SENTRY TECHNOLOGY CORP - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549
____________

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM -__________ TO ___________----

COMMISSION FILE NUMBER: 1-12727
_________________

SENTRY TECHNOLOGY CORPORATION

(EXACT NAME OF THE REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 96-11-3349733
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(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)

350 WIRELESS BOULEVARD, HAUPPAUGE, NEW YORK 11788
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (631) 232-2100
---------------

Securities registered pursuant to Section 12(b) of the Act: None.

Securities registered pursuant to Section 12(g) of the Act:

Title of each class:
--------------------

Common Stock, $.001 par value

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes No ___

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regula-tion S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.

At March 28, 2003, the aggregate market value of the voting stock held by
non-affiliates of the Registrant was approximately $751,000 based upon the
closing price of such securities on the OTC Bulletin Board on that date. At
March 28, 2003, the Registrant had outstanding 82,560,347 shares of Common
Stock.

Documents Incorporated by Reference
- --------------------------------------

None.

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PART I
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ITEM 1. BUSINESS
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GENERAL

Sentry Technology Corporation ("Sentry") was formed in connection with the
February 1997 merger of Knogo North America Inc., a Delaware corporation, and
Video Sentry Corporation, a Minnesota corporation. As a result of the merger, we
became the parent corporation of two wholly-owned Delaware subsidiaries:
Knogo North America Inc. ("Knogo") and Video Sentry Corporation ("Video"). This
series of transactions is referred to herein collectively as the "Merger."

Knogo is engaged in the design, manufacture, sale, installation and servicing of
a complete line of electronic article surveillance equipment. Knogo was
incorporated in Delaware in October 1996. Its corporate predecessors had been in
business for more than 30 years.

Video designs, manufactures, markets, installs and services a programmable
traveling closed circuit television surveillance system that delivers a high
quality video picture which is used in a wide variety of applications. Video
also acts as a system integrator for conventional CCTV products that it markets,
installs and services. Video's predecessor was founded in 1990 and made its
first sales in 1992. Video was merged into Knogo as of December 31, 2000.

RECENT DEVELOPMENTS

Our strategy following the Merger in 1997 was to use Knogo's engineering staff
and excess manufacturing capacity resulting from a 1994 restructuring for the
reengineering and production of its proprietary and patented SentryVision
programmable traveling closed circuit television surveillance ("CCTV") systems.
With the reengineering completed, management believed that sales of SentryVision
, which had fallen in the final year that Video was a separate corporation,
would rebound.

While the engineering staff was able to resolve substantially the design and
manufacturing problems associated with SentryVision , the sales of the system
did not achieve the levels anticipated by the Company.

Furthermore, while still profitable, sales of Knogo's Electronic Article
Surveillance ("EAS") systems have continued to erode due to the attention we
gave to the reengineering and marketing of SentryVision as well as competition
from lower-priced "off-the-shelf" systems and competition from larger,
better-financed competitors such as Sensormatic Electronics Corporation and
Checkpoint Systems Inc. In addition, due to a non-compete provision entered into
by Knogo in 1994, we were not permitted to market our EAS products outside of
the United States and Canada. The non-compete provision expired at the end of
1999.

We recognized that, because of our continuing operating losses and the depletion
of our tangible assets to fund ongoing operations, our ability to continue to
market our existing SentryVision and EAS products and to develop new products
and product extensions to allow us to remain competitive would require
additional investment.

On January 8, 2001, Dialoc ID Holdings, B.V. ("Dialoc ID"), formerly known as
Dutch A&A Holding, B.V., acquired 23,050,452 shares of the Company's common
stock for $3.0 million, $1.0 million of which was paid in January 2001, and the
remaining balance was paid in equal $1.0 million installments on April 30, 2001
and August 31, 2001. Dialoc ID is a Netherlands company which, through its
subsidiaries, is in the business of development, manufacture, sale and
distribution of various kinds of RFID, access control and anti-theft electronic
article surveillance products and accessories. Concurrent with the share
purchase agreement, the Company entered into a distribution agreement with
Dialoc ID allowing the Company access to new products of Dialoc ID and allowing
Dialoc ID access to the Company's products for an initial period of not less
than two years.

As of January 8, 2001, Dialoc ID owned 37.5 percent of the outstanding common
stock of the Company. Under the share purchase agreement, at any time prior to
January 8, 2002, Dialoc ID had the right to increase its ownership of the
Company's common stock to a total of 51% of the shares of common stock then
outstanding. If the average market value of the Company's common stock, measured
over any 10-day trading period during the one year period following January 8,
2001, was at least $15.0 million, the purchase price for the additional shares
was to be determined by multiplying the actual number of shares to be purchased
by $.001. In November 2001, this market capitalization threshold was met. At
that time, our Board of Directors agreed to extend Dialoc ID's purchase right
until January 8, 2003 in exchange for an extension of the distribution agreement
for one year. On May 14, 2002, Dialoc ID exercised their right to purchase
14,500,000 additional common stock shares at a price of $.001 per share,
increasing its percentage of our outstanding common stock to 48.1% of the
Company's common stock. On January 7, 2003, Dialoc exercised its right to
purchase 4,516,475 additional shares of our common stock at a price of $.001 per
share, increasing its percentage of our outstanding common stock to 51% and it
total common stock ownership to 42,066,927 shares. As a condition to the
investment by Dialoc ID, the Company's stockholders elected three nominees of
Dialoc ID to the Board of Directors at a Special Meeting of Stockholders on
December 8, 2000.

In addition to the election of three nominees of Dialoc ID to the Board of
Directors, other matters which were approved at the December 8, 2000 Special
Meeting of Stockholders, and became effective as of January 8, 2001, were
proposals to amend the Company's certificate of incorporation to: (i) permit the
payment of a dividend of additional shares of Class A Preferred Stock at the
rate of 0.075 shares of Class A Preferred Stock for each share of Class A
Preferred Stock held; (ii) to reclassify Class A Preferred Stock into shares of
common stock on a ratio of five shares of common stock for each share of Class A
Preferred Stock outstanding; and (iii) to increase the number of the Company's
authorized shares of common stock to 140,000,000. As a result of the dividend
and reclassification, 28,666,660 common shares were issued to former Class A
Preferred Stockholders.

The Company has incurred reduced revenue levels, decreased financial position
and recurring operating losses over the past several years. During 2002, delays
in orders received and the loss of other purchase orders caused the Company to
operate in a cash flow deficit, borrow the maximum amounts available under our
credit facility, and pursue potential sources of debt or equity financing.
While the Company was successful in completing many of its business plan goals
for 2002, we were unable to meet our projected revenue growth targets. As a
result, On January 7, 2003, we initiated our restructuring plan. We believe the
successful implementation of this restructuring will result in substantial gross
margin improvements and reductions in operating expenses beginning after the
first quarter of 2003. There can be no assurance, however, that changes in our
plans or other events affecting our operations will not result in accelerated or
unexpected cash requirements, or that we will be successful in achieving
positive cash flow from operations or that additional debt or equity financing
will be available on terms that are satisfactory to Sentry, or that any such
debt or equity financing will be sufficient to provide the full amount of
funding necessary. Our future cash requirements are expected to depend on
numerous factors, including, but not limited to: (i) the ability to generate
positive cash flow from operations, and the extent thereof, (ii) the ability to
raise additional capital or obtain additional financing, and (iii) economic
conditions. Sentry will require liquidity and working capital to finance
increases in receivables and inventory associated with sales growth, payments to
past due vendors and, to a lesser extent, for capital expenditures.

THE SENTRYVISION SYSTEM

SentryVision refers to our family of traveling CCTV surveillance systems. Over
the years, Video has developed various generations of traveling CCTV
surveillance systems including the H-System, OH-System, the original
SentryVision and currently the new and improved SmartTrack system.

All versions of the product consist of a camera carriage unit, a continuous
track enclosed with tinted or mirrored glass enclosure and electronic control
equipment. The carriage unit moves within the enclosure and carries one or two
PTZ CCTV cameras, electronic transmission components and motor drives. The
carriage track and enclosure are designed to custom lengths for more complete
viewing. The carriage unit transmits video and control signals from the
camera(s) through two copper conductors running inside the enclosure to a
receiver unit located at one end of the carriage track. The copper conductors
also carry power to the camera carriage, eliminating the need for power or
communication cables. From the receiver unit, the video signals are relayed to a
central monitoring location by wire or fiber optics, where a system operator can
position or move the camera carriage to obtain the best vantage point while
viewing and recording the continuous, live video pictures. The system design
supports conventional peripheral devices, such as analog and digital
videocassette recorders, alarm inputs, fixed cameras, PTZ dome cameras,
switches/multiplexers, voice intercom systems, panic buttons and remote viewing
capability using dedicated phone lines or internet technology.

Unlike our previous products, our recently developed SentryVision SmartTrack
system features one or two state-of-the-art pan, tilt and zoom ("PTZ") domes
providing for 360 unobstructed views to eliminate most blind spots.
Additionally, SmartTrack utilizes sophisticated software that provides six tours
and up to 60 presets per camera carriage to allow programmable viewing and
recording with or without an operator. The improvements made to the carriage
make the new SmartTrack system the fastest and most reliable traveling CCTV
surveillance system in the history of SentryVision product offerings.
SmartTrack is our premier product, replacing all previous generations of
SentryVision products.

Sentry's proprietary CCTV system, called SentryVision , is designed to provide
enhanced loss prevention surveillance in retail stores and distribution centers
as well as to provide monitoring and deterrence of illegal and unsafe activities
in a variety of other locations such as parking garages, correctional
facilities, warehouses, transportation centers and public transit terminals.
SentryVision may also be employed in a broad range of operational and process
monitoring applications in commercial manufacturing and industrial settings. As
of December 31, 2002, 1,272 SentryVision systems had been installed in
customer locations in North America. Current customers include Lowe's Home
Centers, Target Stores, Mills Fleet Farm, Winn Dixie, Federal Express, Symbol
Technologies, Menards, UPS, J.C. Penney, Canadian Tire, Reno Depot, Estee
Lauder, Kohl's Department Stores, Disney Direct Marketing and Duke University.
In addition, during 2002, the Company's international distributors installed 60
SentryVision systems in customer locations throughout Western and Eastern
Europe, Latin America and Asia. Our international customers include Carrefour,
Auchon, Cora, Castorama, B & Q, and Coop. We believe that, by providing expanded
surveillance coverage and enhanced flexibility to select the locations watched,
SentryVision has enabled customers to significantly reduce inventory
shrinkage, increase theft apprehension rates and improve safety and security.
Based on the price of its system and the experience of Sentry's customers to
date, we believe SentryVision is a cost-effective solution which can improve
the operations of our customers.

