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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-K

[X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
       SECURITIES EXCHANGE ACT OF 1934

                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998

                                       OR

[  ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
       EXCHANGE ACT OF 1934

                 FOR THE TRANSITION PERIOD OF           TO

                           COMMISSION FILE NO. 1-3410

                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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                        DELAWARE                                                                        13-3317668
            (STATE OR OTHER JURISDICTION OF                                                       (I.R.S. EMPLOYER
             INCORPORATION OR ORGANIZATION)                                                 IDENTIFICATION NUMBER)

                399 EXECUTIVE BOULEVARD
                      ELMSFORD, NY                                                                           10523
        (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                                                        (ZIP CODE)
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                                 (914) 592-2355
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
                                      NONE

          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                     COMMON STOCK, $.01 PAR VALUE PER SHARE

                                (TITLE OF CLASS)

     Indicate by check mark whether the registrant:  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports, and (2) has been subject to such
filing requirements for the past 90 days. Yes  __   No  X

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

     The aggregate market value of the common stock, $.01 par value, held by
non-affiliates of the registrant on December 15, 1999 was $20,454,000.

     The aggregate number of shares of common stock, $.01 par value, outstanding
on December 15, 1999 was 13,636,000.

                      DOCUMENTS INCORPORATED BY REFERENCE:

                                      NONE

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                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                                 1998 FORM 10-K

                            ------------------------

                               TABLE OF CONTENTS

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PART I
--------
Item 1.   Business....................................................    1
Item 2.   Properties..................................................   12
Item 3.   Legal Proceedings...........................................   12
Item 4.   Submission of Matters to a Vote of Security Holders.........   14

PART II
--------
Item 5.   Market for Registrant's Common Equity and Related
            Stockholder Matters.......................................   15
Item 6.   Selected Financial Data.....................................   16
Item 7.   Management's Discussion and Analysis of Financial Condition
            and Results of Operations.................................   17
Item 7A.  Quantitative and Qualitative Disclosures About Market
            Risk......................................................   25
Item 8.   Financial Statements and Supplementary Data.................   25
Item 9.   Changes in and Disagreements With Accountants on Accounting
            and Financial Disclosure..................................   25

PART III
--------
Item 10.  Directors, Executive Officers and Key Employees of
            Registrant................................................   26
Item 11.  Executive Compensation......................................   28
Item 12.  Security Ownership of Certain Beneficial Owners and
            Management................................................   32
Item 13.  Certain Relationships and Related Transactions..............   33

PART IV
--------
Item 14.  Exhibits, Financial Statement Schedules, and Reports on Form
            8-K.......................................................   35

Index to Financial Statements.........................................   36

Financial Statements..................................................  F-1
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                                     PART I

ITEM 1.  BUSINESS.

     American Bank Note Holographics, Inc. ("ABNH") originates, mass-produces
and markets holograms. Our holograms are used primarily for security
applications such as counterfeiting protection for credit and other transaction
cards, identification cards and documents of value, as well as for tamper
resistance and authentication of high-value consumer and industrial products.
Our ability to control the diffraction of light ("origination") using
proprietary processes in a secure, controlled manufacturing environment has
enabled us to become a market leader in security holography. Our products are
used by over 200 companies worldwide, including MasterCard, VISA, American
Express, Discover, Diners Club, Europay, Merck and Eli Lilly, as well as
agencies of the United States government and certain foreign governments. We
also produce non-secure holograms for packaging and promotional applications.

     We believe we have a number of strengths that provide us with a competitive
advantage in the security sector of the holography industry, including:

     - our reputation as a quality supplier of secure holograms with 18 years of
       experience in the industry,

     - our expertise in holographic technology and production and our extensive
       patent portfolio,

     - our origination laboratories, which enable us to produce distinctive
       holograms with a variety of security features that make them difficult to
       counterfeit, and

     - our two efficient, ISO 9000 certified manufacturing facilities, which
       allow us to mass produce high-quality holograms at a low cost in a secure
       environment.

     In January 1999, ABNH disclosed that its previously issued financial
statements for 1996, 1997 and the first three quarters of 1998 all required
restatement. This gave rise either directly or indirectly to several other
issues that were significant to ABNH. We have restated those financial
statements which are included in this Form 10-K, and we have devoted substantial
resources to address the various issues that arose from the need to restate
these financial statements.

THE HOLOGRAPHY INDUSTRY

     A hologram is a laser-generated, three-dimensional reproduction of an
object, produced on a two-dimensional surface. A hologram controls the
diffraction of light at pre-determined angles to create specific visual imagery.
When a hologram is viewed from different angles, features such as depth and
movement, unseen in normal two-dimensional photographs, are seen by the viewer.
Holograms can also include information that is visible only with the aid of
special devices.

     The holography market is divided into three main sectors: security,
promotion and packaging.

     SECURITY

     The security sector of the holography market includes credit and other
transaction cards, product authentication and documents of value. Holography,
combining art and science, allows each customer to develop its own unique
hologram with which to identify and protect its product. The secure hologram can
also incorporate certain covert data, which are only machine readable, about the
particular products shipped or purchased. Holograms provide the following major
benefits as security devices:

     - the three-dimensional imagery, combined with the high degree of skill and
       capital investment required to replicate holograms and various
       proprietary hidden and visible security features, makes exact duplication
       and replication of holograms on a mass-production basis extremely
       difficult and presents obstacles to counterfeiting,

     - the unique visual aspects of a hologram are easily recognizable, making
       authentication of products and documents possible by both experts and
       laymen without special machinery, equipment or training, and
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     - the adhesives used to affix the hologram permanently to a product or a
       document may be specially designed to make it readily apparent if there
       is any attempt to remove or tamper with the hologram.

     The security sector of the holography market includes:

     Transaction Cards.  In the early 1980's, we began marketing our secure
holograms for use on credit cards and, as a result, helped to create and expand
the security sector of the holography market. Since that time, the use of
holograms on credit cards and other transaction cards has continued to grow. The
most common examples of secure holograms are the distinctive MasterCard globes
and VISA dove found on their various credit and transaction cards. In recent
years, consumers demanding fast, convenient and secure methods of payment have
increasingly supplemented traditional payment systems such as checks and cash
with card-based payments, such as debit, credit and charge cards.

     Product Authentication.  The use of product authentication holograms is
driven by concerns regarding counterfeiting, piracy, pilfering, diversion and
other infractions that can result in lost sales, lost goodwill and product
liability claims. Holograms have gained increasing acceptance as authentication
devices in, among others, the electronics, pharmaceutical, licensed consumer
products (e.g., clothing, sporting goods and software) and entertainment event
marketing industries and in high value consumer and industrial products (e.g.,
laser printers, electronic components, computer hardware and software,
videocassettes and compact discs). Product authentication holograms are either
machine or hand-applied to individual products. A holographic label that is
tampered with can become permanently damaged, leaving a visible footprint on the
product. Customers distinguish hologram providers in the product authentication
sector of the holography market on the basis of security features offered,
secure production control capabilities and price.

     Documents of Value.  Concerns over counterfeiting and copying have led to
an increased use of holograms on documents of value, including currency,
passports, business cheques, gift certificates, vouchers, certificates of
deposit, stamps (postage and revenue), tickets and other financial instruments.
We believe that an increasing number of countries are using holograms in their
currencies and we expect the market for holograms on currency to continue to
grow.

     PROMOTION

     The unique visual appeal of holograms makes them attractive for use on
consumer products and for retail advertising. Promotional holography is used for
"short run," low-end products, including greeting cards, decorative clothing,
point-of-purchase displays, and for certain advertising. The manufacturing
processes utilized for the creation of promotional holograms are not as complex,
secure or proprietary as those used in creating security holograms. Competition
is based primarily on price, turn-around time, design and reliability.

     PACKAGING

     Holograms can also be used as ribbons and papers for gift-packaging and
paper and plastic wrapping for packaging of food and other products. These
lower-margin, commodity-type holograms are generally used on consumer product
packaging solely for their eye-catching appeal, including packaging for candy,
beer, toothpaste, soft-drinks and other consumer products. The manufacturing
processes utilized for the creation of packaging holograms are not as complex,
secure or proprietary as those used in creating security holograms. Customers
distinguish between suppliers primarily based upon quality, price and production
capacity.

STRATEGY

     In 1999, we started to implement a strategy that included the following
components:

     Build a New, Strong Management Team and Workforce.  In 1999, ABNH's
Chairman and Chief Executive Officer, President and Chief Operating Officer, VP
Finance, Controller, and VP Operations all resigned from their positions with
ABNH. As a result, ABNH recruited the following persons to its management team:
Kenneth Traub, President; Salvatore D'Amato, Chairman; Russell LaCoste,
Executive Vice President of Corporate Development and Marketing; Alan Goldstein,
Chief Financial Officer; George Condos, Controller; and Peter Sorbo, Director of
Research and Development and Engineering. We also
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restructured operations to improve accountability and reduce expenses. We
believe that we have been successful in retaining our most important employees
and we have created a much stronger management team and organization. We intend
to continue to strengthen our organization.

     Improve Capital Structure and Reduce Debt.  At the time of its initial
public offering, ABNH had approximately $5.2 million of secured bank debt and
nominal cash. Following the disclosure of the need to restate its prior period
financial statements, ABNH was notified by its commercial bankers, led by The
Chase Manhattan Bank, that it was in default on its bank debt. In early 1999, we
implemented improved cost control and balance sheet management initiatives in
order to improve cash flow and reduce debt. We also negotiated an amendment to
the loan agreement with Chase which waived the existing defaults, and then
closed a refinancing with Foothill Capital Corporation, which enabled us to
repay the Chase facility and improve our capital structure. We believe that this
improvement to our capital structure gives us additional flexibility to invest
in the business for the long term.

     Improve Operating Controls.  We are in the process of implementing new
financial and manufacturing software to comply with Year 2000 issues and to
improve our management reporting capabilities. We believe these systems will
significantly improve the information available to management to manage the
business. We have also put in place new policies and procedures and changed
reporting relationships and responsibilities.

     Reestablish Credibility Among Our Constituents and Within Our
Industry.  This year, ABNH was under a great deal of scrutiny by concerned
customers, suppliers, employees, lenders, stockholders, lawyers, regulators and
others. We hope to reestablish our credibility through the continued execution
of the strategy described herein. We also hope to continue to enhance our
reputation in our industry through increased attention to product quality,
innovation and customer service.

     Protect and Enhance Our Position in Our Core Transaction Card Business.  We
hold a leadership position in the market for holograms on transaction cards as a
result of our relationships with companies such as MasterCard, VISA, Europay,
Diners Club and Discover. We have managed these relationships very closely in
1999, and hope to continue to strengthen them. This year we extended our
position in this market with a new relationship with American Express. We hope
to leverage our strong position and expertise in producing holograms for
transaction cards into other growth opportunities including identification
cards, product authentication and documents of value.

     Develop New Products and Innovations.  We have been a leading innovator in
the origination and mass production of secure holograms and we expect to
continue to emphasize the development of new technologies and products for our
target markets. Currently, we are seeking to develop higher resolution
holograms, new ways to increase the information stored on a hologram and
improvements to machine-readable features on our holograms. We are also
developing improvements to our products that have applications for tamper
apparent seals, bank notes (currency), personal identification documents and
other markets.

     Develop New Market Opportunities.  We have started to pursue new
applications and markets for our products. For instance, we believe there is an
increasing demand for holograms on bank notes, and we have started to develop
improved solutions that better meet the needs and requirements of this market.

     Protect and Leverage Our Intellectual Property Position.  We believe our
patent portfolio is very valuable and we intend to leverage our intellectual
property and patent rights. This year, we succeeded in persuading a competitor
to pay past due royalties in connection with a patent license agreement that we
had entered into previously. We intend to continue to protect our intellectual
property and enforce our patent rights.

     Grow through Strategic Acquisitions.  While much of our time during 1999
was spent on the issues described above, in 2000 we intend to pursue strategic
acquisitions that provide operating synergies or access to new customers or
technologies.

PRODUCTS

     Our secure holography products can be grouped into three categories:
embossed holograms on hot stamp foils, pressure-sensitive labels and laminates.

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     Embossed Holograms on Hot Stamp Foils.  These holograms are designed for
permanent application to plastic (e.g., transaction cards), paper (e.g.,
currency) and other substrates through the application of heat and pressure to
the hologram. We use specific heat activated adhesives to ensure even bonding of
the hologram to the substrate, and the exposed side of the hologram is treated
with protective coatings to ensure durability and wear resistance. Our embossed
holograms on hot stamp foils also possess a degree of flexibility that helps
them to avoid problems such as cracking or flaking. Our customers for embossed
holograms on hot stamp foils include MasterCard, approved manufacturers of VISA
cards, American Express, Discover, Diners Club and Europay.

     Pressure Sensitive Labels.  These labels are designed to be applied using
pressure by hand or by machine to create a permanent bond to the intended
substrate. We have developed proprietary and patent pending features that make
tampering apparent. If removed, the label leaves a distinctive mark or pattern
and the removed material is unusable. The labels can be laser numbered or
ink-jet numbered for security, control and traceability. These labels are
designed primarily as a security device for branded merchandise, luxury goods
and pharmaceuticals. Our customers for pressure sensitive labels include 3M,
Merck, Eli Lilly, Playboy and Sony.

     Laminates.  Laminates are used primarily in identification products. We
have patented our method of making the hologram visible at specific angles and
invisible at other pre-determined angles. Our patented see-through, demetallized
product also protects the information on the identification document (card,
passport or paper credential) from alteration and provides additional security.
Fully metallized laminates are used on products such as hang tags for apparel,
"full face" transaction cards and magazine covers. Adhesives for laminates can
be formulated for application through both heat and pressure as well as pressure
only, depending upon the customer's specific requirements. Our customers for
laminates include the U.S. government, China and Colombia.

PRODUCTION PROCESS

     We are one of the most experienced security production companies in the
holographic industry. We have two ISO certified security production facilities
containing a total of nine origination laboratories and 17 mass replication
lines as well as extensive security and quality control procedures. We also have
a large and sophisticated distribution network for secure holographic products.

     Our production process is integrated to handle most aspects of production,
including raw materials sourcing, processing, finishing, packaging, storage and
logistics. From time to time, we subcontract certain production functions to
third parties. The production process consists of the following four steps:

     DESIGN

     The first step of the production process is the design of the hologram. In
the art department, our experienced personnel work with the customer to develop
a conceptual design that incorporates the necessary features, both security and
non-security, to satisfy the customer's requirements.

     ORIGINATION

     After the design has been completed, various laser-ready components
(magnetic floppy disc, three dimensional sculpture, flat art, etc., referred to
as "information") are delivered to one of our nine origination studios.

     The conversion from information to hologram is based on our ability to
record light in an organized format. Coherent light, which is delivered by a
laser, is best understood as light which has one wavelength of the visible
spectrum and possesses a high degree of organization. The coherent light is
split into two beams (the object beam and the reference beam) directed toward
photo-resist treated glass. The object beam is interfered with by the
information before continuing its travel toward the photo-resist treated glass.
The reference beam is not interfered with and travels directly toward the
photo-resist treated glass.

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     The object beam then interferes with the reference beam, creating an
interference pattern which is recorded on the light sensitive photo-resist
glass. After developing the photo-resist glass, the film is re-illuminated
approximating the original angle(s) of the reference beam. The resulting
interference pattern within the film reflects some of the light, striking it
into a re-creation of the pattern of light that originally came from the object
beam, due to a property of light called diffraction. The reflected light, now
organized and containing all information that the object beam once carried,
allows the viewer to see all of the information in three dimensions, true color
or with other desired effect.

     There are less complex methods of creating a hologram origination than the
process described above. However, in our opinion, the above process produces the
clarity, depth perception, movement and mass replication properties that are
essential components of our secure holograms. We further believe that our
largest competitors in the security sector may use similar processes.

     PLATE MAKING

     Once the origination process is completed, a plate is created in order to
permit mass production. The "one-on" image is "step and repeated" to a
pre-determined size with multiple identical images recorded on a photo-resist
glass. The glass is then converted to a production plate in an electrolytic
process where nickel is grown on the surface of the glass. Nickel is used
because its molecular nature allows for an exact transfer of the origination to
the production plate. We believe that our proprietary plate making process is an
important component of our ability to mass produce our secure holograms.

     The electrolytic process creates different "generations" of plates prior to
the production phase. Each generation, identical to the last, creates a more
wear resistant plate for use in a mass production environment, thereby extending
the useful life of the plate. The production plate will have varying degrees of
hardness, depending upon the processes used in production.

     MASS PRODUCTION

     Manufacturing specifications are determined in collaboration with the
customer. We and the customer typically enter into production planning where
drawings and overall specifications are written and distributed to the various
production and quality control departments.

     We employ two methods of mass-production of holograms. Hard embossing
transfers images to an aluminum foil/polyester substrate through heat and
pressure. Heat and pressure on the holographic plate force the holographic image
into the foil, which is then converted into the final product.

     The other method of production is In-Situ Polymeric Replication, which was
developed by us. Using this method, a polymer is transferred to a substrate
(polyester, polypropylene, etc.) which is then put in contact with the
holographic plate so that holographic imagery is replicated. The material is
then metallized using a vacuum deposition process.

     Finishing for both methods may include some combination of demetallization,
application of adhesive, slitting, die-cutting and custom numbering. The
completed holographic material may then be applied to the customer's product.

RESEARCH AND PRODUCT DEVELOPMENT

     We have devoted significant attention to research and product development
to continue to enhance our origination, replication and mass production
capabilities. Our R&D has enabled us to create new technologies and proprietary
production processes and to deliver innovative products to the marketplace.

     Over the past several years, members of our staff have developed a number
of new products, including a tamper-apparent label and a tamper-apparent heat
seal laminate for use in identification card and passport products. We are
seeking to develop new ways to deliver higher resolution beyond what is
currently available in the security sector of the holography market.
Additionally, the development of machine-readable holograms has been a priority
for the research and product development department. Machine-readable technology
may

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enable holographic products to be compatible with optical bar code technology
for a variety of applications, including both simple product validation or
authentication and more sophisticated uses.

MANUFACTURING SUPPORT

     The research and product development department assists the manufacturing
department in addressing various process and quality issues. Our research and
product development staff has also been involved in several manufacturing
process improvements, including the discovery of a means to increase
significantly the lifetime of nickel plate shims and the development of an
automated plate layout program that has reduced layout time from two weeks to
less than one day.

MANUFACTURING FACILITIES

     See "Item 2. -- Properties."

SALES AND MARKETING

     In 1998, we provided holographic products to over 200 customers worldwide.
We are the exclusive supplier of holograms to MasterCard and we believe we are
one of only two authorized manufacturers of VISA holograms for sale to approved
manufacturers of VISA cards. In addition, we supply holograms to American
Express, Diners Club, Discover, Europay and numerous other companies.

     We currently employ an Executive Vice President of Corporate Development
and Marketing, a Vice President of Sales and Marketing, three full-time,
incentive-compensated salespeople and three sales service personnel. We also
utilize incentive-based international sales agents around the world.

     All pricing decisions are made centrally by our operating executives. We
focus some of our marketing efforts on trade shows such as Expopak, the
International Holographics Manufacturers Association trade show, the
International Card Manufacturers Association trade show and the Card
Tech/SecurTech trade show. In the future, we intend to participate in security,
transaction card, brand protection, packaging, pharmaceutical, labeling and
document trade shows, both domestically and internationally.

COMPETITION

     The holography industry is highly competitive and highly fragmented. A
number of our competitors are larger or are divisions of larger companies, and
have greater financial resources, than us. In the holography industry,
competition is generally based on technology, price, product quality and
customer service. We also compete with other non-holographic methods or devices.
We believe our position in the security sector of the holography market is
attributable to our technical expertise, years of experience and reputation in
the mass production of secure holograms.

TRADEMARKS AND PATENTS

     We utilize a combination of patents, trade secrets and confidentiality
agreements, as well as restricted access and other forms of intellectual
property protection, to safeguard certain of our proprietary technology and
processes. We also hold certain trademarks with respect to certain products and
services. We currently hold approximately 35 U.S. patents and numerous foreign
patents, as well as patents pending and service marks that are used in our
business. We believe our patent portfolio is valuable and we intend to continue
to leverage the value of our intellectual property and patent rights.

     There can be no assurance as to the degree of protection offered by our
patents, the success of any of our enforcement actions or the likelihood that
patents will be issued for pending applications. Competitors in the United
States and foreign countries may have applied for or obtained, or may in the
future apply for and obtain, patents that will prevent, limit or interfere with
our ability to make and sell some of our products.

     In 1997, our United States patent numbers 4,728,377 and 4,913,504 (the
"Gallagher Patents"), which relate to a certain process for applying a hologram,
were invalidated by a U.S. federal court. While the

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invalidation of these U.S. patents does not prevent us from producing and
marketing any of our holograms, it does prevent us from asserting these patents
against parties that are making, selling and using the claimed inventions of
these patents solely in the United States. However, the corresponding foreign
patents remain valid and outstanding, and we believe they are important patents
in the international holographic industry. This year, we succeeded in persuading
a foreign competitor to pay us past due royalties in excess of $800,000 and to
resume paying royalties under a license agreement that we had entered into
previously relating to certain foreign counterparts of the Gallagher patents.

EMPLOYEES

     As of December 15, 1999, we employed 94 persons, of which 57 are covered by
collective bargaining agreements. We consider our relations with our employees
to be good.

RISK FACTORS

     IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS

     In addition to other information in this Annual Report on Form 10-K, the
following risk factors should be carefully considered in evaluating us and our
business because such factors currently have a significant impact or may have a
significant impact on our business, operating results or financial condition.
This Form 10-K contains forward-looking statements that have been made pursuant
to the provisions of the Private Securities Litigation Reform Act of 1995.
Actual results could differ materially from those projected in the forward-
looking statements as a result of the risk factors set forth below and elsewhere
in this form.

