**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

 

ý**            QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended September 30, 2004**

 

**OR**

 

o**            TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transitionperiod from          to          **

 

**CommissionFile Number 1-14227**

 

**AMERICANBANK 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.) |

 

**399****  ****Executive Boulevard**

Elmsford, New York, 10523

(Address of principalexecutive offices, including zip code)

 

**(914)****     ****592-2355**

(Registrant’s telephonenumber, including area code)

 

**Not applicable**

(Former name, former addressand 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.

 

ýYes  oNo

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act).

 

oYes  ýNo

 

Theaggregate number of shares of common stock, $.01 par value, outstanding onNovember 5, 2004 was 18,488,845.

 

 

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** **

**AMERICAN BANK NOTE HOLOGRAPHICS, INC.**

 

**FORM 10-Q**

 

## **INDEX**

 
| PART I - FINANCIAL  INFORMATION                                                                                      |   |
|----------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                 |   |
| Item 1. Financial  Statements                                                                                        |   |
|                                                                                                                 |   |
| Condensed Balance Sheets as ofSeptember 30, 2004 (Unaudited)  and December 31, 2003                                  |   |
|                                                                                                                 |   |
| Unaudited Condensed  Statements of Operations  For the Three  and Nine Months Ended September 30, 2004 and 2003 |   |
|                                                                                                                 |   |
| Unaudited Condensed  Statements of Cash Flows  For the Nine  Months Ended September 30, 2004 and 2003           |   |
|                                                                                                                 |   |
| Notes  to Unaudited Condensed Financial Statements                                                                   |   |
|                                                                                                                 |   |
| Item  2. Management’s Discussion and Analysis of Financial Condition and Results of  Operations                 |   |
|                                                                                                                 |   |
| Item  3. Quantitative and Qualitative Disclosures About Market Risk                                                  |   |
|                                                                                                                 |   |
| Item 4. Controls and  Procedures                                                                                     |   |
|                                                                                                                 |   |
| PART II - OTHER INFORMATION                                                                                          |   |
|                                                                                                                 |   |
| Item 1. Legal Proceedings                                                                                            |   |
|                                                                                                                 |   |
| Item  4. Submission of Matters to a Vote of Security Holders                                                         |   |
|                                                                                                                 |   |
| Item 6.  Exhibits                                                                                                    |   |

 

2

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PART I - FINANCIALINFORMATION

 

ITEM I. FINANCIAL STATEMENTS

 

AMERICANBANK NOTE HOLOGRAPHICS, INC.

CONDENSED BALANCE SHEETS

(Inthousands, except share data)

 

 

 
| ** **                                                                                                              | ** ** | **September 30,**