Sentry sold its first systems in 1992 for installation in parking garage
security surveillance applications, but quickly moved its market focus into the
retail sector. In this sector, we have identified a number of specific market
segments for which SentryVision is well suited for loss prevention
surveillance, including home centers, mass merchandise chains, supermarkets,
hypermarkets and drug stores, as well as related distribution centers. The key
application is inventory loss prevention in the stores, stock rooms and
distribution centers.

SentryVision is typically installed in large retail stores which use a
checkout area at the front of the store and product display configurations and
high merchandise shelving which form rows and aisles. Video specializes in
designing system applications which are customized to fit a customer's specific
needs and which integrate the customer's existing surveillance equipment (PTZ
dome and fixed-mount cameras) with SentryVision . The flexibility of the
system allows the customer to specify target-coverage areas ranging from stock
rooms to total store coverage and focus on shoplifting, employee theft or
performance evaluation of client personnel. Typically, SentryVision has been
installed near the ceiling between the rows of cash registers and the ends of
the merchandise aisles. This allows the retailer to easily observe both the cash
handling activities of cashiers in the checkout area and customer activities
between the merchandise rows, despite the presence of hanging signs and other
obstructions. The entire sales floor can be monitored efficiently by focusing up
and down the aisles and by moving the carriage horizontally from aisle to aisle,
or from cash register to cash register. In addition, with the use of camera pan,
tilt and zoom lens features, activities in each area can be monitored in greater
detail. Results from Video's current installations indicate significant
improvements in detecting shoplifting and employee theft.

More recently, retailers have integrated SentryVision with "front end"
packages of conventional CCTV cameras, dedicated to monitoring the registers and
allowing users to locate the traveling camera track where the maximum coverage
of in-store traffic can be monitored. The SentryVision system is today
generally sold in conjunction with conventional CCTV applications. Customers
using the SentryVision system have reported significant reductions in
theft-related inventory shrinkage.

RETAIL MARKET APPLICATIONS
- ----------------------------
- - Home Centers. Video has installed 839 systems in more than 340 store locations
for 8 customers in the home center segment of the retail market. Typical of our
customers in this market are Lowe's Home Centers, with more than 850 stores in
45 states, and Mills Fleet Farm, a 24 store regional hardware, home supply and
discount retail chain. Both companies required systems for total floor coverage.
We applied different solutions to this common problem in each case. Lowe's Home
Centers chose to integrate track cameras with PTZ dome and fixed-mount cameras,
while Mills Fleet Farm chose to use only the track camera system.

- - Mass Merchandise Chains. Video has installed 101 systems for customers in this
segment, including Sears, Navy Exchange and Target Stores. The targeted coverage
varies extensively in these installations from only stock rooms to total store
coverage. The equipment package provided in each case varies with the
application and location of the need.

- - Supermarkets. Video has installed 34 systems in 32 store locations for 7
supermarket customers. The targeted coverage in most of these installations has
been the entire retail space. Supermarket chains using SentryVision include
Kroger, Marsh, Cub Foods, Winn-Dixie and Fiesta Mart.

INDUSTRIAL MARKET APPLICATIONS
- --------------------------------
- - Distribution Centers. Video also provides loss prevention surveillance for
distribution centers and warehouses, and has installed 101 systems in
distribution centers for 41 different retailers including Kohl's Department
Stores, Target Stores, Borders Group, Disney Direct Marketing, Barnes & Noble,
Robinsons-May, Ross, Saks, Guess, Tower Records, Big Dog, Food Lion, the Gap,
Bealls and J.C. Penney. Traveling through a facility from an overhead position,
the SentryVision system can monitor activities occurring between the stacked
rows of cartons or lines of hanging garments. The system can also move a
surveillance camera into position to monitor shipping and receiving docks and
parked delivery trucks. To achieve surveillance capabilities equivalent to those
of the SentryVision system, a conventional PTZ dome system or fixed-mount CCTV
camera would have to be installed at every desired vantage point, requiring
numerous cameras, additional equipment and wiring and increased installation and
operating costs.

- - Manufacturing and Transportation Facilities. So far SentryVision use in
factories has been limited, but the benefits of continuous tracking of
industrial operations and processes indicate future growth potential. Continued
expansion of the SentryVision dealer program is expected to generate increased
installations in factories manufacturing electronics, pharmaceuticals, computers
and other high value products and in various wholesale distribution and
transportation facilities. Express package and other high throughput
distribution facilities are also good prospects for a continuous tracking CCTV
system for theft prevention. Installations include Symbol Technologies, AT&T
Wireless, Federal Express, UPS, Wyeth-Ayerst Labs, USF Logistics and Thompson
Electronics.

- - Internet Data Centers. Video markets SentryVision systems to internet data
centers (IDC's). Most IDC's are full service business internet providers with
state-of-the-art systems that host, monitor and maintain mission-critical
web-sites, e-commerce platforms and business applications for small to medium
sized businesses. SentryVision systems are used to heighten security through
remote video monitoring. Installations include FirstWorld Communications, Inc.,
Savvis and The Discovery Channel.

INSTITUTIONAL MARKET APPLICATIONS
- -----------------------------------
- - Parking, Corrections, and Government Institutions. We have 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 has been installed in correctional facilities in Texas, Michigan,
New Mexico and Illinois, with reported safety benefits of continuous coverage in
dormitory, recreation and visitation areas. SentryVision installations have
also been completed in various government agencies including the Federal Reserve
Bank, U.S. Postal Service and U.S. Immigration Service.

CONVENTIONAL CCTV SYSTEMS

Conventional CCTV is cost effective in many applications and is the most widely
used loss prevention system in North America. Conventional CCTV uses all the
basic components of the video surveillance industry including fixed and dome
cameras, VCR's, monitors, switchers, multiplexers and controllers. As all of
this equipment is manufactured for Video by outside vendors, we can provide our
customers with state-of-the-art equipment for specific applications at favorable
costs. We believe that, while less profitable than SentryVision and
traditional EAS products, the CCTV products complement our other surveillance
systems and provide retailers with further protection against internal theft and
external shoplifting activities. CCTV systems can also be electronically
connected to EAS systems, causing a video record to be generated when a theft
alarm is triggered.

While we believe that conventional CCTV and SentryVision are complementary
security solutions, many companies have traditionally viewed them as competing
solutions and have selected between conventional CCTV systems and SentryVision
systems for their security solutions.

Remote video transmission and digital recording are 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 multiplexer, and
eliminating the videotape. Video markets digital video recording and a remote
video transmission unit developed by third-party vendors including Kalatel and
Integral.

We continue to expand conventional CCTV installations in industrial and
institutional facilities. Significant installations have been made for express
package companies, including Federal Express, United Parcel Service, Emery Air
Freight and Airborne Express. The use of CCTV surveillance also continues to
grow in both new and existing correctional facilities and Sentry now has CCTV
installations in both state and county facilities.

In 2002, we continued marketing CCTV to the school market. Successful
installations were completed with reported benefits including decreased
vandalism and improved safety. In schools, conventional CCTV is an extremely
cost effective security option with Digital Recording and Remote Video
Transmission becoming attractive options for large school districts.

Our largest single school CCTV installation was at the Norristown (PA) High
School with 111 cameras, using digital recording and fiber optic cabling. It is
an advanced cost effective system with video from all cameras instantly
accessible on their network.

EAS SYSTEMS

EAS systems consist of detection devices which are triggered when articles or
persons tagged with reusable tags or disposable labels, (referred to as tags),
pass through the detection device. The EAS systems which Sentry manufactures are
based upon three distinct technologies. One, the Radio Frequency ("Knoscape RF")
System, uses medium radio frequency transmissions in the two to nine megahertz
range. Second, the "Ranger " system uses ultra-high frequency radio signals in
the 902 megahertz and 928 megahertz bands. Third, the Magnetic ("Knoscape MM ")
system uses very low frequency electromagnetic signals in the range of 218 hertz
to nine kilohertz. Since 1996, Sentry has been an authorized distributor of the
library security systems and related products of Minnesota Mining and
Manufacturing Company ("3M"). We cancelled our distribution agreement with 3M
effective December 31, 2002.

The principal application of Sentry's products is to detect and deter
shoplifting and employee theft in supermarket, department, discount, specialty
and various other types of retail stores including bookstores, video, liquor,
drug, shoe, sporting goods and other stores. The use of these products reduces
inventory shrinkage by deterring shoplifting, increases sales potential by
permitting the more open display of greater quantities of merchandise, reduces
surveillance responsibilities of sales and other store personnel and, as a
result, increases profitability for the retailer. In addition, Sentry's EAS
systems are used in non-retail establishments to detect and deter theft, in
office buildings to control the loss of office equipment and other assets, in
nursing homes and hospitals for both asset and patient protection, and in a
variety of other applications.

The U.S. market for retail EAS systems and tags is estimated by industry sources
at $570 million and is growing at an estimated rate of 8 percent per year.

At December 31, 2002, the approximate number of EAS Systems sold or leased by
Sentry and its predecessors exceeded 25,500.

