10QSB 1 skvy10qsb-march2006.txt SENTRY TECHNOLOGY 10-QSB MARCH 2006 (1ST QUARTER 2006) FORM 10-QSB SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended March 31, 2006 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission File Number 1-12727 ---------- SENTRY TECHNOLOGY CORPORATION ----------------------------- (Exact name of small business issuer as specified in its charter) Delaware 96-11-3231714 ---------- ------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1881 Lakeland Avenue, Ronkonkoma, NY 11779 ----------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) 631-739-2000 ------------ (Registrant's telephone number, including area code) (Former name, former address and former fiscal year, if changed since last report) 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 - As of May 12, 2006, there were 120,728,804 shares of Common Stock outstanding. SENTRY TECHNOLOGY CORPORATION ----------------------------- INDEX ----- Page No. -------- PART I. FINANCIAL INFORMATION ------------------------------- Item 1. Financial Statements (Unaudited) Consolidated Balance Sheets -- March 31, 2006 and December 31, 2005 3 Consolidated Statements of Operations -- Three Months Ended March 31, 2006 and 2005 4 Consolidated Statements of Cash Flows -- Three Months Ended March 31, 2006 and 2005 5 Notes to Consolidated Financial Statements - March 31, 2006 6 - 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 - 13 Item 3. Controls and Procedures 14 PART II. OTHER INFORMATION ---------------------------- Item 6. Exhibits 14 - 15 Signatures 15 ------ PART I. FINANCIAL INFORMATION ------------------------------- Item 1. Financial Statements (Unaudited)
SENTRY TECHNOLOGY CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands) March 31, December 31, 2006 2005 ---------- ------------- (Unaudited) (Audited) ASSETS -------------- CURRENT ASSETS Cash and cash equivalents $ 638 $ 842 Accounts receivable, less allowance for doubtful accounts of $84 and $141, respectively 2,152 2,762 Inventories 2,909 2,709 Prepaid expenses and other assets 452 318 ---------- --------- Total current assets 6,151 6,631 PROPERTY, PLANT AND EQUIPMENT, net 610 637 GOODWILL 1,564 1,564 OTHER ASSETS 529 563 ---------- --------- $8,854 $9,395 ========== ========= LIABILITIES AND SHAREHOLDERS' EQUITY ---------------------------------------------------- CURRENT LIABILITIES Revolving line of credit and term loan $ 1,507 $ 2,039 Accounts payable 537 489 Accrued liabilities 1,577 925 Obligations under capital leases - current portion 6 6 Deferred income 129 135 ---------- --------- Total current liabilities 3,756 3,594 OBLIGATIONS UNDER CAPITAL LEASES - non-current portion --- 1 DEFFERED TAX LIABILITY 58 58 CONVERTIBLE DEBENTURES 1,914 1,904 MINORITY INTEREST 1,148 1,140 ---------- --------- Total liabilities 6,876 6,697 SHAREHOLDERS' EQUITY Common stock, $0.001 par value; authorized 160,000 shares issued and outstanding 120,729 and 120,629 shares 121 121 Additional paid-in capital 48,795 48,783 Accumulated deficit (47,138) (46,408) Other accumulated comprehensive income 200 202 ---------- --------- Total shareholders' equity 1,978 2,698 ---------- --------- $8,854 $9,395 ========== ========= See notes to the consolidated financial statements.
SENTRY TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)
Three Months Ended March 31, -------------------- 2006 2005 -------------------------------- (Unaudited) REVENUES Sales $ 2,285 $1,913 Service, installation and other 423 580 -------- ------- 2,708 2,493 COSTS AND EXPENSES: Cost of sales 1,256 980 Customer service expenses 523 749 Selling, general and administrative expenses 1,353 1,221 Research and development 200 233 -------- ------- 3,332 3,183 -------- ------- OPERATING LOSS (624) (690) INTEREST AND FINANCING EXPENSES 82 91 -------- ------- LOSS BEFORE INCOME TAXES AND MINORITY INTEREST (706) (781) INCOME TAX (BENEFIT) 10 (17) -------- ------- LOSS BEFORE INCOME TAXES (716) (764) MINORITY INTEREST 14 (4) -------- ------- NET LOSS $ (730) $ (760) ======== ======= NET LOSS PER SHARE Basic and diluted $ (0.01) $(0.01) ======== ======= WEIGHTED AVERAGE SHARES Basic and diluted 120,648 120,551 ======== ======== See notes to the consolidated financial statements.