**2004** | ** ** | **December 31,**

**2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|----------------------------|------------|
| ** **                                                                                                              | ** ** | **(Unaudited)**             | ** ** | **(Note A)**               | ** ** |
| ASSETS                                                                                                                  | ** ** | ** **                  | ** ** | ** **                 | ** ** |
| Current Assets:                                                                                                         |       |                        |       |                       |       |
| Cash and cash equivalents                                                                                               |       | $                           | 12,803     |                       | $          | 11,341 |   |
| Accounts receivable, net of allowance for doubtful accounts of $180                                                     |       | 4,214                       |       | 3,174                      |       |
| Inventories                                                                                                             |       | 2,765                       |       | 2,386                      |       |
| Deferred income taxes                                                                                                   |       | 1,038                       |       | 981                        |       |
| Prepaid expenses                                                                                                        |       | 423                         |       | 385                        |       |
| Other                                                                                                                   |       | —                      |       | 150                        |       |
| Total current assets                                                                                                    |       | 21,243                      |       | 18,417                     |       |
| Machinery, equipment and leasehold improvements, net of accumulated  depreciation and amortization of $9,729 and $9,238 |       | 2,683                       |       | 2,490                      |       |
| Other assets                                                                                                            |       | 76                          |       | 113                        |       |
|                                                                                                                    |       |                        |       |                       |       |
| Total Assets                                                                                                            |       | $                           | 24,002     |                       | $          | 21,020 |   |
|                                                                                                                    |       |                        |       |                       |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                              |       |                        |       |                       |       |
| Current Liabilities:                                                                                                    |       |                        |       |                       |       |
| Accounts payable                                                                                                        |       | $                           | 1,373      |                       | $          | 687 |   |
| Accrued expenses                                                                                                        |       | 1,807                       |       | 1,627                      |       |
| Customer advances                                                                                                       |       | 71                          |       | 49                         |       |
| Income taxes payable                                                                                                    |       | 745                         |       | —                     |       |
| Total current liabilities                                                                                               |       | 3,996                       |       | 2,363                      |       |
| Deferred income taxes                                                                                                   |       | 1,213                       |       | 1,208                      |       |
|                                                                                                                    |       |                        |       |                       |       |
| Total liabilities                                                                                                       |       | 5,209                       |       | 3,571                      |       |
|                                                                                                                    |       |                        |       |                       |       |
| Commitments and contingencies                                                                                           |       |                        |       |                       |       |
|                                                                                                                    |       |                        |       |                       |       |
| Stockholders’ Equity:                                                                                              |       |                        |       |                       |       |
| Preferred stock, authorized 5,000,000 shares; no shares issued or  outstanding                                          |       | —                      |       | —                     |       |
| Common stock, par value $.01 per share, authorized 40,000,000 shares;  issued and outstanding 18,483,720 shares         |       | 185                         |       | 185                        |       |
| Additional paid-in capital                                                                                              |       | 23,994                      |       | 23,994                     |       |
| Accumulated deficit                                                                                                     |       | (5,386                      | )          | (6,730                     | )          |
| Total Stockholders’ Equity                                                                                         |       | 18,793                      |       | 17,449                     |       |
|                                                                                                                    |       |                        |       |                       |       |
| Total Liabilities and Stockholders’ Equity                                                                         |       | $                           | 24,002     |                       | $          | 21,020 |   |

 

 

See Notes to Unaudited Condensed Financial Statements.

 

 

3

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AMERICANBANK NOTE HOLOGRAPHICS, INC.

CONDENSED STATEMENTS OFOPERATIONS - UNAUDITED

(Inthousands, except per share data)

 

 

 
| ** **                               | ** ** | **Three Months Ended**

**September 30,** | ** ** | **Nine Months Ended**

**September 30,** | ** ** |
|------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                               | ** ** | **2004**                                  | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenue:                                 | ** ** | ** **                                | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sales                                    |       | $                                         | 5,808      |                                     | $          | 4,629 |   | $ | 15,749 |   | $ | 13,442 |   |
| Royalty income                           |       | —                                    |       | —                                   |       | 13 |   | 47 |   |
|                                     |       | 5,808                                     |       | 4,629                                    |       | 15,762 |   | 13,489 |   |
| Costs and expenses:                      |       |                                      |       |                                     |       |   |   |   |   |
| Cost of goods sold                       |       | 2,413                                     |       | 2,090                                    |       | 6,943 |   | 6,094 |   |
| Selling and administrative               |       | 1,939                                     |       | 1,520                                    |       | 5,373 |   | 4,911 |   |
| Research and development                 |       | 319                                       |       | 339                                      |       | 967 |   | 903 |   |
| Depreciation and amortization            |       | 171                                       |       | 184                                      |       | 495 |   | 547 |   |
|                                     |       | 4,842                                     |       | 4,133                                    |       | 13,778 |   | 12,455 |   |
|                                     |       |                                      |       |                                     |       |   |   |   |   |
| Operating income                         |       | 966                                       |       | 496                                      |       | 1,984 |   | 1,034 |   |
|                                     |       |                                      |       |                                     |       |   |   |   |   |
| Other income:                            |       |                                      |       |                                     |       |   |   |   |   |
| Interest income                          |       | 29                                        |       | 22                                       |       | 77 |   | 73 |   |
| Patent agreement                         |       | —                                    |       | —                                   |       | 178 |   | — |   |
|                                     |       | 29                                        |       | 22                                       |       | 255 |   | 73 |   |
|                                     |       |                                      |       |                                     |       |   |   |   |   |
| Income before provision for income taxes |       | 995                                       |       | 518                                      |       | 2,239 |   | 1,107 |   |
| Provision for income taxes               |       | 397                                       |       | 220                                      |       | 895 |   | 470 |   |
|                                     |       |                                      |       |                                     |       |   |   |   |   |
| Net income                               |       | $                                         | 598        |                                     | $          | 298 |   | $ | 1,344 |   | $ | 637 |   |
|                                     |       |                                      |       |                                     |       |   |   |   |   |
| Net income per share:                    |       |                                      |       |                                     |       |   |   |   |   |
| Basic and diluted                        |       | $                                         | 0.03       |                                     | $          | 0.02 |   | $ | 0.07 |   | $ | 0.03 |   |

