**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

**FORM 10-Q**

**x****     ****QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For the quarterly period ended September 30, 2006**

**OR**

**o****   ****TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 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 its charter)**

| **Delaware**                                   |   | **13-3317668**       |
|------------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of incorporation |   | (I.R.S. Employer     |
| or organization)                               |   | Identification  No.) |

 

**2 Applegate Drive**

**Robbinsville, New Jersey 08691**

(Address ofprincipal executive offices, including zip code)

**(609) 632-0800**

(Registrant’s telephone number, including area code)

**Not applicable**

(Former name, former address and former fiscal year,if changed since last report)

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports) and (2) has been subject to such filing for thepast 90 days.

x Yes o No

Indicate by checkmarkwhether the registrant is a large accelerated filer, an accelerated filer or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act..(Check one):

Large acceleratedfiler o     Acceleratedfiler o    Non-accelerated filer x

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

o Yes x No

The aggregate number ofshares of common stock, $.01 par value, outstanding on October 30, 2006 was18,937,138.

 

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**AMERICAN BANK NOTE HOLOGRAPHICS, INC.**

**FORM 10-Q**

## **INDEX**

| PART I - FINANCIAL INFORMATION                                                                         |   |   |
|--------------------------------------------------------------------------------------------------------|--------|--------|
|                                                                                                   |   |   |
| Item 1. Financial  Statements                                                                          |   |   |
|                                                                                                   |   |   |
| Balance Sheets –  Unaudited as of September 30, 2006 and December 31, 2005                        |   |   |
|                                                                                                   |   |   |
| Statements of  Operations - Unaudited For the Three and Nine Months Ended September 30, 2006  and 2005 |   |   |
|                                                                                                   |   |   |
| Statements of  Cash Flows - Unaudited For the Nine Months Ended September 30, 2006 and 2005            |   |   |
|                                                                                                   |   |   |
| Condensed  Notes to Unaudited 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  1A. Risk Factors                                                                                 |   |   |
|                                                                                                   |   |   |
| Item 4.  Submission of Matters to a Vote of Security Holders                                           |   |   |
|                                                                                                   |   |   |
| Item  6. Exhibits                                                                                      |   |   |

 

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PART I -FINANCIAL INFORMATION

ITEM I.FINANCIAL STATEMENTS

AMERICAN BANK NOTEHOLOGRAPHICS, INC.

BALANCE SHEETS -UNAUDITED

(In thousands,except share data)
| ** **                                                                                                                             | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                             | ** ** | **(Unaudited)**              | ** ** | **(Note A)**           | ** ** |
| ASSETS                                                                                                                                 |       |                         |       |                        |       |
| CURRENT ASSETS:                                                                                                                        |       |                         |       |                        |       |
| Cash and cash  equivalents                                                                                                             |       | $                            | 13,524     |                        | $          | 9,114 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $400 and $500                                                          |       | 4,109                        |       | 6,019                       |       |
| Inventories, net                                                                                                                       |       | 2,160                        |       | 2,940                       |       |
| Deferred income  taxes, net                                                                                                            |       | 1,428                        |       | 2,968                       |       |
| Prepaid expenses  and other                                                                                                            |       | 436                          |       | 331                         |       |
| Income tax  receivable                                                                                                                 |       | 1,090                        |       | 401                         |       |
| Total current  assets                                                                                                                  |       | 22,747                       |       | 21,773                      |       |
| MACHINERY, EQUIPMENT  AND LEASEHOLD IMPROVEMENTS—Net of accumulated depreciation and amortization  of $9,470 and $8,852           |       | 6,306                        |       | 7,224                       |       |
| DEFERRED INCOME TAXES,  NET                                                                                                            |       | 275                          |       | 411                         |       |
| OTHER ASSETS                                                                                                                           |       | 108                          |       | 76                          |       |
| TOTAL ASSETS                                                                                                                           |       | $                            | 29,436     |                        | $          | 29,484 |   |
|                                                                                                                                   |       |                         |       |                        |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                             |       |                         |       |                        |       |
| CURRENT LIABILITIES:                                                                                                                   |       |                         |       |                        |       |
| Accounts payable                                                                                                                       |       | $                            | 1,808      |                        | $          | 3,820 |   |
| Accrued expenses                                                                                                                       |       | 3,055                        |       | 3,834                       |       |
| Customer  advances                                                                                                                     |       | 111                          |       | 204                         |       |
| Income taxes  payable                                                                                                                  |       | —                       |       | 359                         |       |
| Total current  liabilities                                                                                                             |       | 4,974                        |       | 8,217                       |       |
| LONG-TERM LIABILITIES                                                                                                                  |       | 1,383                        |       | 1,957                       |       |
| Total  liabilities                                                                                                                     |       | 6,357                        |       | 10,174                      |       |
|                                                                                                                                   |       |                         |       |                        |       |
| 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 18,936,703 shares and 18,715,469 shares |       | 190                          |       | 187                         |       |
| Additional  paid-in capital                                                                                                            |       | 25,657                       |       | 24,729                      |       |
| Unearned  compensation                                                                                                                 |       | —                       |       | (96                         | )          |
| Accumulated  deficit                                                                                                                   |       | (2,768                       | )          | (5,510                      | )          |
| Total  Stockholders’ Equity                                                                                                       |       | 23,079                       |       | 19,310                      |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                        |       | $                            | 29,436     |                        | $          | 29,484 |   |

 

See Condensed Notes to Unaudited Financial Statements.

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AMERICAN BANK NOTEHOLOGRAPHICS, INC.

STATEMENTS OFOPERATIONS - UNAUDITED

(In thousands,except per share data)
| ** **                                                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                  | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenue:                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Sales                                                       |       | $                                                    | 6,556      |                                                | $          | 8,959 |   | $ | 24,914 |   | $ | 22,216 |   |
| Royalty income                                              |       | —                                               |       | —                                              |       | — |   | 10 |   |
|                                                        |       | 6,556                                                |       | 8,959                                               |       | 24,914 |   | 22,226 |   |
| Costs and  expenses:                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Cost of goods sold, excluding depreciation and amortization |       | 3,297                                                |       | 4,227                                               |       | 11,892 |   | 10,187 |   |
| Selling and administrative                                  |       | 1,949                                                |       | 2,239                                               |       | 7,080 |   | 6,370 |   |
| Research and development                                    |       | 367                                                  |       | 291                                                 |       | 1,303 |   | 872 |   |
| Depreciation and amortization                               |       | 142                                                  |       | 127                                                 |       | 593 |   | 755 |   |
| Facility consolidation                                      |       | (101                                                 | )          | 278                                                 |       | 13 |   | 600 |   |
|                                                        |       | 5,654                                                |       | 7,162                                               |       | 20,881 |   | 18,784 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Operating income                                            |       | 902                                                  |       | 1,797                                               |       | 4,033 |   | 3,442 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Other income:                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Interest income                                             |       | 143                                                  |       | 61                                                  |       | 347 |   | 183 |   |
|                                                        |       | 143                                                  |       | 61                                                  |       | 347 |   | 183 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| INCOME BEFORE  PROVISION FOR INCOME TAXES                   |       | 1,045                                                |       | 1,858                                               |       | 4,380 |   | 3,625 |   |
| PROVISION FOR  INCOME TAXES                                 |       | 304                                                  |       | 742                                                 |       | 1,638 |   | 1,449 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| NET INCOME                                                  |       | $                                                    | 741        |                                                | $          | 1,116 |   | $ | 2,742 |   | $ | 2,176 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| NET INCOME PER  SHARE:                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                       |       | $                                                    | 0.04       |                                                | $          | 0.06 |   | $ | 0.15 |   | $ | 0.12 |   |
| Diluted                                                     |       | $                                                    | 0.04       |                                                | $          | 0.06 |   | $ | 0.14 |   | $ | 0.11 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| WEIGHTED AVERAGE  NUMBER OF SHARES:                         |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                       |       | 18,908                                               |       | 18,618                                              |       | 18,877 |   | 18,562 |   |
| Diluted                                                     |       | 19,505                                               |       | 19,576                                              |       | 19,591 |   | 19,363 |   |

 

See Condensed Notes to Unaudited Financial Statements.

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AMERICAN BANK NOTEHOLOGRAPHICS, INC.

