SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
/X/ 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
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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.)
350 Wireless Boulevard, Hauppauge, New York 11788
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (516) 232-2100
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class: on which registered:
Common Stock, $.001 par value American Stock Exchange
Class A Preferred Stock, $.001 par value American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes /X / No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. /X/ / /
At March 29, 1999, the aggregate market value of the voting stock held by
non-affiliates of the Registrant was approximately $2,447,000 based upon the
closing price of such securities on the American Stock Exchange on that date. At
March 29, 1999, the Registrant had outstanding 9,750,760 shares of Common Stock
and 5,333,334 shares of Class A Preferred Stock.
Documents Incorporated by Reference
None.
PART I
Item 1. Business.
Formation of the Company
At a special meeting of shareholders of Knogo North America Inc., a
Delaware corporation ("Knogo"), and a special meeting of shareholders of Video
Sentry Corporation, a Minnesota corporation ("Video"), each held on February 12,
1997, the shareholders of Knogo and the shareholders of Video, respectively,
approved the Amended and Restated Agreement and Plan of Reorganization and
Merger, dated as of November 27, 1996, as subsequently amended (the "Merger
Agreement"), by and among Knogo, Video, Sentry Technology Corporation, a
Delaware corporation (the "Registrant," the "Company" or "Sentry"), Strip Merger
Corp., a Delaware corporation, and Viking Merger Corp., a Minnesota corporation,
and the transactions contemplated thereby.
Pursuant to the Merger Agreement, on February 12, 1997 (the "Effective
Date"), each of Knogo and Video became a wholly-owned subsidiary of Sentry, with
(a) each former Knogo shareholder being entitled to receive one share of Sentry
Common Stock, par value $.001 per share ("Sentry Common Stock"), and one share
of Sentry Class A Preferred Stock, par value $.001 per share ("Sentry Class A
Preferred Stock"), for each 1.2022 shares held of Knogo Common Stock, par value
$.01 per share, and (b) each former Video shareholder being entitled to receive
one share of Sentry Common Stock for each share held of Video Common Stock, par
value $.01 per share. This series of transactions is referred to herein
collectively as the "Merger."
The Merger was accounted for under the purchase method of accounting.
Although Video shareholders received a majority voting interest in Sentry based
upon their common stock ownership percentage, generally accepted accounting
principles requires consideration of a number of factors, in addition to voting
interest, in determining the acquiring entity for purposes of purchase
accounting treatment. As a result of these factors, further described in Note 1
to the Consolidated Financial Statements, and solely for accounting and
financial reporting purposes, the Merger was accounted for as a reverse
acquisition of Video by Knogo. Accordingly, the financial statements of Knogo
are the historical financial statements of Sentry and the results of Sentry's
operations include the results of operations of Video Sentry after the Effective
Date.
General
Sentry, incorporated in October 1996, is a holding company for Video
and Knogo and their respective subsidiaries. Accordingly, the business of Sentry
is the business conducted by Video and Knogo and their respective subsidiaries.
Prior to the Effective Date, Sentry had not conducted any business activities,
other than those incident to its formation, its execution of the Merger
Agreement and related agreements, and the taking of other actions in connection
with the Merger.
Video designs, manufactures, markets, installs and services a
programmable traveling closed circuit television ("CCTV") surveillance system
that delivers a high quality video picture which is used in a wide variety of
applications. Video also acts as a system integrator of conventional CCTV
products that it markets, installs and services. Video's predecessor was founded
in 1990 and made its first sales in 1992.
Knogo is engaged in the design, manufacture, sale, installation and
servicing of a complete line of electronic article surveillance ("EAS")
equipment. Knogo was incorporated in Delaware in October 1996, while its
corporate predecessors had been in business for over 30 years prior thereto.
Knogo's immediate predecessor, also named Knogo North America, Inc. (the "Knogo
Predecessor") was created in connection with an Amended and Restated Agreement
and Plan of Merger (the "Sensormatic Merger Agreement"), dated as of August 14,
1994, among Sensormatic Electronics Corporation ("Sensormatic"), Knogo
Corporation ("Old Knogo") and the Knogo Predecessor. Pursuant to the Sensormatic
Merger Agreement, Old Knogo merged with and into Sensormatic on December 29,
1994 (the "Sensormatic Merger"). Immediately prior to the Sensormatic Merger,
Old Knogo contributed to the Knogo Predecessor all of Old Knogo's operations in
the United States, Canada and Puerto Rico and distributed all of the stock of
the Knogo Predecessor to the former shareholders of Old Knogo (the "Spinoff").
At the time of the Spinoff, the Knogo Predecessor changed its fiscal year end
from February 28 to December 31.
The SentryVision(r) System
Video's proprietary CCTV system, called SentryVision(r), is well
suited for loss prevention surveillance in retail stores and distribution
centers as well as security surveillance for monitoring and deterring illegal
and unsafe activities in a variety of other locations such as parking garages,
correctional facilities, warehouses, transportation centers and public transit
terminals. The SentryVision(r) system may also be employed in a broad range of
operational and process monitoring applications in commercial manufacturing and
industrial settings. As of December 31, 1998, 992 SentryVision(r) systems had
been installed in approximately 396 customer locations in North America. Current
customers include Lowe's Home Centers, Target Stores, Eckerd Corporation, Mills
Fleet Farm, Winn Dixie, Federal Express, UPS, J.C. Penney, Canadian Tire, Estee
Lauder, Kohl's Department Stores, Disney Direct Marketing and Duke University.
The Company believes that, by expanding surveillance coverage, the
SentryVision(r) systems have 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 Video's customers to
date, the Company believes the SentryVision(r) system is a cost-effective
solution which can improve the operations of its customers.
The SentryVision(r) system consists of a camera carriage unit, a
continuous track with a tinted enclosure and electronic control equipment. The
carriage unit moves within the enclosure and carries two pan/tilt/zoom CCTV
cameras, electronic transmission components and motor drives. The carriage track
and enclosure are designed to custom lengths for more complete viewing. Using
Video's patented transmission technology, 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 videocassette
recorders, alarm inputs, fixed cameras, PTZ dome cameras, switches/multiplexers,
voice intercom systems and panic buttons.
The SentryVision(r) system typically employs two high resolution
cameras facing opposite directions and operates at variable speeds up to 15 feet
per second. The system is designed to allow three control modes: manual control,
automated control or automatic patrol. This configuration enables the system to
respond to control commands provided externally to the system through a serial
interface port. In addition, the SentryVision(r) system utilizes the RS-232
communication protocol, which allows the SentryVision(r) carriage control to be
integrated with any industry standard controller. In the manual control mode,
the combination of carriage movement, camera PTZ features, and the ability to
view from each side of the enclosure, enables the user to manually follow and
record persons engaging in suspected activities from a central control station.
Under the automated control mode, the system operates as a component in an
automated control system. When engaged in the automatic patrol mode, which is
still under development by the Company, the carriage is expected to
automatically travel through pre-programmed "tours" of a facility, affording
precise camera views of intended target locations. The Company anticipates that
such tours may be programmed for full end-to-end facility observation, random
view facility observation, or user-defined facility observation with a series of
stops at precise locations focusing on precise views.
Video 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, the Company has identified a number of
specific market segments for which the SentryVision(r) systems are 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.
The SentryVision(r) system is typically installed in retail stores
which use a checkout area at the front of the store and product display
configurations and high merchandise shelving which form rows and aisles. Video
specializes in designing system applications which are customized to fit a
customer's specific needs and which integrate the customer's existing
surveillance equipment (PTZ dome and fixed-mount cameras) with the
SentryVision(r) system. 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 or employee theft. The SentryVision(r) system is
installed near the ceiling along the rows of cash registers and between 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 tilt and zoom lens features, activities in each area can be
monitored in greater detail. Results from Video's current installations indicate
significant improvements in detecting shoplifting and employee theft. The
SentryVision(r) system is generally sold in conjunction with conventional CCTV
applications. A significant percentage of all SentryVision(r) customers
incorporate conventional CCTV into their overall security solutions. Customers
using the SentryVision(r) system have reported significant reductions in
theft-related inventory shrinkage.
* Retail Market Applications Home Centers. Video has installed 690
systems in 248 store locations for six customers in the home
center segment of the retail market. In the past three years, the
SentryVision(r) system has been installed in 239 locations for
Lowe's Home Centers, a 500 store chain, and in 23 locations for
Mills Fleet Farm, a 32 store regional hardware, home supply and
discount retail chain. Both companies required systems for total
floor coverage, with Lowe's Home Centers choosing to integrate
track cameras with PTZ dome and fixed-mount cameras, while Mills
Fleet Farm chose to use only the track camera system. Video
received Security magazine's "Best" award for New Security
Installation in June 1994 for its installation in the Mills Fleet
Farm store in Brooklyn Park, Minnesota.
According to industry publications, the home center market
consists of approximately 2,300 companies operating over 7,000
stores in the United States, with the top ten companies operating
over 2,500 stores. Typical systems for home center installations
range in price from $30,000 for smaller stores to $150,000 for
larger stores requiring more carriage runs to provide adequate
coverage.
* Mass Merchandise Chains. Video has installed 49 systems in 26
store locations for six customers in this segment, including
Target Stores and TJ Maxx. The targeted coverage varies
extensively in these installations from only stock rooms to total
store coverage. According to industry publications, the mass
merchandise market in the United States had approximately 140
companies operating over 10,000 store locations, with the top ten
companies operating approximately 7,400 of these stores. Typical
systems for mass merchandise stores range in price from $20,000
for smaller stores or target coverage areas to $130,000 for large
systems.
* Supermarkets. Video has installed 25 systems in 24 store
locations for seven supermarket customers. The targeted coverage
in most of these installations has been the entire retail space.
The supermarket segment of the market is very fragmented in the
United States. According to industry publications, approximately
2,000 companies operated nearly 34,000 stores, with over half of
those companies having fewer than four stores. The top 25
companies operate about 40% of the total stores. Typical systems
for supermarket installations range in price from $15,000 for
smaller stores to $50,000 for larger stores.
* Drug Stores. Video has installed 25 systems in 25 store locations
for three drug store customers, including a major national drug
store chain of approximately 1,750 stores. The targeted coverage
area for these customers is the entire store. According to
industry publications, the drug store market consisted of
approximately 1,800 companies operating approximately 45,000
stores. Typical systems for the drug store market range in price
from $15,000 for smaller stores to $50,000 for larger stores.
Industrial Market Applications
* Distribution Centers. Video also provides loss prevention
surveillance for distribution centers and warehouses, and has
installed 63 systems in 27 distribution centers for 21 different
customers including Kohl's, Target Stores, Borders Group, Disney
Direct Marketing and J.C. Penney. Traveling through a facility
from an overhead position, the SentryVision(r) 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(r) 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. Typical systems for
distribution center installations range in price from $50,000 for
a small system to over $200,000 for a large system.
* Manufacturing and Transportation Facilities. So far
SentryVision(r) use in factories has been limited but the
benefits of continuous tracking of industrial operations and
processes indicate future growth. Continued expansion of the
SentryVision(r) dealer program will 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. Recent installations include Federal Express
and UPS. Typical systems for manufacturing and transportation
facilities range in price from $40,000 for a small system to over
$200,000 for a large system.
Institutional Market Applications
* Corrections, Parking and Government Institutions. The Company has
installed 108 systems in three parking garages at Duke
University's Medical Center with major benefits identified as
savings in guard costs, vandalism, safety and theft.
SentryVision(r) has been installed in correctional facilities in
Texas, California, New Mexico and Illinois. Expansion of
correctional applications is expected due to reported safety
benefits of continuous coverage in dormitory, recreation and
visitation areas. As successful installations take place,
requests for proposals have increased. SentryVision(r)
installations have also been completed in various government
agencies including the Federal Reserve Bank, US Postal Service,
US Immigration Service and the US Marine Corps.
Conventional CCTV System
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, VCR's, monitors, switchers, multiplexers and controllers. As all
of this equipment is manufactured for Video by outside vendors, the Company can
provide its customers with state-of-the-art equipment for specific applications
at favorable costs. The Company believes that, while less profitable than
SentryVision(r) and traditional EAS products, the CCTV products complement the
Company's 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 an alarm is triggered.
Many companies have traditionally selected between conventional CCTV
systems and SentryVision(r) systems for their security solutions. The Company
has received indications that Lowe's Home Centers expects the bulk of its orders
in 1999 to be for conventional CCTV systems.
Remote video transmission and digital recording are other potential
growth areas for Video. These systems allow customers to monitor remote sites
using existing communication lines and a PC-based system. Video camera images
are stored and manipulated digitally, substituting the PC for the VCR and
eliminating the videotape. Video markets the remote video transmission system
with software developed by Prism Video, Inc., a third-party vendor.