RADIO FREQUENCY AND RANGER DETECTION SYSTEMS

Sentry manufactures and distributes the Knoscape RF system, the principal
application of which is to detect and deter shoplifting and employee theft of
clothing and hard goods in retail establishments. Sentry also manufactures and
distributes the Ranger system, which the Company believes is a particularly
useful and cost efficient EAS system for high fashion retail stores with wide
mall-type exit areas which ordinarily would require multiple Knoscape RF systems
for adequate protection. The Knoscape RF and Ranger systems consist of radio
signal transmission and monitoring equipment installed at exits of protected
areas, such as doorways, elevator entrances and escalator ramps. The devices are
generally located in panels or pedestals anchored to the floor for a vertical
arrangement or mounted in or suspended from the ceiling (Silver Cloud) and
mounted in or on the floor in a horizontal arrangement. The panels or pedestals
are designed to harmonize with the decor of the store. The monitoring equipment
is activated by tags, containing electronic circuitry, attached to merchandise
transported through the monitored zone. The circuitry in the tag interferes with
the radio signals transmitted through the monitoring system, thereby triggering
alarms, flashing lights or indicators at a central control point, or triggering
the transmission of an alarm directly to the security authorities. By means of
multiple installations of horizontal Knoscape RF systems or installation of one
or more Ranger systems, the Company's products have the ability to protect any
size entrance or exit.

Non-deactivatable reusable tags are manufactured in a variety of sizes and types
and are attached directly to the articles to be protected by means of specially
designed fastener assemblies. A reusable tag is removed from the protected
article, usually by a clerk at the checkout desk, by use of a decoupling device
specially designed to facilitate the removal of the fastener assemblies with a
minimum of effort. Removal of the tag without a decoupler is very difficult and
unauthorized removal will usually damage the protected article and thereby
reduce its value to a shoplifter. Optional reminder stations automatically
remind the store clerk, by means of audiovisual indicators, to remove the tag
when the article is placed on the cashier's desk.

Disposable labels can be applied to products either by placing them directly on
the outside packaging of the item or hidden within the product by the
manufacturer. These labels can be deactivated, at the checkout desk, through the
use of a deactivation device.

Knoscape RF and Ranger systems generally have an economic useful life of six
years (although many of Knogo's systems have been operating for longer periods),
have a negligible false alarm rate and are adaptable to meet the diversified
article surveillance needs of individual retailers.

MAGNETIC DETECTION SYSTEMS

The primary application of Knoscape MM systems is to detect and deter theft in
"hard goods" applications such as supermarkets, bookstores and in other
specialty stores such as video, drug, liquor, shoe, record and sporting goods.

Knoscape MM systems use detection monitors which are activated by
electromagnetically sensitized strips. The MM targets are typically attached to
the articles to be protected and are easily camouflaged on a wide array of
products. The detection monitors used by the Knoscape MM systems are installed
at three to five foot intervals at the exits of protected areas. The magnetic
targets can be supplied in many forms and are attractively priced, making them
suitable for a variety of retail applications. In addition, the MM targets can
be manufactured to be activated and deactivated repeatedly while attached to the
articles to be protected. Accurate deactivation is also very important when the
item to be protected is a personal accessory that will be carried by its owner
from place to place, such as pocket books, pens, lipstick, shoes, camera film
and cameras.

The Knoscape MM system offers retailers several features not available in
Knoscape RF and Ranger systems. Since the target is very small, relatively
inexpensive and may be inserted at the point of manufacture or packaging, it
provides retailers with a great deal of flexibility and is practical for
permanent attachment to a wide variety of hard goods, especially low
profit-margin products. The target can be automatically deactivated at
check-out, eliminating the risk of triggering alarms when merchandise leaves the
store and saving sales personnel valuable time. Since the targets can be
incorporated directly into a price tag or the article itself, they are
convenient to use.

BOOKINGS

Of Sentry's bookings for the year ended December 31, 2002, approximately 32
percent were attributable to SentryVision , 45 percent to CCTV, 20 percent to
EAS and 3 percent to 3M library security systems. Of Sentry's bookings for the
year ended December 31, 2001, approximately 23 percent were attributable to
SentryVision , 40 percent to CCTV, 31 percent to EAS and 6 percent to 3M library
security systems. For the year ended December 31, 2000, approximately 17 percent
were attributable to SentryVision , 39 percent to CCTV, 39 percent to EAS, and 5
percent to 3M library security systems.

MAJOR CUSTOMERS

Although the composition of our largest customers has changed from year to year,
a significant portion of our revenues has been attributable to a limited number
of major customers. In 2002, 2001 and 2000, Lowe's Home Centers accounted for
40%, 22% and 14%, respectively, of total revenues. In 2001 and 2000, Goody's
Family Clothing accounted for 11% and 15%, respectively, of total revenues.
While we believe that one or more major customers could account for a
significant portion of our sales for at least the next two years, we anticipate
that our customer base will continue to expand and that in the future we will be
less dependent on major customers.

PRODUCTION

SENTRYVISION AND CCTV PRODUCTS
- ---------------------------------

Sentry's manufacturing operations consist primarily of the assembly of its
camera carriages and control units using materials and manufactured components
purchased from third parties. Sentry 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 Sentry and manufactured to Sentry'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 and finished assembly
undergoes a quality assurance check by Sentry prior to its shipment to an
installation site. All SmartTrack electronic circuit board enclosures are tested
and burned in for 72 hours. Upon completion, the finished product is tested and
run for an additional 24 hours resulting in approximately 3,000 travel and PTZ
cycles prior to quality assurance sign off. Sentry is not subject to any state
or federal environmental laws, regulations or obligations to obtain related
licenses or permits in connection with its manufacturing and assembly
operations.

EAS PRODUCTS
- -------------

Sentry produces at our facilities in Hauppauge, New York, or purchases through
suppliers, its Knoscape RF, Ranger, Knoscape MM and KnoGlo, or their components.
Production consists of final assembly operations of printed circuitry,
electronic and mechanical components that Sentry purchases from various
suppliers. Independent contractors using existing molds and tooling produce
plastic cases and antenna coils for the tags to Sentry's specifications. Through
product redesign efforts, final assembly machines were modified to reduce
production complexities. As a result, increased production run rates of this
product have been realized, simultaneously increasing production quality and
reducing manpower. Sentry is not dependent on any one supplier or group of
suppliers of components for its systems. Our policy is to maintain our inventory
at a level that is sufficient to meet projected demand for its products. We do
not anticipate any difficulties in continuing to obtain suitable components for
EAS products at competitive prices in sufficient quantities as and when needed.

MARKETING

In 2002, we marketed our products through the direct efforts of approximately 13
salespersons located in select metropolitan areas across the United States and
Canada, as well as through dealers/system integrators. Marketing efforts include
participation in trade shows, targeted direct mailings and telemarketing. In
addition, the effort is augmented through our Website which provides enhanced
product and market oriented information. Internationally, we market SentryVision
through large system integrators and distributors including Ultrak, Chubb,
Cegelec, Intrepid and BSC. As part of the 2003 restructuring plan we have
reduced the number of direct salespersons to four, whose efforts are now
supplemented through six in-house sales support staff and independent sales
representatives.

SENTRYVISION AND CCTV PRODUCTS
- ---------------------------------

To date, most SentryVision and conventional CCTV Systems have been sold on a
direct sale basis. Typical billing arrangements for SentryVision systems
involve invoicing 50% of total sale upon shipment of the product and 50% on the
completion of the installation.

While most of the current SentryVision and conventional CCTV sales have been
made to home centers, retail chains and distribution centers, our marketing plan
for Video also emphasized a dealer program for institutional, industrial and
international prospects.

Beginning in mid-1998, we began a program to market SentryVision through
qualified security dealers and integrators. Much of the industrial and
institutional SentryVision /CCTV prospects are serviced by local security
companies who design and install integrated CCTV, access control and alarm
systems. By working with these companies, we are able to reach a far larger
number of SentryVision prospects and penetrate the market more rapidly. The
program has generated interest through trade advertising, direct mail and trade
show participation. Domestic dealers did not generate significant SentryVision
installations in industrial and institutional facilities in 2002. Prior sales
were made through ADT, STG, Siemans, Mosler and Security Link.

In addition, we market SentryVision internationally using independent
distributors. The agreements require the distributor to purchase a minimum
dollar amount of the Company's product during the term of the agreement to
retain distributor status. We sell our products to independent distributors at
prices below those charged to end-users because distributors typically make
volume purchases and assume marketing, customer training, installation,
servicing and financing responsibilities. As of December 31, 2002, we have
distributors in Canada, UK, France, Mexico, Belgium, Holland, Italy, Singapore,
Brazil, Argentina, Hungary and Romania.

During 2002, Video placed in service 186 SentryVision systems and 4,449 CCTV
cameras, as compared to 97 SentryVision systems and 4,257 CCTV cameras in 2001
and 84 SentryVision systems and 3,424 CCTV cameras in 2000.

EAS PRODUCTS
- -------------

Sentry EAS systems are marketed on both a direct sales and lease basis, with
direct sales representing the majority of the business. The terms of the
standard leases are generally from one to five years. The sales prices and lease
rates vary based upon the type of system purchased or leased, number and types
of targets included, the sophistication of the system employed and, in the case
of a lease, its term. In the case of the Knoscape MM systems, detection targets
which are permanently attached to the item to be protected are sold to the
customer even when the system is leased. Therefore, in the case of either a sale
or lease of a Knoscape MM system, as the customer replenishes its inventory,
additional targets will be required for those items to be protected. We also
market a more expensive, removable, reusable detection tag for use with the
Knoscape MM systems on certain products such as clothing and other soft goods.

During each of the years ended December 31, 2002, 2001 and 2000 Sentry placed in
service 590, 675 and 347, respectively, Knoscape RF, Ranger, and Knoscape MM
systems.

RF and Ranger systems continue to be used by apparel and department stores which
have wide exit areas and a desire for deterrence based on reusable hard tags.
Both the Silver Cloud and Knoscape RF systems are universal in that they can
detect both 2 MHz hard tags and 8 MHz labels. Knogo also markets an 8MHz P-2000
RF system designed for both hard and soft good customers. The P-2000 system is
economical and self-installable by the customer.

Supermarkets, bookstores, video stores and specialty stores remain good
prospects for MM systems due to the small size and low cost of Micro-Magnetic
strips. Since 2000, Knoscape MM Systems feature updated digital electronics.
Knoscape MM Systems detect virtually all manufacturers' magnetic strips and can
universally replace older magnetic strip systems manufactured by various EAS
vendors.

