**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

** **

**FORM 10-Q**

** **
| x          | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934**                                                        |
|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                     |
| ** ** | ** ** | **For the  quarterly period ended March 31, 2006**                                                                                                        |
| ** ** | ** ** | ** **                                                                                                                                                     |
| ** ** | ** ** | **OR**                                                                                                                                                         |
|       |       |                                                                                                                                                           |
| o          | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934**                                                       |
|       |       |                                                                                                                                                           |
|       | ** ** | **For the  transition period  from                    to** |
|       |       |                                                                                                                                                           |
| ** ** |       | **Commission  File Number 1-14227**                                                                                                                            |
|       |       |                                                                                                                                                           |

** **

**AMERICAN BANK NOTE HOLOGRAPHICS, INC.**

**(Exact name of Registrant as specified in its charter)**

** **
| **Delaware**                                                                        | ** ** | **13-3317668**                        |
|-------------------------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation  or organization)                    |       | (I.R.S. Employer  Identification No.) |
| ** **                                                                          |
| **2  Applegate Drive**                                                              |
| **Robbinsville,  New Jersey 08691**                                                 |
| (Address of  principal 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) |

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports) and (2) has been subject to such filing forthe past 90 days.   xYes     o No

Indicate bycheckmark whether the registrant is a large accelerated filer, an acceleratedfiler or a non-accelerated filer. (See definition of accelerated filer andlarge accelerated filer in Rule 12b-2 of the Exchange Act). (Checkone):

Large accelerated filer o     Acceleratedfiler o    Non-accelerated filer x

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes o   x No

The aggregatenumber of shares of common stock, $.01 par value, outstanding on May 8,2006 was 18,883,144.

 

 

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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   March 31, 2006 and December 31, 2005             |
|                                                                                                |
| Statements of Operations - Unaudited  For the Three Months Ended March 31, 2006 and 2005       |
|                                                                                                |
| Statements of Cash Flows - Unaudited   For the Three Months Ended March 31, 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 6. Exhibits                                                                                    |

 

2

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**PART I- FINANCIAL INFORMATION**

**ITEM I. FINANCIAL STATEMENTS**

**AMERICANBANK NOTE HOLOGRAPHICS, INC.BALANCE SHEETS - UNAUDITED(In thousands, except share data)**

 
| ** **                                                                                                                             | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                             | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| ** **                                                                                                                             | ** ** | **(Unaudited)**    | ** ** | **(Note A)**     | ** ** |
| ASSETS                                                                                                                                 | ** ** | ** **         | ** ** | ** **            | ** ** |
| CURRENT ASSETS:                                                                                                                        |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                              |       | $                  | 13,298     |                  | $          | 9,114 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $500 and $500                                                          |       | 5,191              |       | 6,019                 |       |
| Inventories, net                                                                                                                       |       | 3,081              |       | 2,940                 |       |
| Deferred income taxes, net                                                                                                             |       | 2,936              |       | 2,968                 |       |
| Prepaid expenses and other                                                                                                             |       | 257                |       | 331                   |       |
| Income tax receivable                                                                                                                  |       | —             |       | 401                   |       |
| Total current assets                                                                                                                   |       | 24,763             |       | 21,773                |       |
| MACHINERY,  EQUIPMENT AND LEASEHOLD  IMPROVEMENTS—Net of accumulated depreciation and amortization  of $9,031 and $8,852          |       | 6,750              |       | 7,224                 |       |
| DEFERRED INCOME  TAXES, NET                                                                                                            |       | 196                |       | 411                   |       |
| OTHER ASSETS                                                                                                                           |       | 72                 |       | 76                    |       |
| TOTAL ASSETS                                                                                                                           |       | $                  | 31,781     |                  | $          | 29,484 |   |
|                                                                                                                                   |       |               |       |                  |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                             | ** ** | ** **         | ** ** | ** **            | ** ** |
| CURRENT LIABILTIES:                                                                                                                    |       |               |       |                  |       |
| Accounts payable                                                                                                                       |       | $                  | 5,074      |                  | $          | 3,820 |   |
| Accrued expenses                                                                                                                       |       | 3,421              |       | 3,834                 |       |
| Customer advances                                                                                                                      |       | 547                |       | 204                   |       |
| Income taxes payable                                                                                                                   |       | 280                |       | 359                   |       |
| Total current liabilities                                                                                                              |       | 9,322              |       | 8,217                 |       |
| LONG-TERM  LIABILTIES                                                                                                                  |       | 1,760              |       | 1,957                 |       |
| Total liabilities                                                                                                                      |       | 11,082             |       | 10,174                |       |
|                                                                                                                                   |       |               |       |                  |       |
| COMMITMENTS  AND CONTINGENCIES STOCKHOLDRS’ 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 18,888,144 shares and 18,715,469  shares |       | 189                |       | 187                   |       |
| Additional paid-in capital                                                                                                             |       | 24,970             |       | 24,729                |       |
| Unearned compensation                                                                                                                  |       | —             |       | (96                   | )          |
| Accumulated deficit                                                                                                                    |       | (4,460             | )          | (5,510                | )          |
| Total Stockholders’ Equity                                                                                                        |       | 20,699             |       | 19,310                |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                       |       | $                  | 31,781     |                  | $          | 29,484 |   |

 

See Condensed Notes to Unaudited Financial Statements.