Video's customers include ten of the top 20 United States retailers.
According to STORES magazine, the top 20 retailers have approximately 45,000
stores. The Company's strategy is to build upon Video's initial retail sales by
implementing a direct sales program targeting the "Big Box" retail market,
including the top 100 United States retailers.
The Company continues to expand conventional CCTV installations in
industrial and institutional facilities. During 1998, three express package
companies became significant customers, Federal Express, United Parcel Service
and Emery Air Freight. The use of CCTV surveillance continues to grow in both
new and existing correctional facilities and Sentry now has CCTV installations
in 7 state or county facilities.
In 1998 The Company began a new program marketing CCTV to the school
(K-12) market. Several 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 Remote
Video Transmission an attractive option for large school districts.
The Company estimates the US retail CCTV market to be approximately
$300 million per year. Comparable estimates for the institutional and industrial
CCTV markets are $98 million and $193 million per year, respectively.
EAS Systems
The EAS systems which Knogo manufactures are based upon three distinct
technologies. One, the Swept Radio Frequency ("Knoscape RF(tm)") system, uses
medium frequency transmissions in the two to nine megahertz range. Second, the
Dual Radio Frequency ("Ranger (tm)") system, uses ultra-high frequency radio
signals in the 902 megahertz and 928 megahertz bands. Third, the Micro-Magnetics
("Knoscape MM(tm)") system, uses very low frequency electromagnetic signals in
the range of 218 hertz to nine kilohertz. Knogo also manufactures a
non-electronic dye-stain pin ("KnoGlo(tm)"). Since 1996, Knogo has been an
authorized distributor of the library security systems and related products of
Minnesota Mining and Manufacturing Company ("3M").
The principal application of Knogo'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, Knogo'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.
Knogo has also devoted resources to the development of its asset
protection business in non-traditional areas, particularly in the area of
manufactured hard goods such as printed circuit boards, computer processor and
memory chips and related components. No significant revenue has been received to
date in connection with this line of business.
EAS systems consist of detection devices which are triggered when
articles or persons tagged with wafers or tags pass through the detection
device. The principal application of the Knoscape RF(tm) and Ranger(tm) systems
is to detect and deter theft of soft goods such as clothing, while the Knoscape
MM(tm) systems are primarily used to detect and deter the theft of hard goods
including packaged goods, books and videos.
At December 31, 1998, the approximate number of Knogo's EAS Systems
sold or leased exceeded 24,300.
Swept and Dual Radio Frequency Detection Systems
Knogo manufactures and distributes the Knoscape RF(tm) system, the
principal application of which is to detect and deter shoplifting and employee
theft of clothing in retail establishments. Knogo also manufactures and
distributes the Ranger(tm) system, which the Company believes is a particularly
useful and cost efficient EAS system for high fashion retail stores with wide
mall-type exit areas which ordinarily would require multiple Knoscape RF(tm)
systems for adequate protection. The Knoscape RF(tm) and Ranger(tm) 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 and
mounted in or on the floor for 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(tm) systems or installation of
one or more Ranger (tm) systems, the Company's products have the ability to
protect any size entrance or exit.
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 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.
Knoscape RF(tm) and Ranger (tm) systems generally have an economic
useful life of six years (although many of Knogo's systems have been operating
for longer periods), have a negligible false alarm rate and are adaptable to
meet the diversified article surveillance needs of individual retailers.
Magnetic Detection Systems
The primary application of Knoscape MM(tm) 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(tm) systems use detection monitors which are activated by
electromagnetically sensitized strips. The MM targets are typically attached to
the articles to be protected and are easily camouflaged on a wide array of
products. The detection monitors used by the Knoscape MM(tm) 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, which the Company believes is a
particularly desirable feature for use with items such as compact discs,
CD-ROM's and videotapes, which may be "checked-out" and later returned. 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(tm) system offers retailers several features not
available in Knoscape RF(tm) and Ranger (tm) 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, they are convenient to use.
KnoGlo(tm)
KnoGlo(tm), a non-electronic, dye-stain pin, releases an indelible
liquid when tampered with. Used with passive locking mechanisms without
electronics, KnoGlo(tm) is often a retailer's first step in loss prevention.
KnoGlo(tm) is also employed in stores with EAS systems as an extra layer of
protection. Such protection is useful in problem areas (near mall door openings,
for example) or where users must maximize selling space.
Bookings
Of Sentry's bookings for the year ended December 31, 1998,
approximately 18% were attributable to SentryVision(r), 28% to CCTV, 47% to EAS
and 7% to 3M library security systems. For the year ended December 31, 1997,
approximately 46% were attributable to SentryVision(r) (including several
multi-year orders), 15% were attributable to CCTV, 30% to EAS, 9% to 3M library
security systems. For the year ended December 31, 1996, approximately 23% were
attributable to CCTV and 77% to EAS.
Major Customers
Although the composition of the Company's largest customers has
changed from year to year, a significant portion of the Company's revenues has
been attributable to a limited number of major customers. Sales to Sensormatic
accounted for 10% and 20% of total revenues in 1997 and 1996 respectively. In
1998 and 1997, Lowe's Home Centers accounted for 22% and 18%, respectively, of
total sales. In 1996 Goody's Family Clothing accounted for 13%, of total
revenues. No other customers accounted for more than 10% of the Company's sales
during 1998, 1997 or 1996. While the Company believes that one or more major
customers could account for a significant portion of the Company's sales for at
least the next two years, the Company anticipates that its customer base will
continue to expand and that in the future the Company will be less dependent on
major customers.
Production
Video
Video's manufacturing operations consist primarily of the assembly of
its camera carriages and control units using materials and manufactured
components purchased from third parties. Video is not dependent upon any
particular supplier for these materials or components. Some parts are stock,
"off-the-shelf" components, and other materials and system components are
designed by Video and manufactured to Video's specifications. Final assembly
operations are conducted at the Company's facilities in Hauppauge, New York.
System components and parts include cameras, circuit boards, electric motors and
a variety of machined parts. Each system component undergoes a quality assurance
check by Video prior to its shipment to an installation site. Video 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.
Product installation and service are performed and monitored by the
Company's customer service department. Installations typically take from three
days to three weeks and consist of 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.
Knogo
Knogo produces at the Company's facilities in Hauppauge, New York, or
purchases through suppliers, its Knoscape RF(tm), Ranger(tm), Knoscape MM(tm)
and KnoGlo(tm), or their components. Production consists of assembling
electronic and mechanical components and printed circuitry which Knogo purchases
from various suppliers. Knogo's specially designed tools, plastic cases for the
tags, and the target bands used in Knogo's system for patient and personnel
control, are produced to Knogo's specifications by independent contractors using
existing molds and tooling. Knogo is not dependent on any one supplier or group
of suppliers of components for its systems. The Company's policy is to maintain
Knogo's inventory at a level which is sufficient to meet projected demand for
its products. The Company does not anticipate any difficulties in continuing to
obtain suitable components for Knogo at competitive prices in sufficient
quantities as and when needed.
In October, 1998 the Company ceased manufacturing at its Cidra, Puerto
Rico facility and consolidated all manufacturing and assembly at the Company's
Hauppauge, New York facility. The Puerto Rico facility was sold in February
1999.
Marketing
The Company markets its products for Video and Knogo, jointly, through
the direct efforts of approximately 25 salespersons located in select
metropolitan areas across the United States and Canada, as well as through a
network of over 100 dealers/system integrators. Marketing efforts include
participation in trade shows, advertising in trade publications, targeted direct
mailings and telemarketing.
Video
To date, virtually all SentryVision(r) and conventional CCTV Systems
have been sold on a direct sale basis. Typical billing arrangements for
SentryVision(r) systems have been invoicing 50% of total cost upon shipment of
the product and 50% on the completion of the installation.
While most of the current SentryVision(r) and conventional CCTV sales
have been made to home centers, retail chains and distribution centers, the
Company's 1998 marketing plan for Video also emphasized correctional facilities,
institutional and industrial prospects. These efforts resulted in
SentryVision(r) or conventional CCTV installations in seven correctional
facilities, five school districts and in multiple facilities for major express
package delivery companies.
Beginning in mid-1998, the Company began a program to market
SentryVision(r) through qualified security dealers and integrators. Much of the
industrial and institutional SentryVision(r)/CCTV prospects are serviced by
local security companies who design and install integrated CCTV, access control
and alarm systems. By working with these companies, the Company is able to reach
a far larger number of SentryVision(r) prospects and penetrate the market more
rapidly. During the 2nd half of 1998, the program generated much interest
through trade advertising, direct mail and trade show participation. By year
end, a non-exclusive contractual relationship with over 100 security dealers was
established. These and additional dealers are expected to generate significant
SentryVision(r) installations in industrial and institutional facilities in
1999.
In addition, the Company began to market SentryVision(r)
internationally using independent distributors. The distribution agreements
generally appoint a distributor for a specified term as the exclusive
distributor for a specified territory. The agreements require the distributor to
purchase a minimum dollar amount of the Company's product during the term of the
agreement to retain exclusivity. The Company sells its 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, 1998,
the Company had signed distribution agreements for Canada, Brazil, UK, France,
Switzerland, Spain, Portugal, South Africa and Korea.
During 1998 Video placed in service 198 SentryVision(r) systems and
4,405 CCTV cameras and peripherals.
Knogo
Knogo 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(tm) 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(tm) system, as the customer replenishes its
inventory, additional targets will be required for those items to be protected.
The Company also markets a more expensive, removable, reusable detection tag for
use with the Knoscape MM(tm) systems on certain products such as clothing and
other soft goods.
During the year ended December 31, 1998, Knogo placed in service 439
Knoscape RF(tm), Ranger(tm), and Knoscape MM(tm) systems, compared to 600
systems in the prior year. The Company does not believe that the loss of any one
EAS customer would have a material adverse effect on the Company's business.
RF and Ranger systems will continue to be used by apparel and
department stores due to wide exit areas and desire for deterrence of reusable
hard tags. Both the Silver Cloud(tm) and Knoscape RF systems are universal in
that they can detect both 2 MHZ hard tags and 8 MHZ labels. 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. In 1999,
Knoscape MM Systems will feature updated digital electronics. Knoscape MM
Systems detect virtually all manufacturers' magnetic strips and can universally
replace older magnetic strip systems manufactured by various EAS vendors.
The library market continues to be a substantial market for magnetic
technology. In March 1996, 3M and Knogo entered into a strategic alliance to
provide universal asset protection to libraries across North America. The
agreement, recently extended through March 2002, permits Knogo to act as a
distributor of all of 3M's library products, including the 3M Tattle-Tape(tm)
Security Strips, detection systems, 3M SelfCheck System hardware and software
and other 3M library materials flow management products and accessories to
public, academic and government libraries. In 1998, the Company designed and
developed for 3M a new library specific magnetic EAS system which in turn will
be added to this product listing. Under the agreement 3M provides service and
installation for all new and existing Knogo library customers throughout North
America.
The Company markets EAS technology services to the computer industry
through its patented SecureBoard(tm) process. The Company believes that the
integration of Knogo's SecureBoard(tm) system into an overall loss prevention
program in the computer industry would significantly curb thefts of PC boards,
memory chips and other computer components. Using SecureBoard(tm) technology,
licensed KNOGO ENABLED(tm) board manufacturers can embed EAS material into an
internal layer of a printed circuit board, making SecureBoard(tm) the first EAS
system to be compatible with high volume printed circuit board manufacturing
processes. While marketing continues, no significant revenue was produced from
this market to date.
Backlog
The Company's backlog of orders was approximately $4.1 million at
December 31, 1998 as compared with approximately $10.3 million at December 31,
1997. The decrease is due primarily to the timing of orders from the Company's
major customers. The Company anticipates that substantially all of the backlog
at the end of 1998 will be delivered during 1999. In the opinion of management,
the amount of backlog is not indicative of intermediate or long-term trends in
the Company's business.
Seasonal Aspects of the Business
The Company's current customers are primarily dependent on retail
sales which are seasonal and subject to significant fluctuations which are
difficult to predict. In the Company's experience, orders and installations are
generally the lowest in the first quarter of each year.
Service
Installation services are performed by both the Company's personnel
and carefully screened and supervised subcontractors. Repair and maintenance
services for Video and Knogo are performed primarily by the Company's personnel.
All products sold or leased are covered either by a short warranty period or an
extended warranty period. Generally, Video's products provide for a one-year
warranty and Knogo's products for a 90-day warranty. After the warranty period,
the Company offers to its customers the option of entering into a maintenance
contract with the Company or paying for service on a per call basis.
Throughout 1998, the Company's focus was on recruiting and training
entry level installers for SentryVision(r) and CCTV. The plan was to
strategically locate teams throughout North America for cost effective coverage.