STATEMENTS OF CASHFLOWS - UNAUDITED

(In thousands)
| ** **                                                                                   | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| ** **                                                                                   | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                       | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Net income                                                                                   |       | $                                                   | 2,742      |   | $ | 2,176 |   |
| Adjustments to reconcile net income to net cash  provided by (used in) operating activities: |       |                                                |       |   |   |
| Depreciation and amortization                                                                |       | 593                                                 |       | 755 |   |
| Write-off of fixed assets                                                                    |       | 254                                                 |       | — |   |
| Deferred income taxes, net                                                                   |       | 1,760                                               |       | 47 |   |
| Compensation costs related to share-based payment  arrangements                              |       | 793                                                 |       | — |   |
| (Recovery) provision for doubtful accounts                                                   |       | (100                                                | )          | 70 |   |
| (Recovery) provision for inventories                                                         |       | (3,056                                              | )          | 320 |   |
| Excess tax benefits from share-based payment  arrangements                                   |       | (12                                                 | )          | — |   |
| Changes in operating assets and liabilities:                                                 |       |                                                |       |   |   |
| Accounts receivable                                                                          |       | 2,010                                               |       | (2,273 | ) |
| Inventories                                                                                  |       | 3,836                                               |       | (2,944 | ) |
| Prepaid expenses and other                                                                   |       | (139                                                | )          | (144 | ) |
| Income tax receivable                                                                        |       | (689                                                | )          | — |   |
| Accounts payable                                                                             |       | (2,082                                              | )          | 1,885 |   |
| Accrued expenses                                                                             |       | (679                                                | )          | (161 | ) |
| Customer advances                                                                            |       | (93                                                 | )          | (1 | ) |
| Income taxes payable                                                                         |       | (359                                                | )          | (143 | ) |
| Long-term liabilities                                                                        |       | (574                                                | )          | 329 |   |
| Net cash  provided by (used in) operating activities                                         |       | 4,205                                               |       | (84 | ) |
|                                                                                         |       |                                                |       |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                       |       |                                                |       |   |   |
| Decrease in short-term investments                                                           |       | —                                              |       | 1,989 |   |
| Capital expenditures                                                                         |       | (333                                                | )          | (4,193 | ) |
| Cancellation of fixed asset purchase commitment                                              |       | 376                                                 |       | — |   |
| Net cash  provided by (used in) investing activities                                         |       | 43                                                  |       | (2,204 | ) |
|                                                                                         |       |                                                |       |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                       |       |                                                |       |   |   |
| Proceeds from exercise of stock options, net of  taxes                                       |       | 150                                                 |       | 388 |   |
| Excess tax benefits from share-based payment  arrangements                                   |       | 12                                                  |       | — |   |
| Net cash provided by financing activities                                                    |       | 162                                                 |       | 388 |   |
|                                                                                         |       |                                                |       |   |   |
| INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                                            |       | 4,410                                               |       | (1,900 | ) |
| CASH AND CASH  EQUIVALENTS, BEGINNING OF YEAR                                                |       | 9,114                                               |       | 11,357 |   |
|                                                                                         |       |                                                |       |   |   |
| CASH AND CASH  EQUIVALENTS, END OF PERIOD                                                    |       | $                                                   | 13,524     |   | $ | 9,457 |   |
|                                                                                         |       |                                                |       |   |   |
| SUPPLEMENTAL  CASH FLOW INFORMATION:                                                         |       |                                                |       |   |   |
| Taxes paid                                                                                   |       | $                                                   | 908        |   | $ | 1,785 |   |
| Capital expenditures included in accounts payable                                            |       | $                                                   | 70         |   | $ | 380 |   |
| Non-cash  settlement of accounts payable                                                     |       | $                                                   | 958        |   | $ | — |   |
| Reversal of  accrued restoration costs                                                       |       | $                                                   | 100        |   | $ | — |   |
| Amendment to  lease agreement                                                                |       | $                                                   | 130        |   | $ | — |   |

 

See Condensed Notes to Unaudited Financial Statements.

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AMERICAN BANK NOTEHOLOGRAPHICS, INC.

CONDENSEDNOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE A- BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

AmericanBank Note Holographics, Inc. (“ÁBNH” or the “Company”) originates, produces,markets and sells secure holograms and products incorporating secure holograms.The Company’s products are used primarily in security applications includingauthentication of transaction cards, identity documents, value documents andvarious consumer products.  Our abilityto create distinctive, secure optically variable devices, to reproduce themwith high quality and to distribute them securely has enabled us to become amarket leader in security holography. Our products are sold to over 200companies worldwide, including MasterCard, VISA, American Express, Discover,Diners Club, Sears, Nordstrom, Quaker State, Nike, Janssen-Cilag and Gennoma,as well as agencies of the United States government and certain foreigngovernments. We also produce non-secure holograms for design and promotionalapplications.  The Company operates inone reportable industry segment.

Thepreparation of our financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make use of estimates and assumptions that impact the reportedamounts of assets and liabilities at the date of the financial statements andthe reported amounts of revenue and expenses during the reporting period.  On an ongoing basis, we evaluate ourestimates, including those related to bad debts, stock-based compensation,inventories, intangible assets and taxes. These estimates and assumptions are based on historical results andtrends as well as our forecasts as to how these estimates and assumptions mightchange in the future.  In addition, theseestimates and assumptions have been influenced by our current assumptions ofthe potential impact of the VISA Decision as defined and more fully describedunder “Business Information” on the following page.

Theaccompanying unaudited financial statements have been prepared in accordancewith accounting principles generally accepted in the United States of Americafor interim financial information and with the instructions to Form 10-Q andArticle 10 of Regulation S-X.  Accordingly, they do not include allof the information and footnotes required by accounting principles generallyaccepted in the United States of America for complete financial statements. Inthe opinion of management, all adjustments that are normal and recurring andare considered necessary for a fair statement have been included. Operatingresults for the three and nine months ended September 30, 2006 are notnecessarily indicative of the results that may be expected for the year endingDecember 31, 2006.

Thebalance sheet at December 31, 2005 has been derived from the audited financialstatements at that date but does not include all of the information andfootnotes required by accounting principles generally accepted in the UnitedStates of America for complete financial statements.

Forfurther information, refer to the financial statements and footnotes theretoincluded in the Company’s annual report on Form 10-K for the year endedDecember 31, 2005, as filed with the United States Securities and ExchangeCommission (“SEC”).

REVENUERECOGNITION

Ourproducts are sold on a fixed price basis under purchase orders and contractswith customers. 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 thebuyer of the product informs the Company that the product has been used.Additionally, pursuant to the request of and agreement with a certain customer,completed items are stored on behalf of this customer at the Company’s on-sitesecured facility, and in that instance, sales are recognized when all of thefollowing have occurred: the customer has ordered the goods pursuant to a fixedprice purchase order, the manufacturing process is complete, the goods havebeen transferred to the on-site secured facility and are ready for shipment,the risk of ownership has passed to the customer, the customer has been billedfor the order and collection of the invoice is considered reasonably assured.In certain cases the Company has agreed to maintain an inventory of productsfor a customer to ensure quick turn around of deliveries.  The Company only accepts returns of productsold to customers when the product is determined to not be in conformance withthe specifications previously agreed upon with such customers in accordancewith the terms of its warranty policy (within 180 days of such sale) andgenerally replaces

6

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theproduct.

Customeradvances represent payments received from customers for products which have notyet been shipped.  These customeradvances are classified as current liabilities on the accompanying balancesheets.

Shippingand handling amounts billed to customers are included in sales and amounted to$182,000 and $283,000 for the three months ended September 30, 2006 and 2005,respectively. Shipping and handling amounts billed to customers in the ninemonths ended September 30, 2006 and 2005 amounted to $739,000 and $546,000,respectively. Shipping and handling costs are included in selling andadministrative expenses.

BASIC AND DILUTEDNET INCOME PER SHARE

Basic and dilutedearnings per share are calculated in accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 128, “Earnings Per Share.”

The followingtable sets forth the reconciliation of basic weighted average sharesoutstanding and diluted weighted average shares outstanding:
| **(Amounts in thousands)**                    | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                              | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Basic weighted  average shares outstanding              |       | 18,908                                               |       | 18,618                                              |       | 18,877 |   | 18,562 |   |
|                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Dilutive effect  of stock options and restricted shares |       | 597                                                  |       | 958                                                 |       | 714 |   | 801 |   |
|                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Diluted weighted  average shares outstanding            |       | 19,505                                               |       | 19,576                                              |       | 19,591 |   | 19,363 |   |

 

Thediluted earnings per share calculations exclude the effect of stock optionswhen the options’ exercise prices exceed the average market price of the commonshares during the period. For the three and nine-month periods ended September30, 2006, the numbers of stock options not included in the computations were539,000 and 538,000, respectively. For the three and nine-month periods endedSeptember 30, 2005, the numbers of stock options not included in thecomputations were 121,000 and 124,000, respectively. These stock options wereoutstanding at the end of each of the respective periods.

BUSINESSINFORMATION

Sales to MasterCard wereapproximately 41% and 30% of sales for the three months ended September 30,2006 and 2005, respectively and were approximately 36% and 33% of sales for thenine months ended September 30, 2006 and 2005, respectively. The Company has anagreement with MasterCard, as amended, in which MasterCard has retained theCompany as its exclusive supplier of MasterCard holograms as well asholographic magnetic stripe (HoloMagTM) through February 28, 2013, subject toautomatic renewal if not terminated by either party. Sales to MasterCard ofHoloMag have not been material in the three and nine month periods endedSeptember 30, 2006 and are not expected to be material for the year. AtSeptember 30, 2006 and December 31, 2005, accounts receivable from thiscustomer totaled $1.8 million and $1.5 million, respectively.

If we were to lose asubstantial portion of our business with MasterCard without replacing it withnew product sales, our business, operating results and financial conditionwould be materially and adversely affected. In addition, if we fail to obtainanticipated orders from MasterCard or if we experience delays or cancellationsof orders from MasterCard, our business, operating results and financialperformance will be materially and adversely affected.

