**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM10-K**

 

| ý                                                                                                                                                         | **ANNUAL  REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                     |
| **For the fiscal year ended December 31,  2004**                                                                                                          |
|                                                                                                                                                           |
| **OR**                                                                                                                                                         |
|                                                                                                                                                           |
| **o**                                                                                                                                                          | **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. 1-14227**

 

**AMERICAN BANK NOTE HOLOGRAPHICS, INC.**

(Exact Name of Registrant as Specified in ItsCharter)

 

| **DELAWARE**                                                    |   | **13-3317668**                           |
|-----------------------------------------------------------------|--------|------------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization) |   | (I.R.S. Employer  Identification Number) |
|                                                            |   |                                     |
| **399 EXECUTIVE BOULEVARD  ELMSFORD, NY**                       |   | **10523**                                |
| (Address of Principal Executive Offices)                        |   | (Zip Code)                               |

 

**(914) 592-2355**

(Registrant’s telephone number, includingarea 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)

 

Indicateby check mark whether the registrant: (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports, and (2) has been subject to such filingrequirements for the past 90 days. YES ý  NO o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 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 informationstatements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. ý

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Exchange Act Rule 12b-2). YES o   NO ý

 

The aggregate market value of the common stock, $0.01 par value, heldby non-affiliates of the registrant, based upon the closing sale price of thecommon stock on June 30, 2004, was approximately $32,859,300.  Shares of common stock held by each officerand director and by each person who controls 10% or more of the outstandingvoting power of the registrant have been excluded in that such persons may bedeemed to be affiliates.  Thisdetermination of affiliate status is not necessarily a conclusive determinationfor other purposes.

 

The aggregate number of shares of common stock, $.01 par value,outstanding on March 15, 2005 was 18,517,907.

 

DOCUMENTS INCORPORATED BY REFERENCE

**NONE**

 

 

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AMERICAN BANK NOTE HOLOGRAPHICS, INC.

 

2004 Form 10-K

 

**Table of Contents**

 
| Part I                        |                                                                                                                |
|-------------------------------|---------------------------------------------------------------------------------------------------------------------|
|                          |                                                                                                                |   |
| Item 1.                       | Business.                                                                                                           |   |
| Item 2.                       | Properties.                                                                                                         |   |
| Item 3.                       | Legal Proceedings.                                                                                                  |   |
| Item 4.                       | Submission of Matters to a Vote of Security  Holders.                                                               |   |
|                          |                                                                                                                |   |
| Part II                       |                                                                                                                |   |
|                          |                                                                                                                |   |
| Item 5.                       | Market for Registrant’s Common Equity,  Related Stockholder Matters and Issuer Purchases of Equity Securities. |   |
| Item 6.                       | Selected Financial Data.                                                                                            |   |
| Item 7.                       | Management’s Discussion and Analysis of  Financial Condition and Results of Operations.                        |   |
|                          |                                                                                                                |   |
| Item 7A.                      | Quantitative and Qualitative Disclosures  About Market Risk.                                                        |   |
| Item 8.                       | Financial Statements and Supplementary  Data.                                                                       |   |
| Item 9.                       | Changes In and Disagreements With  Accountants on Accounting and Financial Disclosure.                              |   |
| Item 9A.                      | Control Procedures.                                                                                                 |   |
| Item 9B.                      | Other Information.                                                                                                  |   |
|                          |                                                                                                                |   |
| Part III                      |                                                                                                                |
|                          |                                                                                                                |   |
| Item 10.                      | Directors and Executive Officers of  Registrant.                                                                    |   |
| Item 11.                      | Executive Compensation.                                                                                             |   |
| Item 12.                      | Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters.                    |   |
| Item 13.                      | Certain Relationships and Related  Transactions.                                                                    |   |
| Item 14.                      | Principal Accountant Fees and Services                                                                              |   |
|                          |                                                                                                                |   |
| Part IV                       |                                                                                                                |   |
|                          |                                                                                                                |   |
| Item 15.                      | Exhibits and Financial Statement Schedules.                                                                         |   |
|                          |                                                                                                                |   |
| Index to Financial Statements |                                                                                                                |

 

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**Part I.**

 

**Item 1.BUSINESS.**

 

American BankNote Holographics, Inc. (“ABNH” or the “Company”) originates, produces andmarkets holograms. Our holograms are used primarily for security applicationssuch as counterfeiting protection and authentication of transaction cards,identification cards, documents of value and consumer products. Our ability tocreate distinctive, secure optically variable devices, to reproduce them withhigh quality and to distribute them securely has enabled us to become a marketleader in security holography. Our products are used by over 200 companiesworldwide, including MasterCard, VISA, American Express, Discover, Diners Club,Quaker State, Sony, Sears, Exxon Mobil and Eli Lilly, as well as agencies ofthe United States government and certain foreign governments. We also producenon-secure holograms for design and promotional applications.

 

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

 

•                  ourreputation as a quality supplier of secure holograms with over 20 years ofexperience in the industry,

 

•                  ourexpertise in holographic technology and production techniques which enables usto offer effective security solutions for a variety of end use markets andapplication environments,

 

•                  oursecure production and distribution processes and capabilities which qualify usto meet the security requirements of security conscious customers,

 

•                  ourorigination laboratories, which enable us to produce distinctive holograms witha variety of security features that make them difficult to counterfeit, and

 

•                  ourISO 9001:2000 certified manufacturing facilities, which allow us to massproduce our products in accordance with the highest quality standards.

 

**TheHolography Industry**

 

A hologram isa unique type of image that is created through the diffraction of light atpre-determined angles to create various visual effects.  Holograms are created with special laserconfigurations and do not use ink, thereby enabling a holographic image to beeasily distinguished from a traditionally printed or copied image. When ahologram is viewed from different angles, the viewer is able to see featuressuch as depth and movement, which would not typically be possible in mosttwo-dimensional images. Holograms can also include information that isdetectable only with the aid of special devices.

 

The holographyindustry is divided into two main sectors: security and non-security.

 

***Security***

 

The securitysector of the holography industry includes products that protect andauthenticate transaction cards, documents of value, consumer and industrialproducts and identification cards. Using holography, and other techniques, wecan develop a unique holographic security device for each customer with whichto identify and protect the customer’s products. Holograms provide thefollowing major benefits as security devices:

 

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•                  difficultto copy - holograms cannot be copied with conventional copying equipment suchas color copiers or scanners. The unique properties and high resolution of asecurity hologram make it extremely difficult to replicate even withspecialized equipment and expertise.

 

•                  overtfeatures - the unique visual aspects of a hologram are easily recognizable,making authentication of products and documents practical for the generalpublic without special machinery, equipment or training.  Overt features that we offer include:

 

•                  3-DImagery - an image that has three dimensions and gives the illusion of depth orvarying distances.

 

•                  TrueColor-a holographic image that gives the illusion of color.

 

•                  Parallax- images created on different planes that move in relation to one another whenviewed from different angles.

 

•                  SecondaryFlip Image - an image that appears and disappears when viewed at certainangles.

 

•                  DiffractiveMercurial - a bright, sharp, color shifting two-dimensional image.

 

•                  Animation- a two or three-dimensional image that gives the illusion of motion.

 

•                  covertfeatures - hidden features that can only be detected with high-poweredmicroscopes or specialized readers can be incorporated into a hologram to makeit more difficult to counterfeit, facilitate verification in the field andsupport forensic investigation. Covert features that we offer include:

 

•                  HiddenLatent Image - a hidden element within a holographic image that ismachine-readable only with a proprietary reader.

 

•                  HoloScanTM- ABNH’s hidden machine readable code within a holographic image that can beread with special readers.

 

•                  MicroImagery - text or a logo within a holographic image that is visible only undermagnification.

 

•                  NanoImagery - microscopic text or a logo within a holographic image that is visibleonly with high-powered magnification.

 

•                  physical features - features that can becombined with holographic materials to increase the security of the holographicproduct. Physical features that we offer include:

 

•                  Micro-demetallization- a feature whereby a designed portion of the vacuum deposited aluminummaterials are removed from the holographic film to create additional uniqueaesthetic features that can be used to differentiate and authenticate thematerials.  This can be used to create see through screens, additionalmicro text in the metallization layer, and images that are only visible undermagnification.

 

•                  TamperApparent - an invisible feature used in labels which when combined with theholographic image will act as a self destructive layer and produce apredictable release pattern that indicates that a product has been tamperedwith or altered.  This release pattern can be in the form of a customizedor generic design.

 

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•                  Holomagnetics– an integrated hologram and magnetic stripe that is functionally equivalent toa traditional magnetic stripe, but has the security of an integrated hologram.

 

•                  Taggants– unique features which are added during the manufacturing process to theholographic films or coatings that are verifiable by specialized equipment.

 

The securitysector of the holography industry addresses concerns relating tocounterfeiting, diversion, tampering and fraud. The cost of the hologram isgenerally relatively small compared to the value of the item being protectedand the risk of loss. Consequently, customers typically select suppliersprimarily based on the effectiveness of their security solutions, quality,reliability and price.

 

Our research,product development, marketing and sales activities are primarily focused onthe security sector of the holography industry. We offer a diverse set of security, authentication and design features.Based on customer specific needs and applications, we can combine thesetechniques creating a unique set of effects in a well-constructed and effectiveholographic security product.

 

***Non-Security***

 

Thenon-security sector of the holography industry includes design, packaging andother decorative applications.

 

The uniquevisual appeal of holograms makes them attractive for use on consumer products.Holograms are used to enhance the design of a wide variety of productsincluding greeting cards, decorative clothing, point-of-purchase displays, andfor other promotional uses. Holograms are also used for packaging of food andother products. These holograms are generally used on consumer productpackaging for their eye-catching appeal, including packaging for candy, beer,toothpaste, soft drinks and other consumer products. Non-secure holograms aregenerally not as complex, secure or proprietary as security holograms. Since thereare more companies capable of producing non-secure holograms than there arequalified to produce and market security holograms, the competition is moreintense in the non-security sector, and the margins are typically lower than inthe security market. Customers in the non-security sector of the holographicindustry typically distinguish between suppliers primarily based upon price,quality and production capacity.

