**SECURITIES AND EXCHANGECOMMISSION**

 

**Washington, DC 20549**

 

**FORM 10-Q**

 

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

 

**For the quarterly period ended June 30, 2005**

 

**OR**

 

**o****   ****TRANSITION REPORT PURSUANT TO SECTION 13OR 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 sincelast report)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the Registrant was required to filesuch reports) and (2) has been subject to such filing for the past 90days.

 

ý Yes   o No

 

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

 

o Yes   ý No

 

The aggregate number ofshares of common stock, $.01 par value, outstanding on August 1, 2005 was18,595,969.

 

 

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**AMERICAN BANK NOTE HOLOGRAPHICS, INC.**

 

**FORM 10-Q**

 

## **INDEX**

## ** **

| PART I -  FINANCIAL INFORMATION                                                                              |   |
|-------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                              |   |
| Item 1.  Financial Statements                                                                                     |   |
|                                                                                                              |   |
| Condensed Balance Sheets as of June 30, 2005  (Unaudited) and December 31, 2004                         |   |
|                                                                                                              |   |
| Condensed Statements of Operations—Unaudited For the  Three and Six Months Ended June 30, 2005 and 2004 |   |
|                                                                                                              |   |
| Condensed Statements of Cash Flows—Unaudited For the  Six Months Ended June 30, 2005 and 2004           |   |
|                                                                                                              |   |
| 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 6. Exhibits                                                                                                  |   |

 

2

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PART I - FINANCIALINFORMATION

 

ITEM I. FINANCIALSTATEMENTS

 

AMERICAN BANK NOTEHOLOGRAPHICS, INC.

CONDENSED BALANCE SHEETS

(In thousands, exceptshare data)

 
| ** **                                                                                                                             | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                             | ** ** | **(Unaudited)**         | ** ** | **(Note A)**                | ** ** |
| ASSETS                                                                                                                                 | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current Assets:                                                                                                                        |       |                    |       |                        |       |
| Cash and cash equivalents                                                                                                              |       | $                       | 11,605     |                        | $          | 11,357 |   |
| Short-term investments                                                                                                                 |       | —                  |       | 1,989                       |       |
| Accounts receivable, net of allowance for doubtful  accounts of $190 and $180                                                          |       | 4,411                   |       | 3,889                       |       |
| Inventories                                                                                                                            |       | 5,613                   |       | 3,394                       |       |
| Deferred income taxes                                                                                                                  |       | 1,042                   |       | 983                         |       |
| Prepaid expenses                                                                                                                       |       | 168                     |       | 317                         |       |
| Total current assets                                                                                                                   |       | 22,839                  |       | 21,929                      |       |
| Machinery, equipment and leasehold improvements, net  of accumulated depreciation and amortization of $10,460 and $10,062              |       | 5,609                   |       | 3,172                       |       |
| Other assets                                                                                                                           |       | 99                      |       | 110                         |       |
|                                                                                                                                   |       |                    |       |                        |       |
| Total Assets                                                                                                                           |       | $                       | 28,547     |                        | $          | 25,211 |   |
|                                                                                                                                   |       |                    |       |                        |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                              |       |                    |       |                        |       |
| Current Liabilities:                                                                                                                   |       |                    |       |                        |       |
| Accounts payable                                                                                                                       |       | $                       | 3,282      |                        | $          | 1,519 |   |
| Accrued expenses                                                                                                                       |       | 2,478                   |       | 2,065                       |       |
| Deferred revenue                                                                                                                       |       | 136                     |       | —                      |       |
| Customer advances                                                                                                                      |       | 110                     |       | 69                          |       |
| Income taxes payable                                                                                                                   |       | 858                     |       | 1,058                       |       |
| Total current liabilities                                                                                                              |       | 6,864                   |       | 4,711                       |       |
| Other long-term liabilities                                                                                                            |       | 1,160                   |       | 1,186                       |       |
|                                                                                                                                   |       |                    |       |                        |       |
| Total liabilities                                                                                                                      |       | 8,024                   |       | 5,897                       |       |
|                                                                                                                                   |       |                    |       |                        |       |
| 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 18,591,969 shares and 18,515,907  shares |       | 186                     |       | 185                         |       |
| Additional paid-in capital                                                                                                             |       | 24,206                  |       | 24,058                      |       |
| Accumulated deficit                                                                                                                    |       | (3,869                  | )          | (4,929                      | )          |
| Total Stockholders’ Equity                                                                                                        |       | 20,523                  |       | 19,314                      |       |
|                                                                                                                                   |       |                    |       |                        |       |
| Total Liabilities and Stockholders’ Equity                                                                                        |       | $                       | 28,547     |                        | $          | 25,211 |   |

 

See Notes to Unaudited Condensed Financial Statements.

