**SECURITIES AND EXCHANGECOMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

 

**ý****        ****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For the quarterly period ended June 30,2004**

 

**OR**

 

**o****   ****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from             to             **

 

**Commission File Number 1-14227**

 

**AMERICAN BANK NOTE HOLOGRAPHICS, INC.**

(Exact name of Registrant as specified in itscharter)

 
| **Delaware**                                                                        | ** ** | **13-3317668**                        |
|-------------------------------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction of  incorporation  or organization)                    |       | (I.R.S. Employer  Identification No.) |
|                                                                                |       |                                  |
| **399 Executive Boulevard  Elmsford, New York, 10523**                              |
| (Address of principal executive offices,  including zip code)                       |
|                                                                                |       |                                  |
| **(914) 592-2355**                                                                  |
| (Registrant’s telephone number, including  area code)                          |
|                                                                                |       |                                  |
| **Not applicable**                                                                  |
| (Former name, former address and former  fiscal year, if changed since last report) |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports) and (2) has been subject to suchfiling for the past 90 days.

 

ý  Yes  o  No

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).

 

o  Yes  ý  No

 

The aggregate number of shares of common stock, $.01 par value,outstanding on July 30, 2004 was 18,483,720.

 

 

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**AMERICAN BANK NOTE HOLOGRAPHICS, INC.**

 

**FORM 10-Q**

 

## **INDEX**

 
| PART I -  FINANCIAL INFORMATION                                                                               |   |
|---------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                          |   |
| Item 1.  Financial Statements                                                                                 |   |
|                                                                                                          |   |
| Condensed Balance Sheets as of  June 30, 2004 (Unaudited) and December 31, 2003                     |   |
|                                                                                                          |   |
| Unaudited Condensed Statements of  Operations  For the Three and Six Months Ended June 30, 2004 and 2003 |   |
|                                                                                                          |   |
| Unaudited Condensed Statements of Cash  Flows  For the Six Months Ended June 30, 2004 and 2003           |   |
|                                                                                                          |   |
| Notes to Unaudited Condensed Financial  Statements                                                            |   |
|                                                                                                          |   |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations           |   |
|                                                                                                          |   |
| Item 3. Quantitative and Qualitative Disclosures  About Market Risk                                           |   |
|                                                                                                          |   |
| Item 4.  Controls and Procedures                                                                              |   |
|                                                                                                          |   |
| PART II  - OTHER INFORMATION                                                                                  |   |
|                                                                                                          |   |
| Item 1.  Legal Proceedings                                                                                    |   |
|                                                                                                          |   |
| Item 6.  Exhibits and Reports on Form 8-K                                                                     |   |

 

i

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PART I - FINANCIALINFORMATION

 

ITEM I. FINANCIALSTATEMENTS

 

AMERICAN BANK NOTE HOLOGRAPHICS, INC.

CONDENSEDBALANCE SHEETS

(In thousands, except share data)