 

**Marketsand Products**

 

We have fivetarget markets, and we market various products to meet the needs of thesemarkets:

 

***Transaction Cards***. In the early 1980’s, webegan 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. Sincethat time, holograms have been established as an important fraud preventiondevice on credit cards and other transaction cards. They are also commonly usedto enhance the brand image of a transaction card issuer. Our products include:

 

HolographicHot-Stamp Patch. Our largest source of revenue sinceour inception has been security holograms embossed into hot-stamp foil, forcredit card authentication. Holographic hot-stamp patches can also enhance thedesign and branding of a card. Our customers for this product include the issuersor printers of MasterCard, Visa, American Express, Discover, Diners Club andvarious other retail and payment cards. We are the market leader in thissegment and have developed a secure, global distribution system for secureholograms to the payment card industry.

 

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HoloMagTM.Our technology for combining a hologram with the magnetic stripe on a card.HoloMag not only enables efficient utilization of real estate on the card withattractive imagery on the magnetic stripe, but it significantly enhances cardsecurity. Multiple levels of security plus distinct visual recognition makethis device a very effective tool against counterfeiting.

 

HoloCardTM.HoloCard incorporates a hologram on a card’s entire face, creating a customizedmarketing tool and a counterfeit deterrent. A full-faced hologramcan support brand recognition, product enhancement campaigns, customerretention and overall product differentiation efforts.

 

***Identification Documents.*** We provide secureholographic laminates and patches for identity documents such as national IDcards, passports, government credentials, military credentials and drivers’licenses. We have patents on demetallized holograms which are transparent andused to see printed information under the holograms.

 

We believethere are significant security advantages for demetallized holograms used on IDcards and other documents.  We currentlysupply demetallized laminates for certain secure U.S. government credentials aswell as national identity cards for certain foreign countries.  We believe there is a need to improve thesecurity of many identity documents used in the United States and othercountries, and we are proposing security holograms as a component of thesecurity enhancements that are being considered by major issuers ofidentification documents.

 

***Product Authentication and Security Packaging.***The use of holograms for product authentication and security packaging isdriven by concerns regarding counterfeiting, piracy, pilfering, diversion andother infractions that can result in lost sales, lost goodwill and productliability claims. Holograms are used as authentication devices in, amongothers, pharmaceuticals, licensed consumer products and high value consumer andindustrial products. Product authentication holograms are either machine orhand-applied to individual products. A holographic label that is tampered withcan become permanently damaged, leaving a visible footprint on the product. Ourproducts for this market segment include:

 

HolographicLabels. Our pressure-sensitive label is available witha broad array of authenticating features such as demetallizing, latent imagery,machine readability and other overt and covert features. By combining multiplesecurity techniques, we achieve higher levels of security and make the entireproduct or package easier to authenticate and difficult to simulate.

 

HoloSealTM.HoloSeal integrates several key security features into one innovative device. Ahigh security hologram, customized tamper-apparent break pattern, black lightverification system and machine-readable embedded code are all features of thissecurity label. In addition, HoloSeal can be manufactured to be transparent orsemi-transparent so that printed regulatory or marketing copy can be seenthrough the hologram.

 

HoloCapTM.HoloCap is ABNH’s innovative approach to sealing bottles or containers with ahigher level of security. Utilizing an induction seal process, this applicationprovides for authentication, tamper-resistance and branding. A holographiclayer becomes part of the seal itself. HoloCap can be combined with othersecurity features to create an effective approach for the security needs of awide range of sealed products.

 

HolographicShrink Sleeves. ABNH has developed a heat-shrink sealwith an integrated holographic stripe that can be applied to the lids ofbottles to deter product fraud and tampering. By including overt and covertsecurity features within the hologram, a customized tamper-apparent break patternand an embedded black light verification system, ABNH’s holographic shrinksleeves provide manufacturers of bottled goods with a tool to combat criminalsthat, at the same time, can be easily integrated into a customer’s existingmanufacturing operations.

 

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***Documents of Value.*** Concerns overcounterfeiting and copying have led to an increased use of holograms producedby international suppliers for international markets for currency, checks, giftcertificates, tax stamps and other financial instruments. Holographic productsfor paper documents of value include:

 

HolographicThread. A holographic thread is a security device madeup of a narrow-strip hologram, approximately 2-5 millimeters wide, and is typicallyincorporated into the paper substrate at the security paper mill. The hologramis often partially embedded into the paper creating a window orserpentine-thread. This holographic product offers both visual and covertsecurity features and helps raise the recognition and perceived value of thedocument it is embedded into.  We produceholographic material for security threads with our proprietary process, whichwe believe provides significant advantages for brighter and more durableholographic threads compared to other methods of holographic replication.

 

HolographicRibbons. A holographic ribbon is ananti-counterfeiting device that can be used on documents of value such aschecks and currency. The system is comprised of a narrow strip hologram made ofhot-stamp foil and slit into ribbons that are applied on security paper byeither the paper maker or the printer.

 

HolographicPatch. A holographic patch is created by embossing ahologram into hot-stamp foil, and is used for authenticating currency and othersecure documents. It is machine applied for registered placement and quality.Depending on the design of the document, patches can be created to meetspecific size, shape, creative and security requirements. A holographic patchis applied with heat and pressure forming a distinctly recognizable, securitycomponent of the document.

 

***Commercial.*** We also produce holographicimagery for decorative and promotional purposes. Our products for this marketinclude pressure sensitive labels with a rich array of designs and wide webholographic patterns for flexible packaging applications.

 

**Strategy**

 

*Protect andEnhance Our Position in Our Core Transaction Card Business.*We hold a leadership position in the market for holograms on transaction cardsas a result of our relationships with companies such as MasterCard, VISA, AmericanExpress, Diners Club, Discover and many of the major security cardmanufacturers. We intend to maintain our leadership position in the cardindustry and grow through excellent customer service and the distribution ofnew products, such as HoloMag, that address the security needs and designobjectives of this market.

 

*Focus Salesand Marketing.* We have narrowed the focus of our sales and marketing efforts to thosespecific applications within our target markets in which we can establish andsustain competitive advantages through a combination of productdifferentiation, intellectual property and market position.

 

*Broaden andEnhance Our Security Offerings*. We are developingbetter security solutions for our target markets which incorporate innovativeapplications of holography and other complimentary technologies.

 

*ControlCosts*. We intend to invest in more efficientoperations and prudently manage our expenses to strengthen our competitiveposition and enhance profitability.

 

*StrengthenOperational Capabilities*. We intend to invest inenhancing our production and operational capabilities to broaden our productrange, improve the products and services we provide to our customers and togain operational efficiencies.

 

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**ProductionProcess**

 

We are one ofthe most experienced security production companies in the holographic industry.We have ISO certified security production facilities containing a total of nineorigination laboratories and twenty-one mass replication lines as well asextensive security and quality control procedures. We will be investing inmoving, consolidating, enhancing and expanding these production capabilities in2005. We also have a distribution network for secure holographic products.

 

Our productionprocess is integrated to handle most aspects of production, including materialssourcing, processing, finishing, packaging, storage and logistics. From time totime, we subcontract certain production functions or customer orders to thirdparties. The production process consists of the following steps:

 

***Design***

 

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

 

***Origination***

 

After thedesign has been completed, various laser-ready components (magnetic disc,three-dimensional sculpture, flat art, etc., referred to as “information”) aredelivered to our origination studios.

 

The conversionfrom information to hologram is based on our ability to record light in anorganized format. Coherent light, which is delivered by a laser, is bestunderstood as light, which has one wavelength of the visible spectrum andpossesses a high degree of organization. The coherent light is split into twobeams (the object beam and the reference beam) directed toward photo-resisttreated glass. The object beam is interfered with by the information beforecontinuing its travel toward the photo-resist treated glass. The reference beamis not interfered with and travels directly toward the photo-resist treatedglass.

 

The objectbeam then interferes with the reference beam, creating an interference pattern,which is recorded on the light sensitive photo-resist glass. After developingthe photo-resist glass, the film is re-illuminated approximating the originalangle(s) of the reference beam. The resulting interference pattern within thefilm reflects some of the light, striking it into a re-creation of the patternof light that originally came from the object beam, due to a property of lightcalled diffraction. The reflected light, now organized and containing allinformation that the object beam once carried, allows the viewer to see all ofthe information in three dimensions, true color or with other desired effects.There are less complex methods of creating a hologram origination than theprocess described above. However, in our opinion, the above process producesthe clarity, depth perception, movement and mass replication properties thatare essential components of our secure holograms. We believe that our largestcompetitors in the security sector may use similar processes among others.

 

***Plate Making***

 

Once theorigination process is completed, a plate is created in order to permit massproduction. The “one-up” image is “step and repeated” to a pre-determined sizewith multiple identical images recorded on a photo-resist glass. We havedesigned and built a proprietary step and repeat process to create very preciseplates for mass production of tightly registered images. The glass is thenconverted to a production plate in an electrolytic process where nickel isgrown on the surface of the glass. Nickel is used because its molecular natureallows for an exact transfer of the origination to the production plate.

 

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We believethat our plate making process is an important component of our ability tomass-produce our secure holograms with high precision.

 

Theelectrolytic process creates different “generations” of plates prior to theproduction phase. Each generation, identical to the last, creates a more wearresistant plate for use in a mass production environment, thereby extending theuseful life of the plate. The production plate will have varying degrees ofhardness, depending upon the processes used in production.

 

***Mass Production***

 

Manufacturingspecifications are determined in collaboration with the customer. We typicallyenter into production planning with the customer where drawings and overallspecifications are written and distributed to the various production andquality control departments.

 

We employthree methods of mass-production of holograms. Hard embossing transfers imagesto an aluminum foil/polyester substrate through heat and pressure. Heat andpressure on the holographic plate force the holographic image into the foil,which is then converted into the final product. Soft or compliant embossingpermits embossing into pre-metallized and other films and allows for embossingon wider-web materials.

