**SECURITIES
AND EXCHANGE COMMISSION**
 
 **Washington,
D.C. 20549**
 **____________**
 
 **FORM
10-KSB**
 
 **þ**
    **ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934**
 
 **For
the fiscal year ended December 31, 2004**
 
 **OR**
 
 **o**
    **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 þ No o
 
 Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regula-tion 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. þ
 
 The
issuer’s revenues for the latest fiscal year were $16,665,000.
 
 At April
12, 2005, the aggregate market value of the voting stock held by non-affiliates
of the Registrant was approximately $6,811,000 based upon the closing price of
such securities on the OTC Bulletin Board on that date. At April 6, 2005, the
Registrant had outstanding 120,558,804 shares of Common Stock.
 
 Documents
Incorporated by Reference
 
 None.
  2
  **PART
I**
 **Item
1. BUSINESS**
 
 **GENERAL**
 
 Sentry
Technology Corporation ("Sentry") is engaged in the design, sale, installation
and servicing of a complete line of Radio Frequency (RF) and Electro-Magnetic
(EM) electronic article surveillance (EAS) systems and Closed Circuit Television
(CCTV) solutions. The CCTV product line features the proprietary SentryVision®
SmartTrack patented traveling surveillance system. The Company’s products are
used by retailers to deter shoplifting and internal theft and by industrial and
institutional customers to protect assets and people. Sentry was incorporated in
Delaware in 1996. Its corporate predecessors had been in business for more than
38 years.
 
 On April
30, 2004, Sentry acquired all the outstanding common stock and Series “A”
preference shares of ID Security Systems Canada, Inc., an Ontario corporation,
and all the outstanding capital stock of ID Systems USA, Inc., a Pennsylvania
corporation, (collectively “ID Systems”). The acquisition expands our product
offering to include proximity Access Control and Radio Frequency Identification
(RFID) solutions.
 
 
 **RECENT
DEVELOPMENTS**
 
 Over the
last several years, our largest shareholder, Dialoc ID Holdings B.V. (“Dialoc”)
was not able to provide us with additional financial support. On April 19, 2004,
Dialoc sold 39,066,927 Sentry common shares (representing approximately 46% of
the total issued and outstanding shares of Sentry) to a group of investors. Of
the group, Saburah Investments Inc. (“Saburah”) acquired 22,758,155 shares, Mr.
Robert Furst 14,554,386 shares and Dr. Morton Roseman 1,754,386 shares. Mr.
Peter Murdoch, President, CEO and Director of Sentry, is the owner of Saburah.
Mr. Furst is a long-standing member of Sentry’s Board of Directors. As a result
of this transaction, Messers Angel and de Nood, Principals of Dialoc, resigned
from Sentry’s Board of Directors.
 
 In
addition to the purchase of Sentry’s common shares, Saburah also acquired 100%
of ID Security Systems Canada, Inc. and ID Systems USA, Inc. The price paid to
Dialoc by Saburah and Murdoch for Sentry and ID Systems shares in cash, debt
assumption and other consideration was approximately $3.6 million plus the
surrender of Murdoch’s 15% interest in Dialoc. Saburah also agreed to make a
payment to Dialoc in the future equal to approximately 6% of any payment it
received from Checkpoint Systems Inc. (“Checkpoint”) resulting from litigation
brought by ID Canada against Checkpoint.
 
 On April
30, 2004, Sentry purchased from Saburah Investments, Inc., an Ontario
corporation, all of the outstanding common shares and Series "A" preference
shares of ID Security Systems Canada, Inc., an Ontario corporation, and all of
the outstanding capital stock of ID Systems USA, Inc., a Pennsylvania
corporation. ID Systems is a Toronto based company engaged in anti-shoplifting
technology, security labeling, radio frequency identification (RFID), access
control and library security. Sentry acquired ID Systems from Saburah in
exchange for 30,000,000 Sentry common shares. The price paid per Sentry share
for the securities of ID Systems was valued at approximately $0.11. A special
committee of Sentry's Board of Directors received an opinion from
Corporate  Valuation
Services confirming that the price paid for the acquisition of ID Systems was
fair from the point of view of Sentry shareholders. As part of the purchase
agreement, the proceeds of the ID Systems litigation settlement will be
distributed to the former ID Systems’ shareholders. However Saburah and Sentry
agreed that Sentry may require Saburah to purchase additional Sentry common
shares under certain circumstances. Sentry's Board of Directors and shareholders
owning a majority of Sentry common stock approved the acquisition of ID Systems.
 
 Other
benefits flowing to Sentry/ID Systems via the purchase of ID Systems are as
follows:
 
 ·
    ID
      Systems and Sentry continue as the exclusive distributor in North and
      South America for a period of five years for all Dialoc products including
      Laserfuse radio frequency security labels and all RFID
      products.
  3
  ·
    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.
 
 On April
30, 2004, Sentry entered into a $2,000,000 secured convertible debenture with
Brascan Technology Fund (“Brascan”), an alternative investment fund established
by Brascan Asset Management, to invest in early stage, technology-based
companies with high growth potential.
 
 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 Brascan 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 Brascan affiliates and expects to
      be a supplier of security and identification products to the Brascan
      affiliates.
 ·
    Brascan
      was issued warrants for 5,000,000 shares of Sentry common stock, priced at
      $0.15 per share, exercisable anytime within the next four
      years.
 ·
    Brascan
      is entitled to one seat on Sentry’s Board of Directors or will participate
      as an observer.
 
 The
Debenture is secured by a general security interest over all the assets and
properties of Sentry. The amount is subordinate to the existing credit
facilities. Sentry acquired ID Systems as a condition of the financing.
 
 On August
1, 2004, ID Systems and Checkpoint entered into a settlement agreement effective
July 30, 2004, pursuant to which Checkpoint agreed to pay $19.95 million in full
and final settlement of claims covered by the antitrust litigation. Payment in
full was received on August 5, 2004. As provided when Sentry purchased ID
Systems, the proceeds of the settlement were distributed to former shareholders
of ID Systems, after payment of litigation fees and expenses. The agreement
includes mutual releases between the parties for complaints arising from
activities prior to the date of the agreement, except for any contractual
obligations and any future claims for patent, copyright or trademark
infringement. The agreement is not an acknowledgement of any wrongdoing or
liability by either party. A Stipulation of Dismissal has been filed with the
Third Circuit Court of Appeals to finally conclude the legal proceedings. During
the third quarter of 2004, Sentry and its subsidiaries received $753,000 through
the repayment of debt incurred by Dialoc prior to the ID Systems acquisition and
reimbursement of litigation expenses.
 
 While
Sentry did not obtain an interest in the litigation settlement, Saburah and
Sentry agreed that Sentry might require Saburah to purchase additional Sentry
common shares equal to approximately 4.5% of any amount received (net of legal
fees and expenses) from Checkpoint. The price per share was set at 80% of the
previous 20 days trading average prior to the announcement of the settlement.
Our Board of Directors has exercised this option and based on the settlement
amount, Sentry sold to Saburah approximately 4.8 million shares for $641,000 on
November 5, 2004. These transactions, totaling $1.4 million, represent the total
cash flowing to Sentry directly and indirectly as a
result of the Checkpoint lawsuit.
  4
  After the
acquisition of ID Systems and sale of additional shares as a result of the
litigation settlement, Sentry has 120,553,804 shares of common stock
outstanding. Mr. Murdoch, directly or indirectly through his ownership of
Saburah, owns or controls 49.5% of the outstanding common stock of
Sentry.
 
 
 **THE
SENTRYVISION® SYSTEM**
 
 SentryVision®
refers to our family of proprietary traveling CCTV surveillance systems. Over
the years, Sentry has developed various generations of traveling CCTV
surveillance systems including the H-System, OH-System, the original
SentryVision® and currently the improved SmartTrack system.
 
 All
versions of the product consist of a camera carriage unit, a continuous track
enclosed with tinted or mirrored glass enclosure and electronic control
equipment. The carriage unit moves within the enclosure and carries one or two
PTZ CCTV cameras, electronic transmission components and motor drives. The
carriage track and enclosure are designed to custom lengths for more complete
viewing. The carriage unit transmits video and control signals from the
camera(s) through two copper conductors running inside the enclosure to a
receiver unit located at one end of the carriage track. The copper conductors
also carry power to the camera carriage, eliminating the need for power or
communication cables. From the receiver unit, the video signals are relayed to a
central monitoring location by wire or fiber optics, where a system operator can
position or move the camera carriage to obtain the best vantage point while
viewing and recording the continuous, live video pictures. The system design
supports conventional peripheral devices, such as analog and digital
videocassette recorders, alarm inputs, fixed cameras, PTZ dome cameras,
switches/multiplexers, voice intercom systems, panic buttons and remote viewing
capability using dedicated phone lines or internet technology.
 
 Unlike
our previous products, our SentryVision® SmartTrack system features one or two
state-of-the-art pan, tilt and zoom ("PTZ") domes providing for 360 unobstructed
views to eliminate most blind spots. Additionally, SmartTrack utilizes
sophisticated software that provides six tours and up to 60 presets per camera
carriage to allow programmable viewing and recording with or without an
operator. The improvements made to the carriage make the new SmartTrack system
the fastest and most reliable traveling CCTV surveillance system in the history
of SentryVision® product offerings. SmartTrack is our premier product, replacing
all previous generations of SentryVision® products.
 
 SentryVision®
is designed to provide enhanced loss prevention surveillance in retail stores
and distribution centers as well as to provide monitoring and deterrence of
illegal and unsafe activities in a variety of other locations such as parking
garages, correctional facilities, warehouses, transportation centers and public
transit terminals. SentryVision® may also be employed in a broad range of
operational and process monitoring applications in commercial manufacturing and
industrial settings. As of December 31, 2004, SentryVision® systems had been
installed at the following customer locations in North America: Lowe's Home
Centers, Target Stores, Mills Fleet Farm, Winn Dixie, Federal Express, Cabellas,
Fred Meyer, Symbol Technologies, Menards, UPS, J.C. Penney, Canadian Tire, Reno
Depot, Estee Lauder, Kohl's Department Stores and Disney Direct Marketing. In
addition, during 2004, the Company's international distributors installed
SentryVision® systems in customer locations throughout Western and Eastern
Europe, Latin America and Asia. Our international customers include ASDA
Wal-Mart, Carrefour, Auchan, Cora, Castorama, B & Q, Tesco and Coop. We
believe that, by providing expanded surveillance coverage and enhanced
flexibility to select the locations watched, SentryVision® has enabled customers
to significantly reduce inventory shrinkage, increase theft apprehension rates
and improve safety and security. Based on the price of its system and the
experience of Sentry's customers to date, we believe SentryVision® is a
cost-effective solution, which can improve the operations of our customers.
 
 Sentry
sold its first systems in 1992 for installation in parking garage security
surveillance applications, but quickly moved its market focus into the retail
sector. In this sector, we have identified a number of specific market segments
for which SentryVision® is well suited for loss prevention surveillance,
including home centers, mass merchandise chains, supermarkets, hypermarkets and
drug stores, as well as related distribution centers. The key application is
inventory loss prevention in the stores, stock rooms and distribution centers.
  5
  SentryVision®
is typically installed in large retail stores which use a checkout area at the
front of the store and product display configurations and high merchandise
shelving which form rows and aisles. Sentry specializes in designing system
applications which are customized to fit a customer's specific needs and which
integrate the customer's existing surveillance equipment (PTZ dome and
fixed-mount cameras) with SentryVision®. The flexibility of the system allows
the customer to specify target-coverage areas ranging from stock rooms to total
store coverage and focus on shoplifting, employee theft or performance
evaluation of client personnel. Typically, SentryVision® has been installed near
the ceiling between the rows of cash registers and the ends of the merchandise
aisles. This allows the retailer to easily observe both the cash handling
activities of cashiers in the checkout area and customer activities between the
merchandise rows, despite the presence of hanging signs and other obstructions.
The entire sales floor can be monitored efficiently by focusing up and down the
aisles and by moving the carriage horizontally from aisle to aisle, or from cash
register to cash register. In addition, with the use of camera pan, tilt and
zoom lens features, activities in each area can be monitored in greater detail.
Results from Sentry's current installations indicate significant improvements in
detecting shoplifting and employee theft.
 
 Retailers
have also integrated SentryVision® with "front end" packages of conventional
CCTV cameras, dedicated to monitoring the registers and allowing users to locate
the traveling camera track where the maximum coverage of in-store traffic can be
monitored. The SentryVision® system is today generally sold in conjunction with
conventional CCTV applications. Customers using the SentryVision® system have
reported significant reductions in theft-related inventory shrinkage.
 
 Our
SentryVision® Mobile allows the user to view and control video images from the
SmartTrack traveling CCTV system using a mobile hand held computer and wireless
communication network. The earlier generation SentryVision® Mobile product
operated on a wireless Personal Digital Assist (PDA) using Windows CE. The new
version now runs on the latest, tablet style wireless computer under Windows XP
and is significantly faster than the earlier PDA version. The increased speed
and computing power offered by the tablet gives the user real time video
viewing. Customers are no longer required to sit in front of a video console to
manage the SmartTrack system.
 
 Recently,
we introduced SentryVision® Server, which is an IP addressable digital video
server, giving users the ability to capture, stream, view and store video images
using a web browser with the reliability of the Linux OS. The SentryVision®
Server comes with software that allows multiple users to simultaneously connect
to a variety of SentryVision® DVMS (Digital Video Management System) via LAN -
across TCIP/IP networks. The system uses a Windows-based application for
configuration and a browser-based client for remote viewing of live and recorded
video for quick and easy investigation of security issues, as well as policies
and procedure compliance.
 
 **Retail
Market Applications**
 - Home
Centers. Sentry has installed systems in the home center segment of the retail
market. This market has by far been the greatest market for the SmartTrack
systems. Typical of our customers in this market are Lowe's Home Centers, with
more than 1,050 stores in 46 states, and Mills Fleet Farm, a 30 store regional
hardware, home supply and discount retail chain. Both companies required systems
for total floor coverage. We applied different solutions to this common problem
in each case. Lowe's Home Centers chose to integrate track cameras with PTZ dome
and fixed-mount cameras, while Mills Fleet Farm chose to use only the track
camera system.
 
 - Mass
Merchandise Chains. Sentry has installed systems for customers including Sears,
Navy Exchange, Walgreens and Target Stores. The targeted coverage varies
extensively in these installations from only stock rooms to total store
coverage. The equipment package provided in each case varies with the
application and location of the need.
 
 -
Supermarkets. Sentry has installed systems in supermarket customers including
Kroger, Marsh, Cub Foods, Winn-Dixie and Fiesta Mart. The targeted coverage in
most of these installations has been the entire retail space.
  6
  **Industrial
Market Applications**
 -
Distribution Centers. Sentry also provides loss prevention surveillance for
distribution centers and warehouses, and has installed systems for retailers
including TJ Maxx, Big Lots, Home Depot, Kohl's Department Stores, Target
Stores, Borders Group, Disney Direct Marketing, Barnes & Noble,
Robinsons-May, Ross, Saks, Guess, Tower Records, Big Dog, Food Lion, Roundy’s,
the Gap, Bealls and J.C. Penney. Traveling through a facility from an overhead
position, the SentryVision® system can monitor activities occurring between the
stacked rows of cartons or lines of hanging garments. The system can also move a
surveillance camera into position to monitor shipping and receiving docks and
parked delivery trucks. To achieve surveillance capabilities equivalent to those
of the SentryVision® system, a conventional PTZ dome system or fixed-mount CCTV
camera would have to be installed at every desired vantage point, requiring
numerous cameras, additional equipment and wiring and increased installation and
operating costs.
 
 -
Manufacturing and Transportation Facilities. So far SentryVision® use in
factories has been limited, but the benefits of continuous tracking of
industrial operations and processes indicate future growth potential. Continued
expansion of the SentryVision® dealer program is expected to generate increased
installations in factories manufacturing electronics, pharmaceuticals, computers
and other high value products and in various wholesale distribution and
transportation facilities. Express package and other high throughput
distribution facilities are also good prospects for a continuous tracking CCTV
system for theft prevention. Installations include Watkins Motor Lines, Symbol
Technologies, AT&T Wireless, Federal Express, UPS, Wyeth-Ayerst Labs, USF
Logistics and Thompson Electronics.
 
 -
Internet Data Centers. Sentry markets SentryVision® systems to Internet data
centers (IDC's). Most IDC's are full service business internet providers with
state-of-the-art systems that host, monitor and maintain mission-critical
web-sites, e-commerce platforms and business applications for small to medium
sized businesses. SentryVision® systems are used to heighten security through
remote video monitoring. Installations include Dallas Exchange, TIAA-CREF,
Savvis and The Discovery Channel.
 