The library market continues to be a substantial market for magnetic technology.
In March 1996, 3M and Sentry entered into a strategic alliance to provide
universal asset protection to libraries across North America. The agreement
permitted Sentry to act as a distributor of all of 3M's library products,
including the 3M Tattle-Tape 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. Under
the agreement, 3M provided service and installation for all new and existing
Sentry library customers throughout North America. In exchange for these
agreements, we agreed not to compete against 3M for sales and service of EAS
Systems in the library market until March 2004.

Sales of 3M library products declined in 2002 and 2001 due to 3M's direct sales
practices in competition with Sentry making it uneconomical to sell these
products. As a result, we have discontinued our distribution agreement with 3M
effective December 31, 2002.

DIALOC ID SECURITY PRODUCTS

In February 2001, we introduced a new EAS system manufactured by Dialoc ID,
which is housed in slender, self-contained Plexiglas panels. The new 9000 PL 8.2
MHz system provides retailers with clear lines of sight at the front end along
with the durability of solid Plexiglas. The panels can be custom printed with
the retailer's logo for enhanced image and trade name awareness. The system's
electronics, which are built-in to the base of the Plexiglas antenna, provide
detection of 8.2 MHz labels and hard tags in aisles up to six feet wide. The
9000 PL system is offered in both single and dual aisle configurations and is
compatible with all existing 8.2 MHz tags and checkout accessories. The
Plexiglas RF system is the first in a series of new products being brought to
market by the Company as a result of a distribution agreement with Dialoc ID.
In addition, through Sentry, Dialoc ID will introduce LaserFuse, a new RF label
technology, which is compatible with, and an alternative to, the labels offered
by Checkpoint Systems, Inc. In the future, we will also sell Dialoc ID products
in the proximity access control and RFID markets.

BACKLOG

Our backlog of orders was approximately $5.2 million at December 31, 2002, as
compared to approximately $6.0 million at December 31, 2001 and approximately
$5.8 million at December 31, 2000. We anticipate that substantially all of the
backlog present as of December 31, 2002 will be delivered within 12 months.

SEASONAL ASPECTS OF THE BUSINESS

Our current customers are primarily dependent on retail sales which are seasonal
and subject to significant fluctuations which are difficult to predict.

SERVICE

Installation services are performed by our personnel and by carefully screened
and supervised subcontractors as well as authorized dealers and distributors.
Repair and maintenance services are performed primarily by the Company's
personnel. All products sold or leased are covered by a warranty period,
generally, one year. After the warranty period, we offer our customers the
option of entering into a maintenance contract with the Company or paying for
service on a per call basis.

Installations of SentryVision systems typically take from three days to
several weeks and involve mounting the enclosures, installing the controller
unit, installing the carriage assembly, and connecting control and transmission
cables to the central monitoring location. Items such as high voltage power
termination wiring are typically the responsibility of the end user.

Throughout 1999, a great deal of our efforts were directed at servicing the
existing SentryVision systems, as reliability problems were not completely
resolved. Our engineering efforts were directed at resolving electronic
problems, which resulted in numerous service calls and in the re-design of
printed circuit boards to upgrade them and increase their performance and
reliability. These issues were substantially resolved in the first half of 1999.
Mechanical reliability issues then became our focus in the latter half of 1999
as system problems continued. These issues appear to have been largely resolved
with the development and introduction in 1999 of new drive and idler wheels,
brush block assemblies and wire harnesses.

The use of subcontractors supervised by Company employees proved cost effective
with no sacrifice in quality. A network of qualified contractors was
established. In the second half of 1999, we released 34 installation employees
and retained only our most technically skilled employees. We intend to continue
to focus on EAS, SentryVision and CCTV technical service and maintenance and
continue to expand our contractor network for installation work.

This strategy has resulted in significant cost savings. In addition, we retain
our reputation of technical expertise within the industry and management efforts
can be focused on increased electronics training for our employees, distributors
and sub-contractors.

Since 2000, we have added Service Partners and installation contractors in 25
key market areas. In total, we have more than 86 trained service technicians in
the field to augment service provided by Company employees. Many of these
partners are factory trained and have contractual commitments to provide prompt,
quality service at our direction. The field service management structure was
also modified so that two of our most experienced managers will focus
exclusively on quality control with our service partners.

In addition, our Call Center was reorganized and a new supervisor appointed.
Technical support functions were transferred to our Design Center personnel and
all service requests are now screened extensively via telephone. Initial results
have been highly successful in lowering the number of on-site visits required to
resolve service issues.

In 2001, we focused on improving the quality of our service delivery system and
we were successful. Telephone surveys were conducted after installations were
completed and we achieved a 96% approval rating. Our employees remained focused
on technical service and maintenance.

Technician headcount was reduced to 29 at the end of 2002 as we continued to
develop expertise among our service and installation partner companies. Company
employees now perform only technical service and our well-established partner
network performs all installations. The model remains cost-effective and allows
us to scale our efforts up or down as business requires without the risk of a
fixed cost structure.

Our Design Center personnel continued to screen all service requests and were
able to close almost 500 calls over the telephone, avoiding costly service
calls. In addition, careful screening allowed us to ship replacement parts in
advance of the technician's arrival increasing our ability to complete calls in
a single visit.

Customer service is a priority and we are focused on continued improvements in
2003. We anticipate that increased installation and service work can be
supported by the existing headcount and infrastructure.

COMPETITION

We operate in a highly competitive market with many companies engaged in the
business of furnishing security services designed to protect against shoplifting
and theft. In addition to EAS systems using the concept of tagged merchandise,
such services use, among other things, conventional PTZ dome and fixed mount
CCTV systems, traveling CCTV systems, mirrors, guards, private detectives and
combinations of the foregoing. We compete principally on the basis of the nature
and quality of its products and services and the adaptability of these products
to meet specific customer needs and price requirements.

To our knowledge, there are several other companies that market, directly or
through distributors, conventional closed circuit video systems and/or EAS
equipment to retail stores, of which Sensormatic (acquired by Tyco/ADT),
Checkpoint Systems, Inc., Philips, Inc., Pelco Manufacturing, Inc., Panasonic,
Inc., and Ultrak, Inc. (recently purchased by Honeywell) are the Company's
principal competitors. ADT has also begun marketing a traveling CCTV system in
the U.S. Outside the U.S., we are aware of other companies that market other
types of traveling CCTV systems including Lextar Technologies, Ltd. in
Australia, T.E.B., Sensormatic and DETI in France and Moving Cameras Ltd. in the
UK. Some of our competitors have far greater financial resources, more
experienced marketing organizations and a greater number of employees than the
Company.

In connection with the merger of Knogo's international EAS business with
Sensormatic in December 1994, Knogo agreed with Sensormatic that Knogo would 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. Since then, Sentry has promoted selected EAS systems and tags
through a distribution network outside of North America although Sentry is not
permitted to use the Knogo name outside of the United States and Canada.

PATENTS AND OTHER INTELLECTUAL PROPERTY

Although patent protection is advantageous to Sentry, we do not consider any
single patent or patent license we own or hold to be material to our operations.
We believe that our competitive position ultimately will depend on our
experience, know-how and proprietary data, engineering, marketing and service
capabilities and business reputation, all of which are outside the scope of
patent protection.

SENTRYVISION
- ------------

Sentry has a United States patent covering the cable-free transmission of a
video signal to and from the carriage. This technology prevents degradation of
the video signal which can result from the movement of and prolonged friction
caused by the carriage. Three additional U.S. patents were received for
improvements made to the original technology which has been incorporated into
the SmartTrack product. Sentry also has received a corresponding European patent
and eleven foreign country patents. We intend to seek patent protection on
specific aspects of the SentryVision system, as well as for certain aspects of
new systems which may be developed for Sentry. There can be no assurance that
any patents applied for will be issued, or that the patents currently held, or
new patents, if issued, will be valid if contested or will provide any
significant competitive advantage to Sentry.

We are not aware of any infringement of patents or intellectual property held by
third parties. However, if Sentry is determined to have infringed on the rights
of others, Sentry may be required to obtain licenses from such other parties.
There can be no assurance that the persons or organizations holding desired
technology would grant licenses at all or, if licenses were available, that the
terms of such licenses would be acceptable to the Company. In addition, we could
be required to expend significant resources to develop non-infringing
technology.

Sentry has also relied on the registration of trademarks and trade names, as
well as on trade secret laws and confidentiality agreements with its employees.
While we intend to continue to seek to protect Sentry's proprietary technology
and developments through patents, trademark registration, trade secret laws and
confidentiality agreements, we do not rely on such protection to establish and
maintain Sentry's position in the marketplace. Management believes that
improvement of Sentry's existing products, reliance upon trade secrets and on
unpatented proprietary know-how, and the development of new products will be as
important as patent protection in establishing and maintaining a competitive
advantage.

EAS PRODUCTS
- -------------

Sentry has 26 United States and Canadian patents and one patent applications
relating to (i) the method and apparatus for the detection of movement of
articles and persons and accessory equipment employed by Sentry in its Knoscape
RF, Ranger and Knoscape MM systems, (ii) various specific improvements used in
the Knoscape RF, Ranger and Knoscape MM systems and (iii) various electrical
theft detection methods, apparatus and improvements not presently used in any of
Sentry's EAS systems.

Sensormatic and Knogo license certain patent rights and technology to each
other, for use in their respective territories, pursuant to the License
Agreement dated December 29, 1994, entered into in connection with the 1994
Sensormatic transaction.

RESEARCH AND DEVELOPMENT

As of December 31, 2002, Sentry Technology Corporation had 9 full time employees
engaged in research, engineering and product development. In addition, the
Company may retain consultants to assist in specific areas related to research,
engineering and product development. For the years ended December 31, 2002,
2001 and 2000, approximately $0.5 million, $0.7 million and $0.9 million,
respectively, was expended on Company-sponsored research.

As a direct result of prior efforts to improve product reliability, most
engineering tasks in 2002 focused on adding features to the SmartTrack System
and towards reducing the cost of manufactured products. Enhancements were made
to the electro-mechanical, electronic, software, and optical portions of the
SmartTrack System.

Mechanical reliability and extended service life was accomplished through
various improvements in material and the application of new assembly techniques.

Electronics controlling video modulation were improved resulting in sharper
images. Improved circuit design also contributed to greater system reliability.