 

See Notes to Unaudited Condensed Financial Statements.

 

4

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AMERICANBANK NOTE HOLOGRAPHICS, INC.

CONDENSED STATEMENTS OF CASHFLOWS - UNAUDITED

(Inthousands)

 

 

 
| ** **                                                                         | ** ** | **Nine Months Ended**

**September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                                 | ** ** | **2003** | ** ** |
| ** **                                                                         | ** ** | ** **                               | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                              | ** ** | ** **                               | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                                        | 1,344      |   | $ | 637 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |       |                                     |       |   |   |
|                                                                               |       |                                     |       |   |
| Depreciation and amortization                                                      |       | 495                                      |       | 547 |   |
| Deferred income taxes                                                              |       | (52                                      | )          | 470 |   |
| Provision for doubtful accounts                                                    |       | —                                   |       | (30 | ) |
| Changes in operating assets and liabilities:                                       |       |                                     |       |   |   |
| Accounts receivable                                                                |       | (1,040                                   | )          | 477 |   |
| Inventories                                                                        |       | (379                                     | )          | 331 |   |
| Prepaid expenses and other                                                         |       | 145                                      |       | 272 |   |
| Accounts payable and accrued expenses                                              |       | 866                                      |       | (655 | ) |
| Customer advances                                                                  |       | 22                                       |       | 24 |   |
| Income taxes payable                                                               |       | 745                                      |       | — |   |
|                                                                               |       |                                     |       |   |   |
| Net cash provided by operating activities                                          |       | 2,146                                    |       | 2,073 |   |
|                                                                               |       |                                     |       |   |   |
| Cash flows from investing activities:                                              |       |                                     |       |   |   |
| Capital expenditures                                                               |       | (684                                     | )          | (201 | ) |
|                                                                               |       |                                     |       |   |   |
| Net cash used in investing activities                                              |       | (684                                     | )          | (201 | ) |
|                                                                               |       |                                     |       |   |   |
| Increase in cash and cash equivalents                                              |       | 1,462                                    |       | 1,872 |   |
| Cash and cash equivalents, beginning of period                                     |       | 11,341                                   |       | 8,659 |   |
|                                                                               |       |                                     |       |   |   |
| Cash and cash equivalents, end of period                                           |       | $                                        | 12,803     |   | $ | 10,531 |   |
|                                                                               |       |                                     |       |   |   |
| Supplemental cash payments:                                                        |       |                                     |       |   |   |
| Taxes                                                                              |       | $                                        | 181        |   | $ | 5 |   |

 

See Notes to Unaudited Condensed Financial Statements.

 

5

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AMERICANBANK NOTE HOLOGRAPHICS, INC.

NOTES TO UNAUDITED CONDENSEDFINANCIAL STATEMENTS

 

NOTEA - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

AmericanBank Note Holographics, Inc. (the “Company”) originates, mass-produces, andmarkets secure holograms. Holograms are used for security, packaging andpromotional applications. The Company operates in one reportable industrysegment.

 

Theaccompanying unaudited condensed financial statements have been prepared inaccordance with U.S. generally accepted accounting principles for interimfinancial information and with the instructions to Form 10-Q and Article 10 ofRegulation S-X.  Accordingly, they do notinclude all of the information and footnotes required by U.S. generallyaccepted accounting principles for complete financial statements. In theopinion of management, all adjustments (consisting of normal recurringaccruals) considered necessary for a fair presentation have been included.Operating results for the three and nine months ended September 30, 2004 arenot necessarily indicative of the results that may be expected for the yearending December 31, 2004.