 **Institutional
Market Applications**
 -
Corrections and Government Institutions. SentryVision® has been installed in
correctional facilities in Michigan, New Mexico and Illinois, with reported
safety benefits of continuous coverage in dormitory, recreation and visitation
areas. SentryVision® installations have also been completed in various
government agencies including the Federal Reserve Bank, U.S. Postal Service,
Central Intelligence Agency and U.S. Immigration Service.
 
 
 **CONVENTIONAL
CCTV SYSTEMS**
 
 Conventional
CCTV is cost effective in many applications and is the most widely used loss
prevention system in North America. Conventional CCTV uses all the basic
components of the video surveillance industry including fixed and dome cameras,
digital video recorders, VCR's, monitors, switchers, multiplexers and
controllers. As all of this equipment is manufactured for Sentry by outside
vendors, we can provide our customers with state-of-the-art equipment for
specific applications at favorable costs. We believe that, while less profitable
than SentryVision® and traditional EAS products, the CCTV products complement
our other surveillance systems and provide retailers with further protection
against internal theft and external shoplifting activities. CCTV systems can
also be electronically connected to EAS systems, causing a video record to be
generated when a theft alarm is triggered.
 
 While we
believe that conventional CCTV and SentryVision® are complementary security
solutions, many companies have traditionally viewed them as competing solutions
and have selected between conventional CCTV systems and SentryVision® systems
for their security solutions.
  7
  Remote
video transmission and digital recording are continuing growth areas for Sentry.
These systems allow customers to monitor remote sites using existing
communication lines and a PC-based system. Video camera images are stored and
manipulated digitally, substituting the PC for the VCR and multiplexer, and
eliminating the videotape. Sentry markets digital video recording and a remote
video transmission unit developed by third-party vendors including GE Security
and TeleWatch.
 
 We
continue to expand conventional CCTV installations in industrial and
institutional facilities. Significant installations have been made for express
package companies, including Federal Express, United Parcel Service, Emery Air
Freight and Airborne Express. The use of CCTV surveillance also continues to
grow in both new and existing correctional facilities and Sentry now has CCTV
installations in both state and county facilities.
 
 The
school market is another CCTV segment. Successful installations were completed
with reported benefits including decreased vandalism and improved safety. In
schools, conventional CCTV is an extremely cost effective security option with
Digital Recording and Remote Video Transmission becoming attractive options for
large school districts.
 
 Our
largest single school CCTV installation was at the Norristown (PA) High School
with 111 cameras, using digital recording and fiber optic cabling. It is an
advanced, cost effective system with video from all cameras instantly accessible
on their network.
 
 
 **EAS
SYSTEMS**
 
 EAS
systems consist of detection devices that are triggered when articles or persons
tagged with reusable tags or disposable labels, (referred to as tags), pass
through the detection device. The EAS systems that Sentry manufactures are based
upon three distinct technologies. One, the Radio Frequency ("Knoscape RF")
System, uses medium radio frequency transmissions in the two to nine megahertz
range. Second, the "Ranger " system uses ultra-high frequency radio signals in
the 902 megahertz and 928 megahertz bands. Third, the Electromagnetic ("Knoscape
MM ") system uses very low frequency electromagnetic signals in the range of 218
hertz to nine kilohertz.
 
 The
principal application of Sentry's products is to detect and deter shoplifting
and employee theft in supermarket, department, discount, specialty and various
other types of retail stores including bookstores, video, liquor, drug, shoe,
sporting goods and other stores. The use of these products reduces inventory
shrinkage by deterring shoplifting, increases sales potential by permitting the
more open display of greater quantities of merchandise, reduces surveillance
responsibilities of sales and other store personnel and, as a result, increases
profitability for the retailer. In addition, Sentry's EAS systems are used in
non-retail establishments to detect and deter theft, in office buildings to
control the loss of office equipment and other assets, in nursing homes and
hospitals for both asset and patient protection, and in a variety of other
applications.
 
 The North
and South American market for retail EAS systems and tags is estimated by
industry sources in excess of $500 million and is growing at an estimated rate
of 8 percent per year.
 
 At
December 31, 2004, the approximate number of EAS Systems sold or leased by
Sentry and its predecessors exceeded 25,927.
 
 **Radio
Frequency and Ranger Detection Systems**
  8
  Sentry
manufactures and distributes the Knoscape RF system, the principal application
of which is to detect and deter shoplifting and employee theft of clothing and
hard goods in retail establishments. Sentry also manufactures and distributes
the Ranger system, which the Company believes is a particularly useful and cost
efficient EAS system for high fashion retail stores with wide mall-type exit
areas that ordinarily would require multiple Knoscape RF systems for adequate
protection. The Knoscape RF and Ranger systems consist of radio signal
transmission and monitoring equipment installed at exits of protected areas,
such as doorways, elevator entrances and escalator ramps. The devices are
generally located in panels or pedestals anchored to the floor for a vertical
arrangement or mounted in or suspended from the ceiling (Silver Cloud) and
mounted in or on the floor in a horizontal arrangement. The panels or pedestals
are designed to harmonize with the decor of the store. The monitoring equipment
is activated by tags containing electronic circuitry, attached to merchandise
transported through the monitored zone. The circuitry in the tag interferes with
the radio signals transmitted through the monitoring system, thereby triggering
alarms, flashing lights or indicators at a central control point, or triggering
the transmission of an alarm directly to the security authorities. By means of
multiple installations of horizontal Knoscape RF systems or installation of one
or more Ranger systems, the Company's products have the ability to protect any
size entrance or exit.
 
 Non-deactivatable
reusable tags are manufactured in a variety of sizes and types and are attached
directly to the articles to be protected by means of specially designed fastener
assemblies. A 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 Sentry’s systems have been operating for longer periods), have
a negligible false alarm rate and are adaptable to meet the diversified article
surveillance needs of individual retailers.
 
 **Electromagnetic
Detection Systems**
 
 The
primary application of Knoscape MM systems is to detect and deter theft in "hard
goods" applications such as supermarkets, bookstores and in other specialty
stores such as video, drug, liquor, shoe, record and sporting goods.
 
 Knoscape
MM systems use detection monitors that are activated by electromagnetically
sensitized strips. The MM targets are typically attached to the articles to be
protected and are easily camouflaged on a wide array of products. The detection
monitors used by the Knoscape MM systems are installed at three to five foot
intervals at the exits of protected areas. The magnetic targets can be supplied
in many forms and are attractively priced, making them suitable for a variety of
retail applications. In addition, the MM targets can be manufactured to be
activated and deactivated repeatedly while attached to the articles to be
protected. Accurate deactivation is also very important when the item to be
protected is a personal accessory that will be carried by its owner from place
to place, such as pocket books, pens, lipstick, shoes, camera film and cameras.
 
 The
Knoscape MM system offers retailers several features not available in Knoscape
RF and Ranger systems. Since the target is very small, relatively inexpensive
and may be inserted at the point of manufacture or packaging, it provides
retailers with a great deal of flexibility and is practical for permanent
attachment to a wide variety of hard goods, especially low profit-margin
products. The target can be automatically deactivated at check-out, eliminating
the risk of triggering alarms when merchandise leaves the store and saving sales
personnel valuable time. Since the targets can be incorporated directly into a
price tag or the article itself, they are convenient to use.
 
 **DIALOC
ID SECURITY PRODUCTS**
 
 Under a
five-year license agreement, we also distribute EAS systems manufactured by
Dialoc ID. The 9000-P 8.2 MHz system, which is housed in slender, self-contained
Plexiglas panels, provides retailers with clear lines of sight at the front end
along with the durability of solid Plexiglas. The panels can be custom printed
with the retailer's logo for enhanced image and trade name awareness. The
system's electronics, which are built-in to the base of the Plexiglas antenna,
provide detection of 8.2 MHz labels and hard tags in aisles up to six feet wide.
The 9000 PL system is offered in both single and dual aisle configurations and
is compatible with all existing 8.2 MHz tags and checkout accessories. In
addition, through Sentry, Dialoc ID anticipates it will introduce LaserFuse, a
new RF label technology, which will be compatible with, and an alternative to,
the labels offered by Checkpoint Systems, Inc.
  9
  **PATRON
SELF CHECK BOOK BORROWING SYSTEMS**
 
 Libraries
worldwide are struggling to reduce operating costs by applying cost effective
technology solutions. The ID Systems QuickCheck patron self check book borrowing
system offers an ideal solution to gain an increasing share of the estimated
$100 million library security market in North America. The QuickCheck system is
RFID ready and provides for user access to circulation software, automatic
security strip deactivation, automatic return ticket printing, user access to
book renewals, multi-lingual software interface and on-screen user instructions.
QuickCheck systems have been installed in Harris County Public Library,
Vancouver Public Library, Ottawa Public Library, McGill University Library and
Calgary Public Library.
 
 **PROXIMITY
ACCESS CONTROL SYSTEMS**
 
 We are
beginning to manufacture and distribute the ID Systems ZapLoc system, a complete
line of cost effective, feature rich access control readers, controllers and
software. The ZapLoc access system is managed by ZapWare, a simple, yet powerful
software program for designing even the most complex access rights for
cardholders. Its ODBC architecture allows exporting data to virtually any
compatible application with flexibility not available from other access systems.
The system contains the equipment needed to install and operate a one door
proximity access control right out of the box. For larger applications, readers
and controllers can be added in a one-to-one relationship, resulting in
substantial savings in per door cost over controller-based systems. ZapWare has
no limit to the number of transactions or cardholders and can control from one
to 992 doors with ease.
 
 In
addition, we offer the ZapTrack time and attendance system. The ZapTrack
terminal offers simple, user specified cardholder control. Bi-directional
communication with the ZapWare access control software program allows
cardholders to receive personal online information. ZapTrack also functions as
an access control reader and can control and interact with remote devices.
Information can be exported to payroll accounting systems. The multi-function
ZapTrack system is ideal for use in university, library, retail, industrial and
office building applications.
 
 **RADIO
FREQUENCY IDENTIFICATION (RFID)**
 
 RFID is a
wireless electronic data collection system that uses radio frequency signals to
identify and track objects using readers and tiny integrated circuits in label
format. Applications include library management, warehousing, parcel tracking,
inventory control, asset protection and supply chain management. We are in the
initial stages of introducing ISO standard, RFID labels, tags and readers for
library management and upgrades to its access control systems. ****
 
 **PRODUCT
AUTHENTICATION**
 
 Product
Authentication is a specific use technology, identifying fraudulent
documentation and/or “knock-off” products. With our patented, application
specific electromagnetic label imbedded in an object, an EM reader will quickly
determine the authenticity of the item. We anticipate introducing products to
address this need.
 
 **BOOKINGS**
  10
  Of
Sentry's bookings for the year ended December 31, 2004, approximately 32 percent
were attributable to SentryVision®, 26 percent to CCTV and 42 percent to EAS. 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
percent to Access Control. For the year ended December 31, 2002, approximately
32 percent were attributable to SentryVision®, 45 percent to CCTV and 23 percent
to EAS.
 
 
 **MAJOR
CUSTOMERS**
 
 Although
the composition of our largest customers has changed from year to year, a
significant portion of our revenues has been attributable to a limited number of
major customers. In 2004, 2003 and 2002, Lowe's Home Centers accounted for 30%,
44% and 40%, respectively, of total revenues. In January 2005, Lowe’s Home
Centers notified us that they would not be renewing their annual maintenance
contract, which represented $0.9 million of our revenues in 2004. While we still
anticipate selling Sentry products to Lowe’s in the future, the maintenance
contract contributed towards the selection of vendors for replacement and add-on
CCTV business in new and existing Lowe’s locations. We anticipate that this
decision will result in a substantial decrease in future revenues from Lowe’s on
a comparative basis. While we believe that one or more major customers could
account for a significant portion of our sales for at least the next two years,
we anticipate that our customer base will continue to expand and that in the
future we will be less dependent on major customers.
 
 
 **PRODUCTION**
 
 **SentryVision®
and CCTV Products**
 
 Sentry's
manufacturing operations continued the shift to out-sourcing in 2004. 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 finished assembly undergoes a quality assurance check by Sentry
prior to its shipment to an installation site. All SentryVision® carriage
assemblies are tested and burned in for 24 hours, resulting in approximately
3,000 travel and PTZ cycles prior to quality assurance sign off. Sentry is not
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. In 2005, we intend to shift the sourcing of components and
parts to our suppliers for a more turn-key outsourced manufacturing
model.
 
 **EAS
Products**
 
 Sentry
produces at our facilities in Ronkonkoma, New York, or purchases through
suppliers, its RF, Ranger, and MM systems, or their components. Production
consists of final assembly operations of electronic and mechanical components
that Sentry purchases from various suppliers. Independent contractors using
existing molds and tooling produce plastic cases and antenna coils for the tags
to Sentry's specifications. Sentry is not dependent on any one supplier or group
of suppliers of components for its systems.
 
 Our
policy is to maintain our inventory at a level that is sufficient to meet
projected demand for its products. We do not anticipate any difficulties in
continuing to obtain suitable components for our products at competitive prices
in sufficient quantities as and when needed.
 
 **Security
Labels**
 
 As a
result of the acquisition of ID Systems, we obtained a 51% interest in Custom
Securities Industries Inc. (“CSI”), an Ontario company. Since its founding in
1988, CSI has established a world wide reputation for innovation and excellence
in the Electronic Article Surveillance (EAS) Industry. Extensive experience and
know how in the leading EAS technologies, combined with expertise in converting,
in house development of proprietary products and the use of specially designed
converting equipment, enables CSI to offer custom tailored solutions with a
rapid turn around time.
  11
  Over the
years, CSI has acquired a wide range of knowledge and developed its own trade
secrets and manufacturing procedures to ensure competitive pricing, a broad
range of high quality products, and the ability to supply products in both small
and large volumes.
 
 CSI
offers EAS products compatible with Radio Frequency (RF), Electromagnetic (EM),
and Accousto-Magnetic (AM) technologies. Whatever the particular application,
from standard EM pressure sensitive labels to sequentially printed barcode
labels, products are available. Recently CSI has also introduced Source Tagging
Solutions for the Radio Frequency and Accousto-Magnetic technologies. These
products are successfully meeting the needs of retailers in the hardware, auto
aftermarket, food and general merchandise categories. CSI specializes in custom
solutions for hard to tag items.
 
 Long term
associations with leading suppliers of EAS sensor materials, films and papers,
pressure sensitive materials and adhesives enables CSI to handle the most
demanding of label product needs with either standard or custom solutions. CSI
offers a wide selection of labels and fashion tags. Our products are made with
high performance materials, such as extremely low coercivity amorphous alloys
and ultra stable deactivation ribbon.
 
 CSI’s
manufacturing equipment incorporates computer and control technology, including
PLC's, Motion Controllers, Servo Motors, many different types of position and
movement sensors, along with a very large inventory of specialized tooling and
dies.
 
 Besides
providing security labels to Sentry and ID Systems, CSI’s customers include
Tyco, Checkpoint, Dialoc ID, KMA and Retailers Advantage.
 
 **MARKETING**
 
 We
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 2004, as part of our restructuring plan,
we reduced the number of direct salespersons to four, whose efforts were
supplemented through six in-house sales support staff and independent sales
representatives. ID Systems markets its EAS products to smaller local and
regional retailers through selected dealers and distributors. Sales are made
into the library market on both a direct basis as well as through catalogs and
dealers.
 
 We market
our products primarily through participation in trade shows and through
telemarketing. In addition, these efforts are augmented through our Website,
which provides enhanced product and market oriented information.
Internationally, we market SentryVision® through large system integrators and
distributors including Honeywell, ADT, Chubb, Cegelec, Intrepid and
BSC.
 
 As a
result of the Brascan financing and ID System merger, we have strengthened our
direct sales force and centralized its management in our Toronto
office.
 
 **SentryVision®
and CCTV Products**
 
 To date,
most SentryVision® and conventional CCTV Systems have been sold on a direct sale
basis. Typical billing arrangements for SentryVision® systems involve invoicing
50% of total sale upon shipment of the product and 50% on the completion of the
installation.
 