 

3

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AMERICANBANK NOTE HOLOGRAPHICS, INC.STATEMENTS OF OPERATIONS - UNAUDITED(In thousands, except per share data)

 
| ** **                                                  | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                  | ** ** | **March 31,**               | ** ** |
| ** **                                                  | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| REVENUE:                                                    | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Sales                                                       |       | $                                | 9,988      |   | $ | 6,400 |   |
| Royalty income                                              |       | —                           |       | 10 |   |
| Total revenue                                               |       | 9,988                            |       | 6,410 |   |
|                                                        |       |                             |       |   |   |
| COSTS AND EXPENSES:                                         |       |                             |       |   |   |
| Cost of goods sold, excluding depreciation and amortization |       | 4,836                            |       | 2,799 |   |
| Selling and administrative                                  |       | 2,765                            |       | 1,918 |   |
| Research and development                                    |       | 457                              |       | 273 |   |
| Depreciation and amortization                               |       | 227                              |       | 351 |   |
| Facility consolidation                                      |       | 40                               |       | 107 |   |
| Total costs and expenses                                    |       | 8,325                            |       | 5,448 |   |
|                                                        |       |                             |       |   |   |
| Operating income                                            |       | 1,663                            |       | 962 |   |
|                                                        |       |                             |       |   |   |
| Interest income                                             |       | 87                               |       | 54 |   |
|                                                        |       |                             |       |   |   |
| INCOME BEFORE  PROVISION FOR INCOME TAXES                   |       | 1,750                            |       | 1,016 |   |
|                                                        |       |                             |       |   |   |
| PROVISION FOR  INCOME TAXES                                 |       | 700                              |       | 406 |   |
|                                                        |       |                             |       |   |   |
| NET INCOME                                                  |       | $                                | 1,050      |   | $ | 610 |   |
|                                                        |       |                             |       |   |   |
| NET INCOME PER SHARE:                                       |       |                             |       |   |   |
| Basic                                                       |       | $                                | 0.06       |   | $ | 0.03 |   |
| Diluted                                                     |       | $                                | 0.05       |   | $ | 0.03 |   |
|                                                        |       |                             |       |   |   |
| WEIGHTED AVERAGE NUMBER  OF SHARES:                         |       |                             |       |   |   |
| Basic                                                       |       | 18,829                           |       | 18,518 |   |
| Diluted                                                     |       | 19,913                           |       | 19,110 |   |

 

See Condensed Notes to Unaudited Financial Statements.

4

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AMERICANBANK NOTE HOLOGRAPHICS, INC.STATEMENTS OF CASH FLOWS - UNAUDITED(In thousands)

 
| ** **                                                                          | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                          | ** ** | **March 31,**               | ** ** |
| ** **                                                                          | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **                                                                          | ** ** | ** **                       | ** ** | ** ** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                              | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Net income                                                                          |       | $                                | 1,050      |   | $ | 610 |   |
| Adjustments to  reconcile net income to net cash provided by  operating activities: |       |                             |       |   |   |
| Depreciation and amortization                                                       |       | 227                              |       | 351 |   |
| Deferred income taxes, net                                                          |       | 247                              |       | (25 | ) |
| Compensation costs related to share-based payment  arrangements                     |       | 233                              |       | — |   |
| Increase in allowance for doubtful accounts                                         |       | —                           |       | 10 |   |
| Increase in provision for inventories                                               |       | 730                              |       | 39 |   |
| Excess tax benefits from share-based payment  arrangements                          |       | (1                               | )          | — |   |
| Changes in  operating assets and liabilities:                                       |       |                             |       |   |   |
| Accounts receivable                                                                 |       | 828                              |       | (1,013 | ) |
| Inventories                                                                         |       | (871                             | )          | (877 | ) |
| Prepaid expenses and other                                                          |       | 77                               |       | 78 |   |
| Income tax receivable                                                               |       | 401                              |       | — |   |
| Accounts payable                                                                    |       | 1,199                            |       | (68 | ) |
| Accrued expenses                                                                    |       | (413                             | )          | 4 |   |
| Customer advances                                                                   |       | 343                              |       | 388 |   |
| Income taxes payable                                                                |       | (79                              | )          | (559 | ) |
| Long-term liabilities                                                               |       | (197                             | )          | 148 |   |
| Net cash  provided (used) by operating activities                                   |       | 3,774                            |       | (914 | ) |
|                                                                                |       |                             |       |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                              |       |                             |       |   |   |
| Increase in short-term investments                                                  |       | —                           |       | (6,119 | ) |
| Capital refunds (expenditures)                                                      |       | 303                              |       | (478 | ) |
| Net cash  provided by (used in) investing activities                                |       | 303                              |       | (6,597 | ) |
|                                                                                |       |                             |       |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                              |       |                             |       |   |   |
| Proceeds from exercise of stock options                                             |       | 106                              |       | 4 |   |
| Excess tax benefits from share-based payment  arrangements                          |       | 1                                |       | — |   |
| Net cash provided by financing activities                                           |       | 107                              |       | 4 |   |
|                                                                                |       |                             |       |   |   |
| INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                                   |       | 4,184                            |       | (7,507 | ) |
| CASH AND CASH  EQUIVALENTS, BEGINNING OF YEAR                                       |       | 9,114                            |       | 11,357 |   |
|                                                                                |       |                             |       |   |   |
| CASH AND CASH  EQUIVALENTS, END OF PERIOD                                           |       | $                                | 13,298     |   | $ | 3,850 |   |
|                                                                                |       |                             |       |   |   |
| SUPPLEMENTAL CASH FLOW  INFORMATION:                                                |       |                             |       |   |   |
| Taxes paid                                                                          |       | $                                | 73         |   | $ | 990 |   |
| Capital  expenditures included in accounts payable                                  |       | $                                | 55         |   | $ | 456 |   |

 

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 secureholograms. The Company’s products are used primarily in security applicationsincluding authentication of transaction cards, identity documents, valuedocuments and various consumer products. Our ability to create distinctive,secure optically 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 Eli Lilly, as well as agencies of theUnited States government and certain foreign governments. We also producenon-secure holograms for design and promotional applications. The Companyoperates in one reportable industry segment.