As the CCTV/SentryVision(r) business grew, Sentry was able to keep pace with the
installation schedules. Hotel and meal costs for installation teams, however,
began to quickly grow as the Company was successful in selling larger
CCTV/SentryVision(r) projects for which installations lasted from a week to a
month. To reduce the costs, some major installations were selectively
sub-contracted to local contractors. This resulted in lower installation costs
without a sacrifice in installation quality and cost versus employee labor.
Sentry expects to support the growth of the CCTV/SentryVision(r)
business in 1999 exclusively through the use of subcontractors, while
maintaining only currently existing installation and service capabilities. This
strategy should result in a substantial expense savings when compared to the
cost of enlarging the Company's installation staff.
Qualified supervisors will inspect subcontracted jobs and provide
technical support as needed. In addition, these supervisors will provide
training and support for the existing and additional domestic and international
distributors and dealers.
The use of subcontractors for installations is expected to grow in the
years ahead. Sentry's employee base will become more technically skilled as the
mechanical work diminishes. The Company will focus on EAS, SentryVision(r) and
CCTV technical service and maintenance and subcontract installation. In this
way, the Company retains its reputation of technical expertise within the
industry.
Competition
The Company operates 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, mirrors, guards, private
detectives and combinations of the foregoing. The Company competes 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 the Company's knowledge, there are several other companies that
market, directly or through distributors, traditional closed circuit video
systems and/or EAS equipment to retail stores, of which Sensormatic, Checkpoint
Systems, Inc., Phillips, Inc., Pelco Manufacturing, Inc., and Ultrak, Inc. are
the Company's principal competitors. Outside the US, the Company is aware of
other companies that market other types of traveling CCTV systems including
Lextar Technologies, Ltd. in Australia, T.E.B. and DETI in France and Moving
Cameras Ltd. in the UK. Some of the Company's competitors have far greater
financial resources, more experienced marketing organizations and a greater
number of employees than the Company.
In connection with the Spinoff and Sensormatic Merger, Knogo agreed
with Sensormatic that Knogo will not compete with Sensormatic in selling EAS and
conventional CCTV products in areas outside of the United States, Canada and
Puerto Rico through the period ending December 29, 1999. However, the agreement
does not affect Sentry's ability to sell its SentryVision(r) system worldwide.
Patents and Other Intellectual Property
Video
Video's core United States patent, which expires in 2011, covers the
cable-free transmission of the 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. A U.S. patent
application was recorded in 1998 for improvements made to such technology. Video
also has received a corresponding European patent and nine foreign country
patents. The Company also has pending four patents for additional corresponding
foreign patents. The Company intends to seek patent protection on specific
aspects of the SentryVision(r) system, as well as for certain aspects of new
systems which may be developed for Video. 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 Video.
The Company is not aware of any infringement of patents or
intellectual property held by third parties. However, if Video is determined to
have infringed on the rights of others, Video and/or the Company 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, the Company could be required to expend
significant resources to develop non-infringing technology.
The Company is aware of an Australian patent and an Australian patent
application describing certain aspects of a product which in some respects is
similar to the SentryVision(r) system. The Company's patent attorneys have
advised it that the Australian patent and Australian patent application appear
to have lapsed. To the Company's knowledge, the holder of the Australian patent
is not currently marketing, within the United States or Europe, the product
covered by the Australian patent. In addition, no issued patents or patent
applications corresponding to the Australian patent or the Australian patent
application have been uncovered in the United States or any other foreign
country.
The Company is also aware of a British patent application from a third
party disclosing aspects of a device which is in some respects similar to the
SentryVision(r) system. The Company's patent attorneys have advised it that the
British patent application appears to have lapsed. In addition, no issued
patents or patent applications corresponding to the British patent application
have been uncovered in the United States or any other foreign country. To the
Company's knowledge, the applicant is not currently marketing the product
described in the application.
Video has also relied on the registration of trademarks and
tradenames, as well as on trade secret laws and confidentiality agreements with
its employees. While the Company intends to continue to seek to protect Video's
proprietary technology and developments through patents, trademark registration,
trade secret laws and confidentiality agreements, the Company does not rely on
such protection to establish and maintain Video's position in the marketplace.
The Company's management believes that improvement of Video'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.
Knogo
Knogo has 25 United States and Canadian patents and three patent
applications relating to (i) the method and apparatus for the detection of
movement of articles and persons and accessory equipment employed by Knogo in
its Knoscape RF(tm), Ranger(tm) and Knoscape MM(tm) systems, (ii) various
specific improvements used in the Knoscape RF(tm), Ranger(tm) and Knoscape MM
(tm) systems and (iii) various electrical theft detection methods, apparatus and
improvements not presently used in any of Knogo's EAS systems. Although patent
protection is advantageous to Knogo, the Company's management does not consider
any single patent or patent license owned or held by Knogo to be material to its
operations, but believes that Knogo's competitive position ultimately will
depend on its experience, know-how and proprietary data, engineering, marketing
and service capabilities and business reputation, all of which are outside the
scope of patent protection.
Sensormatic and Knogo license certain patent rights and technology of
Old Knogo to each other, for use in their respective territories, pursuant to
the License Agreement dated December 29, 1994, entered into in connection with
the Sensormatic Merger. In addition, Sensormatic has rights to manufacture and
sell SuperStrip within the United States, Canada and Puerto Rico. In 1998, the
Company filed a first U.S. patent application for optically identifying
counterfeit goods and a second U.S. patent application for confirming the
authenticity of an article using a magnetic reader.
Research and Development
At December 31, 1998, Sentry had 14 employees located in the United
States engaged either full- or part-time in research and engineering and product
development. The Company may from time to time retain consultants for specific
project assistance. For the years ended December 31, 1998, 1997 and 1996,
approximately $1,342,000, $1,658,000 and $1,686,000, respectively, was expended
on Company-sponsored research.
Video
During 1998, the majority of the Company's research and development
expenditures were directed towards improving the reliability, performance, and
manufacturability of the SentryVision(r) product.
While continuing to support and upgrade the installed base of the
current generation SentryVision(r) system and the previous generation systems,
the Company recognized the need to develop newer versions of these systems which
will offer substantial improvements in cost, performance, and ease of
installation. A two phase approach to this goal has been implemented by the
research and development group. The first, and more immediate of these two
efforts was to build on the improvements already made to the current
SentryVision(r) product while maintaining compatibility with the existing
system. The second, a longer term project, is the development of a substantially
new system which offers better performance and lower cost by exploiting PC
control technologies and dramatic reduction in the size of the carriage and
associated track. In 1998, the Company substantially completed the first of
these projects, and made significant progress on the second.
Knogo
The Company continued its research and development activities with
respect to EAS products. In 1998, these included the development of a new Silver
Cloud overhead system which detects all 8 MHz hard tags and disposable paper
tags sold by the Company and others in the industry. In addition, continued
improvements were made to the performance of Knoscape RF(tm) and Ranger(tm)
systems.
During 1998, Sentry designed and developed for 3M a new magnetic EAS
library system which resulted in revenues to the Company of $1.2 million. It
also completed its project for the development of a low-cost 8 MHz system for
another third party for lower-tier retail environments.
Regulation
Because Knogo's EAS systems and Video's surveillance and CCTV systems
use radio transmission and electromagnetic wave principles, such systems are
subject to regulation by the Federal Communications Commission ("FCC") under the
Communications Act of 1934. In those instances where it has been required,
certification of such products by the FCC has been obtained. As new products are
developed by the Company, application will be made to the FCC for certification
or licensing when required. No assurance can be given that such certification or
licensing will be obtained or that current rules and regulations of the FCC will
not be changed in an adverse manner.
Sentry's business plan calls for the sale and use of Sentry's products
in domestic markets and, where consistent with contractual obligations, in
international markets. Sentry's products may be subject to regulation by
governmental authorities in various countries having jurisdiction over
electronic and communication use. Sentry intends to apply for certification of
its products to comply with the requirements under the regulations of the
countries in which it plans to market its products. No assurance can be given
that such certification will be obtained or that current rules and regulations
in such countries will not be changed in a manner adverse to Sentry.
The Company believes it is in material compliance with applicable
United States, state and local laws and regulations relating to the protection
of the environment.
Employees
At December 31, 1998, the Company and its subsidiaries employed 216
full-time employees, of whom four were engaged in executive capacities, 21 in
administrative and clerical capacities, 13 in engineering, research and
development, 56 in production, 33 in marketing and sales and 89 in customer
service. None of the Company's employees are employed pursuant to collective
bargaining agreements. The Company believes that its relations with its
employees are good.
Item 2. Properties.
The Company's principal executive, sales and administrative offices,
and its United States production, research and development and distribution
facilities are located in Hauppauge, New York, in a 68,000 square foot facility
leased by the Company. At December 31, 1998, the Company owned a 55,000 square
foot manufacturing facility in Cidra, Puerto Rico and a one-story building
consisting of approximately 6,000 square feet in Villa Park, Illinois. Both
facilities were sold in February 1999. The former facilities of Video in Eden
Prairie, Minnesota have been sublet through the period ending with the
termination of the overlease on March 31, 1999.
Item 3. Legal Proceedings.
Although the Company is involved in ordinary, routine litigation
incidental to its business, it is not presently a party to any other legal
proceeding, the adverse determination of which, either individually or in the
aggregate, would be expected to have a material adverse affect on the Company's
business or financial condition.
Item 4. Submission of Matters to a Vote of Security Holders.
During the fourth quarter of the fiscal year ended December 31, 1998,
there were no matters submitted to a vote of the Company's security holders,
through the solicitation of proxies or otherwise.
PART II
Item 5. Market for the Company's Common Equity and Related Stockholder Matters.
(a) Price Range of Common Stock.
The following table sets forth, for the periods indicated, the high,
low and closing sales prices per share of common stock as reported on the
American Stock Exchange composite tape.
Stock Prices
High Low Close
1998
First Quarter $2 $ 1 1/4 $ 1 1/4
Second Quarter 1 1/2 7/8 1 1/16
Third Quarter 1 1/8 9/16 13/16
Fourth Quarter 1 1/2 5/8
1999
First Quarter
(through March 29, 1999) $11/16 $5/16 $ 5/16
(b) Holders of Common Stock.
The Common Stock began trading on the American Stock Exchange on
February 13, 1997 under the symbol "SKV." Prior to such date, no public market
for the Common Stock existed. As of March 29, 1999, the Company had 9,750,760
shares of Common Stock issued and outstanding, which were held by 264 holders of
record and approximately 4,000 beneficial owners.
(c) Dividends.
The payment of future dividends will be a business decision to be made
by the Board of Directors of Sentry from time-to-time based upon the results of
operations and financial condition of Sentry and such other factors as the Board
of Directors considers relevant. Sentry has not paid, and does not presently
intend to pay or consider the payment of, any cash dividends on the Common
Stock. In addition, covenants in the Company's credit agreement prohibit the
Company from paying cash dividends without the consent of the lender.
Sentry is required to pay certain annual or semiannual dividends on
the Class A Preferred Stock. Under the terms of the Company's loan agreement as
presently in effect, no consent of the Company's commercial lender is required
for such payment. However, based on current discussions with the Company's
lender, cash dividends on the Class A Preferred Stock are expected to be
restricted. The annual dividend rate on each share of the Class A Preferred
Stock has been fixed at five percent (5%) of the $5.00 per share face value (the
"Face Value") of such stock, payable as described below. The holders of shares
of the Class A Preferred Stock are entitled to receive dividends on the
following dates (each, a "dividend payment date"): February 12, 1998 and 1999,
August 12, 1999 and 2000, February 12, 2000 and 2001; the 12 month period ending
on each of the first two dividend payment dates is an "annual dividend period,"
the six month period ending on each of the next four dividend payment dates is a
"semi-annual dividend period," and each such annual dividend period or
semi-annual dividend period is a "dividend period." Dividends (whether or not
declared) are payable in additional shares of the Class A Preferred Stock during
the two annual dividend periods ending on the first two dividend payment dates
subsequent to issuance of the Class A Preferred Stock, such that holders shall
receive a dividend of 1/20th of a share of Class A Preferred Stock for each
share of Class A Preferred Stock held. The last such dividend was paid on
February 12, 1999. Beginning with the August 12, 1999 dividend, the holders of
shares of the Class A Preferred Stock are entitled to receive, in preference to
dividends on all classes of equity securities of Sentry to which the Class A
Preferred Stock ranks prior (such securities, the "Junior Stock"), and whether
or not declared, a dividend payable in cash, out of funds legally available for
the payment of dividends, of $0.25 for each share of Class A Preferred Stock
held, which dividend shall accrue semi-annually and be due in equal installments
on each of the last four dividend payment dates. All dividends paid with respect
to shares of the Class A Preferred Stock pursuant to this paragraph shall be
paid pro rata to the holders entitled thereto.