 While
most of the current SentryVision® and conventional CCTV sales have been made to
home centers, retail chains and distribution centers, our marketing plan for
Sentry also emphasized a dealer program for institutional, industrial and
international prospects.
  12
  We also
market SentryVision® through qualified security dealers and integrators. Much of
the industrial and institutional SentryVision® / CCTV prospects are serviced by
local security companies who design and install integrated CCTV, access control
and alarm systems. By working with these companies, we expected to be able to
reach a far larger number of SentryVision® prospects and penetrate the market
more rapidly. The program has generated interest through trade advertising,
direct mail and trade show participation. Domestic dealers did not generate
significant SentryVision® installations in industrial and institutional
facilities in 2004. Prior sales were made through ADT, STG, Siemans, Mosler and
Security Link.
 
 In
addition, we market SentryVision® internationally using independent distributors
on both an exclusive and nonexclusive basis. We sell our products to independent
distributors at prices below those charged to end-users because distributors
typically make volume purchases and assume marketing, customer training,
installation, servicing and financing responsibilities. As of December 31, 2004,
we have distributors in Canada, UK, France, Mexico, Belgium, Holland, Italy,
Poland, Singapore, Russia, Spain, Brazil, Argentina, Hungary, Romania, Taiwan,
Lebanon, Australia and the United Arab Emirates.
 
 During
2004, Sentry placed in service 229 SentryVision® systems and 2,626 CCTV cameras,
as compared to 197 SentryVision® systems and 2,996 CCTV cameras in 2003 and 186
SentryVision® systems and 4,449 CCTV cameras in 2002.
 
 **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, 2004 and 2003 Sentry placed in service 202 and 226
Knoscape RF, Ranger, and Knoscape MM systems.
 
 RF and
Ranger systems continue to be used by apparel and department stores that have
wide exit areas and a desire for deterrence based on reusable hard tags. Both
the Silver Cloud and Knoscape RF systems are universal in that they can detect
both 2 MHz hard tags and 8 MHz labels. Knogo also markets an 8MHz P-2000 RF
system designed for both hard and soft good customers. The P-2000 system is
economical and self-installable by the customer.
 
 Supermarkets,
bookstores, video stores and specialty stores remain good prospects for MM
systems due to the small size and low cost of Micro-Magnetic strips. Knoscape MM
Systems feature updated digital electronics. Knoscape MM Systems detect
virtually all manufacturers' magnetic strips and can universally replace older
magnetic strip systems manufactured by various EAS vendors.
 
 The
library market continues to be a substantial market for magnetic technology.
Previously, 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. Sales of 3M library products had
declined through 2002 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. We
were subject to an agreement not to compete against 3M for sales and service of
EAS Systems in the library market, which expired in March 2004.
  13
  **BACKLOG**
 
 Our
backlog of orders was approximately $2.2 million at December 31, 2004, as
compared to approximately $3.2 million at December 31, 2003 and approximately
$5.2 million at December 31, 2002. We have experienced a trend, particularly
with our major customers, of receiving fewer long-term blanket orders than in
the past. We anticipate that substantially all of the backlog present as of
December 31, 2004 will be delivered within 12 months.
 
 
 **SEASONAL
ASPECTS OF THE BUSINESS**
 
 Our
current customers are primarily dependent on retail sales, which are seasonal
and subject to significant fluctuations and are difficult to predict.
 
 
 **SERVICE**
 
 Installation
services are performed by our personnel and by carefully screened and supervised
subcontractors as well as authorized dealers and distributors. Repair and
maintenance services are performed primarily by our personnel. All products sold
are covered by a warranty period, generally, one year. After the warranty
period, we offer our customers the option of entering into a maintenance
contract with the Company or paying for service on a per call basis.
 
 Installations
of SentryVision® systems typically take from three days to several weeks and
involve mounting the enclosures, installing the controller unit, installing the
carriage assembly, and connecting control and transmission cables to the central
monitoring location. Items such as high voltage power termination wiring are
typically the responsibility of the end user.
 
 The use
of subcontractors supervised by Company employees proved cost effective with no
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. Our technical staff
now focuses on EAS, SentryVision® and CCTV service and maintenance and we rely
on 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
 
 Technician
headcount stood at 23 throughout 2004, as we continued to develop expertise
among our service and installation partner companies. Our 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 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.
 
 The loss
of the Lowe’s maintenance contract in the beginning of 2005 will lead to a
reduced technician headcount. It is anticipated that we will release eight field
employees in the first quarter, leaving fifteen strategically located
technicians throughout North America. We anticipate that this level of coverage
will be adequate, coupled with our maturing Service Partner Network, to service
our customer base.
 
 Customer
service remains a priority and we are focused on continued improvements in 2005.
  14
  **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 Security, Pelco Manufacturing, Inc., Panasonic, Inc. and Honeywell are
the Company's principal competitors. Outside the U.S., we are aware of other
companies that market other types of traveling CCTV systems including Lextar
Technologies, Ltd. in Australia, T.E.B., Sensormatic and DETI in France and
Moving Cameras Ltd. in the UK. Some of our competitors have far greater
financial resources, more experienced marketing organizations and a greater
number of employees than the Company.
 
 
 **PATENTS
AND OTHER INTELLECTUAL PROPERTY**
 
 Although
patent protection is advantageous to Sentry, we do not consider any single
patent or patent license we own or hold to be material to our operations. We
believe that our competitive position ultimately will depend on our experience,
know-how and proprietary data, engineering, marketing and service capabilities
and business reputation, all of which are outside the scope of patent
protection.
 
 **SentryVision®**
 
 Sentry
has a United States patent covering the cable-free transmission of a video
signal to and from the carriage. This technology prevents degradation of the
video signal, which can result from the movement of and prolonged friction
caused by the carriage. Three additional U.S. patents were received for
improvements made to the original technology, which has been incorporated into
the SmartTrack product. Sentry also has received a corresponding European patent
and eleven foreign country patents. We intend to seek patent protection on
specific aspects of the SentryVision® system, as well as for certain aspects of
new systems which may be developed for Sentry. There can be no assurance that
any patents applied for will be issued, or that the patents currently held, or
new patents, if issued, will be valid if contested or will provide any
significant competitive advantage to Sentry.
 
 We are
not aware of any infringement of patents or intellectual property held by third
parties. However, if Sentry is determined to have infringed on the rights of
others, Sentry may be required to obtain licenses from such other parties. There
can be no assurance that the persons or organizations holding desired technology
would grant licenses at all or, if licenses were available, that the terms of
such licenses would be acceptable to the Company. In addition, we could be
required to expend significant resources to develop non-infringing technology.
 
 Sentry
has also relied on the registration of trademarks and trade names, as well as on
trade secret laws and confidentiality agreements with its employees. While we
intend to continue to seek to protect Sentry's proprietary technology and
developments through patents, trademark registration, 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.
  15
  **EAS
Products**
 
 Sentry
has 21 United States and Canadian patents and one patent application relating to
(i) the method and apparatus for the detection of movement of articles and
persons and accessory equipment employed by Sentry in its Knoscape RF, Ranger
and Knoscape MM systems, (ii) various specific improvements used in the Knoscape
RF, Ranger and Knoscape MM systems and (iii) various electrical theft detection
methods, apparatus and improvements not presently used in any of Sentry's EAS
systems.
 
 **Product
Authentication**
 
 Sentry’s
Custom Security Industry subsidiary has two United States patents related to a
product authentication. One patent is for a system that measures certain
magnetic properties of a marker with an electronic reader utilizing an
electromagnetic search field and the second patent is for a unique reader
suitable for this system.
 
 **RESEARCH
AND DEVELOPMENT**
 
 As of
December 31, 2004, Sentry Technology Corporation had 9 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,
2004, 2003 and 2002, approximately $0.8 million, $0.7 million and $0.5 million,
respectively, was expended on Company-sponsored research.
 
 The
SmartTrack System continued to benefit from product improvement efforts focused
on adding features and reducing the cost of manufactured products. Enhancements
were made to the electro-mechanical, electronic, software, and optical portions
of the SmartTrack System. These development efforts resulted in improved
reliability and extended service life. Various improvements in material and the
application of new assembly techniques enhanced the SmartTrack System during
2004.
 
 Extensive
development in software during 2004 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.
 
 EM
product offerings were enhanced through development of a new antenna panel. The
design incorporates a contemporary furniture style that compliments a wide
variety of environments. Technological advances in the design simplify the
installation process and result in a more reliable system.
 
 
 **REGULATION**
 
 Because
Sentry's EAS and CCTV systems use radio transmission and electromagnetic wave
principles, such systems are subject to regulation by the Federal Communications
Commission ("FCC") under the Communications Act of 1934. In those instances
where it has been required, certification of such products by the FCC has been
obtained. As we develop new products, application will be made to the FCC for
certification or licensing when required. No assurance can be given that such
certification or licensing will be obtained or that current rules and
regulations of the FCC will not be changed in an adverse manner.
 
 Our
business plan calls for the sale and use of Sentry's products in domestic
markets and, where consistent with contractual obligations, in international
markets. Sentry's products may be subject to regulation by governmental
authorities in various countries having jurisdiction over electronic and
communication use. We intend to apply for certification of 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.
  16
  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**
 
 At
December 31, 2004, the Company and its subsidiaries employed 102 full-time
employees, of whom 21 were employed in administrative and clerical capacities,
10 in engineering, research and development, 28 in production and manufacturing
support, 13 in sales and marketing and 30 in customer service and support. None
of our employees are employed pursuant to collective bargaining agreements.
 
 
 **Item
2. PROPERTIES**
 
 Our
principal executive, administrative offices, research and development and
distribution facilities are located in Ronkonkoma, New York, in a 20,000 square
foot facility leased by the Company. In addition, we maintain a sales,
administrative and distribution office in a leased 7,400 square foot facility in
Toronto, Ontario. Our CSI subsidiary leases facilities for manufacturing and
distribution totaling 7,000 square feet located in Thornhill, Ontario.
 
 
 **Item
3. LEGAL PROCEEDINGS**
 
 In August
2004, Bi-County Park Associates, Inc. d/b/a Ashlind Properties brought an action
against us for the recovery of a real estate brokerage commission in the amount
of $250,000 relating to the termination of its lease on its former Hauppauge
facility. We believe there is no merit to this claim and we are actively
defending such action.
 
 Although
we are involved in ordinary, routine litigation incidental to our business, we
are not presently a party to any other legal proceeding, the adverse
determination of which, either individually or in the aggregate, would be
expected to have a material adverse affect on the Company's business or
financial condition.
 
 
 **Item
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**
 
 During
the fiscal year ended December 31, 2004, there were no matters submitted to a
vote of the Company's security holders through the solicitation of proxies or
otherwise.
  17
  **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
    
    Low2003First
      Quarter
    
    $
    0.03
    
    $
    0.01Second
      Quarter
    
    
    0.08
    
    
    0.01Third
      Quarter
    
    
    0.14
    
    
    0.02Fourth
      Quarter
    
    
    0.21
    
    
    0.092004First Quarter
    
    $
    0.25
    
    $
    0.12Second
      Quarter
    
    
    0.29
    
    
    0.14Third
      Quarter
    
    
    0.18
    
    
    0.10Fourth
      Quarter
    
    
    0.19
    
    
    0.092005First
      Quarter..(through March 31, 2005)
    
    $
    0.28
    
    $
    0.13
 
 
 
 The
Company's Common Stock is quoted on the OTC Bulletin Board ("OTCBB") under the
symbol SKVY.
 
 (b)
    Holders
      of Common Stock.
 
 As of
April 12, 2005, the Company had 120,558,804 shares of Common Stock issued and
outstanding, which were held by 369 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 agreements prohibit the Company from
paying cash dividends without the consent of the lenders.
  18
  **Item
6.****MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION****AND
RESULTS OF OPERATIONS**
 
 **Critical
Accounting Policies**
 
 Management’s
discussion and analysis of its financial position and results of operations are
based upon the Company’s consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses and related disclosure of contingent
assets and liabilities. Actual results could differ from those estimates.
Management believes that the critical accounting policies and areas that require
the most significant judgments and estimates to be used in the preparation of
the consolidated financial statements are allowance for doubtful accounts,
inventory obsolescence and accrued warranty.
 
 Allowance
for Doubtful Accounts -- We maintain an allowance for doubtful trade accounts
receivable for estimated losses resulting from the inability of our customers to
make required payments. In determining collectibility, we review available
customer financial statement information, credit rating reports as well as other
external documents and public filings. When it is deemed probable that a
specific customer account is uncollectible, that balance is included in the
reserve calculation. Actual results could differ from these estimates under
different assumptions.
 
 Inventory
Obsolescence --We write down our inventory for estimated obsolescence or
unmarketable inventory equal to the difference between the cost of inventory and
the estimated market value based upon assumptions about future demand and market
conditions. If actual future demand or market conditions are less favorable than
those we project, additional inventory write-downs may be required.
 
 Impairment
of long-lived assets -- We review our long-lived assets, property and equipment,
intangible assets, goodwill and other assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of these assets may
not be fully recoverable. Impairment is measured at fair value. If impairment
indicators exist, we determine whether the projected undiscounted cash flows
will be sufficient to cover the carrying value of such assets. This requires us
to make significant judgments about the expected future cash flows of the asset
group. The future cash flows are dependent on general and economic conditions
and are subject to change.
 
 Accrued
Warranty -- We provide for the estimated cost of product warranty at the time
revenue is recognized. We calculate the reserve utilizing historical product
failure rates and service repair costs by product family. These rates are
reviewed and adjusted periodically. We utilize judgment for estimating these
costs and adjust our estimates as actual results become available.
 
 Revenue
Recognition -- We offer our security devices for sale or lease. We recognize
revenue when installation is complete or other post-shipment obligations have
been satisfied. For those products not requiring installation, or if
installation costs are not material, the Company recognizes revenues upon
shipment.  Service revenues are recognized when earned and maintenance
revenues are recognized ratably over the service contract period.
 
 Related
Party Transactions -- Details of related party transactions are included in Item
12 and in Notes 2 and 12 of the Financial Statements of this Form
10-KSB.
  19
  Selected
Financial Data
 
 The table
below sets forth selected consolidated historical financial data of the Company
for the years ended December 31, 2000, 2001, 2002, 2003 and 2004. 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,
    
    2000
    
    2001
    
    2002
    
    2003
    
    2004**Selected
      Statement of Operations Data:**Total
      revenues
    
    $
    19,865
    
    $
    17,299
    
    $
    14,704
    
    $
    13,126
    
    $
    16,665Cost
      of sales
    
    
    11,120
    
    
    8,879
    
    
    7,382
    
    
    5,179
    
    
    6,351Customer
      service expenses
    
    
    4,464
    
    
    4,361
    
    
    4,240
    
    
    3,977
    
    
    4,175Selling,
      general and administrative expenses
    
    
    7,576
    
    
    5,773
    
    
    5,287
    
    
    3,692
    
    
    4,642Restructuring
      and impairment charges
    
    
    2,981
    
    
    -
    
    
    -
    
    
    -
    
    
    -Income
      (loss) before income taxes
    
    
    (7,821
    )
    
    (2,911
    )
    
    (3,356
    )
    
    (1,049
    )
    
    253Extraordinary
      item - Gain on extinguishment of debt
    
    
    -
    
    
    -
    
    
    -
    
    
    738
    
    
    -Cumulative
      effect of change in accounting principal
    
    
    301
    
    
    -
    
    
    -
    
    
    -
    
    
    -Net
      income (loss)
    
    
    (8,122
    )
    
    (2,911
    )
    
    (3,356
    )
    
    181
    
    
    31Preferred
      stock dividends
    
    
    1,337
    
    
    25
    
    
    -
    
    
    -
    
    
    -Return
      to common shareholders from redemption of preferred stock
    
    
    -
    
    
    27,198
    
    
    -
    
    
    -
    
    
    -Net
      income (loss) available to common shareholders
    
    
    (9,459
    )
    
    24,262
    
    
    (3,356
    )
    
    181
    
    
    31Net
      income (loss) per common share:Basic
    
    
    (0.97
    )
    
    0.40
    
    
    (0.05
    )
    
    0.00
    
    
    0.00Diluted
    
    
    (0.97
    )
    
    0.39
    
    
    (0.05
    )
    
    0.00
    
    
    0.00As
      of December 31,
    
    
    2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004**Selected
      Balance Sheet Data:**Working
      capital
    
    $
    2,173
    
    $
    2,235
    
    $
    (768
    )
    $
    (285
    )
    $
    4,545Total
      assets
    
    
    13,845
    
    
    11,561
    
    
    7,992
    
    
    4,093
    
    
    12,247Property,
      plant and equipment, net
    
    
    3,324
    
    
    2,962
    
    
    2,563
    
    
    209
    
    
    689Obligations
      under capital leases
    
    
    2,892
    
    
    2,751
    
    
    2,652
    
    
    18
    
    
    13Convertible
      debentures
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    1,862Minority
      interest
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    1,045Total
      common shareholders' equity (deficit)
    
    
    (25,794
    )
    
    2,891
    
    
    (451
    )
    
    (125
    )
    
    4,345
  20
  **Results
of Operations**
 
 ***Year
Ended December 31, 2004 Compared with Year Ended December 31,
2003***
 
 On April
30, 2004, Sentry purchased from Saburah Investments, Inc. all of the outstanding
common shares and Series "A" preference shares of ID Security Systems Canada,
Inc., and all of the outstanding capital stock of ID Systems USA, Inc.
(collectively, "ID Systems"). ID Systems is a Toronto based company engaged in
anti-shoplifting technology, security labeling, radio frequency identification
(RFID), access control and library security. Our consolidated statements of
operations include the revenues and expenses of ID Systems from May 1,
2004.
 