Extensive development in software during 2002 resulted in improved user
interfaces, additional support for industry protocols, and allowed the use of a
wider range of camera options.

Improved optics through the use of higher-grade plastic enclosures have
eliminated image distortion and reduced the cost of the system.

Additional projects included revisions to EAS products.

RF systems have been enhanced through improvements in the electronics resulting
in shorter installation times and greater system stability. Introducing acrylic
antenna panels for a more modern look enhanced visual aesthetics of the Knoscape
RF product.

The Ranger system has been upgraded to use recently available integrated
circuits resulting in greater system stability.

REGULATION

Because Sentry's EAS and CCTV systems use radio transmission and electromagnetic
wave principles, such systems are subject to regulation by the Federal
Communications Commission ("FCC") under the Communications Act of 1934. In those
instances where it has been required, certification of such products by the FCC
has been obtained. As new products are developed by the Company, application
will be made to the FCC for certification or licensing when required. No
assurance can be given that such certification or licensing will be obtained or
that current rules and regulations of the FCC will not be changed in an adverse
manner.

Sentry's business plan calls for the sale and use of Sentry's products in
domestic markets and, where consistent with contractual obligations, in
international markets. Sentry's products may be subject to regulation by
governmental authorities in various countries having jurisdiction over
electronic and communication use. Sentry intends to apply for certification of
its products to comply with the requirements under the regulations of the
countries in which it plans to market its products. No assurance can be given
that such certification will be obtained or that current rules and regulations
in such countries will not be changed in a manner adverse to Sentry.

We believe we are in material compliance with applicable United States, state
and local laws and regulations relating to the protection of the environment.

Industry Canada, the department of the Canadian federal government that
regulates and licenses the radio frequency spectrum in Canada, has brought to
our attention that several hundred of the units of the earlier generation of
Ranger 1 and 2 EAS devices sold by our Knogo subsidiary to retailers in Canada
do not comply with the relevant Industry Canada technical standards, and may
cause interference to other users of the radio spectrum. Industry Canada has
written to the customers concerned to apprise them of the situation, and to
demand that the non-compliant devices be removed or replaced with compliant
ones. The Company worked with Industry Canada officials and the retailers
concerned to put in place a replacement program and a schedule that will satisfy
both the retailers and Industry Canada. All identified retailers have
subsequently upgraded to compliant EAS devices. Under the Radiocommunication Act
(Canada) (the "Act") which it administers, Industry Canada has extensive powers
to, among other measures, confiscate radio equipment that is non-compliant, and
to initiate prosecutions for alleged violations of the regulatory provisions in
the Act. However, Industry Canada's normal practice is to use co-operative
approaches to problems of technical non-compliance or radio interference, and to
work with the parties concerned to resolve such problems within a reasonable
time frame. As a result of our continuing efforts in co-operating with Industry
Canada, we believe that all remaining issues relating to the Ranger 1 and 2
problems have been resolved.

EMPLOYEES

At December 31, 2002, the Company and its subsidiaries employed 117 full-time
employees, of whom 19 were employed in administrative and clerical capacities, 6
in engineering, research and development, 26 in production, 20 in marketing and
sales and 46 in customer service and support. None of our employees are employed
pursuant to collective bargaining agreements. As part of our restructuring
plan, our headcount was reduced by approximately 50% on March 7, 2003.

PROPERTIES

The Company's principal executive, sales and administrative offices, and its
production, research and development and distribution facilities are located in
Hauppauge, New York, in a 68,000 square foot facility leased by the Company.

LEGAL PROCEEDINGS

Although we are involved in ordinary, routine litigation incidental to our
business, we are not presently a party to any other legal proceeding, the
adverse determination of which, either individually or in the aggregate, would
be expected to have a material adverse affect on the Company's business or
financial condition.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

During the fiscal year ended December 31, 2002, 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
over-the-counter bulletin board.

Stock Prices
------------
High Low Close
---- --- -----
2001
First Quarter $ 0.093 $ 0.040 $ 0.045
Second Quarter 0.210 0.045 0.125
Third Quarter 0.200 0.080 0.110
Fourth Quarter 0.255 0.100 0.150

2002
First Quarter $ 0.220 $ 0.120 $ 0.140
Second Quarter 0.210 0.080 0.100
Third Quarter 0.100 0.050 0.080
Fourth Quarter 0.070 0.010 0.020

2003
First Quarter
(through March 28,2003) $ 0.030 $ 0.010 $ 0.020

The Company's Common Stock is quoted on the OTC Bulletin Board ("OTCBB") using
the symbol SKVY. The Company's Class A Preferred Stock ("SKVYP") traded on the
OTCBB prior to its redemption effective January 8, 2001.

(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 28, 2003, the Company had 82,560,347 shares
of Common Stock issued and outstanding, which were held by 293 holders of record
and approximately 2,900 beneficial owners.

(c) Dividends.

The payment of future dividends will be a business decision to be made by
the Board of Directors of Sentry from time-to-time based upon the results of
operations and financial condition of Sentry and such other factors as the Board
of Directors considers relevant. Sentry has not paid, and does not presently
intend to pay or consider the payment of, any cash dividends on the Common
Stock. In addition, covenants in the Company's credit agreement prohibit the
Company from paying cash dividends without the consent of the lender.

(d) Redemption of Class A Preferred Stock.

At a special meeting of shareholders held on December 8, 2000, a proposal
was adopted to pay a one-time stock dividend of .075 of a share of preferred
stock to preferred stockholders on the effective date of the Dialoc ID
investment, and immediately thereafter each share of preferred stock was
reclassified into five shares of common stock. The Dialoc ID investment took
place on January 8, 2001, at which time the preferred shares were reclassified
into 28,666,660 shares of common stock.

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 table below sets forth selected consolidated historical financial data
of the Company for the years ended December 31, 1998, 1999, 2000, 2001 and 2002.
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 includes 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)

Years Ended December 31,. . . . . . . . . . . . . . . . . . . . . 1998 1999 2000 2001 2002
-------- --------- --------- -------- --------

SELECTED STATEMENT OF OPERATIONS DATA:
Total revenues. . . . . . . . . . . . . . . . . . . . . . . . . . $28,156 $ 22,281 $ 19,865 $17,299 $14,536
Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . 14,412 14,339 11,120 8,879 7,382
Customer service expenses . . . . . . . . . . . . . . . . . . . . 6,253 5,457 4,464 4,361 4,240
Selling, general and administrative
expenses . . . . . . . . . . . . . . . . . . . . . . . . . . 10,118 9,169 7,576 5,773 5,227
Restructuring and impairment
charges . . . . . . . . . . . . . . . . . . . . . . . . . . . - 3,026 2,981 - -
Gain on sale of assets. . . . . . . . . . . . . . . . . . . . . . - 503 - - -
Loss before income taxes. . . . . . . . . . . . . . . . . . . . . (4,483) (11,034) (7,821) (2,911) (3,356)
Loss before cumulative effect
of change in accounting principal . . . . . . . . . . . . . . (4,504) (11,034) (7,821) (2,911) (3,356)

Cumulative effect of change in accounting principal . . . . . . . - - 301 - -
Net loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4,504) (11,034) (8,122) (2,911) (3,356)
Preferred stock dividends . . . . . . . . . . . . . . . . . . . . 1,263 1,326 1,337 25 -

Return to common shareholders from redemption of preferred stock. - - - 27,198 -
Net income (loss) available to
common shareholders. . . . . . . . . . . . . . . . . . . . . . (5,767) (12,360) (9,459) 24,262 (3,356)
Net income (loss) per common share:
Basic. . . . . . . . . . . . . . . . . . . . . . . . . . . . . (0.59) (1.27) (0.97) 0.40 (0.05)
Diluted. . . . . . . . . . . . . . . . . . . . . . . . . . . . (0.59) (1.27) (0.97) 0.39 (0.05)

As of December 31,

SELECTED BALANCE SHEET DATA:. . . . . . . . . . . . . . . . . . . 1998 1999 2000 2001 2002
-------- --------- --------- -------- --------
Working capital . . . . . . . . . . . . . . . . . . . . . . . . . $12,668 $ 6,290 $ 2,173 $ 2,235 $ (768)
Total assets. . . . . . . . . . . . . . . . . . . . . . . . . . . 33,496 22,007 13,845 11,561 7,992
Property, plant and equipment, net. . . . . . . . . . . . . . . . 4,348 3,934 3,324 2,962 2,563
Obligations under capital leases. . . . . . . . . . . . . . . . . 3,241 3,058 2,892 2,751 2,652
Redeemable cumulative preferred stock . . . . . . . . . . . . . . 26,517 27,843 29,180 - -

Total common shareholders' equity (deficit) . . . . . . . . . . . (3,975) (16,335) (25,794) 2,891 (451)

Item 7. Management's Discussion and Analysis of Financial
- ------- ------------------------------------------------------
Condition and Results of Operations.
---------------------------------------

CRITICAL ACCOUNTING POLICIES

Management's discussion and analysis of its financial position and results
of operations are based upon the Company's consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States of America. The preparation of these financial
statements requires management to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses and related
disclosure of contingent assets and liabilities. Actual results could differ
from those estimates. Management believes that the critical accounting policies
and areas that require the most significant judgments and estimates to be used
in the preparation of the consolidated financial statements are allowance for
doubtful accounts, inventory obsolescence and accrued warranty.

Allowance for Doubtful Accounts -- We maintain an allowance for doubtful
trade accounts receivable for estimated losses resulting from the inability of
our customers to make required payments. In determining collectibility, we
review available customer financial statement information, credit rating reports
as well as other external documents and public filings. When it is deemed
probable that a specific customer account is uncollectible, that balance is
included in the reserve calculation. Actual results could differ from these
estimates under different assumptions.

Inventory Obsolescence --We write down our inventory for estimated
obsolescence or unmarketable inventory equal to the difference between the cost
of inventory and the estimated market value based upon assumptions about future
demand and market conditions. If actual future demand or market conditions are
less favorable than those we project, additional inventory write-downs may be
required.