 

Thebalance sheet at December 31, 2003 has been derived from the audited financialstatements at that date but does not include all of the information andfootnotes 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 year endedDecember 31, 2003, as filed with the United States Securities and ExchangeCommission (“SEC”).

 

REVENUERECOGNITION

 

TheCompany recognizes revenue in accordance with the provisions of the SEC’s StaffAccounting Bulletin (“SAB”) No. 104, “Revenue Recognition (an amendment of SAB101, “Revenue Recognition”).” Specifically, sales and the related cost of goods sold are generallyrecognized at the latter of the time of shipment or when title passes tocustomers. In some situations, the Company has shipped product where the saleis contingent upon the customers’ use of the product. In these situations, theCompany does not recognize sales upon product shipment, but rather when thebuyer of the product informs the Company that the product has been used.  Additionally, pursuant to terms with acertain customer, completed items are stored on behalf of the customer at the Company’son-site secured facility and, in that instance, sales are recognized when allof the following have occurred: the customer has ordered the goods, themanufacturing process is complete, the goods have been transferred to theon-site secured facility and are ready for shipment, the risk of ownership haspassed to the customer and the customer has been billed for the order.

 

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$92,000 and $316,000 for the three and nine months ended September 30, 2004,respectively, and $105,000 and $270,000 for the three and nine months endedSeptember 30, 2003, respectively. Shipping and handling costs are included in selling and administrativeexpenses.

 

BASICAND DILUTED NET INCOME PER SHARE

 

Basicnet income per share is computed based on the weighted average number ofoutstanding shares of common stock. The basic weighted average number of sharesoutstanding were 18,483,720 in each of the three and nine months endedSeptember 30, 2004 and 2003. Diluted net income per share is computed bydividing net income by the weighted average number of shares of common stockoutstanding and dilutive potential shares of common stock. For the three andnine months ended September 30, 2004, the diluted number of weighted averageshares outstanding was 18,808,489 and 18,823,452, respectively, which includesdilutive stock options of 324,769 shares and 339,732 shares, respectively. Forthe three and nine months ended September 30, 2003, the diluted number of 

 

6

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weightedaverage shares outstanding was 18,608,109 and 18,509,767, respectively, whichincludes dilutive stock options of 124,389 shares and 26,047 shares,respectively.

 

BUSINESSINFORMATION

 

Sales to MasterCard wereapproximately 37% and 45% of sales for the three months ended September 30,2004 and 2003, respectively, and 36% and 28% of sales for the nine months endedSeptember 30, 2004 and 2003, respectively. The Company entered into anagreement with MasterCard dated February 28, 2003, which replaced the agreementdated February 1, 1996, as amended.  TheCompany and MasterCard entered into an amendment to this agreement on September29, 2003, in which MasterCard retained the Company to produce a new hologramfor the Debit MasterCard and extended the agreement to February 28, 2011,subject to automatic renewal if not terminated by either party.  The loss of all or a substantial portion ofthe sales to MasterCard would have a material adverse effect on the financialposition, results of operations and cash flows of the Company. At September 30,2004 and December 31, 2003, accounts receivable from this customer totaled $1.4million and $1.0 million, respectively.

 

Salesof VISA holograms to manufacturers of VISA credit cards were approximately 28%and 34% of sales for the three months ended September 30, 2004 and 2003,respectively, and 31% and 31% of sales for the nine months ended September 30,2004 and 2003, respectively. The loss of a substantial portion of the sales tomanufacturers of VISA credit cards would have a material adverse effect on thefinancial position, results of operations and cash flows of the Company.Accounts receivable from these customers approximated $1.3 million at bothSeptember 30, 2004 and December 31, 2003.