 Consolidated
revenues were 27% higher in the year ended December 31, 2004 than in the year
ended December 31, 2003. ID Systems’ revenues for the eight months period ended
December 31, 2004 represented $4.1 million of total revenues. The backlog of
orders, which we expect to deliver within twelve months, decreased to $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:
 
 %2004
    
    2003
    
    Change(in
      thousands)EAS
    
    $
    5,286
    
    $
    1,888
    
    
    180CCTV
    
    
    3,214
    
    
    3,650
    
    
    (12
    )SentryVisionÒ
    
    
    3,784
    
    
    3,091
    
    
    22Total
      sales
    
    
    12,284
    
    
    8,629
    
    
    42Service,
      installation and other
    
    
    4,381
    
    
    4,497
    
    
    (3
    )Total
      revenues
    
    $
    16,665
    
    $
    13,126
    
    
    27
 
 
 The
increase in sales of EAS products in 2004 was attributable to ID Systems’ sales,
which represented $3.8 million of the total. Sentry’s historical comparative
sales of EAS systems and tags decreased in 2004. The decrease in CCTV revenues
is primarily a result of lower sales to two customers. We had sales of $0.6
million in 2003 to Home Depot, which did not repeat in 2004 and we lost $0.5
million in revenues in 2004 from a significant customer that decided to source
their purchases from the CCTV manufacturer this year. SentryVision® sales
increased both domestically and internationally. Sales to our international
dealers and distributors represented $1.6 million of total SentryVision® sales
in 2004 as compared to $1.2 million in 2003. Our sales
of SentryVision® products to our international dealers and distributors are
denominated in U.S. dollars, therefore the strengthening of the Euro against the
U.S. dollar had no significant impact on revenues. Service,
installation and other revenues decreased 2004 primarily as a result of lower
CCTV installations than in 2003. Even though EAS sales increased substantially,
the installation revenues associated with EAS systems are significantly lower
than those for CCTV and SentryVision® sales. In
addition, Lowe’s negotiated a lower rate per store for the maintenance contract
in 2004 than in 2003. Total
revenues from Lowe’s Home Centers represented $5.0 million in 2004 as compared
to $5.8 million in 2003. Of the $0.8 million decrease, $0.6 million was a
reduction in SentryVision® sales and $0.2 million was a reduction in service and
installation income.
 
 In
January 2005, Lowe’s Home Centers notified us that they would not be renewing
their annual maintenance contract, which represented $0.9 million of our
revenues in 2004. While we still anticipate selling Sentry products to Lowe’s in
the future, the maintenance contract contributed towards the selection of
vendors for replacement and add-on CCTV business in new and existing Lowe’s
locations. We anticipate that this decision will result in a substantial
decrease in future revenues from Lowe’s on a comparative basis.
  21
  Cost of
sales was 52% of sales in 2004 compared to 60% in 2003. We continue to see
margin improvements as a result of the outsourcing of all significant
manufacturing operations, which we began in the second quarter of 2003. The
decrease in the cost of sales percentage in 2004 as compared to 2003 is
primarily the result of the elimination of the charge to cost of sales of under
absorbed fixed overhead costs due to the termination of in-house manufacturing
and the move to a smaller facility. As a percentage of sales, the costs
associated with ID Systems sales were slightly higher than Sentry’s historical
costs as a higher portion of their sales are made through dealer and
distributors which carry lower margins than sales made direct to end users.
 
 Our
customer service expenses increased by 5% in 2004 as compared to 2003. Of the
increase 4% was due to the ID Systems acquisition. In 2004, we decreased the
number of customer service employees and increased the use of outside service
contractors in order to manage our total net customer service costs during
fluctuations in activity levels between periods. However, our efforts were
hampered somewhat by our inability to maintain a proper level of service parts
during the first six months of 2004, due to inadequate trade credit and
financial resources, which resulted in inefficiencies.
 
 Selling,
general and administrative expenses were 26% higher in 2004 when compared to
2003. While our historical costs decreased as a result of our restructuring in
2003, our acquisition of ID Systems added $1.1 million in selling, general and
administrative expenses during the eight months they were included in the 2004
results.
 
 The
increase in research and development costs in 2004 when compared to 2003 is also
primarily a result of the ID Systems acquisition.
 
 As a
result of the restructuring of operations, the increase in sales activity levels
and the acquisition of ID Systems, we were able to show operating income of $0.7
million in 2004 as compared to an operating loss of $0.4 million in
2003.
 
 Total
interest and financing costs decreased by $259,000 in 2004 as compared to 2003.
Bank interest expense increased by $39,000 in 2004 due to higher average
borrowings and slightly higher interest rates under our revolving credit and
term loan facility with CIT and the ID Systems credit facility with Bank of
Montreal. Interest under capital leases decreased by $156,000 as a result of the
cancellation of the sale and leaseback agreement on our former headquarters
facility. While interest and financing costs related to the Brascan Technology
financing added $151,000 in 2004, we were able to eliminate, in the second half
of 2004, the costly financing costs associated with purchase order financing,
resulting in a savings of $293,000 for the entire year.
 
 During
2003, we entered into settlements with certain vendors for past due obligations
which resulted in a gain of approximately $526,000 (net of $351,000 income
taxes), which represents the difference between the amounts due before the
settlement and the total amount payable, including the value of the common
stock, as a result of the settlement. In addition, on July 9, 2003, we entered
into a settlement agreement with our former landlord regarding the termination
of its long-term capital and operating leases for our facility in Hauppauge, New
York. We recognized an extraordinary gain of $212,000 (net of $141,000 income
taxes) in 2003, representing the difference between the carrying amounts of
outstanding obligations to the landlord less the net book value of the property
on the date of the settlement.
 
 The
income tax provision of $140,000 in 2004 principally results from taxable income
of our ID Systems subsidiaries, which cannot be offset by Sentry’s net operating
loss carryforwards. The $492,000 income tax provision recognized on the
extraordinary gains in 2003 was offset by equivalent income tax benefits
generated from the 2003 loss from operations and the utilization of net
operating loss carryforwards.
 
 As a
result of the foregoing, we had net income of $31,000 in the year ended December
31, 2004 as compared to $181,000 in the year ended December 31,
2003.
 
 ***Year
Ended December 31, 2003 Compared with Year Ended December 31,
2002***
 
 22
  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 expected to deliver within twelve months, decreased to $3.2 million at
December 31, 2003 as compared to $5.2 million at December 31, 2002. Total
revenues for the periods presented are broken out as follows:
 
 2003
    
    2002
    
    Change(in
      thousands)EAS
    
    $
    1,843
    
    $
    2,579
    
    
    (29%)CCTV
    
    
    3,650
    
    
    4,657
    
    
    (22%)SentryVisionÒ
    
    
    3,091
    
    
    2,408
    
    
    28%3M
      library products
    
    
    45
    
    
    256
    
    
    (82%)Total
      sales
    
    
    8,629
    
    
    9,900
    
    
    (13%)Service,
      installation and other
    
    
    4,497
    
    
    4,804
    
    
    (6%)Total
      revenues
    
    $
    13,126
    
    $
    14,704
    
    
    (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 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
continued 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 the 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 were 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 was 60% in 2003 compared to 75% 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 was 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 anticipated 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 carried
substantially higher financing fees than the revolving credit line. Interest
under this facility was $290,000 higher in 2003 than in 2002. We expected 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.
 
 23
  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**
 
 As a
result of certain transactions detailed below, our financial condition has
substantially strengthened. Since December 31, 2003, our working capital has
increased from $(0.3) million to $4.5 million, total assets increased from $4.1
million to $12.2 million and shareholders’ equity increased from $(0.1) million
to $4.3 million. We have eliminated the use of expensive purchase order
financing to finance inventory purchases and we are reestablishing credit with
new and existing vendors.
 
 In the
second quarter of 2003, to address our reduced revenue levels, decreased
financial position and recurring operating losses, our Board of Directors
approved a restructuring plan to strengthen the Company’s operating efficiencies
and to better align its operations with current economic and market conditions.
We were successful in implementing many changes to our business plan during 2003
including the downsizing of operations and relocation to smaller facilities, the
negotiations with past due trade creditors and former landlord, the outsourcing
of manufacturing and the expansion of our Service Partner program to augment
service and installations. The successful implementation of this restructuring
has resulted in substantial gross margin improvements and reductions in
operating expenses beginning after the first quarter of 2003.
 
 Over the
last several years, our largest shareholder, Dialoc ID Holdings B.V. (“Dialoc”)
was not able to provide us with additional financial support. On April 19, 2004,
Dialoc sold 39,066,927 Sentry common shares (representing approximately 46% of
the total issued and outstanding shares of Sentry) to a group of investors. Of
the group, Saburah Investments Inc. (“Saburah”) acquired 22,758,155 shares, Mr.
Robert Furst 14,554,386 shares and Dr. Morton Roseman 1,754,386 shares. Peter L.
Murdoch, President, CEO and Director of Sentry, is the owner of Saburah. Mr.
Furst is also a long-standing member of Sentry’s Board of Directors. As a result
of this transaction, Messers Angel and de Nood, Principals of Dialoc, resigned
from Sentry’s Board of Directors.
 
 In
addition to the purchase of Sentry’s common shares, Saburah also acquired 100%
of ID Security Systems Canada, Inc. and ID Systems USA, Inc. (“ID Systems”). ID
Systems is a Toronto based company engaged in anti-shoplifting technology,
security labeling, radio frequency identification (RFID), access control and
library security. The price 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.
  24
  On April
30, 2004, Sentry purchased from Saburah Investments, Inc., an Ontario
corporation, all of the outstanding common shares and Series "A" preference
shares of ID Security Systems Canada, Inc., an Ontario corporation, and all of
the outstanding capital stock of ID Systems USA, Inc., a Pennsylvania
corporation (collectively, "ID Systems"). ID Systems is a Toronto based company
engaged in anti-shoplifting technology, security labeling, radio frequency
identification (RFID), access control and library security. Sentry acquired ID
Systems from Saburah in exchange for 30,000,000 Sentry common shares. The price
paid per Sentry share for the securities of ID Systems was valued at
approximately $0.11. A special committee of Sentry's Board of Directors received
an opinion from Corporate Valuation Services confirming that the price paid for
the acquisition of ID Systems was fair from the point of view of Sentry
shareholders. Sentry's Board of Directors and shareholders owning a majority of
Sentry common stock approved the acquisition of ID Systems.
 
 The
purchase price of the acquisition was approximately $3.4 million representing
$3.3 million in the value of Sentry common stock issued and $0.1 in transaction
expenses. Sentry acquired $1.7 million in net tangible assets and assigned the
remaining $1.7 million to goodwill. (See Note B to the condensed consolidated
financial statements). On an ongoing basis, Sentry will evaluate the carrying
value of the goodwill versus the discounted cash benefit expected to be realized
from the performance of the underlying operations and adjust for any impairment
in value.
 
 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.
 
 On April
30, 2004, ID Systems entered into new credit facilities with maximum
availability of Canadian $1.75 million (U.S. $1.5 million) with the Bank of
Montreal. The facilities provide working capital for ID Systems and the assets
of ID Systems secure all borrowings.
 
 We
continued to pursue additional debt or equity financing through our financial
advisors and on April 30, 2004, Sentry entered into a $2,000,000 secured
convertible debenture with Brascan Technology Fund (“Brascan”), an alternative
investment fund established by Brascan Asset Management, to invest in early
stage, technology-based companies with high growth potential. The proceeds of
the financing will be used primarily for working capital.
 
 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 Brascan 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 Brascan affiliates and expects to
      be a supplier of security and identification products to the Brascan
      affiliates.
 ·
    Brascan
      was issued warrants for 5,000,000 shares of Sentry common stock, priced at
      $0.15 per share, exercisable anytime within the next four
      years.
 ·
    Brascan
      is entitled to one seat on Sentry’s Board of Directors or will participate
      as an observer.
  25
  The
Debenture is secured by a general security interest over all the assets and
properties of Sentry. The amount is subordinate to the existing CIT and Bank of
Montreal credit facilities.
 
 Sentry
also acquired ID Systems as a condition of the financing.
 
 Sentry’s
Board of Directors and shareholders owning a majority of Sentry common stock
approved the transaction with Brascan.
 
 On August
1, 2004, ID Systems and Checkpoint entered into a settlement agreement effective
July 30, 2004, pursuant to which Checkpoint agreed to pay $19.95 million in full
and final settlement of claims covered by the antitrust litigation. Payment in
full was received on August 5, 2004. As provided when Sentry purchased ID
Systems, the proceeds of the settlement will be distributed to former
shareholders of ID Systems, after payment of litigation fees and expenses. The
agreement includes mutual releases between the parties for complaints arising
from activities prior to the date of the agreement, except for any contractual
obligations and any future claims for patent, copyright or trademark
infringement. The agreement is not an acknowledgement of any wrongdoing or
liability by either party. A Stipulation of Dismissal has been filed with the
Third Circuit Court of Appeals to finally conclude the legal
proceedings.
 
 While
Sentry did not obtain an interest in the litigation settlement, Saburah and
Sentry agreed that Sentry might require Saburah to purchase additional Sentry
common shares equal to approximately 4.5% of any amount received (net of legal
fees and expenses) from Checkpoint. The price per share was set at 80% of the
previous 20 days trading average prior to the announcement of the settlement.
Our Board of Directors exercised this option and based on the settlement amount,
Sentry sold to Saburah approximately 4.8 million shares for $641,000. We
received the funds from Saburah in November 2004 and the stock sale was recorded
in the fourth quarter of 2004. Sentry also was reimbursed for legal costs
advanced by ID Systems, as well as for loans and trade receivables of
approximating $753,000, which was received in the third quarter of 2004. These
transactions, totaling $1.4 million, represent the total cash flowing to Sentry
directly and indirectly as a result of the Checkpoint lawsuit.
 
 After the
acquisition of ID Systems and sale of additional shares as a result of the
litigation settlement, Sentry had 120,548,804 shares of common stock
outstanding. Mr. Murdoch, directly or indirectly through his ownership of
Saburah, owns or controls 49.5% of the outstanding common stock of Sentry.
 
 As of
December 31, 2004, we had borrowings of approximately $1.8 million with CIT, the
maximum amount available under the revolving credit facility and $0.9 million
with the Bank of Montreal. Through the first half of 2004, most of our trade
vendors continued to require cash in advance or COD payments for our purchases.
Prior to the Brascan financing, we had to supplement our borrowings under the
CIT credit facility with expensive purchase order financing through EPK
Financial Corporation ("EPK"). As a result of the Brascan financing, during the
second quarter of 2004, we repaid all amounts owed to EPK and discontinued our
use of this facility. Also as of December 30, 2004, we amended our financing
agreement with CIT extending the expiration date of the facility from March 22,
2005 to June 30, 2005. The forbearance agreement expiration date was also
extended until June 30, 2005.  We are
currently in negotiations with a new financial institution to provide a global
credit facility to replace both the CIT and Bank of Montreal credit
facilities.
 
 We will
require liquidity and working capital to finance increases in receivables and
inventory associated with sales growth, payments to past due vendors and, to a
lesser extent, for capital expenditures. We had no material capital expenditure
or purchase commitments , other
than the Dialoc distribution agreement, as of
December 31, 2004. We anticipate that current cash reserves, cash generated by
the operations of Sentry and its new ID Systems’ subsidiaries, as well as the
financing provided by the Brascan transaction and the sale of stock to Saburah
will be adequate to finance the Company’s anticipated working capital
requirements as well as future capital expenditure requirements for at least the
next twelve months.
  26
  The table
below summarizes aggregate maturities contractual obligations as of December 31,
2004.
 