 
| ** **                                                                                                               | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                               | ** ** | **(Unaudited)**         | ** ** | **(Note A)**                | ** ** |
| ASSETS                                                                                                                   | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current Assets:                                                                                                          |       |                    |       |                        |       |
| Cash and cash equivalents                                                                                                |       | $                       | 13,048     |                        | $          | 11,341 |   |
| Accounts receivable, net of allowance for  doubtful accounts of $180                                                     |       | 3,331                   |       | 3,174                       |       |
| Inventories                                                                                                              |       | 2,267                   |       | 2,386                       |       |
| Deferred income taxes                                                                                                    |       | 978                     |       | 981                         |       |
| Prepaid expenses                                                                                                         |       | 152                     |       | 385                         |       |
| Other                                                                                                                    |       | —                  |       | 150                         |       |
| Total  current assets                                                                                                    |       | 19,776                  |       | 18,417                      |       |
| Machinery, equipment and leasehold  improvements, net of accumulated depreciation and amortization of $9,559 and  $9,238 |       | 2,660                   |       | 2,490                       |       |
| Other assets                                                                                                             |       | 88                      |       | 113                         |       |
|                                                                                                                     |       |                    |       |                        |       |
| Total Assets                                                                                                             |       | $                       | 22,524     |                        | $          | 21,020 |   |
|                                                                                                                     |       |                    |       |                        |       |
| LIABILITIES AND STOCKHOLDERS’  EQUITY                                                                               |       |                    |       |                        |       |
| Current Liabilities:                                                                                                     |       |                    |       |                        |       |
| Accounts payable                                                                                                         |       | $                       | 1,018      |                        | $          | 687 |   |
| Accrued expenses                                                                                                         |       | 1,535                   |       | 1,627                       |       |
| Customer advances                                                                                                        |       | 101                     |       | 49                          |       |
| Income taxes payable                                                                                                     |       | 449                     |       | —                      |       |
| Total current liabilities                                                                                                |       | 3,103                   |       | 2,363                       |       |
| Deferred income taxes                                                                                                    |       | 1,226                   |       | 1,208                       |       |
|                                                                                                                     |       |                    |       |                        |       |
| Total liabilities                                                                                                        |       | 4,329                   |       | 3,571                       |       |
|                                                                                                                     |       |                    |       |                        |       |
| Commitments and contingencies                                                                                            |       |                    |       |                        |       |
|                                                                                                                     |       |                    |       |                        |       |
| Stockholders’ Equity:                                                                                               |       |                    |       |                        |       |
| Preferred stock, authorized 5,000,000  shares; no shares issued or outstanding                                           |       | —                  |       | —                      |       |
| Common stock, par value $.01 per share,  authorized 40,000,000 shares; issued and outstanding 18,483,720 shares          |       | 185                     |       | 185                         |       |
| Additional paid-in capital                                                                                               |       | 23,994                  |       | 23,994                      |       |
| Accumulated deficit                                                                                                      |       | (5,984                  | )          | (6,730                      | )          |
| Total Stockholders’ Equity                                                                                          |       | 18,195                  |       | 17,449                      |       |
|                                                                                                                     |       |                    |       |                        |       |
| Total Liabilities and Stockholders’ Equity                                                                          |       | $                       | 22,524     |                        | $          | 21,020 |   |

 

See Notes to Unaudited Condensed Financial Statements.

 

1

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AMERICAN BANK NOTE HOLOGRAPHICS, INC.

CONDENSEDSTATEMENTS OF OPERATIONS - UNAUDITED

(In thousands, except per share data)

 
| ** **                               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                               | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenue:                                 | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sales                                    |       | $                                     | 4,907      |                                | $          | 4,275 |   | $ | 9,941 |   | $ | 8,813 |   |
| Royalty income                           |       | 3                                     |       | 3                                   |       | 13 |   | 47 |   |
|                                     |       | 4,910                                 |       | 4,278                               |       | 9,954 |   | 8,860 |   |
| Costs and expenses:                      |       |                                  |       |                                |       |   |   |   |   |
| Cost of goods sold                       |       | 2,260                                 |       | 1,988                               |       | 4,530 |   | 4,004 |   |
| Selling and administrative               |       | 1,751                                 |       | 1,628                               |       | 3,434 |   | 3,391 |   |
| Research and development                 |       | 365                                   |       | 296                                 |       | 648 |   | 564 |   |
| Depreciation and amortization            |       | 164                                   |       | 184                                 |       | 324 |   | 363 |   |
|                                     |       | 4,540                                 |       | 4,096                               |       | 8,936 |   | 8,322 |   |
|                                     |       |                                  |       |                                |       |   |   |   |   |
| Operating income                         |       | 370                                   |       | 182                                 |       | 1,018 |   | 538 |   |
|                                     |       |                                  |       |                                |       |   |   |   |   |
| Other income:                            |       |                                  |       |                                |       |   |   |   |   |
| Interest income                          |       | 25                                    |       | 26                                  |       | 48 |   | 51 |   |
| Patent agreement                         |       | 178                                   |       | —                              |       | 178 |   | — |   |
|                                     |       | 203                                   |       | 26                                  |       | 226 |   | 51 |   |
|                                     |       |                                  |       |                                |       |   |   |   |   |
| Income before provision for income taxes |       | 573                                   |       | 208                                 |       | 1,244 |   | 589 |   |
| Provision for income taxes               |       | 229                                   |       | 88                                  |       | 498 |   | 250 |   |
|                                     |       |                                  |       |                                |       |   |   |   |   |
| Net income                               |       | $                                     | 344        |                                | $          | 120 |   | $ | 746 |   | $ | 339 |   |
|                                     |       |                                  |       |                                |       |   |   |   |   |
| Net income per share:                    |       |                                  |       |                                |       |   |   |   |   |
| Basic and diluted                        |       | $                                     | 0.02       |                                | $          | 0.01 |   | $ | 0.04 |   | $ | 0.02 |   |

 

See Notes to Unaudited Condensed FinancialStatements.