 

3

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AMERICAN BANK NOTEHOLOGRAPHICS, INC.

CONDENSED STATEMENTS OFOPERATIONS - UNAUDITED

(In thousands, except pershare data)

 
| ** **                               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                               | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue:                                 | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sales                                    |       | $                                     | 6,857      |                                | $          | 4,907 |   | $ | 13,257 |   | $ | 9,941 |   |
| Royalty income                           |       | —                                |       | 3                                   |       | 10 |   | 13 |   |
|                                     |       | 6,857                                 |       | 4,910                               |       | 13,267 |   | 9,954 |   |
| Costs and expenses:                      |       |                                  |       |                                |       |   |   |   |   |
| Cost of goods sold                       |       | 3,161                                 |       | 2,260                               |       | 5,960 |   | 4,530 |   |
| Selling and administrative               |       | 2,213                                 |       | 1,751                               |       | 4,131 |   | 3,434 |   |
| Research and development                 |       | 308                                   |       | 365                                 |       | 581 |   | 648 |   |
| Depreciation and amortization            |       | 277                                   |       | 164                                 |       | 628 |   | 324 |   |
| Facility consolidation                   |       | 215                                   |       | —                              |       | 322 |   | — |   |
|                                     |       | 6,174                                 |       | 4,540                               |       | 11,622 |   | 8,936 |   |
|                                     |       |                                  |       |                                |       |   |   |   |   |
| Operating income                         |       | 683                                   |       | 370                                 |       | 1,645 |   | 1,018 |   |
|                                     |       |                                  |       |                                |       |   |   |   |   |
| Other income:                            |       |                                  |       |                                |       |   |   |   |   |
| Interest income                          |       | 68                                    |       | 25                                  |       | 122 |   | 48 |   |
| Patent agreement                         |       | —                                |       | 178                                 |       | — |   | 178 |   |
|                                     |       | 68                                    |       | 203                                 |       | 122 |   | 226 |   |
|                                     |       |                                  |       |                                |       |   |   |   |   |
| Income before provision for income taxes |       | 751                                   |       | 573                                 |       | 1,767 |   | 1,244 |   |
| Provision for income taxes               |       | 301                                   |       | 229                                 |       | 707 |   | 498 |   |
|                                     |       |                                  |       |                                |       |   |   |   |   |
| Net income                               |       | $                                     | 450        |                                | $          | 344 |   | $ | 1,060 |   | $ | 746 |   |
|                                     |       |                                  |       |                                |       |   |   |   |   |
| Net income per share:                    |       |                                  |       |                                |       |   |   |   |   |
| Basic and diluted                        |       | $                                     | 0.02       |                                | $          | 0.02 |   | $ | 0.06 |   | $ | 0.04 |   |

 

See Notes to Unaudited Condensed Financial Statements.

 

4

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AMERICAN BANK NOTEHOLOGRAPHICS, INC.

CONDENSED STATEMENTS OFCASH FLOWS - UNAUDITED

(In thousands)

 
| ** **                                                                         | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **                                                                         | ** ** | ** **                          | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                              | ** ** | ** **                          | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                                   | 1,060      |   | $ | 746 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                |       |   |   |
| Depreciation and amortization                                                      |       | 628                                 |       | 324 |   |
| Deferred income taxes                                                              |       | (85                                 | )          | 21 |   |
| Provision for doubtful accounts                                                    |       | 10                                  |       | — |   |
| Changes in operating assets and liabilities:                                       |       |                                |       |   |   |
| Accounts receivable                                                                |       | (532                                | )          | (157 | ) |
| Inventories                                                                        |       | (2,219                              | )          | 119 |   |
| Prepaid expenses and other                                                         |       | 157                                 |       | 405 |   |
| Accounts payable and accrued expenses                                              |       | 1,444                               |       | 215 |   |
| Deferred revenue                                                                   |       | 136                                 |       | — |   |
| Customer advances                                                                  |       | 41                                  |       | 52 |   |
| Income taxes payable                                                               |       | (200                                | )          | 449 |   |
|                                                                               |       |                                |       |   |   |
| Net cash provided by operating activities                                          |       | 440                                 |       | 2,174 |   |
|                                                                               |       |                                |       |   |   |
| Cash flows from investing activities:                                              |       |                                |       |   |   |
| Decrease (increase) in short-term investments                                      |       | 1,989                               |       | (4,621 | ) |
| Capital expenditures                                                               |       | (2,330                              | )          | (467 | ) |
|                                                                               |       |                                |       |   |   |
| Net cash used in investing activities                                              |       | (341                                | )          | (5,088 | ) |
|                                                                               |       |                                |       |   |   |
| Cash flows from financing activities:                                              |       |                                |       |   |   |
| Proceeds from exercise of stock options                                            |       | 149                                 |       | — |   |
|                                                                               |       |                                |       |   |   |
| Net cash provided by financing activities                                          |       | 149                                 |       | — |   |
|                                                                               |       |                                |       |   |   |
| Increase (decrease) in cash and cash equivalents                                   |       | 248                                 |       | (2,914 | ) |
| Cash and cash equivalents, beginning of period                                     |       | 11,357                              |       | 7,340 |   |
|                                                                               |       |                                |       |   |   |
| Cash and cash equivalents, end of period                                           |       | $                                   | 11,605     |   | $ | 4,426 |   |
|                                                                               |       |                                |       |   |   |
| Supplemental cash flow information:                                                |       |                                |       |   |   |
| Taxes paid                                                                         |       | $                                   | 990        |   | $ | 11 |   |
| Capital expenditures included in accounts payable                                  |       | $                                   | 732        |   | $ | 24 |   |