 

The othermethod of mass production we employ is casting. We developed a proprietarycasting method involving ultraviolet curing, which we refer to as In-SituPolymeric Replication. Using this method, a polymer is transferred to asubstrate (polyester, polypropylene, etc.) which is then put in contact withthe holographic plate so that holographic imagery is replicated. The materialis then metallized using a vacuum deposition process.

 

Finishing foreach of these methods may include some combination of metallization,demetallization, application of adhesive, magnetic coating, slitting,die-cutting, lamination and custom numbering. The completed holographicmaterial may then be applied to the customer’s product.

 

We perform theabove processes through a combination of our internal production resources andoutside subcontractors.

 

**Quality**

 

Through theISO 9001:2000 certification program, we continually make improvements to ourprocesses through the use of an effective and efficient business managementsystem.

 

Ourmanufacturing facilities located in Elmsford, New York and Huntingdon Valley,Pennsylvania are ISO certified.

 

Ourmanufacturing facility located in Elmsford, New York includes our artdepartment, origination labs, plate making and replication and maintains theISO 9001:2000 standard covering quality assurance for design, development andproduction.

 

Ourmanufacturing facility located in Huntingdon Valley, Pennsylvania maintains ISO9001:2000 certification covering quality assurance for production.

 

In 2005, weintend to move and consolidate our facilities from Elmsford, New York andHuntingdon Valley, Pennsylvania into a new facility in Robbinsville, NewJersey. (See “Manufacturing Facilities” below and “Item 2. Properties”). Wewill begin the ISO 9001-2000 certification process for this facility during2005.

 

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**InformationTechnology**

 

We haveimplemented an integrated enterprise resource planning system that providesinformation for management decision making. We made improvements to this system in 2004 and we intend to makefurther improvements in 2005 in connection with the move to the new facility inRobbinsville, New Jersey.

 

**Researchand Product Development**

 

We havedevoted significant attention to research and product development to continueto enhance our origination, replication and mass production capabilities. Ourresearch and development has enabled us to create new technologies andproprietary production processes and to deliver innovative products to themarketplace. We intend to continue to make on-going investments in research anddevelopment in order to:

 

•                  Developbetter solutions for our customers’ problems.

•                  Createfeatures which differentiate our products from those of our competitors.

•                  Developand improve processing techniques to improve the quality and reduce the costsof our products.

 

**Manufacturing Facilities**

 

On December 14,2004, we entered into agreements to lease a 134,000 square foot modernmanufacturing and office building in Robbinsville, New Jersey, which will bethe future site of our primary operations. We will be doing construction withinthis facility to meet our specialized operational and security requirementsthrough approximately May 2005. The new facility provides substantial room forexpansion as we will consolidate our operations that are currently beingconducted within a 58,000 square foot facility in Elmsford, New York and a30,000 square foot facility in Huntingdon Valley, Pennsylvania into the newfacility in Robbinsville, New Jersey. We are also acquiring additional equipmentand technology to be installed in the new facility in order to broaden ourcapabilities to serve our target customers, expand capacity and improveefficiency. See “Item 2. Properties.”

 

**Sales and Marketing**

 

In 2004, weprovided holographic products to over 200 customers worldwide. We are theexclusive supplier of holograms to MasterCard and we are one of two authorizedmanufacturers of VISA holograms for sale to approved manufacturers of VISAcards. In addition, we supply holograms to American Express, Diners Club,Discover, Sony, Sears, Eli Lilly, Quaker State, agencies of the United Statesgovernment, foreign governments and other companies.

 

In the salesdepartment we currently employ a Vice President of Sales, a Vice President ofCorporate Development, three full-time, incentive-compensated salespeople andtwo customer sales service personnel. We also utilize incentive-basedinternational sales agents around the world.

 

Our salesprocess generally involves identifying a customer problem, designing a solutionfor the customer problem, creating samples for customer evaluation and testing.Most of our target customers are credit card issuers, government agencies andlarge corporations that are experiencing counterfeiting or other securityproblems. The sales process is generally at least three months, and in somecases, the sales process can last several years.

 

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Pricingdecisions are generally made centrally by our operating executives. We focussome of our marketing efforts on trade shows such as the Card Tech/SecureTechtrade show, Cartes and a number of other security industry conferences.

 

**Competition**

 

The holographicindustry is highly competitive and highly fragmented. A number of ourcompetitors are larger, and have greater financial resources, than us. Theindustry has become increasingly competitive over the past several years as lowcost foreign producers have entered our target markets, and low costholographic producers that previously focused on non-security applications areincreasingly competing in security applications. The holographic industry hasalso experienced consolidation, which has increased the breadth and scale ofsome of our competitors. In the holographic industry, competition is generallybased on technology, price, product quality and customer service. We alsocompete with other non-holographic methods or devices.

 

**Trademarks and Patents**

 

We utilize acombination of patents, trade secrets and confidentiality agreements, as wellas restricted access and other forms of intellectual property protection, tosafeguard certain of our proprietary technology and processes. We also holdcertain trademarks with respect to certain products and services. We currentlyhold approximately 30 U.S. patents and numerous foreign patents, as well aspatents pending and service marks that are used in our business.

 

We cannotassure you that the degree of protection offered by our patents is sufficient,the success of any of our enforcement actions or the likelihood that patentswill be issued for pending applications. Competitors in the U.S. and foreigncountries may have applied for or obtained, or may in the future apply for andobtain, patents that will prevent, limit or interfere with our ability to makeand sell some of our products.

 

**Employees**

 

As of March 15,2005, we employed 106 persons of which 61 are covered by collective bargainingagreements.  We consider our relationswith our employees to be good.  We areparty to collective bargaining agreements with Paper, Allied-Industrial,Chemical & Energy Workers International Union Local 1-0318 (“Local 1-0318”)and PACE International Union Local 286 (“Local 286”).  The agreement with Local 1-0318 has athree-year term, will expire on December 31, 2006 and covers 21 employeesin our Elmsford, New York facility. In connection with our****moveto Robbinsville, New Jersey, we have entered into a closure agreement withLocal 1-0318, dated March 19, 2005, that provides for the termination of thecontract with Local 1-0318, which will occur in approximately May 2005.****The agreement with Local 286 has a five-year term, willexpire on January 28, 2010, currently covers 40 employees and will cover approximately60 employees in our Robbinsville, New Jersey facility when the facility becomesoperational in 2005.

 

**AvailableInformation**

 

Our investor relations website is accessable through www.abnh.com.  We make available on this website under thecaption “Investor Relations (SEC Filings)” free of charge, our annual reports onForm 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K andamendments to those reports as soon as reasonably practicable after weelectronically file or submit such materials to the Securities and ExchangeCommission.

 

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**Risk Factors**

 

*ImportantFactors Regarding Forward-Looking Statements*

 

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

 

*Our quarterly and annualoperating results may fluctuate and the price of our common stock may change inresponse to those fluctuations.*

* *

Our quarterlyand annual operating results have varied in the past and may vary significantlyin the future depending on factors such as:

 

•                  timingof customer orders,

•                  customerbusiness cycles,

•                  cancellationor expiration of customer contracts or programs,

•                  cardexpiration patterns,

•                  inventoryreplenishment,

•                  increasedcompetition,

•                  changesin our and our competitors’ pricing policies,

•                  patentexpiration and fluctuating amounts of royalty income,

•                  changesin the cost of materials or labor,

•                  costand availability of the services of subcontractors,

•                  costsof recruiting or relocating personnel,

•                  increasedresearch and development expenses,

•                  expensesassociated with litigation,

•                  financingcosts,

•                  marketacceptance of our products,

•                  thetime required for customer testing and evaluation,

•                  costsassociated with implementing changes in operations,

•                  investmentsin new technology and equipment,

•                  changesin facility requirements,

•                  changesin our business strategy, and

•                  generaleconomic factors.

 

Because ourrevenues and operating results may fluctuate, it is possible that in somefuture quarter, our revenues or operating results will be below theexpectations of public market analysts and investors, which could cause ourstock price to decrease.

 

*We depend on sales to creditcard manufacturers for a substantial portion of our business, the loss of whichwould significantly reduce our revenues.*

* *

Sales tocredit card companies accounted for approximately 84% of our total sales in2004 and 76% of our total sales in 2003. Sales to MasterCard and approved manufacturers of VISA brand creditcards together accounted for approximately 66% of our total sales in 2004 and63% of our total sales in 2003.

 

12

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We enteredinto an agreement with MasterCard dated February 28, 2003, which replacedthe agreement dated February 1, 1996, as amended.  We entered into an amendment to thisagreement on September 29, 2003, in which MasterCard retained us toproduce a new hologram for the Debit MasterCard and extended the agreement to February 2011,subject to automatic renewal if not terminated by either party.  Currently, we are one of two companiesauthorized to manufacture and sell VISA Dove holograms to manufacturers of VISAbrand credit cards. On March 15, 2005, VISA announced its intention to phaseout the Dove hologram that we supply for the front of the VISA card, and toreplace it with an integrated holographic magnetic stripe. We expect to supply ourholographic magnetic stripe product, HoloMagTM, for VISAcards, but we cannot assure you that future sales of HoloMag to VISA’s authorizedcard manufacturers will be as successful or profitable as our historical salesof the VISA Dove hologram.  Furthermore,we have limited experience in producing and selling HoloMag.  We do not have a contract with VISA thatcommits them or their authorized card manufacturers to purchase any Doveholograms or HoloMag from us.  If we wereto lose a substantial portion of our business with either MasterCard or VISA withoutreplacing it with new product sales, our business, operating results andfinancial condition would be materially and adversely affected. In addition, ifwe fail to obtain anticipated orders from these customers or if we experiencedelays or cancellations of orders from these customers, our business andfinancial performance will be materially and adversely affected.