Thepreparation of our financial statements in conformity with U.S. generallyaccepted accounting principles requires management to make use of estimates andassumptions that impact the reported amounts of assets and liabilities at thedate of the financial statements and the reported amounts of revenue andexpenses during the reporting period. On an ongoing basis, we evaluate ourestimates, including those related to bad debts, stock-based compensation,inventories and intangible assets. These estimates and assumptions are based onhistorical results and trends as well as our forecasts as to how these mightchange in the future. In addition, these estimates and assumptions have beeninfluenced by our current knowledge of the potential impact of the VISADecision as defined and more fully described under “Business Information” onthe following page.

Theaccompanying unaudited financial statements have been prepared in accordancewith generally accepted accounting principles for interim financial informationand with the instructions to Form 10-Q and Article 10 ofRegulation S-X. Accordingly, they do not include all of the information andfootnotes required by U.S. generally accepted accounting principles forcomplete financial statements. In the opinion of management, all adjustments(consisting of normal recurring adjustments) considered necessary for a fairpresentation have been included. Operating results for the three months ended March 31,2006 are not necessarily indicative of the results that may be expected for theyear ending December 31, 2006.

Thebalance sheet at December 31, 2005 has been derived from the auditedfinancial statements at that date but does not include all of the informationand footnotes required by U.S. generally accepted accounting principles forcomplete financial statements.

Forfurther information, refer to the financial statements and footnotes theretoincluded in the Company’s annual report on Form 10-K for the yearended December 31, 2005, as filed with the United States Securities andExchange Commission (“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 and collection of the invoice is considered probable. In somesituations, the Company has shipped product where the sale is contingent uponthe customers’ use of the product. In these situations, the Company does notrecognize sales upon product shipment, but rather when the buyer of the productinforms the Company that the product has been used. Additionally, pursuant tothe request of and agreement with a certain customer, completed items arestored on behalf of this customer at the Company’s on-site secured facility,and in that instance, sales are recognized when all of the following haveoccurred: the customer has ordered the goods pursuant to a fixed price purchaseorder, the manufacturing process is complete, the goods have been transferredto the on-site secured facility and are ready for shipment, the risk ofownership has passed to the customer, the customer has been billed for theorder and collection of the invoice is considered probable. In certain casesthe Company has agreed to maintain an inventory of products for a customer toensure 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 the product.

6

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Customeradvances represent payments received from customers for products which have notyet been shipped. These customer advances are classified as current liabilitieson the accompanying balance sheets.

Shippingand handling amounts billed to customers are included in sales and amounted to$350,000 and $111,000  for the threemonths ended March 31, 2006 and 2005, respectively. Shipping and handlingcosts are included in selling and administrative expenses.

BASIC AND DILUTEDNET INCOME PER SHARE

Basicnet income per share is computed based on the weighted average number ofoutstanding shares of common stock including outstanding restricted stock. Thebasic weighted average number of shares outstanding was 18,828,672 and18,517,747 for the three months ended March 31, 2006 and 2005,respectively. Diluted net income per share is computed by dividing net incomeby the weighted average number of shares of common stock outstanding anddilutive potential shares of common stock. For the three months ended March 31,2006, the diluted number of weighted average shares outstanding was 19,912,620which includes dilutive stock options of 1,083,948 shares. For the three monthsended March 31, 2005, the diluted number of weighted average sharesoutstanding was 19,110,139 which included dilutive stock options of 592,392shares. Options to purchase 347,388 and 119,500 shares of common stock at March 31,2006 and 2005, respectively, were not included in the computation of dilutedearnings per share because the options’ exercise prices were greater than theaverage market price of the common shares, and therefore, the effect onearnings per share would be anti-dilutive.

BUSINESSINFORMATION

Sales to MasterCard wereapproximately 34% and 33% of sales for the three months ended March 31,2006 and 2005, respectively. The Company has an agreement with MasterCard, asamended, in which MasterCard has retained the Company as its exclusive supplierof MasterCard holograms as well as holographic magnetic stripe (HoloMagTM) throughFebruary 28, 2013, subject to automatic renewal if not terminated byeither party. At March 31, 2006 and December 31, 2005, accountsreceivable from this customer totaled $2.2 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.

Salesof VISA holograms (which includes HoloMag starting in the three month periodended September 30, 2005) to manufacturers of VISA transaction cards wereapproximately 39% and 23% of sales for the three months ended March 31,2006 and 2005, respectively. Currently we are one of two companies authorizedto manufacture and sell the VISA Dove hot stamp hologram to manufacturers ofVISA brand transaction cards.****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 intoan Agreement with VISA, pursuant to which we were authorized to supply HoloMagto VISA-approved card manufacturers. On March 14, 2006, we were informedby VISA that, as a result of a small number of incidents in which certain cardterminals had been affected by electro-static discharge (“ESD”) from staticelectricity carried on cards incorporating HoloMag, VISA is informing itsmember financial institutions and authorized card manufacturers that (i) VISAwill no longer approve VISA card designs which incorporate the current versionof HoloMag, (ii) VISA strongly recommends that their members attempt toavoid further issuance of cards incorporating the current version of HoloMagand (iii) VISA recommends that their members follow an alternate carddesign incorporating a conventional magnetic stripe and Dove hot stamp hologramand VISA provided notice to us that it was revoking our right to produceHoloMag under its agreement (the “VISA Decision”). In its correspondence to usrelating to HoloMag, VISA also stated its view that “a remediation program forimpacted stakeholders may be necessary” and that VISA would seekindemnification from us for such costs and/or claims. VISA has recommended toits members that cards bearing the HoloMag product already in the market bereplaced as soon as practical.