Sales of VISA holograms(which included HoloMag starting in the three month period ended September 30,2005) to manufacturers of VISA transaction cards were approximately 28% and 42%of sales for the three months ended September 30, 2006 and 2005, respectivelyand were approximately 34% and 31% of sales for the nine months ended September30, 2006 and 2005, respectively. Currently we are a supplier of the VISA Dovehot stamp hologram to manufacturers of VISA brand transaction cards, althoughthere can be no assurance that VISA will not discontinue or replace the Dovehot stamp hologram in the future.****There can beno assurance that we will continue to be an authorized supplier of VISA securityproducts, or that VISA authorized card manufacturers will continue to purchasethe Dove hot stamp hologram, or any other security product, from us in thefuture.  To the extent sales of

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VISA Dove hot stamp hologramsdecline significantly from historical levels, our business, operating resultsand financial condition will be materially and adversely affected. On March 15,2005, VISA announced its intention to phase out the Dove hot stamp hologramthat we supply for the front of the VISA card, and to replace it with anintegrated holographic magnetic stripe. On April 8, 2005, we entered into anAgreement with VISA, pursuant to which we were authorized to supply HoloMag toVISA-approved card manufacturers (the “VISA HoloMag Agreement”). On March 14,2006, we were informed by VISA that, as a result of a small number of incidentsin which certain card terminals had been affected by electro-static discharge (“ESD”)from static electricity carried on cards incorporating HoloMag, VISA isinforming its member financial institutions and authorized card manufacturersthat (i) VISA will no longer approve VISA card designs which incorporatethe current version of HoloMag, (ii) VISA strongly recommends that their membersattempt to avoid further issuance of cards incorporating the current version ofHoloMag and (iii) VISA recommends that their members follow an alternatecard design incorporating a conventional magnetic stripe and Dove hot stamphologram and VISA provided notice to us that it was revoking our right toproduce HoloMag under the VISA HoloMag Agreement (the “VISA Decision”).  In its correspondence to us relating toHoloMag, VISA also stated its view that “a remediation program for impactedstakeholders may be necessary” and that VISA would seek indemnification from usfor such costs and/or claims. VISA has recommended to its members that cardsbearing the HoloMag product already in the market be replaced as soon aspractical.  Following the VISA Decisionwe ceased sales of VISA HoloMag to card manufacturers. By letter dated November7, 2006, we were advised by VISA that effective immediately VISA wasterminating the VISA HoloMag Agreement. We believe that we have been in compliance with the VISA HoloMagAgreement and that the HoloMag product complies with all standards andspecifications contained in such agreement, and that VISA was not entitled toterminate such agreement as provided in its letter. We are continuing toevaluate VISA’s actions and claims. Accounts receivable from manufacturers ofVISA transaction cards approximated $2.4 million and $3.4 million at September30, 2006 and December 31, 2005, respectively.

We have invented atechnology and methods of significantly reducing ESD and we have filed patentapplications on these inventions. We have incorporated our invention into ourHoloMag product and our testing shows that our second generation HoloMagproduct generally exhibits no more ESD than a standard black magnetic stripe.We are currently offering to customers a second generation version of HoloMagand anticipate shipping the product in limited quantities in early 2007,although no assurance can be given that such second generation version ofHoloMag will be accepted by our customers.

We purchase certain keymaterials used in the manufacture of our products, and subcontract certainproduction functions or products from third parties some of which are solesuppliers.   In some cases, we do nothave supply contracts with our suppliers, and operate on a purchase orderbasis. In the case of HoloMag, we have a single supplier, CFC International,Inc., with whom we have a supply contract which was amended on July 26, 2006. Alsoat that time we negotiated a settlement with CFC International, Inc. thatresulted in a reduction of our payable to them of approximately $1.0 million.We may not be able to find alternative sources in a timely manner if oursuppliers or subcontractors become unwilling or unable to supply us, or if theyincrease their prices. Our inability to obtain key product components or tohave certain processes performed on our behalf could cause delays or reduceproduct shipments, which could cause our relationship with customers to sufferand materially and adversely affect our financial condition, results ofoperations and cash flows.

STOCK-BASEDCOMPENSATION PLANS

In December 2004, theFinancial Accounting Standards Board issued Statement No. 123(R) (FAS 123R),Share-Based Payment, revising FAS 123 and requiring that all share-basedpayments to employees be recognized in the financial statements. We adopted thenew statement effective January 1, 2006, using the modified-prospectivetransition method described in the statement. Under this method, we arerequired to recognize compensation expense for all awards granted after theadoption based on the grant date fair value estimated in accordance with FAS123R and for the unvested portion of previously granted options that remainoutstanding as of the adoption date based on the grant date fair value inaccordance with the original provisions of FAS 123. In the three and ninemonths ended September 30, 2006, operating income was reduced by $275,000 and$793,000, respectively, for stock-based payment compensation expense for bothstock options and restricted stock. Stock-based compensation in the thirdquarter affected cost of goods sold by $69,000, selling, general andadministrative expenses by $171,000 and research and development expenses by$35,000. Stock-based compensation for the nine months ended September 30, 2006affected cost of goods sold by $192,000, selling, general and administrativeexpenses by $502,000 and research and development expenses by $99,000.Stock-based compensation expense reduced our quarterly and nine month netincome by $195,000 and $496,000, respectively, and our basic and fully dilutedearnings per share by

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$0.01and $0.03,respectively, for the three and nine month periods ended September 30, 2006.Prior periods have not been adjusted. Unearned compensation on restrictedshares has been reclassified to additional paid in capital beginning January 1,2006.

Prior to adoptingFAS 123R, we applied the intrinsic value-based method of accounting prescribedin APB Opinion No. 25 and, accordingly, did not recognize compensation expensefor stock option grants made at an exercise price equal to or in excess of thefair market value of the stock at the date of grant.

Thefollowing table details the effect on the Company’s net income and basic anddiluted net income per share had compensation expense for stock-based awardsbeen recorded in the three and nine months ended September 30, 2005 based onthe fair-value method under SFAS 123.
| (In thousands, except per share amounts)                                                        | ** ** | **Three Months Ended  September 30, 2005** | ** ** | **Nine Months Ended  September 30, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Net income, as reported                                                                                                  |       | $                                                              | 1,116      |                                                          | $          | 2,176 |   |
| Add: Stock-based employee compensation, as reported                                                                      |       | —                                                         |       | —                                                        |       |
| Deduct:Stock-based  employee compensation expense determined under fair value based method for  all awards, net of taxes |       | 62                                                             |       | 165                                                           |       |
| Pro forma net income                                                                                                     |       | $                                                              | 1,054      |                                                          | $          | 2,011 |   |
|                                                                                                                     |       |                                                           |       |                                                          |       |
| Basic net income per share, as reported                                                                                  |       | $                                                              | 0.06       |                                                          | $          | 0.12 |   |
| Basic net income per share, proforma                                                                                     |       | $                                                              | 0.06       |                                                          | $          | 0.11 |   |
| Diluted net income per share, as reported                                                                                |       | $                                                              | 0.06       |                                                          | $          | 0.11 |   |
| Diluted net  income per share, proforma                                                                                  |       | $                                                              | 0.05       |                                                          | $          | 0.10 |   |

 

We usethe Black-Scholes option pricing model to calculate the fair value of options.The key assumptions for this valuation method include the expected term of theoption, stock price volatility, risk-free interest rate, dividend yield, exerciseprice, and forfeiture rate. Many of these assumptions are judgmental and highlysensitive in the determination of compensation expense. Under the assumptions,indicated below, the weighted average fair value of the stock option grants inthe nine months ended September 30, 2006 and 2005 were $4.46 and $2.85,respectively. The table below indicates the key assumptions used in thevaluation calculations for options granted in the nine months ended September30, 2006 and 2005 and a discussion of our methodology for developing each ofthe assumptions used in the valuation model:
|                          | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------|------------|-----------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| Term                     |       | 4.9  years                                          |       | 7.5  years |   |
| Volatility               |       | 105.0%                                              |       | 63.0% |   |
| Dividend yield           |       | 0.0%                                                |       | 0.0% |   |
| Risk-free  interest rate |       | 4.72%  – 5.19%                                 |       | 4.07%  – 4.60% |   |
| Forfeiture rate          |       | 5.8%                                                |       | — |   |

 

Term –This is the period of time over which the options granted are expected toremain outstanding. Options granted have a maximum term of ten (10) years. Anincrease in the expected term will increase compensation expense.

Volatility– This is the measure of the amount by which a stock price has fluctuated or isexpected to fluctuate. Volatilities are based on historical volatility of ABNH’sshares, and other factors such as expected volatility arising from plannedchanges in our business operations. An increase in the expected volatility willincrease compensation expense.

Risk-freeinterest rate – This is the U.S. Treasury rate for the week of the grant havinga term equal to the expected term of the options granted. An increase in therisk-free interest rate will increase compensation expense.

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Dividendyield – We did not make any dividend payments during the last five years and wehave no plans to make any dividend payments in the foreseeable future. Anincrease in the dividend yield will decrease compensation expense.