 

*We are in a competitive,highly-fragmented industry with many companies competing to deliver ahighly-specialized product, which may lead to declining sales or reduced pricesfor our products.*

* *

The holographyindustry is highly competitive. A number of our competitors are larger than usor are divisions of larger companies, and have greater financial resources,than us. Our competitors, which are numerous and may have more resources thanus, may take away market share or compete with us on the basis of price, whichmay erode our prices and margins. The industry has become increasinglycompetitive over the past several years as low cost foreign producers haveentered our target markets, and low cost holographic producers that previouslyfocused on non-security applications are increasingly competing in securityapplications.  Increasing competition inthe market for our security holograms has resulted in declining sales pricesfor these products over the past several years and sales prices are continuingto decline. Competitive pressures may force us to reduce prices, which canadversely affect our results of operations.

 

Competition isbased on a number of factors, such as:

 

•                  price,

•                  technology,

•                  productquality, and

•                  customerservice.

 

In addition,an increased use of non-holographic methods or devices in place of our productscould reduce demand for our products. We cannot assure you that we will havesufficient resources to make the technological advances necessary to maintainany competitive advantages. We also cannot assure you that the bases ofcompetition in the industries in which we compete will not shift.

 

*If we are not able tosuccessfully protect our intellectual property our business could be materiallyand adversely affected.*

 

Our business isdependent to some extent upon our proprietary technology. We utilize acombination of patents, trade secrets and confidentiality agreements, as wellas restricted access and other forms of intellectual property protection tosafeguard certain of our proprietary technology and processes. We also holdcertain trademarks with respect to certain products and services. We cannot becertain as to the degree of protection offered by any of our patents or as tothe likelihood that patents will be issued for any of our pending applications.Certain of our patents have expired and others have been declared invalid inthe past. Other patents will expire over the next several years. The expirationof patents has resulted in our royalty income decreasing materially in 2004 and2003 from the 2002 amounts. We can not assure you that we will be able tomaintain the confidentiality of our trade secrets or that our confidentialityagreements will provide meaningful protection of our trade secrets or otherproprietary information. In addition, litigation may be necessary in the futureto enforce our intellectual property rights or to

 

13

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determine thevalidity and scope of our patents or of the proprietary rights of others. Suchlitigation might result in substantial costs and diversion of resources andmanagement attention.

 

*If our products infringe onthe intellectual property rights of third-parties, our business may suffer ifwe are sued for infringement or cannot obtain licenses to these rights oncommercially acceptable terms.*

* *

We are subjectto the risk of adverse claims and litigation alleging infringement by us of theintellectual property rights of others. In the past, third-parties haveclaimed, and may in the future claim, infringement by our products. Any suchclaims, with or without merit, could result in significant litigation costs anddiversion of management attention, and could require us to enter into royaltyand license agreements that may be disadvantageous to us or cause other harm toour business.  If litigation issuccessful against us, it could result in invalidation of our proprietaryrights and liability for damages, which could have a material adverse effect onour business and financial condition.

 

*The relocation of ourprimary operations, including our manufacturing operations may subject us toincreased costs and a disruption in our operations.*

* *

Weintend to relocate and consolidate our primary operations, including ourmanufacturing operations from our Elmsford, New York and Huntingdon Valley,Pennsylvania facilities to a new facility in Robbinsville, New Jersey inapproximately May 2005. We expect to incur significant costs in transitioningour operations to this location. These costs shall include costs associatedwith our existing leases, vacating our current facilities, relocating,terminating and recruiting certain employees, moving equipment and otherrelated expenses.  The leases for ourcurrent facilities in Elmsford, New York and Huntingdon Valley, Pennsylvaniarun through December 2007 and July 2007, respectively.  Any difficulties in the relocation of ouroperations may also disrupt our manufacturing activities, which could delayproduct shipments, increase production costs and could cause our relationshipswith customers to suffer and materially and adversely affect our financialcondition, results of operations and cash flows.

 

*We depend on third-partysuppliers and subcontractors for some key product components and processes, andwe may not be able to find alternative sources in a timely manner if thosesuppliers or subcontractors fail to supply us.*

* *

We purchasecertain key materials used in the manufacture of our holograms and outsourcecertain key processes from third-party suppliers, some of which are sole sourcerelationships, with whom we do not have supply contracts. We may not be able tofind alternative sources in a timely manner if our suppliers or subcontractorsbecome unwilling or unable to supply us, or if they increase their prices. Ourinability to obtain key product components or to have certain processesperformed on our behalf could cause delays or reduce product shipments, whichcould cause our relationship with customers to suffer and materially andadversely affect our financial condition, results of operations and cash flows.

 

*Our common stock trades onthe OTC Bulletin Board, which may adversely affect the price of our commonstock.*

 

Our commonstock trades on the over-the-counter bulletin board (OTCBB), an electronicquotation service. Our current stock price does not meet the minimum stockprice requirement of the New York Stock Exchange or NASDAQ. The OTCBB does notimpose listing standards or requirements, does not provide automatic tradeexecutions and does not maintain relationships with quoted issuers. Stockstraded on the OTCBB may experience:

 

•                  aloss of market makers,

•                  alack of readily available bid and ask prices,

•                  agreater spread between the bid and ask prices of its stock, and

 

14

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•                  ageneral loss of liquidity compared to established stock exchanges or the NASDAQNational Market.

 

In addition,many investors have policies against purchasing or holding OTCBB securities.Both trading volume and the market value of our stock have been, and willcontinue to be, affected by trading on the OTCBB, which may adversely affectthe price of our stock and make it difficult for our stockholders to reselltheir shares.

 

*If we were unable tocontinue to attract and retain qualified employees, our business, operatingresults and financial condition could be materially and adversely affected.*

* *

Our futuresuccess depends on our ability to attract and retain qualified:

 

•                  management,

•                  engineering,

•                  manufacturing,

•                  researchand development,

•                  salesand marketing, and

•                  supportpersonnel.

 

Competitionfor these individuals is intense, and we cannot assure you that we will be ableto retain our existing personnel or attract and retain additional personnel.

 

*We may be subject to significantproduct liability in connection with the products which we provide to ourcustomers.*

* *

We provideholograms in connection with a wide range of our customers’ products, in whichcase it is possible that we are subjecting ourselves to product liabilities inassociation with those products or in connection with the holograms used withthose products. Although we maintain product liability insurance, there can beno assurance that such insurance would be available to cover any such claim oravailable in amounts sufficient to cover all potential liabilities.

 

*Since a significantpercentage of our sales are derived from overseas customers, our exports andbusiness may be subject to some risks related to doing businessinternationally.*

* *

Sales derivedfrom customers outside the United States were 21% of our total sales in 2004and 28% of our total sales in 2003. Our international sales are subject torisks, including:

 

•                  U.S.and international regulatory requirements and policy changes,

•                  exchangerate fluctuations,

•                  politicaland economic instability,

•                  difficultiesin accounts receivable collection,

•                  tariffsand other barriers, and

•                  difficultyin attracting, retaining and managing international representatives.

 

These factorsmay have a material adverse effect on our future international sales and,consequently our business, financial condition or results of operations.

 

15

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*Our business is subject toenvironmental regulation and is always subject to environmental liability.*

 

Our operationsare subject to federal, state and local environmental laws and regulations. Ifwe fail to comply with applicable rules and regulations, we could be subject tomonetary damages and injunctive action, which could materially and adverselyaffect our business, financial condition or results of operations. To theextent future laws and regulations are adopted or interpretations of existinglaws and regulations change, new requirements may be imposed on our futureactivities or may create liability retroactively.

 

*The issuance of shares ofour common stock upon exercise of outstanding options, together with thepotential sales of such shares in the public market, could result insubstantial dilution of your investment, a detrimental effect on our liquidityand ability to raise additional capital, and a significant decline in themarket value of our common stock.*

* *

As of March 15,2005, we had approximately 18,517,907 shares of our common stock issued andoutstanding and 2,729,000 additional shares of common stock reserved forissuance upon exercise of outstanding stock options. If the holders of sharesof common stock acquired upon the exercise of outstanding options were to sella significant amount of their shares into the open market, the market price ofour common stock could be adversely affected. The sales might also make it moredifficult for us to sell equity or equity-related securities in the future at aprice we deem appropriate.

 

*Crane & Co. Inc. hascertain rights which could adversely affect the market price of our commonstock.*

 

On June 30,2000, we entered into a stock purchase agreement with Crane & Co., Inc. (“Crane”)under which Crane purchased 3,387,720 shares of our common stock. In connectionwith the transaction, Crane received the right to cause us to register itsshares for public resale and to include its shares in any future registrationof our securities, subject to certain exceptions. Any sales of such shares byCrane could have a negative effect on the market price of our common stock.

 

*Our principal stockholders,executive officers and directors have substantial influence over all mattersrequiring stockholder approval, including a change of control that you mightotherwise approve.*

 

Our executiveofficers and directors and entities related to them, in the aggregate,beneficially own approximately 24.5% of our common stock as of March 15,2004, which includes 18.3% owned by Crane & Co., Inc., an investor relatedto Douglas A. Crane, one of our directors. These stockholders acting togetherhave the ability to exert substantial influence over all matters requiringapproval by our stockholders. These matters include the election and removal ofdirectors and any merger, consolidation or sale of all or substantially all ofour assets. Such a concentration of ownership could have the effect ofdelaying, deferring or preventing a change in control, or impeding a merger orconsolidation, takeover or other business combination.

 

*Effects of anti-takeoverprovisions could inhibit the acquisition of ABNH.*

 

Ourcertificate of incorporation permits our board of directors to issue up to5,000,000 shares of preferred stock and to fix the rights, preferences,privileges and restrictions of such shares without any further vote or actionby our stockholders. Although we have no current plans to issue shares ofpreferred stock, the potential issuance of preferred stock may have the effectof:

 

•                  discouragingpotential acquisitions proposals,

•                  delayingor preventing a change in control, and

•                  limitingthe price that investors might be willing to pay in the future for shares ofour common stock.