 

See Notes to Unaudited Condensed Financial Statements.

 

5

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AMERICAN BANK NOTEHOLOGRAPHICS, INC.

NOTES TO UNAUDITEDCONDENSED FINANCIAL STATEMENTS

 

NOTE A - BASIS OFPRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

American Bank NoteHolographics, Inc. (the “Company”) originates, mass-produces, and marketssecure holograms. Holograms are used for security, packaging and promotionalapplications. The Company operates in one reportable industry segment.

 

The accompanyingunaudited condensed financial statements have been prepared in accordance withU.S. generally accepted accounting principles for interim financial informationand 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 six months ended June 30, 2005 are notnecessarily indicative of the results that may be expected for the year ending December 31,2005.

 

The balance sheet at December 31,2004 has been derived from the audited financial statements at that date butdoes not include all of the information and footnotes required by U.S.generally accepted accounting principles for complete financial statements.

 

For further information,refer to the financial statements and footnotes thereto included in the Company’sannual report on Form 10-K for the year ended December 31, 2004,as filed with the United States Securities and Exchange Commission (“SEC”).

 

REVENUE RECOGNITION

 

The Company recognizesrevenue in accordance with the provisions of the SEC’s Staff AccountingBulletin (“SAB”) No. 104, “Revenue Recognition (an amendment of SAB 101, “RevenueRecognition”).”  Specifically, sales andthe related cost of goods sold are generally recognized at the latter of thetime of shipment or when title passes to customers. In some situations, theCompany has shipped product where the sale is contingent upon the customers’use of the product. In these situations, the Company does not recognize salesupon product shipment, but rather when the buyer of the product informs theCompany that the product has been used. Additionally, pursuant to terms with a certain customer, completed itemsare stored on behalf of the customer at the Company’s on-site secured facilityand, in that instance, sales are recognized when all of the following haveoccurred: the customer has ordered the goods, the manufacturing process iscomplete, the goods have been transferred to the on-site secured facility andare ready for shipment, the risk of ownership has passed to the customer andthe customer has been billed for the order.

 

Customer advances representpayments received from customers for products which have not yet beenshipped.  These customer advances areclassified as current liabilities on the accompanying balance sheets.

 

Shipping and handlingamounts billed to customers are included in sales and amounted to $152,000 and$263,000 for the three and six months ended June 30, 2005, respectively,and $116,000 and $224,000 for the three and six months ended June 30, 2004,respectively.  Shipping and handlingcosts are included in selling and administrative expenses.

 

BASIC AND DILUTED NETINCOME PER SHARE

 

Basic net income pershare is computed based on the weighted average number of outstanding shares ofcommon stock. The basic weighted average number of shares outstanding were 18,550,331and 18,533,230 for the three and six months ended June 30, 2005,respectively, and 18,483,720 for each of the three and six months ended June 30,2004. Diluted net income per share is computed by dividing net income by theweighted average number of shares of common stock outstanding and dilutivepotential shares of common stock. For the three and six months ended June 30,2005, the diluted number of weighted average shares outstanding was 19,401,664 and19,255,093, respectively, which includes dilutive stock options of 851,333shares and 721,863 shares, respectively. For the three and six months ended June 30,2004, the diluted number of weighted average shares outstanding was 18,945,209

 

6

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and 18,830,933,respectively, which includes dilutive stock options of 461,489 shares and347,213 shares, respectively.