Whenever, at any time or times, any dividend payable shall be in
arrears, the holders of the outstanding shares of Class A Preferred Stock shall
have the right, voting separately as a class, to elect two directors of Sentry
no later than two years after such dividend shall be, and continue, in arrears.
Upon the vesting of such right of the holders of Class A Preferred Stock, the
maximum authorized number of members of the Sentry Board shall automatically be
increased by two and the two vacancies so created shall be filled by vote of the
holders of the outstanding shares of Class A Preferred Stock. The right of the
holders of Class A Preferred Stock to elect two members of the Sentry Board as
aforesaid shall continue until such time as all dividends in arrears shall have
been paid in full, at which time such right shall terminate, except as herein or
by law expressly provided, subject to revesting in the event of each and every
subsequent default of the character above described.
No cash dividends may be paid on any Junior Stock until all
accumulated dividends on the Class A Preferred Stock shall have been paid. If
the Sentry Board declares, and Sentry pays or sets funds apart for payment of,
any dividend on any of the Junior Stock, the holders of the Class A Preferred
Stock shall share equally, share and share alike, in the distribution of any and
all dividends declared on such Junior Stock, provided that for this purpose each
share of Class A Preferred Stock shall be treated as one share of such Junior
Stock.
(d) Redemption Provisions of Class A Preferred Stock.
The shares of Class A Preferred Stock may be redeemed at the option of
the Company beginning February 12, 1998, and are mandatorily redeemable on
February 12, 2001. The redemption price is $5.00 per share plus the amount, if
any, by which the average of the closing prices for a share of Common Stock
during the twenty trading-day period before redemption exceeds $5.00 (such
aggregate price, the "Redemption Price").
Optional Redemption. Subject to the mandatory redemption provisions of
the Class A Preferred Stock summarized below, Sentry may, at its option, redeem
the Class A Preferred Stock for cash at any time in whole at the Redemption
Price, together with accrued and unpaid dividends, if any, thereon. If Sentry
completes a Public Offering (as defined below) or an Acquisition (as defined
below) more than 35 days prior to the Mandatory Redemption Date (as defined
below), then Sentry may, at its option, redeem the Class A Preferred Stock for
Common Stock at the then applicable Redemption Price.
"Public Offering" means an underwritten public offering of Common
Stock with net proceeds resulting therefrom in excess of $12,000,000.
"Acquisition" means an acquisition by Sentry of property of or securities issued
by a third party in which the consideration paid by Sentry (i) consists, in
whole or in part, of shares of Common Stock and (ii) the aggregate value of such
shares of Common Stock exceeds $12,000,000; provided that such aggregate value
shall be based upon the number of such shares of Sentry Common Stock multiplied
by the average of the closing prices for a share of Common Stock during the
twenty trading-day period before the closing date of such Acquisition.
Mandatory Redemption. On February 12, 2001 (the "Mandatory Redemption
Date"), so long as any shares of the Class A Preferred Stock shall be
outstanding, Sentry shall redeem any issued and outstanding Class A Preferred
Stock at the then applicable Redemption Price, together with accrued and unpaid
dividends, if any, thereon, for cash or Common Stock, at Sentry's option. If
funds are not legally available for the payment of the Mandatory Redemption and
the Company does not issue Common Stock to pay the Redemption Price, each
outstanding share of Class A Preferred Stock shall automatically convert into a
subordinated promissory note payable one year from the Mandatory Redemption Date
and bearing interest at a rate of 6% per annum. The notes shall be subordinated
to the prior payment in full of all senior indebtedness, as defined in the
Certificate of Designation.
For additional information with respect to the Class A Preferred
Stock, see Note 1 to the Consolidated Financial Statements.
Item 6. Selected Financial Data
The Company was incorporated in October 1996. However, information
with respect to the results of operations of the Company in this Form 10-K is
presented as if the Spinoff and Sensormatic Merger were consummated as of March
1, 1994. The table below sets forth selected consolidated historical financial
data of the Company for the ten-month period ended December 31, 1994 and the
years ended December 31, 1995, 1996, 1997 and 1998. This consolidated financial
data includes certain assets and liabilities of Knogo, on a historical basis,
relating to Knogo's operations in the United States, Canada and Puerto Rico
prior to February 12, 1997 and include the results of operations of Video Sentry
after that date. The selected consolidated historical financial data should be
read in conjunction with the audited Consolidated Financial Statements of the
Company included in Item 8 and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included in Item 7.
(Amounts in thousands except for per share data)
Ten Months
Ended Year
December 31, Ended December 31,
1994 1995 1996 1997 1998
Summary of Operations Data:
Sales, service, rentals and other $13,724 $17,361 $18,612 $21,996 $26,364
Sales to affiliates/Sensormatic 6,957 12,043 4,651 2,570 1,792
Total revenues 20,681 29,404 23,263 24,566 28,156
Cost of sales 10,041 14,425 11,935 12,882 14,412
Customer service expenses 3,353 3,235 2,932 4,772 6,253
Selling, general and administrative
expenses 9,548 8,235 7,345 9,629 10,118
Gain on sale of assets - - 2,462 - -
Write-off of in-process research and
development - - - 13,200 -
Income (loss) before income taxes (2,858) 1,941 1,847 (17,743) (4,483)
Net income (loss) (2,833) 1,731 1,183 (17,917) (4,504)
Preferred stock dividends - - - 1,067 1,263
Net income (loss) available to
common shareholders (2,823) 1,731 1,183 (18,984) (5,767)
Net income (loss) per common share:
basic * 0.37 0.25 (2.08) (0.59)
diluted * 0.35 0.23 (2.08) (0.59)
Selected Balance Sheet Data:
(at end of period)
Working capital $9,559 $11,326 $18,076 $12,415 $12,668
Total assets 26,522 29,338 32,857 35,937 33,496
Property, plant and equipment, net 9,842 9,081 7,288 6,948 4,348
Obligations under capital leases 945 748 3,546 3,313 3,241
Redeemable cumulative preferred stock - - - 25,254 26,517
Total common shareholders' equity 20,888 22,669 25,248 1,792 (3,975)
See the notes to the Consolidated Financial Statements included elsewhere herein.
* Historical per share data for earnings and dividends have not been
presented for the ten months ended December 31, 1994 as Knogo was not a
publicly-held company during this period.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Results of Operations
Year Ended December 31, 1998 Compared with Year Ended December 31, 1997
Consolidated revenues were 15% higher in the year ended December 31,
1998 than in the year ended December 31, 1997. Revenues from customers other
than Sensormatic were $26,364,000 or 94% of total revenues as compared to
$20,820,000 or 85% of total revenues in the prior year. This represents a 27%
increase in revenues from non-Sensormatic customers in 1998 over the prior year.
The backlog of unfilled orders expected to be delivered within twelve months was
$4.1 million at December 31, 1998 compared to $10.3 million at December 31,
1997. The reduction in backlog is primarily due to the timing of blanket orders
received from its major customers as of year end.
Sales increased 26% primarily as a result of higher sales of
traditional CCTV products which increased 90% to $6.9 million or 30% of sales in
1998 as compared to $3.6 million or 20% of sales in 1997. Sales of the
SentryVision(r) traveling CCTV surveillance systems increased 43% to $6.2
million or 27% of sales in 1998 as compared to $4.3 million or 24% of sales in
the previous year. EAS system sales decreased slightly to $7.6 million from $7.7
million representing 34% and 43% of sales in 1998 and 1997, respectively. Sales
of 3M library systems decreased 17% to $1.9 million or 9% of sales as compared
to $2.3 million or 13% in 1997. The Company continued its efforts to market CCTV
and SentryVision(r) systems to parking garages, transportation centers, retail
and distribution centers, correctional facilities and educational market
segments. EAS and 3M library system sales declined as a result of both
competitive pressures and continued marketing focus on CCTV products.
Although the supply agreement with Sensormatic expired and minimum
purchase obligations ended as of June 30, 1997, Sensormatic continued to
purchase certain EAS products from the Company at substantially similar margins.
Sales to Sensormatic decreased by 30% to $1.8 million in 1998 as compared to
$2.6 million in 1997. Sensormatic has indicated it will continue to purchase
certain EAS products from the Company in the future.
The decline in service revenues and other of 8% or $0.3 million was
primarily related to a decrease in service billings from the EAS customer base.
Included in other revenues in 1998 were $1.2 million in engineering fees from 3M
for the design and development of a new EAS library system. In 1997, other
revenues included $1.2 million representing the cumulative profits on the
shortfall on minimum orders under the supply agreement with Sensormatic.
During 1998, Sentry embarked on a program to reduce operating and
manufacturing costs through the consolidation of facilities company-wide. The
most significant portions of the program included the relocation of its CCTV
design center from Illinois to its corporate headquarters in New York, which was
completed in the second quarter, and the closing of its Puerto Rico
manufacturing plant which was completed before year end. The Puerto Rico
facility was originally established in 1985 as a low cost operation for the
labor intensive manufacturing of Knogo's worldwide supply of EAS tags and, in
later years, detection systems. Primarily as a result of the 1994 acquisition by
Sensormatic of Knogo's international EAS business, sales of EAS tags and systems
declined resulting in excess capacity in the Puerto Rico plant. Additionally,
technological advances made in the EAS products and in the CCTV products
acquired in the merger with Video Sentry Corporation resulted in a lower labor
content in all of the Company's manufactured products. Manufacturing operations
previously performed in Puerto Rico have been transferred to available space in
its New York distribution center. Based on current production levels, the
Company anticipates that the consolidation of facilities will result in future
annual savings in excess of $1 million through reductions in cost of sales and
operating expenses. Management believes that the New York facility will have
more than sufficient production capacity to meet Sentry's projected future
growth. The overall cost of these facility consolidations was $1.2 million in
1998. Of such charges, $0.8 million was included in cost of sales relating to
costs to move inventory and manufacturing equipment, hiring and training costs
and certain inventory write-downs and $0.4 million was included in selling,
general and administrative expenses related to the write-down of one of our
facilities to net realizable value, employee separation costs and the net losses
on the disposal of excess equipment.
Cost of sales to customers other than Sensormatic and excluding the
consolidation of facility charges above were 55% of such sales in 1998 as
compared to 62% in 1997. The reduction in percentage in 1998 is primarily
attributable to better product sourcing and engineering improvements in the CCTV
and SentryVision(r) product lines.
Customer service expenses increased 31% in 1998 as compared to 1997
due to a higher number of customer service representatives required to install
and maintain the increasing CCTV and SentryVision(r) customer base.
Selling, general and administrative expenses increased 5% to $10.1
million from $9.6 million but decreased as a percentage of total revenues to 36%
from 39% in 1998 and 1997, respectively. The increase in spending in 1998 is
primarily related to the consolidation of facilities charges noted above, higher
warranty and financing costs offset by lower sales and marketing expenses.
The Company's research and development costs decreased by 19% in 1998
as compared to 1997. Efforts in 1998 were primarily directed towards
improvements in the Sentry Vision(r) systems and the design and development of a
new EAS library system for 3M.
At the consummation of the merger in the first quarter of 1997, Sentry
recorded for that period a non-recurring charge of $13,200,000 relating to
purchased in-process research and development. The amount was based on the
purchase price allocation and a valuation of existing technology and technology
in-process. The charge for in-process research and development equaled its
estimated current fair value based on the risk adjusted cash flows of
specifically identified technologies for which the technological feasibility has
not been established and alternative future uses did not exist.
Net interest expense increased by $345,000 in 1998 over 1997 primarily
due to borrowings under the Company's revolving credit agreement, which became
effective at the beginning of 1998.
Sentry's income taxes in 1998 and 1997 represent provisions on the
cumulative earnings of the Puerto Rico manufacturing which cannot be offset by
operating losses of other subsidiaries.
As a result of the foregoing, Sentry had a net loss of $4,504,000 in
the year ended in December 31, 1998 as compared to a net loss of $17,917,000 in
the year ended December 31, 1997.
Preferred stock dividends of $1,263,000 and $1,067,000 have been
accrued in 1998 and 1997, respectively. These amounts have been paid-in-kind as
of February 12, 1999 and 1998, respectively.
Year Ended December 31, 1997 Compared with Year Ended December 31, 1996
Consolidated revenues were 6% higher in the year ended December 31,
1997 than in the year ended December 31, 1996. Revenues from customers other
than Sensormatic were $20,820,000 or 85% of total revenues as compared to
$17,525,000 or 75% of total revenues in the prior year. This represents a 19%
increase in revenues from non-Sensormatic customers in 1997 over the prior year.
The backlog of unfilled orders expected to be delivered within 12 months was
$10.3 million at December 31, 1997 compared to $1.7 million at December 31,
1996.