 

16

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We are alsosubject to Section 203 of the Delaware General Corporation Law whichgenerally prohibits a Delaware corporation from engaging in any of a broadrange of business combinations with any interested stockholder for a period ofthree years following the date on which the stockholder became an interestedstockholder.

 

**Item 2.PROPERTIES.**

 

We maintainsecure hologram manufacturing facilities in Elmsford, New York, HuntingdonValley, Pennsylvania and Dalton, Massachusetts. On December 14, 2004, weentered into certain agreements to lease a new facility located inRobbinsville, New Jersey, which will be the future site of our primaryoperations. We expect to cease operations in our Elmsford, New York andHuntingdon Valley, Pennsylvania facilities by approximately May 2005.  We believe that following the move of ourprincipal operations to Robbinsville, New Jersey our facilities will beadequate to meet our current requirements and provide the additional spacenecessary to allow for the acquisition of new equipment to upgrade and expandour production capabilities.

 

Our 134,000square foot leased facility at Robbinsville, New Jersey will serve as ourheadquarters and include substantially all of our principal operations,including our design, engineering, research and development, holographicorigination, plate making and manufacturing and quality control for numerousholographic products. We expect this facility to be operational inapproximately May 2005.  The initiallease term for the new facility is through May 2017 and at the expiration ofthe lease, we have options to renew the lease for three consecutive five yearperiods and we also have an option to purchase the building.

 

Our 57,200square foot leased facility at Elmsford, New York currently serves as ourheadquarters and includes our design, engineering, research and development,holographic origination, plate making and manufacturing and quality control forcertain of our holographic products.  Weexpect to vacate this facility in approximately May 2005.  This lease expires in December 2007 andwe are currently searching for a suitable tenant, if any, to sublease thefacility for the duration of the lease term following the cessation of ouroperations in this facility.

 

Our 30,000square foot leased facility at Huntingdon Valley, Pennsylvania is currentlydedicated to the manufacturing and quality control for certain of ourholographic products.  We expect tovacate this facility by approximately May 2005. This lease expires in July 2007 and we are currently searching fora suitable tenant, if any, to sublease the facility for the duration of thelease term following the cessation of our operations in this facility.

 

Our 2,400square foot leased facility at Dalton, Massachusetts was opened in 2000 and isalso dedicated to the production of security holograms. The lease, which is forsuccessive one year periods ending on October 31, automatically renewsunless 120 days advance notice is given by either party not to renew. We willcontinue to occupy this facility after our relocation to the Robbinsville, NewJersey facility.

 

Each of our facilitiesis constantly monitored for security, and has uniformed security personnel onsite, 24 hours a day, seven days a week. Our Director of Security isresponsible for the physical security of each facility, access and egress,monitoring employee integrity, and safeguarding of machinery, materials,work-in-process and finished product until shipping. The security departmentwitnesses material destruction and supervises the transfer of securityshipments. Each facility is equipped with full perimeter alarms enhanced bywindow glass break sensors, internal motion detectors and closed circuit videomonitoring of security sensitive areas.

 

17

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**Item 3.LEGAL PROCEEDINGS.**

 

We currently,and from time to time, are involved in litigation (as both plaintiff anddefendant) incidental to the conduct of our business; however, we are not aparty to any lawsuit or proceeding which, in our opinion, is likely to have amaterial impact on our financial position, results of operations or cash flows.

 

**Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.**

 

None.

 

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**Part II**

 

**Item 5.****MARKET FOR REGISTRANT’S COMMON EQUITY, RELATEDSTOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.**

 

Our commonstock has been quoted on the NASD’s Over-the-Counter Bulletin Board quotationservice under the symbol “ABHH,” since March 31, 2000.  Our securities are not listed or quoted onany exchange or other quotation system.

 

The followingtable sets forth the high and low closing prices of our common stock for eachquarter of 2003, 2004 and the period from January 1 through March 18 of 2005.

 
| ** **                             | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------------------------------|------------|----------|------------|---------|------------|
| **2003**                               |       |     |       |    |       |   |   |
| First Quarter                          |       | $        | 0.98       |    | $          | 0.71 |   |
| Second Quarter                         |       | 1.22     |       | 0.79    |       |
| Third Quarter                          |       | 1.29     |       | 1.05    |       |
| Fourth Quarter                         |       | 1.53     |       | 1.08    |       |
|                                   |       |     |       |    |       |
| **2004**                               |       |     |       |    |       |   |   |
| First Quarter                          |       | $        | 2.40       |    | $          | 1.50 |   |
| Second Quarter                         |       | 2.95     |       | 1.88    |       |
| Third Quarter                          |       | 2.58     |       | 1.96    |       |
| Fourth Quarter                         |       | 3.98     |       | 2.45    |       |
|                                   |       |     |       |    |       |
| **2005**                               |       |     |       |    |       |
| First Quarter (through March 18, 2005) |       | $        | 3.50       |    | $          | 2.75 |   |

 

As of March 1,2005, there were approximately 530 holders of record of our common stock.Because many of our shares of common stock are held of record by brokers andother institutions on behalf of stockholders, we are unable to estimate thetotal number of beneficial stockholders represented by these record holders.

 

We have notpaid cash dividends during the past two fiscal years. We have no plans orintentions of paying dividends in the foreseeable future.

 

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**Item 6.****SELECTED FINANCIAL DATA.**

 
| ** **                                                      | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                      | ** ** | **2000 (b)**                | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
| STATEMENT OF INCOME DATA:                                       |       |                        |       |   |   |   |   |   |   |   |   |
| Revenue:                                                        |       |                        |       |   |   |   |   |   |   |   |   |
| Sales (a)                                                       |       | $                           | 19,029     |   | $ | 20,016 |   | $ | 18,665 |   | $ | 18,284 |   | $ | 21,263 |   |
| Royalty income                                                  |       | 444                         |       | 466 |   | 555 |   | 48 |   | 13 |   |
|                                                            |       | 19,473                      |       | 20,482 |   | 19,220 |   | 18,332 |   | 21,276 |   |
| Costs and expenses:                                             |       |                        |       |   |   |   |   |   |   |   |   |
| Cost of goods sold                                              |       | 8,876                       |       | 9,962 |   | 8,926 |   | 8,279 |   | 9,161 |   |
| Selling and administrative (a)                                  |       | 8,085                       |       | 7,314 |   | 7,136 |   | 6,518 |   | 7,070 |   |
| Research and development                                        |       | 928                         |       | 1,233 |   | 1,143 |   | 1,142 |   | 1,270 |   |
| Depreciation and amortization                                   |       | 1,076                       |       | 1,097 |   | 800 |   | 739 |   | 830 |   |
| Facility consolidation                                          |       |                        |       |   |   |   |   |   |   | 242 |   |
| Impairment of goodwill and fixed assets (c)                     |       | —                      |       | — |   | 9,298 |   | — |   | — |   |
|                                                            |       | 18,965                      |       | 19,606 |   | 27,303 |   | 16,678 |   | 18,573 |   |
|                                                            |       |                        |       |   |   |   |   |   |   |   |   |
| Operating income (loss)                                         |       | 508                         |       | 876 |   | (8,083 | ) | 1,654 |   | 2,703 |   |
|                                                            |       |                        |       |   |   |   |   |   |   |   |   |
| Other income (expense):                                         |       |                        |       |   |   |   |   |   |   |   |   |
| Interest, net                                                   |       | (512                        | )          | 258 |   | 113 |   | 97 |   | 121 |   |
| Settlement with Former Parent                                   |       | 519                         |       | — |   | — |   | — |   | — |   |
| Settlement of shareholder litigation                            |       | (3,508                      | )          | — |   | — |   | — |   | — |   |
| Patent settlement and other                                     |       | —                      |       | — |   | 691 |   | — |   | 178 |   |
|                                                            |       | (3,501                      | )          | 258 |   | 804 |   | 97 |   | 299 |   |
|                                                            |       |                        |       |   |   |   |   |   |   |   |   |
| Income (loss) before provision for (benefit  from) income taxes |       | (2,993                      | )          | 1,134 |   | (7,279 | ) | 1,751 |   | 3,002 |   |
| Provision for (benefit from) income taxes                       |       | (1,110                      | )          | 543 |   | 858 |   | 744 |   | 1,201 |   |
| Net income (loss)                                               |       | $                           | (1,883     | ) | $ | 591 |   | $ | (8,137 | ) | $ | 1,007 |   | $ | 1,801 |   |
|                                                            |       |                        |       |   |   |   |   |   |   |   |   |
| Net income (loss) per share:                                    |       |                        |       |   |   |   |   |   |   |   |   |
| Basic and diluted                                               |       | $                           | (0.12      | ) | $ | 0.03 |   | $ | (0.44 | ) | $ | 0.05 |   | $ | 0.10 |   |
|                                                            |       |                        |       |   |   |   |   |   |   |   |   |
| Weighted average shares outstanding:                            |       |                        |       |   |   |   |   |   |   |   |   |
| Basic                                                           |       | 15,421                      |       | 18,484 |   | 18,484 |   | 18,484 |   | 18,489 |   |
| Diluted                                                         |       | 15,421                      |       | 18,484 |   | 18,484 |   | 18,526 |   | 18,907 |   |

 
|                            |       | **December 31,** |       |
|---------------------------------|------------|------------------|------------|
| ** **                      | ** ** | **2000**         | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
| BALANCE SHEET DATA:             |       |             |       |   |   |   |   |   |   |   |   |
| Working capital                 |       | $                | 10,377     |   | $ | 11,884 |   | $ | 14,091 |   | $ | 16,054 |   | $ | 17,218 |   |
| Total assets                    |       | 29,134           |       | 28,586 |   | 20,130 |   | 21,020 |   | 25,211 |   |
| Total debt                      |       | —           |       | — |   | — |   | — |   | — |   |
| Total stockholders’ equity |       | 23,988           |       | 24,579 |   | 16,442 |   | 17,449 |   | 19,314 |   |
|                                 |            |                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(a)          Saleshave been adjusted for 2000 to reflect the reclassification of shipping chargesbilled to customers, which were previously netted in selling and administrativeexpenses.