Accrued Warranty -- We provide for the estimated cost of product warranty at the
time revenue is recognized. We calculate the reserve utilizing historical
product failure rates and service repair costs by product family. These rates
are reviewed and adjusted periodically. We utilize judgment for estimating these
costs and adjust our estimates as actual results become available.

Related Party Transactions -- Details of related party transactions are
included in Item 13 and in Notes 2 and 12 of the Financial Statements of this
Form 10-K.

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2002 COMPARED WITH YEAR ENDED DECEMBER 31, 2001

Consolidated revenues were 16% lower in the year ended December 31, 2002
than in the year ended December 31, 2001. We sell our products predominantly
into the retail market. Our overall domestic revenues continued to be impacted
by the post September 11 soft economic environment, resulting in a slowdown or
delay in new retail store openings of some of our customers. The backlog of
orders, which we expect to deliver within twelve months, decreased to $5.2
million at December 31, 2002 as compared to $6.0 million at December 31, 2001.
Total revenues for the periods presented are broken out as follows:

2002 2001 Change
---- ---- ------
(in thousands)
EAS $ 2,530 $ 5,600 (55%)
CCTV 4,578 4,833 (5%)
SentryVision 2,368 1,772 34%
3M library products 256 622 (59%)
-------- --------
Total sales 9,732 12,827 (24%)
Service, installation and other 4,804 4,472 7%
-------- --------
Total revenues $ 14,536 $ 17,299 (16%)
= ====== = ====== ====

The decline in EAS sales in 2002 is primarily a result of lower sales to
two of our largest EAS customers, which have opened fewer new stores in 2002,
and lower sales to our Mexican distributor. The decrease in CCTV revenues and
increase in SentryVision revenues is primarily a result of a decision by our
largest customer to resume purchasing our traveling camera products in 16
existing store locations in 2002. We continue to see a growing trend for
product acceptance and increased market opportunities for traveling camera
systems both domestically and internationally. Sales of 3M library products
declined due to 3M's direct sales practices in competition with Sentry, making
it uneconomical for us to sell 3M products in the library marketplace. As a
result, we have cancelled our distribution agreement with 3M effective December
31, 2002. Service revenues increased as a result of the higher base of
installed systems no longer under warranty but were partially offset by lower
installation revenues resulting from lower EAS and CCTV sales.
Cost of sales, as a percentage of sales, were 76% in 2002 as compared to
69% in 2001. The reduction of sales in 2002 and related decrease in production
levels resulted in significant manufacturing inefficiencies, including the under
absorption of labor and overhead. In addition, there were higher scrap and
rework costs and higher provisions for slow moving inventories in 2002 as
compared to 2001.
Customer service expenses decreased 3% in 2002 as compared to 2001 despite
an increase in maintenance and service revenues. This is primarily a result of
the successful implementation of a new service delivery model, which reduced our
fixed costs through a reduction in the number of the Company's customer service
employees and a greater reliance on trained and qualified installation and
service partners.
Selling, general and administrative expenses decreased 9% to $5.2 million
in 2002 from $5.8 million in 2001 primarily as a result of continuing cost
saving measures including further subleasing of our office space, lower phone
costs, lower selling expenses and lower bad debt and warranty costs.

Research and development costs continued to decrease in 2002 when compared
to the previous year primarily due to a reduction in prototype costs associated
with the development of the SentryVision SmartTrack system, which was released
in 2001.

Interest expense decreased slightly in 2002 over 2001 primarily due to
lower average borrowings under our revolving credit agreement and lower interest
rates.

Due to net losses, we have not provided for income taxes in either of the
periods presented. The book benefit for taxable losses generated in both
periods presented was offset by recording a full valuation allowance. Such
valuation allowance was recorded because management does not believe that the
utilization of the tax benefits from operating losses, and other temporary
differences are "more likely than not" to be realized, as required by accounting
principles generally accepted in the United States of America.

As a result of the foregoing, Sentry had a net loss of $3.4 million in the
year ended December 31, 2002 as compared to a net loss of $2.9 million in the
year ended December 31, 2001.

We recorded preferred stock dividends of $25,000 in the first quarter of
2001 prior to the redemption of the Class A Preferred Stock on January 8, 2001.

Effective January 8, 2001, and just prior to the Dialoc ID investment, there was
a payment of a dividend of additional shares of Class A Preferred Stock at the
rate of 0.075 shares of Class A Preferred Stock for each share of Class A
Preferred Stock held and immediately thereafter a reclassification of the Class
A Preferred Stock into common stock at a ratio of five shares of common stock
for each share of Class A Preferred Stock outstanding. The reclassification of
the Class A Preferred Shares resulted in a return to the common shareholders of
$27.2 million, which was recorded in the first quarter of 2001. This amount
represents the difference between the fair market value of the common stock
issued and the carrying amount of the preferred stock redeemed.

YEAR ENDED DECEMBER 31, 2001 COMPARED WITH YEAR ENDED DECEMBER 31, 2000

Consolidated revenues were 13% lower in the year ended December 31, 2001
than in the year ended December 31, 2000. Our overall domestic revenues
continued to be impacted by the soft economic environment resulting in a
slowdown or delay in new retail store openings of some of our customers. As
part of our reorganization of our sales department, more than one-third of our
account executives were terminated by June 2001. Following the release to the
sales force in September of the new SmartTrack traveling camera system, we were
able to hire replacements in the middle of the fourth quarter. In addition,
some large contracts expected earlier in the last quarter of the year were not
received until the latter part of December 2001, delaying revenue recognition
until the installations could be completed in 2002. The backlog of orders,
which we expect to deliver within twelve months, increased to $6.0 million at
December 31, 2001 as compared to $5.8 million at December 31, 2000. Also
Sensormatic stopped ordering EAS OEM equipment resulting in a $1.5 million
reduction of revenues. Total revenues for the periods presented are broken out
as follows:

2001 2000 Change
---- ---- ------
(in thousands)
EAS $ 5,600 $ 7,545 (26%)
CCTV 4,833 5,340 (9%)
SentryVision 1,772 1,713 3%
3M library products 622 1,103 (44%)
------- -------
Total sales 12,827 15,701 (18%)
Service, installation and other 4,472 4,164 7%
------- -------
Total revenues $17,299 $19,865 (13%)
======= ======= ====

The decline in EAS sales in 2001 is primarily a result of lower OEM sales
to Sensormatic and lower sales to one of our major customers. We do not
currently expect an increase in sales to Sensormatic in the future. The decline
in CCTV was primarily related to a decrease in sales to the same customer. We
are encouraged by the increase in SentryVision SmartTrack sales which gained
momentum since the product was released to production in September 2001. Part
of our sales strategy was to offer system trials to new and existing customers
under a "Test-A-Track" program. Under this program, we install a system on a
nominal cost trial basis. At the end of the trial, if satisfied, the customer
purchases the system. To date, we have received only positive feedback from our
customers on the features and reliability of SmartTrack resulting in new sales
opportunities. In addition, we have offered new SmartTrack carriage upgrades to
existing customers that result in lower revenue than new system sales. We have
been successful selling SmartTrack to several domestic and international
large-scale security dealer integrators with repeat order opportunities. We see
a growing trend for product acceptance and increased market opportunities for
traveling camera systems both domestically and internationally. Sales of 3M
library products declined as we focused our sales efforts on Sentry produced
products. Service revenues increased as a result of the higher installed
equipment base of systems no longer under warranty.

Cost of sales as a percentage of sales were 69% in 2001 as compared to 64%
in 2000, excluding special charges described below. Higher scrap and rework
costs and production inefficiencies due to reduced volume in our manufacturing
operations were the primary cause of the increase in the percentage in the
current year. In 2000, as part of our restructuring plan, we included in cost
of sales special charges of $1.0 million primarily representing provisions for
obsolete or excess inventory. Those charges, in 2000, were a result of a
combination of the introduction of SmartTrack, which replaced earlier generation
SentryVision systems, and the substitution of certain Dialoc ID systems which
were expected to replace systems in our EAS product lines.

Customer service expenses decreased 2% in 2001 as compared to 2000 and the
department generated a small profit due primarily to the successful
implementation of a new service delivery model which included a reduction in the
number of our customer service representatives and increased use of trained and
qualified installation and service partners.

Selling, general and administrative expenses decreased 24% to $5.8 million
in 2001 from $7.6 million in 2000 primarily as a result of continuing cost
saving measures, reduced infrastructure, lower selling expenses due to reduced
sales and the elimination of the amortization of the goodwill, which was
written-off in 2000.

Research and development costs continued to decrease in 2001 when compared
to the previous year due to further consolidation of facilities. The primary
emphasis in the current year continued to be directed towards the completion of
the new SentryVision SmartTrack system, which was released to production at the
end of the third quarter. Additional savings were achieved through the shared
research and development activities with Dialoc ID as a result of their
investment.

Interest expense decreased by $0.1 million in 2001 over 2000 primarily due
to lower average borrowings under our revolving credit agreement and lower
interest rates.

In February 1997, we acquired the SentryVision product line through the
merger with Video Sentry Corporation and assigned a value of $4.4 million to its
patent and existing technology. At that time, we assigned a seven-year life to
the technology. After the merger, we encountered severe liquidity problems due
to declining sales of this premier product due to design faults, repeated
repairs and the customer's perception that SentryVision was a costly and
unreliable product. The cost of conventional CCTV products also declined during
that period and added features made these systems more competitive when compared
to SentryVision. In addition, several competitors, including the industry's
leader - Sensormatic, produced their own cable free traveling camera systems
that competed directly with us. We considered pursuing a claim for patent
infringement against Sensormatic, but have decided not to pursue the claim at
this time. We have made such significant changes from the original traveling
CCTV system acquired from Video Sentry that they have become the basis for a new
product, which we have named SmartTrack. With the development of the
SentryVision SmartTrack system completed in the fourth quarter of 2000, we
re-assessed the remaining carrying value of the intangible assets related to the
original SentryVision products. Based on our review of the technological
developments in the marketplace, we determined that the original traveling CCTV
surveillance system goodwill and related patents no longer provide us with a
competitive advantage, and as a result, we recorded an impairment charge in 2000
of approximately $3.0 million related to these assets. These impairment charges
were calculated by comparing future discounted net cash flows to the goodwill's
carrying value. Factors leading to the impairment were a combination of
historical losses and insufficient estimated future cash flows from the
SentryVision system.