7

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Therecan be no assurance that VISA authorized card maufacturers will continue topurchase the Dove hot stamp hologram from us in the future. We are continuingto evaluate VISA’s actions and claims.We believe that we are in compliance withour agreement with VISA and that the HoloMag product complies with allstandards and specifications contained in our agreement. Accounts receivablefrom manufacturers of VISA transaction cards approximated $1.9 million and $3.4million at March 31, 2006 and December 31, 2005, respectively.

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 not havesupply contracts with our suppliers, and operate on a purchase order basis. Inthe case of HoloMag, we have a single supplier, CFC International, Inc.,with whom we have a supply contract. We may not be able to find alternativesources in a timely manner if our suppliers or subcontractors become unwillingor unable to supply us, or if they increase their prices. Our inability toobtain key product components or to have certain processes performed on our behalfcould cause delays or reduce product shipments, which could cause ourrelationship with customers to suffer and materially and adversely affect ourfinancial condition, results of operations and cash flows.

STOCK-BASEDCOMPENSATION PLANS

In December 2004, the Financial AccountingStandards Board issued Statement No. 123(R) (FAS 123R), Share-BasedPayment, revising FAS 123 and requiring that all share-based payments toemployees be recognized in the financial statements. We adopted the newstatement 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 FAS123 (R) and for the unvested portion of previously granted options thatremain outstanding as of the adoption date based on the grant date fair valuein accordance with the original provisions of FAS 123. In the quarter ended March 31,2006, operating income was reduced by $233,000 for stock-based paymentcompensation expense, affecting cost of goods sold by $1,000, selling, general,and administrative expenses by $205,000 and research and development expensesby $27,000. Stock-based compensation expense reduced our quarterly net incomeby $140,000 and our basic and fully diluted earnings per share by $0.01. Priorperiods have not been adjusted. Unearned compensation on restricted shares hasbeen 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 compensationexpense for stock option grants made at an exercise price equal to or in excessof the fair 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 months ended March 31, 2005 based on thefair-value method under SFAS 123.

 
| ** **                                                                                                                | ** ** | **Three Months Ended  March 31, 2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| Net income, as  reported                                                                                                  |       | $                                                          | 610        |   |
| Add: Non-cash  employee compensation, as reported                                                                         |       | —                                                     |       |
| Deduct: Stock-based employee compensation  expense determined under fair value based  method for all awards, net of taxes |       | 41                                                         |       |
| Pro forma, net  income                                                                                                    |       | $                                                          | 569        |   |
|                                                                                                                      |       |                                                       |       |
| Basic net income  per share, as reported                                                                                  |       | $                                                          | 0.03       |   |
| Basic net income  per share, pro forma                                                                                    |       | $                                                          | 0.03       |   |
| Diluted net  income per share, as reported                                                                                |       | $                                                          | 0.03       |   |
| Diluted net income per  share, pro forma                                                                                  |       | $                                                          | 0.03       |   |

 

We use the Black-Scholes option pricing model tocalculate the fair value of options. The key assumptions for this valuationmethod include the expected term of the option, stock price volatility,risk-free interest rate, dividend yield, exercise price, and forfeiture rate.Many of these assumptions are judgmental and highly sensitive in thedetermination of compensation expense. Under the assumptions, indicated below,the weighted average fair value of the stock option grants in the period ended March 31,2006 and 2005 were $4.70 and $2.93, respectively. The table below indicates thekey assumptions used in the valuation calculations for options granted in thethree months ended

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March 31, 2006 and 2005 and a discussion of ourmethodology for developing each of the assumptions used in the valuation model:
| ** **               | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------|------------|--------------------------------------------------|------------|
| ** **               | ** ** | **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%  – 4.81%                              |       | 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.An increase in the expected term will increase compensation expense. In thefirst quarter of 2006 we modified our assumption of the expected term toreflect an estimated reduction in the amount of time that options will remainoutstanding as a result of recent events including our facility consolidation.

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.

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 firstestimated as of January 1, 2006 in conjunction with our adoption of FAS123 (R).

Thefollowing table summarizes information about our stock incentive plans for thethree months ended March 31, 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                           |       | 223,000                         |       | $                                                  | 6.00       |                                                                |        |                                                              |       |   |
| Options exercised                         |       | (33,675                         | )          | $                                                  | 1.41       |                                                                |        |                                                              |       |   |
| Options  forfeited                        |       | (6,000                          | )          | $                                                  | 6.00       |                                                                |        |                                                              |       |   |
| Options  outstanding, March 31, 2006 |       | 3,155,263                       |       | $                                                  | 2.66       |                                                                | 5.57  years |                                                              | $          | 2,317 |   |
| Options exercisable,  March 31, 2006 |       | 2,388,131                       |       | $                                                  | 2.29       |                                                                | 4.49 years  |                                                              | $          | 2,009 |   |

 

As of March 31,2006 there was $2,042,000 of total unrecognized compensation cost, net ofestimated forfeitures,  related to stockoptions. These costs are expected to be recognized over a weighted averageperiod of 1.1 years.

The totalintrinsic value of stock options exercised was $148,000. 

Cash received fromstock option exercises in the three months ended March 31, 2006 was$48,000. The income tax

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benefit from stockbased arrangements totaled $59,000 all of which was attributable to stockoption exercises, of which $58,000 was credited to additional paid in capital,.

The followingtable summarizes information about restricted stock awards for the three monthsended March 31, 2006:

 
| ** **                                    | ** ** | **Shares** | ** ** | **Weighted Average  Grant-Date  Fair Value** | ** ** |
|-----------------------------------------------|------------|------------|------------|--------------------------------------------------------|------------|
| Non-vested  balance at December 31, 2005 |       | 15,000     |       | $                                                      | 5.65       |   |
| Granted                                       |       | 139,000    |       | $                                                      | 6.00       |   |
| Vested                                        |       | —     |       | $                                                      | —     |   |
| Forfeited                                     |       | —     |       | $                                                      | 6.00       |   |
| Non-vested balance at  March 31, 2006    |       | 154,000    |       | $                                                      | 5.97       |   |

 

Restrictedstock awards were made under the 2005 Stock Incentive Plan and vest 100% threeyears from the grant date.