Sales increased 18% primarily as a result of the SentryVision(r)
traveling CCTV surveillance system acquired during the Merger which represented
$4.3 million or 24% of sales in 1997. Sales of traditional CCTV products were
flat at $3.6 million in both 1997 and 1996 and represented 20% and 24% of sales,
respectively. Sales of EAS systems declined 23% to $7.7 million or 43% of sales
in 1997 as compared to $9.3 million or 61% in 1996. Sales of 3M library systems
were flat at $2.3 million in both years representing 13% of sales in 1997 and
15% in 1996. EAS System sales declined as a result of both competitive pressures
and the refocusing of Knogo's marketing efforts on Sentry Vision(r).
Sales to Sensormatic decreased 45% to $2.6 million in 1997 as compared
to $4.7 million in 1996. During the first six months of 1997 and in the year
ended 1996 when the Supply Agreement was in place, Sensormatic did not meet its
minimum order amounts and, accordingly, the Company recorded in other revenues
the cumulative profits on the shortfall payable to the Company pursuant to the
agreement. These amounts represented $1.2 million and $1.1 million in 1997 and
1996. Although the Supply Agreement officially expired as of June 30, 1997 and
minimum purchase obligations ended, Sensormatic continued to purchase certain
EAS products from the Company after that period.
The increase in service revenues and other of 18% or $0.6 million in
1997 as compared to 1996 was primarily related to increase in maintenance
contracts from the SentryVision(r) customer base.
Cost of sales to customers other than Sensormatic were 62% of such
sales in 1997 as compared to 59% in 1996. The increase in cost of sales
percentage is primarily related to the change in product mix. Although the
Company made significant cost reductions through better vendor sourcing and
engineering improvements to the SentryVision(r) product line since the Merger,
these systems still carried lower margins than traditional EAS products. Cost of
sales was also negatively impacted by lower fixed cost absorption due to lower
production levels during the year at the Company's Puerto Rico manufacturing
facility. The gross margins on sales to Sensormatic under the Supply Agreement
was fixed at 35%. Margins on the sales to Sensormatic in the second half of the
year after the agreement expired were substantially the same.
Customer service expenses were 63% greater in 1997 as compared to 1996
due to the addition of the Video customer service staff as well as new hires,
technical updates made to the existing installed Video customer base and cross
training for existing staff on EAS and CCTV (including SentryVision(r)) product
lines.
The increase in selling, general and administrative expenses to $9.6
million in 1997 from $7.3 million in 1996 was primarily a result of higher sales
and marketing costs associated with the promotion of the new SentryVision(r)
systems and the amortization of goodwill and intangibles acquired in the Merger
of $1,429,000 in 1997.
The Company's research and development costs, which remained
substantially the same in dollar terms, were directed primarily towards
improvements in the SentryVision(r) systems during the year.
At the consummation of the Merger in the first quarter of 1997, Sentry
recorded for that period a non-recurring charge of $13,200,000 relating to
purchased in process research and development. The amount was based on the
purchase price allocation and a valuation of existing technology and technology
in-process. The charge for in-process research and development equaled its
estimated current fair value based on risk adjusted cash flows of specifically
identified technologies for which the technological feasibility has not been
established and alternative future uses did not exist.
The Company had net interest expense in the current year as compared
to net interest income in 1996. Interest income was $139,000 in 1997 as compared
to $164,000 in 1996. As a result of the Merger, the Company reduced the amount
of its temporary investments. Interest expense was $307,000 in 1997 as compared
to $144,000 in 1996. The increase is primarily related to the capitalized lease
on the Company's corporate headquarters entered into at the end of 1996.
In the first quarter of 1996, the Company sold certain assets to 3M,
consisting of patents and technology, for a purchase price of $3.0 million. The
proceeds, net of certain costs including patent costs, inventory write downs,
new product training costs, legal and other costs, resulted in a gain of
approximately $2.5 million which is included in the results of that period.
Sentry's income taxes in 1997 represent provisions on the cumulative
earnings of the Puerto Rico manufacturing operations which cannot be offset by
operating losses of other subsidiaries. The higher amount in 1996 was primarily
related to the tax on the gain of assets to 3M which were taxed at the statutory
federal tax rate.
As a result of the foregoing, Sentry has a net loss of $17,917,000 in
the year ended December 31, 1997 as compared to net income of $1,183,000 in the
year ended December 31, 1996.
Preferred stock dividends of $1,067,000 have been accrued in 1997.
These amounts were paid-in-kind as of February 12, 1998. See Note 1 to the
Consolidated Financial Statements.
Liquidity and Capital Resources
The Company's liquidity needs over the last three years have been
related to working capital, acquisitions and, to a lesser extent, capital
expenditures. During this time, it has met these liquidity needs primarily
through the proceeds from borrowings under its revolving credit facility, the
sale and leaseback transaction involving its corporate headquarters and the sale
of certain assets to 3M.
The Company has a secured revolving credit facility with GE Capital
Corporation which permits borrowings of up to a maximum of $8 million, subject
to availability under a borrowing base formula consisting of accounts receivable
and inventories. The credit agreement expires on December 31, 1999. The facility
is secured by a lien on substantially all of the Company's assets. At December
31, 1998, the Company had borrowings of $2,765,000 under the facility. Based
upon discussions between Sentry's management and senior lending officers at GE
Capital Corporation, Sentry believes that a new facility will be made available
to it for at least the same amount and on substantially the same terms as are
currently available to the Company (except restricting the payment of cash
dividends -- See "Market for the Company's Common Equity and Related Stockholder
Matters").
Subsequent to year-end the Company sold its Puerto Rico and Illinois
facilities for a gain of approximately $500,000 which will be recorded in the
first quarter of 1999. The cash proceeds, which were in excess of $2 million,
were used to reduce borrowings under the revolving credit facility.
Going forward, Sentry will require liquidity and working capital to
finance increases in receivables and inventory associated with sales growth and,
to a lesser extent, for capital expenditures. The Company anticipates that its
significant 1999 capital expenditures will consist of $700,000 to upgrade
computer hardware and software and to acquire customer service equipment.
The Company anticipates that current cash reserves, cash generated by
operations and the sale of certain facilities in the first quarter of 1999 and
the financing arrangements described above should be sufficient to meet the
Company's working capital requirements as well as future capital expenditure
requirements for the next twelve months.
Recently Issued Accounting Standard
During 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which defines derivatives, requires that
all derivatives be carried at fair value, and provides for hedge accounting when
certain conditions are met. SFAS No. 133 is effective for the Company in fiscal
1999. Although the Company has not fully assessed the implications of SFAS No.
133, the Company does not believe adoption of this statement will have a
material impact on the Company's consolidated financial statements.
Preparation for the Year 2000
Many existing computer programs were designed and developed without
considering the upcoming change in the century, which could lead to the failure
of computer applications or create erroneous results by or at the Year 2000. On
January 1, 2000, any computer system or other equipment using date sensitive
software which uses only two digits to represent the year may recognize "00" as
the year 1900 rather than the year 2000. This could result in a system failure
or miscalculations causing disruptions of operations, including among other
things, a temporary inability to process transactions, send invoices, or engage
in similar activities.
Recognizing the potential impact, the Company began actively resolving
its Year 2000 compliance issues in early 1997. Using internal and external
resources, the Company analyzed and assessed its business systems, including
computer systems, PC's and network hardware, telephone systems, production
process controllers, access control, office equipment and the products it sells.
Upgrades to both mid-range and network computer hardware, operating
systems and related infrastructures have been completed and are now Year 2000
compliant. All critical application software has been reviewed and Year 2000
compliant versions have been obtained. The Company has completed the process of
retrofitting custom modifications to the upgraded versions. All applications
with forward scheduling impact are now considered to be Year 2000 compliant. The
Company believes its manufactured products are Year 2000 compliant.
The cost of becoming compliant is not expected to exceed $320,000 and
approximately $99,000 was incurred in 1998. The remaining costs relate primarily
to hardware upgrades to the Company's PC's and telephone systems which will be
completed by mid-1999. There can be no assurance that the Company will not incur
unanticipated costs or that it will be able to successfully address all Year
2000 issues.
The impact of the Year 2000 issue on the Company will also be affected
by the Year 2000 readiness of its business partners, customers, suppliers and
vendors and providers of facilities, equipment and services. Failure by these
third parties to be Year 2000 compliant may adversely affect, among other
things, the Company's production, revenue and the timing of cash receipts. The
Company has begun to make inquiries of such third parties in this regard and
based on the responses to these inquiries, the Company will decide to what
extent, if any, a contingency plan should be developed. To date, however, the
Company has received only preliminary feedback from such third parties and has
not independently confirmed any information received from such third parties
with respect to Year 2000 issues. As such, there can be no assurance that such
third parties will address the Year 2000 issue and complete their Year 2000
conversion in a timely fashion or will not suffer a Year 2000 business
disruption that may adversely affect the Company's business.
Inflation
The Company does not consider inflation to have a material impact on
the results of operations.
Cautionary Statement Regarding Forward-Looking Statements
The "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and other sections of this Annual Report on Form 10-K
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 below, 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 inherent in
the relatively small number of Video customers, such that any delay or
cancellation of orders from one or more of its 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
subcontractors to provide future installation services; (v) 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"; and (vi) the risk resulting from the limited geographical
market in which the Company may offer its EAS products, exposing the Company to
a possible business downturn caused by a general business decline in that
market; this market limitation is contractual and will continue until December
29, 1999.
Items 8 and 14(a)(1) and 14(a)(2). Financial Statements.
SENTRY TECHNOLOGY CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS Page
INDEPENDENT AUDITORS' REPORT 30
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of December 31, 1998 and 1997 31
Consolidated Statements of Operations for the Years Ended
December 31, 1998, 1997 and 1996 32
Consolidated Statements of Shareholders' Equity for the
Years Ended December 31, 1998, 1997 and 1996 33
Consolidated Statements of Cash Flows for the
Years Ended December 31, 1998, 1997 and 1996 34
Notes to Consolidated Financial Statements 35
SCHEDULE II - Valuation and Qualifying Accounts 48
INDEPENDENT AUDITORS' REPORT
Board of Directors
Sentry Technology Corporation
Hauppauge, New York
We have audited the accompanying consolidated balance sheets of Sentry
Technology Corporation and subsidiaries as of December 31, 1998 and 1997 and the
related consolidated statements of operations, shareholders' equity and cash
flows for each of the three years in the period ended December 31, 1998. Our
audits also included the financial statement schedule listed in the Index at
item 14(a)(1) and (2). These financial statements and financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on the consolidated financial statements and financial
statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
Also, in our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
/s/ Deloitte & Touche LLP
Jericho, New York
March 9, 1999
SENTRY TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
(In Thousands, Except Par Value Amounts)
ASSETS 1998 1997
CURRENT ASSETS
Cash and cash equivalents $873 $2,146
Accounts receivable, less allowance for doubtful
accounts of $651 and $752, respectively 9,308 6,323
Net investment in sales-type leases - current portion 574 613
Inventories 7,382 8,297
Prepaid expenses and other current assets 371 387
Assets held for sale (Note 18) 1,691 -
----------- ----------
Total current assets 20,199 17,766
NET INVESTMENT IN SALES-TYPE LEASES -
Noncurrent portion 466 848
SECURITY DEVICES ON LEASE - Net 65 151
PROPERTY, PLANT AND EQUIPMENT - Net 4,348 6,948
GOODWILL AND OTHER INTANGIBLES, including patent costs,
less accumulated amortization of $3,292 and $1,848, respectively 8,222 9,796
OTHER ASSETS 196 428
------------ -----------
$33,496 $35,937
============ ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Revolving line of credit $2,765 $-
Accounts payable 1,257 1,982
Accrued liabilities 3,080 2,730
Obligations under capital leases - current portion 180 218
Deferred income 249 421
----------- ----------
Total current liabilities 7,531 5,351
OBLIGATIONS UNDER CAPITAL LEASES - Noncurrent portion 3,061 3,095
MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY 362 445
Total liabilities 10,954 8,891
----------- -----------
COMMITMENTS AND CONTINGENCIES (Notes 1, 12 and 13)
REDEEMABLE CUMULATIVE PREFERRED STOCK 26,517 25,254
COMMON SHAREHOLDERS' EQUITY (DEFICIT):
Common stock, $0.001 par value; authorized 40,000 shares,
issued and outstanding 9,751 and 9,751 shares, respectively 10 10
Additional paid-in capital 15,522 16,785
Accumulated deficit (19,507) (15,003)
------------- --------------
Total common shareholders' equity (deficit) (3,975) 1,792
------------- --------------
$33,496 $35,937
============= ==============
See notes to consolidated financial statements.