ForfeitureRate – This is the estimated percentage of options granted that are expected tobe forfeited or canceled before becoming vested. An increase in the forfeiturerate will decrease compensation expense. The forfeiture rate was first estimated as of January 1, 2006 inconjunction with our adoption of FAS 123 (R).

Thefollowing table summarizes information about our stock incentive plans for thenine months ended September 30, 2006.
| ** **                               | ** ** | **Number of  Options** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** **  | **Aggregate  Intrinsic Value** | ** ** |
|------------------------------------------|------------|-----------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|-------------|-------------------------------------|------------|
| ** **                               | ** ** | ** **                  | ** ** | ** **                                 | ** ** | ** **                                          | ** **  | **(in 000’s)**            | ** ** |
| Balance,  December 31, 2005              |       | 2,971,938                   |       | $                                          | 2.41       |                                                |        |                                |       |   |
| Options granted                          |       | 251,000                     |       | $                                          | 5.69       |                                                |        |                                |       |   |
| Options  exercised                       |       | (94,234                     | )          | $                                          | 1.60       |                                                |        |                                |       |   |
| Options  forfeited                       |       | (76,565                     | )          | $                                          | 5.18       |                                                |        |                                |       |   |
| Options  outstanding, September 30, 2006 |       | 3,052,139                   |       | $                                          | 2.63       |                                                | 5.09  years |                                | $          | 3,202 |   |
| Options exercisable,  September 30, 2006 |       | 2,497,862                   |       | $                                          | 2.29       |                                                | 4.30 years  |                                | $          | 2,988 |   |

 

As of September30, 2006 there was $1,565,000 of total unrecognized compensation cost, net ofestimated forfeitures, related to stock options. These costs are expected to berecognized over a weighted average period of 1.02 years.

The totalintrinsic value of stock options exercised during the nine months endedSeptember 30, 2006 was $235,000.

Cash received fromstock option exercises in the nine months ended September 30, 2006 was$150,000. The income tax benefit from stock based arrangements totaled $86,000all of which was attributable to stock option exercises, of which $64,000 wascredited to additional paid in capital.

The followingtable summarizes information about restricted stock awards for the nine monthsended September 30, 2006:
|                                           | ** ** | **Shares** | ** ** | **Weighted Average  Grant-Date  Fair Value** | ** ** | **Fair Value of  Shares Vested** | ** ** |
|-------------------------------------------|------------|------------|------------|--------------------------------------------------------|------------|-------------------------------------------------|------------|
| Non-vested  balance at December 31, 2005  |       | 15,000     |       | $                                                      | 5.65       |                                            |       |   |
| Granted                                   |       | 140,000    |       | $                                                      | 5.98       |                                            |       |   |
| Vested                                    |       | (5,000     | )          | $                                                      | 6.00       |                                            | $          | 2.72 |   |
| Forfeited                                 |       | (12,000    | )          | $                                                      | 6.00       |                                            |       |   |
| Non-vested balance at  September 30, 2006 |       | 138,000    |       | $                                                      | 5.94       |                                            |       |   |
|                                           |            |            |            |                                                        |            |                                                 |            |  |  |

 

Restrictedstock awards were made under the 2005 Stock Incentive Plan and generally vest100% three years from the grant date.

As ofSeptember 30, 2006 there was $655,000 of unrecognized compensation costs, netof estimated forfeitures, related to restricted stock awards. These costs areexpected to be recognized over a weighted average period of 2.3 years.

As ofSeptember 30, 2006 an aggregate of 1,306,878 shares remained available forfuture grants and awards under our stock incentive plans, which cover stockoptions and restricted stock awards. We issue shares to satisfy stock optionexercises and restricted stock awards.

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COMPREHENSIVEINCOME

Comprehensiveincome is equal to net income in all periods.

WARRANTY COSTS

The Company provides forwarranty costs in amounts it estimates will be needed to cover future warrantyobligations for products sold.  Estimatesof warranty costs are based on historical experience and are periodicallyreviewed and adjusted, when necessary. The Company’s product warranty provision is included in accrued expensesin the accompanying balance sheets. Changes in the Company’s warranty provisionare as follows:
|                                 | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                      | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                      | ** ** | **(In thousands)**                              | ** ** | **(In thousands)**                             | ** ** |
| Balance at  beginning of period |       | $                                                    | 785        |                                                | $          | 548 |   | $ | 1,140 |   | $ | 510 |   |
| Warranty  provisions            |       | 60                                                   |       | 110                                                 |       | 180 |   | 230 |   |
| Settlement of  warranty         |       | (92                                                  | )          | (20                                                 | )          | (567 | ) | (102 | ) |
| Balance at September 30         |       | $                                                    | 753        |                                                | $          | 638 |   | $ | 753 |   | $ | 638 |   |

 

RECLASSIFICATIONS –Certain prior year amounts have been reclassified to conform with the currentyear’s presentation.

IMPACT OF RECENTLYISSUED ACCOUNTING STANDARDS – In September 2006, the Financial AccountingStandards Board issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”).SFAS 157 defines fair value, establishes a framework for measuring fairvalue under Generally Accepted Accounting Principles, and expands disclosuresabout fair value measurements. SFAS No. 155 is effective for fiscal yearsbeginning after December 15, 2007. The Company is currently in the processof evaluating the impact that the adoption of SFAS No. 157 will have on itsfinancial position, results of operations and cash flows.

In September 2006,the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effectsof Prior Year Misstatements when Quantifying Misstatements in Current YearFinancial Statements” (“SAB 108”), to address diversity in practice inquantifying financial statement misstatements. SAB 108 requires that theCompany quantifies misstatements based on their impact on each of its financialstatements and related disclosures. The Company will adopt the provisions ofSAB 108 during the fourth quarter of 2006. The Company is currently in theprocess of evaluating the impact that the adoption of SAB 108 will have on itsfinancial position, results of operations and cash flows.

In July 2006, theFinancial Accounting Standards Board issued Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes – an interpretation of SFAS no. 109” (“FIN 48”).FIN 48 clarifies the accounting for uncertainty in income tax positions thatthe Company has taken or expects to take with respect to a tax return. Thepronouncement prescribes a more-likely-than-not threshold for recognition aswell as measurement criteria for changes in such tax positions for financialstatement purposes. In addition, FIN 48 also requires additional qualitativeand quantitative disclosures on unrecognized tax benefits to be included in thenotes to the financial statements.  TheCompany will be required to adopt the provisions of FIN 48 beginning in fiscalyear 2007. The Company is currently assessing the impact of the adoption of FIN48 on its Consolidated Financial Statements.

In November 2004,the Financial Accounting Standards Board issued Statement No. 151 (FAS 151),Inventory costs, an amendment of ARB No. 43, Chapter 4. FAS 151 clarifies thatabnormal amounts of idle facility expense, freight, handling costs and wastedmaterials should be recognized as current period charges. In addition, FAS 151requires that allocation of fixed production overhead to inventory be based onthe normal capacity of the production facilities. FAS 151 is effective forinventory costs incurred during fiscal years beginning after June 15, 2005. We

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adopted FAS 151effective January 1, 2006. The adoption of FAS 151 did not have a material impacton our financial statements.

InMarch 2005, the Financial Accounting Standards Board (“FASB”) issuedinterpretation No. 47, *Accounting for ConditionalAsset Retirement Obligations*, an interpretation of SFAS No. 143.This interpretation clarifies that the term of *conditionalasset retirement obligation* refers to a legal obligation to performan asset retirement activity in which the timing and/or method of settlementare conditional on a future event that may or may not be within the control ofthe entity. The obligation to perform the asset retirement activity isunconditional even though uncertainty exists about the timing and/or method ofsettlement. Accordingly, an entity is required to recognize a liability for thefair value of a conditional asset retirement obligation if the fair value ofthe liability can be reasonably estimated. The provisions of Interpretation 47are effective for fiscal years ending after December 15, 2005. We adoptedInterpretation 47 effective January 1, 2006. The adoption of this statement hadno impact on our financial statement presentation since there have been noconditional asset retirement obligations.

NOTE B –INVENTORIES, NET

Inventoriesconsist of the following:

|                                               | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                    | ** ** | **(Unaudited)**              | ** ** | **(Note A)**           | ** ** |
| ** **                                    | ** ** | **(In thousands)**      | ** ** |
|                                          |       |                         |       |                        |       |
| Finished goods                                |       | $                            | 2,042      |                        | $          | 5,802 |   |
| Finished goods  on consignment with customers |       | 235                          |       | 158                         |       |
| Work in process                               |       | 540                          |       | 644                         |       |
| Raw materials                                 |       | 567                          |       | 616                         |       |
| Subtotal                                      |       | 3,384                        |       | 7,220                       |       |
| Less: Inventory  reserves                     |       | 1,224                        |       | 4,280                       |       |
| Net inventory                                 |       | $                            | 2,160      |                        | $          | 2,940 |   |

 

NOTE C – OTHER LONG-TERM LIABILITIES

Other long-termliabilities at both September 30, 2006 and December 31, 2005 include a $718,000reserve for potential tax liabilities. Also included in other long-termliabilities at September 30, 2006 and December 31, 2005 are $262,000 and$876,000, respectively, of long-term rent on our abandoned facility inElmsford, New York and $384,000 and $363,000, respectively, of deferred rent onour Robbinsville, New Jersey facility. The balance of $19,000 in otherlong-term liabilities at September 30, 2006 is comprised of long-term deferredtax liabilities.