As of March 31,2006 there was $840,000 of unrecognized compensation costs, net of estimatedforfeitures, related to restricted stock awards. These costs are expected to berecognized over a weighted average period of 2.7 years.

As of March 31,2006 an aggregate of 1,255,813 shares remained available for future grants andawards under our stock incentive plans, which cover stock options andrestricted stock awards. We issue shares to satisfy stock option exercises andrestricted stock awards.

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. Estimates of warranty costs are based onhistorical experience and are periodically reviewed and adjusted, whennecessary. The Company’s product warranty provision is included in accruedexpenses in the accompanying balance sheets. Changes in the Company’s warrantyprovision are as follows:

 
| ****                            | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------|------------|--------------------------------------------------|------------|
| ** **                      | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| ** **                      | ** ** | **(In thousands)**                          | ** ** |
| Balance at  beginning of period |       | $                                                | 1,140      |   | $ | 510 |   |
| Warranties  issued              |       | 60                                               |       | 60 |   |
| Settlements made                |       | (300                                             | )          | (65 | ) |
| Balance at  March 31       |       | $                                                | 900        |   | $ | 505 |   |

 

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

IMPACT OF RECENTLYISSUED ACCOUNTING STANDARDS — In December 2004, the Financial AccountingStandards Board issued Statement No. 123(R) (FAS 123R), Share-BasedPayment, revising FAS 123 and requiring that all share-based payments toemployees be recognized in the financial statements. Generally, the approach toaccounting for share-based payments in FAS 123R is similar to the approachdescribed in FAS 123, however, pro forma footnote disclosure will no longer bean alternative to financial statement recognition. This statement, as amended,becomes effective in the first annual period beginning after June 15,2005. We adopted the new statement effective January 1, 2006, using themodified-prospective transition method described in the statement. The adoptionof FAS123R primarily resulted in a change in our method of measuring andrecognizing

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fair value of ourshare-based grants, estimating forfeitures for all unvested awards, andaccounting for awards to retirement eligible employees.

In November 2004,the Financial Accounting Standards Board issued Statement No. 151 (FAS151), Inventory costs, an amendment of ARB No. 43, Chapter 4. FAS 151clarifies that abnormal amounts of idle facility expense, freight, handlingcosts and wasted materials should be recognized as current period charges. Inaddition, FAS 151 requires that allocation of fixed production overhead toinventory be based on the normal capacity of the production facilities. FAS 151is effective for inventory costs incurred during fiscal years beginning after June 15,2005. We adopted FAS 151 effective January 1, 2006. The adoption of FAS151 did not have a material impact on our financial statements.

In March 2005,the Financial Accounting Standards Board (“FASB”) issued interpretation No. 47,*Accounting for Conditional Asset RetirementObligations*, an interpretation of SFAS No. 143. Thisinterpretation clarifies that the term of *conditional asset retirementobligation* refers to a legal obligation to perform an assetretirement activity in which the timing and/or method of settlement areconditional on a future event that may or may not be within the control of theentity. 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 thisstatement had no impact on our financial statement presentation since therehave been no conditional asset retirement obligations.

In December 2004,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 154, *Accounting Changes andError Corrections*, a replacement of APB Opinion No. 20 and SFASNo. 3. This statement changes the requirements for the accounting for andthe reporting of a change in accounting principle. This statement requiresretrospective application to prior period financial statements of changes inaccounting principle, unless it is impracticable to determine either theperiod-specific effects of the cumulative effect of the change. Indirecteffects of a change in accounting principle should be recognized in the periodof the accounting change. The provisions of SFAS No. 154 are effective forfiscal years beginning after December 15, 2005.We adopted this Statementbeginning January 1, 2006.

NOTE B —INVENTORIES, NET

Inventoriesconsist of the following:

 
| ****                                          | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                    | ** ** | **(Unaudited)**          | ** ** | **(Note A)**           | ** ** |
| ** **                                    | ** ** | **(In thousands)**  | ** ** |
|                                          |       |                     |       |                        |       |
| Finished goods                                |       | $                        | 6,594      |                        | $          | 5,802 |   |
| Finished goods  on consignment with customers |       | 182                      |       | 158                         |       |
| Work in process                               |       | 792                      |       | 644                         |       |
| Raw materials                                 |       | 522                      |       | 616                         |       |
| Subtotal                                      |       | 8,090                    |       | 7,220                       |       |
| Less: Inventory  reserves                     |       | 5,009                    |       | 4,280                       |       |
| Net inventory                                 |       | $                        | 3,081      |                        | $          | 2,940 |   |

 

NOTE C — OTHER LONG-TERM LIABILITIES

Other long-termliabilities at both March 31, 2006 and December 31, 2005 include a$800,000 reserve for potential tax liabilities. Also included in otherlong-term liabilities at March 31, 2006 and December 31, 2005 are$600,000 and $800,000, respectively, of long-term rent on our abandonedfacility in Elmsford, New York and $400,000 and $400,000, respectively, ofdeferred rent on our Robbinsville, New Jersey facility.

NOTE D - FACILITYCONSOLIDATION

On December 14,2004, we entered into agreements to lease a 134,000 square foot modernmanufacturing and office

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building in Robbinsville,New Jersey, which is the site of our primary operations following the closure,relocation and consolidation of our prior operations in Elmsford, New York andHuntingdon Valley, Pennsylvania into the Robbinsville facility. We completedthe relocation and consolidation of our operations during 2005. We arecurrently planning to re-open the Huntingdon Valley facility for certainmanufacturing operations and secure storage that is presently performed at acontract facility in Dalton, Massachusetts which will no longer be requiredafter 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 $0.4 million in 2004 and 2005. The termof the lease for the Robbinsville facility extends through May 31, 2017,and at the expiration 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. The base rent on the lease inElmsford, New York is $746,000 per year. The lease on this facility expires on December 31,2007. As this facility was abandoned as part of our move and consolidation in2005 the remaining rent, net of estimated sublease income, through the end ofthe lease term was charged to Facility Consolidation Expense in 2005.