 

BUSINESS INFORMATION

 

Sales toMasterCard were approximately 36% and 37% of sales for the three months ended June 30,2005 and 2004, respectively, and 35% and 36% of sales for the six months ended June 30,2005 and 2004, respectively. The Company has an agreement with MasterCard, asamended, in which MasterCard has retained the Company to produce MasterCardholograms through February 28, 2011, subject to automatic renewal if notterminated by either party.  The loss ofall or a substantial portion of the sales to MasterCard would have a materialadverse effect on the financial position, results of operations and cash flowsof the Company. At June 30, 2005 and December 31, 2004, accountsreceivable from this customer totaled $1.8 million and $1.1 million,respectively.

 

Sales of VISA hologramsto manufacturers of VISA credit cards were approximately 24% and 30% of salesfor the three months ended June 30, 2005 and 2004, respectively, and 23%and 32% of sales for the six months ended June 30, 2005 and 2004,respectively. The loss of a substantial portion of the sales to manufacturersof VISA credit cards would have a material adverse effect on the financialposition, results of operations and cash flows of the Company. Accountsreceivable from these customers approximated $1.5 million and $1.2 million at June 30,2005 and December 31, 2004, respectively.

 

The Company purchasescertain key materials used in the manufacture of its holograms and outsourcescertain key processes from third party suppliers, some of which are sole sourcerelationships, with whom the Company does not have supply contracts. Anyproblems that occur with respect to the delivery, quality or cost of any suchmaterials or processes could have a material adverse effect on the financialposition, results of operations and cash flows of the Company.

 

STOCK-BASED COMPENSATIONPLANS

 

As allowed by SFAS No. 123,the Company has elected to continue to apply the intrinsic value-based methodof accounting prescribed in APB Opinion No. 25 and, accordingly, does notrecognize compensation expense for stock option grants made at an exerciseprice equal to or in excess of the fair market value of the stock at the dateof grant.

 

Had compensation costsfor the Company’s outstanding stock options been determined based on the fairvalue at the grant dates for those options consistent with SFAS No. 123,the Company’s net income and basic and diluted net income per share would havediffered as reflected by the pro forma amounts indicated below:

 
| ** **                                          | ** **                                                                                                        | **Three Months Ended  June 30,**      | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------|-------------------------------------------------------------------------------------------------------------------|--------------------------------------------|------------|-------------------------------------|------------|
| ** **                                          | ** **                                                                                                        | **2005**                                   | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                          | ** **                                                                                                        | **(In thousands, except per share  data)** | ** ** |
|                                                |                                                                                                              |                                       |       |                                |       |   |   |   |   |
| Net income, as reported                             |                                                                                                              | $                                          | 450        |                                | $          | 344 |   | $ | 1,060 |   | $ | 746 |   |
| 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 |                                       | 62         |                                | 30         |   | 103 |   | 60 |   |
| Pro forma, net income                               |                                                                                                              | $                                          | 388        |                                | $          | 314 |   | $ | 957 |   | $ | 686 |   |
|                                                |                                                                                                              |                                       |       |                                |       |   |   |   |   |
| Basic and diluted net income per share, as reported |                                                                                                              | $                                          | 0.02       |                                | $          | 0.02 |   | $ | 0.06 |   | $ | 0.04 |   |
| Basic and diluted net income per share, pro forma   |                                                                                                              | $                                          | 0.02       |                                | $          | 0.02 |   | $ | 0.05 |   | $ | 0.04 |   |
|                                                     |                                                                                                                   |                                            |            |                                     |            |  |  |  |  |  |  |  |  |  |

 

7

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WARRANTY COSTS

 

The Companyprovides for warranty costs in amounts it estimates will be needed to coverfuture warranty obligations for products sold. Estimates of warranty costs are based on historical experience and areperiodically reviewed and adjusted, when necessary.  The Company’s product warranty provision isincluded in accrued expenses in the accompanying balance sheets. Changes in theCompany’s warranty provision are as follows:

 
| ** **                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                     | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                     | ** ** | **(In thousands)**                    | ** ** | **(In thousands)**                  | ** ** |
|                           |       |                                  |       |                                |       |   |   |   |   |
| Balance at beginning of period |       | $                                     | 505        |                                | $          | 524 |   | $ | 510 |   | $ | 510 |   |
| Warranties issued              |       | 60                                    |       | 40                                  |       | 120 |   | 80 |   |
| Settlements made               |       | (17                                   | )          | (78                                 | )          | (82 | ) | (104 | ) |
| Balance at June 30        |       | $                                     | 548        |                                | $          | 486 |   | $ | 548 |   | $ | 486 |   |
|                                |            |                                       |            |                                     |            |  |  |  |  |  |  |  |  |  |

 

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

 

IMPACT OF RECENTLY ISSUEDACCOUNTING STANDARDS — In December 2004, the Financial AccountingStandards Board issued Statement No. 123(R) (FAS 123R), Share-BasedPayment, amending 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 interim or annual period beginning after December 15,2005. The Company expects to adopt the new statement effective January 1,2006, using the modified-prospective transition method described in thestatement. Under this method, the Company will be required to recognizecompensation expense over the remaining vesting period for all awards thatremain unvested as of January 1, 2006. As permitted by FAS 123, theCompany currently accounts for share-based payments to employees using APB 25’sintrinsic value method and, as such, generally recognized no compensation costfor employee stock options. The Company is still assessing the impact that theadoption of FAS 123R will have on its financial position, results of operationsor cash flows.