     WE ARE DEFENDING A CLASS ACTION LAWSUIT INITIATED BY SOME OF OUR
     STOCKHOLDERS.

     A consolidated class action complaint against ABNH, certain of its former
officers and directors, its former parent (American Banknote Corporation), the
four co-lead underwriters of our initial public offering and our auditors, has
been filed in the United States District Court for the Southern District of New
York. The complaint alleges violations of the federal securities laws and seeks
to recover damages on behalf of all purchasers of our common stock during the
class period (July 15, 1998 through February 1, 1999). The complaint seeks
recission of the purchase of shares of our common stock or alternatively,
unspecified compensatory damages, along with costs and expenses including
attorneys' fees. We and certain other defendants have separately moved to
dismiss the complaint. The plaintiffs' discovery requests as well as their
motion for class certification have been stayed pending resolution of the
respective motions to dismiss. We have commenced settlement discussions with
plaintiffs' counsel. We do not believe it is feasible to predict or determine
the outcome or resolution of these proceedings, or to estimate the amounts of,
or potential range of loss with respect thereto. In addition, the timing of the
resolution of these proceedings is uncertain. The range of possible resolutions
could include judgements against us or settlements that could require
substantial payments by us, including costs of defending such suits, which could
have a material adverse effect on our financial position, results of operations
and cash flows.

     WE ARE BEING INVESTIGATED BY THE U.S. ATTORNEY'S OFFICE AND THE SECURITIES
     AND EXCHANGE COMMISSION.

     On February 9, 1999, the Division of Enforcement of the SEC issued a Formal
Order Directing Private Investigation, designating officers to take testimony
and requiring the production of certain documents, in connection with matters
giving rise to the need to restate our previously issued financial statements.
We have provided numerous documents to and continue to cooperate fully with the
SEC staff. We cannot predict the duration of such investigation or its potential
outcome.

     The U.S. Attorney's Office for the Southern District of New York has
commenced an investigation in connection with matters giving rise to the need to
restate our previously issued financial statements, as well as a possible
violation in 1998 of the Foreign Corrupt Practices Act. We have not been advised
that we are a target of such investigation. We have provided numerous documents
to and continue to cooperate fully with the U.S. Attorney's Office. We cannot
predict the duration of such investigation or its potential outcome.

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     OUR COMMON STOCK IS SUSPENDED FROM TRADING ON THE NEW YORK STOCK EXCHANGE
     AND WILL NOT RESUME TRADING ON THE NYSE.

     Our common stock was suspended from trading on the New York Stock Exchange
in August 1999. Following such suspension, the NYSE indicated that it will apply
to delist our common stock. Our common stock will not resume trading on the
NYSE, but we intend to seek to have our common stock traded on another stock
exchange or quoted on Nasdaq. Current pricing information on our common stock
has been available in the "pink sheets" published by National Quotation Bureau,
LLC. The "pink sheets" is an unorganized over-the-counter market which generally
provides significantly less liquidity than established stock exchanges or the
Nasdaq National Market, and quotes for stocks included in the "pink sheets" are
not listed in the financial sections of newspapers as are those for established
stock exchanges and the Nasdaq National Market. Therefore, prices for securities
traded solely in the "pink sheets" may be difficult to obtain, and our
stockholders may find it difficult to resell their shares. Until we are current
with our SEC filings, we are effectively unable to apply to list our common
stock or other securities with a national securities exchange or Nasdaq.

     WE DEPEND ON CREDIT CARD MANUFACTURERS FOR A SUBSTANTIAL PORTION OF OUR
BUSINESS.

     During 1998 and 1997, sales to credit card companies accounted for
approximately 70% and 75%, respectively, of our total sales, including
MasterCard and approved manufacturers of VISA brand credit cards, which together
accounted for approximately 56% and 62% of our total sales in 1998 and 1997,
respectively. If either MasterCard or VISA were to terminate its respective
relationship with us, or if we were to lose a substantial portion of our
business with either of these entities, there would be a material adverse effect
on our business, financial condition and results of operations. See
"Business -- Sales and Marketing." We provide holograms to MasterCard pursuant
to an agreement which expires in February 2003, subject to automatic renewal if
not terminated by either party. During 1999, MasterCard informed us that it
believes that ABNH breached certain terms of the agreement in 1997 and 1998. We
have been working closely with MasterCard to address issues raised by
MasterCard, and we believe our relationship with MasterCard is good.

     Currently, we are one of two companies authorized to manufacture and sell
VISA brand holograms to manufacturers of VISA brand credit cards. There can be
no assurance that we can continue to successfully meet the needs of our
customers. In addition, failure to obtain anticipated orders or delays or
cancellations of orders or significant pressure to reduce prices from key
customers could have a material adverse effect on our future financial
performance.

     WE DEPEND ON SINGLE SUPPLIERS FOR SOME KEY PRODUCT COMPONENTS.

     We have historically purchased certain key materials used in the
manufacture of our holograms from single suppliers with which we do not have
supply contracts. Any problems that occur with respect to the delivery, quality
or cost of any such materials could have a material adverse effect on our
financial condition, results of operations and cash flows.

     OUR MANAGEMENT TEAM IS NEW TO OUR COMPANY.

     During 1999 we experienced substantial and significant turnover in our
senior management and our board of directors. Consequently, we have only
recently assembled our management team. The transition in management could have
an impact on our relationship with our employees, suppliers, customers and other
constituents.

     RECENT EVENTS MAY CAUSE US TO LOSE EXISTING AND POTENTIAL CUSTOMERS AND
SUPPLIERS.

     We have received inquiries from some of our customers and suppliers
relating to the previously disclosed adverse events affecting ABNH. Our
reputation has been adversely impacted and may continue to be affected by these
events. As a consequence, our relationships with existing customers and
suppliers may be strained. In addition, our ability to develop potential
customers or suppliers to maintain and grow our business may be adversely
affected.
                                        8
<PAGE>   11

     OUR QUARTERLY OPERATING RESULTS CAN FLUCTUATE.

     Our future operating results are likely to fluctuate substantially from
quarter to quarter. Since a significant portion of our business is derived from
orders placed by a limited number of large customers, variations in the timing
of such orders could cause significant fluctuations in our operating results.
Other factors that may result in fluctuations in operating results include:

     - customers' promotions,

     - inventory replenishment,

     - card expiration patterns,

     - delivery schedules,

     - changes in the cost of materials or labor,

     - increased R&D expenses,

     - competitive pricing pressures,

     - legal and accounting fees associated with stockholder litigation,
       government investigations and the restatement of our financial
       statements, and

     - financing costs.

     WE ARE IN A COMPETITIVE, HIGHLY-FRAGMENTED INDUSTRY WITH MANY COMPANIES
     COMPETING TO DELIVER A HIGHLY-SPECIALIZED PRODUCT.

     The holography industry is highly competitive. Our competitors, which are
numerous and may have more resources than us, may take away market share or
compete with us on the basis of price, which may erode our prices and margins.
Increasing competition in the market for our security holograms has resulted in
declining sales prices for these products over the past few years.

     Competition is based on a number of factors, such as:

     - technology,

     - price,

     - product quality, and

     - customer service.

In addition, an increased use of non-holographic methods or devices in place of
our products could reduce demand for our products. A number of competitors are
larger or are divisions of larger companies, and have greater financial
resources, than us.

     WE HAVE RECENTLY IMPLEMENTED NEW INFORMATION AND ACCOUNTING SYSTEMS, AND WE
     ARE STILL IMPLEMENTING ADDITIONAL IMPROVEMENTS TO OUR SYSTEMS.

     We are in the process of implementing new financial and manufacturing
software to comply with Year 2000 issues and to improve our management reporting
capabilities. We believe these systems will significantly improve the
information available to management to manage the business. The implementation
of these new systems is time-consuming and expensive. Any problems that we have
in running these systems or that our employees have in adapting to these new
systems could materially and adversely affect our business, financial condition
and results of operations.

                                        9
<PAGE>   12

     OUR BUSINESS DEPENDS UPON OUR INTELLECTUAL PROPERTY WHICH MAY NOT BE
     SUFFICIENTLY PROTECTED FROM INFRINGERS.

     We utilize a combination of patents, trade secrets and confidentiality
agreements, as well as restricted access and other forms of intellectual
property protection, to safeguard certain of our proprietary technology and
processes. We also hold certain trademarks with respect to certain products and
services. We cannot be certain as to the degree of protection offered by any of
our patents or as to the likelihood that patents will be issued for any of our
pending applications. There can be no assurance that we will be able to maintain
the confidentiality of our trade secrets or that our confidentiality agreements
will provide meaningful protection of our trade secrets or other proprietary
information. See "Business -- Trademarks and Patents."

     In addition, litigation may be necessary in the future to enforce our
intellectual property rights or to determine the validity and scope of our
patents or of the proprietary rights of others. Such litigation might result in
substantial costs and diversion of resources and management attention.
Furthermore, our business activities may infringe upon the proprietary rights of
others, and in the past third parties have claimed, and may in the future claim,
infringement by our products. Any such claims, with or without merit, could
result in significant litigation costs and diversion of management attention,
and could require us to enter into royalty and license agreements that may be
disadvantageous to us or suffer other harm to our business. If litigation is
successful against us, it could result in invalidation of our proprietary rights
and liability for damages, which could have a harmful effect on our business.

     WE MAY BE SUBJECT TO SIGNIFICANT PRODUCT LIABILITY IN CONNECTION WITH THE
     PRODUCTS WHICH WE PROVIDE TO OUR CUSTOMERS.

     We provide holograms in connection with a wide range of our customers'
products, in which case it is possible that we are subjecting ourselves to
product liabilities in association with those products or in connection with the
holograms used with those products. Although we maintain product liability
insurance, there can be no assurance that such insurance would be available to
cover any such claim or available in amounts sufficient to cover all potential
liabilities. As a result, product liability claims could have a material adverse
effect on our business, financial condition and results of operations.

     SINCE A SIGNIFICANT PERCENTAGE OF OUR SALES ARE DERIVED FROM OVERSEAS
     CUSTOMERS, OUR EXPORTS AND BUSINESS MAY BE SUBJECT TO SOME RISKS RELATED TO
     DOING BUSINESS INTERNATIONALLY.

     In 1998 and 1997, 28% and 25%, respectively, of our sales were derived from
customers outside the United States. All export sales are denominated in U.S.
dollars. International sales are subject to risks, including:

     - United States and international regulatory requirements and policy
       changes,

     - political and economic instability,

     - difficulties in accounts receivable collection,

     - tariffs and other barriers, and

     - difficulty in attracting, retaining and managing international
       representatives.

We cannot be certain that any of these factors will not have a material adverse
effect on our business, financial condition or results of operations. See "Item
7. -- Management's Discussion and Analysis of Financial Condition and Results of
Operations."

     OUR BUSINESS IS SUBJECT TO ENVIRONMENTAL REGULATION AND IS ALWAYS SUBJECT
     TO ENVIRONMENTAL LIABILITY.

     Our operations are subject to federal, state and local environmental laws
and regulations. If we fail to comply with applicable rules and regulations, we
could be subject to monetary damages and injunctive action, which could
materially and adversely affect our business, financial condition or results of
operations. We believe that we are currently in material compliance with
applicable laws and regulations. However, to the

                                       10
<PAGE>   13

extent future laws and regulations are adopted or interpretations of existing
laws and regulations change, new requirements may be imposed on our future
activities or may create liability retroactively.

     OUR FORMER PARENT COMPANY, ABN, HAS EXPERIENCED FINANCIAL DIFFICULTY DURING
     1999, AND WE MAY HAVE RISKS ASSOCIATED WITH ABN'S POTENTIAL INABILITY TO
     PAY ITS OBLIGATIONS TO US AND TO THIRD PARTIES.

     Our former parent company, ABN, has experienced financial difficulty during
1999. On December 8, 1999, ABN filed a petition and plan of reorganization in
federal bankruptcy court pursuant to Chapter 11 of the U.S. Bankruptcy Code. The
petition seeks approval for a financial restructuring resulting in the
cancellation of certain of ABN's outstanding indebtedness in exchange for equity
in ABN as well as the amendment of the repayment terms of certain other
outstanding indebtedness of ABN. The petition does not seek to affect ABN's
trade obligations or payables in the ordinary course.

     In connection with our IPO, we entered into a number of agreements with ABN
that require ABN to indemnify us under certain circumstances. However, ABN's
financial difficulty may result in its inability to indemnify us. In addition,
we are co-defendants with ABN in some ongoing litigation in which we could be
held jointly and severally liable along with ABN. In such an event the
plaintiffs may be unable to collect any money from ABN and may instead attempt
to pursue collection from us. For more details on this litigation, see "Item
3. -- Legal Proceedings." Any inability of ABN to indemnify us or to pay any
liabilities for which we are jointly and severally liable could have a material
adverse effect on our financial position, results of operations and cash flows.

     WE CURRENTLY HAVE NO INTENTION OF PAYING DIVIDENDS AND ANY DIVIDENDS WE MAY
     PAY WILL DEPEND ON CERTAIN FACTORS.

     We intend to retain all earnings, if any, for use in our business. We do
not anticipate paying cash dividends in the foreseeable future.

     SHARES CURRENTLY HELD BY STOCKHOLDERS MAY BE SUBJECT TO DILUTION DUE TO THE
     POTENTIAL ISSUANCE OF PREFERRED STOCK.

     Our certificate of incorporation permits the issuance of up to 5,000,000
shares of preferred stock and permits the board of directors to fix the rights,
preferences, privileges and restrictions of such shares without any further vote
or action by our stockholders. Although we have no current plans to issue shares
of preferred stock, the potential issuance of preferred stock may have the
effect of:

     - delaying, deferring or preventing a change in control of our company,

     - may discourage bids for the common stock at a premium over the market
       price of the common stock, and

     - may adversely affect the market price of, and the voting and other rights
       of the holders of the common stock.

     WE REMAIN VULNERABLE TO YEAR 2000 COMPLIANCE PROBLEMS IN OUR SYSTEMS AND
     THOSE OF OUR SUPPLIERS AND CUSTOMERS, WHICH COULD POTENTIALLY DISRUPT OUR
     OPERATIONS AND MAY REQUIRE GREATER THAN ANTICIPATED REMEDIAL EXPENSES.

     We are preparing for the impact of the Year 2000 on our operations. Year
2000 issues could include potential problems in our information technology and
other systems that we use in our operations. Year 2000 system failures could
affect routine but critical operations such as forecasting, purchasing,
production, order processing, inventory control, shipping and billing and
collections. In addition, system failures could affect security, payroll
operations and employee safety. Third parties who fail to adequately address
their own Year 2000 issues could also expose us to potential risks.

     Systems and applications that we have identified to date as not currently
being Year 2000 compliant include financial software systems (which process
order entry, purchasing, production management, general

                                       11
<PAGE>   14

ledger, accounts receivable, accounts payable functions, and payroll
applications) and critical applications in our manufacturing facilities. We have
completed the inventory and verification of the Year 2000 readiness of
computer-controlled manufacturing equipment and computer controls for our
manufacturing and office facilities, and we have completed our assessment of the
Year 2000 remediation efforts of our suppliers and customers where there is a
significant business relationship. We expect to complete the conversion or
replacement of the computer information systems for our entire business
operations by December 31, 1999. Our failure to complete our Year 2000
compliance work in a timely manner and the failure of our third-party suppliers
and customers to become Year 2000 compliant could have a material adverse impact
on our business, financial condition and results of operations.

     At this time, we believe that the most likely "worst case" scenario
relating to Year 2000 involves the loss of utility service, rendering us unable
to manufacture and distribute. We have developed a contingency plan that
includes such precautionary measures as managing inventory levels, the
deployment of manual systems, the use of alternate computer software that we
currently own and using outside contractors. At this time, however, we cannot
currently estimate either the likelihood or potential adverse impact of such
failures.

     We currently estimate that the total cost of addressing and remedying Year
2000 issues and enhancing our operating systems will be approximately $425,000,
which does not include internal costs associated with our Year 2000 remediation.
Our internal costs associated with our Year 2000 remediation are being expensed
as incurred, and have not been material to our past performance and are not
expected to be material relative to our future performance. No funds were
expended related to our Year 2000 remediation during 1998. Through October 31,
1999, approximately $380,000 was expended and approximately $45,000 will be
expended during the period November 1, 1999 through December 31, 1999 in
connection with the remediation and testing of our computer systems. Our current
estimates of the amount of costs and time necessary to remediate and test our
computer systems are based on the facts and circumstances existing and known at
this time. These estimates were made using assumptions of future events
including the continued availability of certain resources, implementation
success by key third parties and other factors.

     See "Item 7. -- Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Year 2000 Readiness Disclosure" for more details of
our Year 2000 assessment and compliance efforts.

ITEM 2.  PROPERTIES.

     We maintain secure hologram manufacturing facilities in Elmsford, New York
and Huntingdon Valley, Pennsylvania. We believe that our existing facilities are
adequate to meet our current requirements and that additional suitable space
will be available as needed.

     Our 57,200 square foot facility at Elmsford, New York serves as our
headquarters and includes our art department, origination facilities, plate
making facilities and the manufacturing site for the mass production of numerous
holographic products. Our origination facilities include nine laser
laboratories.

     Our 30,000 square foot facility at Huntingdon Valley, Pennsylvania is
dedicated to the mass production of security holograms primarily for transaction
cards.

     Both facilities are constantly monitored for security, and have uniformed
security personnel on site, 24 hours a day, seven days a week. The Director of
Security is responsible for the physical security of both facilities, access and
egress, monitoring employee integrity, and safeguarding of machinery, materials,
work-in-process and finished product until shipping. The security department
witnesses material destruction and supervises the transfer of security
shipments. Each facility is equipped with full perimeter alarms enhanced by
window glass break sensors, internal motion detectors and closed circuit video
monitoring of security sensitive areas.

ITEM 3.  LEGAL PROCEEDINGS.

     On February 9, 1999, the Division of Enforcement of the SEC issued a Formal
Order Directing Private Investigation, designating officers to take testimony
and requiring the production of certain documents, in
                                       12
<PAGE>   15

connection with matters giving rise to the need to restate ABNH's previously
issued financial statements. We have provided numerous documents to and continue
to cooperate fully with the SEC staff. We cannot predict the duration of such
investigation or its potential outcome.

     The U.S. Attorney's Office for the Southern District of New York has
commenced an investigation in connection with matters giving rise to the need to
restate our previously issued financial statements, as well as a possible
violation in 1998 of the Foreign Corrupt Practices Act. We have not been advised
that ABNH is a target of such investigation. We have provided numerous documents
to and continue to cooperate fully with the U.S. Attorney's Office. We cannot
predict the duration of such investigation or its potential outcome.

     A consolidated class action complaint against ABNH, certain of its former
officers and directors, ABN, the four co-lead underwriters of our IPO and our
auditors, has been filed in the United States District Court for the Southern
District of New York. The complaint alleges violations of the federal securities
laws and seeks to recover damages on behalf of all purchasers of our common
stock during the class period (July 15, 1998 through February 1, 1999). The
complaint seeks rescission of the purchase of shares of our common stock or
alternatively, unspecified compensatory damages, along with costs and expenses
including attorneys' fees. We and certain other defendants have separately moved
to dismiss the complaint. The plaintiffs' discovery requests as well as their
motion for class certification have been stayed pending resolution of the
respective motions to dismiss. We have commenced settlement discussions with
plaintiffs' counsel. We do not believe it is feasible to predict or determine
the outcome or resolution of these proceedings, or to estimate the amounts of,
or potential range of loss with respect thereto. In addition, the timing of the
resolution of these proceedings is uncertain. The range of possible resolutions
could include judgements against us or settlements that could require
substantial payments by us, including costs of defending such suits, which could
have a material adverse effect on our financial position, results of operations
and cash flows.

     On February 14, 1997, James Rigby, Trustee in Bankruptcy for Holosonics,
Inc., Holotron Corp., Meadows Games, Inc. and Fire Diamond, Inc. commenced an
adversary proceeding in the United States Bankruptcy Court for the Western
District of Washington at Seattle against International Banknote Company, Inc.,
ABN and us. The complaint alleged that the defendants were indebted to the
bankruptcy estate for royalty payments under a 1981 license and that we were
liable for unpaid royalties for 1990 in the amount of $226,322, for 1991 in the
amount of $853,582 and through July 1992 in the amount of $568,762, plus
attorney's fees and interest on unpaid amounts. The defendants and Trustee
entered into a settlement agreement which was approved by an order of the
bankruptcy court on September 10, 1999, whereby the defendants agreed to pay the
Trustee $150,000, of which $135,000 has been paid with the balance of $15,000
payable one-hundred twenty days following entry of the order. The full amount of
the settlement has been accrued at December 31, 1998.

     In 1994, plaintiffs, K.A.H. Company, Inc. and Kenneth A. Haines, filed suit
against us, ABN and ABNH Research Co., Inc. in the Supreme Court of the State of
New York, County of New York. A judgment was entered on March 19, 1999 for
$175,639, with attorneys' fees still to be assessed. Plaintiffs' counsel has
stated that he would seek in excess of $300,000 in attorneys' fees. Such
judgment was entered only against ABN, which contends that we should contribute
to the payment of the judgment. The defendants have appealed and the plaintiffs
have filed a cross-appeal, both of which are still pending. The plaintiffs and
defendants are currently engaged in settlement discussions.

     On August 17, 1999, we commenced an action in the Supreme Court of the
State of New York, County of Westchester, seeking recovery of approximately
$350,000 on a claim arising from amounts owed to us for holographic materials
sold and delivered in July 1999. The defendant removed the action to the United
States District Court for the Southern District of New York, where it is
currently pending. On December 1, 1999, we received the defendant's answer to
our complaint and counterclaims alleging millions of dollars in damages arising
from ABNH's alleged breach of a 1993 agreement pursuant to which ABNH sold
holographic material to the defendant and alleged failure to fulfill a May 1998
purchase order. We do not believe that the outcome or resolution of these
proceedings will have a material adverse effect on our financial position,
results of operations or cash flows.