NOTE D - FACILITYCONSOLIDATION

On December 14, 2004, weentered into agreements to lease a 134,000 square foot modern manufacturing andoffice building in Robbinsville, New Jersey, which is the site of our primaryoperations following the closure, relocation and consolidation of our prioroperations in Elmsford, New York and Huntingdon Valley, Pennsylvania into theRobbinsville facility. We completed the relocation and consolidation of ouroperations during 2005.We have re-opened the Huntingdon Valley facility forcertain manufacturing operations and secure storage that was previouslyperformed at a contract facility in Dalton, Massachusetts which will no longerbe leased after the expiration of the lease on the facility in October 2006.

The base rent onthe lease for the Robbinsville, New Jersey facility is $555,000 per year,increasing by 1.9% per year, and the first seven months of the lease wererent-free. We recorded deferred rent of $363,000 in 2005. The term of the leasefor the Robbinsville facility extends through May 31, 2017, and at theexpiration of the term, we have options to renew the lease for three consecutivefive year periods at the then fair market value and also have an option topurchase the building after the end of the original lease term for the adjustedfair market value as defined in the lease agreement. The base rent on the leasein Huntingdon Valley, Pennsylvania is $144,000 per year. The lease on thisfacility expires on June 30, 2007.  Thebase rent on the lease in Elmsford, New York is $746,000 per year. The lease onthis facility expires on December 31, 2007. As this facility was abandoned as partof our move

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and consolidationin 2005 the remaining rent, net of estimated sublease income, through the endof the lease term was charged to Facility Consolidation Expense in 2005.

The following table illustrates the liability balanceand activity related to the relocation and consolidation in the three and ninemonths ended September 30, 2006 and 2005.
|                                      | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                           | ** ** | **(In thousands)**                              | ** ** | **(In thousands)**                             | ** ** |
| Balance at  beginning of period      |       | $                                                    | 1,293      |                                                | $          | 101 |   | $ | 1,683 |   | $ | 15 |   |
|                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Rent payments on  abandoned facility |       | (214                                                 | )          | —                                              |       | (665 | ) | — |   |
| Adjustment for  rent reduction       |       | (131                                                 | )          | —                                              |       | (131 | ) | — |   |
| Severance  payments                  |       | (6                                                   | )          | (58                                                 | )          | (23 | ) | (98 | ) |
| Additions to  liability:             |       |                                                 |       |                                                |       |   |   |   |   |
| Accretion on rent                    |       | 28                                                   |       | —                                              |       | 98 |   | — |   |
| Accrued severance                    |       | —                                               |       | 4                                                   |       | 8 |   | 130 |   |
| Balance at  September 30             |       | $                                                    | 970        |                                                | $          | 47 |   | $ | 970 |   | $ | 47 |   |
|                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Expensed as  incurred:               |       |                                                 |       |                                                |       |   |   |   |   |
| Employee relocation                  |       | $                                                    | 2          |                                                | $          | 50 |   | $ | 46 |   | $ | 98 |   |
| Facility moving costs                |       | —                                               |       | 218                                                 |       | — |   | 366 |   |
| Adjustment for rent reduction        |       | (131                                                 | )          | —                                              |       | (131 | ) | — |   |
| Other costs                          |       | 28                                                   |       | 10                                                  |       | 98 |   | 6 |   |
| Facility consolidation  expense      |       | $                                                    | (101       | )                                                   | $          | 278 |   | $ | 13 |   | $ | 600 |   |

 

NOTE E- COMMITMENTS AND CONTINGENCIES

TheCompany from time to time is involved in litigation (as both plaintiff anddefendant) incidental to the conduct of its business; however, the Company isnot a party to any lawsuit or proceeding which, in the opinion of management ofthe Company, could have a material impact on the Company’s financial position,results of operations or cash flows.

SeeNote A - Business Information for a description of issues relating to the VISADecision.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS

Thefollowing discussion and analysis should be read in conjunction with theCompany’s unaudited financial statements, including the notes thereto,appearing elsewhere in this report.

OVERVIEW

AmericanBank Note Holographics, Inc. (the “Company”) originates, produces, markets andsells secure holograms and products incorporating secure holograms. The Company’sproducts are used primarily in security applications including authenticationof transaction cards, identity documents, value documents and various consumerproducts.  The Company operates in onereportable industry segment. Our ability to create distinctive, secureoptically variable devices, to reproduce them with high quality and todistribute them securely has enabled us to become a market leader in securityholography. Our products are sold to over 200 companies worldwide, includingMasterCard, VISA, American Express, Discover, Diners Club, Sears, Nordstrom,Quaker State, Nike, Janssen-Cilag and Gennoma, as well as agencies of theUnited States government and certain foreign governments. We also producenon-secure holograms for design and promotional applications.

A significant portion ofthe Company’s business is derived from orders placed by certain transactioncard

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companies, includingMasterCard and manufacturers of VISA brand transaction cards, and variations inthe timing of such orders can cause significant fluctuations in the Company’ssales.  Several thousand banks worldwideissue VISA and MasterCard branded cards that incorporate the Company’sholograms.

Sales to MasterCard wereapproximately 41% and 30% of sales for the three months ended September 30,2006 and 2005, respectively and were approximately 36% and 33% of sales for thenine months ended September 30, 2006 and 2005, respectively. The Company has anagreement with MasterCard, as amended, pursuant to which the Company is theexclusive supplier of MasterCard holograms and holographic magnetic stripes,HoloMag.  In the quarter ended September30, 2005, MasterCard advised its member financial institutions around the worldthat it will allow them to choose among card designs that incorporate eitherthe traditional hot stamp hologram or HoloMag, both of which are supplied bythe Company.  Sales to MasterCard ofHoloMag have not been material in the three and nine month periods endedSeptember 30, 2006 and are not expected to be material for the year. Theagreement with MasterCard was amended on August 24, 2005, and expires onFebruary 28, 2013, subject to automatic renewal thereafter. If we were to losea substantial portion of our business with MasterCard without replacing it withnew product sales, our business, operating results and financial conditionwould be materially and adversely affected. In addition, if we fail to obtainanticipated orders from MasterCard or if we experience delays or cancellationsof orders from MasterCard, our business, operating results and financialperformance will be materially and adversely affected.

Sales of VISA holograms(which included HoloMag starting in the three month period ended September 30,2005) to manufacturers of VISA transaction cards were approximately 28% and 42%of sales for the three months ended September 30, 2006 and 2005, respectivelyand were approximately 34% and 31% of sales for the nine months ended September30, 2006 and 2005, respectively. Currently we are a supplier of the VISA Dovehot stamp holograms to manufacturers of VISA brand transaction cards, althoughthere can be no assurance that VISA will not discontinue or replace the Dovehot stamp hologram in the future.****There can beno assurance that we will continue to be an authorized supplier of VISA securityproducts, or that VISA authorized card maufacturers will continue to purchasethe Dove hot stamp hologram, or any other security product, from us in thefuture.  To the extent sales of VISA Dovehot stamp holograms decline significantly from historical levels, our business,operating results and financial condition will be materially and adverselyaffected. On March 15, 2005, VISA announced its intention to phase out the Dovehot stamp hologram that we supply for the front of the VISA card, and toreplace it with an integrated holographic magnetic stripe. On April 8, 2005, weentered into an Agreement with VISA, pursuant to which we were authorized tosupply HoloMag to VISA-approved card manufacturers (the “VISA HoloMagAgreement”). On March 14, 2006, we were informed by VISA that, as a result of asmall number of incidents in which certain card terminals had been affected byelectro-static discharge (“ESD”) from static electricity carried on cardsincorporating HoloMag, VISA is informing its member financial institutions andauthorized card manufacturers that (i) VISA will no longer approve VISAcard designs which incorporate the current version of HoloMag, (ii) VISAstrongly recommends that their members attempt to avoid further issuance ofcards incorporating the current version of HoloMag and (iii) VISArecommends that their members follow an alternate card design incorporating aconventional magnetic stripe and Dove hot stamp hologram and VISA providednotice to us that it was revoking our right to produce HoloMag under the VISAHoloMag Agreement (the “VISA Decision”). In its correspondence to us relating to HoloMag, VISA also stated itsview that “a remediation program for impacted stakeholders may be necessary”and that VISA would seek indemnification from us for such costs and/or claims.VISA has recommended to its members that cards bearing the HoloMag productalready in the market be replaced as soon as practical. Following the VISA Decisionwe ceased sales of VISA HoloMag to card manufacturers. By letter dated November7, 2006, we were advised by VISA that effective immediately VISA was terminatingthe VISA HoloMag Agreement. We believe that we have been in compliance with theVISA HoloMag Agreement and that the HoloMag product complies with all standardsand specifications contained in such agreement, and that VISA was not entitledto terminate such agreement as provided in its letter. We are continuing toevaluate VISA’s actions and claims.