 

2

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AMERICAN BANK NOTE HOLOGRAPHICS, INC.

CONDENSEDSTATEMENTS OF CASH FLOWS - UNAUDITED

(In thousands)

 
| ** **                                                                         | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| ** **                                                                         | ** ** | ** **                          | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                              | ** ** | ** **                          | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                                   | 746        |   | $ | 339 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                                |       |   |   |
| Depreciation and amortization                                                      |       | 324                                 |       | 363 |   |
| Deferred income taxes                                                              |       | 21                                  |       | 250 |   |
| Changes in operating assets and  liabilities:                                      |       |                                |       |   |   |
| Accounts receivable                                                                |       | (157                                | )          | 266 |   |
| Inventories                                                                        |       | 119                                 |       | (17 | ) |
| Prepaid expenses and other                                                         |       | 405                                 |       | 505 |   |
| Accounts payable and accrued expenses                                              |       | 239                                 |       | (782 | ) |
| Customer advances                                                                  |       | 52                                  |       | 14 |   |
| Income taxes payable                                                               |       | 449                                 |       | — |   |
|                                                                               |       |                                |       |   |   |
| Net cash provided by operating activities                                          |       | 2,198                               |       | 938 |   |
|                                                                               |       |                                |       |   |   |
| Cash flows from investing activities:                                              |       |                                |       |   |   |
| Capital expenditures                                                               |       | (491                                | )          | (186 | ) |
|                                                                               |       |                                |       |   |   |
| Net cash used in investing activities                                              |       | (491                                | )          | (186 | ) |
|                                                                               |       |                                |       |   |   |
| Increase in cash and cash equivalents                                              |       | 1,707                               |       | 752 |   |
| Cash and cash equivalents, beginning of  period                                    |       | 11,341                              |       | 8,659 |   |
|                                                                               |       |                                |       |   |   |
| Cash and cash equivalents, end of period                                           |       | $                                   | 13,048     |   | $ | 9,411 |   |
|                                                                               |       |                                |       |   |   |
| Supplemental cash payments:                                                        |       |                                |       |   |   |
| Taxes                                                                              |       | $                                   | 11         |   | $ | 5 |   |

 

See Notes to Unaudited Condensed FinancialStatements.

 

3

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AMERICAN BANK NOTE HOLOGRAPHICS, INC.

NOTES TOUNAUDITED CONDENSED FINANCIAL STATEMENTS

 

NOTE A - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES

 

American Bank Note Holographics, Inc. (the “Company”) originates,mass-produces, and markets secure holograms. Holograms are used for security,packaging and promotional applications. The Company operates in one reportableindustry segment.

 

The accompanying unaudited condensed financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States for interim financial information and with the instructions toForm 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of theinformation and footnotes required by U.S. generally accepted accountingprinciples for complete financial statements. In the opinion of management, alladjustments (consisting of normal recurring accruals) considered necessary fora fair presentation have been included. Operating results for the three and sixmonths ended June 30, 2004 are not necessarily indicative of the resultsthat may be expected for the year ending December 31, 2004.

 

The balance sheet at December 31, 2003 has been derived from theaudited financial statements at that date but does not include all of theinformation and footnotes required by U.S. generally accepted accountingprinciples for complete financial statements.

 

For further information, refer to the financial statements andfootnotes thereto included in the Company’s annual report on Form 10-K for theyear ended December 31, 2003, as filed with the United States Securitiesand Exchange Commission (“SEC”).