SENTRY TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Three Months Ended March 31, ------------------------------------------- 2006 2005 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (730) $(760) Adjustment to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization 69 80 Provision for bad debts 3 3 Deferred income taxes -- (67) Non cash consideration 19 16 Minority interest in net loss of consolidated subsidiary 8 (14) Changes in operating assets and liabilities: Accounts receivable 607 1,479 Inventories (200) (422) Prepaid expenses and other assets (134) 35 Accounts payable and accrued liabilities 700 (78) Deferred income (6) (84) ------- ------- Net cash provided by operating activities 336 188 ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (11) (9) Intangibles -- (1) ------- ------- Net cash used in investing activities (11) (10) ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Net payments under the revolving line of credit (532) (688) Repayment of term loan --- (77) Repayment of notes payable --- (153) Repayment of obligations under capital leases (1) (1) Proceeds from exercise of stock options 6 1 ------- ------- Net cash used in financing activities (527) (918) ------- ------- EFFECTS OF EXCHANGE RATES ON CASH (2) (14) ------- ------- DECREASE IN CASH AND CASH EQUIVALENTS (204) (754) CASH AND CASH EQUIVALENTS, at beginning of period 842 1,965 ------- ------- CASH AND CASH EQUIVALENTS, at end of period $ 638 $1,211 ======= ======= See notes to the consolidated financial statements.
SENTRY TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) March 31, 2006 NOTE 1 -- Basis of Presentation ------------------------------- The consolidated financial statements include the accounts of Sentry Technology Corporation ("the Company") and its majority-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-QSB and their basis of application is consistent with that of the previous year. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Interim results are not necessarily indicative of the results that may be expected for a full year. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in Sentry's Annual Report to Stockholders on Form 10-KSB for the fiscal year ended December 31, 2005, as filed with the Securities and Exchange Commission. Certain prior period amounts have been reclassified to conform to current period presentation. Note 2 -- Recent Accounting Pronouncements ------------------------------------------ In December 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004), "Share Based Payment" ("SFAS No. 123R"). SFAS No. 123R requires the Company to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. The cost of the employee services is recognized as compensation cost over the period that an employee provides service in exchange for the award. SFAS No. 123R is effective January 1, 2006 for the Company and was adopted using a modified prospective method during the quarter ended March 31, 2006. Note 8 provides disclosure on the effect of the adoption of SFAS No. 123R on net income and earnings per share. In March 2006, the FASB issued Statement 156, "Accounting for Servicing of Financial Assets," which amends SFAS 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." In a significant change to current guidance, SFAS No. 156 permits an entity to choose either of the following subsequent measurement methods for each class of separately recognized servicing assets and servicing liabilities: (1) Amortization Method or (2) Fair Value Measurement Method. SFAS No. 156 is effective as of the beginning of an entity's first fiscal year that begins after September 15, 2006. The Company is currently reviewing the effect, if any, the proposed guidance will have on its financial statements. In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140." This Statement permits fair value of remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities"; establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; clarifies that concentrations of credit risk in the form of subordination are not SENTRY TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) March 31, 2006 embedded derivatives; and amended SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities", to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No. 155 is effective for all financial instruments acquired, issued, or subject to a remeasurement (new basis) event occurring after the beginning of an entity's first fiscal year that begins after September 15, 2006. The Company is currently reviewing the effect, if any, the proposed guidance will have on its financial statements. NOTE 3 -- Inventories --------------------- Inventories consist of the following: March 31, 2006 December 31, 2005 -------------- ----------------- (in thousands) Raw materials $ 1,016 $ 1,101 Work-in-process 212 279 Finished goods 1,681 1,329 ----- ----- $ 2,909 $ 2,709 =========== =========== Reserves for excess and obsolete inventory totaled $1,085,000 and $1,261,000 as of March 31, 2006 and December 31, 2005, respectively and have been included as a component of the above amounts. NOTE 4 -- Credit Facilities & Subsequent Event ---------------------------------------------- In May 2005, the Company and certain of its subsidiaries entered into a secured credit facility with Royal Bank of Canada ("RBC") for maximum borrowings of up to Canadian $4.5 million (U.S. $3.9 million), which are subject to certain