                                       13
<PAGE>   16

     In 1998, ABNH fulfilled an order for holograms for approximately $600,000.
In 1999, the customer alleged that ABNH breached its contract with such customer
based on problems that the ultimate user was experiencing with the holograms,
and claimed potential damages in excess of $6 million. We do not believe that
the agreement was breached, and we are in discussions with this customer in an
attempt to resolve this dispute amicably. There can be no assurance, however,
that this matter will be resolved amicably, or that this dispute will not lead
to litigation with the customer.

     We currently and from time to time are involved in litigation (as both
plaintiff and defendant) incidental to the conduct of our business; however,
other than the shareholder litigation described above, we are not a party to any
lawsuit or proceeding which, in our opinion, is likely to have a material impact
on our financial position, results of operations or cash flows.

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

     None.

                                       14
<PAGE>   17

                                    PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
        MATTERS.

     Our common stock was traded on the New York Stock Exchange under the symbol
"ABH" from the time of our initial public offering on July 15, 1998 to August 3,
1999, when trading in our common stock was suspended. The following table sets
forth the high and low closing prices of our common stock for each quarter of
1998 and 1999 during which it traded on the NYSE.

<TABLE>
<CAPTION>
                                                               HIGH      LOW
                                                              ------    -----
<S>                                                           <C>       <C>
1998
Third Quarter (from July 15, 1998)..........................  $ 8.56    $4.88
Fourth Quarter..............................................   18.00     5.81
1999
First Quarter...............................................  $17.00    $1.63
Second Quarter..............................................    3.88     2.06
Third Quarter (through August 2, 1999)......................    3.06     1.63
</TABLE>

     Our common stock was suspended from trading on the NYSE on August 3, 1999
because we had not filed our annual report for the year ended December 31, 1998
or our quarterly report for the quarter ended March 31, 1999 within the SEC's
prescribed time period. Following such suspension, the NYSE indicated that it
would apply to delist our common stock. In the interim, our common stock has
been traded in the over-the-counter market.

     The following table sets forth the high and low closing prices of our
common stock for each quarter of 1999 during which it has traded on the
over-the-counter market.

<TABLE>
<CAPTION>
                                                              HIGH      LOW
                                                              -----    -----
<S>                                                           <C>      <C>
1999
Third Quarter (from August 3, 1999).........................  $3.06    $1.25
Fourth Quarter (through December 15, 1999)..................  $3.05    $1.50
</TABLE>

     The price of our common stock has been quoted on the "pink sheets"
published by the National Quotation Bureau, LLC (ticker symbol: "ABHH"). The
"pink sheets" is an unorganized over-the-counter market which provides
significantly less liquidity than established stock exchanges or the Nasdaq
National Market, and quotes for stocks included in the "pink sheets" are not
listed in the financial sections of newspapers as are those for established
stock exchanges and the Nasdaq National Market.

     As of December 15, 1999, there were approximately 60 holders of record of
our common stock. Because many of our shares of common stock are held of record
by brokers and other institutions on behalf of stockholders, we are unable to
estimate the total number of beneficial stockholders represented by these record
holders.

                                       15
<PAGE>   18

ITEM 6.  SELECTED FINANCIAL DATA.

<TABLE>
<CAPTION>
                                                         YEAR ENDED DECEMBER 31,
                                           ---------------------------------------------------
                                            1994       1995       1996       1997       1998
                                           -------    -------    -------    -------    -------
                                                  (IN THOUSANDS, EXCEPT PER SHARE DATA)
                                                 (AS RESTATED -- SEE NOTE 1)
<S>                                        <C>        <C>        <C>        <C>        <C>
STATEMENT OF INCOME DATA:
Sales....................................  $21,900    $27,865    $27,516    $23,085    $28,669
  Costs and expenses:
     Cost of goods sold..................   14,141     13,787     14,710     12,153     19,064
     Selling and administrative..........    4,673      4,576      4,711      5,813      6,291
     Depreciation and amortization.......    1,066      1,203      1,141      1,136      1,080
                                           -------    -------    -------    -------    -------
                                            19,880     19,566     20,562     19,102     26,435
                                           -------    -------    -------    -------    -------
  Operating income.......................    2,020      8,299      6,954      3,983      2,234
  Other income...........................      244        113        196        821        554
  Interest, net..........................      305        305        305        146       (400)
                                           -------    -------    -------    -------    -------
  Income before taxes on income..........    2,569      8,717      7,455      4,950      2,388
  Taxes on income........................    1,198      3,663      3,117      2,130      1,269
                                           -------    -------    -------    -------    -------
  Net income.............................  $ 1,371    $ 5,054    $ 4,338    $ 2,820    $ 1,119
                                           =======    =======    =======    =======    =======
Net income per share:
  Basic and diluted......................  $  0.10    $  0.37    $  0.32    $  0.21    $  0.08
Weighted average shares outstanding:
  Basic..................................   13,636     13,636     13,636     13,636     13,636
  Diluted................................   13,636     13,636     13,636     13,636     13,701
</TABLE>

<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                           ---------------------------------------------------
                                            1994       1995       1996       1997       1998
                                           -------    -------    -------    -------    -------
                                                             (IN THOUSANDS)
                                                 (AS RESTATED -- SEE NOTE 1)
<S>                                        <C>        <C>        <C>        <C>        <C>
BALANCE SHEET DATA:
Working capital..........................  $10,426    $11,208    $ 9,431    $ 8,684    $ 2,023
  Total assets...........................   30,329     29,366     27,742     27,515     30,820
  Total debt.............................       --         --         --        674      5,968
  Total stockholders' equity.............   26,513     25,452     22,434     21,165     14,530
</TABLE>

---------------
(1) The financial data as of and for the years ended December 31, 1997 and 1996
    have been restated as described in Note 11 to the Financial Statements. As
    of December 31, 1994, retained earnings have been reduced by approximately
    $278,000, net of applicable income taxes, for the effects of certain
    overbillings during 1991 through 1994. Additionally, during the year ended
    December 31, 1994, sales and net income have been reduced by approximately
    $60,000 and $35,000, respectively, for the effects of this overbilling.

                                       16
<PAGE>   19

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS.

     The following discussion and analysis should be read in conjunction with
"Item 6. -- Selected Financial Data" and our financial statements, including the
notes thereto, appearing elsewhere in this report.

     On January 19, 1999, ABNH announced that the audit committee of its board
of directors initiated an investigation into circumstances that gave rise to the
need to restate prior period financial statements. The audit committee's
investigation has since been completed, and, as a result of its findings, ABNH
has restated its previously issued financial statements for 1996, 1997 (see Note
11 to the financial statements) and the first three quarters of 1998. The
effects of the restatement are presented in Note 11 to the financial statements
and have been reflected herein.

OVERVIEW

     ABNH was, until July 20, 1998, a wholly-owned subsidiary of ABN. On that
date, ABN completed the sale of 13,636,000 shares of our common stock in a
public offering, representing ABN's entire investment in ABNH. We did not
receive any proceeds from the IPO. Additionally, in connection with the IPO, the
amounts due from ABN and affiliates of approximately $33.9 million were
cancelled and deemed to be a dividend. Immediately following our IPO, we had
approximately $5.2 million of secured bank debt and nominal cash. As a
wholly-owned subsidiary, we were provided certain corporate and administrative
services by ABN, including financial reporting, treasury functions, tax planning
and compliance, risk management, human resources and legal services.
Additionally, because ABN managed cash and financing requirements centrally,
interest expense and financing requirements prior to the IPO were based on the
existing capital structure. Our results prior to the IPO might have differed
from the results that might have been achieved had we operated as an independent
entity.

     ABNH originates, mass-produces and markets holograms. Our holograms are
used primarily for security applications such as counterfeiting protection for
credit and other transaction cards, identification cards and documents of value,
as well as for tamper resistance and authentication of high-value consumer and
industrial products. Our ability to control the diffraction of light
("origination") using proprietary processes in a secure, controlled
manufacturing environment has enabled us to become a market leader in security
holography. Our products are used by over 200 companies worldwide. We also
produce non-secure holograms for packaging and promotional applications. Our
sales of holograms for credit card security applications generally carry higher
gross margins than sales for other applications.

     Concerns regarding counterfeiting, piracy and other infractions that can
result in lost sales, lost goodwill and product liability claims drive the use
of product authentication holograms. Companies in various industries have
utilized holograms as authentication devices to reduce potential losses. Also,
concerns over counterfeiting and copying have led to an increased use of
holograms on documents of value, including currency, passports, business
cheques, gift certificates, vouchers, certificates of deposit, stamps (postage
and revenue), tickets and other financial instruments.

     Our sales are derived from the sale of our security and commercial
holograms. In 1998, we derived approximately 95% of our sales from security
applications and approximately 5% from commercial applications. A significant
portion of our business was derived from orders placed by a limited number of
large customers, and variations in the timing of such orders can cause
significant fluctuations in our sales.

     We are currently dependent on certain credit card companies for a
substantial portion of our business, including MasterCard and manufacturers of
VISA brand credit cards. Sales to MasterCard were approximately 30%, 35%, and
23%, respectively, and sales to Visa card manufacturers were approximately 26%,
27%, and 31%, respectively, of sales for the years ended December 31, 1998, 1997
and 1996. We are the exclusive supplier of holograms to MasterCard pursuant to
an agreement, as amended, that extends until February 2003. The agreement
provides for automatic two-year renewal periods if not terminated by either
party. During 1999, we were informed by MasterCard that it believes that we
breached certain terms of the agreement in 1998 and 1997. We have been working
closely with MasterCard to address issues raised by MasterCard, and

                                       17
<PAGE>   20

believe our relationship with MasterCard is good. We do not have long-term
purchase contracts with VISA and we supply holograms to approximately 50 VISA
authorized card manufacturers pursuant to purchase orders. Currently we are one
of two companies authorized to manufacture and sell VISA brand holograms to
manufacturers of VISA brand credit cards. If either MasterCard or VISA were to
terminate its respective relationship with us or substantially reduce their
orders, there would be a material adverse effect on our business, financial
condition, results of operations and cash flows.

     Holograms are sold under purchase orders and contracts with customers.
Sales and the related cost of goods sold are generally recognized at the latter
of the time of shipment or when title passes to customers. In some situations,
we have shipped product with the right of return where we are unable to
reasonably estimate the level of returns and/or the sale is contingent upon the
customers' use of the product. In these situations, we do not recognize sales
upon product shipment, but rather when the buyer of the product informs us that
the product has been used. Additionally, pursuant to terms with a certain
customer, completed items are stored on behalf of the customer at our on-site
secured facility and, in that instance, sales are recognized when all of the
following have occurred: the customer has ordered the goods, the manufacturing
process is complete, the goods have been transferred to the on-site secured
facility and are ready for shipment, the risk of ownership has passed to the
customer and the customer has been billed for the order. During the first
quarter of 1998, we recorded sales of approximately $6.5 million under this
arrangement.

     We have historically purchased certain key materials used in the
manufacture of our holograms from single suppliers, with which we do not have
supply contracts. Any problems that occur with respect to the delivery, quality
or cost of any such materials could have a material adverse effect on our
financial position, results of operations and cash flows.

     During 1998, 1997 and 1996, export sales accounted for approximately 28%,
25% and 32%, respectively, of total sales. All of our export sales are presently
denominated in U.S. dollars.

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

     Selling and administrative expenses primarily consist of salaries, benefits
and commissions for our corporate, sales, marketing and administrative personnel
and marketing and advertising expenses for our services and products.

     Sales may fluctuate from quarter to quarter due to changes in customers'
ordering patterns. Customers do not typically provide us with precise forecasts
of future order quantities. Quarterly demand for holograms may be materially
influenced by customers' promotions, inventory replenishment, card expiration
patterns, delivery schedules and other factors which may be difficult for us to
anticipate.

     In accordance with a tax allocation agreement in effect through the date of
our IPO, we were included in the consolidated U.S. Federal income tax return
and, in certain instances, consolidated or combined state and local income tax
returns of ABN and made payments to ABN based on the amounts which would be
payable as Federal, state and local income taxes as if consolidated or combined
returns were not filed. We computed our Federal, state and local income tax
provision as if we were filing separate income tax returns, without regard to
the tax allocation agreement. In October 1999, an affiliate of ABN received an
assessment for approximately $0.9 million of taxes and interest from the City of
New York relating to the years ended December 31, 1990, 1991 and 1992. We were
included in the combined City of New York income tax returns of ABN for the
periods covered by the assessment and had previously made payments to ABN based
on amounts which would have been payable if the combined income tax returns were
not filed. We are contingently liable, jointly and severally, for U.S. Federal,
state and local income taxes for periods in which we are included in the
consolidated or combined income tax returns of ABN. Amounts paid to ABN in
excess of amounts which would have been payable had we filed separate tax
returns have been charged to Due from

                                       18
<PAGE>   21

Former Parent and affiliates. For periods subsequent to our IPO, we will file
our own U.S. Federal and state income tax returns.

COMPARISON OF THE YEAR ENDED DECEMBER 31, 1998 TO THE YEAR ENDED DECEMBER 31,
1997

     Sales.  Sales increased by $5.6 million, or 24.2%, from $23.1 million in
1997 to $28.7 million in 1998. The increase in sales was due primarily to an
increase in sales of security holograms for credit cards of $2.9 million and
other security holograms of $2.7 million. Sales in the fourth quarter of 1998
were impacted by approximately $3.0 million in sales (including the sale of
goods originally shipped on consignment) at discounts from normal selling prices
in exchange for immediate payment. We believe that, in the absence of such
discounts, a portion of these sales would have occurred in 1999; therefore, it
is anticipated that sales, related gross margins and net income will be
adversely affected in the first quarter of 1999. The contractual net unit sales
price applicable to MasterCard was reduced in September 1998 by approximately
5%. At December 31, 1998, we had customer advances approximating $1.5 million
which represented payments received from customers for products, at a discount
from the normal sales price in exchange for immediate payment, which have not
yet been shipped ($1.2 million) and for products shipped with the right of
return ($0.3 million) where we are unable to reasonably estimate the level of
returns. We anticipate that sales will be recognized in 1999 from these
transactions.

     Cost of Goods Sold.  Cost of goods sold increased by $6.9 million, or
56.6%, from $12.2 million in 1997 to $19.1 million in 1998. As a percentage of
sales, cost of goods sold increased from 52.8% in 1997 to 66.6% in 1998. This
increase reflects increases in the amortization of origination costs (which are
charged to costs of goods sold based on the total number of holographic images
estimated to be produced) due to lower volumes of sales than had been originally
estimated (5%), increases in origination costs which were incurred in
anticipation of orders which did not materialize (5%), increased provisions for
obsolete and excess inventory due primarily to quality considerations and lower
of cost or market adjustments (7%), the effects on gross margin of the sales
discounts referred to above (1%), an increase in warranty expense (1%), and
increases in royalty expenses (2%), offset by an increase in the gross margins
on our sales mix (7%).

     Selling and Administrative Expenses.  Selling and administrative expenses
increased by $0.5 million, from $5.8 million in 1997 to $6.3 million in 1998. As
a percentage of sales, selling and administrative expenses decreased from 25.1%
in 1997 to 22.0% in 1998. The increase in expenses is primarily attributable to
increased sales commissions of $0.4 million relating to the increase in sales,
increased administrative salaries of $0.2 million relating to new hires and
salary increases, and increased costs relating to shareholder communications and
other costs associated with public ownership of $0.4 million, offset by a
decrease in provisions for bad debts of $0.4 million.

     Depreciation and Amortization.  Depreciation and amortization remained
relatively unchanged in 1998 compared to 1997. As a percentage of sales,
depreciation and amortization decreased from 4.9% in 1997 to 3.8% in 1998.

     Other Income.  Other income decreased by $0.2 million from $0.8 million in
1997 to $0.6 million in 1998. This decrease in other income was primarily due to
a change in 1997 in the estimate of 1996 royalties resulting from information
not reported by a licensee until 1997.

     Interest, net.  Interest, net decreased by $0.5 million from $0.1 million
in net income in 1997 to $0.4 million net expense in 1998. This decrease was due
to increased interest expense under the revolving credit facility of $0.4
million and a reduction in interest income from ABN of $0.1 million as a result
of the cancellation of the $5.3 million note receivable from ABN that bore
interest at 5.75% per annum, which was included in the deemed dividend discussed
above.

     Income Taxes.  Income taxes for periods prior to the IPO are based on taxes
that would have been paid had we operated on a stand-alone basis. Income taxes
decreased by $0.8 million, from $2.1 million in 1997 to $1.3 million in 1998, as
a result of lower taxable income due to the factors described above. For a
reconciliation of income taxes from the federal statutory rate to our effective
rate, see Note 5 to our financial statements.

                                       19
<PAGE>   22

     Net Income.  As a result of the foregoing, net income decreased by $1.7
million, or 60.7%, from $2.8 million in 1997 to $1.1 million in 1998.

COMPARISON OF THE YEAR ENDED DECEMBER 31, 1997 TO THE YEAR ENDED DECEMBER 31,
1996

     Sales.  Sales decreased by $4.4 million, or 16.0%, from $27.5 million in
1996 to $23.1 million in 1997. The decrease in sales was due primarily to a
decrease in commercial hologram sales of $2.2 million and a decrease of $2.2
million in sales of security holograms for credit cards.

     Cost of Goods Sold.  Cost of goods sold decreased by $2.5 million, or
17.0%, from $14.7 million in 1996 to $12.2 million in 1997. As a percentage of
sales, cost of goods sold decreased from 53.5% in 1996 to 52.8% in 1997.

     Selling and Administrative Expenses.  Selling and administrative expenses
increased by $1.1 million, or 23.4%, from $4.7 million in 1996 to $5.8 million
in 1997. As a percentage of sales, selling and administrative expenses increased
from 17.1% in 1996 to 25.1% in 1997. This increase in selling and administrative
expenses was due primarily to a bad debt charge of $800,000 associated with a
product development project. In addition, approximately $300,000 of expenses
were incurred in 1997 in connection with our ISO 9000 certification.

     Depreciation and Amortization.  Depreciation and amortization remained
relatively unchanged from 1996 to 1997. As a percentage of sales, depreciation
and amortization increased from 4.1% in 1996 to 4.9% in 1997.

     Other Income.  Other income increased by $0.6 million from $0.2 million in
1996 to $0.8 million in 1997. This increase was primarily due to a change in
1997 in the estimate of 1996 royalties resulting from information not reported
by a licensee until 1997.

     Interest, net.  Interest, net, decreased by $0.2 million from $0.3 million
in 1996 to $0.1 million in 1997 as a result of interest on the revolving credit
facility. Interest income in both years represents interest on a note due from
ABN.

     Income Taxes.  Income taxes for periods prior to the IPO are based on taxes
that would have been paid had we operated on a stand-alone basis. Income taxes
decreased by $1.0 million from $3.1 million in 1996 to $2.1 million in 1997, as
a result of lower taxable income due to the factors described above. For a
reconciliation of income taxes from the federal statutory rate to our effective
rate, see Note 5 to our financial statements.

     Net Income.  As a result of the foregoing, net income decreased by $1.5
million, or 34.9%, from $4.3 million in 1996 to $2.8 million in 1997.

SEASONALITY

     Our sales have not generally exhibited substantial seasonality. However,
our sales and operating results to date have, and future sales and therefore
operating results may, continue to fluctuate from quarter to quarter. The degree
of fluctuation will depend on a number of factors, including the timing and
level of sales, any change in the pricing of our products and the mix of
products sold. Because a significant portion of our business is expected to be
derived from orders placed by a limited number of large customers, variations in
the timing of such orders could cause significant fluctuations in our operating
results. Customers do not typically provide us with precise forecasts of future
order quantities. Quarterly demand for holograms may be materially influenced by
customers' promotions, inventory replenishment, card expiration patterns,
delivery schedules and other factors which may be difficult for us to
anticipate. Other factors that may result in fluctuations in operating results
include the timing of new product announcements and the introduction of new
products and new technologies by us or our competitors, delays in research and
development of new products, increased R&D expenses, availability and cost of
materials from our suppliers, competitive pricing pressures and financing costs.

                                       20
<PAGE>   23

LIQUIDITY AND CAPITAL RESOURCES

     At December 31, 1998, we had $4.3 million in cash and cash equivalents and
working capital of $2.0 million. This cash balance included cash generated from
sales in the fourth quarter of 1998 at a discount from the normal sales price in
exchange for immediate payment and from customer advances, as well as the
effects of an increase in accounts payable. A substantial portion of this cash
was subsequently utilized for repayments under our revolving credit agreement,
the payment of trade payables, and for costs relating to the audit committee
investigation discussed above. We estimate that the total amount to be expended
in connection with the audit committee investigation and related restatement
efforts will approximate $4.0 million. These costs will be charged to operations
as incurred and will adversely impact 1999 operating results and cash flows. At
September 30, 1999, we had $1.0 million of cash and cash equivalents, $2.3
million payable under our revolving credit agreement with Foothill Capital
Corporation and no further availability under the borrowing base formula of our
revolving credit agreement.