 ContractualObligations
    
    Total
    
    Less
      than 1 Year
    
    1-3Years
    
    4-5Years
    
    After
      5Years(In
      Thousands)Operating
      leases
    
    $
    545
    
    $
    283
    
    $
    260
    
    $
    2
    
    $
    -Capital
      leases
    
    
    16
    
    
    7
    
    
    9
    
    
    -
    
    
    -Notes
      payable & term loans
    
    
    1,021
    
    
    838
    
    
    183
    
    
    -
    
    
    -Convertible
      debentures
    
    
    2,000
    
    
    -
    
    
    -
    
    
    2,000
    
    
    -Total
    
    $
    2,783
    
    $
    1,128
    
    $
    452
    
    $
    2,002
    
    $
    -
 
 **Recent
Accounting Pronouncements**
 
 In
December 2004, the FASB issued SFAS No. 123(R), "Accounting for Stock-Based
Compensation" ("SFAS No. 123(R)"). SFAS No. 123(R) establishes standards for the
accounting for transactions in which an entity exchanges its equity instruments
for goods or services. This statement focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment
transactions. SFAS No. 123(R) requires that the fair value of such equity
instruments be recognized as an expense in the historical financial statements
as services are performed. Prior to SFAS No. 123(R), only certain pro forma
disclosures of fair value were required. The provisions of this statement are
effective as of the beginning of the first interim reporting period that begins
after June 15, 2005. The adoption of SFAS No.123(R) is not expected to have a
material impact on the Company’s financial position or results of
operations.
 
 In
November 2004, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 151 "Inventory Costs." This statement amends Accounting Research
Bulletin No. 43, Chapter 4, "Inventory Pricing" and removes the "so abnormal"
criterion that under certain circumstances could have led to the capitalization
of these items. SFAS No. 151 requires that idle facility expense, excess
spoilage, double freight and re-handling costs be recognized as current-period
charges regardless of whether they meet the criterion of "so abnormal." SFAS 151
also requires that allocation of fixed production overhead expenses to the costs
of conversion be based on the normal capacity of the production facilities. The
provisions of this statement shall be effective for all fiscal years beginning
after June 15, 2005. The adoption of SFAS No.151 is not expected to have a
material impact on the Company’s financial position or results of
operations.
 
 On
December 16, 2004, the FASB issued SFAS No. 153, "Exchange of Non-monetary
Assets", an amendment of Accounting Principles Board ("APB") Opinion No. 29,
which differed from the International Accounting Standards Board's ("IASB")
method of accounting for exchanges of similar productive assets. Statement No.
153 replaces the exception from fair value measurement in APB No. 29, with a
general exception from fair value measurement for exchanges of non-monetary
assets that do not have commercial substance. The statement is to be applied
prospectively and is effective for non-monetary asset exchanges occurring in
fiscal periods beginning after June 15, 2005. The adoption of SFAS No.153 is not
expected to have a material impact on the Company’s financial position or result
of operations.
 
 **Inflation**
 
 The
Company does not consider inflation to have a material impact on the results of
operations.
  27
  **Cautionary
Statement Regarding Forward-Looking Statements**
 
 The
"Management’s Discussion and Analysis of Financial Condition and Results of
Operations" and other sections of this Annual Report on Form 10-KSB contain
"forward-looking statements" (as defined in the Private Securities Litigation
Reform Act of 1995 or the "PSLRA") that are based on current expectations,
estimates and projections about the industry in which the Company operates, as
well as management’s beliefs and assumptions. Words such as "expects,"
"anticipates" and "believes" and variations of such words and similar
expressions generally indicate that a statement is forward-looking. The Company
wishes to take advantage of the "safe harbor" provisions of the PSLRA by
cautioning readers that many important factors discussed herein, among others,
may cause the Company's results of operations to differ from those expressed in
the forward-looking statements. These factors include: (i) the risk that any
delay or cancellation of orders from one or more of Sentry’s major customers may
have a material adverse effect on the Company’s financial condition; (ii) the
risk that anticipated growth in the demand for the Company's products in the
retail, commercial and industrial sectors will not develop as expected, whether
due to competitive pressures in these markets or to any other failure to gain
market acceptance of the Company’s products; (iii) the risk that anticipated
revenue growth through the domestic and international dealers programs does not
develop as expected; (iv) the risk that the Company may not find sufficient
qualified Service Partners to provide future installation services; (v) the risk
that the Company will not be able to retain key personnel; (vi) the risk that
the borrowing availability under existing or new credit facilities will not be
adequate to meet the Company's growth requirements; and (vii) the risk arising
from the large market position and greater financial and other resources of
Sentry's principal competitors, as described under "Item 1.
Business—Competition.”
  28
  **Item
7.********FINANCIAL
STATEMENTS**
 
 
 **SENTRY
TECHNOLOGY CORPORATION**
 **AND
SUBSIDIARIES**
 
 **REPORT
ON AUDITS OF**
 **CONSOLIDATED
FINANCIAL STATEMENTS**
 
 **YEARS
ENDED DECEMBER 31, 2004, 2003 AND 2002**
 
 
 
 CONTENTSPageCONSOLIDATED
      FINANCIAL STATEMENTS:Report of Independent Registered Public Accounting
      Firm
    30Balance sheets
    31Statements of operations
    32Statements of shareholders' equity
    33Statements of cash flows
    34Notes to financial statements
    35
      - 49
  29
   Report of Independent Registered Public Accounting
Firm
 
 
 To the
Board of Directors and Stockholders of
 Sentry
Technology Corporation
 Ronkonkoma,
New York
 
 
 We have
audited the accompanying consolidated balance sheets of Sentry Technology
Corporation and subsidiaries (the "Company") as of December 31, 2004 and 2003
and the related consolidated statements of operations, shareholders' equity and
cash flows for each of the three years in the period ended December 31, 2004.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on the consolidated financial
statements based on our audits.
 
 We
conducted our audits in accordance with auditing standards of the Public Company
Accounting Oversight Board (United Stares). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
 
 In our
opinion, such consolidated financial statements present fairly, in all material
respects, the financial position of Sentry Technology Corporation and
subsidiaries as of December 31, 2004 and 2003 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2004 in conformity with U.S. generally accepted accounting
principles.
 
 
 /s/ Holtz
Rubenstein Reminick LLP
 
 
 Melville,
New York
 March 29,
2005
  30
  **SENTRY TECHNOLOGY CORPORATION**
 **AND
SUBSIDIARIES**
 **CONSOLIDATED
BALANCE SHEETS**
 **(In
Thousands, Except Par Value Amounts)**
 
 
 December
      31,2004
    
    2003ASSETSCurrent
      Assets:Cash
      and cash equivalents
    
    $
    1,965
    
    $
    210Accounts
      receivable, less allowance for doubtful accounts of $338 and $304,
      respectively
    
    
    3,500
    
    
    1,482Inventories
    
    
    3,314
    
    
    1,855Prepaid
      expenses and other current assets
    
    
    525
    
    
    126Total
      current assets
    
    
    9,304
    
    
    3,673PROPERTY
      AND EQUIPMENT, net
    
    
    689
    
    
    209GOODWILL
    
    
    1,564
    
    
    ---OTHER
      ASSETS
    
    
    690
    
    
    211$
    12,247
    
    $
    4,093LIABILITIES
      AND SHAREHOLDERS' EQUITYCurrent
      Liabilities:Revolving
      line of credit and term loan
    
    $
    2,640
    
    $
    1,515Accounts
      payable
    
    
    799
    
    
    566Accrued
      liabilities
    
    
    1,146
    
    
    1,601Obligations
      under capital leases - current portion
    
    
    5
    
    
    5Deferred
      income
    
    
    169
    
    
    271Total
      current liabilities
    
    
    4,759
    
    
    3,958NOTES
      PAYABLE
    
    
    189
    
    
    247OBLIGATIONS
      UNDER CAPITAL LEASES, noncurrent portion
    
    
    8
    
    
    13DEFERRED
      TAX LIABILITY
    
    
    39
    
    
    ---CONVERTIBLE
      DEBENTURES
    
    
    1,862
    
    
    ---MINORITY
      INTEREST
    
    
    1,045
    
    
    ---Total
      liabilities
    
    
    7,902
    
    
    4,218COMMITMENTS
      AND CONTINGENCIESSHAREHOLDERS'
      EQUITY (DEFICIT):Common
      stock, $0.001 par value; authorized 140,000 shares, issued and outstanding
      120,549 and 85,756 shares, respectively
    
    
    121
    
    
    86Additional
      paid-in capital
    
    
    48,779
    
    
    44,658Accumulated
      deficit
    
    
    (44,718
    )
    
    (44,749
    )Note
      receivable from shareholder
    
    
    ---
    
    
    (120
    )Equity
      adjustment from foreign currency conversion
    
    
    163
    
    
    ---Total
      shareholders' equity (deficit)
    
    
    4,345
    
    
    (125
    )$
    12,247
    
    $
    4,093
  See notes to consolidated financial
statements
 
 31
 
 **SENTRY
TECHNOLOGY CORPORATION**
 **AND
SUBSIDIARIES**
 **CONSOLIDATED STATEMENTS OF OPERATIONS**
 **(In
Thousands, Except Per Share Amounts)**
  Years
      Ended December 31,2004
    
    2003
    
    2002REVENUES:Sales
    
    $
    12,284
    
    $
    8,629
    
    $
    9,900Service,
      installation and other revenues
    
    
    4,381
    
    
    4,497
    
    
    4,80416,665
    
    
    13,126
    
    
    14,704COST
      AND EXPENSES:Cost
      of sales
    
    
    6,351
    
    
    5,179
    
    
    7,382Customer
      service expenses
    
    
    4,175
    
    
    3,977
    
    
    4,240Selling,
      general and administrative expenses
    
    
    4,642
    
    
    3,692
    
    
    5,287Research
      and development
    
    
    832
    
    
    656
    
    
    54816,000
    
    
    13,504
    
    
    17,457OPERATING
      INCOME (LOSS)
    
    
    665
    
    
    (378
    )
    
    (2,753
    )INTEREST
      AND FINANCING EXPENSE, net
    
    
    412
    
    
    671
    
    
    603INCOME
      (LOSS) BEFORE INCOME TAXES, MINORITY INTEREST AND EXTRAORDINARY
      ITEM
    
    
    253
    
    
    (1,049
    )
    
    (3,356
    )INCOME
      TAX EXPENSE (BENEFIT)
    
    
    140
    
    
    (492
    )
    
    -INCOME
      (LOSS) BEFORE MINORITY INTEREST ANDEXTRAORDINARY
      ITEM
    
    
    113
    
    
    (557
    )
    
    (3,356
    )MINORITY
      INTEREST
    
    
    (82
    )
    
    ---
    
    
    ---INCOME
      (LOSS) BEFORE EXTRAORDINARY ITEM
    
    
    31
    
    
    (557
    )
    
    (3,356
    )EXTRAORDINARY
      ITEM - Gain on extinguishment of debt, net of $492 income
      taxes
    
    
    ---
    
    
    738
    
    
    ---NET
      INCOME (LOSS)
    
    $
    31
    
    $
    181
    
    $
    (3,356
    )BASIC
      INCOME (LOSS) PER COMMON SHARE:Income
      (loss) before extraordinary item
    
    $
    0.00
    
    $
    (0.01
    )
    $
    (0.05
    )Extraordinary
      item
    
    
    0.00
    
    
    0.01
    
    
    0.00Net
      income (loss)
    
    $
    0.00
    
    $
    0.00
    
    $
    (0.05
    )WEIGHTED
      AVERAGE BASIC COMMON SHARES
    
    
    106,532
    
    
    84,153
    
    
    72,193
 See notes
to consolidated financial statements
  32
 **SENTRY
TECHNOLOGY CORPORATION**
 **AND
SUBSIDIARIES**
 **CONSOLIDATED
STATEMENTS OF SHAREHOLDERS' EQUITY**
 **(In
Thousands)**
 **YEARS
ENDED DECEMBER 31, 2004, 2003 AND 2002**
 
 TotalNote
    
    Accumulative
    
    CommonAdditional
    
    
    
    Receivable
    
    Other
    
    Shareholders'
    
    ComprehensiveCommon
      Stock
    
    Paid-in
    
    Accumulated
    
    from
    
    Comprehensive
    
    Equity
    
    IncomeShares
    
    Amount
    
    Capital
    
    Deficit
    
    Shareholder
    
    Income
    
    (Deficit)
    
    (Loss)BALANCE,
      January 1, 2002
    
    
    61,543
    
    $
    62
    
    $
    44,403
    
    $
    (41,574
    )
    $
    -
    
    $
    -
    
    $
    2,891Net
      loss and comprehensive loss
    
    
    -
    
    
    -
    
    
    -
    
    
    (3,356
    )
    
    -
    
    
    -
    
    
    (3,356
    )
    $
    (3,356
    )Net
      proceeds from common stock issued to Dialoc
    
    
    14,500
    
    
    14
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    14Exercise
      of stock options
    
    
    2,001
    
    
    2
    
    
    118
    
    
    -
    
    
    (120
    )
    
    -
    
    
    -BALANCE,
      December 31, 2002
    
    
    78,044
    
    
    78
    
    
    44,521
    
    
    (44,930
    )
    
    (120
    )
    
    -
    
    
    (451
    )Net
      income and comprehensive income
    
    
    -
    
    
    -
    
    
    -
    
    
    181
    
    
    -
    
    
    -
    
    
    181
    
    $
    181Settlement
      of debt and lease obligations
    
    
    3,193
    
    
    3
    
    
    137
    
    
    -
    
    
    -
    
    
    -
    
    
    140Net
      proceeds from common stock issued to Dialoc
    
    
    4,517
    
    
    5
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    5Exercise
      of stock options
    
    
    2
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -BALANCE,
      December 31, 2003
    
    
    85,756
    
    
    86
    
    
    44,658
    
    
    (44,749
    )
    
    (120
    )
    
    -
    
    
    (125
    )Net
      income
    
    
    -
    
    
    -
    
    
    -
    
    
    31
    
    
    -
    
    
    -
    
    
    31
    
    $
    31Repayment
      of note receivable from shareholder
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    120
    
    
    -
    
    
    120Issuance
      of warrants
    
    
    -
    
    
    -
    
    
    215
    
    
    -
    
    
    -
    
    
    -
    
    
    215Acquisition
      of ID Systems
    
    
    30,000
    
    
    30
    
    
    3,270
    
    
    -
    
    
    -
    
    
    -
    
    
    3,300Net
      proceeds from common stock sold to Saburah
    
    
    4,795
    
    
    5
    
    
    636
    
    
    -
    
    
    -
    
    
    -
    
    
    641Retired
      stock
    
    
    (5
    )
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -Exercise
      of stock options
    
    
    3
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -Equity
      adjustment from foreign currency translation
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    163
    
    
    163
    
    
    163Comprehensive
      income
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    $
    194BALANCE,
      December 31, 2004
    
    
    120,549
    
    $
    121
    
    $
    48,779
    
    $
    (44,718
    )
    $
    -
    
    $
    163
    
    $
    4,345
 See notes
to consolidated financial statements
  33
 **SENTRY
TECHNOLOGY CORPORATION**
 **AND
SUBSIDIARIES**
 **CONSOLIDATED
STATEMENTS OF CASH FLOWS**
 **(In
Thousands)**
 
 Years
      Ended December 31,2004
    
    2003
    
    2002CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income (loss)
    
    $
    31
    
    $
    181
    
    $
    (3,356
    )Adjustments
      to reconcile net income (loss) to net cash(used
      in) provided by operating activities:Depreciation
      and amortization
    
    
    169
    
    
    262
    
    
    474Amortization
      of intangibles and other assets
    
    
    60
    
    
    90
    
    
    42Provision
      for bad debts
    
    
    (14
    )
    
    (16
    )
    
    (226
    )Non-cash
      consideration
    
    
    136
    
    
    ---
    
    
    ---Minority
      interest in net income of consolidated subsidiary
    
    
    208
    
    
    ---
    
    
    ---Extraordinary
      gain on extinguishments of debt
    
    
    ---
    
    
    (1,230
    )
    
    ---Changes
      in operating assets and liabilities:Accounts
      receivable
    
    
    (823
    )
    
    6
    
    
    1,467Inventories
    
    
    (196
    )
    
    1,290
    
    
    1,595Prepaid
      expenses and other assets
    
    
    179
    
    
    118
    
    
    142Accounts
      payable and accrued liabilities
    
    
    (612
    )
    