limitations based on a percentage of eligible accounts receivable and inventories as defined in the agreement. Interest is payable at a rate of Royal Bank of Canada prime rate (5.5% at March 31, 2006), plus 1.75% per annum. Borrowings under this facility are secured by substantially all of the Company's assets. As of March 31, 2006, the Company had borrowings of $1.5 million under this facility and had excess borrowing capacity of approximately $0.09 million. In May 2006, the Company amended the credit agreement with RBC by extending the term of the agreement through May 2007 and modifying certain financial covenants. In addition, the maximum borrowings under the facility were reduced to U.S. $3 million. However, RBC increased the borrowing base formula Company by Canadian $1.0 million (U.S. $856,000) in exchange for additional security provided by two of the Company's directors. NOTE 5 - Comprehensive Income (Loss) ------------------------------------ Comprehensive income (loss) is as follows: Three Months Ended March 31, 2006 2005 ---- ---- (in thousands) Net income (loss): $ (730) $ (760) Other comprehensive income (loss): Foreign currency translation adjustments (2) (14) -------- -------- Comprehensive income (loss) $ (732) $ (774) ======== ======== SENTRY TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) March 31, 2006 NOTE 6 -- Related Party Transactions ------------------------------------ In May 2006, Mr. Murdoch, Sentry's CEO and Director and Mr. Furst, a Sentry Director, provided personal guarantees to RBC, the Company's lender, in the amount of Canadian $1 million (U.S. $856,000) in exchange for the bank providing increased availability under its credit facility to the Company by the same amount. In consideration of these guarantees, Mr. Murdoch and Mr. Furst will receive a fee of $43,000, to be shared between them, paid in 12 equal monthly installments. As additional consideration, they will receive fully vested, two year warrants to purchase approximately 2.9 million shares of the Company's common stock, at an exercise price of $0.10 per share. The fair value of these warrants will be recorded in accordance with SFAS No. 123R "Share-Based Payment" in the second quarter of 2006 and will be written off over the period of the guarantee. NOTE 7 -- Earnings Per Share ---------------------------- The earnings per share calculations (basic and diluted) at March 31, 2006 and 2005 are based upon the weighted average number of common shares outstanding during each period. There are no reconciling items in the numerator or denominator of the earnings per share calculations in either of the periods presented. Options to purchase 2,372,000 and 1,299,512 shares of common stock with a weighted average exercise price of $0.25 and $0.58 were outstanding at March 31, 2006 and 2005, respectively, but were not included in the computation of diluted net loss per share because their effect would be antidilutive. NOTE 8 -- Stock Based Compensation ---------------------------------- The Company's 1997 Plan, which is shareholder approved, permits the grant of share options and shares to its employees for up to 6,369,365 shares of common stock as stock compensation and 3,300,738 shares were available for grant as of March 31, 2006. All stock options under the 1997 Plan are granted at the fair market value of the common stock at the grant date. Employee stock options vest ratably usually over a three or five-year period and generally expire 10 years from the grant date. Stock options granted to non-employee directors usually vest immediately. Accounting for Employee Awards: ---------------------------------- Effective January 1, 2006, the Company's Plan is accounted for in accordance with the recognition and measurement provisions of SFAS No. 123R, which replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees, and related interpretations. SFAS 123R requires compensation costs related to share-based payment transactions, including employee stock options, to be recognized in the financial statements. In addition, the Company adheres to the guidance set forth within Securities and Exchange Commission ("SEC") Staff Accounting Bulletin ("SAB") No. 107, which provides the Staff's views regarding the interaction between SFAS No. 123R and certain SEC rules and regulations and provides interpretations with respect to the valuation of share-based payments for public companies. Prior to January 1, 2006, the Company accounted for similar transactions in accordance with APB No. 25 which employed the intrinsic value method of measuring compensation cost. Accordingly, compensation expense was not recognized for fixed stock options if the exercise price of the option equaled or exceeded the fair value of the underlying stock at the grant date. SENTRY TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) March 31, 2006 While SFAS No. 123R encouraged recognition of the fair value of all stock-based awards on the date of grant as expense over the vesting period, companies were permitted to continue to apply the intrinsic value-based method of accounting prescribed by APB No. 25 and disclose certain pro-forma amounts as if the fair value approach of SFAS No. 123R had been applied. In December 2002, SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of SFAS No. 123, was issued, which, in addition to providing alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation, required more