 

REVENUE RECOGNITION

 

The Company recognizes revenue in accordance with the provisions of theSEC’s Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition (anamendment of SAB 101, “Revenue Recognition”).” Specifically, sales and the related cost of goods sold are generallyrecognized at the latter of the time of shipment or when title passes tocustomers. In some situations, the Company has shipped product where the saleis contingent upon the customers’ use of the product. In these situations, theCompany does not recognize sales upon product shipment, but rather when the buyerof the product informs the Company that the product has been used.  Additionally, pursuant to terms with acertain customer, completed items are stored on behalf of the customer at theCompany’s on-site secured facility and, in that instance, sales are recognizedwhen all of the following have occurred: the customer has ordered the goods,the manufacturing process is complete, the goods have been transferred to theon-site secured facility and are ready for shipment, the risk of ownership haspassed to the customer and the customer has been billed for the order.

 

Customer advances represent payments received from customers forproducts which have not yet been shipped. These customer advances are classified as current liabilities on theaccompanying balance sheets.

 

Shipping and handling amounts billed to customers are included in salesand amounted to $116,000 and $224,000 for the three and six months endedJune 30, 2004, respectively, and $90,000 and $165,000 for the three andsix months ended June 30, 2003, respectively.  Shipping and handling costs are included inselling and administrative expenses.

 

BASIC AND DILUTED NET INCOME PER SHARE

 

Basic net income per share is computed based on the weighted averagenumber of outstanding shares of common stock. The basic weighted average numberof shares outstanding were 18,483,720 in each of the three and six months endedJune 30, 2004 and 2003. Diluted net income per share is computed bydividing net income by the weighted average number of shares of common stockoutstanding and dilutive potential shares of common stock. For the three andsix months ended June 30, 2004, the diluted number of weighted averageshares outstanding was 18,945,209 and 18,830,933, respectively, which includesdilutive stock options of 461,489 shares and 347,213 shares, respectively. Forthe three and six months ended June 30, 2003, the diluted number ofweighted average

 

4

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shares outstanding was 18,499,332 and 18,487,691, respectively, whichincludes dilutive stock options of 15,612 shares and 3,971 shares,respectively.

 

BUSINESS INFORMATION

 

Sales to MasterCard were approximately 37% and 25% of sales for thethree months ended June 30, 2004 and 2003, respectively, and 36% and 18%of sales for the six months ended June 30, 2004 and 2003, respectively.The Company entered into an agreement with MasterCard dated February 28,2003, which replaced the agreement dated February 1, 1996, as amended.  The Company and MasterCard entered into an amendmentto this agreement on September 29, 2003, in which MasterCard retained theCompany to produce a new hologram for the Debit MasterCard and extended theagreement to February 28, 2011, subject to automatic renewal if notterminated by either party.  The loss ofall or a substantial portion of the sales to MasterCard would have a materialadverse effect on the financial position, results of operations and cash flowsof the Company. At June 30, 2004 and December 31, 2003, accountsreceivable from this customer totaled $1.3 million and $1.0 million,respectively.

 

Sales of VISA holograms to manufacturers of VISA credit cards wereapproximately 30% and 28% of sales for the three months ended June 30,2004 and 2003, respectively, and 32% and 30% of sales for the six months endedJune 30, 2004 and 2003, respectively. The loss of a substantial portion ofthe sales to manufacturers of VISA credit cards would have a material adverseeffect on the financial position, results of operations and cash flows of theCompany. Accounts receivable from these customers approximated $1.4 million and$1.3 million at June 30, 2004 and December 31, 2003, respectively.

 

The Company purchases certain key materials used in the manufacture ofits holograms and outsources certain key processes from third party suppliers,some of which are sole source relationships, with whom the Company does nothave supply contracts. Any problems that occur with respect to the delivery,quality or cost of any such materials or processes could have a materialadverse effect on the financial position, results of operations and cash flowsof the Company.

 

STOCK-BASED COMPENSATION PLANS

 

As allowed by SFAS No. 123, the Company has elected to continue toapply the intrinsic value-based method of accounting prescribed in APB OpinionNo. 25 and, accordingly, does not recognize compensation expense for stockoption grants made at an exercise price equal to or in excess of the fairmarket value of the stock at the date of grant.