 

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. The Company currently believes that the adoption of FAS 151 will not havea material impact on its financial statements.

 

In March 2005, theFinancial Accounting Standards Board (“FASB”) issued interpretation No. 47,*Accounting for Conditional Asset Retirement Obligations*,an interpretation of SFAS No. 143. This interpretation clarifies that theterm of *conditional asset retirement obligation*refers to a legal obligation to perform an asset retirement activity in whichthe timing and/or method of settlement are conditional on a future event thatmay or may not be within the control of the entity. The obligation to performthe asset retirement activity is unconditional even though uncertainty existsabout the timing and/or method of settlement. Accordingly, an entity isrequired to recognize a liability for the fair value of a conditional assetretirement obligation if the fair value of the liability can be reasonablyestimated. The provisions of Interpretation 47 are effective for fiscal yearsending after December 15, 2005. The adoption of this statement will nothave an impact to the Company’s 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

 

8

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cumulative effect of thechange. Indirect effects of a change in accounting principle should berecognized in the period of the accounting change. The provisions of SFAS No. 154are effective for fiscal years beginning after December 15, 2005. TheCompany will adopt this Statement beginning January 1, 2006.

 

NOTE B - INVENTORIES

 

Inventories consist ofthe following:

 
| ** **                                   | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                   | ** ** | **(Unaudited)**         | ** ** | **(Note A)**                | ** ** |
| ** **                                   | ** ** | **(In thousands)**      | ** ** |
|                                         |       |                    |       |                        |       |
| Finished goods                               |       | $                       | 3,886      |                        | $          | 1,749 |   |
| Finished goods on consignment with customers |       | 228                     |       | 231                         |       |
| Work in process                              |       | 1,026                   |       | 1,044                       |       |
| Raw materials                                |       | 473                     |       | 370                         |       |
|                                         |       | $                       | 5,613      |                        | $          | 3,394 |   |

 

NOTE C - OTHER LONG-TERM LIABILITIES

 

Other long-term liabilities at both June 30, 2005 andDecember 31, 2004 include an $800,000 reserve for potential taxliabilities.  Also included in otherlong-term liabilities at June 30, 2005 and December 31, 2004 are $360,000 and$386,000, respectively, of long-term deferred income taxes.

 

NOTE D - FACILITYCONSOLIDATION

 

On December 14,2004, the Company entered into certain agreements to lease a new 134,000 squarefoot facility located in Robbinsville, New Jersey which will be the site of theCompany’s primary operations following the closure, relocation and consolidationof its operations in Elmsford, New York and Huntingdon Valley, Pennsylvaniainto the Robbinsville site.  The Company hasbegun the relocation as well as the expansion of its manufacturing operationsin connection with this consolidation.

 

The lease is effective asof December 14, 2004 and expires on May 31, 2017. Under theagreements the Company has the right to renew the lease for three consecutivefive year terms and also has an option to purchase the building.

 

The Company currentlyexpects to incur expenses totaling approximately $3.6 million associated withits existing leases, vacating its current facilities, relocating andterminating certain employees, moving equipment and other related expenseswhich will be substantially complete in the third quarter of 2005.  Approximately $2.6 million of the totalexpenses will be paid in cash ratably through the fourth quarter of 2007.    The remainder of these expenses will bepaid in cash as incurred through the fourth quarter of 2005. Of theapproximately $3.6 million the Company expects to incur, $0.3 million and $0.2million was incurred in 2005 and 2004, respectively, and are classified asfacility consolidation expenses on the accompanying statement of operations.

 

NOTE E - COMMITMENTS ANDCONTINGENCIES

 

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

 

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

 

The following discussionand analysis should be read in conjunction with the Company’s unauditedfinancial statements, including the notes thereto, appearing elsewhere in thisreport.

 

OVERVIEW

 

The Company originates,mass-produces and markets holograms. The Company’s holograms are used primarilyfor security applications such as counterfeiting protection for credit andother transaction cards, identification cards and documents of value, as wellas for tamper resistance and authentication of high-value consumer andindustrial products.  The Company alsoproduces non-secure holograms for packaging and promotional applications.  The

 

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Company’s sales ofholograms for security applications generally carry higher gross margins thansales for non-security applications.