     On July 20, 1998, contemporaneously with our IPO, we entered into a $30.0
million credit facility agreement, consisting of a $20.0 million acquisition
facility and a $10.0 million working capital facility, maturing on July 20,
2004, which replaced a facility we had entered into with an affiliate of ABN.
Substantially all of our assets were secured under the terms of the credit
agreement. At the time of the IPO, approximately $5.2 million was due and owing
under the credit agreement. At December 31, 1998, the $5.6 million outstanding
under the credit agreement exceeded the maximum permitted borrowings, as
defined, pursuant to the borrowing base formula, as defined, under the credit
agreement. In February 1999, the lenders notified us that we were in default
under the credit agreement. On March 31, 1999, the credit agreement was amended,
whereby the maximum permitted borrowings was reduced to the lesser of $4.5
million or the maximum permitted borrowings under a borrowing base formula, as
defined. Borrowings under the amended credit agreement bore interest at the
lender's alternate base rate, as defined, plus 0.5%. On July 20, 1999, the
amended credit agreement was further amended, whereby (1) all existing events of
default were waived, (2) the latest maturity date of all loans outstanding was
changed to January 20, 2000 and (3) the maximum permitted borrowings was reduced
to $4.0 million, which was to decline monthly until December 31, 1999 when the
maximum permitted borrowings was to be $2.6 million. The second amended credit
agreement provided for borrowings under a revolving credit line bearing interest
at the lender's alternate base rate, as defined, plus 2% (8.0% at December 31,
1998), subject to a borrowing base formula, as defined. As consideration for the
second amended credit agreement, we paid a fee of $40,000 and issued warrants to
purchase up to 781,645 shares of our common stock, subject to anti-dilution
rights, at $4.50 per share. Such warrants were terminated on September 29, 1999
pursuant to the second amended credit agreement when amounts outstanding under
the second amended credit agreement were repaid, as described below.

     On September 29, 1999, amounts then outstanding under the second amended
credit agreement were repaid when we entered into a loan and security agreement
with Foothill Capital Corporation, a subsidiary of Wells Fargo Bank, maturing on
September 29, 2004. The loan and security agreement, which is secured by
substantially all of our assets, provides for borrowings in an aggregate amount
up to $10.0 million (which may be increased to $15.0 million with the consent of
the parties), subject to a borrowing base formula, under a revolving credit
facility, term loan and capital expenditure loan. Borrowings under the loan and
security agreement bear interest at the lender's reference rate, as defined,
plus 1.5%, which may decrease to 1.25%, 1.00%, or 0.5% under certain
circumstances. Under the terms of the loan and security agreement, the maximum
amounts of the term and capital expenditure loans are approximately $1.0 million
and $2.0 million, respectively, and are repayable in sixty equal monthly
installments.

     The loan and security agreement contains covenants customary for credit
facilities of a similar nature, including limitations on our ability to, among
other things, (1) declare dividends or repurchase or redeem stock, (2) prepay,
redeem or repurchase debt, incur liens and engage in sale-leaseback
transactions, (3) make loans and investments, (4) incur additional debt, (5)
amend or otherwise alter material agreements or enter into restrictive
agreements, (6) make capital expenditures in any fiscal year in excess of $2.5
million, (7) engage in mergers, acquisitions and asset sales, (8) engage in
certain transactions with affiliates and (9) materially alter the nature of our
business. Additionally, under the terms of the loan and security agreement, we
are required to achieve Year 2000 compliance by December 31, 1999. We are also
required to
                                       21
<PAGE>   24

comply with specified financial covenants and ratios and must provide to the
lender our March 31 and June 30, 1999 unaudited financial statements by December
15, 1999 and our September 30, 1999 unaudited financial statements by December
31, 1999. The loan and security agreement provides for events of default
customary for transactions of this type, including nonpayment,
misrepresentation, breach of covenant, cross-defaults, bankruptcy, adverse
judgments in excess of $0.2 million, and change of ownership and control.

     As a result of the amended credit agreement, in the first quarter of 1999
we will write off unamortized deferred financing costs of approximately $0.4
million relating to the credit agreement. As a result of the second amended
credit agreement, in the third quarter of 1999 we will write off unamortized
deferred financing costs of approximately $59,000 relating to the amended credit
agreement. As a result of the loan and security agreement, in the third quarter
of 1999 we will write off the remaining unamortized deferred financing costs
(approximately $31,000) relating to the second amended credit agreement.

     During 1998 and 1997, the weighted average interest rate of outstanding
borrowings was approximately 8.4% and 9.0%, respectively. The average aggregate
borrowings during 1998 and 1997 was approximately $5.2 million and $0.9 million,
respectively.

     Prior to our IPO, our cash accounts had been controlled on a centralized
basis by ABN and, accordingly, cash receipts and disbursements had been received
or made through ABN and were recorded as due from ABN and affiliates. Subsequent
to our IPO, we maintain our own centralized cash management system. Prior to our
IPO, cash had been provided to ABN in the ordinary course of business by way of
intercompany advances to service its debt obligations and for general corporate
purposes. Upon consummation of our IPO, these intercompany advances were
cancelled and included in the deemed dividend to ABN of $33.9 million.
Immediately following our IPO, we had approximately $5.2 million of secured bank
debt and nominal cash.

     For the year ended December 31, 1998, our operating activities provided
cash flow of $7.4 million compared to $4.0 million and $4.6 million of cash flow
provided by operating activities in 1997 and 1996, respectively. The increase in
cash flows was primarily due to sales in the fourth quarter of 1998, at a
discount from the normal sales price in exchange for immediate payment, and
customer advances, as discussed above, as well as an increase in amounts owed to
vendors.

     Investing activities for the years ended December 31, 1998, 1997 and 1996
used cash flows of approximately $0.4 million, $0.5 million, and $0.4 million,
respectively. These activities primarily reflected capital expenditures for the
respective years. We anticipate that capital expenditures in 1999 and 2000 will
be approximately $0.6 million and $0.7 million, respectively. These amounts
include approximately $0.4 million in 1999 for new systems which will be year
2000 compliant, with the balance relating to capital expenditures required to
improve production capabilities.

     Financing activities for the years ended December 31, 1998, 1997 and 1996
used cash flows of $3.0 million, $3.4 million and $7.4 million, respectively.
The activity in 1998 was comprised of advances to ABN and affiliates ($7.8
million) and deferred financing costs ($0.5 million), offset by borrowings under
the revolving credit agreement and other borrowings ($5.3 million). The activity
in 1997 and 1996 was comprised principally of advances to ABN and affiliates
($4.1 million and $7.4 million, respectively) and, in 1997, was offset by $0.7
million of borrowings under the then existing revolving credit facility.

     We believe that cash flows from operations, together with cash balances and
availability of funds under the loan and security agreement, will be sufficient
to meet working capital needs, service debt and fund capital expenditures for
the next twelve months.

     We are a party to certain legal proceedings that may affect our financial
position. For a description of these proceedings, see "Item 3. -- Legal
Proceedings."

     On August 3, 1999, the New York Stock Exchange suspended trading in our
common stock for failure to deliver its Annual Report on Form 10-K for the year
ended December 31, 1998 and its Quarterly Report on Form 10-Q for the three
months ended March 31, 1999 on a timely basis. Following the suspension, the
NYSE notified us of its intent to apply for delisting of our common stock. Our
common stock will not resume

                                       22
<PAGE>   25

trading on the NYSE, but we intend to seek to have our common stock traded on
another stock exchange or quoted on Nasdaq.

NEW ACCOUNTING STANDARDS

     In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1, Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use ("SOP 98-1"). SOP 98-1
requires computer software costs associated with internal use software to be
expensed as incurred until certain capitalization criteria are met. We adopted
SOP 98-1 on January 1, 1999. Adoption of this statement did not have a material
impact on our financial position, results of operations, or cash flows.

     In April 1998, the AICPA issued Statement of Position 98-5, Reporting on
the Cost of Start-Up Activities ("SOP 98-5"). SOP 98-5 requires all costs
associated with pre-opening, pre-operating and organization activities to be
expensed as incurred. We adopted SOP 98-5 on January 1, 1999. Adoption of this
statement did not have a material impact on our financial position, results of
operations, or cash flows.

     In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, which, as amended,
is effective for fiscal years beginning after June 15, 2000. SFAS No. 133
requires the recognition of all derivatives in the balance sheets as either
assets or liabilities measured at fair value. We will adopt SFAS No. 133 for the
2001 fiscal year. We are currently evaluating the impact SFAS No. 133 will have
on our financial position, results of operations and cash flows.

YEAR 2000 READINESS DISCLOSURE

     The Year 2000 issue is the result of computer programs using only the last
two digits to refer to a year. Therefore, these computer programs do not
properly recognize a year that begins with "20" instead of the familiar "19." If
not corrected, these computer applications could fail or create erroneous
results. The global extent of the potential impact of the Year 2000 problem is
not yet known, and if not timely corrected, it could adversely affect the
economy and us. We use computer information systems and manufacturing equipment,
which may be affected. We also rely on suppliers and customers who are also
dependent on systems and equipment, which use date sensitive software. We
recognize the importance of the Year 2000 issue and it has been given high
priority.

     Late in 1997 we began to review the production equipment used in the
manufacture of our products as well as the systems related to the infrastructure
of our manufacturing and office facilities. We inventoried and verified Year
2000 readiness of computer controlled manufacturing equipment and computer
controls for our manufacturing and office facilities. This equipment included
the air conditioning and heating systems, the elevator and all manufacturing
equipment. This process was validated by equipment manufacturers and was
completed in December 1998.

     In December 1998, we began evaluating and testing our internal computer
information systems. This effort involved plans for creating or purchasing
replacement systems for those computer information systems which were developed
internally as well as obtaining versions of software purchased from third
parties which are Year 2000 compliant. We expect to have converted or replaced
computer information systems for our entire business operations by the end of
the fourth quarter of 1999 with an estimated total cost of approximately
$425,000, which does not include internal costs associated with our Year 2000
remediation. Our internal costs associated with our Year 2000 remediation are
being expensed as incurred, and have not been material to our past performance
and are not expected to be material relative to our future performance. No funds
were expended relating to our Year 2000 remediation during 1998. Through October
31, 1999, approximately $380,000 was expended and approximately $45,000 will be
expended in November and December 1999. Our current estimates of the amount of
costs and time necessary to remediate and test our computer systems are based on
the facts and circumstances existing and known at this time. These estimates
were made using assumptions of future events including the continued
availability of certain resources, implementation success by key third parties
and other factors.

     We are in the process of implementing new financial and manufacturing
software to comply with the Year 2000 issues and to improve our management
reporting capabilities. All mission critical portions of the

                                       23
<PAGE>   26

software have been pilot tested to insure the correct operation of the hardware
and software. We have begun testing in parallel the new financial and
manufacturing software, and expect that such testing will include data through
November 30, 1999 with an expected completion date of December 15, 1999. Once
such parallel testing is completed, we will consider our mission critical
hardware and software to be Year 2000 compliant. As the new financial and
manufacturing software is implemented and tested, our Year 2000 contingency plan
has also been modified to include the Year 2000 compliant capabilities of the
new portions of the software.

     Also, in late 1998 we began to assess the Year 2000 remediation efforts of
our suppliers, including providers of services such as utilities, and customers
where there is a significant business relationship. These efforts however
provide no assurances that we will not be affected by the Year 2000 problems of
other organizations. This process was completed in March 1999. To date, however,
the information received from our suppliers and customers indicate that their
respective Year 2000 remediation efforts are on target to achieve Year 2000
compliance by December 31, 1999.

     If we are unsuccessful or if the remediation efforts of our key suppliers
or customers are unsuccessful with regard to Year 2000 remediation, there may be
a material adverse impact on our results and financial condition. A worst case
scenario would include the loss of utility service, rendering us unable to
manufacture and distribute. Our contingency plan includes such precautionary
measures as managing inventory levels, the deployment of manual systems, the use
of alternate computer software that we currently own and the use of outside
contractors. At this time, however, we are unable to quantify any potential
adverse impact but will continue to monitor and evaluate the situation.

IMPACT OF INFLATION

     In recent years, inflation has not had a significant impact on our
historical operations. There can be no assurance that inflation will not
adversely affect our operations in the future, particularly in emerging markets
where inflationary conditions tend to be more prevalent.

UNAUDITED QUARTERLY RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1998
AND 1997

<TABLE>
<CAPTION>
                                                                     YEAR ENDED DECEMBER 31, 1998(A)
                                          --------------------------------------------------------------------------------------
                                              FIRST QUARTER          SECOND QUARTER           THIRD QUARTER
                                          ---------------------   ---------------------   ---------------------
                                              AS                      AS                      AS
                                          PREVIOUSLY      AS      PREVIOUSLY      AS      PREVIOUSLY      AS
                                           REPORTED    RESTATED    REPORTED    RESTATED    REPORTED    RESTATED   FOURTH QUARTER
                                          ----------   --------   ----------   --------   ----------   --------   --------------
                                                                  (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                       <C>          <C>        <C>          <C>        <C>          <C>        <C>
Sales(b)................................    $7,035     $10,176      $9,581      $4,636     $10,524      $5,091       $ 8,766
Cost of goods sold......................     2,438       4,609       4,007       2,100       3,781       1,930        10,425
Net income (loss).......................     1,793       2,510       2,279         387       2,771         294        (2,072)
Net income (loss) per share -- basic and
  diluted...............................    $ 0.13     $  0.18      $ 0.17      $ 0.03     $  0.20      $ 0.02       $ (0.15)
</TABLE>

<TABLE>
<CAPTION>
                                                               YEAR ENDED DECEMBER 31, 1997(A)
                                ---------------------------------------------------------------------------------------------
                                    FIRST QUARTER          SECOND QUARTER           THIRD QUARTER          FOURTH QUARTER
                                ---------------------   ---------------------   ---------------------   ---------------------
                                    AS                      AS                      AS                      AS
                                PREVIOUSLY      AS      PREVIOUSLY      AS      PREVIOUSLY      AS      PREVIOUSLY      AS
                                 REPORTED    RESTATED    REPORTED    RESTATED    REPORTED    RESTATED    REPORTED    RESTATED
                                ----------   --------   ----------   --------   ----------   --------   ----------   --------
                                                            (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                             <C>          <C>        <C>          <C>        <C>          <C>        <C>          <C>
Sales.........................    $5,241      $6,198      $6,296      $5,969      $8,104      $7,786     $11,274     $ 3,132
Cost of goods sold............     2,629       3,556       2,591       3,189       2,617       2,348       4,075       3,060
Net income (loss).............       657         633       1,422         909       2,275       2,245       3,185        (967)
Net income (loss) per share --
  basic and diluted...........    $ 0.05      $ 0.05      $ 0.10      $ 0.07      $ 0.17      $ 0.16     $  0.23     $ (0.07)
</TABLE>

---------------
(a) The financial statements each of the quarters in the period ended September
    30, 1998 and the year ended December 31, 1997 have been restated. See Note
    11 to the financial statements.

(b) In the first quarter of 1998, ABNH recorded sales of $6.5 million related to
    a customer order which was transferred to ABNH's on-site secured facility
    (See Note 1 to the financial statements).

                                       24
<PAGE>   27

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

     We do not engage in significant activity with respect to market risk
sensitive instruments. Accordingly, our risk with respect to market risk
sensitive instruments is immaterial.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

     The Financial Statements and Supplementary Data required by this item are
filed as part of this Form 10-K. See Index to Financial Statements on page F-1
of this Form 10-K.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

     Not applicable.

                                       25
<PAGE>   28

                                    PART III

ITEM 10.  DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES OF REGISTRANT

     The following table sets forth certain information concerning our
directors, executive officers and key employees. All directors hold office until
the next annual meeting of stockholders or until their successors have been
elected and qualified. Officers are appointed by the board of directors and
serve at the discretion of the board.

<TABLE>
<CAPTION>
NAME                                              AGE                     POSITION(S)
----                                              ---                     -----------
<S>                                               <C>   <C>
DIRECTORS AND EXECUTIVE OFFICERS:
Salvatore F. D'Amato............................  71    Chairman of the Board
Kenneth H. Traub................................  38    President, Chief Operating Officer and Director
Stephen A. Benton*..............................  58    Director
C. Gerald Goldsmith*............................  71    Director
Russell LaCoste.................................  49    Executive Vice President, Corporate Development
                                                          and Marketing
Alan Goldstein..................................  52    Vice President and Chief Financial Officer
KEY EMPLOYEES:
Michael T. Banahan..............................  41    Vice President, Sales and Marketing
George Condos...................................  37    Controller
</TABLE>

---------------
* Member of the audit committee.

     Salvatore F. D'Amato has served as our Chairman of the Board since April
1999 and as a director since March 1999. He was also our Chairman of the Board
and President from 1983 to 1990. Mr. D'Amato was President and a director of
ABN, our former parent corporation, from 1977 to 1983. Prior thereto he served
as Vice President, Engineering and Senior Vice President, Operations with ABN.
Mr. D'Amato holds a masters degree in Engineering from Columbia University.

     Kenneth H. Traub has served as our President and Chief Operating Officer
since February 1999, as our consultant since January 1999 and as a director
since April 1999. Previously, Mr. Traub co-founded Voxware, Inc., a developer of
digital speech processing technologies, and served on its board of directors
from February 1995 to January 1998 and as its Executive Vice President, Chief
Financial Officer and Secretary from February 1995 to April 1998. Prior thereto,
Mr. Traub was Vice President of Trans-Resources, Inc., a diversified
multinational holding company. Mr. Traub holds an M.B.A. from the Harvard
Graduate School of Business Administration and a B.A. from Emory University.

     Stephen A. Benton has served as a director since July 1998. Dr. Benton is
the founding head of the Spatial Imaging Group at the Massachusetts Institute of
Technology, where he has been a faculty member since 1982. He is a fellow of the
Optical Society of America and the Society for Imaging Science and Technology.
Dr. Benton holds a Ph.D. in Applied Physics from Harvard University.

     C. Gerald Goldsmith has served as a director since July 1998. Mr. Goldsmith
has been an independent investor and financial advisor for over 20 years. He is
a director of ABN, Innkeepers USA Trust, Plymouth Rubber Company, Inc., Palm
Beach National Bank & Trust Company and Intracoastal Health System. Mr.
Goldsmith holds an M.B.A. from the Harvard Graduate School of Business
Administration.

     Russell LaCoste has served as our Executive Vice President, Corporate
Development and Marketing since October 1999. He also served as our Vice
President, Sales and Marketing from 1984 to 1992. Mr. LaCoste was Vice President
of Sales and Marketing of Kurz Transfer Products, a manufacturer of specialty
printing products, from September 1995 to October 1999. From 1992 to September
1995, he was President of Optigraphics Corporation, a specialty printer. Mr.
LaCoste holds a B.S. in Marketing from the University of Vermont and an M.B.A.
from the University of Bridgeport.

                                       26
<PAGE>   29

     Alan Goldstein has served as our Vice President and Chief Financial Officer
since April 1999 and as our consultant since February 1999. Mr. Goldstein was
Vice President and Chief Accounting Officer of Complete Management, Inc., a
physician management company, from June 1997 to July 1998, and Vice President
and Chief Financial Officer of RF International, Inc., a multinational
transportation services holding company, from July 1994 to December 1996. During
other periods Mr. Goldstein acted as an independent consultant. Mr. Goldstein
holds a B.S. in Business Administration from Boston University and a M.S. in
Accounting from Long Island University. Mr. Goldstein is a Certified Public
Accountant.

     Michael T. Banahan has served as our Vice President, Sales and Marketing
since May 1999. He also served as a senior member of our sales department from
1989 to May 1999. Mr. Banahan holds a B.A. in Marketing Management from the
University of Rhode Island.

     George Condos has served as our Controller since May 1999 and as our
consultant since February 1999. Mr. Condos was Controller of PSR Logistics, a
transportation company, from January 1997 to August 1998. From February 1995 to
January 1997, he was District Controller and Office Manager at Browning-Ferris
Industries, a waste management and recycling company. From 1991 to February
1995, he was Controller of United Carting Company, a waste services company. Mr.
Condos holds a B.S. in Accounting from Fairleigh Dickinson University.

COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934

     Section 16(a) under the Securities Exchange Act of 1934 requires our
executive officers and directors, and persons who beneficially own more than ten
percent of our common stock, to file initial reports of ownership and reports of
changes in ownership with the SEC. Executive officers, directors and greater
than ten percent beneficial owners are required by the SEC to furnish us with
copies of all Section 16 forms they file.

     Based upon a review of the copies of such forms furnished to us and written
representations from our executive officers and directors, we believe that the
reporting requirements of Section 16, as amended, applicable to our executive
officers, directors and greater than ten percent beneficial owners were complied
with on a timely basis for all transactions that occurred during 1998, except
that Stephen A. Benton and C. Gerald Goldsmith, each of whom became a director
of ABNH and received a grant of options to purchase ABNH common stock in July
1998, failed to timely report such events on Form 3. These events have been
subsequently reported.

                                       27
<PAGE>   30

ITEM 11.  EXECUTIVE COMPENSATION.

     The following table provides information concerning compensation paid to or
earned during 1996, 1997 and 1998 by each individual who served as our CEO
during 1998 and the next three most highly compensated executive officers during
1998 (the "Named Executive Officers"). None of our other executive officers
earned salary and bonus in excess of $100,000 during 1998.

                           SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
                                                                                     LONG-TERM
                                                 ANNUAL COMPENSATION                COMPENSATION
                                        --------------------------------------    ----------------
                                                                                  SHARES OF COMMON
                                                                OTHER ANNUAL      STOCK UNDERLYING
                                         SALARY      BONUS     COMPENSATION(1)        OPTIONS
NAME                            YEAR      ($)         ($)            ($)                (#)
----                            ----    --------    -------    ---------------    ----------------
<S>                             <C>     <C>         <C>        <C>                <C>
Morris Weissman(2)............  1996          --         --             --                 --
                                1997          --         --             --                 --
                                1998          --         --             --            400,000
Joshua C. Cantor(3)...........  1996     250,000         --            440                 --
                                1997     250,000     25,000         31,908                 --
                                1998     250,000         --          8,924            200,000
Richard P. Macchiarulo(4).....  1996          --         --             --                 --
                                1997      87,847     28,280             --                 --
                                1998      99,167         --          1,670             40,000
Jeffrey N. Dugal (5)..........  1996          --         --             --                 --
                                1997      51,897     12,500          1,925                 --
                                1998     120,750      5,190          3,150             40,000
</TABLE>

---------------
(1) Other Annual Compensation for Messrs. Cantor, Macchiarulo and Dugal consists
    of the use of automobiles paid for by us.