 

TheCompany purchases certain key materials used in the manufacture of itsholograms and outsources certain key processes from third party suppliers, someof which are sole source relationships, with whom the Company does not havesupply contracts. Any problems that occur with respect to the delivery, qualityor cost of any such materials or processes could have a material adverse effecton the financial position, results of operations and cash flows of the Company.

 

STOCK-BASEDCOMPENSATION PLANS

 

As allowed by SFAS No. 123, the Company has elected tocontinue to apply the intrinsic value-based method of accounting prescribed inAPB Opinion No. 25 and, accordingly, does 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.

 

Hadcompensation costs for the Company’s outstanding stock options been determinedbased on the fair value at the grant dates for those options consistent withSFAS No. 123, the Company’s net income and basic and diluted net income pershare would have differed as reflected by the pro forma amounts indicatedbelow:

 
| ** **                                                                                                               | ** ** | **Three Months Ended**

**September 30,**  | ** ** | **Nine Months Ended**

**September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                                               | ** ** | **2004**                                   | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                     |       | **(In  thousands, except per share data)** |       |
| Net income, as reported                                                                                                  |       | $                                          | 598        |                                     | $          | 298 |   | $ | 1,344 |   | $ | 637 |   |
| Add: Non-cash employee compensation, as reported                                                                         |       | —                                     |       | —                                   |       | — |   | — |   |
| Deduct: Stock-based employee compensation expense determined under  fair value based method for all awards, net of taxes |       | 18                                         |       | 12                                       |       | 54 |   | 34 |   |
|                                                                                                                     |
|                                                                                                                     |
| Pro forma, net income                                                                                                    |       | $                                          | 580        |                                     | $          | 286 |   | $ | 1,290 |   | $ | 603 |   |
|                                                                                                                     |       |                                       |       |                                     |       |   |   |   |   |
| Basic and diluted net income per share, as reported                                                                      |       | $                                          | 0.03       |                                     | $          | 0.02 |   | $ | 0.07 |   | $ | 0.03 |   |
| Basic and diluted net income per share, pro forma                                                                        |       | $                                          | 0.03       |                                     | $          | 0.02 |   | $ | 0.07 |   | $ | 0.03 |   |

 

7

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WARRANTYCOSTS

 

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,** |       |
|--------------------------------|--------|---------------------------------------------|------------|--------------------------------------------|------------|
|                           |   | ** **                                  |       |
|                           |   | **2004**                                    | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2003** |   |
|                           |   | **(In  thousands)**                         |       | **(In  thousands)**                        |       |
| Balance at beginning of period |   | $                                           | 486        |                                       | $          | 513 |   | $ | 510 |   | $ | 605 |   |
| Warranties issued              |   | 40                                          |       | 40                                         |       | 120 |   | 120 |   |
| Settlements made               |   | (56                                         | )          | (83                                        | )          | (160 | ) | (255 | ) |
| Balance at September 30        |   | $                                           | 470        |                                       | $          | 470 |   | $ | 470 |   | $ | 470 |   |

 

 

 

NOTEB - INVENTORIES

 

Inventoriesconsist of the following:

 
| ** **                                   | ** ** | **September  30,**

**2004** | ** ** | **December  31,**

**2003** | ** ** |
|----------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                   | ** ** | **(Unaudited)**              | ** ** | **(Note A)**                | ** ** |
|                                         |       | **(In  thousands)**          |       |
|                                         |       |                         |       |                        |       |
| Finished goods                               |       | $                            | 1,205      |                        | $          | 800 |   |
| Finished goods on consignment with customers |       | 308                          |       | 417                         |       |
| Work in process                              |       | 932                          |       | 764                         |       |
| Raw materials                                |       | 320                          |       | 405                         |       |
|                                         |       | $                            | 2,765      |                        | $          | 2,386 |   |

 

NOTEC - COMMITMENTS AND CONTINGENCIES

 

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

 

 

8

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ITEM 2. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL 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

 

TheCompany originates, mass-produces and markets holograms. The Company’sholograms are used primarily for security applications such as counterfeitingprotection for credit and other transaction cards, identification cards anddocuments of value, as well as for tamper resistance and authentication ofhigh-value consumer and industrial products. The Company also produces non-secure holograms for packaging andpromotional applications.  The Company’ssales of holograms for security applications generally carry higher grossmargins than sales for non-security applications.