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.

Currentaccounts payable include certain amounts that the Company is disputing with avendor, the ultimate resolution of such disputes may result in reduction inexpense and accounts payable.

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

ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS

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, marketsand sells secure holograms and products incorporating secure holograms. TheCompany’s products are used primarily in security applications includingauthentication of transaction cards, identity documents, value documents andvarious consumer products. The Company operates in one reportable industrysegment. Our ability to create distinctive, secure optically variable devices,to reproduce them with high quality and to distribute them securely has enabledus to become a market leader in security holography. Our products are sold toover 200 companies worldwide, including MasterCard, VISA, American Express,Discover, Diners Club, Sears, Nordstrom, Quaker State, Nike, Janssen-Cilag andEli Lilly, as well as agencies of the United States government and certainforeign governments. We also produce non-secure holograms for design andpromotional applications.

A significant portion ofthe Company’s business is derived from orders placed by certain transactioncard companies, including MasterCard and manufacturers of VISA brandtransaction cards, and variations in the timing of such orders can causesignificant fluctuations in the Company’s sales. Several thousand banksworldwide issue VISA and MasterCard branded cards that incorporate the Company’sholograms.

Sales to MasterCard wereapproximately 34% and 33% of sales for the three months ended March 31,2006 and 2005, respectively. The Company has an agreement with MasterCard, asamended, pursuant to which the Company is the exclusive supplier of MasterCardholograms and holographic magnetic stripes, HoloMag. In the quarter ended September 30,2005, 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. The agreement with MasterCard was amended on August 24, 2005,and expires on February 28, 2013, subject to automatic renewal thereafter.If we were to lose a substantial portion of our business

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with MasterCard withoutreplacing it with new product sales, our business, operating results andfinancial condition would be materially and adversely affected. In addition, ifwe fail to obtain anticipated orders from MasterCard or if we experience delaysor cancellations of orders from MasterCard, our business, operating results andfinancial performance will be materially and adversely affected.

Salesof VISA holograms (which includes HoloMag starting in the three month periodended September 30, 2005) to manufacturers of VISA transaction cards wereapproximately 39% and 23% of sales for the three months ended March 31,2006 and 2005, respectively. Currently we are one of two companies authorizedto manufacture and sell the VISA Dove hot stamp holograms to manufacturers ofVISA brand transaction cards.****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 intoan Agreement with VISA, pursuant to which we were authorized to supply HoloMagto VISA-approved card manufacturers. On March 14, 2006, we were informedby VISA that, as a result of a small number of incidents in which certain cardterminals had been affected by electro-static discharge (“ESD”) from staticelectricity carried on cards incorporating HoloMag, VISA is informing itsmember financial institutions and authorized card manufacturers that (i) VISAwill no longer approve VISA card designs which incorporate the current versionof HoloMag, (ii) VISA strongly recommends that their members attempt toavoid further issuance of cards incorporating the current version of HoloMagand (iii) VISA recommends that their members follow an alternate carddesign incorporating a conventional magnetic stripe and Dove hot stamp hologramand VISA provided notice to us that it was revoking our right to produceHoloMag under its agreement (the “VISA Decision”). In its correspondence to usrelating to HoloMag, VISA also stated its view that “a remediation program forimpacted stakeholders may be necessary” and that VISA would seekindemnification from us for such costs and/or claims. VISA has recommended toits members that cards bearing the HoloMag product already in the market bereplaced as soon as practical. There can be no assurance that our customerswill continue to purchase the Dove hot stamp hologram from us in the future. Weare continuing to evaluate VISA’s actions and claims.We believe that we are incompliance with our agreement with VISA and that the HoloMag product complieswith all standards and specifications contained in our agreement.

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 and collection of the invoice is considered probable. In somesituations, the Company has shipped product where the sale is contingent uponthe customers’ use of the product. In these situations, the Company does notrecognize sales upon product shipment, but rather when the buyer of the productinforms the Company that the product has been used. Additionally, pursuant tothe request of and agreement with a certain customer, completed items arestored on behalf of this customer at the Company’s on-site secured facility,and in that instance, sales are recognized when all of the following haveoccurred: the customer has ordered the goods pursuant to a fixed price purchaseorder, the manufacturing process is complete, the goods have been transferredto the on-site secured facility and are ready for shipment, the risk ofownership has passed to the customer, the customer has been billed for theorder and collection of the invoice is considered probable. In certain casesthe Company has agreed to maintain an inventory of products for a customer toensure quick turn around of deliveries. The Company only accepts returns ofproduct sold to customers when the product is determined to not be inconformance with the specifications previously agreed upon with such customersin accordance with the terms of its warranty policy and generally replaces theproduct. The Company generally provides replacement product for up to 180 daysfrom original shipment as a warranty for defective product. Shipping andhandling amounts billed to customers are included in sales and amounted to $0.3million and $0.1 million in the three months ended March 31, 2006 and2005, respectively.

Wepurchase certain key materials used in the manufacture of our products, andsubcontract certain production functions or products from third parties some ofwhich are sole suppliers.  In some cases,we do not have supply contracts with our suppliers, and operate on a purchaseorder basis. In the case of HoloMag, we have a single supplier, CFCInternational, Inc., with whom we have a supply contract. We may not beable to 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.

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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 Companyoutsources to third parties. As a result, costs of goods sold are affected byproduct mix, manufacturing yields, supplier prices and changes in the cost ofraw materials and labor.