(2) Mr. Weissman served as Chairman of the Board and Chief Executive Officer
    from 1990 to April 1999.

(3) Mr. Cantor served as Executive Vice President and General Manager from
    November 1995 to May 1997 and as President from May 1997 to February 1999.

(4) Mr. Macchiarulo served as Vice President -- Finance from June 1997 to
    February 1999.

(5) Mr. Dugal served as Vice President -- Operations from June 1997 to February
    1999.

                                       28
<PAGE>   31

     The following table provides information concerning option grants during
1998 to the Named Executive Officers. No options were exercised during 1998.

                             OPTION GRANTS IN 1998

<TABLE>
<CAPTION>
                                                                                      POTENTIAL REALIZABLE
                                                                                        VALUE AT ASSUMED
                                                                                      ANNUAL RATES OF STOCK
                                                                                       PRICE APPRECIATION
                                                 INDIVIDUAL GRANTS                       FOR OPTION TERM
                                ---------------------------------------------------   ---------------------
                                SHARES OF    PERCENT OF
                                  COMMON       TOTAL
                                  STOCK       OPTIONS
                                UNDERLYING   GRANTED TO   EXERCISE
                                OPTIONS(1)   EMPLOYEES      PRICE      EXPIRATION        5%          10%
NAME                               (#)        IN 1998     ($/SHARE)       DATE           ($)         ($)
----                            ----------   ----------   ---------   -------------   ---------   ---------
<S>                             <C>          <C>          <C>         <C>             <C>         <C>
Morris Weissman(2)............   400,000        40.6%       8.50      July 13, 2008   2,138,242   5,418,725
Joshua C. Cantor(3)...........   200,000        20.3%       8.50      July 13, 2008   1,069,121   2,709,362
Richard P. Macchiarulo(4).....    40,000         4.1%       8.50      July 13, 2008     213,824     541,872
Jeffrey N. Dugal(5)...........    40,000         4.1%       8.50      July 13, 2008     213,824     541,872
</TABLE>

---------------
(1) All of the options terminated unexercised upon the officers' resignations in
    1999.

(2) Mr. Weissman served as Chairman of the Board and Chief Executive Officer
    from 1990 to April 1999.

(3) Mr. Cantor served as Executive Vice President and General Manager from
    November 1995 to May 1997 and as President from May 1997 to February 1999.

(4) Mr. Macchiarulo served as Vice President -- Finance from June 1997 to
    February 1999.

(5) Mr. Dugal served as Vice President -- Operations from June 1997 to February
    1999.

     The following table provides information concerning the number and value of
unexercised options held by each of the Named Executive Officers on December 31,
1998.

                          1998 YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
                                                SHARES OF COMMON STOCK       VALUE OF UNEXERCISED IN-THE-
                                                UNDERLYING UNEXERCISED             MONEY OPTIONS AT
                                                      OPTIONS(#)               DECEMBER 31, 1998($)(1)
                                             ----------------------------    ----------------------------
NAME                                         EXERCISABLE    UNEXERCISABLE    EXERCISABLE    UNEXERCISABLE
----                                         -----------    -------------    -----------    -------------
<S>                                          <C>            <C>              <C>            <C>
Morris Weissman(2).........................      --            400,000           --           3,600,000
Joshua C. Cantor(3)........................      --            200,000           --           1,800,000
Richard P. Macchiarulo(4)..................      --             40,000           --             360,000
Jeffrey N. Dugal(5)........................      --             40,000           --             360,000
</TABLE>

---------------
(1) Based on the difference between $17.50, which was the closing price per
    share on December 31, 1998, and $8.50, the exercise price per share of the
    options.

(2) Mr. Weissman served as Chairman of the Board and Chief Executive Officer
    from 1990 to April 1999.

(3) Mr. Cantor served as Executive Vice President and General Manager from
    November 1995 to May 1997 and as President from May 1997 to February 1999.

(4) Mr. Macchiarulo served as Vice President -- Finance from June 1997 to
    February 1999.

(5) Mr. Dugal served as Vice President -- Operations from June 1997 to February
    1999.

1998 STOCK INCENTIVE PLAN

     Subsequent to our IPO, we adopted the 1998 Stock Incentive Plan for the
purpose of granting various stock incentives to our key employees. The board of
directors (or a committee appointed by the board of

                                       29
<PAGE>   32

directors) has discretionary authority, subject to certain restrictions, to
administer the plan. The total number of shares reserved for issuance under the
plan is 1,363,000 shares of common stock. Options to purchase 1,249,000 shares
of common stock were outstanding under the plan as of October 31, 1999. Options
to purchase an additional 180,000 shares of common stock were outstanding
outside the plan as of October 31, 1999. The exercise price of options granted
under the plan may not be less than 100% of the fair market value of our common
stock on the date such option was granted. Generally, the unexercised portion of
any option automatically terminates upon the termination of the optionee's
employment with us, unless otherwise determined by the board of directors;
provided, however, that any extension shall not extend beyond the expiration of
the option, generally ten years. Upon a change in control, outstanding options
will generally become fully vested and may be exercised immediately.

     We intend to file a registration statement on Form S-8 under the Securities
Act of 1933, as amended, to register all shares of Common Stock issuable under
the 1998 Stock Incentive Plan.

RETIREMENT PLANS

     Retirement benefits were provided by ABN to eligible employees through the
defined contribution retirement plan of ABN; the aggregate contributions to such
plan which have been charged to our operations was approximately $0.2 million in
each of the years ended 1998, 1997 and 1996, respectively. We continue to be a
participating employer in this plan, although we plan to terminate our
participation in this plan and start our own defined contribution plan.

     Certain of our employees participate in an affiliate of ABN's defined
benefit pension plan. Benefits under the plan were frozen in 1992 and were based
on years of service and average final compensation. The liability for benefits
under this plan, which is substantially funded, is the responsibility of an
affiliate of ABN. The total pension expense relating to our employees in the
aggregate for the past three years was less than $10,000.

DIRECTOR COMPENSATION

     Each member of the board of directors who is not an officer or an owner of
more than 5% of our outstanding common stock will receive compensation of $1,500
per meeting for serving on the board of directors. We also will reimburse
directors for any expenses incurred in attending meetings of the board of
directors and the committees thereof. Upon their initial election to the board
of directors, each non-employee Board member is granted options to purchase
15,000 shares of our common stock. Such options are exercisable at the fair
market value of the common stock at the date of grant. These options become
vested and exercisable for up to 33 1/3% of the total option shares upon the
first anniversary of the grant of the options and for an additional 33 1/3% of
the total option shares upon each succeeding anniversary until the option is
fully exercisable at the end of the third year. The arrangements for directors'
compensation are presently under review.

EMPLOYMENT AGREEMENTS

     We entered into an employment agreement with Salvatore F. D'Amato in April
1999 for an initial term of two years. The agreement provides for a base salary
of $14,300 per month. In addition, Mr. D'Amato is eligible to receive bonuses at
the discretion of our board of directors. Also in connection with the agreement,
we granted to Mr. D'Amato options to purchase up to 175,000 shares of our common
stock at an exercise price of $2.50 per share. In the event of Mr. D'Amato's
termination for any reason other than for cause, as defined in the agreement, or
in the event of his resignation for good reason, as defined in the agreement, we
are required to continue to pay his salary then in effect, together with any
bonus that may have accrued, for the remainder of his employment term. Upon
termination of Mr. D'Amato's employment following a change of control, or Mr.
D'Amato's resignation for good reason within one year of a change of control, we
are required to pay him an amount equal to $171,600. In connection with his
employment agreement, Mr. D'Amato agreed not to compete with us during his term
of employment and for one year thereafter.

                                       30
<PAGE>   33

     We entered into an employment agreement with Kenneth Traub in February 1999
for an initial term of one year. The agreement provides for an annual base
salary of $250,000, to be increased by not less than 3% per year upon renewal.
In addition, Mr. Traub is eligible to receive bonuses at the discretion of our
board of directors, including a target bonus of $25,000 per quarter. Also in
connection with the agreement, we granted to Mr. Traub options to purchase up to
250,000 shares of our common stock at an exercise price of $1.75 per share. In
May 1999, Mr. Traub was granted additional options to purchase up to 100,000
shares of our common stock at an exercise price of $2.50 per share. In the event
of Mr. Traub's termination for any reason other than for cause, as defined in
the agreement, or in the event of his resignation for good reason, as defined in
the agreement, (1) we are required to pay him (x) his salary then in effect with
any bonus which may have been accrued or which otherwise would have been granted
by the board to him for a period of two years following such termination without
cause or (y) 50% of his salary then in effect with any bonus which may have been
accrued or which otherwise would have been granted by the board to him for a
period of two years following such resignation for good reason, (2) we are
required to continue any benefits to Mr. Traub and (3) all unvested options to
purchase common stock granted under the 1998 Stock Incentive Plan to him will
vest immediately. Upon termination of Mr. Traub's employment following a change
of control, or Mr. Traub's resignation for a good reason, as defined in the
agreement, following a change in control, we are required to pay him as
severance an amount equal to twice his salary then in effect if such termination
or resignation is within one year of such change of control and an amount equal
to three times his salary then in effect if such termination or resignation is
more than one year after such change of control. In connection with his
employment agreement, Mr. Traub agreed not to compete with us during his term of
employment and for one year thereafter.

     We entered into an employment agreement with Alan Goldstein in April 1999
for an initial term of one year. The agreement provides for an annual base
salary of $160,000, to be increased by not less than 3% per year upon renewal.
In addition, Mr. Goldstein is eligible to receive bonuses at the discretion of
our board of directors, including a target bonus of $10,000 per quarter. In
connection with the agreement, we granted to Mr. Goldstein options to purchase
up to 100,000 shares of our common stock at an exercise price of $2.50 per
share. In the event of Mr. Goldstein's termination for any reason other than for
cause, as defined in the agreement, or in the event of his resignation for good
reason, as defined in the agreement, (1) we are required to pay him his salary
then in effect with any bonus which may have been accrued or which otherwise
would have been granted by the board to him for a period of six months following
such termination or resignation for good reason, (2) we are required to continue
any benefits to Mr. Goldstein and (3) all unvested options to purchase common
stock granted under the 1998 Stock Incentive Plan to him will vest immediately.
Upon termination of Mr. Goldstein's employment following a change of control, or
Mr. Goldstein's resignation for a good reason, as defined in the agreement,
following a change in control, we are required to pay him as severance an amount
equal to nine months of his salary then in effect. In connection with his
employment agreement, Mr. Goldstein agreed not to compete with us during his
term of employment and for one year thereafter.

     We entered into an employment agreement with Russell LaCoste in September
1999. The agreement provides for a base salary of $225,000 per year. In
addition, Mr. LaCoste is eligible to receive bonuses at the discretion of our
board of directors, including a target bonus of $10,000 per quarter. Also in
connection with the agreement, we granted to Mr. LaCoste options to purchase up
to 150,000 shares of our common stock at an exercise price of $2.50 per share.
In the event of Mr. LaCoste's termination for any reason other than for cause,
we are required to continue to pay him his salary then in effect for a period of
three months following such termination. Upon termination of Mr. LaCoste's
employment within three months before or after a change of control, we are
required to pay him an amount equal to $250,000.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

     Matters concerning executive officer compensation are addressed by our
entire board of directors because we do not have a compensation committee. No
interlocking relationship exists between our board of directors and the board of
directors or compensation committee of any other company.

                                       31
<PAGE>   34

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

     The following table sets forth as of December 15, 1999 certain information
regarding beneficial ownership of our common stock by (1) each person who is
known to us to be the beneficial owner of more than 5% of the outstanding shares
of our common stock, (2) each director, (3) each of the Named Executive Officers
and (4) all directors and executive officers as a group. All persons listed have
sole voting and investment power with respect to their shares unless otherwise
indicated. The address of all persons listed is c/o American Bank Note
Holographics, Inc., 399 Executive Boulevard, Elmsford, NY 10523 unless otherwise
indicated.

<TABLE>
<CAPTION>
NAME AND ADDRESS                                              NUMBER(1)   PERCENTAGE
----------------                                              ---------   ----------
<S>                                                           <C>         <C>
Putnam Investments, Inc.(2).................................  1,920,102      14.1%
  One Post Office Square
  Boston, MA 02109
Libra Advisors, LLC(3)......................................    711,100       5.2%
  277 Park Avenue, 26th Floor
  New York, NY 10172
Salvatore F. D'Amato........................................      2,000         *
Kenneth H. Traub(4).........................................     83,333         *
Stephen A. Benton(5)........................................      5,000         *
C. Gerald Goldsmith(6)......................................      6,000         *
Morris Weissman(7)..........................................     20,000         *
  c/o American Banknote Corporation
  410 Park Avenue
  New York, NY 10022
Joshua C. Cantor(8).........................................         --         *
  14 Settlers Lane
  Westfield, NJ 07090
Richard P. Macchiarulo(9)...................................         --         *
  3165 32nd Street
  Astoria, NY 11106
Jeffrey N. Dugal(10)........................................         --         *
All executives officers and directors as a group (6
  persons)(11)..............................................     99,833         *
</TABLE>

---------------
  *  Less than 1%.

 (1) Beneficial ownership is determined in accordance with the rules of the SEC,
     and includes general voting power and/or investment power with respect to
     securities. Shares of common stock subject to options currently exercisable
     or exercisable within 60 days of December 15, 1999 are deemed outstanding
     for computing the percentage beneficially owned by the person holding such
     options.

 (2) The information provided is based solely on a Schedule 13G filed with the
     SEC on February 4, 1999. Putnam Investments, Inc., which is a wholly-owned
     subsidiary of Marsh & McLennan Companies, Inc., wholly owns two registered
     investment advisers: Putnam Investment Management, Inc., which is the
     investment adviser to the Putnam family of mutual funds and which
     beneficially owns 877,200 shares of our common stock, and The Putnam
     Advisory Company, Inc., which is the investment adviser to Putnam's
     institutional clients and which beneficially owns 1,042,902 shares of our
     common stock. Both subsidiaries have dispository power over the shares as
     investment managers, but each of the mutual fund's trustees have voting
     power over the shares held by each fund, and The Putnam Advisory Company,
     Inc. has shared voting power over the shares held by the institutional
     clients. Putnam Investments, Inc. and Marsh & McLennan Companies, Inc. have
     declared that the filing of a Schedule 13G with the SEC shall not be deemed
     an admission by either or both of them that they are, for the purposes of
     Section 13(d) or 13(g) under the Securities Exchange Act of 1934, as
     amended, the beneficial owner of any shares of our common stock, and have
     further stated that neither of them have any power to vote or dispose of,
     or direct the voting or disposition of, any shares of our common stock.

 (3) The information provided is based solely on a Schedule 13G filed with the
     SEC on October 8, 1999. Libra Advisors, LLC is the general partner of Libra
     Fund, L.P., which owns 676,100 shares of common

                                       32
<PAGE>   35

     stock, and the investment advisor of an offshore fund that owns 35,000
     shares of common stock. Libra Advisors, LLC has the power to vote and to
     direct the voting of and the power to dispose and direct the disposition of
     these 711,100 shares. Ranjon Tandon is the sole voting member and manager
     of Libra Advisors, LLC and may be deemed to have the power to vote and to
     direct the voting of and the power to dispose and direct the disposition of
     the 711,100 shares of common stock beneficially owned by Libra Advisors,
     LLC.

 (4) Consists of 83,333 shares of common stock subject to options currently
     exercisable or exercisable within 60 days of December 15, 1999.

 (5) Consists of 5,000 shares of common stock subject to currently exercisable
     options.

 (6) Includes 5,000 shares of common stock subject to currently exercisable
     options.

 (7) Mr. Weissman served as Chairman of the Board and Chief Executive Officer
     from 1990 to April 1999. The information regarding Mr. Weissman's
     beneficial ownership of our common stock is based solely on a review of
     filings made with the SEC.

 (8) Mr. Cantor served as Executive Vice President and General Manager from
     November 1995 to May 1997 and as President from May 1997 to February 1999.
     The information regarding Mr. Cantor's beneficial ownership of our common
     stock is based solely on a review of filings made with the SEC.

 (9) Mr. Macchiarulo served as Vice President -- Finance from June 1997 to
     February 1999. The information regarding Mr. Macchiarulo's beneficial
     ownership of our common stock is based solely on a review of filings made
     with the SEC.

(10) Mr. Dugal served as Vice President -- Operations from June 1997 to February
     1999. The information regarding Mr. Dugal's beneficial ownership of our
     common stock is based solely on a review of filings made with the SEC.

(11) Includes 93,333 shares of common stock subject to options currently
     exercisable or exercisable within 60 days of December 15, 1999.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

     Prior to our IPO in July 1998, we were a wholly-owned subsidiary of ABN.
ABN does not own any of our common stock following the IPO. In connection with
the IPO, we entered into a number of agreements with ABN relating to the
transition period and to defining our ongoing relationships following the IPO,
as follows:

          Separation Agreement.  This agreement provides that:

           - we will generally indemnify ABN, including its officers, directors,
             employees and affiliates, against all costs, liabilities and
             expenses relating to the IPO and the conduct by us of our business,
             including as a result of guarantees by ABN of any of our
             obligations,

           - ABN will indemnify us against all costs, liabilities and expenses
             relating to the conduct by ABN of its business, including as a
             result of guarantees by us of any obligations of ABN,

           - immediately prior to the closing of the IPO, we will have a nominal
             amount of unrestricted cash and ABN shall be entitled to all
             unrestricted cash on hand,

           - ABN will indemnify and hold us harmless for all federal, foreign,
             state and local franchise, income, sales, use, transfer and other
             tax liabilities or obligations, including interest and penalties,
             attributable to ABN's consolidated group activities (other than our
             activities) for all periods,

           - we will indemnify and hold harmless ABN for all federal, foreign,
             state and local franchise, income, sales, use, transfer and other
             tax liabilities or obligations, including interest and penalties,
             attributable to our activities for all periods, and

           - we and ABN will cross-indemnify each other for certain other
             matters.

                                       33
<PAGE>   36

          License Agreement.  This agreement provides us with the right to use
     the "American Bank Note" name for a one-year term, automatically renewable
     for consecutive one-year periods, for an annual fee of $1. Additionally, we
     and ABN granted each other perpetual, paid-up royalty-free licenses for any
     patents, trademarks or other proprietary technology used by the other in
     its respective business. We agreed not to use the name "American Bank Note"
     or any variation thereof in connection with any business, enterprise or
     venture outside of the holography industry and not to sublicense the name
     to third parties.

          Transitional Services Agreement.  ABN agreed to provide or cause to be
     provided to us certain specified corporate and administrative services for
     a one-year transitional period after our IPO. The agreement provides that
     the services will be provided for fees, which will be no greater than ABN's
     costs. No services were provided under the agreement.

          Employee Benefits Allocation Agreement.  This agreement governs the
     allocation of responsibilities and costs regarding employee benefit plans
     and related matters. The agreement provides that we shall establish new
     benefit and insurance plans for our employees, and will cooperate with ABN
     with respect to certain shared responsibilities during the transitional
     period. ABN will be solely responsible for any contributions that may be
     required following the IPO with respect to service prior thereto for our
     employees who were covered under the ABN defined benefit retirement plan.

                                       34
<PAGE>   37

                                    PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

     (a) (1) Financial Statements

              The financial statements required by this item are submitted in a
              separate section beginning on page F-1 of this report.

         (2) Financial Statement Schedules

              The financial statement schedule required by this item is
              submitted in a separate section on page S-1 of this report.

              Schedules other than that included at page S-1 of this report have
              been omitted because of the absence of conditions under which they
              are required or because the required information is included in
              our financial statements or notes thereto.

         (3) Exhibits

              See (c) below.

     (b)      Reports on Form 8-K

              None.

     (c)      Exhibits

<TABLE>
    <C>    <S>
     3.1   Amended and Restated Certificate of Incorporation.*
     3.2   Amended and Restated By-Laws.*
     4.1   Form of Common Stock Certificate.*
    10.1   Form of Separation Agreement.*
    10.2   Form of License Agreement.*
    10.3   Form of Transitional Services Agreement.*
    10.4   Form of Employee Benefits Allocation Agreement.*
    10.5   Form of 1998 Stock Incentive Plan.*
    10.6   Form of Defined Contribution Plan.*
    10.7   Production Agreement between MasterCard International
           Incorporated and American Bank Note Holographics, Inc.,
           dated as of February 1, 1996.*
    10.8   Letter Agreement, dated June 29, 1998, between MasterCard
           International Incorporated and American Bank Note
           Holographics, Inc., amending the Production Agreement dated
           as of February 1, 1996.+
    10.9   Letter Agreement, dated March 3, 1999, between MasterCard
           International Incorporated and American Bank Note
           Holographics, Inc., further amending the Production
           Agreement dated as of February 1, 1996.
    10.10  Loan and Security Agreement, dated as of September 29, 1999,
           between Foothill Capital Corporation and American Bank Note
           Holographics, Inc.
    10.11  Employment Agreement, dated April 20, 1999, between
           Salvatore F. D'Amato and American Bank Note Holographics,
           Inc.
    10.12  Employment Agreement, dated February 3, 1999, between
           Kenneth H. Traub and American Bank Note Holographics, Inc.
    10.13  Employment Agreement, dated April 30, 1999, between Alan
           Goldstein and American Bank Note Holographics, Inc.
    10.14  Employment Agreement, dated September 15, 1999, between
           Russell LaCoste and American Bank Note Holographics, Inc.
    27.1   Financial Data Schedule.
</TABLE>

---------------
* Incorporated by reference from the Registration Statement on Form S-1
  (Registration No. 333-51845).

+ Portions have been omitted pursuant to a request for confidential treatment.

     (d)     Financial Statement Schedules

     See (a)(2) above.