 

A significant portion of the Company’s business isderived from orders placed by certain credit card companies, includingMasterCard and manufacturers of VISA brand credit cards, and variations in thetiming of such orders can cause significant fluctuations in the Company’ssales. Sales to MasterCard were approximately 36% and 37% of sales for thethree months ended June 30, 2005 and 2004, respectively, and 35% and 36%of sales for the six months ended June 30, 2005 and 2004, respectively.The Company has an agreement with MasterCard, as amended, in which MasterCardretained the Company to produce MasterCard holograms through February 28,2011, subject to automatic renewal if not terminated by either party.  Sales of VISA holograms to manufacturers ofVISA credit cards were approximately 24% and 30% of sales for the three monthsended June 30, 2005 and 2004, respectively, and 23% and 32% of sales forthe six months ended June 30, 2005 and 2004, respectively. Currently weare one of two companies authorized to manufacture and sell VISA brandholograms to manufacturers of VISA brand credit cards.****OnMarch 15, 2005, VISA announced its intention to phase out the Dovehologram that we supply for the front of the VISA card, and to replace it withan integrated holographic magnetic stripe. On April 8, 2005, we enteredinto an Agreement with VISA, pursuant to which we are authorized to supply the holographicmagnetic stripe to VISA-approved card manufacturers. We cannot assure you thatfuture sales of our holographic magnetic stripe to VISA’s authorized cardmanufacturers will be as successful or profitable as our historical sales ofthe VISA Dove hologram. If we were to lose a substantial portion of ourbusiness with either MasterCard or VISA without replacing it with new productsales, our business, operating results and financial condition would bematerially and adversely affected. In addition, if we fail to obtainanticipated orders from these customers or if we experience delays orcancellations of orders from these customers, our business and financialperformance will be materially and adversely affected.

 

Holograms are sold underpurchase orders and contracts with customers. Sales and the related cost ofgoods sold are generally recognized at the latter of the time of shipment orwhen title passes to customers. In some situations, the Company has shippedproduct where the sale is contingent upon the customers’ use of the product. Inthese situations, the Company does not recognize sales upon product shipment,but rather when the buyer of the product informs the Company that the producthas 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.

 

The Company purchasescertain key materials used in the manufacture of its holograms and outsourcescertain key processes from third party suppliers, some of whom are sole sourcerelationships, with which it does not have supply contracts. Any problems thatoccur with respect to the delivery, quality or cost of any such materials orprocesses could have a material adverse effect on the Company’s financialposition, results of operations and cash flows.

 

Sales may fluctuate fromquarter to quarter due to changes in customers’ ordering patterns. Customers donot typically provide the Company with precise forecasts of future orderquantities. Quarterly demand for holograms may be materially influenced bycustomers’ promotions, inventory replenishment, card expiration patterns,delivery schedules and other factors which may be difficult for the Company toanticipate.

 

Cost of goods soldincludes raw materials such as nickel, foils, films and adhesives; labor costs;manufacturing overhead; and hologram origination costs (which represent costsof a unique master hologram that is made to customer specifications and is anintegral part of the production process). As a result, costs of goods sold areaffected by product mix, manufacturing yields, costs of hologram originationsand changes in the cost of raw materials and labor.

 

Selling andadministrative expenses primarily consist of salaries, benefits and commissionsfor the Company’s corporate, sales, marketing and administrative personnel,marketing and promotion expenses, legal and accounting expenses and expensesassociated with being a public company.

 

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COMPARISON OF THREE MONTHSENDED JUNE 30, 2005 TO THREE MONTHS ENDED JUNE 30, 2004

 

*Sales.*  Sales increased by $2.0 million, or 39.7%,from $4.9 million for the three months ended June 30, 2004 to $6.9 millionfor the three months ended June 30, 2005. The increase was primarily due to the implementation of new customerprograms in the transaction card and identity document markets and growth withexisting customers.

 

*Cost ofGoods Sold.*  Cost ofgoods sold increased by $0.9 million, from $2.3 million for the three monthsended June 30, 2004 to $3.2 million for the three months ended June 30,2005.  As a percentage of sales, cost ofgoods sold remained constant at 46.1% for both of the three month periods endedJune 30, 2004 and 2005.  Cost ofgoods sold in the current period included approximately $0.3 million of costs associatedwith operating an additional facility including duplicative rent, utilities andsupplies.

 

*Sellingand Administrative.* Selling and administrative expenses increased $0.4 million from $1.8million for the three months ended June 30, 2004 to $2.2 million for thethree months ended June 30, 2005. As a percentage of sales, selling andadministrative expenses decreased from 35.7% for the three months ended June 30,2004 to 32.3% for the same period in 2005. The increase in expenses was primarily due to higher professional feesand travel as well as costs associated with operating an additional facilityincluding duplicative rent, utilities, supplies and recruitment for the newfacility.