    65
    
    
    313Deferred
      income
    
    
    (102
    )
    
    (123
    )
    
    91Net
      cash (used in) provided by operating activities
    
    
    (964
    )
    
    643
    
    
    542CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of property and equipment
    
    
    (161
    )
    
    (81
    )
    
    (41
    )Intangibles
    
    
    (76
    )
    
    (16
    )
    
    (15
    )Net
      cash provided by the acquisition of ID Systems
    
    
    31
    
    
    ---
    
    
    ---Net
      cash used in investing activities
    
    
    (206
    )
    
    (97
    )
    
    (56
    )CASH
      FLOWS FROM FINANCING ACTIVITIES:Net
      borrowing (payments) on the revolving line of credit
    
    
    329
    
    
    (1,372
    )
    
    (566
    )Proceeds
      of term loan
    
    
    ---
    
    
    845
    
    
    100Repayment
      of term loan
    
    
    (203
    )
    
    (25
    )
    
    (67
    )Proceeds
      of bridge loan
    
    
    100
    
    
    ---
    
    
    ---Repayment
      of bridge loan
    
    
    (100
    )
    
    ---
    
    
    ---Proceeds
      of convertible debenture and warrants
    
    
    2,000
    
    
    ---
    
    
    ---Repayment
      of obligations under capital leases
    
    
    (5
    )
    
    (55
    )
    
    (124
    )Proceeds
      of sale of stock, net
    
    
    641
    
    
    5
    
    
    14Net
      cash provided by (used in) financing activities
    
    
    2,762
    
    
    (602
    )
    
    (643
    )EFFECT
      OF EXCHANGE RATE CHANGES
    
    
    163
    
    
    ---
    
    
    ---INCREASE
      (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    1,755
    
    
    (56
    )
    
    (157
    )CASH
      AND CASH EQUIVALENTS, beginning of year
    
    
    210
    
    
    266
    
    
    423CASH
      AND CASH EQUIVALENTS, end of year
    
    $
    1,965
    
    $
    210
    
    $
    266SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Cash
      paid during the year for:Interest
    
    $
    341
    
    $
    676
    
    $
    633Income
      taxes
    
    $
    72
    
    $
    ---
    
    $
    ---
 See notes
to consolidated statements
  34
  **SENTRY
TECHNOLOGY CORPORATION**
 **AND
SUBSIDIARIES**
 
 **NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS**
 
 **YEARS
ENDED DECEMBER 31, 2003 AND 2002**
 
 
 **1.**
    **Significant
      Accounting Policies****:**
 
 a.
    Business
 
 Sentry
Technology Corporation ("Sentry"), a publicly traded Delaware Corporation, was
established on February 12, 1997. Its corporate predecessors had been in
business for more than 38 years.
 The
Company is engaged in the design, manufacture, distribution, installation and
service of systems designed to be used by retailers to deter shoplifting and
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, 2004, 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. For those products not requiring installation
or if installation costs are not material, the Company recognizes revenues upon
shipment.
 
 Service
revenues are recognized when earned and maintenance revenues are recognized
ratably over the service contract period.
 
 Included
in accounts receivable at December 31, 2004 and 2003 are unbilled accounts
receivable of $129,000 and $41,000, respectively.
 
 d.
    Cash
      and cash equivalents
 
 The
Company considers all highly liquid temporary investments with original
maturities of less than ninety days to be cash equivalents.  Temporary
cash investments are placed with high credit quality financial institutions. At
times, the Company’s cash deposits with any one financial institution may exceed
federally insured limits.
 
 e.
    Allowance
      for doubtful accounts
 
 Losses
from uncollectible accounts are provided for by utilizing the allowance for
doubtful accounts method based upon management's estimate of uncollectible
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.
  35
  f.
    Inventories
 
 Inventories
are stated at the lower of cost (first-in, first-out method) or
market.
 
 g.
    Product
      warranty
 
 Provisions
for estimated expenses related to product warranties are made at the time
products are sold. These estimates are established using historical information
on the nature, frequency, and average cost of warranty claims.
 
 h.
    Depreciation
      and amortization
 
 Depreciation
of security devices on lease and property and equipment is provided for using
the straight-line method over their related estimated useful lives. Security
devices on lease generally have estimated useful lives of six years, except the
cost of security devices related to operating leases with purchase options are
depreciated over the life of the lease.
 
 i.
    Patents
      and other intangibles
 
 Cost and
expenses incurred in obtaining patents are amortized over the remaining life of
the patents, not exceeding 17 years, on a straight-line basis. Costs assigned to
other intangibles, including trade secrets, distribution agreements and customer
relationships, are being amortized on a straight line basis over their estimated
useful lives of 5 to 15 years. Estimated annual amortization expense for the
next five succeeding fiscal years will range from $74,000 in 2005 to $49,000 in
2009.
 
 j.
    Goodwill
 
 Goodwill
represents the excess of acquisition cost over the fair value of net assets
acquired in business combinations. In accordance with Statement of Financial
Accounting Standards (SFAS) No. 142, goodwill is not amortized but reviewed
annually for impairment.
 
 k.
    Impairment
      of long-lived assets
 
 The
Company reviews its long-lived assets, property and equipment, intangible
assets, goodwill and other assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of these assets may not be fully
recoverable. To determine recoverability of its long-lived assets, the Company
evaluates the probability that future undiscounted net cash flows, without
interest charges, will be less than the carrying amount of the assets.
Impairment is measured at fair value. The Company completed its annual review of
goodwill impairment and determined that goodwill was not impaired.
 
 l.
    Fair
      value of financial instruments
 
 It is
management's belief that the carrying amounts of the Company's financial
instruments (cash and cash equivalents, accounts receivable, revolving line of
credit, accounts payable and obligations under capital leases) approximate their
fair value at December 31, 2004 and 2003 due to the short maturity of these
instruments or due to the terms of such instruments approximating instruments
with similar terms currently available to the Company.
 
 m.
    Deferred
      income
 
 Deferred
income consists of rentals related to operating leases and maintenance contracts
billed or paid in advance.
  36
  n.
    Income
      taxes
 
 The
Company accounts for income taxes under SFAS No. 109, Accounting for Income
Taxes, which requires an asset and liability approach to financial accounting
and reporting for income taxes. Deferred tax assets and liabilities are
determined based on differences between financial reporting and tax bases of
assets and liabilities, and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to
reverse.
 
 o.
    Stock-based
      compensation
 
 The
Company accounts for stock-based awards to employees using the intrinsic value
method in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees."
 
 SFAS No.
123, Accounting for Stock-Based Compensation, requires the disclosure of pro
forma net income and earnings per share had the Company adopted the fair value
method as of the beginning of 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 2004, 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:
 
 2004
    
    2003
    
    2002(In
      thousands, except per share data)Net
      income (loss):As
      reported
    
    $
    31
    
    $
    181
    
    $
    (3,356
    )Less
      stock based compensation expense determined under thefair value
      method for all awards, net of related tax effects
    
    
    (12
    )
    
    (74
    )
    
    2Pro
      forma
    
    $
    19
    
    $
    107
    
    $
    (3,354
    )Net
      income (loss) per share:As
      reported
    
    $
    -
    
    $
    -
    
    $
    (0.05
    )Pro
      forma
    
    $
    -
    
    $
    -
    
    $
    (0.05
    )
 
 p.
    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 $(79,000),
$12,000 and ($16,000) for the years ended December 31, 2004, 2003 and 2002,
respectively.
  37
  q.
    Shipping
      and handling costs
 
 Shipping
and handling costs are included in selling, general and administrative expenses
and approximated $251,000, $215,000 and $190,000 in 2004, 2003 and 2002,
respectively.
 
 r.
    Use
      of estimates
 
 The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
 
 s.
    Reclassifications
 
 Certain
prior year balances have been reclassified to conform to current year
classifications.
 
 t.
    Recent
      accounting pronouncements
 
 In
December 2004, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 123(R), "Accounting for Stock-Based Compensation" ("SFAS No.
123(R)"). SFAS No. 123(R) establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services. This statement focuses primarily on accounting for transactions in
which an entity obtains employee services in share-based payment transactions.
SFAS No. 123(R) requires that the fair value of such equity instruments be
recognized as an expense in the historical financial statements as services are
performed. Prior to SFAS No. 123(R), only certain pro forma disclosures of fair
value were required. The provisions of this statement are effective as of the
beginning of the first interim reporting period that begins after June 15, 2005.
The adoption of SFAS No.123(R) is not expected to have a material impact on the
Company’s financial position or results of operations.
 
 In
November 2004, the FASB issued SFAS No. 151 "Inventory Costs." This statement
amends Accounting Research Bulletin No. 43, Chapter 4, "Inventory Pricing" and
removes the "so abnormal" criterion that under certain circumstances could have
led to the capitalization of these items. SFAS No. 151 requires that idle
facility expense, excess spoilage, double freight and re-handling costs be
recognized as current-period charges regardless of whether they meet the
criterion of "so abnormal." SFAS 151 also requires that allocation of fixed
production overhead expenses to the costs of conversion be based on the normal
capacity of the production facilities. The provisions of this statement shall be
effective for all fiscal years beginning after June 15, 2005. The adoption of
SFAS No.151 is not expected to have a material impact on the Company’s financial
position or results of operations.
 
 On
December 16, 2004, the FASB issued SFAS No. 153, "Exchange of Non-monetary
Assets", an amendment of Accounting Principles Board ("APB") Opinion No. 29,
which differed from the International Accounting Standards Board's ("IASB")
method of accounting for exchanges of similar productive assets. Statement No.
153 replaces the exception from fair value measurement in APB No. 29, with a
general exception from fair value measurement for exchanges of non-monetary
assets that do not have commercial substance. The statement is to be applied
prospectively and is effective for non-monetary asset exchanges occurring in
fiscal periods beginning after June 15, 2005. The adoption of SFAS No.153 is not
expected to have a material impact on the Company’s financial position or result
of operations.
 
 
 **2.**  **Capital
Transactions and ID Systems Acquisition:**
  38
  Our
largest shareholder had been Dialoc ID Holdings B.V. (“Dialoc”). On April 19,
2004, Dialoc sold 39,066,927 Sentry common shares (representing approximately
46% of the total issued and outstanding shares of Sentry) to a group of
investors. Of the group, Saburah Investments Inc. (“Saburah”) acquired
22,758,155 shares, Mr. Robert Furst 14,554,386 shares and Dr. Morton Roseman
1,754,386 shares. Mr. Peter Murdoch, President, CEO and Director of Sentry, is
the owner of Saburah. Mr. Furst is a long-standing member of Sentry’s Board of
Directors. As a result of this transaction, Messers Angel and de Nood,
Principals of Dialoc, resigned from Sentry’s Board of Directors.
 
 In
addition to the purchase of Sentry’s common shares, Saburah also acquired 100%
of ID Security Systems Canada, Inc. and ID Systems USA Inc. (“ID Systems”). The
price paid to Dialoc by Saburah and Murdoch for Sentry and ID Systems shares in
cash, debt assumption and other consideration was approximately $3.6 million
plus the surrender of Murdoch’s 15% interest in Dialoc. Saburah also agreed to
make a payment to Dialoc in the future equal to approximately 6% of any payment
it receives from Checkpoint Systems Inc. (“Checkpoint”) resulting from
litigation brought by ID Canada against Checkpoint.
 
 On April
30, 2004, Sentry purchased from Saburah Investments, Inc., an Ontario
corporation, all of the outstanding common shares and Series "A" preference
shares of ID Security Systems Canada Inc., an Ontario corporation, and all of
the outstanding capital stock of ID Systems USA, Inc., a Pennsylvania
corporation (collectively, "ID Systems"). ID Systems is a Toronto based company
engaged in anti-shoplifting technology, security labeling, radio frequency
identification (RFID), access control and library security. Sentry acquired ID
Systems from Saburah in exchange for 30,000,000 Sentry common shares. The price
paid per Sentry share for the securities of ID Systems was valued at
approximately $0.11. A special committee of Sentry's Board of Directors received
an opinion from Corporate Valuation Services confirming that the price paid for
the acquisition of ID Systems was fair from the point of view of Sentry
shareholders. As part of the purchase agreement, the proceeds of the ID Systems
litigation settlement will be distributed to the former ID Systems’
shareholders. However Saburah and Sentry have agreed that Sentry may require
Saburah to purchase additional Sentry common shares under certain circumstances.
Sentry's Board of Directors and shareholders owning a majority of Sentry common
stock approved the acquisition of ID Systems.
 
 Other
benefits flowing to Sentry/ID Systems via the purchase of ID Systems are as
follows:
 
 ·
    ID
      Systems and Sentry continue as the exclusive distributor in North and
      South America for a period of five years for all Dialoc products including
      Laserfuse radio frequency security labels and all RFID
      products.
 
 ·
    Dialoc
      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.
 
 The
purchase price of the ID Systems acquisition was as follows:
 
 (in
      thousands)Value
      of Sentry Technology Corporation common stock
    
    $
    3,300Transaction
      costs
    
    
    88Total
      purchase price
    
    $
    3,388
  39
  Under the
purchase method of accounting, the total purchase price as detailed above was
allocated to ID System’s net tangible assets and intangible assets based on
their fair values as of April 30, 2004, which were as follows:
 
 (in
      thousands)Cash
    
    $
    119Accounts
      receivable
    
    
    1,181Inventories
    
    
    1,263Prepaid
      expenses and other current assets
    
    
    754Property
      and equipment
    
    
    458Deferred
      charges
    
    
    69Bank
      debt
    
    
    (998
    )Accounts
      payable and accrued liabilities
    
    
    (449
    )Other
      liabilities
    
    
    (843
    )Net
      tangible assets
    
    
    1,554Goodwill
      and other intangibles
    
    
    1,834Total
      purchase price
    
    $
    3,388
 
 Other
intangible assets acquired ($270,000) include trade secrets ($150,000 - 10 year
life), patents ($60,000 - 15 year life) and customer relationships ($60,000 - 5
year life).
 On an
ongoing basis, Sentry will evaluate the carrying value versus the discounted
cash benefit expected to be realized from the performance of the underlying
operations and adjust for any impairment in value.
 
 The
accompanying consolidated statements of operations include the revenues and
expenses of ID Systems from May 1, 2004.
 
 The
following supplemental pro forma information illustrates the effects of the
acquisition on the historical operating results for the years ended December 31,
2004 and 2003 as if the acquisition had occurred at the beginning of each
respective period:
 
 2004
    
    2003(In
      thousands, except per share data)Revenues
    
    $
    18,128
    
    $
    19,566Income
      (loss) before extraordinary item
    
    $
    (92
    )
    $
    (130)*Net
      income (loss)
    
    $
    (92
    )
    $
    608*Net
      income (loss) per share
    
    $
    (0.00
    )
    $
    0.01
 
 * The
income (loss) before extraordinary item in the year ended December 31, 2003
includes an income tax benefit of $492,000 resulting from the utilization of net
operating loss carryforwards. Net income in 2003 includes both the income tax
benefit and the extraordinary gains of $738,000 from the extinguishment of debt.
 
 **3.**  **Convertible
Debenture** **:**
 
 On April
30, 2004, Sentry entered into a $2,000,000 secured convertible debenture with
Brascan Technology Fund (“Brascan”), an alternative investment fund established
by Brascan Asset Management, to invest in early stage, technology-based
companies with high growth potential.
 
 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.
  40
  ·
    Conversion
      is at the option of Brascan 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 Brascan affiliates and expects to
      be a supplier of security and identification products to the Brascan
      affiliates.
 
 ·
    Brascan
      was issued warrants for 5,000,000 shares of Sentry common stock, priced at
      $0.15 per share, exercisable anytime within the next four
      years.
 
 ·
    Brascan
      is entitled to one seat on Sentry’s Board of Directors or will participate
      as an observer.
 
 The
Debenture is secured by a general security interest over all the assets and
properties of Sentry. The amount is subordinate to the existing CIT and Bank of
Montreal credit facilities.
 
 The
proceeds of the financing, to be used primarily for working capital, were
initially allocated between the debenture ($1,835,000) and the warrants
($165,000) based on their respective fair values in accordance with EITF 00-27
(Application of Issue 98-5 to Certain Convertible Instruments). The difference
between the face value of the debenture and the allocated value is being charged
to interest and financing expenses over the term of the debenture.
 