We have invented atechnology and methods of significantly reducing ESD and we have filed patentapplications on these inventions. We have incorporated our invention into ourHoloMag product and our testing shows that our second generation HoloMagproduct generally exhibits no more ESD than a standard black magnetic stripe.We are currently offering to customers a second generation version of HoloMagand anticipate shipping the product in limited quantities in early 2007,although  no assurance can be given thatsuch second generation version of HoloMag will be accepted by our customers.

Ourproducts are sold on a fixed price basis under purchase orders and contractswith customers. 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

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whenthe buyer of the product informs the Company that the product has been used.Additionally, pursuant to the request of and agreement with a certain customer,completed items are stored on behalf of this customer at the Company’s on-sitesecured facility, and in that instance, sales are recognized when all of thefollowing have occurred: the customer has ordered the goods pursuant to a fixedprice purchase order, the manufacturing process is complete, the goods havebeen transferred to the on-site secured facility and are ready for shipment,the risk of ownership has passed to the customer, the customer has been billedfor the order and collection of the invoice is considered reasonably assured.  In certain cases the Company has agreed tomaintain an inventory of products for a customer to ensure quick turn around ofdeliveries.  The Company only acceptsreturns of product sold to customers when the product is determined to not bein conformance with the specifications previously agreed upon with suchcustomers in accordance with the terms of its warranty policy and generallyreplaces the product. The Company generally provides replacement product for upto 180 days from original shipment as a warranty for defective product. Shippingand handling amounts billed to customers are included in sales and amounted to$182,000 and $283,000 for the three months ended September 30, 2006 and 2005,respectively.  Shipping and handlingamounts billed to customers in the nine months ended September 30, 2006 and2005 amounted to $739,000 and $546,000 respectively. Shipping and handlingcosts are included in selling and administrative expenses.

We purchase certain keymaterials used in the manufacture of our products, and subcontract certain productionfunctions or products from third parties some of which are sole suppliers.   In some cases, we do not have supplycontracts with our suppliers, and operate on a purchase order basis. In thecase of HoloMag, we have a single supplier, CFC International, Inc., with whomwe have a supply contract which was amended on July 26, 2006. Also at that timewe negotiated a settlement with CFC International, Inc. that resulted in areduction of our payable to them of approximately $1.0 million. We may not be ableto find alternative sources in a timely manner if our suppliers orsubcontractors become unwilling or unable to supply us, or if they increasetheir prices. Our inability to obtain key product components or to have certainprocesses performed on our behalf could cause delays or reduce productshipments, which could cause our relationship with customers to suffer andmaterially and adversely affect our financial condition, results of operationsand cash flows.

Sales may fluctuate fromquarter to quarter due to changes in customers’ ordering patterns. Customers donot typically provide us with precise forecasts of future order quantities.Quarterly demand for our products may be materially influenced by customers’promotions, inventory replenishment, card expiration patterns, deliveryschedules and other factors, such as the VISA Decision, which may be difficultfor us to anticipate.

Costof goods sold includes raw materials such as nickel, foils, films andadhesives; labor costs; manufacturing overhead; and hologram origination costs(which represent costs of a unique master hologram that is made to customerspecifications and is an integral part of the production process). Cost ofgoods sold also includes the cost of certain processes that the Company outsourcesto third parties. As a result, costs of goods sold are affected by product mix,manufacturing yields, supplier prices and changes in the cost of raw materialsand labor.

Sellingand administrative expenses primarily consist of salaries, benefits and commissionsfor the Company’s corporate, sales, customer service, marketing andadministrative personnel, marketing and promotion expenses, legal andaccounting expenses and expenses associated with being a public company. TheCompany also includes the cost of shipping and handling product deliveries thatare billed to customers in selling and administrative expenses. The cost ofshipping and handling is included in selling and administrative expenses andamounted to $246,000 and $314,000 for the three months ended September 30, 2006and 2005, respectively, and $860,000 and $627,000 for the nine months endedSeptember 30, 2006 and 2005, respectively.

Stock-based compensationexpense

Beginning in the firstquarter of 2006, we were required to record the expense of share-based paymenttransactions pursuant to Statement of Financial Accounting Standards No. 123(R) (“FAS 123R”). Under the modified prospective method, we were not requiredto restate the prior year financial statements or include in the current yearany expenses related to stock option grants vested as of December 31, 2005.

We use theBlack-Scholes option pricing model to calculate the fair value of options. Thekey assumptions for this valuation method include the expected term of theoption, stock price volatility, risk-free interest rate, dividend yield,exercise price, and forfeiture rate. Many of these assumptions are judgmentaland highly sensitive in the determination of compensation expense. In the firstquarter of 2006 we modified our assumption of the expected

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term from that used underFAS 123 to reflect an estimated reduction in the amount of time that optionsgranted will remain outstanding as a result of our historical trends. Weincreased our expected volatility based on recent events which resulted insignificantly higher volatility than in previous periods. Under FAS 123R we arerequired to estimate forfeitures rather than recording forfeitures when theyoccur as previously permitted. Our estimated forfeiture rate was determined by reviewinghistorical trends. We will continue to review our Black-Scholes assumptions andmodify them as needed in the future. Changes in these assumptions may lead tovariations in the compensation expense that we record in future periods.

In the three and nine monthsended September 30, 2006, operating income was reduced by $275,000 and$793,000, respectively, for stock-based payment compensation expense for bothstock options and restricted stock. Stock-based compensation in the thirdquarter affected cost of goods sold by $69,000, selling, general andadministrative expenses by $171,000 and research and development expenses by$35,000. Stock-based compensation for the nine months ended September 30, 2006affected cost of goods sold by $192,000, selling, general and administrativeexpenses by $502,000 and research and development expenses by $99,000.Stock-based compensation expense reduced our quarterly and nine month netincome by $195,000 and $496,000, respectively, and our basic and fully dilutedearnings per share by $0.01and $0.03, respectively, for the three and ninemonth periods ended September 30, 2006. Prior periods have not been adjusted.Unearned compensation on restricted shares has been reclassified to additionalpaid in capital beginning January 1, 2006.

Impact of the VISADecision

In the quarter endedDecember 31, 2005, as a result of the VISA Decision, we recorded a pre-taxcharge amounting to approximately $5.0 million of which $4.8 million wasrecorded in cost of goods sold and was principally related to the carryingvalue of our HoloMag inventory. Also included in the charge were increases inour provisions for accounts receivable and potential non-ESD related warrantyclaims. During the three months ended September 30, 2006 we evaluated theseprovisions and determined that the amounts previously recorded for potentialnon-ESD related warranty claims and the allowance for doubtful accounts werestill appropriate. We will continue to review our estimates on an ongoing basisas a part of our closing process and make appropriate changes to our reservelevels based upon the facts at the time. Certain shipments of HoloMag that werecompleted and invoiced during the quarter ended March 31, 2006 were notrecognized as revenue as the collection of these amounts was not consideredprobable as a result of the VISA Decision. Subsequent to completing and filingour financial statements for the three months ended March 31, 2006approximately $0.9 million and $0.2 million was collected and accordingly the revenuewas recorded in the quarter ended June 30, 2006 and September 30, 2006,respectively. Approximately $1.2 million remains uncollected at September 30,2006. Revenue will be recognized in the future in the event that additionalamounts are collected. Additionally as a result of the VISA Decision, in thenine months ended September 30, 2006 we wrote-off approximately $0.8 million ofoverhead costs that were not absorbed into inventory and approxiamtely $0.3million of costs that were on the balance sheet relating to a terminatedmanufacturing project.

COMPARISONOF THREE MONTHS ENDED SEPTEMBER 30, 2006 TO THREE MONTHS ENDED SEPTEMBER 30,2005

*Sales.*  Sales decreased by $2.4 million, or 26.8%,from $9.0 million for the three months ended September 30, 2005 to $6.6 millionfor the three months ended September 30, 2006. The decrease was primarily due to lower sales to the transaction card market,in particular lower sales of our HoloMagTM integrated holographic magneticsecurity stripe product to manufacturers of Visa transaction cards as a resultof the VISA Decision as described above. Partially offsetting this decline was anincrease in sales to the identity document market. As a result of the VISADecision we currently expect that sales in the quarter ending December 31, 2006will be substantially less than sales in the comparable prior year period.

*Cost ofGoods Sold, excluding depreciation and amortization.*  Cost of goods sold decreased by $0.9 million,from $4.2 million for the three months ended September 30, 2005 to $3.3 millionfor the three months ended September 30, 2006 primarily as a result of thevolume decrease and cost reductions associated with the consolidation of ourfacilities in Robbinsville, New Jersey, partially offset by approximately $0.5million of overhead costs that were not absorbed into inventory. Also includedin the three months ended September 30, 2006 was approximately $0.1 million ofstock-based compensation expense. As a percentage of sales, cost of goods soldincreased from 47.2% for the three months ended September 30, 2005 to 50.3% forthe three months ended September 30, 2006.