prominent pro-forma disclosures in both the annual and interim financial statements. The Company complied with these disclosure requirements for all applicable periods prior to January 1, 2006. In adopting SFAS 123R, the Company applied the modified prospective approach to transition. Under the modified prospective approach, the provisions of SFAS 123R are to be applied to new awards and to awards modified, repurchased, or cancelled after the required effective date. Additionally, compensation cost for the portion of awards for which the requisite service has not been rendered that are outstanding as of the required effective date shall be recognized as the requisite service is rendered on or after the required effective date. The compensation cost for that portion of awards shall be based on the grant-date fair value of those awards as calculated for either recognition or pro-forma disclosures under SFAS 123R. As a result of the adoption of SFAS 123R, the Company's results for the three month period ended March 31, 2006 include share-based compensation expense totaling approximately $6,000. Such amounts have been included in the Consolidated Statements of Operations within selling, general and administrative expenses. No income tax benefit has been recognized in the income statement for share-based compensation arrangements as the Company has provided for 100% valuation allowance on net deferred tax assets. No stock option compensation expense was recorded under APB No. 25 in the Statements of Operations for the three months ended March 31, 2005. Employee stock option compensation expense in 2006 is the estimated fair value of options granted amortized on a straight-line basis over the requisite service period for entire portion of the award. The Company has not adjusted the expense by estimated forfeitures, as required by SFAS 123R for employee options, since the forfeiture rate based upon historical data was determined to be immaterial. Accounting for Non-employee Awards: -------------------------------------- The Company previously accounted for options granted to its non-employee consultants and non-employee registered representatives using the fair value cost in accordance with SFAS 123 and EITF No. 96-18. The adoption of SFAS 123R and SAB 107 as of January 1, 2006, had no material impact on the accounting for non-employee awards. The Company continues to consider the additional guidance set forth in EITF Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees" ("EITF 96-18"). There was no stock compensation expense related to non-employee options for the three month periods ended March 31, 2006 and 2005. The weighted average estimated fair value of stock options granted in the three months ended March 31, 2006 and 2005 was $0.07 and $0.08, respectively. The fair value of options at the date of grant was estimated using the Black-Scholes option pricing model. During 2006, the Company took into consideration guidance under SFAS 123R and SAB 107 when reviewing and updating assumptions. SENTRY TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) March 31, 2006 The expected volatility is based upon historical volatility of our stock and other contributing factors. The expected term is based upon observation of actual time elapsed between date of grant and exercise of options for all employees. Previously such assumptions were determined based on historical data. The assumptions made in calculating the fair values of options are as follows: Three Months Ended March 31, 2006 2005 ---- ---- Risk-free interest rate 4.375% 4.0% Expected dividend yield 0% 0% Expected lives 3 years 1 year Expected volatility 104% 94% The following table illustrates the pro forma effect on net loss and loss per share as if the fair value recognition provisions of SFAS No. 123R had been applied to all outstanding and unvested awards in the prior year comparable period: Three Months Ended March 31, 2005 -------------- Net loss, as reported $ (760) Add: Stock based compensation expense included in reported net loss --- Deduct: Employee stock option compensation expense determined under fair value based method for all employee awards (no tax effect) (6) --------- Pro forma net loss $(766) ========= Net loss per common share: As reported-basic and diluted $ (0.01) ========= Pro forma-basic and diluted $ (0.01) ========= The following table represents the Company's stock options granted, exercised and forfeited during the three months ended March 31, 2006:
Weighted Number of Weighted Average Aggregate Shares Average Remaining Intrinsic Subject to Exercise Contractual Value Issuance Price Term ($000) ----------- -------- ----------- --------- Outstanding at December 31, 2005 2,431,524 0.35 Granted 300,000 0.10 Cancelled (259,524) 1.05 Exercised (100,000) 1.07 ----------- -------- Outstanding at March 31, 2006 2,372,000 0.25 7.72 years 0 =========== ======== =========== ========= Exercisable at March 31, 2006 847,000 0.54 2.98 years 0 =========== ======== =========== =========
