiscal years ended December 31, 2003 of our Chief Executive Officer and Chief Financial Officer:
LONG-TERM ALL OTHER ANNUAL COMPENSATION COMPENSATION COMPENSATION (1) ---------------------- ------------- ---------------- SECURITIES NAME AND UNDERLYING PRINCIPAL POSITION. . . . . . . . . . . . . . YEAR SALARY BONUS OPTIONS (#) --------------------------------------------- ---- ------ ----- ----------- Peter L. Murdoch 2003 $ 50,000 - - - President and CEO 2002 87,500(2) - - - 2001 150,000 2,000,000 - Peter J. Mundy, 2003 131,160 - - $ - Vice President - CFO, 2002 131,160 - - 1,967 Secretary and Treasurer 2001 131,160 - - 2,492 ________________________
(1) Amounts shown consist of our matching contributions under the Retirement Savings 401(k) Plan. (2) Mr. Murdoch deferred $62,500 of salary in 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 $50,000 or 10% of the annual salary and bonus reported in the table for such individual. OPTIONS GRANTED IN LAST FISCAL YEAR No options were granted during fiscal year 2003. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES The following table sets forth for each of the persons named in the Summary Compensation Table the number of options exercised during 2003 and the amount realized by each such officer. In addition, the table shows the number of options that the named executive officer held as of December 31, 2003, both exercisable (E) and unexercisable (U), and the value of such options as of that date.
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED IN OPTIONS THE MONEY OPTIONS AT SHARES AT YEAR-END(#) YEAR END($) ACQUIRED ON VALUE EXERCISABLE/ EXERCISABLE/ NAME EXERCISE (#) REALIZED ($) UNEXERCISABLE UNEXERCISABLE ----------------- ------------- ------------- --------------------- ----------------------- Peter L. Murdoch - - E - E - - - U - U - Peter J. Mundy - - E 669,218 E $10,500 U - U -
_______________ COMPENSATION OF DIRECTORS Directors who are also our full-time employees receive no additional compensation for their services as Directors. In response to Sentry's financial condition, the Directors agreed to waive their annual retainer for 2003. In addition, each non-employee Director is eligible to participate in our 1997 Stock Incentive Plan. On February 20, 2001, each non-employee Director, at that time, received a grant of options to purchase 30,000 shares of our common stock at an exercise price of $0.0625, vesting in equal portions over a three-year period. 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 $150,000 per year for 2001 and 2002 and $50,000 for 2003. For 2004, the amount has been set at $50,000. 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 has waived these increases for the years 2002, 2003 and 2004. The employment agreement for Mr. Mundy renews automatically on January 8 for one-year terms. His annual salary is presently $131,160. 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. The Board of Directors endorses the view that the value of compensation paid to our executive officers, and the Chief Executive Officer in particular, should be closely linked to increases in the value of our common stock. Accordingly, our Board supports option awards under our 1997 Stock Incentive Plan and participation by executive officers in the Retirement Savings 401(k) Plan, which includes our common stock fund among its investment holdings. A substantial portion of the total compensation of the executive officers, including the Chief Executive Officer, is dependent on increases in the value of our common stock. The number of stock options granted to executive officers is not determined by reference to any formulas but is determined by the Board's evaluation of the particular officer's ability to influence our long-term growth and profitability. Our Board also considers our performance against certain competitors, its general performance against internal goals established by management and the executive's relative contribution thereto. 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. [GRAPHIC OMITED]
SENTRY TECHNOLOGY CORPORATION STOCK PERFORMANCE DATA (APPEARS AS A LINE GRAPH) 12/31/99 TO 12/31/03 12/31/99 12/31/00 12/31/01 12/31/02 12/31/03 Sentry Technology Corporation. . . . . $ 100 $ 67 $ 160 $ 21 $ 144 S&P 600 Small Cap Index. . . . . . . . $ 100 $ 111 $ 117 $ 99 $ 137 S&P Elec. Equip. Index . . . . . . . . $ 100 $ 83 $ 42 $ 20 $ 35
ITEM 11.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ------------------------------------------------------------------------------ The following table sets forth the beneficial ownership of our common stock at March 3, 2004, 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 March 28, 2004, 85,755,610 shares of common stock were outstanding.