Due to net losses, we have not provided for income taxes in either of the
periods presented.

As a result of the foregoing, Sentry had a net loss of $2.9 million in the
year ended December 31, 2001 as compared to a net loss of $8.1 million in the
year ended December 31, 2000.

We recorded preferred stock dividends of $25,000 and $1.3 million in 2001
and 2000. In connection with the waiver of certain financial covenants under
the agreement with our commercial lender, we were not allowed to pay cash
dividends, including the cash dividend on our preferred stock which would
otherwise have been payable in August of 1999, February and August 2000. At a
special meeting of shareholders held on December 8, 2000, a proposal was adopted
to pay a one-time stock dividend of .075 of a share of Class A Preferred Stock
to preferred stockholders in lieu of accrued dividends on the effective date of
the Dialoc ID investment, and immediately thereafter to reclassify each share of
preferred stock into five shares of common stock. The Dialoc ID investment took
place on January 8, 2001. The reclassification of the Class A Preferred Stock
resulted in a return to the common shareholders of $27.2 million, which was
recorded in the first quarter of 2001. This amount represents the difference
between the fair market value of the common stock issued and the carrying amount
of the preferred stock redeemed.

LIQUIDITY AND CAPITAL RESOURCES

On March 22, 2002, we entered into a new three-year revolving line of
credit and term loan with the CIT Group/Business Credit, Inc. ("CIT") for
maximum borrowings of $8 million, which are subject to certain limitations based
on a percentage of eligible accounts receivable and inventories as defined in
the agreement. Interest on the revolving line of credit is payable monthly at
the JPMorgan Chase Bank prime rate (4.25% at December 31, 2002), plus 2% per
annum. We are required to pay a commitment fee of 0.375% per annum on any
unused portion of the credit facility. Borrowings under the line are secured by
substantially all of our assets. The terms of the agreement, among other
matters, places restrictions on capital expenditures and prohibits the payment
of dividends. As of December 31, 2002, we had borrowings of approximately $2.0
million, the maximum amount available under the facility. In addition, we
entered into a $100,000 term loan with CIT. The principal is being repaid to
CIT in twelve equal monthly installments of $8,333 beginning May 1, 2002.
Interest on the term note is at prime plus 2.25%. The balance on the term loan
at December 31, 2002 was $33,000. In December 2002, we hired the consulting
firm of Clear Thinking Group, to provide us with crisis management services and
to assist us in presenting a plan to CIT to fund an over-advance facility to
assist Sentry through its transition to its restructuring plan. Subsequent to
year-end, we were successful in obtaining from CIT an over-advance facility of
up to $300,000.

We will require positive cash flow from operations to meet our working capital
needs over the next twelve months. We anticipated receiving significant
additional purchase orders from specific customers during 2002. While some of
these purchase orders were eventually received, the delay of those received and
loss of other orders caused us to: (i) operate in a cash flow deficit for the
year; (ii) borrow the maximum amounts available under our credit facility; and
(iii) pursue potential sources of debt or equity financing.

On October 10, 2002, we entered into a purchase order financing facility
with EPK Financial Corporation ("EPK"). Purchase order financing is short term
funding used to finance the purchase or manufacture of specific goods that we
have pre-sold to credit worthy end customers. Funding entails EPK providing
funds directly to vendors to allow us to secure the inventory we need to fulfill
customers' orders. Sentry's costs for each financing transaction will be equal
to 3.5% of Sentry's selling price, plus 1.85% on the maximum outstanding funded
amount each ten calendar days or portion thereof, until EPK is paid in full,
plus expenses. In connection with this facility, an Intercreditor Agreement was
entered into between EPK, CIT and Sentry. Under this agreement, CIT
subordinated its rights and interests in the collateral related to each
transaction to EPK. Currently, under the terms of the Intercreditors Agreement,
the maximum amount subordinated to EPK at any time is limited to $440,000.
Sentry will use the funds provided by EPK to fund vendor purchases to complete
orders currently in backlog.

Through 2002, we were not successful in achieving positive cash flow from
operations and as a result, our payables to vendors are substantially in excess
of terms. Most of our vendors have us on a COD basis. We are currently working
with several investment banking firms to assist the Company in conducting an
organized search and evaluation regarding a possible corporate transaction to
gain access to greater resources and to exploit Sentry's products and
technological advances. We are looking to raise in excess of $4 million in debt
or equity financing to assist the Company in satisfying our trade payables
situation and to achieve our longer-term goals.

We have incurred reduced revenue levels, decreased financial position and
recurring operating losses over the past several years. To further address the
continuing losses, our business plan for 2002 included the following:

- - Entering into a new three-year financing agreement.
- - Addition of new products, including high-end EAS systems and disposable
tags and labels, proximity access control and RFID, through our
distribution agreement with Dialoc ID.
- - Increased promotion of SmartTrack, our new entry in the SentryVision
family of products.
- - Strengthening our international dealer network with new and financially
stronger business partners.
- - Joint participation with Dialoc ID in trade show activity and a refocus on
expanding business with existing customers.
- - Continuation and expansion of our Service Partner program to augment
service provided by our employees.
- - Further subletting of office space in our corporate offices.
- - Continued emphasis on growing international dealer base.
- - Various additional cost cutting and cost saving initiatives.

While we were successful in completing the above named goals, we were unable to
meet our projected revenue growth targets. Our order flow with our largest
customer, Lowe's Home Center increased, but we were unable to replace other lost
business with sufficient new customer orders. While indications appear that
the retail economy is picking up, we believe that our markets will remain
sluggish for the next year. In addition, the uncertainties surrounding the
impact of the war could have a further impact on our 2003 results.

As a result, in December 2002, the Board of Directors approved a restructuring
plan to strengthen our operating efficiencies and to better align our operations
with current economic and market conditions. The revised business plan calls
for the following:

- - Significantly downsize our operations including the elimination of
approximately 60 of 117 positions to support a business with sales
of approximately $15 million.
- - Negotiate with the current landlord to move out of its present corporate
facility and relocate to a smaller and less costly facility.
- - Dedicate a substantial portion of our remaining resources towards
maintaining and improving our relationships with our 30 largest
customers.
- - Outsource all non-essential manufacturing and assembly operations to
qualified subcontractors.
- - Further expand our Service Partner program to augment service provided by
our employees.
- - Negotiate a settlement with past due trade vendors.

On January 7, 2003, we initiated our restructuring plan. Due to the size of the
layoff, Sentry was required to give the terminated employees a 60-day notice
period. The costs associated with these restructuring activities will be
expensed as they are incurred. We believe the successful implementation of this
restructuring will result in substantial gross margin improvements and
reductions in operating expenses beginning after the first quarter of 2003.

There can be no assurance, however, that changes in our plans or other events
affecting our operations will not result in accelerated or unexpected cash
requirements, or that we will be successful in achieving positive cash flow from
operations or that additional debt or equity financing will be available on
terms that are satisfactory to Sentry, or that any such debt or equity financing
will be sufficient to provide the full amount of funding necessary. Our future
cash requirements are expected to depend on numerous factors, including, but not
limited to: (i) the ability to generate positive cash flow from operations, and
the extent thereof, (ii) the ability to raise additional capital or obtain
additional financing, and (iii) economic conditions.

Sentry will require liquidity and working capital to finance increases in
receivables and inventory associated with sales growth, payments to past due
vendors and, to a lesser extent, for capital expenditures. We had no material
capital expenditure or purchase commitments as of December 31, 2002.

Under the terms of the share purchase agreement, Dialoc ID had the right to
acquire up to 51% of our common stock. On May 13, 2002, Dialoc ID exercised
their purchase right for an additional 14,500,000 shares of newly issued common
stock at an exercise price of $0.001 per share. As a result of this
transaction, as of December 31, 2002, Dialoc ID owned 42,067,017 shares
representing 48.1% of our common stock outstanding. On January 7, 2003, they
brought their ownership to 51% through the exercise of 4,516,475 shares of newly
issued common stock at an exercise price of $0.001 per share.

Currently, Dialoc ID is not able to provide additional financial support for
Sentry. If we are not able to raise additional debt or equity financing, we
could be forced into a bankruptcy or be required to liquidate our assets. In
this scenario, most likely, our secured lender would receive the bulk of any
proceeds.

The table below summarizes aggregate maturities of future minimum lease
payments under noncancelable operating and capital leases as of December 31,
2002.

Contractual Less than 1-3 4-5 After 5
Obligations Total 1 Year Years Years Years
- ----------- --------- ----- ----- -------
(In Thousands)

Operating Leases $ 2,877 $ 205 $ 617 $ 411 $ 1,644
Capital Leases 5,301 394 1,148 753 3,006
------- ------ ------- ------- -------
Total $ 8,178 $ 599 $ 1,765 $ 1,164 $ 4,650
======= ====== ======= ======= =======

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board issued Financial
Accounting Standards No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible
Assets." SFAS No. 142 addresses financial accounting and reporting for acquired
goodwill and other intangible assets. Under SFAS No. 142, goodwill and some
intangible assets will no longer be amortized, but rather reviewed for
impairment on a periodic basis. The provisions of this Statement are required to
be applied starting with fiscal years beginning after December 15, 2001. This
Statement is required to be applied at the beginning of the Company's fiscal
year and to be applied to all goodwill and other intangible assets recognized in
its financial statements at that date. Impairment losses for goodwill and
certain intangible assets that arise due to the initial application of this
Statement are to be reported as resulting from a change in accounting principle.
Goodwill and intangible assets acquired after June 30, 2001, will be subject
immediately to the provisions of this Statement. The adoption of SFAS No. 142
did not have a material impact on our financial statements.

In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." SFAS No. 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. We are required to adopt the provisions of
SFAS No. 143 effective January 1, 2003. The adoption of SFAS No. 143 is not
expected to have a material impact on our financial statements.

In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No.144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
The adoption of SFAS No. 144 did not have a material impact on our financial
statements.