 

(b)         Duringthe year ended December 31, 2000, we incurred costs of $3.4 million regardingthe settlement of the shareholder litigation, and $0.1 million in connectionwith fines and costs incurred regarding the SEC and U.S. Attorneyinvestigations. In addition, we reversed $0.5 million from accounts payable andaccrued expenses resulting from a settlement, which we entered into with ourFormer

 

20

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Parent. These costs are includedin other income (expense) on the accompanying statement of operations.Additionally in the third quarter of 2000, our insurance carriers agreed to payus $750,000 as a product liability reimbursement, which we included in cost ofsales.

 

(c)          Asa result of our annual test for impairment of goodwill, we recorded animpairment charge of $7.4 million during the quarter ended December 31, 2002(see Item 7. Management’s Discussion and Analysis ofFinancial Condition and Results of Operations and Note 1 of the Notes to theFinancial Statements).   As aresult of our review of long-lived assets for impairment during the quarterended December 31, 2002, we recorded an impairment charge of $1.9 million (seeItem 7. Management’s Discussion and Analysis of FinancialCondition and Results of Operations and Note 1 of the Notes to the FinancialStatements).

 

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**Item 7.****MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS.**

 

The followingdiscussion and analysis should be read in conjunction with “Item 6. Selected Financial Data” and our financial statements, includingthe notes thereto, which appear elsewhere in this report.

 

**Overview**

 

ABNH was,until July 20, 1998, a wholly-owned subsidiary of American Banknote Corporation(“ABN” or the “Former Parent”). On that date, ABN completed the sale of13,636,000 shares of our common stock in an initial public offering (the “Offering”),representing ABN’s entire investment in ABNH. We did not receive any proceedsfrom the Offering.

 

ABNHoriginates, mass-produces and markets holograms. Our holograms are usedprimarily for security applications such as counterfeiting protection forcredit and other transaction cards, identification cards and documents ofvalue, as well as for tamper resistance and authentication of high-valueconsumer and industrial products. We also produce non-secure holograms forpackaging and promotional applications. Our sales of holograms for securityapplications generally carry higher gross margins than sales for non-securityapplications.

 

Concerns regardingcounterfeiting, piracy and other infractions that can result in lost sales,lost goodwill and product liability claims drive the use of productauthentication holograms. Companies in various industries utilize holograms asauthentication devices to reduce potential losses.

 

A significantportion of our business is derived from orders placed by credit card companies,including MasterCard and manufacturers of VISA brand credit cards andvariations in the timing of such orders can cause significant fluctuations inour sales. Sales to MasterCard for the years ended December 31, 2004, 2003 and2002 were approximately 35%, 33%, and 41%, respectively. We entered into anagreement with MasterCard dated February 28, 2003, which replaced the agreementdated February 1, 1996, as amended.  Weentered into an amendment to this agreement on September 29, 2003, in whichMasterCard retained us to produce a new hologram for the Debit MasterCard andextended the agreement to February 2011, subject to automatic renewal if notterminated by either party.  The new agreementprovides that MasterCard will receive three sequential price reductions ofapproximately 3% each, effective at the beginning of 2003, 2004 and 2006.  We are currently the exclusive supplier toMasterCard.  Sales to VISA cardmanufacturers were approximately 31%, 30%, and 26%, respectively, of sales forthe years ended December 31, 2004, 2003 and 2002.  Currently we are one of two companiesauthorized to manufacture and sell VISA Dove holograms to manufacturers of VISAbrand credit cards. On March 15, 2005, VISA announced its intention to phaseout the Dove hologram that we supply for the front of the VISA card, and toreplace it with an integrated holographic magnetic stripe.  We expect to supply our holomagnetic stripeproduct, HoloMag, for VISA cards, but we cannot assure you that future sales ofHoloMag to VISA’s authorized card manufacturers will be as successful orprofitable as our historical sales of the VISA Dove hologram.  We do not have a contract with VISA thatcommits them or their authorized card manufacturers to purchase any Doveholograms or HoloMag from us.  If we wereto lose a substantial portion of our business with either MasterCard or VISA withoutreplacing it with new product sales, our business, operating results andfinancial condition would be materially and adversely affected. In addition, ifwe fail to obtain anticipated orders from these customers or if we experiencedelays or cancellations of orders from these customers, our business andfinancial performance will be materially and adversely affected.

 

Holograms aresold under purchase orders and contracts with customers. Sales and the relatedcost of goods sold are generally recognized at the latter of the time ofshipment or when title passes to customers. In some situations, we have shippedproduct where the sale is contingent upon the customers’ use of the product. Inthese situations, we do not recognize sales upon product shipment, but ratherwhen the buyer of the product informs us that the product has been used.Additionally, pursuant to terms with a certain customer, completed items arestored on behalf of the customer at our on-site secured facility and, in thatinstance, sales are recognized when all of the following have occurred: thecustomer has ordered the goods, the manufacturing process is complete, thegoods have been transferred to the on-site secured facility and are ready forshipment, the risk of ownership has passed to the customer and the customer hasbeen billed for the order. At December 31, 2004 and 2003, accounts receivablefrom this customer totaled $1.1 million and $1.0 million, respectively.

 

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We purchasecertain key materials used in the manufacture of our holograms and outsourcecertain key processes from third party suppliers, some of which are sole sourcerelationships, with whom we do not have supply contracts. Any problems thatoccur with respect to the delivery, quality or cost of any such materials orprocesses could have a material adverse effect on our financial position,results of operations and cash flows.

 

During 2004,2003 and 2002, export sales accounted for approximately 21%, 28% and 27%,respectively, of total sales. All of our export sales are presently denominatedin U.S. dollars.

 

Sales mayfluctuate from quarter to quarter due to changes in customers’ orderingpatterns. Customers do not typically provide us with precise forecasts offuture order quantities. Quarterly demand for holograms may be materiallyinfluenced by customers’ promotions, inventory replenishment, card expirationpatterns, delivery schedules and other factors which may be difficult for us toanticipate.

 

Cost of goodssold includes raw materials such as nickel, foils, films and adhesives; laborcosts; manufacturing overhead; and hologram origination costs (which representcosts of a unique master hologram that is made to customer specifications andis an integral part of the production process). As a result, costs of goodssold are affected by product mix, manufacturing yields, costs of materials andservices from our suppliers and labor.

 

Selling andadministrative expenses primarily consist of salaries, benefits and commissionsfor our corporate, sales, marketing and administrative personnel, marketing andpromotion expenses, legal and accounting expenses and expenses associated withbeing a public company.

 

**Critical AccountingPolicies**

 

We make use of estimatesand assumptions that impact the reported amounts of assets and liabilities atthe date of the financial statements and the reported amounts of revenue andexpenses during the reporting period.  Onan ongoing basis, we evaluate our estimates, including those related to baddebts, inventories and intangible assets. These estimates and assumptions are based on historical results andtrends as well as our forecasts as to how these might change in the future.

 

We believe the following critical accounting policies, among others,impact the significant judgments and estimates we use in the preparation of ourfinancial statements:

 

**RevenueRecognition**

 

We recognizerevenue in accordance with the provisions of the Securities and ExchangeCommission’s (“SEC”) Staff Accounting Bulletin (“SAB”) No. 104, “RevenueRecognition.” Specifically, sales and the related cost of goods sold aregenerally recognized at the latter of the time of shipment or when title passesto customers. In some situations, we have shipped product where the sale iscontingent upon the customers’ use of the product. In these situations, we donot recognize sales upon product shipment, but rather when the buyer of theproduct informs us that the product has been used. Additionally, pursuant toterms with a certain customer, completed items are stored on behalf of thecustomer at our on-site secured facility and, in that instance, sales are recognizedwhen all of the following have occurred: the customer has ordered the goods,the manufacturing process is complete, the goods have been transferred to theon-site secured facility and are ready for shipment, the risk of ownership haspassed to the customer and the customer has been billed for the order.

 

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**Allowance for Doubtful Accounts**

 

We maintain allowancesfor doubtful accounts for estimated losses resulting from the inability of ourcustomers to make the required payments. We recognize allowance for doubtful accounts based on the length of timethe receivables are past due, the current business environment and ourhistorical experience.  If the financialcondition of our customers were to deteriorate or if economic conditions wereto worsen, additional allowances may be required in the future.

 

**Inventory Valuation**

 

Inventories are stated at the lower of cost or market with cost beingdetermined on the first-in, first-out (FIFO) method.  At each balance sheet date, we evaluate ourending inventory for excess quantities and obsolescence.  We provide reserves for estimatedobsolescence equal to the difference between the cost of the inventory and itsestimated market value.  We fully reservefor inventories deemed obsolete.  Iffuture demand or market conditions are less favorable than our projections,additional inventory write-downs may be required.

 

**Impairment of Goodwill and Long-Lived Assets**

 

We account for goodwill and long-lived assets in accordance with SFASNo. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”) and SFAS No.144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFASNo. 144”). SFAS No. 142, which provides that goodwill should not be amortizedbut instead tested for impairment on an annual basis, was adopted by us onJanuary 1, 2002.  The impairment testingis performed in two steps: (i) the determination of impairment, based on ourfair value compared with our carrying value, and (ii) if there is an indicationof impairment, this step measures the amount of impairment loss by comparingthe implied fair value of goodwill with the carrying amount of thatgoodwill.    We performed the annual testfor impairment required by SFAS No. 142 during the year ended December 31,2002.  At that time, our fair value(based on quoted market prices) was found to be less than our carrying amount,and accordingly, we recorded a $7.4 million impairment charge for the yearended December 31, 2002.  This chargerepresents the full impairment of the goodwill that was on our balance sheetprior to December 31, 2002. SFAS No. 144 requires that long-lived assets andcertain identifiable intangibles be reviewed for impairment whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable. Recoverability of assets to be held and used is measured by acomparison of the carrying amount of an asset to future net cash flows expectedto be generated by the asset. If such assets are considered to be impaired, theimpairment to be recognized is measured by the amount by which the carryingamount of the assets exceeds the fair value of the assets.  Assets to be disposed of are reported at thelower of the carrying amount or fair value less costs to sell. During the yearended December 31, 2002, we recorded a charge for the impairment of long-livedassets of $1.9 million to write off fixed assets consisting of master plateswhich will no longer be used. This charge represents the full impairment ofthis long-lived asset that was on our balance sheet prior to December 31, 2002.The goodwill and the long-lived assets arose through purchase accounting by ourFormer Parent, as it related to us, in connection with our Former Parent’s 1990merger.