SHARES OF PERCENT NAME AND ADDRESS OF BENEFICIAL OWNERS. . . . . . . . . . . . . . . COMMON STOCK OF CLASS(1) ------------------------------------------------------------------ ------------ ------------- Dialoc ID Holdings B.V. Daltonstraat 42-44 3846 BX Harderwijk The Netherlands 42,066,927 49.1% William A. Perlmuth c/o Stroock & Stroock & Lavan LLP 180 Maiden Lane New York, NY 10038 6,096,049 (2) 7.1% SHARES OF PERCENT DIRECTORS AND EXECUTIVE OFFICERS . . . . . . . . . . . . . . . . . COMMON STOCK OF CLASS(1) ------------------------------------------------------------------ ------------ ------------- Peter L. Murdoch(5) 2,101,500 2.5% Peter J. Mundy 865,185 (3) 1.0% Willem Angel(5) 60,000 (4) * Cor S. A. De Nood(5) 30,000 (4) * Jonathan G. Granoff 90,000 (4) * Robert D. Furst, Jr. 1,737,756 (6) 2.0% All Sentry Directors and executive officers as a group (6 persons) 4,884,441 (7) 5.6%
__________________________ * Less than one percent (1) Based on 85,755,610 shares of common stock outstanding as of March 3, 2004. 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) Consists of (a) 5,199,499 shares of common stock held by Mr. Perlmuth as Trustee of the Trust U/W/O of Arthur J. Minasy, (b) 873,513 shares of Common stock held by Mr. Perlmuth as trustee under trusts for the benefit of Mr. Minasy's adult children, and (c) 23,037 shares of common stock beneficially owned by Mr. Perlmuth. Mr. Perlmuth resigned his position as a member of the Board of Directors on June 18, 2002. (3) Includes 669,218 shares of common stock issuable upon the exercise of stock options exercisable within 60 days from the date hereof. (4) Includes 30,000 shares of common stock exercisable upon the exercise of stock options exercisable within 60 days from the date hereof. (5) Excludes shares of Common Stock owned by Dialoc ID of which Messrs. Murdoch, Angel and DeNood are shareholders. (6) Includes 354,000 shares of common stock issuable upon the exercise of stock options and warrants exercisable within 60 days from the date hereof. (7) Includes 1,113,218 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 --------- -------------------------------------------------- As a result of the Dialoc ID investment, Sentry entered into a distribution agreement with Dialoc ID, which contemplates a two-way distribution relationship between the companies. Under the agreement, Sentry has the rights to sell Dialoc ID's EAS, access control and RFID products and accessories and Sentry gives Dialoc ID the rights to sell its EAS and CCTV products and accessories. Pricing for products under the agreements are at the lowest prices charged to affiliates. In addition, Dialoc ID received an annual management fee for product marketing and product engineering management from Sentry in the amount of $50,000 in 2002. Also, Peter Murdoch, a shareholder of Dialoc ID through a trust, receives an annual salary of $50,000 in the capacity of President of Sentry. Purchases from Dialoc ID were $173,000 and $140,000 in 2003 and 2002, respectively. Services and sales to Dialoc ID were $67,000 and $79,000 in 2003 and 2002, respectively. The net amount payable to Dialoc ID as of December 31, 2003 was $129,000. ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K ------------------------------------------------- (a) The following documents are filed as a part of this report on Form 10-KSB: (1) (2) Consolidated Financial Statements of the Company and its subsidiaries for the year ended December 31, 2003 and Financial Statement Schedules required to be filed by Items 8 and 14(d) of Form 10-KSB. See Table of Contents to Consolidated Financial Statements of Sentry Technology Corporation and its subsidiaries on page 23. (3) Exhibits required to be filed by Item 601 of Regulation S-K: Management Contracts or Compensatory Plans or Arrangements: ----------------------------------------------------------------- 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). Other Exhibits: --------------- 2.1 Amended and Restated Agreement and Plan of Reorganization and Merger, dated as of November 27, 1996 among Video 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). 3.1 Amended and Restated Certificate of Incorporation of the Company, together with Form of Certificate of Designations of Sentry Technology Corporation Class A Preferred Stock. Incorporated by reference to Exhibit 3.1 to Company's Registration Statement on Form S-4 (No. 333-20135). 3.2 Bylaws of the Company. Incorporated by reference to Exhibit 3.2 to Company's Registration Statement on Form S-4 (No. 333-20135). 10.6 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. 10.7 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. 10.8 Lease Agreement dated December 24, 1996 between Knogo North America Inc. and NOG (NY) QRS 12-23, Inc. Incorporated by reference to Exhibit 10.10 to the Company's annual report on Form 10-K for fiscal 1997. 