 

Asignificant portion of the Company’s business is derived from orders placed bycertain credit card companies, including MasterCard and manufacturers of VISAbrand credit cards, and variations in the timing of such orders can causesignificant fluctuations in the Company’s sales. Sales to MasterCard wereapproximately 37% and 45% of sales for the three months ended September 30,2004 and 2003, respectively, and 36% and 28% of sales for the nine months endedSeptember 30, 2004 and 2003, respectively. The Company entered into an agreementwith MasterCard dated February 28, 2003, which replaced the agreement datedFebruary 1, 1996, as amended. The Company and MasterCard entered into anamendment to this agreement on September 29, 2003, in which MasterCard retainedthe Company to produce a new hologram for the Debit MasterCard and extended theagreement to February 28, 2011, subject to automatic renewal if not terminatedby either party.  Sales of VISA hologramsto manufacturers of VISA credit cards were approximately 28% and 34% of sales forthe three months ended September 30, 2004 and 2003, respectively, and 31% and31% of sales for the nine months ended September 30, 2004 and 2003,respectively. The Company does not have long-term purchase contracts with VISAand supplies holograms to approximately 50 VISA authorized card manufacturerspursuant to purchase orders. Currently the Company is one of two companiesauthorized to manufacture and sell VISA brand holograms to manufacturers ofVISA brand credit cards. If either MasterCard or VISA were to terminate itsrespective relationship with the Company or substantially reduce their orders,there would be a material adverse effect on the Company’s business, financialcondition, results of operations and cash flows.

 

Hologramsare sold under purchase orders and contracts with customers. Sales and therelated cost of goods sold are generally recognized at the latter of the timeof shipment or when title passes to customers. In some situations, the Companyhas shipped product where the sale is contingent upon the customers’ use of theproduct. In these situations, the Company does not recognize sales upon productshipment, but rather when the buyer of the product informs the Company that theproduct has been used. Additionally, pursuant to terms with a certain customer,completed items are stored on behalf of the 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, the manufacturingprocess is complete, the goods have been transferred to the on-site securedfacility and are ready for shipment, the risk of ownership has passed to thecustomer and the customer has been billed for the order. At September 30, 2004and December 31, 2003, accounts receivable from this customer totaled $1.4million and $1.0 million, respectively.

 

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

 

Salesmay fluctuate from quarter to quarter due to changes in customers’ orderingpatterns. Customers do not typically provide the Company with precise forecastsof future order quantities. Quarterly demand for holograms may be materiallyinfluenced by customers’ promotions, inventory replenishment, card expirationpatterns, delivery schedules and other factors which may be difficult for theCompany to anticipate.

 

9

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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). As a result,costs of goods sold are affected by product mix, manufacturing yields, costs ofhologram originations and changes in the cost of raw materials and labor.

 

Sellingand administrative expenses primarily consist of salaries, benefits andcommissions for the Company’s corporate, sales, marketing and administrativepersonnel, marketing and promotion expenses, legal and accounting expenses andexpenses associated with being a public company.

 

COMPARISONOF THREE MONTHS ENDED SEPTEMBER 30, 2004 TO THREE MONTHS ENDED

SEPTEMBER30, 2003

 

*Sales.*  Sales increased by $1.2 million, or 25.5%,from $4.6 million for the three months ended September 30, 2003 to $5.8 millionfor the three months ended September 30, 2004. The increase was primarily due to the implementation of new customerprograms in the transaction card, identity document and product authenticationmarkets.

 

*Cost ofGoods Sold.*  Cost ofgoods sold increased by $0.3 million, from $2.1 million for the three monthsended September 30, 2003 to $2.4 million for the three months ended September30, 2004.  As a percentage of sales, costof goods sold decreased from 45.2% in the three months ended September 30, 2003to 41.5% for the same period in 2004. The decrease of 3.7% was primarily due to the increase in sales volume.