 

*Researchand Development. *Researchand development expenses decreased $0.1 million from $0.4 million for the threemonths ended June 30, 2004 to $0.3 million for the same period in 2005.The decrease was primarily due to a decrease in testing expenses due to fewersamples for new products.

 

*Depreciationand Amortization.* Depreciation and amortization increased $0.1 million from $0.2 millionfor the three months ended June 30, 2004 to $0.3 million for the sameperiod in 2005. The increase was primarily due to the acceleration ofdepreciation and amortization on equipment and leasehold improvements to beabandoned upon the consolidation of the Company’s operations in its newfacility in Robbinsville, New Jersey.

 

*FacilityConsolidation Expenses.*Facility consolidation expenses of$0.2 million pertain to expenses incurred for the Company’s new facility inRobbinsville, New Jersey and consist primarily moving expenses for machineryand equipment.

 

*InterestIncome*.  Interestincome increased $43,000 from $25,000 for the three months ended June 30,2004 to $68,000 for the three months ended June 30, 2005 due to higherinterest rates in effect during the current period.

 

*PatentAgreement.* During the three months ended June 30, 2004 theCompany entered into an agreement with a competitor in which the Company waspaid $178,000, which did not recur in the current period.

 

COMPARISON OF SIX MONTHSENDED JUNE 30, 2005 TO SIX MONTHS ENDED JUNE 30, 2004

 

*Sales*.  Sales increased by $3.4 million, or 33.4%,from $9.9 million for the six months ended June 30, 2004 to $13.3 millionfor the six months ended June 30, 2005. The increase was primarily due to the implementation of new customerprograms in the transaction card and identity document markets and growth withexisting customers.

 

*Cost ofGoods Sold*.  Cost ofgoods sold increased by $1.5 million, from $4.5 million for the six monthsended June 30, 2004 to $6.0 million for the six months ended June 30,2005.  As a percentage of sales, cost ofgoods sold decreased from 45.6% in the six months ended June 30, 2004 to 45.0%for the same period in 2005.  The decreaseof 0.6 percentage points was primarily due to the increase in sales volume.Cost of goods sold in the current period included approximately $0.4 million ofcosts associated with operating an additional facility including duplicativerent, utilities and supplies.

 

*Sellingand Administrative*. Selling and administrative expenses increased $0.7 million from $3.4million for the six months ended June 30, 2004 to $4.1 million for the sixmonths ended June 30, 2005. As a percentage of sales, selling andadministrative expenses decreased from 34.5% for the six months ended June 30,2004 to 31.2% for the six months ended June 30, 2005. The increase inexpenses was primarily due to higher commission and travel

 

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expenses as well as costsassociated with operating an additional facility including duplicative rent,utilities, supplies and recruitment for the new facility.

 

*Researchand Development*.* *Research and development expenses decreased$0.1 million from $0.7 million for the six months ended June 30, 2004 to $0.6million for the same period in 2005. The decrease was primarily due to a decreasein testing expenses for new products.

 

*Depreciationand Amortiza*tion.  Depreciationand amortization increased $0.3 million from $0.3 million for the six monthsended June 30, 2004 to $0.6 million for the same period in 2005. Theincrease was primarily due to the acceleration of depreciation and amortizationon equipment and leasehold improvements to be abandoned upon the consolidationof the Company’s operations in its new facility in Robbinsville, New Jersey.

 

*FacilityConsolidation Expenses.*Facility consolidation expenses of$0.3 million pertain to expenses incurred for the Company’s new facility inRobbinsville, New Jersey and consist primarily of expenses for the moving ofmachinery and equipment, employee relocation and severance.

 

*InterestIncome*.  Interestincome increased $74,000 from $48,000 for the six months ended June 30,2004 to $122,000 for the six months ended June 30, 2005 due to higherinterest rates in effect during the current period.

 

*PatentAgreement.* During the six months ended June 30, 2004 theCompany entered into an agreement with a competitor in which the Company waspaid $178,000, which did not recur in the current period.

 

LIQUIDITY AND CAPITALRESOURCES

 

At June 30, 2005,the Company had $11.6 million in cash and cash equivalents and working capitalof $16.0 million.

 

The Company’soperating activities provided cash of $0.4 million for the six months ended June 30,2005, compared to $2.2 million of cash provided for the six months ended June 30,2004. The decrease was primarily due to the build-up of inventory inanticipation of the facility consolidation program. Investing activities forthe six months ended June 30, 2005 used cash of $0.3 million as a resultof capital expenditures, primarily associated with the new facility, of $2.3million being offset by sales of short-term investments of $2.0 million.Investing activities for the six months ended June 30, 2004 used cash of$5.1 million primarily as a result of capital expenditures of $0.5 million and purchasesof short-term investments of $4.6 million. Financing activities for the sixmonths ended June 30, 2005 provided cash of $0.1 million due to theexercise of stock options. There were no financing activities for the six-monthperiod ended June 30, 2004.