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*Sellingand Administrative.* Selling and administrative expenses decreased $0.3 million from $2.2million for the three months ended September 30, 2005 to $1.9 million for thethree months ended September 30, 2006. As a percentage of sales, selling andadministrative expenses increased from 25.0% for the three months endedSeptember 30, 2005 to 29.7% for the same period in 2006.  The decrease in expenses was primarily due toreduced salaries and related costs and a reduction in bad debt expenseresulting from a reduction in the allowance for doubtful accounts partiallyoffset by higher costs for outside services and increased costs associated withbeing a public company. Also included in the three months ended September 30,2006 was approximately $0.2 million of stock-based compensation expense. Theincrease in costs as a percentage of sales was primarily due to the volumedecrease partially offset by lower selling, general and administrative costs.

*Researchand Development. *Researchand development expenses increased $0.1 million from $0.3 million for the threemonths ended September 30, 2005 to $0.4 million for the same period in 2006primarily as a result of higher research and development costs associated withthe invention to reduce ESD and development of the second generation HoloMagproduct as well as higher product testing costs for new product applications.Also included in the three months ended September 30, 2006 was approximately $35,000of stock-based compensation expense.

*Depreciationand Amortization.* Depreciation and amortization amounted to $0.1 million for the threemonths ended September 30, 2005, and 2006. Higher depreciation expenses resulting from additions to fixed assetsduring the fourth quarter of 2005 and first three quarters of  2006 at the Robbinsville, New Jersey facilitywere offset by the reversal of a portion of the anticipated costs previouslyrecorded for renovation of the vacated facility in Elmsford, New York as aresult of a settlement with the buildings owner.

*FacilityConsolidation Expenses.*Facility consolidation expenses, inthe three months ended September 30, 2006 and September 30, 2005 amounted to($0.1) million and $0.3 million, respectively. The credit for the three monthsended September 30, 2006 resulted from expenses related to employee relocationsand additional expenses incurred on the abandoned facility rent which were morethan offset by the impact of a settlement with the owner of the abandonedfacility in Elmsford, New York that reduced the remaining rent owed under ourlease by 10%. Costs recorded in the prior year period were primarily foremployee severance, employee relocation and moving of equipment to the Company’snew facility in Robbinsville, New Jersey.

*InterestIncome*.  Interestincome increased $82,000 from $61,000 for the three months ended September 30,2005 to $143,000 for the three months ended September 30, 2006 due to higheraverage balances of cash and cash equivalents and higher interest rates ineffect during the current period.

*IncomeTaxes.* The provision for income taxes decreased $0.4 millionfrom $0.7 million in the three months ended September 30, 2005 to $0.3 millionin the three months ended September 30, 2006. As a percentage of Income beforetaxes, the provision for income taxes decreased from 40.0% in the three monthsended September 30, 2005 to 29.1% in the three months ended September 30, 2006.The decrease in the provision was due to the effect of lower income beforeincome taxes as well as adjustments recorded in the three months endedSeptember 30, 2006 for estimated deductions and credits for the full year 2006and adjustments to the provision for the actual deductions and tax credits thatwe recorded when filing our 2005 income tax returns which differed from thosein the income tax provision at September 30, 2005. The 10.9 percentage pointchange in the provision as a percentage of income before income taxes resultedfrom these adjustments.

COMPARISON OF NINEMONTHS ENDED SEPTEMBER 30, 2006 TO NINE MONTHS ENDED SEPTEMBER 30, 2005

*Sales*.  Sales increased by $2.7 million, or 12.1%,from $22.2 million for the nine months ended September 30, 2005 to $24.9million for the nine months ended September 30, 2006.  The increase was primarily due to highersales of our HoloMagTM integrated holographic magnetic security stripe productto customers in the transaction card market including sales to VISA card manufacturers which amounted to $4.2million in the nine months ended September 30, 2006, an increase of $1.9million over the comparable prior year period. We had recognized $3.1 millionof VISA HoloMag revenues in the quarter ended March 31, 2006 prior to the VISADecision and also recognized $0.9 million and $0.2 million of revenue in theperiods ended June 30, 2006 and September 30, 2006, respectively relating toamounts collected in those periods on VISA HoloMag shipments made in thequarter ended March 31, 2006 that was not recognized as revenue at that timedue to the VISA Decision as described above. In the nine

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monthsended September 30, 2006 we also experienced growth of several products for thetransaction card market as well as in the product authentication market whichwas partially offset by a decline in sales to the identity document marketgenerally as a result of the timing of changes in customer programs.

*Cost ofGoods Sold, excluding depreciation and amortization*. Cost ofgoods sold increased by $1.7 million, from $10.2 million for the nine monthsended September 30, 2005 to $11.9 million for the nine months ended September30, 2006 primarily as a result of the volume increase, additional inventorycharges as a result of the VISA Decision, additional overhead costs that werenot absorbed into inventory partially offset by lower fixed costs resultingfrom the consolidation of facilities in Robbinsville, the reduction of costsrelating to a negotiated settlement with a vendor and the elimination ofduplicate facility costs incurred in 2005. Also included in the nine-monthsended September 30, 2006 was approximately $0.2 million of stock-basedcompensation expense. As a percentage of sales, cost of goods sold increasedfrom 45.9% for the nine months ended September 30, 2005 to 47.7% for the ninemonths ended September 30, 2006.

*Sellingand Administrative*. Selling and administrative expenses increased $0.7 million from $6.4million for the nine months ended September 30, 2005 to $7.1 million for thenine months ended September 30, 2006. As a percentage of sales, selling andadministrative expenses decreased from 28.7% for the nine months endedSeptember 30, 2005 to 28.4% for the nine months ended September 30, 2006. Theincrease in expenses was primarily due to higher legal costs, higher benefitcosts and higher salaries and wages partially offset by lower variablecompensation costs and lower bad debt expense. Also included in the nine-monthsended September 30, 2006 was approximately $0.5 million of stock-basedcompensation expense.

*Researchand Development*.* *Research and development expensesincreased $0.4 million from $0.9 million for the nine months ended September30, 2005 to $1.3 million for the same period in 2006 primarily as a result ofhigher research and development costs associated with the invention to reduceESD and development of the second generation HoloMag product as well as highersalaries and wages due to manpower additions. Also included in the nine-monthsended September 30, 2006 was approximately $0.1 million of stock-basedcompensation expense.

*Depreciationand Amortiza*tion. Depreciation and amortization decreased $0.2 million from $0.8 millionfor the nine months ended September 30, 2005 to $0.6 million for the sameperiod in 2006. The decrease was primarily due to a negotiated settlement ofthe restoration costs associated with the abandoned facility in Elmsford, NewYork and the write-off of certain assets used at the Elmsford, New Yorkfacility prior to its closure in connection with the consolidation of theCompany’s operations into its new facility in Robbinsville, New Jersey.

*FacilityConsolidation Expenses.*Facility consolidation expensesdecreased $0.6 million from the nine months ended September 30, 2005. Expensesin 2006, which related primarily to employee relocations and accretion costs onthe Elmsford, New York abandoned facility rent, were offset by a creditrecorded which resulted from a negotiated settlement with the owner of theElmsford facility which reduced the amount of rent owed by 10%. The expenses in2005 were principally for moving of machinery and equipment, employeerelocation and severance as a result of the consolidation of facilities intoRobbinsville, New Jersey.

*InterestIncome*.  Interestincome increased $0.1 million from $0.2 million for the nine months ended September30, 2005 to $0.3 million for the nine months ended September 30, 2006 due tohigher average balances of cash and cash equivalents and higher interest ratesin effect during 2006.

*IncomeTaxes.* The provision for income taxes increased $0.2 million from$1.4 million in the nine months ended September 30, 2005 to $1.6 million in thenine months ended September 30, 2006. As a percentage of Income before taxes,the provision for income taxes decreased from 40.0% in the nine months endedSeptember 30, 2005 to 37.4% in the nine months ended September 30, 2006. Theincrease in the provision was due to the effect of higher income before incometaxes partially offset by the impact of adjustments recorded in the threemonths ended September 30, 2006 for estimated deductions and credits for thefull year 2006 and adjustments to the provision for the actual deductions andtax credits that we recorded when filing our 2005 income tax returns whichdiffered from those in the income tax provision at September 30, 2005. The 2.6percentage point decrease in the provision as a percentage of income beforeincome taxes resulted from these adjustments.

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LIQUIDITY ANDCAPITAL RESOURCES

AtSeptember 30, 2006, the Company had $13.5 million in cash and cash equivalentsand working capital of $17.8 million.

The Company’s operatingactivities provided cash of $4.2 million for the nine months ended September30, 2006, compared to a use of cash $0.1 million for the nine months endedSeptember 30, 2005. The increase in cash in 2006 was primarily due to netincome of $2.7 million adjusted for non-cash costs of $0.3 million as well asdecreases in accounts receivable and inventories, a tax receivable as a resultof overpaying estimated income taxes in 2005 partially offset by decreasedaccounts payable and accrued liabilities. For the nine months ended September30, 2005 cash increased primarily as a result of net income of $2.2 millionadjusted for non-cash costs of $1.2 million and higher accounts payablepartially offset by higher inventories and accounts receivable all due to thegrowth in sales experienced in that time period. Investing activities for thenine months ended September 30, 2006 provided no cash primarily as a result ofthe return of progress payments made to the manufacturer of a special machinethat was not accepted by the Company offset by capital expenditures in thenine-month period. Investing activities in the nine months ended September 30,2005 amounted to a use of $2.2 million of cash as a result of capitalexpenditures of $4.2 million partially offset by the sale of short-terminvestments of $2.0 million. Financing activities for the nine months endedSeptember 30, 2006 and 2005 provided cash of $0.2 million and $0.4 million,respectively due to the exercise of stock options.