 

*Sellingand Administrative.*  Selling andadministrative expenses increased $0.4 million from $1.5 million for the threemonths ended September 30, 2003 to $1.9 million for the three months ended September30, 2004. As a percentage of sales, selling and administrative expensesincreased from 32.8% for the three months ended September 30, 2003 to 33.4% forthe same period in 2004.  The increasewas primarily due to an increase in selling expenses of $0.1 million primarilyrelated to selling salaries, commissions, benefits and outside sales agentexpenses and administrative expenses of $0.3 million, primarily due to salariesand benefits, professional fees, travel and recruitment.

 

*Researchand Development. *Research anddevelopment expenses remained relatively unchanged.

 

*Depreciationand Amortization.*  Depreciationand amortization remained relatively unchanged.

 

*InterestIncome*.  Interest income remainedrelatively unchanged.

 

COMPARISONOF NINE MONTHS ENDED SEPTEMBER 30, 2004 TO NINE MONTHS ENDED

SEPTEMBER30, 2003

 

*Sales*.  Sales increased by $2.3 million, or 17.2%,from $13.4 million for the nine months ended September 30, 2003 to $15.7million for the nine months ended September 30, 2004.  The increase was primarily due to theexpansion of certain existing customer accounts and the implementation of newcustomer programs in the transaction card, identity document and productauthentication markets.

 

*RoyaltyIncome*.  Royalty income remainedrelatively unchanged.

 

*Cost ofGoods Sold*.  Cost ofgoods sold increased by $0.8 million, from $6.1 million for the nine monthsended September 30, 2003 to $6.9 million for the nine months ended September30, 2004.  As a percentage of sales, costof goods sold decreased from 45.3% in the nine months ended September 30, 2003to 44.1% for the same period in 2004. The decrease of 1.2% was primarily due to the increase in sales volume.

 

*Sellingand Administrative*.  Selling andadministrative expenses increased $0.5 million from $4.9 million for the ninemonths ended September 30, 2003 to $5.4 million in the current period. As apercentage of sales, selling and administrative expenses decreased from 36.5%for the nine months ended September 30, 2003 to 34.1% for the nine 

 

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monthsended September 30, 2004. The increase in expenses was primarily due to anincrease in selling expenses of $0.1 million, primarily related to increases inselling salaries, commissions, benefits and outside sales agent expenses andadministrative expenses of $0.4 million, primarily due to salaries andbenefits, professional fees, travel and recruitment.

 

*Researchand Development*.* *Research and development expensesincreased $0.1 million from $0.9 million for the nine months ended September30, 2003 to $1.0 million for the same period in 2004. The increase wasprimarily due to an increase in research and development testing expenses inthe current period.

 

*Depreciationand Amortiza*tion. Depreciation and amortization remained relatively unchanged.

 

*InterestIncome*.  Interest income remainedrelatively unchanged.

 

*PatentAgreement.* On April 13, 2004, the Company entered into anagreement with a third party in which the Company was paid $0.2 million and theCompany granted a limited release and a limited license to use certain of theCompany’s patents for certain products that were previously produced by thethird party.

 

LIQUIDITYAND CAPITAL RESOURCES

 

AtSeptember 30, 2004, the Company had $12.8 million in cash and cash equivalentsand working capital of $17.2 million.

 

The Company’s operatingactivities provided cash of $2.1 million for the nine months ended September30, 2004, compared to $2.0 million of cash provided for the nine months endedSeptember 30, 2003.  Cash flows providedby net income and adjustments to reconcile net income to net cash provided byoperating activities were $1.8 million in the nine months ended September 30,2004. Cash flows provided by changes in operating assets and liabilities were$0.3 in the nine months ended September 30, 2004 primarily due to changes inaccounts payable and accrued expenses, income taxes payable and prepaidexpenses and other assets being offset by changes in accounts receivable andinventories. For the nine months ended September 30, 2003, cash flows providedby net income and adjustments to reconcile net income to net cash provided byoperating activities provided cash of $1.6 million and cash flows provided bythe net changes in operating assets and liabilities were $0.4 million,primarily due to changes in accounts receivable, inventories and prepaidexpenses and other assets being offset by changes in accounts payable andaccrued expenses.