SENTRY TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) March 31, 2006 The aggregate intrinsic value of options has been shown as $0 because the weighted average exercise price of the price of the outstanding and exercisable option shares exceeded the quarter end market price of the Company's common stock. A total of 100,000 stock options were exercised the first quarter of 2006 and no options were exercised in the first quarter of 2005. The intrinsic value of the options exercised was $6,000 for the period ended March 31, 2006. As of March 31, 2006, there was $119,000 of total unrecognized compensation cost, net of estimated forfeitures, related to all unvested stock options, which is expected to be recognized over a weighted average period of approximately 3.9 years. Item 2. Management's Discussion and Analysis of Financial Condition and Results -------------------------------------------------------------------------------- of Operations. -------------- Certain Factors That May Affect Future Results ---------------------------------------------- Information contained or incorporated by reference in this periodic report on Form 10-QSB and in other SEC filings by Sentry contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 which can be identified by the use of forward-looking terminology such as "believes," "expects," "may," "will," "should" or "anticipates" or the negative thereof, other variations thereon or comparable terminology, or by discussions of strategy. These forward-looking statements involve certain significant risks and uncertainties, and actual results may differ materially from the forward-looking statements. For further details and discussion of these risks and uncertainties see Sentry Technology Corporation's SEC filings including, but not limited to, its annual report on Form 10-KSB. No assurance can be given that future results covered by the forward-looking statements will be achieved, and other factors could also cause actual results to vary materially from the future results covered in such forward-looking statements. We do not undertake to publicly update or revise any of our forward-looking statements even if experience or future changes show that the indicated results or events will not be realized. Results of Operations: ------------------------ Consolidated revenues were 9% higher in the quarter ended March 31, 2006 as compared to the quarter ended March 31, 2005. This was despite a decrease in revenues from Lowe's of approximately $0.5 million on a comparable basis. Non-Lowe's revenues increased 39% in the first quarter of 2006. Our backlog of orders, which we expect to deliver within the next twelve months, was $2.1 million at March 31, 2006 as compared to $1.2 million at December 31, 2005. SENTRY TECHNOLOGY CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Total revenues for the periods presented are broken out as follows: Q-1 Q-1 % Change 2006 2005 Incr (Decr) ---- ---- ----------- (in thousands) EAS $ 1,511 $ 1,050 44% CCTV 207 313 (34%) SentryVision 567 550 3% ------- ------ ----- Total sales 2,285 1,913 19% Service, installation and other 423 580 (27%) ------- ------ ------ Total revenues $ 2,708 $ 2,493 9% ======= ======= ====== The increase in EAS sales is primarily attributable to an increase in North American library sales of our QuickCheck patron self check book-borrowing systems and increased sales to Mexico and Latin America. CCTV revenues decreased principally as a result of lower sales to Lowe's. There was an increase in domestic sales of our SentryVision Smart Track system, which was offset somewhat by lower sales to our international dealers and distributors. Our international sales are denominated in U.S. dollars, therefore the strengthening of the Euro and other foreign currencies against the U.S. dollar had no significant impact on revenues. Service and maintenance revenues were substantially lower as a result of cancellation of the Lowe's maintenance contract. Installation revenues were slightly higher in the first quarter of 2006 as compared to the first quarter of 2005. Even though EAS sales increased substantially, the installation revenues associated with EAS systems are lower than for CCTV and SentryVision sales. Cost of sales were 55% of total sales in the three month period ended March 31, 2006 compared to 51% in the three month period ended March 31, 2005. The increase in percentage is principally a result of the increase in dealer sales in Mexico and Latin America that carry lower margins than sales made to end users. We continue to see strong domestic margins in 2006 on the SmartTrack product lines as a result of our outsourcing of manufacturing. The decrease in customer service expenses in the first quarter of 2006 as compared to the first quarter of 2005 is primarily a result of a decrease in the number of customer service employees and lower outside service contractors costs. Due to the loss of the Lowe's maintenance agreement in the first quarter of 2005, we terminated twelve customer service employees as of the end of March 2005. Selling, general and administrative expenses were 11% higher in the three month period ended March 31, 2006 when compared to the same period of the previous year. The increases in expenses are principally a result of higher sales and marketing expenses and higher product warranty costs. We have increased funding of sales and marketing programs, which we expect will continue to increase our business with new and existing customers. In the first quarter of 2006, we hired on additional sales person and a new VP of Sales and Marketing, with prior experience with our industry's largest competitor. The first quarter of 2006 also includes $35,000 resulting from the settlement of audit fees with our predecessor auditors. The reduction in research and development in the first quarter of 2006 when