On December 14, 2004, weentered into agreements to lease a 134,000 square foot modern manufacturing andoffice building in Robbinsville, New Jersey, which is the site of our primaryoperations following the closure, relocation and consolidation of our prioroperations in Elmsford, New York and Huntingdon Valley, Pennsylvania into theRobbinsville facility. We completed the relocation and consolidation of ouroperations during 2005. We have re-opened the Huntingdon Valley facility forcertain manufacturing operations and secure storage that was previouslyperformed at a contract facility in Dalton, Massachusetts which will no longerbe leased after the expiration of the lease on the Dalton facility in October2006.

The base rent on thelease for the Robbinsville, New Jersey facility is $555,000 per year,increasing by 1.9% per year, and the first seven months of the lease wererent-free. We recorded deferred rent of $0.4 million in 2005. The term of thelease for the Robbinsville facility extends through May 31, 2017, and at theexpiration of the term, we have options to renew the lease for threeconsecutive five year periods at the then fair market value and also have anoption to purchase the building after the end of the original lease term forthe adjusted fair market value as defined in the lease agreement. The base renton the lease in Huntingdon Valley, Pennsylvania is $144,000 per year. The leaseon this facility expires on June 30, 2007.

During the quarter endedSeptember 30, 2006 we entered into an amendment to the lease on the Elmsford,New York facility. Under the terms of the amendment, we and the buildings owneragreed to (i) a ten percent (10%) reduction of the fixed annual rentretroactive to April 1, 2006, (ii) the payment of $100,000 as a contributiontowards the cost of demolition and restoration of the facility, (iii) theCompany provided a letter of credit in favor of owner in the amount of$789,606.80 in the event of an un-cured default of payments under the leaseagreement, and (iv) acceleration of payments by the Company under the leaseagreement in the event the facility is sub-leased. The base rent on the leasein Elmsford, New York following the amendment is $671,000 per year. The leaseon this facility expires on December 31, 2007. As this facility was abandonedas part of our move and consolidation in 2005 the remaining rent, net ofestimated sublease income, through the end of the lease term was charged toFacility Consolidation Expense in 2005. As a result of the terms of theamendment in the quarter ended September 30, 2006, we revised these costs toreduce the remaining rent and eliminate the estimated sublease income whichresulted in a reduction in the facility consolidation expense of $0.1 million.

We completed the move andconsolidation of our operations into the Robbinsville, New Jersey facility in2005. We recorded costs totaling $3.0 million in 2004 and 2005 relating to theconsolidation and expect to record additional costs amounting to $0.2 millionin 2006 and $0.4 million in 2007. Of the costs recorded to-date we expect topay approximately $2.0 million in cash ratably from the first quarter of 2006through the fourth quarter of 2007. Expenses incurred for the consolidationwere primarily associated with the Elmsford lease, vacating the facility,relocating and terminating certain employees, moving equipment and otherrelated expenses.

The Company believes thatcash flows from operations and its cash balances will be sufficient to meet working

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capital needs and fundcapital expenditures for the foreseeable future after considering the potentialimpact of the VISA Decision.

SPECIALNOTE REGARDING FORWARD - LOOKING STATEMENTS

Certainstatements in this Form 10-Q, including without limitation, statementscontaining the words “believes,” “intends,” “expects,” “anticipates,” and wordsof similar import, constitute “forward-looking statements” within the meaningof the private securities litigation reform act of 1995.  Such forward-looking statements are based oncurrent management expectations. Numerous factors, including those disclosedherein, those related to transaction card industry trends and those detailed inour filings with the Securities and Exchange Commission (as set forth under Item1A. “Risk Factors” in our Annual Report on Form 10-K for the year endedDecember 31, 2005), may cause results to differ materially from thoseanticipated in the forward-looking statements. Many of the factors that will determine our future results are beyondour capability to control or predict. These statements are subject to risks anduncertainties and therefore actual results may differ materially. Readersshould not place undue reliance on such forward-looking statements whichreflect management’s view only as of the date hereof. We undertake noobligation to revise or update any forward-looking statements, or to make anyother forward-looking statements, whether as a result of new information,future events or otherwise.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK

TheCompany does not engage in significant activity with respect to market risksensitive instruments. Accordingly, our risk with respect to market risksensitive instruments is immaterial.

ITEM 4. CONTROLS AND PROCEDURES

**The Company carried out an evaluation, under thesupervision and with the participation of management, including the Company’sChief Executive Officer and Chief Financial Officer, of the effectiveness ofthe design and operation of the Company’s disclosure controls and procedures asof the end of the period covered by this report pursuant to Exchange Act Rule13a-15.  Based upon that evaluation, theChief Executive Officer and Chief Financial Officer concluded that the Company’sdisclosure controls and procedures were effective in timely alerting them tomaterial information relating to the Company required to be included in theCompany’s periodic Securities and Exchange Commission filings and ensureinformation required to be included by the Company in reports it files orsubmits under the Securities Exchange Act is recorded, processed, summarizedand reported, within the time periods specified in the SEC rules andforms.  There were no changes in theCompany’s internal control over financial reporting that occurred during theCompany’s most recent fiscal quarter that would have materially affected, orare reasonably likely to materially affect, the Company’s internal control overfinancial reporting.**

PART II – OTHERINFORMATION

ITEM 1A. RISK FACTORS

In addition to the otherinformation set forth in this report, you should carefully consider the factorsdiscussed in Part I, Item 1A. “Risk Factors” in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2005, which couldmaterially affect our business, financial position and results of operations.There are no material changes from the risk factors set forth in Part I, Item1A, “Risk Factors,” of the Company’s Annual Report on Form 10-K for the yearended December 31, 2005.  See also PartI, Item 2, Management’s Discussion and Analysis of Financial Condition andResults of Operations in this report under the heading “Overview.”

ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS

On August 22,2006, the Company held its annual meeting of stockholders.  For more information on the followingproposals, refer to the Company’s proxy statement dated July 24, 2006, therelevant portions of which are incorporated herein by reference.

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1.               Thestockholders elected each of the five nominees to the Company’s Board ofDirectors who will serve until the 2007 annual meeting of stockholders or untiltheir successors are elected and qualified:
| Director                   | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|----------------------------|------------|------------|------------|--------------|------------|
| Kenneth H. Traub           |       | 17,552,253 |       | 412,475      |       |
| Salvatore F.  D’Amato |       | 17,644,354 |       | 320,374      |       |
| Fred J. Levin              |       | 17,923,754 |       | 40,974       |       |
| Jordan S. Davis            |       | 17,844,054 |       | 120,674      |       |
| Richard L.  Robbins        |       | 17,929,453 |       | 35,275       |       |
|                       |       |       |       |         |       |
| Total                      |       | 17,964,728 |       |         |       |

 

2.               The stockholdersratified the selection of PricewaterhouseCoopers LLP as the registered publicaccounting firm of the Company:
| For             |   | 17,943,736 |   |
|-----------------|--------|------------|--------|
| Against         |   | 19,361     |   |
| Abstain         |   | 1,631      |   |
| Broker Non-vote |   | 0          |   |
| Total           |   | 17,964,728 |   |

 

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ITEM6.  EXHIBITS

10.1         Amendmentdated as of September 12, 2006 by and between American Bank Note Holographics,Inc. and Mack-Cali CW Realty Associates L.L.C. to the Lease Agreement betweenthe American Bank Note Holographics, Inc. and the Robert Martin Company,Mack-Cali’s predecessor in interest, dated July 23, 1992, as amended pursuantto the First Amendment dated August 19, 1993.

31.1          Certification of Kenneth H. Traub pursuant toExchange Act Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of theSarbanes-Oxley Act of 2002.

31.2        Certification of Mark J. Bonney pursuant to Exchange Act Rules 13a-14 and15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1         Certificationof Kenneth H. Traub pursuant to 18 U.S.C. Section 1350, as adopted pursuant toSection 906 of the Sarbanes-Oxley Act of 2002.

32.2         Certification of Mark J. Bonneypursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

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#### **SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Company has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.
|                         | AMERICAN BANK NOTE                    |
|-------------------------|---------------------------------------|
|                    | HOLOGRAPHICS, INC.                    |
|                    |                                  |
|                    | By:                                   | /s/ Kenneth H. Traub |   |
|                    | Kenneth H. Traub                      |
|                    | President and Chief Executive Officer |
|                    |                                  |
|                    | By:                                   | /s/ Mark J. Bonney |   |
|                    | Mark J. Bonney                        |
|                    | Executive Vice President,             |
|                    | Chief Financial Officer and           |
|                    | Chief Accounting  Officer             |
|                    |                                  |
| Date: November 14, 2006 |                                  |

 

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