10.9 Distribution Agreement dated March 26, 1996 between Knogo North America Inc. and Minnesota Mining and Manufacturing Company. Incorporated by reference to Exhibit 10.11 to the Company's annual report on Form 10-K for fiscal 1997. 10.11 Amendment No. 1 dated December 22, 1998, to the Distribution Agreement dated March 26, 1996 between Knogo North America Inc. and Minnesota Mining and Manufacturing Company. Incorporated by reference to Exhibit 10.13 to the Company's annual report on Form 10-K for fiscal 1998. 10.16 First Amendment, dated September 18, 2000, to Lease Agreement (dated December 24, 1996) between the Company and NOG (NY) QRS 12-23, Inc., incorporated by reference to Exhibit 10.19 to Company's Registration Statement on Form S-4 (No. 333-47018). 10.20 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. 10.24 Securities Purchase Agreement, dated August 8, 2000, between Sentry Technology Corporation and Dialoc ID, incorporated by reference to Exhibit 10.1 to Company's Current Report on Form 8-K, dated August 10, 2000. 10.25 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. 10.29 Financing Agreement between Knogo North America Inc. and The CIT Group/Business Credit, Inc. dated March 22, 2002, incorporated by reference to Exhibit 10.29 to Company's annual report on Form 10-K for fiscal 2001. 10.30 Master Agreement between Sentry Technology Corporation and EPK Financial Corporation, dated October 10, 2002, incorporated by reference to Exhibit 10.30 to the Company's Quarterly Report on Form 10-Q dated November 14, 2002. 10.31 Master Agreement between Knogo North America Inc. and EPK Financial Corporation, dated October 10, 2002, incorporated by reference to Exhibit 10.31 to the Company's Quarterly Report on Form 10-Q dated November 14, 2002. 10.32 Intercreditor Agreement between Knogo North America Inc., EPK Financial Corporation and The CIT Group/Business Credit, Inc., dated October 16, 2002, incorporated by reference to Exhibit 10.32 to the Company's Quarterly Report on Form 10-Q dated November 14, 2002. 10.33 Letter amendment to the Intercreditor Agreement between Knogo North America Inc., EPK Financial Corporation and The CIT Group/Business Credit, Inc., dated January 14, 2003. Incorporated by reference to Exhibit 10.33 to the Company's annual report on Form 10-KSB for fiscal 2002. 10.34 Letter amendment to the Intercreditor Agreement between Knogo North America Inc., EPK Financial Corporation and The CIT Group/Business Credit, Inc., dated July 10, 2003 10.35 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. 10.36 Forbearance Agreement between The CIT Group/Business Credit, Inc. and Knogo North America Inc., dated December 8, 2003 21 Subsidiaries of the Company. Incorporated by reference to Exhibit 21 to the Company's annual report on Form 10-K for fiscal 1997. 23.1 Consent of Holtz Rubenstein & Co., 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-K, 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 2003. 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 Holtz Rubenstein & Co., LLP as the Company's independent accountants, the board of directors considered whether the provision of such services is compatible with maintaining independence. All of the services provided and fees charged by Holtz Rubenstein & Co., LLP in 2003 were approved by the board of directors. 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 for 2003 and 2002 were $58,000 and $50,000, respectively, net of expenses. AUDIT-RELATED FEES There was $9,000 of other fees billed during 2003 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 for 2003 and 2002. ALL OTHER FEES There were no other fees billed by our independent auditors during the last two fiscal years for products and services provided. 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: March 15, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K 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 Peter J. Mundy Accounting Officer, Secretary and Treasurer /s/ Willem Angel Director ------------------ Willem Angel /s/ Robert D. Furst, Jr. Director ---------------------------- Robert D. Furst, Jr. Director ---------------------------- Jonathan G. Granoff /s/ Cor S.A. De Nood Director ------------------------ Cor S.A. De Nood Dated: March 15, 2004 EXHIBIT INDEX 10.34 Letter amendment to the Intercreditor Agreement between Knogo North America Inc., EPK Financial Corporation and The CIT Group/Business Credit, Inc., dated July 10, 2003. 10.36 Forbearance Agreement between The CIT Group/Business Credit, Inc. and Knogo North America Inc., dated December 8, 2003 23.1 Consent of Holtz Rubenstein & Co., 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.