 

Had compensation costs for the Company’s outstanding stock options beendetermined based on the fair value at the grant dates for those optionsconsistent with SFAS No. 123, the Company’s net income and basic and dilutednet income per share would have differed as reflected by the pro forma amountsindicated below:

 
| ** **                                                                                                                      | ** ** | **Three Months Ended  June 30,**     | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                                      | ** ** | **2004**                                  | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                      | ** ** | **(In thousands, except per share data)** | ** ** |
|                                                                                                                            |       |                                      |       |                                |       |   |   |   |   |
| Net income, as reported                                                                                                         |       | $                                         | 344        |                                | $          | 120 |   | $ | 746 |   | $ | 339 |   |
| Add:   Non-cash employee compensation, as reported                                                                         |       | —                                    |       | —                              |       | — |   | — |   |
| Deduct:   Stock-based employee compensation expense determined under fair value  based method for all awards, net of taxes |       | 18                                        |       | 15                                  |       | 36 |   | 22 |   |
| Pro forma, net income                                                                                                           |       | $                                         | 326        |                                | $          | 105 |   | $ | 710 |   | $ | 317 |   |
|                                                                                                                            |       |                                      |       |                                |       |   |   |   |   |
| Basic and diluted net income per share, as  reported                                                                            |       | $                                         | 0.02       |                                | $          | 0.01 |   | $ | 0.04 |   | $ | 0.02 |   |
| Basic and diluted net income per share, pro  forma                                                                              |       | $                                         | 0.02       |                                | $          | 0.01 |   | $ | 0.04 |   | $ | 0.02 |   |

 

5

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WARRANTY COSTS

 

The Company provides for warranty costs in amounts it estimates will beneeded to cover future warranty obligations for products sold.  Estimates of warranty costs are based onhistorical experience and are periodically reviewed and adjusted, whennecessary.  The Company’s productwarranty provision is included in accrued expenses in the accompanying balancesheets. Changes in the Company’s warranty provision are as follows:

 
| ** **                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                     | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                     | ** ** | **(In thousands)**                    | ** ** | **(In thousands)**                  | ** ** |
| ** **                     | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance at beginning of period |       | $                                     | 524        |                                | $          | 579 |   | $ | 510 |   | $ | 605 |   |
| Warranties issued              |       | 40                                    |       | 40                                  |       | 80 |   | 80 |   |
| Settlements made               |       | (78                                   | )          | (106                                | )          | (104 | ) | (172 | ) |
| Balance at June 30        |       | $                                     | 486        |                                | $          | 513 |   | $ | 486 |   | $ | 513 |   |

 

NOTE B - INVENTORIES

 

Inventories consist of the following:

 
| ** **                                    | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                    | ** ** | **(Unaudited)**         | ** ** | **(Note A)**                | ** ** |
| ** **                                    | ** ** | **(In thousands)**      | ** ** |
|                                          |       |                    |       |                        |       |
| Finished goods                                |       | $                       | 747        |                        | $          | 800 |   |
| Finished goods on consignment with  customers |       | 350                     |       | 417                         |       |
| Work in process                               |       | 866                     |       | 764                         |       |
| Raw materials                                 |       | 304                     |       | 405                         |       |
|                                          |       | $                       | 2,267      |                        | $          | 2,386 |   |

 

NOTE C - COMMITMENTS AND CONTINGENCIES

 

The Company currently and from time to time is involved in litigation(as both plaintiff and defendant) incidental to the conduct of its business;however, the Company is not a party to any lawsuit or proceeding which, in theopinion of management of the Company, could have a material impact on theCompany’s financial position, results of operations or cash flows.

 

6

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ITEM 2. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis should be read in conjunctionwith the Company’s unaudited financial statements, including the notes thereto,appearing elsewhere in this report.

 

OVERVIEW

 

The Company originates, mass-produces and markets holograms. TheCompany’s holograms are used primarily for security applications such ascounterfeiting protection for credit and other transaction cards, identificationcards and documents of value, as well as for tamper resistance andauthentication of high-value consumer and industrial products.  The Company also produces non-secureholograms for packaging and promotional applications.  The Company’s sales of holograms for securityapplications generally carry higher gross margins than sales for non-securityapplications.