                                       35
<PAGE>   38

                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                              PAGE
                                                              ----
<S>                                                           <C>
INDEPENDENT AUDITORS' REPORT................................  F-1
FINANCIAL STATEMENTS:
  Balance Sheets, December 31, 1998 and 1997 (Restated).....  F-2
  Statements of Income for the Years Ended December 31,
     1998, 1997 (Restated) and 1996 (Restated)..............  F-3
  Statements of Stockholders' Equity for the Years Ended
     December 31, 1998, 1997 (Restated) and 1996
     (Restated).............................................  F-4
  Statements of Cash Flows for the Years Ended December 31,
     1998, 1997 (Restated) and 1996 (Restated)..............  F-5
  Notes to Financial Statements.............................  F-6
  Schedule II- Valuation and Qualifying Accounts............  S-1
</TABLE>

                                       36
<PAGE>   39

                          INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders of
  American Bank Note Holographics, Inc.
  Elmsford, New York

     We have audited the accompanying balance sheets of American Bank Note
Holographics, Inc. as of December 31, 1998 and 1997, and the related statements
of income, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1998. Our audits also included the financial
statement schedule listed in the accompanying Table of Contents. These financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audits.

     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

     In our opinion, such financial statements present fairly, in all material
respects, the financial position of American Bank Note Holographics, Inc. as of
December 31, 1998 and 1997, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1998 in conformity
with generally accepted accounting principles. Also, in our opinion, such
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.

     As discussed in Note 10 to the financial statements, the Company is
involved in certain litigation and potential litigation.

     As discussed in Note 11 to the financial statements, the accompanying 1997
and 1996 financial statements have been restated.

Deloitte & Touche LLP
New York, New York
November 11, 1999 (except as to paragraph 7 of Note 10,
the date of which is November 16, 1999, and
paragraph 6 of Note 10, the date of which is December 1, 1999)

                                       F-1
<PAGE>   40

                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                                 BALANCE SHEETS
                           DECEMBER 31, 1998 AND 1997
                       (IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
                                                               1998          1997
                                                              -------   --------------
                                                                        (AS RESTATED-
                                                                         SEE NOTE 11)
<S>                                                           <C>       <C>
                                        ASSETS
CURRENT ASSETS:
     Cash and cash equivalents..............................  $ 4,319      $   253
     Accounts receivable, net of allowance for doubtful
      accounts of
       $131 and $168........................................    4,023        5,897
     Inventories, net of allowances of $2,756 and $467......    5,827        6,031
     Deferred income taxes..................................    1,777          708
     Prepaid expenses and other.............................      427           95
                                                              -------      -------
          Total current assets..............................   16,373       12,984
MACHINERY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS -- Net......    5,325        5,695
OTHER ASSETS................................................      680           43
EXCESS OF COST OVER NET ASSETS ACQUIRED -- Net of
  accumulated amortization of $1,919 and $1,568.............    8,442        8,793
                                                              -------      -------
TOTAL ASSETS................................................  $30,820      $27,515
                                                              =======      =======
                         LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
     Revolving credit.......................................  $ 5,591      $   674
     Current portion of notes payable.......................      304           --
     Accounts payable.......................................    4,376        2,244
     Accrued expenses.......................................    2,619        1,382
     Customer advances......................................    1,460           --
                                                              -------      -------
          Total current liabilities.........................   14,350        4,300
OTHER LONG-TERM LIABILITIES, INCLUDING NOTES PAYABLE........      477          460
DEFERRED INCOME TAXES.......................................    1,463        1,590
                                                              -------      -------
          Total liabilities.................................   16,290        6,350
                                                              -------      -------
COMMITMENTS AND CONTINGENCIES -- Note 10
STOCKHOLDERS' EQUITY:
     Preferred Stock, authorized 5,000,000 shares; no shares
      issued or outstanding
     Common Stock, par value $.01 per share, authorized,
      30,000,000 shares; issued and outstanding, 13,636,000
      shares................................................      136          136
     Additional paid-in capital.............................   11,627       11,627
     Retained earnings......................................    2,767       35,536
     Due from Former Parent and affiliates..................       --      (26,134)
                                                              -------      -------
          Total stockholders' equity........................   14,530       21,165
                                                              -------      -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY..................  $30,820      $27,515
                                                              =======      =======
</TABLE>

                       See notes to financial statements.
                                       F-2
<PAGE>   41

                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                              STATEMENTS OF INCOME
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                               1998      1997      1996
                                                              -------   -------   -------
                                                                          (AS RESTATED-
                                                                          SEE NOTE 11)
<S>                                                           <C>       <C>       <C>
SALES.......................................................  $28,669   $23,085   $27,516
                                                              -------   -------   -------
COSTS AND EXPENSES:
     Cost of goods sold.....................................   19,064    12,153    14,710
     Selling and administrative.............................    6,291     5,813     4,711
     Depreciation and amortization..........................    1,080     1,136     1,141
                                                              -------   -------   -------
                                                               26,435    19,102    20,562
                                                              -------   -------   -------
          Operating income..................................    2,234     3,983     6,954
                                                              -------   -------   -------
OTHER -- Net:
     Royalty income.........................................      554       785       128
     Intercompany interest income...........................      183       305       305
     Other income...........................................       --        36        68
     Interest expense.......................................     (583)     (159)       --
                                                              -------   -------   -------
                                                                  154       967       501
                                                              -------   -------   -------
INCOME BEFORE TAXES ON INCOME...............................    2,388     4,950     7,455
TAXES ON INCOME.............................................    1,269     2,130     3,117
                                                              -------   -------   -------
NET INCOME..................................................  $ 1,119   $ 2,820   $ 4,338
                                                              =======   =======   =======
NET INCOME PER SHARE:
     Basic and diluted......................................  $  0.08   $  0.21   $  0.32
                                                              =======   =======   =======
</TABLE>

                       See notes to financial statements.
                                       F-3
<PAGE>   42

                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                       STATEMENTS OF STOCKHOLDERS' EQUITY
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                    DUE FROM
                                          COMMON STOCK     ADDITIONAL                FORMER
                                        ----------------    PAID-IN     RETAINED   PARENT AND
                                        SHARES    AMOUNT    CAPITAL     EARNINGS   AFFILIATES    TOTAL
                                        -------   ------   ----------   --------   ----------   -------
<S>                                     <C>       <C>      <C>          <C>        <C>          <C>
BALANCE, JANUARY 1, 1996 (as
restated -- see Note 11)..............   13,636    $136     $11,627     $28,378     $(14,689)   $25,452
     Change during year...............       --      --          --          --       (7,356)    (7,356)
     Net income.......................       --      --          --       4,338           --      4,338
                                        -------    ----     -------     -------     --------    -------
BALANCE, DECEMBER 31, 1996 (as
  restated -- see Note 11)............   13,636     136      11,627      32,716      (22,045)    22,434
     Change during year...............       --      --          --          --       (4,089)    (4,089)
     Net income.......................       --      --          --       2,820           --      2,820
                                        -------    ----     -------     -------     --------    -------
BALANCE, DECEMBER 31, 1997 (as
  restated -- see Note 11)............   13,636     136      11,627      35,536      (26,134)    21,165
     Change during year...............       --      --          --          --       (7,754)    (7,754)
     Deemed dividend to Former Parent
       and affiliates (see Note 1)....       --      --          --     (33,888)      33,888         --
     Net income.......................       --      --          --       1,119           --      1,119
                                        -------    ----     -------     -------     --------    -------
BALANCE, DECEMBER 31, 1998............   13,636    $136     $11,627     $ 2,767     $     --    $14,530
                                        =======    ====     =======     =======     ========    =======
</TABLE>

                       See notes to financial statements.
                                       F-4
<PAGE>   43

                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                            STATEMENTS OF CASH FLOWS
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                               1998      1997      1996
                                                              -------   -------   -------
                                                                          (AS RESTATED-
                                                                          SEE NOTE 11)
<S>                                                           <C>       <C>       <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
     Net income.............................................  $ 1,119   $ 2,820   $ 4,338
     Adjustments to reconcile net income to net cash
       provided by operating activities:
       Depreciation and amortization........................    1,080     1,136     1,141
       Deferred income taxes................................   (1,196)     (279)      508
     Changes in operating assets and liabilities:
       Accounts receivable..................................    1,874       696    (2,198)
       Inventories..........................................      204    (1,081)     (144)
       Prepaid expenses and other...........................     (459)      127        19
       Accounts payable, accrued expenses and other.........    3,313       574       976
       Customer advances....................................    1,460        --        --
                                                              -------   -------   -------
          Net cash provided by operating activities.........    7,395     3,993     4,640
                                                              -------   -------   -------
CASH FLOWS FROM INVESTING ACTIVITIES:
     Capital expenditures...................................     (359)     (461)     (390)
                                                              -------   -------   -------
          Net cash used in investing activities.............     (359)     (461)     (390)
                                                              -------   -------   -------
CASH FLOWS FROM FINANCING ACTIVITIES:
     Advances to Former Parent and affiliates, net..........   (7,754)   (4,089)   (7,356)
     Deferred financing costs...............................     (510)       --        --
     Notes payable, net.....................................      377        --        --
     Revolving credit borrowings, net.......................    4,917       674        --
                                                              -------   -------   -------
          Net cash used in financing activities.............   (2,970)   (3,415)   (7,356)
                                                              -------   -------   -------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............    4,066       117    (3,106)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................      253       136     3,242
                                                              -------   -------   -------
CASH AND CASH EQUIVALENTS, END OF YEAR......................  $ 4,319   $   253   $   136
                                                              =======   =======   =======
SUPPLEMENTAL CASH PAYMENTS:
     Taxes (including amounts paid to Former Parent)........  $ 2,799   $ 5,485   $ 3,179
                                                              =======   =======   =======
     Interest...............................................  $    --   $   159   $    --
                                                              =======   =======   =======
</TABLE>

                       See notes to financial statements.
                                       F-5
<PAGE>   44

                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                         NOTES TO FINANCIAL STATEMENTS
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     American Bank Note Holographics, Inc. (the "Company") was, until July 20,
1998 (the "Offering Date"), a wholly-owned subsidiary of American Banknote
Corporation (the "Former Parent"). On the Offering Date, the Former Parent
completed the sale of 13,636,000 shares of the Company's common stock in a
public offering (the "Offering"), representing its entire investment in the
Company. The Company did not receive any proceeds from the Offering.
Additionally, in connection with the Offering, the amounts due from the Former
Parent and affiliates of approximately $33.9 million were cancelled and deemed
to be a dividend (see Note 7). Immediately following the Offering, the Company
had approximately $5.2 million of secured bank debt and nominal cash. For
financial reporting purposes, the amounts due from the Former Parent and
affiliates prior to the Offering Date have been classified within stockholders'
equity.

     On June 11, 1998, the Company declared a 1,363.6 to one stock split,
effective July 2, 1998, in the form of a stock dividend, of its Common Stock and
increased its authorized Common Stock to 30,000,000 shares and its authorized
Preferred Stock to 5,000,000 shares. The accompanying financial statements give
retroactive effect to the consummation of the stock split.

     As a wholly-owned subsidiary, the Company was provided certain corporate
and administrative services by its Former Parent, including financial reporting,
treasury functions, tax planning and compliance, risk management, human
resources and legal services. Additionally, because the Former Parent managed
cash and financing requirements centrally, interest expense and financing
requirements prior to the Offering Date were based on the existing capital
structure. The financial position and operations of the Company may differ from
the results that may have been achieved had the Company operated as an
independent entity.

     The Company originates, mass-produces, and markets secure holograms.
Holograms are used for security, packaging and promotional applications. The
Company operates in one reportable industry segment.

     USE OF ESTIMATES -- The preparation of financial statements, in conformity
with generally accepted accounting principles, requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of sales and expenses during
the reporting period. Actual results may differ materially from those estimates.

     CASH AND CASH EQUIVALENTS -- All highly liquid investments with a maturity
of three months or less, when purchased, are considered to be cash equivalents.

     CONCENTRATIONS OF CREDIT RISK -- A significant portion of the Company's
accounts receivable are due from credit card issuers and related credit card
manufacturers located throughout the United States and Europe. The Company
establishes its credit polices based on an ongoing evaluation of its customers'
creditworthiness and competitive market conditions and does not require
collateral. The Company establishes its allowance for doubtful accounts based on
an assessment of exposures to credit losses at each balance sheet date and
believes its allowance for doubtful accounts is sufficient, based on the credit
exposures outstanding at December 31, 1998.

     INVENTORIES AND SALES RECOGNITION -- Inventories are stated at the lower of
cost or market with cost being determined on the first-in, first-out (FIFO)
method. Hologram originations (which represent costs of a unique master
hologram, that is made to customer specifications and is an integral part of the
production process) are capitalized and charged to cost of goods sold over the
estimated production period.

     Sales and the related cost of goods sold are generally recognized at the
latter of the time of shipment or when title passes to customers. In some
situations, the Company has shipped product with the right of return where the
Company is unable to reasonably estimate the level of returns and/or the sale is
contingent upon the customers' use of the product. In these situations, the
Company does not recognize sales upon product
                                       F-6
<PAGE>   45
                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                         NOTES TO FINANCIAL STATEMENTS
          YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 -- (CONTINUED)

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
   POLICIES -- (CONTINUED)
shipment, but rather when the buyer of the product informs the Company that the
product 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-site
secured facility and, in that instance, sales are recognized when all of the
following have occurred: the customer has ordered the goods, the manufacturing
process is complete, the goods have been transferred to the on-site secured
facility and are ready for shipment, the risk of ownership has passed to the
customer and the customer has been billed for the order. At December 31, 1997,
accounts receivable from this customer totaled $1.6 million. There were no
amounts receivable from this customer at December 31, 1998. In the first quarter
of 1998, the Company recorded sales of approximately $6.5 million under this
arrangement.

     At December 31, 1998, customer advances approximating $1.5 million
represent payments received from customers for products which have not yet been
shipped ($1.2 million) and for products shipped with the right of return ($0.3
million) where the Company is unable to reasonably estimate the level of
returns. These customer advances are classified as current liabilities on the
accompanying balance sheets.

     ROYALTY INCOME -- The Company enters into licensing agreements with certain
manufacturers under which the Company receives royalty payments. Royalty
payments due under licensing agreements are recognized as income either based
upon shipment reports from licensees, where available, or estimated shipments by
such licensees.

     DEPRECIATION AND AMORTIZATION -- Machinery and equipment is recorded at
cost and depreciated by the straight-line method over the estimated useful lives
of 5 to 22 years.

     Amortization of leasehold improvements is computed by the straight-line
method based upon the remaining term of the applicable lease, or the estimated
useful life of the asset, whichever is shorter.

     LONG-LIVED ASSETS -- The Company reviews its long-lived assets for
impairment when changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. Such changes in circumstances may include, among
other factors, a significant change in technology that may render an asset or an
asset group obsolete or noncompetitive, a significant change in the extent or
manner in which an asset is used, evidence of a physical defect in an asset or
asset group or an operating loss. If changes in circumstances indicate that the
carrying amount of an asset may not be recoverable, the Company estimates the
future cash flows (undiscounted and without interest charges) expected to result
from the use of the asset and its eventual disposition, and records an
impairment loss (equal to the amount by which the carrying amount of the asset
exceeds the fair value of the asset) if such estimated cash flows are less than
the carrying amount of the asset.

     Assets to be disposed of and assets not expected to provide any future
service potential to the Company are recorded at the lower of carrying amount or
fair value less costs to sell.

     INTANGIBLE ASSETS -- The excess of cost over net assets acquired is being
amortized over 30 years by the straight-line method. The Company reviews
enterprise level goodwill for impairment when changes in circumstances, similar
to those described above for long-lived assets, indicate that the carrying value
may not be recoverable. Under these circumstances, the Company estimates future
cash flows using the recoverability method (undiscounted and including related
interest charges), as a basis for recording any impairment loss. An impairment
loss is then recorded to adjust the carrying value of goodwill to the
recoverable amount. The impairment loss taken is no greater than the amount by
which the carrying value of the net assets of the business exceeds its fair
value.

     DEFERRED FINANCING COSTS -- Costs incurred in connection with obtaining
financing are deferred and amortized as a charge to interest expense over the
term of the related borrowing using the interest method.
                                       F-7
<PAGE>   46
                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                         NOTES TO FINANCIAL STATEMENTS
          YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 -- (CONTINUED)

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
   POLICIES -- (CONTINUED)
     WARRANTY COSTS -- The Company provides for warranty costs in amounts it
estimates will be needed to cover future warranty obligations for products sold
during the year. Estimates of warranty costs are periodically reviewed and
adjusted, when necessary, to consider actual experience.

     RESEARCH AND DEVELOPMENT -- Research and development costs are expensed as
incurred (1998 -- $0.3 million, 1997 -- $0.5 million and 1996 -- $0.6 million).

     INCOME TAXES -- The Company accounts for income taxes under the liability
method in accordance with Statement of Financial Accounting Standards ("SFAS")
No. 109, Accounting for Income Taxes. The provision for income taxes includes
deferred income taxes resulting from items reported in different periods for
income tax and financial statement purposes. Deferred tax assets and liabilities
represent the expected future tax consequences of the differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax basis.

     STOCK-BASED COMPENSATION PLANS -- SFAS No. 123, Accounting for Stock-Based
Compensation, allows either adoption of a fair value method for accounting for
stock-based compensation plans or continuation of accounting for stock-based
compensation plans under Accounting Principles Board ("APB") Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations with
supplemental disclosures.

     The Company has chosen to account for its stock options using the intrinsic
value based method prescribed in APB Opinion No. 25 and, accordingly, does not
recognize compensation expense for stock option grants made at an exercise price
equal to or in excess of the fair market value of the stock at the date of
grant. Pro forma net income and net income per share amounts as if the fair
value method had been adopted are presented in Note 8. SFAS No. 123 does not
impact the Company's results of operations, financial position or cash flows.

     BASIC AND DILUTED NET INCOME PER SHARE -- Basic net income per share is
computed based on the weighted average number of outstanding shares of common
stock, after giving retroactive effect to the stock split. The basic weighted
average number of shares outstanding were 13,636,000 for each of the years ended
December 31, 1998, 1997 and 1996. Diluted net income per share is computed by
dividing net income by the weighted average number of shares of common stock
outstanding and dilutive potential shares of common stock (all related to
outstanding stock options in 1998). For the year ended December 31, 1998, the
dilutive effect of approximately 65,000 equivalent shares related to stock
options was used in determining the diluted weighted average shares outstanding.
For the years ended December 31, 1998, 1997 and 1996, the diluted weighted
average number of shares outstanding were 13,701,000, 13,636,000 and 13,636,000,
respectively.

     BUSINESS INFORMATION -- Sales to MasterCard were approximately 30%, 35% and
23% of sales for the years ended December 31, 1998, 1997 and 1996, respectively.
Approximately 75% of the 1998 MasterCard sales were recorded in the first
quarter of 1998. At December 31, 1997, accounts receivable from MasterCard
approximated $1.6 million. The Company is the exclusive supplier of holograms to
MasterCard pursuant to an agreement, as amended, that extends until February
2003. The agreement provides for automatic two-year renewal periods if not
terminated by either party. During 1999, the Company was informed by MasterCard
that it believes that the Company breached certain terms of the agreement in
1998 and 1997. The Company has been working closely with MasterCard to address
issues raised by MasterCard, and believes its relationship with MasterCard is
good. The loss of all or a substantial portion of the sales to MasterCard,
however, would have a material adverse effect on the financial position, results
of operations and cash flows of the Company.

                                       F-8
<PAGE>   47
                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                         NOTES TO FINANCIAL STATEMENTS
          YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 -- (CONTINUED)

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
   POLICIES -- (CONTINUED)
     Sales to manufacturers of VISA credit cards (approximately 50 customers)
were approximately 26%, 27% and 31% of sales for the years ended December 31,
1998, 1997 and 1996, respectively. The loss of a substantial portion of the
sales to these customers would have a material adverse effect on the financial
position, results of operations and cash flows of the Company. At December 31,
1998 and 1997, accounts receivable from these customers approximated $1.0
million and $2.5 million, respectively.

     The Company has historically purchased certain key materials used in the
manufacture of its holograms from single suppliers, with which it does not have
supply contracts. Any problems that occur with respect to the delivery, quality
or cost of any such materials could have a material adverse effect on the
financial position, results of operations and cash flows of the Company.

     EXPORT SALES -- U.S. export sales were 28%, 25% and 32% of sales for the
years ended December 31, 1998, 1997 and 1996, respectively. All export sales are
denominated in United States dollars. At December 31, 1998 and 1997, accounts
receivable from these customers approximated $1.2 million and $0.8 million,
respectively.

     COMPREHENSIVE INCOME -- In 1998, the Company adopted SFAS No. 130,
Reporting Comprehensive Income, which establishes rules for the reporting of
comprehensive income and its components. For each of the years ended December
31, 1998, 1997 and 1996, there was no difference between the Company's net
income and comprehensive income.

     RECLASSIFICATIONS -- Certain prior year amounts have been reclassified to
conform to the current year's presentation.

     NEW ACCOUNTING STANDARDS -- In March 1998, the American Institute of
Certified Public Accountants ("AICPA") issued Statement of Position 98-1,
Accounting for the Costs of Computer Software Developed or Obtained for Internal
Use ("SOP 98-1"). SOP 98-1 requires computer software costs associated with
internal use software to be expensed as incurred until certain capitalization
criteria are met. The Company adopted SOP 98-1 on January 1, 1999. Adoption of
this statement did not have a material impact on the Company's financial
position, results of operations, or cash flows.

     In April 1998, the AICPA issued Statement of Position 98-5, Reporting on
the Cost of Start-Up Activities ("SOP 98-5"). SOP 98-5 requires all costs
associated with pre-opening, pre-operating and organization activities to be
expensed as incurred. The Company adopted SOP 98-5 on January 1, 1999. Adoption
of this statement did not have a material impact on the Company's financial
position, results of operations, or cash flows.