Sellingand administrative expenses primarily consist of salaries, benefits andcommissions for 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.  The Company also includes the cost of shippingand handling product deliveries that are billed to customers in selling andadministrative expenses. Shipping and handling amounted to $414,000 and$130,000 for the three months ended March 31, 2006 and 2005, respectively.

Stock-based compensation expense

Beginning in the first quarter of 2006, we wererequired to record the expense of share-based payment transactions pursuant toStatement of Financial Accounting Standards No. 123 (R) (“FAS 123R”).Under the modified prospective method, we were not required to restate the prioryear financial statements or include in the current year any expenses relatedto stock option grants vested as of December 31, 2005.

We use the Black-Scholes option pricing model tocalculate the fair value of options. The key assumptions for this valuationmethod include the expected term of the option, stock price volatility,risk-free interest rate, dividend yield, exercise price, and forfeiture rate.Many of these assumptions are judgmental and highly sensitive in thedetermination of compensation expense. In the first quarter of 2006 we modifiedour assumption of the expected term from that used under FAS 123 to reflect anestimated reduction in the amount of time that options granted will remainoutstanding as a result of recent events including our facility consolidation.We increased our expected volatility based on recent events which resulted insignificantly higher volatility than in previous periods. Under FAS 123 (R) weare required to estimate forfeitures rather than recording forfeitures whenthey occur as previously permitted. Our estimated forfeiture rate wasdetermined by reviewing historical trends. We will continue to review ourBlack-Scholes assumptions and modify them as needed in the future. Changes inthese assumptions may lead to variations in the compensation expense that werecord in future periods.

In the quarter ended March 31, 2006, operatingincome was reduced by $233,000 for stock-based payment compensation expense,affecting cost of goods sold by $1,000, selling, general, and administrativeexpenses by $205,000 and research and development expenses by $27,000.Stock-based compensation expense reduced our quarterly net income by $140,000and our basic and fully diluted earnings per share by $0.01.

Impact of the VISADecision

In the quarter ended December 31, 2005, as aresult of the VISA Decision, we recorded a pre-tax charge amounting toapproximately $5.0 million of which $4.8 million was recorded in cost of goodssold and was principally related to the value of our HoloMag inventory. Alsoincluded in the charge were increases in our provisions for accounts receivableand potential non-ESD related warranty claims. During the three months ended March 31,2006 we evaluated these provisions and determined that the amounts previouslyrecorded for inventory obsolescence, potential non-ESD related warranty claimsand the allowance for doubtful accounts were still appropriate. We willcontinue to review the valuation of these accounts on an ongoing basis as apart of our closing process and make appropriate changes to our reserve levelsbased upon the facts at the time. Certain shipments of HoloMag that werecompleted and invoiced during the quarter ended March 31, 2006 have notbeen recognized as revenue as the collection of these amounts is not consideredprobable as a result of the VISA Decision. Revenue will be recognized in thefuture in the event that such amounts are collected.

 

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COMPARISONOF THREE MONTHS ENDED MARCH 31, 2006 TO THREE MONTHS ENDED

MARCH 31,2005

*Sales.*Salesincreased by $3.6 million, or 56.1%, from $6.4 million for the three monthsended March 31, 2005 to $10.0 million for the three months ended March 31,2006. The increase was primarily due to higher sales of our HoloMagTM integratedholographic magnetic security stripe product to the transaction card market aswell as expansion of existing programs in the identity document market, thetransaction card, and product authentication markets. HoloMag products shippedto several customers in the quarter ended March 31, 2006 with sales to themanufacturers of VISA brand transaction cards prior to the VISA Decisionamounting to $3.1 million. Sales of HoloMag to VISA authorized cardmanufacturers ceased immediately after the VISA Decision as described above.Sales growth in the quarter was also affected by the value of the HoloMagproduct which sells for substantially higher prices than a conventional hotstamp hologram due to its unique design and high security features. As a resultof the VISA Decision we expect sales to decline in the quarter ending June 30,2006.

*Cost ofGoods Sold, excluding depreciation and amortization.*Cost ofgoods sold increased by $2.0 million, from $2.8 million for the three monthsended March 31, 2005 to $4.8 million for the three months ended March 31,2006 primarily as a result of the volume increase and a $1.0 million increasein inventory reserves as a result of the VISA Decision. As a percentage ofsales, cost of goods sold increased from 43.7% for the three months ended March 31,2005 to 48.4% for the three months ended March 31, 2006. The increase wasprimarily due to increases in the warranty provision and in inventory reservesassociated with volume increases and the VISA Decision.

*Sellingand Administrative.*Selling and administrative expensesincreased $0.8 million from $1.9 million for the three months ended March 31,2005 to $2.7 million for the three months ended March 31, 2006. As apercentage of sales, selling and administrative expenses decreased from 30.0%for the three months ended March 31, 2005 to 27.7% for the same period in2006. The increase in expenses was primarily due to higher shipping chargeswhich increased due to higher product shipments, higher legal expenses and highercosts associated with being a public company. The decrease in percentage ofsales was primarily due to the volume increase in sales, partially offset byhigher general and administrative costs.

*Researchand Development.*Research and development expenses increased$184,000 from $273,000 for the three months ended March 31, 2005 to$457,000 for the same period in 2006 primarily as a result of higherdevelopment costs associated with the development of the second generationHoloMag product as well as higher salaries and wages due to manpower additions.

*Depreciationand Amortization.*Depreciation and amortization decreased$124,000 from $351,000 for the three months ended March 31, 2005 to$227,000 for the same period in 2006. The decrease was primarily due to theacceleration of depreciation on equipment and leasehold improvements in thefirst quarter of 2005 in connection with the consolidation of the Company’soperations in its new facility in Robbinsville, New Jersey.