*** EXHIBIT 10.34 LETTER AMENDMENT TO THE INTERCREDITOR AGREEMENT BETWEEN KNOGO NORTH AMERICA INC., EPK FINANCIAL CORPORATION AND THE CIT GROUP/BUSINESS CREDIT, INC., DATED JULY 10, 2003. This letter shall serve as an amendment to the Intercreditor Agreement between KNOGO NORTH AMERICA INC. ("KNOGO"), EPK FINANCIAL CORPORATION ("EPK") and THE CIT GROUP/BUSINESS CREDIT, INC. ("CIT") dated October 16, 2002. Point 2(a) shall now read as follows: "Notwithstanding anything herein to the contrary, CIT subordination of its liens hereunder is limited solely to EPK Collateral which has been designated in a Purchase Order Certificate and in which EPK has filed and perfected its security interest and shall apply to EPK Obligations not to exceed $650,000.00 " All other terms and conditions of the Intercreditor Agreement dated October 16, 2002 and the amendment to the Intercreditor Agreement dated November 20, 2002 shall remain unchanged. Dated on this 10 day of July 2003. KNOGO NORTH AMERICA INC. By: /s/ Peter J. Mundy ---------------------------- Title: VP-CFO -------------------------- EPK FINANCIAL CORPORATION By: /s/ Edward King ---------------------------- Title: President -------------------------- THE CIT GROUP/BUSINESS CREDIT, INC. By: /s/ Andrew Hausspiegel ------------------------------- Title: Vice President ---------------------------- EXHIBIT 10.36 FORBEARANCE AGREEMENT ---------------------- December 8, 2003 Knogo North America, Inc. 1881 Lakeland Avenue Ronkonkoma, New York 11779 Gentlemen: We refer to the Financing Agreement between us dated March 22, 2002, as amended, herein the "Financing Agreement"). Capitalized terms used herein and defined in the Financing Agreement shall have the same meanings specified therein unless otherwise specifically defined herein. As you know the updated inventory appraisal performed by Hilco on January 25, 2003 confirmed a significant decline in the net orderly liquidation value. As a result thereof, we have the immediate right under the Financing Agreement to establish Availability Reserves to reflect the results of the appraisal and the adjusted Inventory advance percentage. In addition, if we were to immediately implement such Availability Reserves as a result of such appraisal and the adjusted Inventory advance percentage, the outstanding balance of your Overadvance would be significantly increased. Pursuant to the Financing Agreement such Overadvance is due and payable to us at any time upon our demand. You have requested that we, and subject to the terms, provisions and conditions of this agreement we have agreed to, forbear from (i) immediately establishing such Availability Reserves to reflect the results of the Hilco appraisal and the adjusted Inventory advance percentage and (ii) demanding immediate payment of the entire outstanding Overadvance (herein the "Forbearance Actions"). To induce us not to take the Forbearance Actions, it is hereby mutually agreed that: (A) effective immediately, the dollar amount in the definitions of "Revolving Line of Credit" and "Line of Credit" shall be reduced from $8,000,000 to $3,000,000, and the Inventory Loan Cap which as of November 26, 2003 was $845,057 shall be reduced to $0 on the date hereof and effective immediately we shall no longer make revolving advances to you against Eligible Inventory and Eligible Inventory shall be excluded from the Borrowing Base. (B) The outstanding balance of loans and advances to you against Eligible Inventory was $845,057 (the "Inventory Loan") on November 26, 2003. You shall pay to us an amount equal to $25,000 on December 31, 2003 and an amount equal to $10,000 commencing on January 29, 2004 and on the last Wednesday of each month thereafter until June 25, 2004 or until such Inventory Loan is paid in full. Provided that after June 25, 2004, we will negotiate in good faith to amend the monthly payment schedule based on satisfactory future cash flow projections from the Company, provided further that in the event that we fail to agree upon an amended payment schedule payments shall continue at $10,000 for each month thereafter. You hereby authorize and instruct us to charge each such payment to your Revolving Loan Account of the respective due date thereof. In the event that any additional Overadvance (based solely upon advances against Eligible Accounts Receivable) in excess of $300,000 arises as a result thereof you shall immediately pay such amount to us. (C) notwithstanding any provision to the contrary contained in the Financing Agreement, the total amount of Eligible Accounts Receivable owing to you from Lowe's Companies and its subsidiaries and affiliates ("Lowes") shall not exceed $2,000,000 in the aggregate at any time. (D) you shall at all times continue to engage the consulting and advisory services of Clear Thinking Group ("CTG") and shall authorize and instruct CTG to respond fully and promptly to any and all inquiries and/or requests that we may make upon them from time to time. (E) until termination of the Financing Agreement and full final payment of all Obligations thereunder you shall: (1) have at the end of each Fiscal Quarter set forth below an Fixed Charge Coverage Ratio of not less than the ratio set forth below for the applicable period: Period Ratio ------ ----- (i) For the Fiscal Quarter ending _____________, 200__ ____ to 1.0 (ii) For the Fiscal Quarter ending _____________, 