 

A significant portion of the Company’s business is derived from ordersplaced by certain credit card companies, including MasterCard and manufacturersof VISA brand credit cards, and variations in the timing of such orders cancause significant fluctuations in the Company’s sales. Sales to MasterCard wereapproximately 37% and 25% of sales for the three months ended June 30,2004 and 2003, respectively, and 36% and 18% of sales for the six months endedJune 30, 2004 and 2003, respectively. The Company entered into anagreement with MasterCard dated February 28, 2003, which replaced theagreement dated February 1, 1996, as amended. The Company and MasterCardentered into an amendment to this agreement on September 29, 2003, inwhich MasterCard retained the Company to produce a new hologram for the DebitMasterCard and extended the agreement to February 28, 2011, subject toautomatic renewal if not terminated by either party.  Sales of VISA holograms to manufacturers ofVISA credit cards were approximately 30% and 28% of sales for the three monthsended June 30, 2004 and 2003, respectively, and 32% and 30% of sales forthe six months ended June 30, 2004 and 2003, respectively. The Companydoes not have long-term purchase contracts with VISA and supplies holograms toapproximately 50 VISA authorized card manufacturers pursuant to purchaseorders. Currently the Company is one of two companies authorized to manufactureand sell VISA brand holograms to manufacturers of VISA brand credit cards. Ifeither MasterCard or VISA were to terminate its respective relationship withthe Company or substantially reduce their orders, there would be a materialadverse effect on the Company’s business, financial condition, results ofoperations and cash flows.

 

Holograms are sold under purchase orders and contracts with customers.Sales and the related cost of goods sold are generally recognized at the latterof the time of shipment or when title passes to customers. In some situations,the Company has shipped product where the sale is contingent upon thecustomers’ use of the product. In these situations, the Company does notrecognize sales upon product shipment, but rather when the buyer of the productinforms the Company that the product has been used. Additionally, pursuant toterms with a certain customer, completed items are stored on behalf of thecustomer at the Company’s on-site secured facility and, in that instance, salesare recognized when all of the following have occurred: the customer hasordered the goods, the manufacturing process is complete, the goods have beentransferred to the on-site secured facility and are ready for shipment, therisk of ownership has passed to the customer and the customer has been billedfor the order. At June 30, 2004 and December 31, 2003, accountsreceivable from this customer totaled $1.3 million and $1.0 million,respectively.

 

The Company purchases certain key materials used in the manufacture ofits holograms and outsources certain key processes from third party suppliers,some of whom are sole source relationships, with which it does not have supplycontracts. Any problems that occur with respect to the delivery, quality orcost of any such materials or processes could have a material adverse effect onthe Company’s financial position, results of operations and cash flows.

 

Sales may fluctuate from quarter to quarter due to changes incustomers’ ordering patterns. Customers do not typically provide the Companywith precise forecasts of future order quantities. Quarterly demand forholograms may be materially influenced by customers’ promotions, inventoryreplenishment, card expiration patterns, delivery schedules and other factorswhich may be difficult for the Company to anticipate.

 

7

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Cost of goods sold includes raw materials such as nickel, foils, filmsand adhesives; labor costs; manufacturing overhead; and hologram originationcosts (which represent costs of a unique master hologram that is made tocustomer specifications and is an integral part of the production process). Asa result, costs of goods sold are affected by product mix, manufacturingyields, costs of hologram originations and changes in the cost of raw materialsand labor.

 

Selling and administrative expenses primarily consist of salaries,benefits and commissions for the Company’s corporate, sales, marketing andadministrative personnel, marketing and promotion expenses, legal andaccounting expenses and expenses associated with being a public company.

 

COMPARISON OF THREE MONTHS ENDED JUNE 30, 2004 TO THREE MONTHSENDED JUNE 30, 2003

 

*Sales.* Sales increased by $0.6 million, or 14.8%, from $4.3 million for thethree months ended June 30, 2003 to $4.9 million for the three monthsended June 30, 2004.  The increasewas due to an increase in sales of holograms for transaction cards primarilyresulting from an increase in sales to MasterCard, which was the result of atemporary reduction in purchases by MasterCard in the first half of 2003 aswell as expansion of other transaction card programs and the implementation ofa new secure government ID program.