*FacilityConsolidation Expenses.*Facility consolidation expenses, inthe three months ended March 31, 2006 and March 31, 2005 amounted to$40,000 and $107,000, respectively and pertained to expenses incurred for theCompany’s new facility in Robbinsville, New Jersey.

*InterestIncome*. Interest income increased $33,000 from $54,000 forthe three months ended March 31, 2005 to $87,000 for the three monthsended March 31, 2006 due to higher interest rates in effect during thecurrent period.

LIQUIDITY ANDCAPITAL RESOURCES

At March 31,2006, the Company had $13.3 million in cash and cash equivalents and workingcapital of $15.4 million.

The Company’s operatingactivities provided cash of $3.8 million for the three months ended March 31,2006, compared to a net usage of cash of $0.9 million for the three monthsended March 31, 2005. The increase in cash was primarily due to a decreasein accounts receivable, an increase in accounts payable for inventory and a taxreceivable as a result of overpaying estimated income taxes in 2005 partiallyoffset by an increase in inventories. Investing activities for the three monthsended March 31, 2005 provided cash of $0.3 million primarily as a resultof the return of progress payments made to the manufacturer of a special machinethat was not accepted by the

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Company partially offsetby capital expenditures in the three-month period. Investing activities in thethree months ended March 31, 2005 amounted to $6.6 million resulting fromthe purchase of short-term investments of $6.1 million and capital expenditures,primarily associated with the Robbinsville New Jersey facility, of $0.5million. Financing activities for the three months ended March 31, 2006provided cash of $0.1 million due to the exercise of stock options. There wereno financing activities for the three months ended March 31, 2005.

On December 14,2004, we entered into agreements to lease a 134,000 square foot modernmanufacturing and office building in Robbinsville, New Jersey, which is thesite of our primary operations following the closure, relocation andconsolidation of our prior operations in Elmsford, New York and HuntingdonValley, Pennsylvania into the Robbinsville facility. We completed therelocation and consolidation of our operations during 2005. We are currentlyplanning to re-open the Huntingdon Valley facility for certain manufacturingoperations and secure storage that is presently performed at a contractfacility in Dalton, Massachusetts which will no longer be required after theexpiration of the lease on the facility in October 2006.

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 2004 and 2005. The termof the lease for the Robbinsville facility extends through May 31, 2017,and at the expiration 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. The base rent on the lease inElmsford, New York is $746,000 per year. The lease on this facility expires on December 31,2007. As this facility was abandoned as part of our move and consolidation in2005 the remaining rent, net of estimated sublease income, through the end ofthe lease term was charged to Facility Consolidation Expense in 2005.

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 $0.3 millionin 2006 ($40,000 recorded in the quarter ended March 31, 2006) and 2007,respectively. Of the costs recorded to-date we expect to pay approximately $2.1in cash ratably from the first quarter of 2006 through the fourth quarter of2007. Expenses incurred for the consolidation were primarily associated withthe Elmsford lease, vacating the facility, relocating and terminating certainemployees, moving equipment and other related expenses.

The Company believes thatcash flows from operations and its cash balances will be sufficient to meetworking capital needs and fund capital expenditures for the foreseeable futureafter considering the potential impact of the VISA Decision.

SPECIALNOTE REGARDING FORWARD - LOOKING STATEMENTS

Certainstatements in this Form 10-Q, including without limitation,statements containing the words “believes,” “intends,” “expects,” “anticipates,”and words of similar import, constitute “forward-looking statements” within themeaning of the private securities litigation reform act of 1995. Suchforward-looking statements are based on current management expectations.Numerous factors, including those disclosed herein, those related totransaction card industry trends and those detailed in our filings with theSecurities and Exchange Commission (as set forth under Item 1A. “Risk Factors”in our Annual Report on Form 10-K for the year ended December 31,2005), may cause results to differ materially from those anticipated in theforward-looking statements. Many of the factors that will determine our futureresults are beyond our capability to control or predict. These statements aresubject to risks and uncertainties and therefore actual results may differmaterially. Readers should not place undue reliance on such forward-lookingstatements which reflect management’s view only as of the date hereof. Weundertake no obligation to revise or update any forward-looking statements, orto make any other forward-looking statements, whether as a result of newinformation, future events or otherwise.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET 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.

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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 Rule 13a-15.Based upon that evaluation, the Chief Executive Officer and Chief FinancialOfficer concluded that the Company’s disclosure controls and procedures wereeffective in timely alerting them to material information relating to theCompany required to be included in the Company’s periodic Securities andExchange Commission filings. There were no changes in the Company’s internalcontrol over financial reporting that occurred during the Company’s most recentfiscal quarter that would have materially affected, or are reasonably likely tomaterially affect, the Company’s internal control over financial reporting.**

PART II — OTHERINFORMATION

ITEM 1A. RISKFACTORS

In addition to the other information set forth in thisreport, you should carefully consider the factors discussed in Part I,Item 1A. “Risk Factors” in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2005, which could materially affect ourbusiness, financial position and results of operations. There are no materialchanges from the risk factors set forth in Part I, Item 1A, “Risk Factors,”of the Company’s Annual Report on Form 10-K for the year ended December 31,2005.

ITEM 6. EXHIBITS

| 31.1   |   | Certification of Kenneth H. Traub pursuant to  Exchange Act Rules 13a-14 and 15d-14, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                  |
| 31.2   |   | Certification of Mark J. Bonney pursuant to Exchange  Act Rules 13a-14 and 15d-14, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.   |
|   |   |                                                                                                                                                                  |
| 32.1   |   | Certification of Kenneth H. Traub pursuant to 18  U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.               |
|   |   |                                                                                                                                                                  |
| 32.2   |   | Certification of Mark J. Bonney pursuant to 18  U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-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: May 15,2006

 

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