SENTRY TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(In Thousands, Except per Share Amounts)
1998 1997 1996
REVENUES:
Sales $22,639 $17,965 $15,208
Sales to Sensormatic 1,792 2,570 4,651
Service revenues and other 3,725 4,031 3,404
------------ ---------- -----------
28,156 24,566 23,263
COSTS AND EXPENSES:
Cost of sales 13,200 11,177 8,897
Cost of sales to Sensormatic 1,212 1,705 3,038
Customer services expenses 6,253 4,772 2,932
Selling, general and administrative expenses 10,118 9,629 7,345
Research and development 1,343 1,658 1,686
Purchased in-process research and development (Note 1) - 13,200 -
Interest expense (income) 513 168 (20)
------------ ---------- -----------
32,639 42,309 23,878
------------ ---------- -----------
OPERATING LOSS (4,483) (17,743) (615)
OTHER INCOME - Gain on sale of assets (Note 16) - - 2,462
------------ ---------- -----------
INCOME (LOSS) BEFORE INCOME TAXES (4,483) (17,743) 1,847
INCOME TAXES 21 174 664
------------ ---------- -----------
NET INCOME (LOSS) (4,504) (17,917) 1,183
PREFERRED STOCK DIVIDENDS 1,263 1,067 -
------------ ---------- -----------
NET INCOME (LOSS) ATTRIBUTED TO
COMMON SHAREHOLDERS $(5,767) $(18,984) $1,183
============ =========== ===========
NET INCOME (LOSS) PER COMMON SHARE:
Basic $(0.59) $(2.08) $0.25
============ =========== ===========
Diluted $(0.59) $(2.08) $0.23
============ =========== ===========
WEIGHTED AVERAGE COMMON SHARES:
Basic 9,751 9,114 4,796
============ =========== ===========
Diluted 9,751 9,114 5,074
============ =========== ===========
See notes to consolidated financial statements.
SENTRY TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(In Thousands)
Retained Total Reedemable
Additional Earnings Common Cumulative
Common Stock Paid-In (Accumulated Shareholders' Preferred
Shares Amount Capital Deficit) Equity Stock
BALANCE, JANUARY 1, 1996 4,758 $5 $20,933 $1,731 $22,669 $-
Net income - - - 1,183 1,183 -
Repayment of obligations under
section 16(b) of the Securitites
and Exchange Act of 1934 - - 220 - 220 -
Income tax benefit related to
revaluation of corporate
headquarters - - 978 - 978 -
Exercise of stock options and
warrants 44 - 198 - 198 -
------------ ---------- ----------- ---------- -------- ---------
BALANCE, DECEMBER 31, 1996 4,802 5 22,329 2,914 25,248 -
Net loss - - - (17,917) (17,917) -
Shares issued to Video Sentry
shareholders in connection with
the merger (Note 1) 4,842 5 19,449 - 19,454 -
Preferred shares issued to former
Knogo N.A. shareholders in
connection with the merger (Note 1) - - (24,009) - (24,009) 24,009
Shares issued to employee benefit
plan 28 - 83 - 83 -
Repayment of obligations under
Section 16(b) of the Securities and
Exchange Act of 1934 - - 15 - 15 -
Preferred stock dividends (Note 1) - - (1,067) - (1,067) 1,067
Exercise of stock options and warrants 79 - (15) - (15) 178
------------ ---------- ----------- ---------- -------- ---------
BALANCE, DECEMBER 31, 1997 9,751 10 16,785 (15,003) 1,792 25,254
Net loss - - - (4,504) (4,504) -
Preferred stock dividends (Note 1) - - (1,263) - (1,263) 1,263
------------ ---------- ----------- ---------- -------- ---------
BALANCE, DECEMBER 31, 1998 9,751 $10 $15,522 $(19,507) $(3,975) $26,517
============ ========== =========== ============ ========== =========
See notes to consolidated financial statements.
SENTRY TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(In Thousands)
1998 1997 1996
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(4,504) $(17,917) $1,183
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Write-off of purchased in-process research and development - 13,200 -
Depreciation and amortization of security devices and property,
plant and equipment 1,106 1,166 1,135
Amortization of intangibles and other assets 1,596 1,570 60
Deferred income taxes - 174 (462)
Provision for bad debts 2 73 91
Income tax benefit related to the revaluation of corporate headquarters - - 978
Loss on impairment of assets 145 - -
Other - - (58)
Changes in operating assets and liabilities:
Accounts receivable (2,987) 537 3,279
Net investment in sales-type leases 421 1,240 (170)
Inventories 915 (485) (836)
Prepaid expenses and other assets 165 443 33
Accounts payable and accrued liabilities (375) (620) (1,895)
Deferred lease rentals (172) 169 (138)
----------- ------------ -----------
Net cash provided by (used in) operating activities (3,688) (450) 3,200
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments made to acquire Video Sentry Corporation - (2,417) -
Purchase of property, plant and equipment - net (94) (288) (378)
Proceeds from sale of corporate headquarters - - 4,536
Security devices on lease 5 (2) (56)
Intangibles (22) (52) (188)
----------- ------------ -----------
Net cash provided by (used in) investing activities (111) (2,759) 3,914
----------- ------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under the revolving line of credit 2,765 - -
Repayment of acquired debt - (2,136) -
Proceeds from shareholder repayment of obligations under
Section 16(b) of the Securities Exchange Act of 1934 - 15 220
Repayment of obligations under capital leases (239) (428) (283)
Exercise of stock options and warrants - 163 198
Other - 83 -
----------- ------------ -----------
Net cash provided by (used in) financing activities 2,526 (2,303) 135
----------- ------------ -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,273) (5,512) 7,249
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 2,146 7,658 409
----------- ------------ -----------
CASH AND CASH EQUIVALENTS, END OF YEAR $873 $2,146 $7,658
=========== ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $509 $310 $248
=========== ============ ============
Income taxes $21 $- $ 90
=========== ============ ============
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
Capital lease obligations incurred for the purchase of building, office
equipment and other assets $167 $165 $3,081
=========== ============ ============
Common stock issued to acquire Video Sentry Corporation $- $19,454 $-
=========== ============ ============
See notes to consolidated financial statements.
SENTRY TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1. BASIS OF PRESENTATION
Sentry Technology Corporation ("Sentry") a newly publicly traded Delaware
Corporation, was established to effect the merger of Knogo North America Inc.
("Knogo N.A.") and Video Sentry Corporation ("Video Sentry") which was
consummated on February 12, 1997 (the "Effective Date"). The merger resulted in
Knogo N.A. and Video Sentry becoming wholly owned subsidiaries of Sentry. The
term "Company" refers to Sentry as of and subsequent to February 12, 1997 and to
Knogo N.A. prior to such date. Prior to the merger, Video Sentry was engaged in
the design, development and marketing of a traveling closed circuit television
security surveillance system throughout the United States.
Pursuant to the merger agreement, Sentry issued one share of common stock for
each one share of Video Sentry common stock outstanding at the effective time of
the merger. Sentry also issued one share of common stock and one share of Class
A Preferred Stock for each 1.2022 shares of Knogo N.A. common stock outstanding.
The Sentry Class A Preferred Stock has a face value of $5.00 per share and a
cumulative dividend rate of 5.0% (the first two years of which are
paid-in-kind). The preferred is non-voting and subject to a mandatory redemption
four years from the date of issuance and optional redemption by Sentry at any
time after one year from the date of issuance. The redemption price will be
equal to $5.00 per preferred share (plus accrued and unpaid dividends as of the
redemption date) plus the amount, if any, by which the market price of Sentry's
common stock at the time of redemption exceeds $5.00 per preferred share. The
preferred stock is non convertible, but the redemption price may, in certain
circumstances, be paid in common stock at Sentry's option. The total number of
Sentry preferred shares authorized is 10,000,000. Undeclared and unpaid
cumulative dividends totaled approximately $1,120,000 as of December 31, 1998.
The merger was accounted for under the purchase method of accounting and,
accordingly, the acquired assets and assumed liabilities were recorded at their
estimated fair market values at the date of acquisition. Goodwill and other
intangible assets in the amount of approximately $10,950,000 were capitalized
and nonrecurring charges of approximately $13,200,000 relating to in-process
research and development were expensed. The goodwill and other intangibles are
being amortized using the straight-line method over a useful life of seven
years. Although Video Sentry shareholders had a majority voting interest in
Sentry based upon their common stock ownership percentage, generally accepted
accounting principles required consideration of a number of factors, in addition
to voting interest, in determining the acquiring entity for purposes of purchase
accounting treatment. Such other which were considered included: (i) key Sentry
management positions were held by individuals previously holding similar such
positions in Knogo N.A.; (ii) the assets, revenues and net earnings of Knogo
N.A. significantly exceed those of Video Sentry; and (iii) the market value of
the securities received by the former holders of Knogo N.A. Common Stock
significantly exceeded the market value of the securities received by the former
holders of Video Sentry Common Stock. As a result of these other factors, and
solely for accounting and financial reporting purposes, the merger was accounted
for as a reverse acquisition of Video Sentry by Knogo N.A.. Accordingly the
financial statements of Knogo N.A. are the historical financial statements of
Sentry and the results of Sentry's operations include the results of operations
of Video Sentry after the Effective Date. Common stock, additional paid-in
capital and the weighted average common shares have been retroactively restated
to the earliest year presented in order to reflect the effect of the
recapitalization of Knogo N.A. common stock for Sentry Technology Corporation
common stock.
The following unaudited pro forma information for the years ended December 31,
1997 and 1996 includes the operations of the Company and Video Sentry
Corporation as if the merger has occurred on January 1, 1996. This pro forma
information gives effect to the amortization expense associated with goodwill
and other intangible asset acquired, dividends accrued on the Sentry Class A
Preferred Stock, adjustments related to the fair market value of the assets
acquired and liabilities assumed, and the related income tax effects. In
addition, this pro forma information excludes the effect of the one-time charges
totaling $13,200,000 relating to purchased research and development.
1997 1996
(In Thousands)
Except per Share Amounts)
Revenues $24,619 $25,899
======= =======
Net Loss $ 5,378 $ 4,900
======= =======
Net loss attributed to common shareholders $ 6,596 $ 6,112
======= =======
Ney loss per common share $ (0.68) $ (0.64)
======= =======
Weighted average common shares 9,684 9,613
======= =======
The Company anticipates that current cash reserves, cash generated by operations
and the sale of certain facilities in the first quarter of 1999, and its
revolving line of credit will be adequate to finance the Company's anticipated
working capital requirements as well as future capital expenditure requirements
for at least the next 12 months.
2. SIGNIFICANT ACCOUNTING POLICIES
Business - The Company is engaged in one segment and line of business, the
design, manufacture, distribution, installation and service of systems designed
to be used by retailers to deter shoplifting and employee theft and by
commercial manufacturng and governmental customers to protect people and assets.
Other than sales to Sensormatic, sales to customers outside the United States
were not significant. Sales to Sensormatic were shipped to locations in Western
Europe.
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.
Revenue Recognition - The Company manufactures security devices which it offers
for sale or lease. Revenue related to the sale of equipment is recorded at the
time of shipment. For sales-type leases, revenue is recognized at the time of
installation or acceptance by the lessee in an amount equal to the present value
of the required rental payments under the fixed, noncancellable lease term. The
difference between the total lease payments and the present value is amortized
over the term of the lease so as to produce a constant periodic rate of return
on the net investment in the lease.
For operating leases, aggregate rental revenue is recognized over the term of
the lease (usually 12-48 months), which commences with date of installation or
acceptance by the lessee. Service revenues are recognized as earned and
maintenance revenues are recognized ratably over the service contract period.
Warranty costs associated with products sold with warranty protection are
estimated based on the Company's historical experience and recorded in the
period the product is sold.
Included in accounts receivable at December 31, 1998 and 1997 is unbilled
accounts receivable of $2,847,000 and $1,146,000, respectively.
Cash and Cash Equivalents - The Company considers all highly liquid temporary
investments with original maturities of less then ninety days to be cash
equivalents.
Inventories - Inventories are stated at the lower of cost (first-in, first-out
method) or market. Component parts and systems in inventory available for
assembly and customer installation are considered as work-in-process.
Security Devices on Lease - Security devices on lease are stated at cost and
consist of completed systems which have been installed.
Depreciation and Amortization - Depreciation of security devices on lease and
property, plant and equipment is provided for using the straight-line method
over their related estimated useful lives. The security devices 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.
Intangibles - Costs and expenses incurred in obtaining patents are amortized
over the remaining life of the patents, not exceeding l7 years, using the
straight-line method.
Impairment of Long-Lived Assets - In accordance with SFAS No. 121, "Accounting
For The Impairment of Long-Lived Assets and For Long-Lived Assets To Be Disposed
Of," the Company reviews its long-lived assets, including security devices on
lease, property and equipment, intangible assets and other assets for impairment
whenever events or changes in circumstances indicate that the carrying amount of
these assets may not be fully recoverable. To determine recoverability of its
long-lived assets, the Company evaluates the probability that future
undiscounted net cash flows, without interest charges, will be less than the
carrying amount of the assets. Impairment is measured at fair value.