compared to the first quarter of 2004 is principally a result of a reduction in the number of engineers offset partially by the increased use of engineering consulting firms. SENTRY TECHNOLOGY CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Total interest and financing costs were lower in the first quarter of 2006 compared to 2005 as a result of lower average bank debt and lower interest rates under the Royal Bank of Canada credit agreement. The income tax expense in all the periods presented principally results from taxable income of one of our Sentry Canada subsidiaries, which cannot be offset by Sentry's net operating loss carryforwards. As a result of the foregoing, Sentry had a net loss of $730,000 in the quarter ended March 31, 2006 as compared to a net loss of $760,000 in the quarter ended March 31, 2005. Liquidity and Capital Resources as of March 31, 2006 At March 31, 2006, we had cash of $0.6 million, working capital of $2.4 million, total assets of $8.9 million and shareholders' equity of $2.0 million. While we had a loss of $0.7 million in the first three months of 2006, we generated net cash from operating activities of $336,000. This was a result of lower amounts of accounts receivable principally due to improved collection efforts as well as an increase in accounts payable and accrued liabilities. We utilized $0.5 million in financing activities through a reduction in borrowings under our credit facility. Availability under the credit facilities is principally based on the level of our receivables and inventory, which declined in the first three months of 2006. Net reductions in our credit facilities were funded through the use of existing cash. The Company and certain of its subsidiaries entered into a secured credit facility, as amended, with Royal Bank of Canada ("RBC") for maximum borrowings of up to Canadian $4.5 million (U.S. $3.9 million), which are subject to certain limitations based on a percentage of eligible accounts receivable and inventories as defined in the agreement. Interest is payable at a rate of RBC prime rate (5.5% at March 31, 2006), plus 1.75% per annum. Borrowings under this facility are secured by substantially all of the Company's assets. As of March 31, 2006, we had borrowings of approximately $1.5 million with RBC and had excess borrowing capacity of $0.09 million. We will require liquidity and working capital to finance increases in receivables and inventory associated with sales growth, payments to past due vendors and, to a lesser extent, for capital expenditures. We had no material capital expenditure or purchase commitments, other than the Dialoc distribution agreement, as of March 31, 2006. Sentry's revenues declined and we incurred an operating loss in 2005. This trend continued through the first quarter of 2006 and substantially reduced the Company's available cash reserves and limited our ability to secure additional bank financing. The Company has instituted certain plans to increase its revenue base as well as preserve its cash, including cost cutting measures and inventory reduction initiatives. In May 2006, we amended our credit agreement by further modifying certain financial covenants and by extending the term of the agreement through May 2007. In addition, the maximum borrowings under the facility were reduced to U.S. $3 million. Mr. Murdoch, Sentry's CEO and Director and Mr. Furst, a Sentry Director, have agreed to provide personal guarantees to RBC in the amount of Canadian $1 million (U.S. $856,000) in exchange for the bank providing increased availability under its credit facility to the Company by the same amount. In consideration of these guarantees, Mr. Murdoch and Mr. Furst will receive a fee of $43,000, to be shared between them, paid in 12 equal monthly installments. As additional consideration, they will receive fully vested, two year warrants to purchase approximately 2.9 million shares of the Company's common stock, at an exercise price $0.10 per share. The fair value of these warrants will be recorded in accordance with SFAS No. 123R "Share-Based Payment" in the second quarter of 2006 and will be written off over the period of the guarantee. After conversations with RBC, management believes that these amendments will be approved in the near future. Based upon the achievement of its plans, as well as the additional borrowing availability as a result of the Directors guaranties, the Company believes that it will have sufficient cash to meet its anticipated operating costs, capital expenditures and debt service requirements for at least the next twelve months. Related Party Transactions ---------------------------- Details of related party transactions are included in Note 6 of this Form 10-QSB. Item 3. Controls and Procedures As of the end of the period covered by this report, Sentry Technology Corporation carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Rule 13a-15 of the Securities and Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information related to the Company that is required to be included in Sentry Technology Corporation's periodic SEC filings. There has been no change in the Company's internal control over financial reporting during the period covered by this report that has materially affected, or is reasonable likely to materially affect, the Company's internal control over financial reporting. PART II - OTHER INFORMATION Item 6 - Exhibits (a) Exhibits: 31.1 - Certification by the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 - Certification by the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 - Certification by the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*** 32.2 - Certification by the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*** *** In accordance with Item 601(b)(32)(ii) of Regulation S-K, this exhibit shall not be deemed "filed" for the purposes of Section 18 of the Securities and Exchange Act of 1934 or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934. SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant had duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SENTRY TECHNOLOGY CORPORATION ----------------------------- Date: May 12, 2006 By: /s/PETER J. MUNDY ------------ ----------------- Peter J. Mundy, Vice President - Finance and Chief Financial Officer (Principal Financial and Accounting Officer) SECTION 302 CERTIFICATION: EXHIBIT 31.1 CERTIFICATION PURSUANT TO RULE 13(A) OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, PETER L. MURDOCH, CERTIFY THAT: 1. I have reviewed this Quarterly Report on Form 10-QSB of Sentry Technology Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this quarterly report; 4. The Registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have: A. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure the material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; B. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principals; C. Evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and D. Disclosed in this report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recent fiscal quarter that materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting. 5. The Registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant's auditors and the Audit Committee of Registrant's Board of Directors (or persons performing the equivalent function): A. All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the Registrant's ability to record, process, summarize and report financial information; and B. Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. DATED: May 12, 2006 BY: /S/ PETER L. MURDOCH ---------------------------- NAME: Peter L. Murdoch TITLE: President and Chief Executive Officer SECTION 302 CERTIFICATION: EXHIBIT 31.2 CERTIFICATION PURSUANT TO RULE 13(A) OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 202 I, PETER J. MUNDY, CERTIFY THAT: 1. I have reviewed this Quarterly Report on Form 10-QSB of Sentry Technology Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this quarterly report; 4. The Registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in exchange act rules 13a-14 and 15d-14) for the Registrant and we have: A. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure the material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; B. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principals; C. Evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and D. Disclosed in this report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recent fiscal quarter that materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting. 5. The Registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent function): A. All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the Registrant's ability to record, process, summarize and report financial information; and B. Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. Dated: May 12, 2006 By: /s/ Peter J. Mundy ---------------------- Name: Peter J. Mundy Title: Vice President and Chief Financial Officer SECTION 906 CERTIFICATION: EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Certification of CEO In connection with the Quarterly Report of Sentry Technology Corporation (the "Company") on Form 10-QSB for the period ended March 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the Report"), I, Peter L. Murdoch, Chief Executive Officer of the Company, certify, pursuant to Section 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) and 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ PETER L. MURDOCH ------------------------------------------------- Peter L. Murdoch President and Chief Executive Officer May 12, 2006 A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. This certification accompanies this Report on Form 10-QSB pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by such Act, be deemed filed by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the Company specifically incorporates it by reference. SECTION 906 CERTIFICATION: EXHIBIT 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Certification of CFO In connection with the Quarterly Report of Sentry Technology Corporation (the "Company") on Form 10-QSB for the period ended March 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the Report"), I, Peter J. Mundy, Chief Financial Officer of the Company, certify, pursuant to Section 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) and 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ PETER J. MUNDY ------------------------------------------------- Peter J. Mundy Vice President and Chief Financial Officer May 12, 2006 A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. This certification accompanies this Report on Form 10-QSB pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by such Act, be deemed filed by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the Company specifically incorporates it by reference.