 

*Royalty Income.*  Royalty income remained relatively unchanged.

 

*Cost of Goods Sold.*  Cost of goods sold increased by $0.3 million,from $2.0 million for the three months ended June 30, 2003 to $2.3 millionfor the three months ended June 30, 2004. As a percentage of sales, cost of goods sold decreased from 46.5% in thethree months ended June 30, 2003 to 46.1% for the same period in2004.  The decrease of 0.4% was primarilydue to the increase in sales volume.

 

*Selling and Administrative.*  Selling and administrative expenses increased$0.1 million from $1.6 million for the three months ended June 30, 2003 to$1.7 million for the three months ended June 30, 2004. As a percentage ofsales, selling and administrative expenses decreased from 38.1% for the threemonths ended June 30, 2003 to 35.7% for the same period in 2004.  The increase was primarily due to an increasein selling expenses including commissions, travel and trade show expenses.

 

*Research and Development. *Researchand development expenses increased $69,000 from $296,000 for the three monthsended June 30, 2003 to $365,000 for the same period in 2004. The increasewas primarily due to an increase in testing expenses for new potentialcustomers.

 

*Depreciation and Amortization.*  Depreciation and amortization remainedrelatively unchanged.

 

*Interest Income*.  Interest income remained relativelyunchanged.

 

*Patent Agreement.* On April 13, 2004, theCompany entered into an agreement with a competitor in which the Company waspaid $178,000 and the Company granted a limited release and a limited licenseto use certain of the Company’s patents for certain products that werepreviously produced by the competitor.

 

COMPARISON OF SIX MONTHS ENDED JUNE 30, 2004 TO SIX MONTHS ENDEDJUNE 30, 2003

 

*Sales*. Sales increased by $1.1 million, or 12.8%, from $8.8 million for the sixmonths ended June 30, 2003 to $9.9 million for the six months endedJune 30, 2004.  The increase was dueto an increase in sales of holograms for transaction cards of $2.4 millionprimarily resulting from an increase in sales to MasterCard, which was theresult of a temporary reduction in purchases by MasterCard in the first half of2003 as well as expansion of other transaction card programs and theimplementation of a new secure government ID program, partially offset by adecrease of $1.3 million for sales of other holograms.

 

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*Royalty Income*.  Royalty income for the six months endedJune 30, 2004 decreased $43,000 from the six months ended June 30,2003 due to the expiration of a patent license agreement.

 

*Cost of Goods Sold*.  Cost of goods sold increased by $0.5 million,from $4.0 million for the six months ended June 30, 2003 to $4.5 millionfor the six months ended June 30, 2004. As a percentage of sales, cost of goods sold increased from 45.4% in thesix months ended June 30, 2003 to 45.6% for the same period in 2004.

 

*Selling and Administrative*.  Selling and administrative expenses remainedrelatively unchanged. As a percentage of sales, selling and administrativeexpenses decreased from 38.5% for the six months ended June 30, 2003 to34.5% for the six months ended June 30, 2004 as a result of the increasein sales.

 

*Research and Development*.* *Research and development expensesincreased $84,000 from $564,000 for the six months ended June 30, 2003 to$648,000 for the same period in 2004. The increase was primarily due to anincrease in testing expenses for new potential customers.

 

*Depreciation and Amortiza*tion.  Depreciation and amortization remainedrelatively unchanged.

 

*Interest Income*.  Interest income remained relativelyunchanged.

 

*Patent Agreement.* On April 13, 2004, theCompany entered into an agreement with a competitor in which the Company waspaid $178,000 and the Company granted a limited release and a limited licenseto use certain of the Company’s patents for certain products that werepreviously produced by the competitor.

 

LIQUIDITY AND CAPITAL RESOURCES

 

At June 30, 2004, the Company had $13.0 million in cash and cashequivalents and working capital of $16.7 million.