In April 2002, SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and
64, Amendment of FASB Statement No. 13, and Technical Corrections" was issued.
This statement provides guidance on the classification of gains and losses from
the extinguishment of debt and on the accounting for certain specified lease
transactions. Certain provisions of this statement related to the classification
of gains and losses from extinguishment of debt are required to be adopted by
the Company beginning with the year ended December 31, 2003. All other
provisions are required to be adopted after May 15, 2002 and early application
is encouraged. It is not anticipated that the adoption of this statement will
have a material impact on the consolidated financial position, consolidated
results of operations or liquidity of the Company.

In June 2002, SFAS No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities" was issued. This statement provides guidance on the
recognition and measurement of liabilities associated with disposal activities
and is effective for the Company on January 1, 2003. The costs associated with
our restructuring plan, which are not expected to be material, will be expensed
as incurred in 2003 in accordance with SFAS No. 146.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123," which amends SFAS No. 123, "Accounting for Stock-Based Compensation," to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. The
transition and annual disclosure provisions of SFAS No. 148 are effective for
fiscal years ending after December 15, 2002. In addition, SFAS No. 148 amends
the disclosure requirements of SFAS No. 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The Company will continue to account for stock-based compensation to
employees under APB Opinion No. 25 and related interpretations.

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 herein, among others,
may cause the Company's results of operations to differ from those expressed in
the forward-looking statements. These factors include: (i) the risk that any
delay or cancellation of orders from one or more of Sentry's two major customers
may have a material adverse effect on the Company's financial condition; (ii)
the risk that anticipated growth in the demand for the Company's products in the
retail, commercial and industrial sectors will not develop as expected, whether
due to competitive pressures in these markets or to any other failure to gain
market acceptance of the Company's products; (iii) the risk that anticipated
revenue growth through the domestic and international dealers programs does not
develop as expected; (iv) the risk that the Company may not find sufficient
qualified Service Partners to provide future installation services; (v) the risk
that the Company will not be able to retain key personnel due to its current
financial condition; (vi) the risk that the borrowing availability under the new
credit facility will not be adequate to meet the Company's growth requirements;
and (vii) the risk arising from the large market position and greater financial
and other resources of Sentry's principal competitors, as described under "Item
1. Business-Competition."

24

Item 8. Financial Statements and Supplementary Data.
- ------- -----------------------------------------------

SENTRY TECHNOLOGY CORPORATION
-----------------------------
AND SUBSIDIARIES
----------------

REPORT ON AUDITS OF
-------------------
CONSOLIDATED FINANCIAL STATEMENTS
---------------------------------
AND SUPPLEMENTARY INFORMATION
-----------------------------

YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
--------------------------------------------

CONTENTS
--------

Page
----
CONSOLIDATED FINANCIAL STATEMENTS:

Independent auditors' reports F-1 - F-2

Balance sheets F-3

Statements of operations F-4

Statements of shareholders' equity F-5

Statements of cash flows F-6

Notes to financial statements F-7 - F-23

SUPPLEMENTARY INFORMATION:

Schedule II - Valuation and Qualifying Accounts F-24

------
Independent Auditors' Report
----------------------------

To the Board of Directors and Stockholders of
Sentry Technology Corporation
Hauppauge, New York

We have audited the accompanying consolidated balance sheet of Sentry Technology
Corporation and subsidiaries (the "Company") as of December 31, 2002, and the
related consolidated statements of operations, shareholders' equity (deficit)
and cash flows for the year then ended. Our audit also includes information as
of and for the year ended December 31, 2002 included in the financial statement
schedule listed in the Index at item 15(a)(2). These financial statements and
the financial statement schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on the consolidated
financial statements and the financial statement schedule based on our audit.

We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides 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, 2002, and the results of their operations and
their cash flows for the year then ended in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion, such information as of and for the year ended December 31, 2002
included in the 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.

The accompanying consolidated financial statements have been prepared assuming
the Company will continue as a going concern. As discussed in Note 4 to the
consolidated financial statements, the Company's recurring losses from
operations and negative cash flow position raise substantial doubt about its
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Note 4. The consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.

/s/ Holtz Rubenstein & Co., LLP

Melville, New York
February 28, 2003

INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Sentry Technology Corporation
Hauppauge, New York

We have audited the accompanying consolidated balance sheet of Sentry Technology
Corporation and subsidiaries (the "Company") as of December 31, 2001, and the
related consolidated statements of operations, shareholders' equity and cash
flows for each of the two years in the period ended December 31, 2001. Our
audits also included the financial statement schedule for each of the two years
in the period ended December 31, 2001 listed in the Index at item 15(a)(2).
These financial statements and the financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on the consolidated financial statements and the financial statement
schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Sentry Technology Corporation and
subsidiaries as of December 31, 2001, and the results of their operations and
their cash flows for each of the two years in the period ended December 31, 2001
in conformity with accounting principles generally accepted in the United States
of America. Also, in our opinion, such financial statement schedule, when
considered in relation to the basic 2001 and 2000 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 22, 2002

SENTRY TECHNOLOGY CORPORATION
-----------------------------
AND SUBSIDIARIES
----------------
CONSOLIDATED BALANCE SHEETS
---------------------------
(IN THOUSANDS, EXCEPT PAR VALUE AMOUNTS)

December 31,

2002 2001
-------------- ---------
ASSETS
- ----------------------------------------------------------------------
Current Assets:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . $ 266 $ 423
Accounts receivable, less allowance for doubtful accounts
of $303 and $763, respectively. . . . . . . . . . . . . . . . . 1,472 2,713
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,145 4,740
Prepaid expenses and other current assets . . . . . . . . . . . . . 237 399
Total current assets . . . . . . . . . . . . . . . . . . . . 5,120 8,275
-------------- ---------
PROPERTY, PLANT AND EQUIPMENT, net . . . . . . . . . . . . . . . . . . 2,563 2,962
PATENTS, less accumulated amortization of $338 and $296, respectively. 207 234
OTHER ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102 90
$ 7,992 $ 11,561
-------------- ---------

LIABILITIES AND SHAREHOLDERS' EQUITY
- ----------------------------------------------------------------------
Current Liabilities:
Revolving line of credit and term loan. . . . . . . . . . . . . . . $ 2,067 $ 2,599
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . 1,807 1,153
Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . 1,523 1,864
Obligations under capital leases - current portion. . . . . . . . . 97 121
Deferred income . . . . . . . . . . . . . . . . . . . . . . . . . . 394 303
Total current liabilities. . . . . . . . . . . . . . . . . . 5,888 6,040
-------------- ---------

OBLIGATIONS UNDER CAPITAL LEASES, noncurrent portion . . . . . . . . . 2,555 2,630
Total liabilities. . . . . . . . . . . . . . . . . . . . . . 8,443 8,670
-------------- ---------

COMMITMENTS AND CONTINGENCIES (Notes 2, 8 and 13)
SHAREHOLDERS' EQUITY (DEFICIT):
Common stock, $0.001 par value; authorized 140,000 shares,
issued and outstanding 78,044 and 61,543 shares, respectively. . 78 62
Additional paid-in capital. . . . . . . . . . . . . . . . . . . . . 44,521 44,403
Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . (44,930) (41,574)
Note receivable from shareholder. . . . . . . . . . . . . . . . . . (120) -
---------
Total shareholders' equity (deficit). . . . . . . . . . . . . (451) 2,891
--------------

$ 7,992 $ 11,561

See notes to consolidated financial statements

SENTRY TECHNOLOGY CORPORATION
-----------------------------
AND SUBSIDIARIES
----------------
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Years Ended
December 31,
-------------

2002 2001 2000
----------- -------------- -----------
REVENUES:
Sales. . . . . . . . . . . . . . . . . . . . $ 9,732 $ 12,827 $ 15,701
Service revenues and other . . . . . . . . . 4,804 4,472 4,164
----------- -------------- -----------
14,536 17,299 19,865
----------- -------------- -----------
COST AND EXPENSES:
Cost of sales. . . . . . . . . . . . . . . . 7,382 8,879 11,120
Customer service expenses. . . . . . . . . . 4,240 4,361 4,464
Selling, general and administrative expenses 5,227 5,773 7,576
Research and development . . . . . . . . . . 548 661 862
Asset impairment charges . . . . . . . . . . - - 2,981
----------- -------------- -----------
17,397 19,674 27,003
----------- -------------- -----------
OPERATING LOSS . . . . . . . . . . . . . . . . (2,861) (2,375) (7,138)
INTEREST EXPENSE . . . . . . . . . . . . . . . 495 536 683
----------- -------------- -----------
LOSS BEFORE INCOME TAXES AND CUMULATIVE
EFFECT ON CHANGE IN ACCOUNTING PRINCIPLE. . (3,356) (2,911) (7,821)

INCOME TAXES . . . . . . . . . . . . . . . . . - - -
----------- -------------- -----------
NET LOSS BEFORE CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE. . . . . . . (3,356) (2,911) (7,821)
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE. . . . . . . . . . . . - - (301)
----------- -------------- -----------
NET LOSS . . . . . . . . . . . . . . . . . . . (3,356) (2,911) (8,122)
PREFERRED STOCK DIVIDENDS. . . . . . . . . . . - (25) (1,337)
RETURN TO COMMON SHAREHOLDERS FROM
REDEMPTION OF PREFERRED STOCK . . . . . . . - 27,198 -
----------- -------------- -----------
NET INCOME (LOSS) ATTRIBUTED TO
COMMON SHAREHOLDERS . . . . . . . . . . . . $ (3,356) $ 24,262 $ (9,459)
=========== ============== ===========
NET INCOME (LOSS) PER COMMON SHARE BEFORE
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE:
Basic . . . . . . . . . . . . . . . . . . . $ (0.05) $ 0.40 $ (0.94)
=========== ============== ===========
Diluted . . . . . . . . . . . . . . . . . . $ (0.05) $ 0.39 $ (0.94)
=========== ============== ===========
NET INCOME (LOSS) PER COMMON SHARE:
Basic . . . . . . . . . . . . . . . . . . . $ (0.05) $ 0.40 $ (0.97)
=========== ============== ===========
Diluted . . . . . . . . . . . . . . . . . . $ (0.05) $ 0.39 $ (0.97)