 Certain
other warrants to purchase 425,000 shares of Sentry common stock at exercise
prices ranging from $0.18 to $0.20 per share were issued in conjunction with the
convertible debenture. The warrants are exercisable over one to three years. The
fair value of these warrants ($49,000) is being charged to operations over the
life of the warrants.
 
 As a
condition of the financing, Sentry also acquired ID Systems.
 
 Sentry’s
Board of Directors and shareholders owning a majority of Sentry common stock
approved the transaction with Brascan.
  41
  **4.**
    ****
    **Inventory****:**
 
 Inventories
consist of the following:
 December
      31,2004
    
    2003(In
      thousands)Raw
      materials
    
    $
    1,206
    
    $
    449Work-in-process
    
    
    292
    
    
    283Finished
      goods
    
    
    1,816
    
    
    1,123$
    3,314
    
    $
    1,855
 
 The
components of inventory shown are net of reserves for excess and obsolete
inventory totaling $1,528,000 and $2,148,000 as of December 31, 2004 and 2003,
respectively.
 
 
 **5.**
    ****
    **Property
      and Equipment****:**
 
 Property
and equipment are stated at cost and are summarized as follows:
 
 EstimatedUsefulLives
    
    December
      31,(Years)
    
    2004
    
    2003(In
      thousands)Machinery
      and equipment
    
    
    3 -
      10
    
    $
    2,270
    
    $
    826Furniture,
      fixtures and office equipment
    
    
    3 -
      10
    
    
    2,349
    
    
    2,148Leasehold
      improvements
    
    
    3 -
      10
    
    
    89
    
    
    664,708
    
    
    3,040Less
      accumulated depreciation
    
    
    
    
    
    4,019
    
    
    2,831$
    689
    
    $
    209
 
 Net
property and equipment located in Canada approximated $585,000 in 2004. 
Depreciation expense on property and equipment in 2004, 2003 and 2002 totaled
$139,000, $261,000 and $466,000, respectively.
 
 
 **6.**
    ****
    **Accrued
      Liabilities****:**
 
 Accrued
liabilities consist of the following:
 December
      31,2004
    
    2003(In
      thousands)Accrued
      salaries, employee benefits and payroll taxes
    
    $
    333
    
    $
    417Purchase
      order financing
    
    
    -
    
    
    291Accrued
      warranty
    
    
    100
    
    
    227Other
      accrued liabilities
    
    
    713
    
    
    666$
    1,146
    
    $
    1,601
  42
  **7.** **Credit
Facilities** **:**
 
 On March
22, 2002, the Company entered into a three-year revolving line of credit and
term loan with CIT Group/Business Credit, Inc. ("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 (5.25% at December 31, 2004), 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 was converted into a term loan with principal repaid to CIT in varying
monthly installments through December 2004 and $20,000 per month thereafter;
certain limitations on eligible accounts receivable from a major customer would
be established and certain financial covenants would be established in the
future. The Company had borrowings on the line of credit totaling $1,108,000 and
$690,000 as of December 31, 2004 and 2003, respectively. The balance on the term
loan was $660,000 and $820,000 at December 31, 2004 and 2003, respectively. As
of December 30, 2004, we amended our financing agreement with CIT extending the
expiration date of the facility from March 22, 2005 to June 30, 2005. The
forbearance agreement expiration date was also extended until June 30,
2005.
 
 On April
30, 2004, Sentry’s subsidiary, ID Security Systems Canada Inc., entered into
credit facilities with Bank of Montreal, replacing its former credit facility.
Facility 1 is a Canadian $1.5 million (U.S. $1.2 million) Overdraft Lending
Facility, which is subject to certain limitations based on a percentage of
eligible accounts receivable and inventories as defined in the agreement.
Interest on the overdraft facility is payable monthly at the Bank of Montreal
commercial prime lending rate (4.25% at December 31, 2004), plus 1% per annum.
Facility 2 is a Canadian $250,000 (U.S. $208,000) Non-Revolving Demand Credit
facility incurred to refinance an existing term loan with a previous lender.
Principal payments of Canadian $6,945 plus interest are payable monthly in
arrears. Borrowings under these facilities are secured by the assets of ID
Systems. At December 31, 2004, approximately U.S. $902,000 was outstanding under
the Bank of Montreal facilities.
 
 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 were 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, CIT and Sentry. Under this agreement, CIT subordinated
its rights and interests in the collateral related to each transaction to EPK.
Under the terms of the Intercreditors Agreement, the maximum amount subordinated
to EPK at any time was limited to $650,000. Sentry used the funds provided by
EPK to fund vendor purchases to complete orders in backlog. The Company funded
$0.7 million of inventory purchases under this facility in 2004 compared to $2.4
million in 2003 and $0.6 million in 2002. At December 31, 2003, the amount owed
to EPK was approximately $291,000. As a
result of the Brascan financing, during the second quarter of 2004, we repaid
all amounts owed to EPK and discontinued our use of this facility.
 
 The Company is currently in negotiations with a new
financial institution to provide a global credit facility to replace both the
CIT and Bank of Montreal credit facilities.
  43
  **8.** **Obligations
Under Capital and Operating Leases** **:**
 
 a.
    Capital
      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.
 
 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.
 
 The
Company also currently leases office equipment under non-cancelable capital
leases with minimum annual rental commitments of $7,000 in 2005, $7,000 in 2006,
$1,000 in 2007 and $1,000 in 2008.
 
 b.
    Operating
      leases
 
 The
Company leases certain administrative and manufacturing facilities and equipment
under non-cancelable operating leases that expire at various dates through 2008.
Rent expense related to operating leases for 2004, 2003 and 2002 was $234,000,
$103,000 and 173,000 per year, respectively. Minimum annual rental commitments
are $283,000 in 2005, $181,000 in 2006, $58,000 in 2007, $22,000 in 2008 and
$2,000 in 2009.
 
 
 **9.** **Common
Shareholders' Equity** **:**
 
 a.
    Earnings
      Per Share ("EPS")
 
 Basic EPS
is determined by using the weighted average number of common shares outstanding
during each period. Diluted EPS further assumes the issuance of common shares
for all dilutive potential common shares outstanding. 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
  44
  In
February 1997, the Company adopted the 1997 Stock Incentive Plan of Sentry
Technology Corporation (the "1997 Plan"). The 1997 Plan initially provided for
grants up to 2,250,000 options to purchase the Company's common stock. Under the
antidilution provisions of the 1997 Plan, as a result of the preferred stock
redemption in January 2001, the shares available for grant were increased by
1,719,365 shares. In March 2001, the Board of Directors approved an additional
increase of 3,600,000 shares available for grant pending ratification by
Sentry's shareholders. In April 2004, in order to meet certain criteria for the
Brascan financing, the Board of Directors reduced the number of shares available
for grant by 5,200,000. The stock option committee may grant awards to eligible
employees in the form of stock options, restricted stock awards, phantom stock
awards or stock appreciation rights. Stock options may be granted as incentive
stock options or nonqualified stock options. Such options normally become
exercisable at a rate of 20% per year over a five-year period and expire ten
years from the date of grant. However, the Saburah investment constituted a
change in control under the 1997 Plan, resulting in the immediate vesting of all
shares issued prior to May 1, 2004. All outstanding stock options were issued at
not less than the fair value of the related common stock at the date of grant.
At December 31, 2004, 1,852,738 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. In March 2002, Mr. Murdoch exercised
the option through the issuance of a promissory note in the amount of $120,000.
In March 2004, Mr. Murdoch repaid the note along with accrued interest in
satisfaction of the note. The note had been reflected as a reduction of
shareholders' equity on the consolidated balance sheet as of December 31,
2003.
 
 Stock
option transactions for the years ended December 31, 2004, 2003 and 2002 are as
follows:
 
 WeightedNumberof
      Shares
    
    AverageExercisePriceBalance,
      January 1, 2002
    
    
    5,821,480
    
    $
    0.49Granted
    
    
    -
    
    
    -Exercised
    
    
    (2,001,000
    )
    
    0.06Canceled
    
    
    (479,188
    )
    
    0.87Balance,
      December 31, 2002
    
    
    3,341,292
    
    
    0.69Granted
    
    
    -
    
    
    -Exercised
    
    
    (2,000
    )
    
    0.05Canceled
    
    
    (1,757,368
    )
    
    0.79Balance,
      December 31, 2003
    
    
    1,581,924
    
    
    0.57Granted
    
    
    -
    
    
    -Exercised
    
    
    (3,000
    )
    
    0.05Canceled
    
    
    (303,608
    )
    
    0.35Balance,
      December 31, 2004
    
    
    1,275,316
    
    $
    0.63
 
 Significant
option groups outstanding at December 31, 2004 and related option price and life
information were as follows:
 
 WeightedAverageRemainingRange
      of
    
    Number
    
    Contractual
    
    NumberExercise
      Price
    
    Outstanding
    
    Life
    
    Exercisable$0.05
      - 0.07
    
    
    622,500
    
    
    5.87
    
    
    622,500$0.31
      - 0.62
    
    
    235,316
    
    
    2.29
    
    
    235,316$1.05
      - 3.00
    
    
    417,500
    
    
    1.61
    
    
    417,5001,275,316
    
    
    3.81
    
    
    1,275,316
  45
  At
December 31, 2004, options to purchase an aggregate of 1,275,316 common shares
were vested and currently exercisable at a weighted average exercise price of
$0.63 expiring through 2011. At December 31, 2004, options for 577,422 common
shares were available for future grants.
 
 As
discussed in Note 1, the Company accounts for its stock-based awards using the
intrinsic value method in accordance with Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees and its related
interpretations. Accordingly, as all options have been granted at exercise
prices equal to fair market value on the date of grant, no compensation expense
has been recognized in the financial statements for employee stock
arrangements.
 
 c.
    Warrants
 
 Sentry
currently has outstanding warrants for 5,725,000 common shares issued in
connection with various financing arrangements. The warrants have exercise
prices ranging from $0.15 to $0.20 and expire from April 29, 2007 through
January 21, 2009.
 
 
 **10.** **Income
Taxes** **:**
 
 The
reconciliation between total tax expense and the expected U.S. Federal income
tax is as follows:
 2004
    
    2003
    
    2002(In
      thousands)Expected
      tax provision (benefit) at 34%
    
    $
    86
    
    $
    (357
    )
    $
    (1,141
    )Add:Nondeductible
      expenses
    
    
    16
    
    
    16
    
    
    26U.S.
      losses producing no tax benefit
    
    
    6
    
    
    -
    
    
    1,115Use
      of net operating loss carry forwards to offset tax on extraordinary
      item
    
    
    -
    
    
    (151
    )
    
    -Foreign
      tax provisions
    
    
    32
    
    
    -
    
    
    -$
    140
    
    $
    (492
    )
    $
    -
 As of
December 31, 2004, the Company had net operating loss carryforwards of
approximately $33 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 (liabilities) at December 31, 2004 and 2003
are comprised of:
 
 Deferred
      Tax Assets (Liabilities)2004
    
    2003(In
      thousands)Assets:Accounts
      receivable
    
    $
    112
    
    $
    121Inventories
    
    
    639
    
    
    859Accrued
      liabilities
    
    
    98
    
    
    91Property
      and equipment
    
    
    353
    
    
    221Net
      operating loss carryforwards
    
    
    13,078
    
    
    12,875Gross
      deferred tax assets
    
    
    14,280
    
    
    14,167Less
      valuation allowance
    
    
    14,268
    
    
    14,167Deferred
      tax assets
    
    
    12
    
    
    -Liabilities:Property
      and equipment
    
    
    (51
    )
    
    -Deferred
      tax liabilities
    
    
    (51
    )
    
    -Net
      deferred tax liability
    
    $
    (39
    )
    $
    -
  46
  The
increase in the valuation allowance for the years ended December 31, 2004 and
2003 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.
 
 The $142,000 income tax provision for 2004 is
principally attributable to foreign taxes on Canadian operations.  The
$492,000 income tax benefit for 2003 represents the utilization of that period's
loss from operations against the tax provision on the extraordinary gain from
debt extinguishment.
 
 
 **11.** **Extraordinary
Item - Gain on the Extinguishment of Debt** **:**
 
 During
2003, the Company entered into a settlement with certain of its vendors for past
due obligations. Under the terms of the settlement, each participating vendor
received a note for approximately 10% of their balance due and two shares of
Sentry common stock for each dollar owed in full satisfaction of their
outstanding balances, which approximated $1,092,000. The notes, approximating
$112,000, are non-interest bearing and are payable in three equal installments
on January 15, 2004, 2005, and 2006. The 2,193,263 shares issued in connection
with this settlement were valued at approximately $105,000, based on the market
value of the stock at the time of the settlement. As a result of this
transaction, the Company realized an extraordinary gain of $877,000 in 2003,
representing the difference between the amounts due before the settlement and
the total amount payable, including the value of the common stock, as a result
of the settlement. The first payment due on the notes as of January 15, 2004 was
delayed due to the pending Brascan financing transaction and was made in May
2004. The second payment was made timely in January 2005.
 
 On July
9, 2003, Sentry entered into a settlement agreement with its landlord regarding
the termination of its long-term capital and operating leases for its facility
in Hauppauge, New York. Under terms of the settlement, Sentry was released from
its current and future liabilities under the leases in exchange for a $250,000,
8% note, payable in 36 equal monthly installments of $7,834, including interest,
commencing November 1, 2003. In addition, Sentry issued the landlord 1,000,000
shares of common stock, for which the fair value of the stock ($33,000) was
determined using the closing price as of July 9, 2003. Sentry was also obligated
to pay rent of $16,000 per month until it vacated the premises on September 30,
2003. The Company recognized a gain of $353,000 in 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 a result of the Brascan financing, Sentry was obligated to
prepay an amount of $50,000 against the note in May 2004, which resulted in a
reduction in the remaining monthly payments to $5,932.
 
 As of
October 1, 2003, Sentry moved its corporate offices and distribution center to a
20,000 square foot facility in Ronkonkoma, New York. The Company entered into a
three-year lease with 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.
 
 **12.** **Related
Party Transactions** **:**
 
 On March
27, 2002, Peter Murdoch, the Company’s President and CEO, exercised a stock
option for two million shares of Sentry common stock at an exercise price of
$0.06 per share, which was paid for through the issuance of a promissory note in
the amount of $120,000. The principal of the note was secured by the option
shares and was repayable no later than January 8, 2006. The note bore interest
at prime less .75%. Mr. Murdoch satisfied the note and accrued interest as of
March 31, 2004. The note had been reflected as a reduction of shareholders’
equity on the balance sheet as of December 31, 2003.
  47
  On
January 22, 2004, Robert Furst, a Sentry Director, made a bridge loan to the
Company in the amount of $100,000. The interest rate on the loan was 15% per
annum and the loan was due on or before April 30, 2004. As additional
consideration for the loan, Mr. Furst received a warrant to purchase 300,000
shares of Sentry common stock at a price of $0.17 per share, which was the
market price on the date of grant (valued at $3,000 and charged to interest and
financing expenses). The warrant expires January 21, 2009. The note was repaid
in full on April 30, 2004.
 
 On August
1, 2004, ID Systems and Checkpoint Systems Inc. entered into a settlement
agreement effective July 30, 2004, pursuant to which Checkpoint agreed to pay
$19.95 million in full and final settlement of claims covered by an antitrust
litigation. Payment in full was received on August 5, 2004. As provided when
Sentry purchased ID Systems, the proceeds of the settlement were distributed to
former shareholders of ID Systems, after payment of litigation fees and
expenses. The agreement includes mutual releases between the parties for
complaints arising from activities prior to the date of the agreement, except
for any contractual obligations and any future claims for patent, copyright or
trademark infringement. The agreement is not an acknowledgement of any
wrongdoing or liability by either party. A Stipulation of Dismissal was filed
with the Third Circuit Court of Appeals to finally conclude the legal
proceedings. During the third quarter of 2004, Sentry and its subsidiaries
received $753,000 through the repayment of debt incurred by Dialoc prior to the
ID Systems acquisition and reimbursement of litigation expenses.
 
 While
Sentry did not obtain an interest in the litigation settlement, Saburah and
Sentry agreed that Sentry might require Saburah to purchase additional Sentry
common shares equal to approximately 4.5% of any amount received (net of legal
fees and expenses) from Checkpoint. The price per share was set at 80% of the
previous 20 days trading average prior to the announcement of the settlement.
Our Board of Directors has exercised this option and based on the settlement
amount, Sentry sold to Saburah approximately 4.8 million shares for $641,000 on
November 5, 2004. These transactions, totaling $1.4 million, represent the total
cash flowing to Sentry directly and indirectly as a
result of the Checkpoint lawsuit.
 