 

The Company’s operating activities provided cash of $2.2 million forthe six months ended June 30, 2004, compared to $0.9 million of cashprovided for the six months ended June 30, 2003.  Cash flows provided by net income andadjustments to reconcile net income to net cash provided by operatingactivities were $1.1 million in the six months ended June 30, 2004. Cashflows provided by changes in operating assets and liabilities were $1.1 in thesix months ended June 30, 2004 primarily due to changes in inventory,prepaid expenses and other assets, accounts payable and accrued expenses andincome taxes payable being offset by changes in accounts receivable. For thesix months ended June 30, 2003, cash flows provided by net income andadjustments to reconcile net income to net cash used in operating activitiesprovided cash of $0.9 million and there was no cash provided by the net changesin operating assets and liabilities.

 

Investing activities for the six months ended June 30, 2004 and2003 used cash of $491,000 and $186,000, respectively, for capitalexpenditures.

 

There were no financing activities for the six-month periods endedJune 30, 2004 and 2003.

 

In the coming quarters, the Company intends to begin implementing acapital investment program which is intended to enhance the efficiency of itsoperations and expand its product line and production capability.

 

The Company has long-term operating leases for offices, manufacturingfacilities and equipment, which expire through 2007.  The Company has renewal options on somelocations, which provide for renewal rents based upon a fixed annual rate orthe greater of a fixed annual rate or increases tied to the consumer priceindex.

 

SPECIAL NOTE REGARDING FORWARD - LOOKING STATEMENTS

 

Certain statements in this Form 10-Q constitute “forward-looking”statements within the meaning of the Private Securities Litigation Reform Actof 1995 (the “Reform Act”). Such “forward-looking” statements involve known andunknown risks, uncertainties and other factors which may cause the actualresults, performance or achievements of the Company, or industry results, to bematerially different from any future results, performance, or achievementsexpressed or implied by such “forward-looking” statements. Such factors aremore fully described under the caption

 

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“Business – Risk Factors” in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2003, which should be considered inconnection with a review of this report.

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK

 

The Company does not engage in significant activity with respect tomarket risk sensitive instruments. Accordingly, our risk with respect to marketrisk sensitive instruments is immaterial.

 

ITEM 4. CONTROLS ANDPROCEDURES

 

The Company carried out an evaluation, underthe supervision and with the participation of management, including theCompany’s Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures as of the end of the period covered by this report pursuant toExchange Act Rule 13a-15.  Based uponthat evaluation, the Chief Executive Officer and Chief Financial Officerconcluded that the Company’s disclosure controls and procedures were effectivein timely alerting them to material information relating to the Companyrequired to be included in the Company’s periodic Securities and ExchangeCommission filings.  There were nochanges in the Company’s internal control over financial reporting thatoccurred during the Company’s most recent fiscal quarter that would havematerially affected, or are reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

PART II - OTHERINFORMATION

 

ITEM 1.  LEGAL PROCEEDINGS

 

Not applicable.

 

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

 

(a)                                  Exhibits

 
| 31.1         Certification of  Kenneth H. Traub pursuant to Exchange Act Rules 13a-14 and 15d-14, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                  |
| 31.2         Certification of  Alan Goldstein pursuant to Exchange Act Rules 13a-14 and 15d-14, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.   |
|                                                                                                                                                                                                                  |
| 32.1         Certification of  Kenneth H. Traub pursuant to 18 U.S.C. Section 1350, as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002.          |
|                                                                                                                                                                                                                  |
| 32.2         Certification of  Alan Goldstein pursuant to 18 U.S.C. Section 1350, as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002.            |

 

(b)                                 Reports on Form 8-K

 

Current report on Form 8-K filed May 12, 2004, reporting the Company’sresults of operations for the quarter ended March 31, 2004.

 

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#### **SIGNATURES**

#### ** **

Pursuant to the requirements of the Securities Exchange Act of 1934,the Company has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|                            | AMERICAN BANK NOTE  HOLOGRAPHICS, INC.                |
|---------------------------------|-------------------------------------------------------|
|                            |                                                  |
|                            | By: /s/ Kenneth H. Traub                              |   |
|                            | Kenneth H. Traub                                      |
|                            | President and Chief Executive Officer                 |
|                            |                                                  |
|                            | By: /s/ Alan Goldstein                                |   |
|                            | Alan Goldstein                                        |
|                            | Vice President,                                       |
|                            | Chief Financial Officer and  Chief Accounting Officer |
|                            |
|                            |
| Date:  August 2, 2004 |
|                                 |                                                       |  |  |

 

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