200__ ____ to 1.0 (iii) For the Fiscal Quarter ending _____________, 200__ ____ to 1.0 (iv) For the Fiscal Quarter ending _____________, 200__ ____ to 1.0 (v) For the Fiscal Quarter ending _____________, 200__ and for each Fiscal Quarter ending thereafter ____ to 1.0 The foregoing ration shall be calculated on a cumulative quarterly basis during the first year from _______________ and on a rolling four quarter average thereafter. (2) achieve EBITDA of at least the following amounts for the following periods: (A) $.00 for the Fiscal Quarter ending, 200; (B) $.00 for the Fiscal Quarter ending, 200; (C) $.00 for the Fiscal Quarter ending, 200__; (D) $.00 for the Fiscal Quarter ending, 200__; (E) $.00 for the Fiscal Quarter ending, 200__, and for each Fiscal Quarter ending thereafter; or EBITDA shall mean, in any period, all earning of the company before all (i) ------ interest and tax obligations, (ii) depreciation and (iii) amortization for said period, all determined in accordance with GAAP on a consistent basis with the latest audited financial statements of the Company, but excluding the effect of extraordinary and/or non-reoccurring gains or losses for such period. Fixed Charge Coverage Ratio shall mean, for the relevant period, the ratio ---------------------------- determined by dividing EBITDA by the sum of (a) all interest obligations paid or due, (b) the amount of principal repaid or scheduled to be repaid on all indebtedness including but not limited to the Term Loan and Subordinated Debt, but excluding any amounts payable to EPK Financial, (c) Capital Expenditures actually incurred, and (d) all federal, state and local income tax expenses due and payable. The foregoing financial covenants have been intentionally left blank pending CIT's receipt of the Company's business plan and cash flow projections for the applicable periods. Such business plan and projections shall be delivered to CIT by December 31, 2003 and shall be in form and substance satisfactory to CIT. Upon CIT's receipt of such satisfactory business plan and projections, CIT and the Company each hereby agrees that financial covenants for the applicable periods shall be (x) negotiated in good faith and (y) set forth in a written amendment to Paragraphs (D)(1) and (D)(2) above. The Company's failure to deliver such satisfactory business plan and projections by December 31, 2003 and/or the failure of CIT and the Company to agree upon such financial covenants and execute such amendment prior to the expiration of thirty (30) days after the date hereof shall constitute a breach of and default under this Forbearance Agreement and a Default and Event of Default under the Financing Agreement. (F) you shall obtain a cash infusion in an amount not less than $1,000,000 (less fees) no later than the close of business on the date occurring one(1) year after the date hereof in the form an equity investment in your common stock or subordinated debt, all on such terms, provisions and conditions as shall be satisfactory to us. Such cash infusion may only be used to meet working capital needs of the Company. Effective immediately, it is hereby mutually agreed that we will not take the Forbearance Actions provided that: (x) No Default and/or Event of Default occurs under the Financing Agreement; and (y) you are not in breach of or default under any of the terms, provisions or conditions contained herein including but not limited to clauses (A) through (F) above (herein each a "Forbearance Condition Precedent" and collectively the "Forbearance Conditions Precedent"). Your failure to comply with or fulfill any of the Forbearance Conditions Precedent shall immediately constitute a Forbearance Termination Event. Upon the earlier of (x) December 8, 2004 or (y) the occurrence of a Forbearance Termination Event, our agreement to forebear above shall become null and void and of no further force or effect between us, and we shall have the immediate right without notice to you to exercise any right or remedy available to us under the Financing Agreement and/or applicable law (including, without limitation the right to establish Availability Reserves and adjust advance percentages against eligible collateral based upon the Hilco appraisal and demand immediate payment of all Overadvances, and the rights to terminate of the Financing Agreement, accelerate all Obligations thereunder, realize upon the Collateral and/or charge the Default Rate of Interest). You, of course, understand that, notwithstanding (i) our decision to refrain from exercising any of our rights and remedies against you as set forth above and (ii) our continuing at this time to make advances to you under the Financing Agreement, subject to the above terms, provisions and conditions we reserve all our rights and remedies (which we may exercise upon the earlier of December 8, 2004 or the occurrence of a Forbearance Termination Event) against you and any guarantors or pledgors, including without limitation the