     In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, which, as amended,
is effective for fiscal years beginning after June 15, 2000. SFAS No. 133
requires the recognition of all derivatives in the balance sheets as either
assets or liabilities measured at fair value. The Company will adopt SFAS No.
133 for the 2001 fiscal year. The Company is currently evaluating the impact
SFAS No. 133 will have on its financial position, results of operations and cash
flows.

                                       F-9
<PAGE>   48
                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                         NOTES TO FINANCIAL STATEMENTS
          YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 -- (CONTINUED)

2. INVENTORIES

<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                              ----------------
                                                               1998      1997
                                                              -------   ------
                                                               (IN THOUSANDS)
<S>                                                           <C>       <C>
Finished goods..............................................  $ 3,430   $   54
Finished goods on consignment with customers................      487      290
Work in process.............................................    3,273    2,413
Origination and cylinder costs*.............................      427    2,581
Raw materials...............................................      966    1,160
                                                              -------   ------
                                                                8,583    6,498
Less: Reserve for obsolescence..............................   (2,756)    (467)
                                                              -------   ------
                                                              $ 5,827   $6,031
                                                              =======   ======
</TABLE>

---------------
* Includes approximately $0.8 million of costs at December 31, 1997 relating to
  work for customers in anticipation of orders in the ordinary course of
  business. There were no such costs as of December 31, 1998.

3. MACHINERY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS

<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                              -----------------
                                                               1998      1997
                                                              -------   -------
                                                               (IN THOUSANDS)
<S>                                                           <C>       <C>
Machinery and equipment.....................................  $11,041   $10,682
Leasehold improvements......................................      888       888
                                                              -------   -------
                                                               11,929    11,570
Accumulated depreciation and amortization...................    6,604     5,875
                                                              -------   -------
                                                              $ 5,325   $ 5,695
                                                              =======   =======
</TABLE>

4. ACCRUED EXPENSES

<TABLE>
<CAPTION>
                                                               DECEMBER 31,
                                                              ---------------
                                                               1998     1997
                                                              ------   ------
                                                              (IN THOUSANDS)
<S>                                                           <C>      <C>
Accrued contract liability..................................  $  472   $  472
Accrued interest expense....................................      94      175
Warranty reserve............................................     445       59
Federal, state and local income taxes.......................     144      190
Salaries and wages..........................................     387      353
Other.......................................................   1,077      133
                                                              ------   ------
                                                              $2,619   $1,382
                                                              ======   ======
</TABLE>

5. TAXES ON INCOME

     In accordance with a tax allocation agreement in effect through the
Offering Date, the Company was included in the consolidated U.S. Federal income
tax return and, in certain instances, consolidated or combined state and local
income tax returns of its Former Parent and made payments to the Former Parent
based on the amounts which would be payable as Federal, state and local income
taxes as if consolidated or

                                      F-10
<PAGE>   49
                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                         NOTES TO FINANCIAL STATEMENTS
          YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 -- (CONTINUED)

5. TAXES ON INCOME -- (CONTINUED)
combined returns were not filed. The Company computed its Federal, state and
local income tax provision as if it was filing separate income tax returns,
without regard to the tax allocation agreement. In October 1999, an affiliate of
the Former Parent received an assessment for approximately $0.9 million of taxes
and interest from the City of New York relating to the years ended December 31,
1990, 1991, and 1992. The Company was included in the combined City of New York
income tax returns of the Former Parent for the periods covered by the
assessment and had previously made payments to the Former Parent based on
amounts which would have been payable if the combined income tax returns were
not filed. The Company is contingently liable, jointly and severally, for U.S.
Federal, state and local income taxes for periods in which it is included in the
consolidated or combined income tax returns of its Former Parent (see Note 10).
Amounts paid to the Former Parent in excess of amounts which would have been
payable had the Company filed separate income tax returns have been charged to
Due from Former Parent and affiliates. For periods subsequent to the Offering
Date, the Company will file its own U.S. Federal and state income tax returns.

     Deferred income taxes arise from temporary differences between the tax
bases of assets and liabilities and their reported amounts in the financial
statements.

     Taxes on income (benefit) are as follows:

<TABLE>
<CAPTION>
                                                                FOR THE YEARS ENDED
                                                                   DECEMBER 31,
                                                             -------------------------
                                                              1998      1997     1996
                                                             -------   ------   ------
                                                                  (IN THOUSANDS)
<S>                                                          <C>       <C>      <C>
Current:
     Federal...............................................  $ 2,025   $1,912   $2,097
     State and local.......................................      440      497      512
                                                             -------   ------   ------
                                                               2,465    2,409    2,609
                                                             -------   ------   ------
Deferred:
     Federal...............................................   (1,020)    (240)     438
     State and local.......................................     (176)     (39)      70
                                                             -------   ------   ------
                                                              (1,196)    (279)     508
                                                             -------   ------   ------
                                                             $ 1,269   $2,130   $3,117
                                                             =======   ======   ======
</TABLE>

     A reconciliation of the taxes on income and the amount computed by applying
the Federal income tax statutory rate of 35% in 1998, 1997 and 1996 follows:

<TABLE>
<CAPTION>
                                                                FOR THE YEARS ENDED
                                                                    DECEMBER 31,
                                                              ------------------------
                                                               1998     1997     1996
                                                              ------   ------   ------
                                                                   (IN THOUSANDS)
<S>                                                           <C>      <C>      <C>
Statutory tax...............................................  $  836   $1,733   $2,609
Amortization of nondeductible goodwill......................     122      122      122
State and local taxes, net of Federal benefit...............     172      298      378
Nondeductible fee...........................................      84       --       --
Other.......................................................      55      (23)       8
                                                              ------   ------   ------
                                                              $1,269   $2,130   $3,117
                                                              ======   ======   ======
</TABLE>

                                      F-11
<PAGE>   50
                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                         NOTES TO FINANCIAL STATEMENTS
          YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 -- (CONTINUED)

5. TAXES ON INCOME -- (CONTINUED)
     The tax effects of the items comprising the Company's deferred income tax
assets and liabilities are as follows:

<TABLE>
<CAPTION>
                                                               DECEMBER 31,
                                                              ---------------
                                                               1998     1997
                                                              ------   ------
                                                              (IN THOUSANDS)
<S>                                                           <C>      <C>
Current deferred tax assets:
     Uniform capitalization of inventory....................  $  168   $  236
     Bad debt reserve.......................................      54       65
     Warranty reserve.......................................     182       25
     Inventory obsolescence.................................   1,131      188
     Accrued vacation.......................................      42       --
     Other liabilities......................................     200      194
                                                              ------   ------
     Net deferred tax asset.................................  $1,777   $  708
                                                              ======   ======
Deferred tax liabilities:
     Excess tax over book depreciation......................  $1,637   $1,774
     Postretirement medical accrual.........................    (174)    (162)
     Supplemental retirement accrual........................      --      (22)
                                                              ------   ------
     Net deferred tax liability.............................  $1,463   $1,590
                                                              ======   ======
</TABLE>

6. REVOLVING CREDIT AGREEMENT

     On July 20, 1998, contemporaneously with the Offering, the Company entered
into a $30.0 million credit facility agreement (the "Credit Agreement"),
consisting of a $20.0 million acquisition facility and a $10.0 million working
capital facility, maturing on July 20, 2004, which replaced a facility the
Company had entered into with an affiliate of its Former Parent. Substantially
all of the Company's assets were secured under the terms of the Credit
Agreement. At the time of the Offering, approximately $5.2 million was due and
owing under the Credit Agreement. At December 31, 1998, the $5.6 million
outstanding under the Credit Agreement exceeded the maximum permitted
borrowings, as defined, pursuant to the borrowing base formula, as defined,
under the Credit Agreement. In February 1999, the lenders notified the Company
that the Company was in default under the Credit Agreement. On March 31, 1999,
the Credit Agreement was amended (the "Amended Credit Agreement"), whereby the
maximum permitted borrowings was reduced to the lesser of $4.5 million or the
maximum permitted borrowings under a borrowing base formula, as defined.
Borrowings under the Amended Credit Agreement bore interest at the lender's
alternate base rate, as defined, plus 0.5%. On July 20, 1999, the Amended Credit
Agreement was amended (the "Second Amended Credit Agreement"), whereby (i) all
existing events of default were waived, (ii) the latest maturity date of all
loans outstanding was changed to January 20, 2000, and (iii) the maximum
permitted borrowings was reduced to $4.0 million, which was to decline monthly
until December 31, 1999 when the maximum permitted borrowings was to be $2.6
million. The Second Amended Credit Agreement provided for borrowings under a
revolving credit line bearing interest at the lender's alternate base rate, as
defined, plus 2% (8.0% at December 31, 1998), subject to a borrowing base
formula, as defined. As consideration for the Second Amended Credit Agreement,
the Company paid a fee of $40,000 and issued warrants to purchase up to 781,645
shares of its Common Stock, subject to antidilution rights, at $4.50 per share.
Such warrants were terminated on September 29, 1999 pursuant to the Second
Amended Credit Agreement when amounts outstanding under the Second Amended
Credit Agreement were repaid, as described below.

                                      F-12
<PAGE>   51
                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                         NOTES TO FINANCIAL STATEMENTS
          YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 -- (CONTINUED)

6. REVOLVING CREDIT AGREEMENT -- (CONTINUED)
     On September 29, 1999, amounts then outstanding under the Second Amended
Credit Agreement were repaid when the Company entered into a Loan and Security
Agreement with Foothill Capital Corporation, a subsidiary of Wells Fargo Bank
(the "Loan and Security Agreement"), maturing on September 29, 2004. The Loan
and Security Agreement, which is secured by substantially all of the Company's
assets, provides for borrowings in an aggregate amount up to $10.0 million
(which may be increased to $15.0 million with the consent of the parties),
subject to a borrowing base formula, under a revolving credit facility, term
loan and capital expenditure loan. Borrowings under the Loan and Security
Agreement bear interest at the lender's reference rate, as defined, plus 1.5%,
which may decrease to 1.25%, 1.00%, or 0.5% under certain circumstances. Under
the terms of the Loan and Security Agreement, the maximum amounts of the term
and capital expenditure loans are approximately $1.0 million and $2.0 million,
respectively, and are repayable in sixty equal monthly installments.

     The Loan and Security Agreement contains covenants customary for credit
facilities of a similar nature, including limitations on the ability of the
Company to, among other things, (i) declare dividends or repurchase or redeem
stock, (ii) prepay, redeem or repurchase debt, incur liens and engage in
sale-leaseback transactions, (iii) make loans and investments, (iv) incur
additional debt, (v) amend or otherwise alter material agreements or enter into
restrictive agreements, (vi) make capital expenditures in any fiscal year in
excess of $2.5 million, (vii) engage in mergers, acquisitions and asset sales,
(viii) engage in certain transactions with affiliates and (ix) materially alter
the nature of its business. Additionally, under the terms of the Loan and
Security Agreement, the Company is required to achieve Year 2000 compliance by
December 31, 1999. The Company is also required to comply with specified
financial covenants and ratios and must provide to the lender its March 31 and
June 30, 1999 unaudited financial statements by December 15, 1999 and its
September 30, 1999 unaudited financial statements by December 31, 1999. The Loan
and Security Agreement provides for events of default customary for transactions
of this type, including nonpayment, misrepresentation, breach of covenant,
cross-defaults, bankruptcy, adverse judgments in excess of $0.2 million, and
change of ownership and control.

     As a result of the Amended Credit Agreement, in the first quarter of 1999
the Company will write off unamortized deferred financing costs of approximately
$0.4 million relating to the Credit Agreement. As a result of the Second Amended
Credit Agreement, in the third quarter of 1999 the Company will write off
unamortized deferred financing costs of approximately $59,000 relating to the
Amended Credit Agreement. As a result of the Loan and Security Agreement, in the
third quarter of 1999 the Company will write off the remaining unamortized
deferred financing costs (approximately $31,000) relating to the Second Amended
Credit Agreement.

     During 1998 and 1997, the weighted average interest rate of outstanding
borrowings was approximately 8.4% and 9.0%, respectively. The average aggregate
borrowings during 1998 and 1997 was approximately $5.2 million and $0.9 million,
respectively.

     At December 31, 1998, the Company has notes payable totaling approximately
$377,000, of which $304,000 is due in 1999, $18,000 in 2000, $19,000 in 2001,
$21,000 in 2002, and $15,000 in 2003. The notes bear interest at rates ranging
from 5.85% to 8.36%.

7. RELATED PARTY TRANSACTIONS

     The financial statements reflect both allocated and, where readily
determinable, actual expenses for services provided by the Company's Former
Parent and affiliates. Where allocations have been utilized, the Company, its
Former Parent and affiliates recorded transactions based upon systematic and
reasonable methods, including but not limited to sales, asset values and
headcount, all as a percent of total.

                                      F-13
<PAGE>   52
                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                         NOTES TO FINANCIAL STATEMENTS
          YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 -- (CONTINUED)

7. RELATED PARTY TRANSACTIONS -- (CONTINUED)
     The amounts by major category of historical transactions with the Former
Parent and affiliates follow:

<TABLE>
<CAPTION>
                                                              FOR THE YEARS ENDED
                                                                  DECEMBER 31,
                                                          ----------------------------
                                                            1998      1997      1996
                                                          --------   -------   -------
                                                                 (IN THOUSANDS)
<S>                                                       <C>        <C>       <C>
Due from (to) Former Parent and affiliates:
  Balance at beginning of year..........................  $ 26,134   $22,045   $14,689
     Income tax liability payable to Former Parent......    (2,272)   (2,307)   (2,778)
     Taxes paid to Former Parent........................     2,422     5,306     3,091
     Cash advances to Former Parent.....................     7,685     2,851     8,606
     Allocation of employee benefits(1).................      (402)   (1,052)     (936)
     Sales to affiliates................................        --       123        30
     Allocation of security services....................      (100)     (198)     (108)
     Sales and administration expenses(2)...............      (244)     (592)     (301)
     Allocation of general liability insurance..........        --      (293)     (508)
     Intercompany interest(3)...........................       156       305       305
     Reversal of SERP liability.........................       (56)       --        --
     Executive benefits(4)..............................       (13)      (54)      (45)
     Other..............................................       578        --        --
     Deemed dividend to Former Parent (see Note 1)......   (33,888)       --        --
                                                          --------   -------   -------
  Balance at end of year................................  $     --   $26,134   $22,045
                                                          ========   =======   =======
</TABLE>

---------------
(1) Primarily medical, life and disability insurance premiums.

(2) Includes legal fees and allocated portion of audit fees.

(3) Included in the above balances is a $5.3 million note receivable from the
    Former Parent that bore interest at 5.75% per annum.

(4) Includes value of restricted stock of the Former Parent.

     The amount of the deemed dividend to the Former Parent is subject to
adjustment based on the Company's taxable income through the Offering Date (see
Note 5).

     For financial reporting purposes, the amounts due from the Former Parent
and affiliates for periods prior to the Offering Date have been classified
within stockholders' equity.

     In addition to the above, the Company sold $0.6 million, $0.4 million and
$0.7 million of holograms in 1998, 1997 and 1996, respectively, to its Former
Parent and affiliates in the normal course of business. Purchases by the Company
from the Former Parent and affiliates in the normal course of business were $0.1
million and $0.3 million in 1997 and 1996, respectively. There were no such
purchases in 1998. At December 31, 1998 and 1997, trade accounts receivable from
the Former Parent and affiliates were $0.2 million and $0.6 million,
respectively. Additionally, the Company acted as a subcontractor to an affiliate
of the Former Parent under a government contract. Sales under this subcontract,
which are billed to the affiliate of the Former Parent approximated $0.3 million
and $82,000 in 1998 and 1997, respectively. At December 31, 1998, trade accounts
receivable from the affiliate of the Former Parent under this subcontract
approximated $0.1 million. At December 31, 1998, accounts payable and accrued
expenses include approximately $0.3 million and $0.2 million, respectively, due
the Former Parent and its affiliates.

                                      F-14
<PAGE>   53
                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                         NOTES TO FINANCIAL STATEMENTS
          YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 -- (CONTINUED)

7. RELATED PARTY TRANSACTIONS -- (CONTINUED)
     In 1997 and 1996, employees of the Company received stock options under the
Former Parent's stock-based compensation plans. No such options were granted in
1998. Had compensation cost for the stock option plans been determined based on
the fair value at the grant award dates, in 1996 and 1997, consistent with the
provisions of SFAS No. 123, Accounting for Stock-Based Compensation, net income
would have been reduced by approximately $13,000 and $22,000, respectively.

     In connection with the Offering, the Company and its Former Parent entered
into a number of agreements relating to the transition period and to defining
their ongoing relationships following the Offering, as follows (see Note 10):

          Separation Agreement -- Provides that:  (i) the Company will generally
     indemnify the Former Parent, including its officers, directors, employees
     and affiliates, against all costs, liabilities and expenses relating to the
     Offering and the conduct by the Company of its business, including as a
     result of guarantees by the Former Parent of any obligations of the
     Company; (ii) the Former Parent will indemnify the Company against all
     costs, liabilities and expenses relating to the conduct by the Former
     Parent of its business, including as a result of guarantees by the Company
     of any obligations of the Former Parent; (iii) immediately prior to the
     closing of the Offering, the Company will have a nominal amount of
     unrestricted cash and the Former Parent shall be entitled to all
     unrestricted cash on hand; (iv) the Former Parent will indemnify and hold
     harmless the Company for all federal, foreign, state and local franchise,
     income, sales, use, transfer and other tax liabilities or obligations,
     including interest and penalties, attributable to the Former Parent's
     consolidated group activities (other than activities of the Company) for
     all periods; (v) the Company will indemnify and hold harmless the Former
     Parent for all federal, foreign, state and local franchise, income, sales,
     use, transfer and other tax liabilities or obligations, including interest
     and penalties, attributable to activities of the Company for all periods;
     and (vi) the Company and the Former Parent will cross-indemnify each other
     for certain other matters.

          License Agreement -- Provides the Company with the right to use the
     American Bank Note name for a one-year term, automatically renewable for
     consecutive one-year periods, for an annual fee of $1. Additionally, the
     Company and Former Parent granted each other perpetual, paid-up
     royalty-free licenses for any patents, trademarks or other proprietary
     technology used by the other in its respective business. The Company agreed
     not to use the name American Bank Note or any variation thereof in
     connection with any business, enterprise or venture outside of the
     holography industry and not to sublicense the name to third parties.

          Transitional Services Agreement -- The Former Parent agreed to provide
     or cause to be provided to the Company certain specified corporate and
     administrative services for a one-year transitional period after the
     Offering. The agreement provides that the services will be provided for
     fees, which will be no greater than the Former Parent's costs. No services
     were provided under the agreement.

          Employee Benefits Allocation Agreement -- Governs the allocation of
     responsibilities and costs regarding employee benefit plans and related
     matters. The agreement provides that the Company shall establish new
     benefit and insurance plans for its employees, and will cooperate with the
     Former Parent with respect to certain shared responsibilities during the
     transitional period. The Former Parent will be solely responsible for any
     contributions that may be required following the Offering with respect to
     service prior thereto for employees of the Company who were covered under
     the Former Parent defined benefit retirement plan.

                                      F-15
<PAGE>   54
                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                         NOTES TO FINANCIAL STATEMENTS
          YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 -- (CONTINUED)

8. 1998 STOCK INCENTIVE PLAN

     Subsequent to the Offering Date, the Company adopted the 1998 Stock
Incentive Plan (the "1998 Plan") for the purpose of granting various stock
incentives to key employees. The Board of Directors (or a committee appointed by
the Board of Directors) has discretionary authority, subject to certain
restrictions, to administer the 1998 Plan. The total number of shares reserved
for issuance under the 1998 Plan is 1,363,000 shares of Common Stock. The
exercise price of options granted under the 1998 Plan may not be less than 100%
of the fair market value of the Common Stock on the date such option was
granted. Options granted under the 1998 Plan generally would become vested and
exercisable for up to 33 1/3% of the total optioned shares upon each succeeding
anniversary of the date of grant. Generally, the unexercised portion of any
option automatically terminates upon the termination of the optionee's
employment with the Company, unless otherwise determined by the Board of
Directors; provided, however, that any extension shall not extend beyond the
expiration of the option, generally ten years. Upon a change in control,
outstanding options will generally become fully vested and may be exercised
immediately.

     A summary of the status of the Company's outstanding stock options as of
December 31, 1998 and changes during the year then ended follows:

<TABLE>
<CAPTION>
                                                                         WEIGHTED
                                                                         AVERAGE
                                                                         EXERCISE
                                                               SHARES     PRICE
                                                              --------   --------
<S>                                                           <C>        <C>
Outstanding, beginning of year..............................        --    $  --
     Granted................................................   984,250     8.50
                                                              --------
Outstanding, end of year....................................   984,250     8.50
                                                              ========
Options exercisable, year-end...............................        --     8.50
                                                              ========
Weighted average fair value of options granted during the
  year......................................................     $6.19
                                                              ========
</TABLE>

     Included in the outstanding options are options to the Company's former
Chairman and Chief Executive Officer (400,000), former President (200,000),
former Vice President-Finance (40,000) and former Vice President of Operations
(40,000), all of which were cancelled upon their resignations in 1999.
Additionally, during 1998, the Company issued 45,000 options to members of its
Board of Directors (which are reflected in the above table) at an exercise price
of $8.50 per share, representing the fair market value of the Company's common
stock on the grant date. During 1999, the Company issued options to its newly
appointed Chairman (175,000 shares at $2.50 per share), President (250,000
shares at $1.75 per share and 100,000 shares at $2.50 per share), Executive Vice
President (150,000 shares at $2.75 per share) and Chief Financial Officer
(100,000 shares at $2.50 per share) at exercise prices equal to the fair market
value of the Company's common stock on the dates of the respective grants.