 

**Results of Operations**

 

**Comparisonof the Year Ended December 31, 2004 to the Year Ended December 31, 2003**

 

*Sales.*Sales increased by $3.0 million, or 16.3%, from $18.3 million in 2003 to $21.3million in 2004. The increase was due to an increase in sales of holograms fortransaction cards to existing customers of $3.0 million, the creation of newprograms for transaction cards for $0.9 million in 2004, and the creation ofnew programs for identification products for $0.4 million in 2004, which waspartially offset by sales of $1.3 million of identification products in 2003that did not recur in 2004.  In addition,we commenced new programs in pharmaceutical and other consumer productprotection which offset a reduction in other lower margin international labelsales.

 

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*RoyaltyIncome.* Royalty income remained relativelyunchanged.

 

*Cost ofGoods Sold.* Cost of goods sold increased by $0.9million, or 10.7%, from $8.3 million in 2003 to $9.2 million in 2004. As apercentage of sales, cost of goods sold decreased from 45.3% in 2003 to 43.1%in 2004. The decrease in cost of goods sold as a percentage of sales of 2% wasprimarily due to greater sales volumes of higher margin products in the currentperiod.

 

*Selling andAdministrative Expenses.* Selling andadministrative expenses increased by $0.6 million, from $6.5 million in 2003 to$7.1 million in 2004. As a percentage of sales, selling and administrativeexpenses decreased from 35.6% in 2003 to 33.3% in 2004. The increase in sellingand administrative expenses is primarily due to an increase in sales salariesof $0.1 million, an increase in other selling expenses of $0.1 millionprimarily due to higher trade show, travel and sample expenses, an increase inadministrative salaries and benefits of $0.3 million and an increase in otheradministrative expenses of $0.1 million primarily related to higherprofessional fees and recruitment expenses.

 

*Researchand Development*. Research and developmentexpenses increased $0.1 million from $1.2 million in 2003 to $1.3 million in2004. The increase was primarily due to the development and testing of newproducts.

 

*Depreciationand Amortization.***Depreciationand amortization expense increased $0.1 million from $0.7 million in 2003 to$0.8 million in 2004 primarily due to new assets in 2004.

 

*FacilityConsolidation Expenses.* Facility consolidation expenses of $0.2 million pertain to expensesincurred for our new facility in Robbinsville, New Jersey and consist primarilyof legal fees, real estate commissions and employee relocation and severanceexpenses.

 

*OtherIncome.* Other income increased $0.2 millionfrom $0.1 million in 2003 to $0.3 million in 2004. The increase was primarilydue to income from a patent settlement agreement with a competitor in 2004.

 

*IncomeTaxes*. Income tax expense increased $0.5million from $0.7 million in 2003 to $1.2 million in 2004. The increase wasprimarily due to an increase in taxable income in 2004.

 

**Comparisonof the Year Ended December 31, 2003 to the Year Ended December 31, 2002**

 

*Sales.*Sales decreased by $0.4 million, or 2.0%, from $18.7 million in 2002 to $18.3million in 2003. The decrease was due to a decrease in sales to MasterCard ofthe original MasterCard hologram of $2.4 million and a discontinuation of theEuropay hologram of $0.4 million which was partially offset by sales of $0.8million of the new Debit MasterCard hologram, an increase in sales ofidentification products of $0.8 million and a net increase in sales of otherproducts of $0.8 million.

 

*RoyaltyIncome.* Royalty income for the year endedDecember 31, 2003 decreased $0.5 million from the year ended December 31, 2002due to the expiration of a patent license agreement.

 

*Cost ofGoods Sold.* Cost of goods sold decreased by $0.6 million,or 7.3%, from $8.9 million in 2002 to $8.3 million in 2003. As a percentage ofsales, cost of goods sold decreased from 47.8% in 2002 to 45.3% in 2003. Thedecrease in cost of goods sold as a percentage of sales of 3% was primarily dueto decreases in provisions for warranty, obsolescence and royalties of 3% andlower production costs of 2% offset by a 2002 vendor reimbursement of 2% whichdid not recur in 2003.

 

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*Selling andAdministrative Expenses.* Selling andadministrative expenses decreased by $0.6 million, from $7.1 million in 2002 to$6.5 million in 2003. As a percentage of sales, selling and administrativeexpenses decreased from 38.2% in 2002 to 35.6% in 2003. The decrease in sellingand administrative expenses is primarily due to a decrease in other selling andadministrative expenses of $0.5 million primarily due to decreases in expensesfor insurance, telephone, travel, show, sales samples and bad debt expenses anda decrease in salaries and benefits of $0.1 million primarily due to lowerheadcount and commissions.

 

*Researchand Development*. Research and developmentexpenses remained relatively unchanged.

 

*Impairmentof Goodwill and Fixed Assets*.  The 2002 impairment charges of $7.4 million,to write off goodwill recorded under the requirements of SFAS No. 142, and $1.9million, to write off fixed assets recorded under the requirements of SFAS No.144, did not recur in 2003.

 

*OtherIncome.* Other income decreased $0.7 millionfrom $0.8 million in 2002 to $0.1 million in 2003. The decrease was primarilydue to income from settlement agreements in 2002 that did not recur in 2003.

 

*IncomeTaxes*. Income tax expense decreased $0.1million from $0.9 million in 2002 to $0.8 million in 2003. The decrease wasprimarily due to a decrease in taxable income in 2003 after giving effect toimpairments of goodwill and fixed assets which are permanent differences fortax purposes.

 

**Seasonality**

 

Our sales havenot generally exhibited substantial seasonality. However, our sales andoperating results to date have, and future sales and therefore operatingresults may, continue to fluctuate from quarter to quarter. The degree offluctuation will depend on a number of factors, including the timing and levelof sales, and any change in the pricing of our products and the mix of productssold. Because a significant portion of our business is expected to be derivedfrom orders placed by a limited number of large customers, variations in thetiming of such orders could cause significant fluctuations in our operatingresults. Customers do not typically provide us with precise forecasts of futureorder quantities. Quarterly demand for holograms may be materially influencedby customers’ promotions, inventory replenishment, card expiration patterns,delivery schedules and other factors which may be difficult for us toanticipate. Other factors that may result in fluctuations in operating resultsinclude the timing of new product announcements and the introduction of new productsand new technologies by us or our competitors, delays in research anddevelopment of new products, increased research and development expenses,availability and cost of materials from our suppliers, and competitive pricingpressures.

 

**Liquidity and Capital Resources**

 

At December31, 2004, we had $11.4 million of cash and cash equivalents, short-terminvestments of $2.0 million and working capital of $17.2 million.

 

On June 30,2000, we entered into a Stock Purchase Agreement (the “Agreement”) with Crane& Co., Inc. (“Crane”). Under the Agreement, we sold 3,387,720 shares of ourcommon stock to Crane for an aggregate purchase price of $9,316,230. TheAgreement also provides that our Board of Directors and the audit committee ofour board of directors each be expanded by one position, which was filled byDouglas A. Crane, a representative of Crane. The Agreement also provides that,for as long as Crane owns at least 51% of the shares of common stock purchasedunder the Agreement, Crane shall be entitled to designate one director on themanagement slate of nominees to our board of directors, and that, should ourboard of directors be expanded to a number greater than six, then our board ofdirectors shall be expanded by another seat, and Crane shall be entitled tonominate an additional director.

 

The Agreementalso contains a standstill provision, whereby Crane agreed, that, among otherthings,

 

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neitherit nor its affiliates, except as otherwise provided for in the Agreement, willacquire more than its current proportionate share of our outstandingsecurities. The standstill provision also provides that Crane will not offer,sell or transfer any of its voting securities of ABNH during a tender orexchange offer if such offer is opposed by our board of directors. Inconnection with the transaction, Crane also received the right to cause us toregister Crane’s shares for public resale and the right to include such sharesin any future registration of our securities, subject to certain exceptions.

 

Net cash provided byoperating activities was $3.4 million for the year ended December 31, 2004, ascompared to $3.1 million of cash provided by operating activities for the prioryear.  For the year ended December 31, 2004,our net income adjusted for non-cash charges provided cash of $2.6 millioncompared to $2.5 million of cash provided by our net income adjusted fornon-cash charges in the prior year.  Forthe year ended December 31, 2004, cash provided by changes in operating assetsand liabilities was $0.8 million compared to cash provided by changes inoperating assets and liabilities of $0.6 million in the prior year.

 

Investingactivities for the year ended December 31, 2004 provided cash flows of  $0.5 million, ascompared to $4.4 million of cash used in 2003. These activities primarilyreflected a decrease in investments in short-term securities of $2.0 millionand capital expenditures of $1.5 million in 2004 and investments in short-termsecurities of $4.0 million and capital expenditures of $0.4 million in 2003.Capital expenditures in 2004 included $1.0 million for leasehold improvementsand equipment to be installed in the new facility in Robbinsville, New Jersey.We anticipate that capital expenditures in 2005 and 2006 will be approximately$6.5 and $3.0 million, respectively. The capital expenditures will be directedat building a high quality, secure manufacturing facility in Robbinsville, NewJersey and enhancing production capabilities, expanding our product line andimproving operating efficiencies.

 

Financingactivities for the year ended December 31, 2004 provided cash of $0.1 millionprimarily due to the issuance of common stock due to the exercise of stockoptions. There were no financing activities for the year ended December 31,2003.