 

Investing activities forthe nine months ended September 30, 2004 and 2003 used cash of $0.7 million and$0.2 million, respectively, for capital expenditures.

 

Therewere no financing activities for the nine-month periods ended September 30,2004 and 2003.

 

TheCompany is implementing a capital investment program which is intended toenhance the efficiency of its operations and expand its product line andproduction capability.

 

TheCompany has long-term operating leases for offices, manufacturing facilitiesand equipment, which expire through 2007. The Company has renewal options on some locations, which provide forrenewal rents based upon a fixed annual rate or the greater of a fixed annualrate or increases tied to the consumer price index.

 

SPECIALNOTE REGARDING FORWARD - LOOKING STATEMENTS

 

Certainstatements in this Form 10-Q constitute “forward-looking” statements within themeaning of the Private Securities Litigation Reform Act of 1995 (the “ReformAct”). Such “forward-looking” statements involve known and unknown risks,uncertainties and other factors which may cause the actual results, performanceor achievements of the Company, or industry results, to be materially differentfrom any future results, performance, or achievements expressed or implied bysuch “forward-looking” statements. Such factors are more fully described underthe caption “Business — Risk Factors” in the Company’s Annual Report on Form10-K for the year ended December 31, 2003, which should be considered inconnection with a review of this report.

 

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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.

 

ITEM 4. CONTROLS ANDPROCEDURES

 

**The Company carried out anevaluation, under the supervision and with the participation of management,including the Company’s Chief Executive Officer and Chief Financial Officer, ofthe effectiveness of the design and operation of the Company’s disclosurecontrols and procedures as of the end of the period covered by this reportpursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and ChiefFinancial Officer concluded that the Company’s disclosure controls andprocedures were effective in timely alerting them to material informationrelating to the Company required to be included in the Company’s periodicSecurities and Exchange Commission filings. There were no changes in the Company’s internal control over financialreporting that occurred during the Company’s most recent fiscal quarter thatwould have materially affected, or are reasonably likely to materially affect,the Company’s internal control over financial reporting.**

PART II - OTHER INFORMATION

 

ITEM 1.  LEGAL PROCEEDINGS

 

Notapplicable.

 

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITIESHOLDERS

 

On August 3, 2004, the Company held its annual meetingof stockholders.  For more information onthe following proposals, refer to the Company’s proxy statement dated May 28,2003, the relevant portions of which are incorporated herein by reference.

 

1.               The stockholders electedeach of the five nominees to the Company’s Board of Directors who will serve untilthe 2004 annual meeting of stockholders or until their successors are electedand qualified:

 
| **Director**              | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|---------------------------|------------|------------|------------|--------------|------------|
|                      |       |       |       |         |       |
| Kenneth H. Traub          |       | 13,148,193 |       | 933,268      |       |
| Salvatore F. D’Amato |       | 14,009,217 |       | 132,244      |       |
| Fred J. Levin             |       | 13,682,074 |       | 459,387      |       |
| Douglas A. Crane          |       | 13,571,802 |       | 569,659      |       |
| Mark J. Bonney            |       | 13,688,796 |       | 452,665      |       |

 

2.               The stockholders ratifiedthe selection of Ernst & Young LLP as the independent auditors of theCompany:

 
| For            |   | 14,064,892 |   |
|----------------|--------|------------|--------|
| Against        |   | 63,587     |   |
| Abstain        |   | 12,982     |   |
| Broker No Vote |   | 0          |   |
|           |   |       |   |
| Total          |   | 14,141,461 |   |

 

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ITEM 6.  EXHIBITS

 

(a)                        Exhibits

 

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

 

31.2    Certification of Alan Goldstein pursuant toExchange Act Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of theSarbanes-Oxley Act of 2002.

 

32.1    Certification of Kenneth H. Traub pursuantto 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

32.2    Certification of Alan Goldstein pursuant to18 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/ Alan Goldstein

_______________

Alan Goldstein

Vice President,

Chief Financial Officer and

Chief Accounting Officer

 

Date:  November 12, 2004

 

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