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, net investment in sales-type leases, accounts
payable and obligations under capital leases) approximate their fair value at
December 31, 1998 and 1997 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.
Deferred Income - Deferred income consist of rentals related to operating leases
and maintenance contracts billed or paid in advance.
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.
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."
Foreign Currency Translation - The functional currency of the Company's foreign
entity is the US dollar. Unrealized foreign exchange transaction gains and
losses are included in selling, general and administrative expenses and amounted
to approximately $120,000, $111,000 and $45,000 for the years ended December 31,
1998, 1997 and 1996, respectively.
Use of Estimates - The preparation of financial statements in conformity with
generally accepted accounting principles 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.
3. NET INVESTMENT IN SALES-TYPE LEASES AND OPERATING LEASE DATA The Company is
the lessor of security devices under agreements expiring in various years
through 2003. The net investment in sales-type leases consist of:
December 31,
1998 1997
(In Thousands)
Minimum lease payments receivable $1,204 $1,713
Allowance for uncollectible minimum lease payments (60) (86)
Unearned income (120) (195)
Unguaranteed residual value 16 29
------------ -----------
Net investment 1,040 1,461
Less current portion 574 613
------------ -----------
Noncurrent portion $466 $848
============ ===========
The future minimum lease payments receivable under sales-type leases and
noncancellable operating leases are as follows:
Sales-Type Operating
Year Ending Leases Leases
December 31, (In Thousands)
1999 $694 $89
2000 408 57
2001 78 14
2002 18 2
2003 6 -
---------- ---------
$1,204 $162
========== ==========
4. INVENTORIES
Inventories consist of the following:
December 31,
1998 1997
(In Thousands)
Raw materials $2,497 $2,662
Work-in-process 3,058 3,765
Finished goods 1,827 1,870
--------- ----------
$7,382 $8,297
========== ==========
Reserves for excess and obsolete inventory totaled $1,318,000 and $1,246,000 as
of December 31, 1998 and 1997, respectively, and have been included as a
component of the above amounts.
5. SECURITY DEVICES ON LEASE
Security devices are stated at cost and are summarized as follows:
December 31,
1998 1997
(In Thousands)
Security devices on lease $154 $276
Less allowance for depreciation 89 125
--------- --------
$65 $151
========= ========
6. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost and are summarized as follows:
Estimated Useful December 31,
Lives (Years) 1998 1997
(In Thousands)
Land $- $506
Buildings and improvements 20-25 3,033 5,744
Machinery and equipment 3-l0 2,613 3,727
Furniture, fixtures and office equipment 3-l0 3,433 3,661
Leasehold improvements 5-l0 250 11
--------- ------
9,329 13,649
Less allowance for depreciation 4,981 6,701
--------- ------
$4,348 $6,948
========= ======
7. OTHER ASSETS
In January 1995, the Company sold its guest house in Puerto Rico for $800,000
which approximated its carrying value. The Company holds notes with a present
value of $136,000 and $236,000 at December 31, 1998 and 1997, respectively,
which are receivable in varying amounts through January 2000.
8. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
December 31,
1998 1997
(In Thousands)
Accrued salaries, employee benefits and payroll taxes $979 $638
Accrued installation costs 549 131
Accrued warranty costs 298 237
Customer deposits payable 206 262
Accrued merger costs - 359
Other accrued liabilities 1,048 1,103
----------- ---------
$3,080 $2,730
=========== =========
9. REVOLVING LINE OF CREDIT
The Company has a revolving line of credit with a financial institution for
maximum borrowings of $8 million through December 31, 1999, which are subject to
certain limitations based on a percentage of eligible accounts receivable and
inventories as defined in the agreement. Interest is payable monthly at the
lender's Index Rate, as defined, (5.3% at December 31, 1998), plus 4.25% per
annum. The Company is required to pay a commitment fee of one quarter of one
percent per annum on any unused portion of the credit facility. Borrowings under
the line is secured by substantially all of the Company's assets. The terms of
the agreement, among other matters, requires the Company to maintain certain
minimum cash flow and net worth levels, a minimum working capital ratio, and
places restrictions on capital expenditures and prohibits the payment of
dividends (other than dividends on the Series A Preferred Stock described in
Note 1). The Company had borrowings on the line of credit totaling $2,765,000
and $0 for the years ended December 31, 1998 and 1997, respectively.
The Company was not in compliance with the minimum cash flow and minimum net
worth covenants of the revolving line of credit as of December 31, 1998. The
financial institution has granted a waiver relating to the noncompliance with
these covenants.
10. OBLIGATIONS UNDER CAPITAL AND OPERATING LEASES
On December 24, 1996, the Company completed a sale-leaseback transaction on the
Company's corporate headquarters. The Company received net proceeds of
approximately $4.5 million which approximated the carrying amount of the land
and building. The lease covers a period of 20 years with quarterly payments of
$131,000. The lease agreement allows for an increase in lease payments for years
4 through 20 based on a formula tied to the Consumer Price Index. 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 have been considered separately
for the purposes of applying the criteria of SFAS No. 13 "Accounting for
Leases." The land portion of the lease has been classified as an operating
lease. Future minimum payments related to the land portion of the lease are as
follows (in thousands):
Year Ending
December 31,
1999 $148
2000 148
2001 148
2002 148
2003 148
Thereafter 1,928
----------
$2,668
==========
The building portion of the lease has been classified as a capital lease. The
Company also leases certain computer and office equipment and related items
under noncancellable capital lease arrangements at varying interest rates
expiring through 2003.
Minimum annual rentals are as follows (in thousands):
Year Ending
December 31,
1999 $537
2000 501
2001 445
2002 445
2003 387
Thereafter 4,886
-----------
7,201
Less amount representing interest 3,960
-----------
Present value of minimum rentals 3,241
Less current portion 180
------------
Noncurrent portion $3,061
===========
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 net book value of the building was $2,730,000 and $2,881,000 at
December 31, 1998 and 1997, respectively. The capitalized lease asset is being
amortized on a straight-line basis over the 20-year lease term. The capitalized
lease obligation is being amortized under the interest method over the 20-year
lease period, utilizing an imputed interest rate of approximately eleven
percent.
Computer and office equipment and related items under capital leases are
included in property and equipment and other assets with a gross value of
$1,178,000 and $1,591,000 at December 31, 1998 and 1997, respectively, and a net
book value of $415,000 and $574,000 at December 31, 1998 and 1997, respectively.
11. COMMON SHAREHOLDERS' EQUITY
a. Earnings Per Share ("EPS") - Basic EPS is determined by using the
weighted average number of common shares outstanding during each period.
Diluted EPS further assumes the issuance of common shares for all
dilutive potential common shares outstanding. The calculation for
earnings per share are as follows:
1998 1997 1996
(In Thousands, Except per Share Amounts)
Net income (loss) $(4,504) $ (17,917) $1,183
Preferred stock dividends (1,263) (1,067) -
----------- ----------- ----------
Net income (loss) attributed to
common shareholders $(5,767) $(18,984) $1,183
=========== =========== ===========
Weighted average common shares 9,751 9,114 4,796
Basic EPS $(0.59) $(2.08) $0.25
=========== =========== ===========
Net income (loss) $(4,504) $(17,917) $1,183
Preferred stock dividends (1,263) (1,067) -
----------- ----------- ----------
Net income (loss) attributed to
common shareholders $(5,767) $(18,984) $1,183
============ =========== ===========
Weighted average common shares 9,751 9,114 4,796
Dilutive effect of common stock
options and warrants - - 278
------------ ----------- -----------
Weighted average common and
common equivalent shares 9,751 9,114 5,074
============ =========== ===========
Diluted EPS $(0.59) $(2.08) $0.23
b. Stock Option Plan - In February 1997, the Company adopted the 1997 Stock
Incentive Plan of Sentry Technology Corporation (the "1997 Plan"). The
1997 Plan provides for grants up to 2,250,000 options to purchase the
Company's common stock. Awards may be granted by the stock option
committee 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 become exercisable at a rate of 20% per year over
a five-year period and expire ten years from the date of grant. 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, 1998,
2,214,233 common shares were reserved for issuance in connection with
the exercise of stock options.
Stock option transactions for the years ended December 31, 1998, 1997
and 1996 are as follows:
Weighted
Average
Number Exercise
of Shares Price
Balance, January 1, 1996 353,353 $2.73
Granted 245,799 6.31
Exercised (27,117) 2.38
Canceled (19,963) 5.07
-------------- ------------
Balance, December 31, 1996 552,072 4.26
Granted 679,500 3.07
Exercised (35,767) 3.17
Canceled (161,988) 5.23
--------------- ------------
Balance, December 31, 1997 1,033,817 3.36
Granted 463,700 2.15
Exercised - -
Canceled (328,156) 2.32
----------------- ------------
Balance, December 31, 1998 1,169,361 $3.17
================= ============
In connection with the merger described in Note 1, employees and directors who
held options to purchase Knogo N.A. common stock were granted substitute options
("Substitute Knogo N.A. Options") under the 1997 Plan to purchase an aggregate
of 552,072 shares of Sentry Common Stock and 552,072 shares of Sentry Class A
Preferred Stock at prices determined pursuant to the formula set forth in the
Merger Agreement. Employees and directors who held outstanding options to
purchase Video Sentry common stock were granted substitute options under the
1997 Plan to purchase 195,000 shares of Sentry Common Stock at prices determined
pursuant to the formula set forth in the Merger Agreement.
At December 31, 1998, options to purchase 1,169,361 shares of common stock were
outstanding at exercise prices ranging from $1.70 to $8.42. At December 31,
1998, options to purchase an aggregate of 572,161 (which include 484,861
outstanding and exercisable substitute Knogo N.A. options) common shares were
vested and currently exercisable at a weighted average exercise price of $4.00
and an additional 597,200 options vest at dates extending through the year 2003.
At December 31, 1998, options for 1,044,872 common shares were available for
future grants.
As discussed in Note 2, 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, no compensation expense has been recognized in the
financial statements for employee stock arrangements. 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. The Company's
calculations were made using the Black-Scholes option pricing model with the
following weighted average assumptions: expected life of five years; stock
volatility, 81.6% in 1998, 74.3% in 1997, and 67.1% in 1996; risk free interest
rates, 5.5% in 1998, 6.5% in 1997, and 7.5% in 1996; 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 1998, 1997, and 1996 awards had been amortized to expense
over the vesting period of the awards, pro forma net income (loss) attributed to
common shareholders would have been $(6,159,000) (($0.63) per diluted share) in
1998, $(19,324,000) (($2.12) per diluted share) in 1997, and $1,061,000 ($0.21
per diluted share) in 1996. However, the impact of outstanding nonvested stock
options granted prior to 1995 has been excluded from the pro forma calculation;
accordingly, the 1998, 1997 and 1996 pro forma adjustments are not indicative of
future period pro forma adjustments, when the calculation will apply to all
applicable stock options.
c. Warrants - At December 31,1998, warrants to purchase 287,500 shares of
common stock were outstanding at exercise prices ranging from $3.38 to
$4.95. Such warrants expire through October 1999. At December 31, 1998,
287,500 common shares were reserved for issuance in connection with the
exercise of these warrants. 12. INCOME TAXES The components of the
Company's income tax provisions are as follows:
1998 1997 1996
(In Thousands)
Current:
Federal $- $- $811
State - - 94
Puerto Rico 21 - 221
------ ------ -------
21 - 1,126
------ ------ ------
Deferred:
Puerto Rico - 174 (462)
------- ------- ---------
- 174 (462)
------- ------- ---------
$21 $174 $664
======= ======== ==========
The reconciliation between total tax expense and the expected U.S. Federal
income tax is as follows:
1998 1997 1996
(In Thousands)
Expected tax expense (benefit) at 34% $(1,524) $(6,033) $628
Add (deduct):
State taxes - - 94
Nondeductible expenses 590 5,024 35
U.S. losses producing no tax benefit 866 767 -
Benefits of nontaxable income of
Puerto Rico subsidiary/losses producing
no tax benefit 107 242 74
Prior years' estimated tax adjustment - - (217)
Other (18) 174 50
------------ ---------- --------
$21 $174 $664
============ ========== ========
Significant components of deferred tax assets and liabilities at December 31,
1998 and 1997 are comprised of:
Deferred Tax Assets (Liabilities)
1998 1997
(In Thousands)
Assets:
Accounts receivable $241 $278
Inventories 488 442
Accrued liabilities 203 175
Property, plant and equipment 45 46
Intercompany transactions 12 16
Net operating loss carryforwards 5,139 4,337
Tax credit carryforwards 209 209
---------- ----------
Gross deferred tax assets 6,337 5,503
Less: Valuation allowance (6,318) (5,455)
19 48
--------- -----------
Liabilities:
Tollgate taxes (19) (37)
Security devices on lease - (11)
--------- -----------
Gross deferred tax liabilities (19) (48)
--------- -----------
Net deferred tax asset (liability) $ - $ -
========= ===========
The increase in the valuation allowance for the years ended December 31, 1998
and 1997 was primarily attributable to the increase in net operating loss
carryforwards for which realization was not more likely than not.