 

On December 14, 2004, the Company entered intoagreements to lease a 134,000 square foot modern manufacturing and officebuilding in Robbinsville, New Jersey, which will be the site of its primaryoperations following the closure, relocation and consolidation of itsoperations in Elmsford, New York and Huntingdon Valley, Pennsylvania into theRobbinsville site. The Company has substantially completed construction withinthis facility to meet its specialized operational and security requirements.  The new facility provides substantial room forexpansion as the Company will consolidate its operations that were beingconducted within a 58,000 square foot facility in Elmsford, New York and a30,000 square foot facility in Huntingdon Valley, Pennsylvania into the newfacility. The Company has also begun acquiring and installing additionalequipment and technology to be installed in the new facility in order tobroaden its capabilities to serve its target customers, expand capacity andimprove efficiency.

 

The base rent on the newlease 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 arerent-free. Through June 30, 2005 the Company has recorded deferred rent of$0.3 million. The Company currently pays a combined base rent of $889,000 peryear for its two existing smaller facilities in Elmsford, New York andHuntingdon Valley, Pennsylvania. The term of the new lease for theRobbinsville, New Jersey facility is through May 31, 2017, and at theexpiration of the term, the Company has options to renew the lease for threeconsecutive five year periods and an option to purchase the building after theend of the original lease term for the adjusted fair market value as defined inthe lease agreement.

 

The Company currentlyanticipates investing approximately $7.4 million through 2005, of whichapproximately $3.1 million has been expended through June 30, 2005,including $.9 million expended in 2004. The estimated $7.4 million includesexpenditures for facility upgrades to customize the Robbinsville, New Jersey facilityfor the

 

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Company’s operational andsecurity requirements as well as the acquisition of new equipment to upgradeand expand our production capabilities.

 

The Company believes that cash flows from operationsand its cash balances will be sufficient to meet working capital needs and fundcapital expenditures, including expenditures relating to the Robbinsville facility,for the next twelve months.

 

The Company alsocurrently expects to incur expenses totaling approximately $3.6 million relatedto the relocation and consolidation of facilities, of which $0.5 million hasbeen incurred through June 30, 2005. The estimated $3.6 million includesthose expenses associated with existing leases, vacating its current facilitiesin Elmsford, New York and Huntingdon Valley, Pennsylvania, relocating andterminating certain employees, moving equipment and other related expenseswhich the Company expects to be substantially complete by the third quarter of2005.  These costs will be presented asfacility consolidation expense on the Company’s financial statements.  Approximately $2.6 million of these expenseswill be paid in cash ratably through the fourth quarter of 2007.    The remainder of these expenses will be paidin cash as incurred through the fourth quarter of 2005.

 

SPECIAL NOTE REGARDINGFORWARD - LOOKING STATEMENTS

 

Certain statements inthis 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 Form 10-Kfor the year ended December 31, 2004, which should be considered inconnection with a review of this report.

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK

 

The Company does notengage in significant activity with respect to market risk sensitive instruments.Accordingly, our risk with respect to market risk sensitive instruments isimmaterial.

 

ITEM 4. CONTROLS ANDPROCEDURES

 

**The Company carried out an evaluation, under thesupervision and with the participation of management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of the Company’s disclosure controls and procedures as ofthe end of the period covered by this report pursuant to Exchange Act Rule 13a-15.  Based upon that evaluation, the ChiefExecutive Officer and Chief Financial Officer concluded that the Company’sdisclosure controls and procedures were effective in timely alerting them tomaterial information relating to the Company required to be included in the Company’speriodic Securities and Exchange Commission filings.  There were no changes in the Company’sinternal control over financial reporting that occurred during the Company’smost recent fiscal quarter that would have materially affected, or are reasonablylikely to materially affect, the Company’s internal control over financialreporting.**

** **

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** **

PART II - OTHERINFORMATION

 

ITEM 6. EXHIBITS

 

 

10.1                           Amendedand Restated Employment Agreement dated June 9, 2005 between the Companyand Alan Goldstein

 

10.2                           EmploymentAgreement dated June 9, 2005 between the Company and Mark J. Bonney.

 

10.3                           Amendmentto the American Bank Note Holographics, Inc. 2000 Stock Incentive Plan.

 

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

 

32.2                           Certificationof Mark J. Bonney pursuant to 18 U.S.C. Section 1350, as adopted pursuantto 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:  August 15, 2005

 

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