     The following table summarizes information about stock options outstanding
at December 31, 1998:

<TABLE>
<CAPTION>
                                                                     WEIGHTED-
                                                                      AVERAGE      WEIGHTED-
                                                                     REMAINING      AVERAGE
                      RANGE OF                          NUMBER      CONTRACTUAL    EXERCISE
                  EXERCISE PRICES                     OUTSTANDING   LIFE (YEARS)     PRICE
                  ---------------                     -----------   ------------   ---------
<S>                                                   <C>           <C>            <C>
$8.50...............................................    984,250         9.5          $8.50
</TABLE>

     The Company applies APB Opinion No. 25 and related interpretations in
accounting for its stock options. Accordingly, no compensation cost has been
recognized for outstanding stock options. Had compensation cost for the
Company's outstanding stock options been determined based on the fair value at
the grant dates for

                                      F-16
<PAGE>   55
                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                         NOTES TO FINANCIAL STATEMENTS
          YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 -- (CONTINUED)

8. 1998 STOCK INCENTIVE PLAN -- (CONTINUED)
those options consistent with SFAS No. 123, the Company's 1998 net income and
basic and diluted net income per share would have differed as reflected by the
pro forma amounts indicated below (in thousands, except per share amounts):

<TABLE>
<S>                                                           <C>
Net income:
     As reported............................................   $1,119
                                                               ======
     Pro forma..............................................   $  132
                                                               ======
Basic and diluted net income per share:
     As reported............................................   $ 0.08
                                                               ======
     Pro forma..............................................   $ 0.01
                                                               ======
</TABLE>

     The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions:

<TABLE>
<S>                                                           <C>
Expected volatility.........................................   71.25%
Risk-free interest rate.....................................    5.48%
Dividend yield..............................................      --
Expected life...............................................     7.5years
</TABLE>

9. EMPLOYEE BENEFITS PLANS

     Certain employees of the Company have rights to benefits under the Former
Parent's defined benefit retirement plan, but are not eligible for any
additional benefits. No contributions are currently required in order to provide
those benefits. Pursuant to the Employee Benefits Allocation Agreement (see Note
7), if contributions should be required in the future, including any
contributions to fully fund plan benefits on termination of the plan, the amount
of such contributions are required to be paid by the Former Parent (see Note
10).

     POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE PLANS -- Prior to the
Offering Date, the Company participated in benefit plans of affiliates of its
Former Parent, which provided certain postretirement health care and life
insurance benefits for certain eligible employees. Under the terms of these
plans, the Company's employees could become eligible for these benefits if they
reached normal retirement age, with certain service requirements during the
period in which the Company participated in those plans. The Company accrued the
estimated cost of retiree benefit payments (other than pensions) during the
years an employee provided services. The Former Parent's plans are not funded.
Under the terms of the Employee Benefits Allocation Agreement (see Note 7), the
Company is not responsible for the benefits to be provided to employees who
retired from the Company prior to the Offering Date or who had qualified for
such benefits as of the Offering Date and is currently assessing whether to
continue this plan for current employees; accordingly, disclosures regarding the
status of this obligation as it relates to the Company have not been provided.
During the years ended December 31, 1998, 1997 and 1996, costs relating to these
plans approximated $21,000, $58,000 and $56,000, respectively.

     RETIREMENT PLANS -- Retirement benefits were provided by the Former Parent
to eligible employees through the defined contribution retirement plan of the
Former Parent; the aggregate contributions to such plan which have been charged
to the Company's operations was approximately $0.2 million in each of the years
ended 1998, 1997 and 1996, respectively. The Company continues to be a
participating employer in this plan, although it plans to terminate its
participation in this plan and start its own defined contribution plan.

                                      F-17
<PAGE>   56
                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                         NOTES TO FINANCIAL STATEMENTS
          YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 -- (CONTINUED)

9. EMPLOYEE BENEFITS PLANS -- (CONTINUED)
     Certain employees of the Company participate in an affiliate of the Former
Parent's defined benefit pension plan. Benefits under the plan were frozen in
1992 and were based on years of service and average final compensation. The
liability for benefits under this plan, which is substantially funded, is the
responsibility of an affiliate of the Former Parent. The total pension expense
relating to the Company's employees in the aggregate for the past three years
was less than $10,000.

     In 1997 and 1996, the Company participated in the Former Parent's
noncontributory supplemental executive retirement plan ("SERP") for certain
senior management employees of the Former Parent and its affiliates. Benefits
under the noncontributory plan are based on years of service and average final
compensation. The plan is unfunded. Following the Offering, the Company's
participants ceased to be eligible for SERP benefits, accordingly, the Company's
obligation under this plan ($56,000) was credited to Due from Former Parent and
affiliates. The aggregate contribution to such plan which has been charged to
operations was approximately $28,000 in 1997 and 1996. No contribution to the
plan was made during the year ended December 31, 1998.

10. COMMITMENTS AND CONTINGENCIES

     SEC AND U.S. ATTORNEY INVESTIGATIONS -- On February 9, 1999, the Division
of Enforcement of the SEC issued a Formal Order Directing Private Investigation,
designating officers to take testimony and requiring the production of certain
documents, in connection with matters giving rise to the need to restate the
Company's previously issued financial statements (see Note 11). The Company has
provided numerous documents to and continues to cooperate fully with the SEC
staff. Management of the Company cannot predict the duration of such
investigation or its potential outcome.

     The U.S. Attorney's Office for the Southern District of New York has
commenced an investigation in connection with matters giving rise to the need to
restate the Company's previously issued financial statements, (see Note 11) as
well as a possible violation in 1998 of the Foreign Corrupt Practices Act. The
Company has not been advised that it is a target of such investigation. The
Company has provided numerous documents to and continues to cooperate fully with
the U.S. Attorney's office. Management of the Company cannot predict the
duration of such investigation or its potential outcome.

     LITIGATION -- A consolidated class action complaint against the Company,
certain of its former officers and directors, its Former Parent, the four
co-lead underwriters of the Offering and its auditors, has been filed in the
United States District Court for the Southern District of New York. The
complaint alleges violations of the federal securities laws and seeks to recover
damages on behalf of all purchasers of the Company's Common Stock during the
class period (July 15, 1998 through February 1, 1999). The complaint seeks
rescission of the purchase of shares of the Company's Common Stock or
alternatively, unspecified compensatory damages, along with costs and expenses
including attorney's fees. The Company and certain other defendants have
separately moved to dismiss the complaint. The Plaintiffs' discovery requests as
well as their motion for class certification have been stayed pending resolution
of the respective motions to dismiss. The Company has commenced settlement
discussions with Plantiffs' counsel. Management of the Company does not believe
it is feasible to predict or determine the outcome or resolution of these
proceedings, or to estimate the amounts of, or potential range of loss with
respect thereto. In addition, the timing of the resolution of these proceedings
is uncertain. The range of possible resolutions could include judgements against
the Company or settlements that could require substantial payments by the
Company, including costs of defending such suits, which could have a material
adverse effect on the Company's financial position, results of operations and
cash flows.

     On February 14, 1997, James Rigby, Trustee in Bankruptcy for Holosonics,
Inc., Holotron Corp., Meadow Games, Inc. and Fire Diamond, Inc. commenced an
adversary proceeding in the United States

                                      F-18
<PAGE>   57
                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                         NOTES TO FINANCIAL STATEMENTS
          YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 -- (CONTINUED)

10. COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
Bankruptcy Court for the Western District of Washington at Seattle against
International Banknote Company, Inc., the Former Parent and the Company. The
complaint alleged that the defendants were indebted to the bankruptcy estate for
royalty payments under a 1981 license and that the Company was liable for unpaid
royalties for 1990 in the amount of $226,322, for 1991 in the amount of $853,582
and through July 1992 in the amount of $568,762, plus attorney's fees and
interest on unpaid amounts. The defendants and Trustee entered into a settlement
agreement which was approved by an order of the Bankruptcy Court on September
10, 1999, whereby the defendants agreed to pay the Trustee $150,000, of which
$120,000 has been paid with the balance payable in two equal monthly
installments of $15,000 each payable ninety and one-hundred twenty days,
respectively, following entry of the order. The full amount of this settlement
has been accrued at December 31, 1998.

     In 1994, plaintiffs, K.A.H. Company, Inc. and Kenneth A. Haines, filed suit
against the Company, the Former Parent and ABNH Research Co., Inc. in the
Supreme Court of the State of New York, County of New York. A judgement was
entered on March 19, 1999 for $175,639, with attorney's fees still to be
assessed. Plaintiffs' counsel has stated that he would seek in excess of
$300,000 in attorney's fees. Such judgement was entered only against the Former
Parent, which contends that the Company should contribute to the payment of the
judgement. The defendants have appealed and the plaintiffs have filed a
cross-appeal, both of which are still pending. The plaintiffs and defendants are
currently engaged in settlement discussions.

     On August 17, 1999, the Company commenced an action in the Supreme Court of
the State of New York, County of Westchester, seeking recovery of approximately
$350,000 on a claim arising from amounts owed to the Company for holographic
materials sold and delivered in July 1999. The defendant removed the action to
the United States District Court for the Southern District of New York, where it
is currently pending. On December 1, 1999, the Company received the defendant's
answers to its complaint and counterclaims alleging millions of dollars in
damages arising from the Company's alleged breach of a 1993 agreement pursuant
to which the Company sold holographic material to the defendant and alleged
failure to fulfill a May 1998 purchase order. Management of the Company does not
believe that the outcome or resolution of these proceedings will have a material
adverse effect on the Company's financial position, results of operations or
cash flows.

     In 1998, the Company fulfilled an order for holograms for approximately
$600,000. In 1999, the customer alleged that the Company breached its contract
with such customer based on problems that the ultimate user was experiencing
with the holograms, and claimed potential damages in excess of $6 million.
Management of the Company does not believe that the agreement was breached, and
is in discussions with this customer in an attempt to resolve this dispute
amicably. There can be no assurance, however, that this matter will be resolved
amicably, or that this dispute will not lead to litigation with the customer.

     The Company currently and from time to time is involved in litigation (as
both plaintiff and defendant) incidental to the conduct of its business;
however, other than the shareholder litigation described above, the Company is
not a party to any lawsuit or proceeding which, in the opinion of management of
the Company, is likely to have a material impact on the Company's financial
position, results of operations or cash flows.

     Amounts accrued for litigation matters represent the anticipated costs
(damages and/or settlement amounts) in connection with pending litigation and
claims. The costs are accrued when it is both probable that an asset has been
impaired or a liability has been incurred and the amount can be reasonably
estimated. The accruals are based upon the Company's assessment, after
consultation with counsel, of probable loss based on the facts and circumstances
of each case, the legal issues involved, the nature of the claim made, the
nature of the damages sought and any relevant information about the plaintiffs,
and other significant factors which vary by case. When it is not possible to
estimate a specific expected cost to be incurred, the Company evaluates the
range of probable loss and records the minimum end of the range. As of December
31, 1998, accruals for

                                      F-19
<PAGE>   58
                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                         NOTES TO FINANCIAL STATEMENTS
          YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 -- (CONTINUED)

10. COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
litigation matters approximated $500,000. No such accruals were recorded as of
December 31, 1997. It is anticipated that the $500,000 accrual will be paid as
follows: $135,000 in 1999 and $365,000 in 2000. The Company believes, based on
information known at December 31, 1998, that anticipated probable costs of
litigation matters as of December 31, 1998 have been adequately provided to the
extent determinable.

     INDEMNIFICATIONS FROM FORMER PARENT -- As described in Notes 5, 7 and 9, in
connection with the Offering, the Company and its Former Parent entered into a
number of agreements, which, among other matters, provide for the
indemnification, under certain circumstances, of the Company by the Former
Parent. During 1999, the Former Parent has experienced significant financial
difficulty, which may result in its inability to perform under the terms of the
indemnifications provided, which could have a material adverse effect on the
Company's financial position, results of operations and cash flows.

     PRODUCT LIABILITY MATTERS -- The Company provides holograms in connection
with a wide range of its customers' products, in which case it is possible that
the Company is subject to product liabilities in association with those products
or in connection with the holograms used with those products. Although the
Company maintains product liability insurance, there can be no assurance that
such insurance would be available to cover any such claim or available in
amounts sufficient to cover all potential liabilities. As a result, product
liability claims could have a material adverse effect on the Company's business,
financial condition, results of operations and cash flows.

     LEASES -- The Company has long-term operating leases for offices,
manufacturing facilities and equipment, which expire through 2007. The Company
has renewal options on some locations, which provide for renewal rents based
upon increases tied to the consumer price index.

     Net rental expense was approximately $1.2 million for each of the years
ended December 31, 1998, 1997 and 1996.

     At December 31, 1998, future minimum lease payments under noncancelable
operating leases are as follows: $1.2 million in 1999; $1.1 million in 2000;
$0.9 million in 2001; $0.9 million in 2002; $0.8 million in 2003; and $2.7
million thereafter.

     EMPLOYMENT AGREEMENTS -- In 1999, the Company entered into employment
agreements with certain officers which provide for among other matters minimum
compensation of approximately $474,000 in 1999, $552,000 in 2000, and $65,000 in
2001. The agreements also provide for discretionary bonuses. In connection with
these agreements, the Company granted options to acquire 775,000 shares of its
Common Stock at prices ranging from $1.75 to $2.75 per share, representing the
fair market value of the Company's Common Stock on the dates of grant.

     NEW YORK STOCK EXCHANGE SUSPENSION OF TRADING -- On August 3, 1999, the New
York Stock Exchange suspended trading in the Company's Common Stock for failure
by the Company to deliver its Annual Report on Form 10-K for the year ended
December 31, 1998 and its Quarterly Report on Form 10-Q for the three months
ended March 31, 1999 on a timely basis. Following the suspension, the New York
Stock Exchange notified the Company of its intent to apply for delisting of the
Company's Common Stock. The Company does not expect to resume trading on the New
York Stock Exchange, but the Company intends to seek to have its security traded
on another stock exchange or the National Association of Securities Dealers
Automated Quotation System.

11. RESTATEMENT

     Subsequent to the issuance of the Company's financial statements for the
years ended December 31, 1997 and 1996, it was determined that certain sales
were improperly recorded. As a result of the restatement, previously reported
sales for the year ended December 31, 1996 were reduced by approximately $1.1
million, resulting in a corresponding increase in previously reported sales for
the year ended December 31, 1997.

                                      F-20
<PAGE>   59
                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                         NOTES TO FINANCIAL STATEMENTS
          YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 -- (CONTINUED)

11. RESTATEMENT -- (CONTINUED)
Additionally, previously reported sales for the year ended December 31, 1997
were reduced, prior to the impact of the increase relating to the 1996 reduction
discussed above, by approximately $9.0 million, resulting in an increase in
sales for the year ended December 31, 1998 (principally in the first quarter) of
approximately $7.5 million. As a result, the accompanying financial statements
as of December 31, 1997 and for the years ended December 31, 1997 and 1996
present the restated results.

     A summary of the effects of the restatement follows (in thousands, except
per share data):

<TABLE>
<CAPTION>
                                                                   BALANCE SHEET
                                                              AS OF DECEMBER 31, 1997
                                                              -----------------------
                                                                  AS
                                                              PREVIOUSLY       AS
                                                               REPORTED     RESTATED
                                                              -----------   ---------
<S>                                                           <C>           <C>
                                       ASSETS
Current assets:
     Cash and cash equivalents..............................   $    253     $    253
     Accounts receivable....................................     14,479        5,897
     Inventories............................................      5,989        6,031
     Deferred income taxes..................................        471          708
     Prepaid expenses and other.............................         95           95
                                                               --------     --------
          Total current assets..............................     21,287       12,984
Machinery, equipment and leasehold improvements, net........      5,695        5,695
Other assets................................................         43           43
Excess of cost over net assets acquired, net................      8,793        8,793
                                                               --------     --------
                                                               $ 35,818     $ 27,515
                                                               ========     ========
                        LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
     Revolving credit.......................................   $    674     $    674
     Accounts payable and accrued expenses..................      3,312        3,626
                                                               --------     --------
          Total current liabilities.........................      3,986        4,300
Other long-term liabilities.................................        460          460
Deferred income taxes.......................................      1,590        1,590
                                                               --------     --------
          Total liabilities.................................      6,036        6,350
                                                               --------     --------
Stockholders' equity:
     Common stock...........................................        136          136
     Additional paid-in capital.............................     11,627       11,627
     Retained earnings......................................     41,015       35,536
     Due from Former Parent and affiliates..................    (22,996)     (26,134)
                                                               --------     --------
          Total stockholders' equity........................     29,782       21,165
                                                               --------     --------
                                                               $ 35,818     $ 27,515
                                                               ========     ========
</TABLE>

                                      F-21
<PAGE>   60
                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                         NOTES TO FINANCIAL STATEMENTS
          YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 -- (CONTINUED)

11. RESTATEMENT -- (CONTINUED)

<TABLE>
<CAPTION>
                                                                     STATEMENTS OF INCOME
                                                                   YEARS ENDED DECEMBER 31,
                                                         ---------------------------------------------
                                                                 1997                    1996
                                                         ---------------------   ---------------------
                                                             AS                      AS
                                                         PREVIOUSLY      AS      PREVIOUSLY      AS
                                                          REPORTED    RESTATED    REPORTED    RESTATED
                                                         ----------   --------   ----------   --------
<S>                                                      <C>          <C>        <C>          <C>
Sales..................................................   $30,915     $23,085     $28,649     $27,516
                                                          -------     -------     -------     -------
Costs and expenses:
     Cost of goods sold................................    11,912      12,153      15,034      14,710
     Selling and administrative........................     6,001       5,813       4,711       4,711
     Depreciation......................................     1,136       1,136       1,141       1,141
                                                          -------     -------     -------     -------
                                                           19,049      19,102      20,886      20,562
                                                          -------     -------     -------     -------
                                                           11,866       3,983       7,763       6,954
                                                          -------     -------     -------     -------
Other, net:
     Royalty income....................................       785         785         128         128
     Intercompany interest income......................       305         305         305         305
     Other income......................................        36          36          68          68
     Interest expense..................................      (159)       (159)         --          --
                                                          -------     -------     -------     -------
                                                              967         967         501         501
                                                          -------     -------     -------     -------
Income before taxes on income..........................    12,833       4,950       8,264       7,455
Taxes on income........................................     5,294       2,130       3,444       3,117
                                                          -------     -------     -------     -------
Net income.............................................   $ 7,539     $ 2,820     $ 4,820     $ 4,338
                                                          =======     =======     =======     =======
Net income per share, basic and diluted................   $  0.55     $  0.21     $  0.35     $  0.32
                                                          =======     =======     =======     =======
</TABLE>

     Additionally, as of January 1, 1996 retained earnings have been reduced by
approximately $278,000, net of applicable income taxes, for the effects of
certain overbillings during 1991 through 1994.

                             *   *   *   *   *   *

                                      F-22
<PAGE>   61

                                                                     SCHEDULE II

                     AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                       VALUATION AND QUALIFYING ACCOUNTS
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

<TABLE>
<CAPTION>
                                                              ADDITIONS
                                                       -----------------------
                                           BALANCE,    CHARGED TO   CHARGED TO                      BALANCE,
                                           BEGINNING   COSTS AND      OTHER                           END
               DESCRIPTION                  OF YEAR     EXPENSES     ACCOUNTS    DEDUCTIONS         OF YEAR
               -----------                 ---------   ----------   ----------   ----------         --------
                                                           (IN THOUSANDS)
<S>                                        <C>         <C>          <C>          <C>                <C>
Year ended December 31, 1998:
     Allowance for doubtful accounts
       (deducted from accounts
       receivable).......................    $168        $  379                     $416 (1)         $  131
                                             ====        ======       ======        ====             ======
     Allowance for obsolescence (deducted
       from inventory)...................    $467        $2,289                     $ --             $2,756
                                             ====        ======       ======        ====             ======
Year ended December 31, 1997 (as
  restated):
     Allowance for doubtful accounts
       (deducted from accounts
       receivable).......................    $245        $  732                     $809 (1)         $  168
                                             ====        ======       ======        ====             ======
     Allowance for obsolescence (deducted
       from inventory)...................    $265        $  202                     $ --             $  467
                                             ====        ======       ======        ====             ======
Year ended December 31, 1996 (as
  restated):
     Allowance for doubtful accounts
       (deducted from accounts
       receivable).......................    $130        $   22                     $(93)(1)(2)      $  245
                                             ====        ======       ======        ====             ======
     Allowance for obsolescence (deducted
       from inventory)...................    $322        $   --                     $ 57             $  265
                                             ====        ======       ======        ====             ======
</TABLE>

---------------
(1) Accounts deemed to be uncollectible, net of recoveries.

(2) Amount of recoveries exceeded amounts deemed uncollectible during year.

                                       S-1
<PAGE>   62

                                   SIGNATURES

     Pursuant to the requirements of section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                        AMERICAN BANK NOTE HOLOGRAPHICS, INC.

                                        By: /s/ KENNETH H. TRAUB
                                           -------------------------------------
                                           Kenneth H. Traub
                                           President and Chief Operating Officer

December 21, 1999

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
                  SIGNATURE                                  TITLE                        DATE
                  ---------                                  -----                        ----
<S>                                            <C>                                  <C>

/s/ KENNETH H. TRAUB                           President, Chief Operating           December 21, 1999
---------------------------------------------  Officer and
Kenneth H. Traub                               Director (Principal Executive
                                               Officer)

/s/ ALAN GOLDSTEIN                             Chief Financial Officer              December 21, 1999
---------------------------------------------  (Principal Financial and
Alan Goldstein                                 Accounting Officer)

/s/ SALVATORE F. D'AMATO                       Chairman of the Board                December 21, 1999
---------------------------------------------
Salvatore F. D'Amato

/s/ STEPHEN A. BENTON                          Director                             December 21, 1999
---------------------------------------------
Stephen A. Benton

/s/ C. GERALD GOLDSMITH                        Director                             December 21, 1999
---------------------------------------------
C. Gerald Goldsmith
</TABLE>