rights to terminate the Financing Agreement, demand payment of all of your Obligations, commence legal action to enforce collection thereof, and realize upon your Accounts and/or all other Collateral pledged to us under or in connection with the Financing Agreement. Subject to the foregoing terms, provisions and conditions nothing contained herein shall be construed as a waiver of our rights to exercise at any time any other right or remedy available to us under the Financing Agreement, the guaranties or applicable law. As an inducement to our entering into this agreement, and in consideration thereof, the Company and each Guarantor hereby acknowledges and agrees that (a) no right of offset, defense, counterclaim, claim, causes of action or objection in favor of the Company or any Guarantor against CIT exists arising out of or with respect to (i) the Financing Agreement or any Guaranty, (ii) any other documents now or heretofore evidencing, securing or in any way relating to the foregoing or (iii) the administration or funding of the Line of Credit; and (b) the Company and each Guarantor does hereby expressly waive, release and relinquish any and all such offsets, defenses, counterclaims, claims, causes of action or objections, if any, against CIT. If the foregoing is in accordance with your understanding of our agreement kindly so indicate by signing and returning the enclosed copy of this letter. In addition, we have asked each of the Guarantors to sign below to confirm that their respective guaranties and/or security or pledge agreements shall continue in full force and effect notwithstanding the foregoing agreement. Very truly yours, THE CIT GROUP/BUSINESS CREDIT, INC. By: /s/ Kim Nguyen ---------------- Title: Assistant Vice President ------------------------ Read and Agreed to: KNOGO NORTH AMERICA INC. By: /s/ Peter J. Mundy --------------------- VP - CFO ---------- Confirmed: SENTRY TECHNOLOGY CORP. By: /s/ Peter J. Mundy --------------------- Title: VP-CFO ------ Exhibit 23.1 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS 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 February 27, 2004 appearing in this Annual Report on Form 10-KSB of Sentry Technology Corporation for the year ended December 31, 2003. /s/ Holtz Rubenstein & Co., LLP Melville, New York March 15, 2004 SECTION 302 CERTIFICATION: Exhibit 31.1 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 Certification of CEO I, Peter L. Murdoch, certify that 1. I have reviewed this annual report on Form 10-KSB of Sentry Technology Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. /s/ PETER L. MURDOCH -------------------------------------- Peter L. Murdoch President and Chief Executive Officer March 15, 2004 SECTION 302 CERTIFICATION: Exhibit 31.2 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 Certification of CFO I, Peter J. Mundy, certify that 1. I have reviewed this annual report on Form 10-KSB of Sentry Technology Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. /s/ PETER J. MUNDY ------------------------------------------- Peter J. Mundy Vice President and Chief Financial Officer March 15, 2004 SECTION 906 CERTIFICATION: Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Certification of CEO In connection with the Annual Report of Sentry Technology Corporation (the "Company") on Form 10-KSB for the period ended December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the Report"), I, Peter L. Murdoch, Chief Executive Officer of the Company, certify, pursuant to Section 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) and 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ PETER L. MURDOCH ----------------------------------- Peter L. Murdoch President and Chief Executive Officer March 15, 2004 A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. This certification accompanies this Report on Form 10-KSB pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by such Act, be deemed filed by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the Company specifically incorporates it by reference. SECTION 906 CERTIFICATION: Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Certification of CFO In connection with the Annual Report of Sentry Technology Corporation (the "Company") on Form 10-KSB for the period ended December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the Report"), I, Peter J. Mundy, Chief Financial Officer of the Company, certify, pursuant to Section 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) and 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ PETER J. MUNDY -------------------------------------------- Peter J. Mundy Vice President and Chief Financial Officer March 15, 2004 A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. This certification accompanies this Report on Form 10-KSB pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by such Act, be deemed filed by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the Company specifically incorporates it by reference.