The income tax benefit relating to the sale of the Company's corporate
headquarters reduced currently payable taxes and was credited to additional
paid-in-capital. Such amount approximated $978,000 for the year ended December
31, 1996.
The Company's Puerto Rico manufacturing subsidiary is exempt from Federal income
taxes under Section 936 of the Internal Revenue Code (as amended under the Small
Business Job Protection Act of 1996). Under the current law, this exemption from
Federal income tax will remain in effect through 2001, will be subject to
certain limits during the years 2002 through 2005, and will be eliminated
thereafter. Also, the Company was granted a partial income tax exemption under
the provisions of the Puerto Rico Industrial Incentives Act of l978 from the
payment of Puerto Rico taxes on income derived from marketing certain products
manufactured by the subsidiary. The grant provides for a 90% exemption from
Puerto Rico taxes until January 1, 2008. The Company provides tollgate taxes on
the earnings of the Puerto Rico subsidiary which it intends to remit, in the
form of a dividend, to the parent company based upon the applicable rates.
13. COMMITMENTS AND CONTINGENCIES
a. Litigation - The Company is a party to litigation arising in the normal
course of business. Management believes the final disposition of such
matters will not have a material adverse effect on the consolidated
financial statements.
b. Supply Agreement - Knogo N.A. had a supply agreement in which
Sensormatic was obligated to purchase products from Knogo N.A. in the
amount of $8,000,000 in 1996 and $4,000,000 in 1997. Such products were
priced to yield Knogo N.A. a 35% gross margin. In 1997 and 1996,
Sensormatic did not meet its minimum order amounts in accordance with
the terms of the supply agreement and, accordingly, the Company recorded
in revenues the cumulative profits on the shortfall. Although the supply
agreement officially expired and minimum purchase obligations ended as
of June 30, 1997, Sensormatic continued to purchase these products at
similar margins from the Company. Included in accounts receivable at
December 31, 1998 and 1997 are amounts due from Sensormatic of $162,000
and $492,000, respectively.
c. License Agreement - Knogo N.A. entered into a license agreement in which
Knogo N.A. has the exclusive right to manufacture and sell existing
Knogo products within the Knogo N.A. territory, and Sensormatic has such
right elsewhere, except that Knogo N.A. and Sensormatic each have the
right to develop and market the SuperStrip technology in the Knogo N.A.
territory.
d. 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 15% of compensation, subject to certain limitations,
with the Company making a matching contribution equal to a designated
percentage of the eligible employee's deferral election. The Company may
also contribute a discretionary contribution, subject to certain
conditions, as defined in the Plan. The Company contributed
approximately $130,000, $215,000, and $110,000 to the Plan for the years
ended December 31, 1998, 1997 and 1996 , respectively.
e. Employment Agreements - The Company and several key executives entered
into employment agreements with remaining terms of one to three years
for which the Company will have a minimum commitment of $880,000.
14. MAJOR CUSTOMERS AND CREDIT CONCENTRATIONS
The Company grants credit to customers who are principally in the retail
industry and libraries. During 1998 and 1997, revenues from a single customer
represented approximately 22% and 18% of total revenues, respectively. During
1996, revenues from a different customer represented 13% of total revenues. No
other customer accounted for more than 10% of total revenues for fiscal 1998,
1997 and 1996.
15. JOINT VENTURE
In January 1996, the Company acquired a controlling interest in K&M Converting
Corp. ("KMCC"), a newly established joint venture entered into with Marian
Rubber Products Co., Inc. ("Marian"). KMCC is the exclusive converter of
magnetic material into disposable targets or labels used in the Company's EAS
systems. The Company contributed $15,000 in cash, $430,000 in inventory, and
$49,000 in machinery to KMCC and issued 20,000 shares of Knogo N.A. common stock
to Marian in exchange for 50.001% of KMCC. The acquisition was accounted for
under the purchase method of accounting and the operating results of KMCC are
included in the consolidated operating results of the Company since the date of
acquisition. Pro forma results of operations assuming KMCC was acquired as of
the beginning of fiscal year ended December 31, 1996 would not differ materially
from the reported results.
16. OTHER INCOME - SALE OF ASSETS
During 1996, the Company completed the sale of certain assets (primarily patents
and technology) of its library security systems business to Minnesota Mining and
Manufacturing Company ("3M") for a purchase price of $3,000,000, paid at
closing. In connection with such sale, the Company and 3M entered into an
agreement pursuant to which the Company has become a distributor of certain of
3M's library systems products for an initial term of three years and has agreed
not to compete with 3M in the sale of security systems products (other than
closed circuit video systems) in the library market except as otherwise
contemplated by the transaction documentation. The parties also settled certain
patent litigation between them. The impact of the transaction resulted in an
increase in cash of $3,000,000 and pretax tax gain of approximately $2,462,000
for the year ended December 31, 1996. The impact on the Company's historical
revenues and net income from the sale of products covered by the patents and
related technology sold is not material.
17. REVENUE BY PRODUCT LINE
Revenues by product line are as follows:
1998 1997 1996
(in thousands)
EAS systems 9,408 10,249 13,989
Traditional CCTV products 6,892 3,623 3,567
Sentry Vision traveling CCTV products 6,202 4,322 -
3M library systems 1,929 2,341 2,303
Service revenues and other 3,725 4,031 3,404
---------- ----------- ----------
Total Revenues $28,156 $24,566 $23,263
=========== =========== ==========
18. SUBSEQUENT EVENT
In February 1999, the Company sold its Puerto Rico manufacturing facility and
Illinois CCTV design center and related land for net proceeds in excess of $2.0
million. At December 31, 1998, included in assets held for sale was $1,691,000
representing the net carrying amount of these properties. A gain representing
the excess of the net proceeds over the carrying value of these properties will
be recognized in the first quarter of 1999.
SCHEDULE II
SENTRY TECHNOLOGY CORPORATION AND SUBSIDIARIES
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
DECEMBER 31, 1998, 1997 AND 1996
(In Thousands)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
Additions
Charged to
Balance at Charged to Other Balance
beginning Cost and Accounts Deductions at end of
Descriptions of Year Expenses - describe - describe Year
(1) (2)
Year ended December 31, 1998:
Allowance for doubtful accounts $752 $2 $11 $114 $651
======== ===== ======= ====== ======
Allowance for uncollectible
minimum lease payments $86 $(26) $60
======== ===== ======= ====== ======
Reserve for excess and obsolete
inventory $1,246 $328 $256 $1,318
======== ===== ======= ====== ======
Year ended December 31, 1997:
Allowance for doubtful accounts $719 $73 $8 $48 $752
======== ===== ======= ====== ======
Allowance for uncollectible
minimum lease payments $157 $(71) $86
======== ===== ======= ====== ======
Reserve for excess and
obsolete inventory $1,691 $444 $889 $1,246
======== ===== ======= ====== ======
Year ended December 31, 1996:
Allowance for doubtful accounts $931 $91 $8 $311 $719
======== ===== ======= ====== ======
Allowance for uncollectible
minimum lease payments $159 $(2) $157
======== ===== ======= ====== ======
Reserve for excess and
obsolete inventory $1,441 $470 $220 $1,691
======== ===== ======= ====== ======
(1) Recoveries of accounts written off.
(2) Amounts written off.
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure.
Not Applicable.
PART III
Item 10. Directors and Executive Officers of the Company.
Item 11. Executive Compensation.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Item 13. Certain Relationships and Related Transactions.
Part III information will be set forth in the Company's definitive proxy
statement for the Company's 1999 Annual Meeting of Stockholders.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) The following documents are filed as a part of this report on Form
10-K:
(1) (2) Consolidated Financial Statements of the Company and its
subsidiaries for the year ended December 31, 1998 and
Financial Statement Schedules required to be filed by Items
8 and 14(d) of Form 10-K. See the Index to Consolidated
Financial Statements of Sentry Technology Corporation and
its subsidiaries.
(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 Thomas A. Nicolette. Incorporated by
reference to Exhibit 10.1 to the Company's Registration
Statement on Form S-4 (No. 333-20135)
10.4 Employment Agreement, dated as of February 12, 1997, between
the Company and Peter J. Mundy. Incorporated by reference to
Exhibit 10.2 to the Company's Registration Statement on Form
S-4 (No. 333-20135).
10.5 Employment Agreement, dated as of February 12, 1997, between
the Company and Peter Y. Zhou. Incorporated by reference to
Exhibit 10.3 to the Company's Registration Statement on Form
S-4 (No. 333-20135).
10.6 Employment Agreement, dated as of March 1, 1998, between the
Company and John Whiteman.
Other Exhibits:
2.1 Amended and Restated Agreement and Plan of Reorganization
and Merger, dated as of November 27, 1996 among Video
Corporation, Knogo North America Inc., Sentry Technology
Corporation, Viking Merger Corp. and Strip Merger Corp., as
amended by Amendment No. 1 to Amended and Restated Agreement
and Plan of Reorganization and Merger, dated as of January
10, 1997. Incorporated by reference to Exhibit 2.1 to
Company's Registration Statement on Form S-4 (No.
333-20135).
3.1 Amended and Restated Certificate of Incorporation of the
Company, together with Form of Certificate of Designations
of Sentry Technology Corporation Class A Preferred Stock.
Incorporated by reference to Exhibit 3.1 to Company's
Registration Statement on Form S-4 (No. 333-20135).
3.2 Bylaws of the Company. Incorporated by reference to Exhibit
3.2 to Company's Registration Statement on Form S-4 (No.
333-20135).
10.7 Loan Agreement and related agreements among the Company,
Knogo North America Inc., Video Sentry Corporation and
General Electric Capital Corporation. Incorporated by
reference to Exhibit 10.7 to the Company's annual report on
Form 10-K for fiscal 1997.
10.8 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.
10.9 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.
10.10 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.
10.11 Distribution Agreement dated March 26, 1996 between Knogo
North America Inc. and Minnesota Mining and Manufacturing
Company. Incorporated by reference to Exhibit 10.11 to the
Company's annual report on Form 10-K for fiscal 1997.
10.12 First Amendment and Waiver to the Loan and Security
Agreement Between the Company and General Election Capital
Corporation Dated June 30, 1998. Incorporated by reference
to Exhibit 10.12 to the Company's quarterly report on Form
10-Q for the quarter ended June 30, 1998.
10.13 Amendment No. 1 dated December 22, 1998, to the Distribution
Agreement dated March 26, 1996 between Knogo North America
Inc. and Minnesota Mining and Manufacturing Company.
21 Subsidiaries of the Company. Incorporated by reference to
Exhibit 21 to the Company's annual report on form 10-K for
fiscal 1997.
23 Consent of Deloitte & Touche LLP
27 Financial Data Schedule
(b) No reports on Form 8-K were filed for the Company during the relevant
period.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SENTRY TECHNOLOGY CORPORATION
By: /S/ Peter J. Mundy
----------------------------
Peter J. Mundy
Vice President-Finance,
Chief Financial Officer,
Secretary and Treasurer
Dated: March 29, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Annual Report on Form 10-K has been signed below by the following persons
in the capacities and on the date indicated.
Signature Title
/s/ THOMAS A. NICOLETTE President, Chief Financial Officer
- --------------------------- and Director
Thomas A. Nicolette
/s/ PETER J. MUNDY Vice President-Finance,
- --------------------------- Chief Financial and Accounting Officer,
Peter J. Mundy Secretary and Treasurer
/s/ WILLIAM A. PERLMUTH Chairman of the Board of Directors
- ---------------------------
William A. Perlmuth
/s/ ROBERT D. FURST, JR. Director
- ---------------------------
Robert D. Furst, Jr.
/s/ PAUL D. MELLIN Director
- ---------------------------
Paul D. Mellin
/s/ ROBERT L. BARBANELL Director
- ---------------------------
Robert L. Barbanell
Dated: March 29, 1999
EXHIBIT INDEX
10.6 Employment Agreement, dated as of March 1, 1998, between the
Company and John Whiteman.
10.13 Amendment No. 1 dated December 22, 1998, to the Distribution
Agreement dated March 26, 1996 between Knogo North America
Inc. and Minnesota Mining and Manufacturing Company.
23 Consent of Deloitte & Touche LLP.
27 Financial Data Schedule