 
 **13.** **Commitments
and Contingencies:**
 
 a.
    401(k)
      Plan
 
 In
January 1997, the Company adopted the Sentry Technology Corporation Retirement
Savings 401(k) Plan (the "Plan"). The Plan permits eligible employees to make
voluntary contributions to a trust, up to a maximum of 35% of compensation,
subject to certain limitations. The Company may elect to contribute a matching
contribution equal to a designated percentage of the eligible employee's
deferral election. The Company may also make discretionary contributions,
subject to certain conditions, as defined in the Plan. No Company contributions
were made in 2004 or 2003. The Company contributed approximately $48,000 to the
Plan for the year ended December 31, 2002.
 
 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 $402,000. Also, the president of the Company’s 51% owned subsidiary, Custom
Security Industries Inc., is entitled to receive 10% of its pretax
profits.
 
 c.
    Litigation
 
 In August
2004, Bi-County Park Associates, Inc. d/b/a Ashlind Properties brought an action
against the Company for the recovery of a real estate brokerage commission in
the amount of $250,000 relating to the termination of its lease on its former
Hauppauge facility. Management believes there is no merit to this claim and is
actively defending such action.
  48
  The
Company is a party to litigation matters and claims, which are normal in the
course of its operations. While the results of such litigation and claims cannot
be predicted with certainty, management believes that the final outcome of such
matters will not have a materially adverse effect on the Company's consolidated
financial position, results of operations and cash flows.
 
 d.
    Distribution
      Agreements
 
 The
Company entered into a five year distribution agreement with Dialoc under which
the Company must purchase a minimum of $1.1 million of Dialoc’s products each
year.
 
 
 **14.**  **Major
Customers and Credit Concentrations** **:**
 
 The
Company grants credit to customers who are principally in the retail industry
and libraries. During 2004, 2003 and 2002, revenues from Lowe’s Home Center
represented approximately 30%, 44% and 40% of total revenues, respectively. No
other customer accounted for more than 10% of total revenues for fiscal 2004,
2003 and 2002.
 
 In
January 2005, Lowe’s Home Centers notified the Company that they would not be
renewing their annual maintenance contract, which represented $850,000 of
revenues in 2004. The Company still anticipates selling Sentry products to
Lowe’s in the future, however, the annual maintenance contract had an impact on
the selection of vendors for replacement and add-on CCTV business in existing
Lowe’s locations. The Company anticipates that this decision will result in a
substantial decrease in future revenues from Lowe’s on a comparative
basis.
 
 Canadian revenues approximated $4,497,000, $247,000
and $216,000 in 2004, 2003 and 2002, respectively.
 
 
 **15.**  **Revenue
by Product Line:**
 
 Revenues
by product line are as follows:
  2004
    
    2003
    
    2002(In
      thousands)EAS
    
    $
    5,286
    
    $
    1,888
    
    $
    2,835CCTV
    
    
    3,214
    
    
    3,650
    
    
    4,657Sentry
      Vision®
    
    
    3,784
    
    
    3,091
    
    
    2,408Service
      revenues and other
    
    
    4,381
    
    
    4,497
    
    
    4,804Total
      revenues
    
    $
    16,665
    
    $
    13,126
    
    $
    14,704
  49
  **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 51,
has been the President and Chief Executive Officer, Director and Chairman of the
Board since January 8, 2001. Mr. Murdoch has extensive experience in the retail
security industry as well as in the sales of technology-based products. He was
Managing Director and President of ID Security Systems Canada, Inc. since its
inception in 1987 until its acquisition by Sentry. From 1997 through 2004, he
served as member of the management committee of Dialoc ID. Prior to joining ID
Security Systems Canada, Inc., Mr. Murdoch was Vice President of Sales for
Catalyst International Business Systems. He is an economics graduate from the
University of Western Ontario. Mr. Murdoch’s term as a Director expires at the
next Annual Meeting.
  **Robert
D. Furst, Jr.** , age 52,
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 54,
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.
  50
  **Executive
Officers**
 
 The
following sets forth information regarding the persons serving as executive
officers of the Company:
 
  **Name**
    **Age**
    **Office**Peter
      L. Murdoch
    51
    Our
      President and Chief Executive Officer since January 8, 2001. Mr. Murdoch
      has extensive experience in the retail security industry as well as in the
      sales of technology-based products. He was Managing Director of ID
      Security Systems Canada, Inc. since its inception in 1987. Beginning in
      1997 he has served as member of the management committee of Dialoc ID.
      Prior to joining ID Security Systems Canada, Inc., Mr. Murdoch was Vice
      President of Sales for Catalyst International Business Systems. He is an
      economics graduate from the University of Western Ontario.Peter
      J. Mundy
    48
    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, 2004, all Section 16(a) filing requirements
applicable to its officers, Directors and greater than ten-percent beneficial
owners were complied with, except the following. Robert D. Furst, Jr., a member
of the Board, filed a late report on Form 4 on January 28, 2005 with the SEC,
for the sale of 400,000 shares of the Company's common stock at prices ranging
from $0.225 per share to $0.26 per share, which sales occurred on January 25,
2005.
  51
  **Item
10. EXECUTIVE COMEPENSATION** **.**
 
 **Summary
Compensation Table**
 
 The
following table summarizes the compensation for our fiscal years ended December
31, 2004 of our Chief Executive Officer and Chief Financial
Officer:
 **Annual
      Compensation**
    
    **Long-Term****Compensation**
    
    **All
      Other****Compensation
      (1)****Name
      and****Principal
      Position**
    
    **Year**
    
    **Salary**
    
    
    
    **Bonus**
    
    **Securities
      Underlying****Options
      (#)**Peter
      L. Murdoch
    
    
    2004
    
    $
    237,962
    
    
    (2
    )
    
    -
    
    
    -
    
    
    -President
      and CEO
    
    
    2003
    
    
    50,000
    
    
    
    
    
    -
    
    
    -
    
    
    -2002
    
    
    87,500
    
    
    (3
    )
    
    -
    
    
    -
    
    
    -Peter
      J. Mundy
    
    
    2004
    
    
    131,160
    
    
    
    
    
    -
    
    
    -
    
    
    -Vice
      President - CFO,
    
    
    2003
    
    
    131,160
    
    
    
    
    
    -
    
    
    -
    
    
    -Secretary
      and Treasurer
    
    
    2004
    
    
    131,160
    
    
    
    
    
    -
    
    
    -
    
    
    1,967
 (1)
    Amount
      shown consists of our matching contributions under the Retirement Savings
      401(k) Plan.
 (2)
    Includes
      amounts paid by ID Systems in 2004 and $62,500 of Sentry salary deferred
      from 2002.
 (3)
    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 2004.
 
 **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 2004 and the amount
realized by each such officer. In addition, the table shows the number of
options that the named executive officer held as of December 31, 2004, both
exercisable (E) and unexercisable (U), and the value of such options as of that
date.
  52
   **Number
      Of Unexercised Options At Year-End (#)**
    **Value
      Of Unexercised In The Money Options At Year End
    ($)****Shares****Acquired
      On**
    **Value**
    **Exercisable/**
    **Exercisable/****Name**
    **Exercise
      (#)**
    **Realized
      ($)**
    **Unexercisable**
    **Unexercisable**Peter
      L. Murdoch
    -
    -
    E
    -
    E
    *-*U
    -
    U
    *-*Peter
      J. Mundy
    -
    -
    E
    469,586
    E
    $18,000U
    **-
    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 2004.
 
 In
addition, each non-employee Director is eligible to participate in our 1997
Stock Incentive Plan. No options were awarded to Directors during the last three
years.
 
 **Employment
Agreements And Compensation Of Executive Officers; Change Of Control
Arrangements**
 
 The Board
set Peter L. Murdoch’s compensation, in the capacity of President, at an annual
salary of approximately $175,000 in 2004, $50,000 in 2003 and $150,000 for 2002.
 
 Our Board
of Directors approves the compensation paid to our other executive officers,
approving or disapproving the recommendation of the Chief Executive Officer. The
Board of Directors also determines the amount of shares and exercise prices for
any stock option grants under our 1997 Stock Incentive Plan, and the amount of
our matching contribution percentage under our Retirement Savings 401(k) Plan,
respectively.
 
 Currently,
Mr. Mundy is compensated pursuant to a written employment agreement providing
for his base salary. This agreement provides for annual salary increases
intended to maintain his base salary against increases in the cost of living as
measured by the United States Department of Labor. Mr. Mundy waived these
increases for the years 2002, 2003 and 2004. The employment agreement for Mr.
Mundy renews automatically on May 1 for one-year terms. His annual salary is
presently $136,013.
 
 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.
  53
  **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.
  54
   
  55
  **Item
11.** **SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**
 
 The
following table sets forth the beneficial ownership of our common stock at April
12, 2005, as to each (i) beneficial owner of five percent or more of the common
stock, (ii) Sentry Director, (iii) executive officer of Sentry, and (iv) all
Directors and executive officers as a group. On April 12, 2005, 120,558,804
shares of common stock were outstanding.
 
 
 **Name
      and Address of Beneficial Owners**
    **Shares
      of**
      **Common
      Stock**
    **Percent******
      **of
      Class(1)**William
      A. Perlmuth
      c/o
      Stroock & Stroock & Lavan LLP
      180
      Maiden Lane
      New
      York, NY 10038
    6,118,952
      (2)
    5.1%******Directors
      and Executive Officers**
    **Shares
      of******
      **Common
      stock**
    **Percent******
      **Of
      Class(1)**Peter
      L. Murdoch(5)
      c/oSaburah
      Investments Inc.
      37
      Voyager Court
      North
      Toronto, Ontario M9W 4Y2
    59,665,093
      (3)
    49.5%Robert
      D. Furst, Jr.
      c/o
      Alternative Strategies Advisors LLC
      601
      Carlson Parkway, Suite 610
      Minnetonka,
      MN 55305
    15,587,142
      (4)
    12.9%Peter
      J. Mundy
    665,553
      (5)
    *Jonathan
      G. Granoff
    90,000
      (6)
    *All
      Sentry Directors and executive officers as a group (4
    persons)
    76,007,788
      (7)
    62.6%
 
 ___________________
 *
    Less
      than one percent
 
 (1)
    Based
      on 120,558,804 shares of common stock outstanding as of April 12, 2005.
      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) 5,199,497 shares of common stock held by Mr. Perlmuth as Trustee of
      the Trust U/W/O of Arthur J. Minasy, (b) 896,418 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
      57,553,593 shares of common stock held by Saburah Investments Inc. of
      which Mr. Murdoch is the 100% owner.
 (4)
    Includes
      354,000 shares of common stock issuable upon the exercise of stock options
      or warrants exercisable within 60 days of the date hereof. Mr. Furst also
      holds a warrant to purchase 2,500,000 common shares from Saburah
      investments Inc., which are excluded from the shares owned. Shares subject
      to this warrant will be issued from shares currently owned by
      Saburah.
 (5)
    Includes
      469,586 shares of common stock issuable upon the exercise of stock options
      exercisable within 60 days from the date
hereof.
 (6)
    Includes
      30,000 shares of common stock exercisable upon the exercise of stock
      options exercisable within 60 days from the date hereof.
 (7)
    Includes
      853,586 shares of common stock issuable upon the exercise of stock options
      and warrants exercisable within 60 days from the date
    hereof.
  56
  **Item
12.**  **CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS**  ****
 
 On March
27, 2002, Peter Murdoch, our President and CEO, exercised a stock option for two
million shares of Sentry common stock at an exercise price of $0.06 per share,
which was paid for through the issuance of a promissory note in the amount of
$120,000. The principal of the note was secured by the option shares and was
repayable no later than January 8, 2006. The note bore interest at prime less
..75%. Mr. Murdoch satisfied the note and accrued interest as of March 31, 2004.
The note had been reflected as a reduction of shareholders’ equity on the
balance sheet as of December 31, 2003.
 
 On
January 22, 2004, Robert Furst, a Sentry Director, made a bridge loan to the
Company in the amount of $100,000. The interest rate on the loan was 15% per
annum and the loan was due on or before April 30, 2004. As additional
consideration for the loan, Mr. Furst received a warrant to purchase 300,000
shares of Sentry common stock at a price of $0.17 per share, which was the
market price on the date of grant (valued at $3,000). The warrant expires
January 21, 2009. The note was repaid in full on April 30, 2004.
 
 
 **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, 2004 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 29.
 
 (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 Sentry Corporation, Knogo North America
      Inc., Sentry Technology Corporation, Viking Merger Corp. and Strip Merger
      Corp., as amended by Amendment No. 1 to Amended and Restated Agreement and
      Plan of Reorganization and Merger, dated as of January 10, 1997.
      Incorporated by reference to Exhibit 2.1 to Company's Registration
      Statement on Form S-4 (No. 333-20135).
  57
  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.
 
 10.16
    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.
 
 10.25
    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.
  58
  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. Incorporated by reference to Exhibit 10.34 to the Company's
      annual report on Form 10-KSB for fiscal
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. Incorporated by reference to Exhibit
      10.36 to the Company's annual report on Form 10-KSB for fiscal
      2003.
 
 10.37
    Amendment
      to Forbearance Agreement and Financing Agreement between The CIT
      Group/Business Credit, Inc. and Knogo North America Inc., dated December
      30, 2004.
 
 21
    Subsidiaries
      of the Company.
 
 23.1
    Consent
      of Holtz Rubenstein Reminick LLP
 
 31.1
    Certification
      by the Chief Executive Officer Pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.
 
 31.2
    Certification
      by the Chief Financial Officer Pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.
 
 32.1
    Certification
      by the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 Adopted
      Pursuant to Section 906 of the Sarbanes-Oxley Act of
    2002.***
 
 32.2
    Certification
      by the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 Adopted
      Pursuant to Section 906 of the Sarbanes-Oxley Act of
    2002.***
 
 ***
    In
      accordance with Item 601(b)(32)(ii) of Regulation S-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 2004.
 
 
 **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 Reminick LLP as the Company's independent
accountants, the board of directors considered whether the provision of such
services is compatible with maintaining independence. The board of directors
approved all of the services provided and fees charged by Holtz Rubenstein
Reminick LLP in 2004.
  59
  **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 2004, 2003 and
2002 were $104,000, $58,000 and $50,000, respectively, net of
expenses.
 
 **Audit-Related
Fees**
 
 There
were $33,000, $9,000 and $0 of other fees billed during 2004, 2003 and 2002,
respectively, for assurance and related services that were reasonably related to
the performance of the audit or review of the Company's financial statements and
not reported under "Audit Fees" above.
 
 **Tax
Fees**
 
 There
were no other fees billed by our independent auditors during the last two fiscal
years for tax compliance.
 
 **All
Other Fees**
 
 There
were no other fees billed by our independent auditors during the last two fiscal
years for products and services provided.
 
 
 **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. MundyPeter
      J. MundyVice
      President-Finance,Chief
      Financial Officer,Secretary
      and Treasurer
  Dated:
April 12, 2005
  60
  Pursuant
to the requirements of the Securities Exchange Act of 1934, this Annual Report
on Form 10-KSB has been signed below by the following persons in the
capacities and on the date indicated.
 
 Signature
    
    Title/s/
      Peter L. Murdoch
    
    Chief
      Executive Officer and DirectorPeter
      L. Murdoch/s/
      Peter J. Mundy
    
    Vice
      President-Finance,Peter
      J. Mundy
    
    Chief
      Financial and Accounting Officer,Secretary
      and Treasurer/s/
      Robert D. Furst, Jr.
    
    DirectorRobert
      D. Furst, Jr./s/
      Jonathan G. Granoff
    
    DirectorJonathan
      G. Granoff
 
 
 Dated:
April 12, 2005
  61
  EXHIBIT
INDEX
  10.37
    Amendment to Forbearance Agreement and Financing
      Agreement between The CIT Group/Business Credit, Inc. and Knogo North
      America Inc., dated December 30, 2004.
 
 21
    Subsidiaries of the Company.
 
 23.1
    Consent of Holtz Rubenstein Reminick
      LLP.
 
 31.1
    Certification by the Chief Executive Officer Pursuant to
      Section 302 of the Sarbanes-Oxley Act of
2002.
 
 31.2
    Certification by the Chief Financial Officer Pursuant to
      Section 302 of the Sarbanes-Oxley Act of
2002.
 
 32.1
    Certification by the Chief Executive Officer Pursuant to
      18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002. ***
 
 32.2
    Certification by the Chief Financial Officer Pursuant to
      18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002. ***
  62