 

On December14, 2004, we entered into agreements to lease a 134,000 square foot modernmanufacturing and office building in Robbinsville, New Jersey, which will bethe future site of our primary operations. We will be doing construction withinthis facility to meet our specialized operational and security requirementsthrough approximately May 2005. The new facility provides substantial room forexpansion as we will consolidate our operations that are currently being conductedwithin a 58,000 square foot facility in Elmsford, New York and a 30,000 squarefoot facility in Huntingdon Valley, Pennsylvania into the new facility inRobbinsville, New Jersey. We are also acquiring additional equipment andtechnology to be installed in the new facility in order to broaden ourcapabilities to serve our target customers, expand capacity and improveefficiency.

 

Our leases forthe Elmsford, New York and Huntingdon Valley, Pennsylvania facilities expireDecember 2007 and July 2007, respectively. The Company is seeking to identifysubtenants for all or a portion of these leases upon vacating the premises.

 

The base rent on the new lease for the Robbinsville, New Jerseyfacility is $555,000 per year, increasing by 1.9% per year, and the first sevenmonths of the lease are rent-free. We currently pay a combined base rent of$933,000 per year for our two existing smaller facilities in Elmsford, New Yorkand Huntingdon Valley, Pennsylvania. The term of the new lease is through May31, 2017, and at the expiration of the term, we have options to renew the leasefor three consecutive five year periods and an option to purchase the building.

 

Wecurrently anticipate investing approximately $7.4 million through 2005, ofwhich approximately $1 million was expended in 2004, in facility upgrades tocustomize the Robbinsville, New Jersey facility for our operational andsecurity requirements as well as the acquisition of new equipment to upgradeand

 

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expand our production capabilities.

 

We believethat cash flows from operations and our cash balances will be sufficient tomeet working capital needs and fund capital expenditures, includingexpenditures relating to the Robbinsville, New Jersey facility, for the nexttwelve months.

 

Wealso currently expect to incur expenses totaling approximately $4.2 million, ofwhich we incurred $0.2 million in 2004, associated with our existing leases,vacating our current facilities in Elmsford, New York and Huntingdon Valley,Pennsylvania, relocating and terminating certain employees, moving equipmentand other related expenses which we expect to be substantially complete by thethird quarter of 2005.  These costs willbe presented as facility consolidation expense on our financialstatements.  Approximately $2.9 millionof these expenses will be paid in cash ratably through the fourth quarter of2007 and approximately $1.3 million of these expenses will be paid in cash asincurred through the fourth quarter of 2005.

 

The following table quantifies our future obligations, which consistprimarily of lease obligations (in thousands):

 
| ** **        | ** ** | **Total** | ** ** | **Less than  1 year** | ** ** | **2-3  years** | ** ** | **4-5  years** | ** ** | **More than  5 years** | ** ** |
|-------------------|------------|-----------|------------|-----------------------|------------|----------------|------------|----------------|------------|------------------------|------------|
|              |       |      |       |                  |       |           |       |           |       |                   |       |
| Lease obligations |       | $         | 10,289     |                  | $          | 1,253          |       | $              | 2,914      |                   | $          | 1,203 |   | $ | 4,919 |   |
|                   |            |           |            |                       |            |                |            |                |            |                        |            |  |  |  |  |  |

 

**Impact ofInflation**

 

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

 

**Unaudited Quarterly Results of Operations forthe Years Ended December 31, 2004 and 2003.**

 
| ** **                             | ** ** | **Year Ended December 31, 2004**          | ** ** |
|----------------------------------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | **First  Quarter**                        | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
| ** **                             | ** ** | **(In Thousands, Except Per Share Data)** | ** ** |
| Sales                                  |       | $                                         | 5,034      |   | $ | 4,907 |   | $ | 5,808 |   | $ | 5,514 |   |
|                                   |       |                                      |       |   |   |   |   |   |   |
| Cost of goods sold                     |       | $                                         | 2,270      |   | $ | 2,260 |   | $ | 2,413 |   | $ | 2,218 |   |
|                                   |       |                                      |       |   |   |   |   |   |   |
| Net income                             |       | $                                         | 402        |   | $ | 344 |   | $ | 598 |   | $ | 457 |   |
|                                   |       |                                      |       |   |   |   |   |   |   |
| Net income per share-basic and diluted |       | $                                         | 0.02       |   | $ | 0.02 |   | $ | 0.03 |   | $ | 0.02 |   |

 
| ** **                             | ** ** | **Year Ended December 31, 2003**          | ** ** |
|----------------------------------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | **First  Quarter**                        | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
| ** **                             | ** ** | **(In Thousands, Except Per Share Data)** | ** ** |
| Sales                                  |       | $                                         | 4,538      |   | $ | 4,275 |   | $ | 4,629 |   | $ | 4,842 |   |
|                                   |       |                                      |       |   |   |   |   |   |   |
| Cost of goods sold                     |       | $                                         | 2,016      |   | $ | 1,988 |   | $ | 2,090 |   | $ | 2,185 |   |
|                                   |       |                                      |       |   |   |   |   |   |   |
| Net income                             |       | $                                         | 219        |   | $ | 120 |   | $ | 298 |   | $ | 370 |   |
|                                   |       |                                      |       |   |   |   |   |   |   |
| Net income per share-basic and diluted |       | $                                         | 0.01       |   | $ | 0.01 |   | $ | 0.02 |   | $ | 0.02 |   |

 

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**Item 7A.****QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

We do notengage in significant activity with respect to market risk sensitiveinstruments. Accordingly, our risk with respect to market risk sensitiveinstruments is immaterial.

 

**Item 8.****FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.**

 

The FinancialStatements and Supplementary Data required by this item are filed as part ofthis Form 10-K. See Index to Financial Statements on page F-1 of this Form10-K.

 

**Item 9.****CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ONACCOUNTING AND FINANCIAL DISCLOSURE.**

 

None

 

**Item 9A.****  CONTROLS AND PROCEDURES**

 

We carried out an evaluation, under the supervision and with theparticipation of management, including our chief executive officer and chieffinancial officer, of the effectiveness of the design and operation of ourdisclosure controls and procedures as of the end of the period covered by thisreport pursuant to Exchange Act Rule 13a-15. Based on this evaluation, our chief executive officer and chieffinancial officer concluded that our disclosure controls and procedures wereeffective in timely alerting them to material information relating to ABNHrequired to be included in our periodic Securities and Exchange Commissionfilings.  There were no changes in ourinternal control over financial reporting that occurred during our most recentfiscal quarter that would have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

 

**Item 9B.****  OTHER INFORMATION**

 

On March 29, 2005, we entered into an amended and restated employmentagreement (the "Employment Agreement") with Kenneth H. Traub for aninitial term of one year, which renews automatically for successive one yearterms, unless we give at least 60 days written notice prior to the end of thecurrent term. The Employment Agreement provides for an annual base salary of$400,000 in 2005, to be increased by not less than 3% per year upon renewal andfurther provides that, if we do not renew his Employment Agreement, Mr. Traubwill receive severance equal to two times his annual salary and bonus. Additionally,Mr. Traub is eligible to receive annual bonuses based on the CompensationCommittee's assessment of Mr. Traub's performance for the prior year based onagreed-upon performance objectives. The target annual bonus is $100,000although any actual bonus may be more or less than such amount. In the event ofMr. Traub's termination by us for any reason other than for cause, as definedin the Employment Agreement, or his resignation for good reason, as defined inthe Employment Agreement, we are generally required to (1) pay him his salarythen in effect with any bonus which may have been accrued or which otherwisewould have been granted by the board to him for a period of two years followingsuch termination, (2) continue to provide employee benefits to Mr. Traub, and(3) accelerate vesting on any unvested options granted to him. Upon thetermination of Mr. Traub's employment by us following a change of control, asdefined in the Employment Agreement, or Mr. Traub's resignation for good reasonfollowing a change in control, we are required to (1) pay him a severanceamount equal to two times his annual salary and bonus then in effect (or, if suchtermination or resignation for good reason is more than one year after suchchange of control, an amount equal to three times his salary and annual bonusthen in effect), (2) accelerate vesting on any unvested options granted underthe Plans (as defined in the Employment Agreement) and any shares of restrictedstock purchased by Mr. Traub, and (3) to the extent such amounts are subject toexcise taxes under Section 4999 of the Internal Revenue Code, provide a taxgross up to him for any additional amounts due. In connection with hisEmployment Agreement, Mr. Traub has agreed not to compete with, or solicitfrom, us during his term of employment and for one year thereafter and hasagreed not to disclose or use our confidential information.

 

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**Part III**

 

**Item 10.****DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT.**

 

The following table sets forth certain information concerning ourdirectors and executive officers. All directors hold office until the nextannual meeting of stockholders or until their successors have been elected andqualified.

 
| **Name**                            | ** ** | **Age**    | ** ** | **Position(s)**                                        |
|-------------------------------------|------------|------------|------------|--------------------------------------------------------|
| **Directors,  Executive Officers:** | ** ** | ** ** | ** ** | ** **                                             |
|                                |       |       |       |                                                   |
| Kenneth H.  Traub                   |       | 43         |       | President,  Chief Executive Officer and Director       |
|                                |       |       |       |                                                   |
| Salvatore F.  D’Amato          |       | 76         |       | Chairman of  the Board                                 |
|                                |       |       |       |                                                   |
| Fred J.  Levin*                     |       | 42         |       | Director                                               |
|                                |       |       |       |                                                   |
| Douglas A.  Crane**                 |       | 44         |       | Director                                               |
|                                |       |       |       |                                                   |
| Mark J.  Bonney*                    |       | 51         |       | Director                                               |
|                                |       |       |       |                                                   |
| Alan  Goldstein                     |       | 58         |       | Vice  President, Chief Financial Officer and Secretary |

 

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*                 Member of the audit and compensationcommittees.

**          Member of the compensation committee.

 

*Kenneth H.Traub* has served as our President and Chief ExecutiveOfficer since March 2000 and as a director since April 1999. From February 1999through March 2000, Mr. Traub served as our President and Chief OperatingOfficer, and from January 1999 through February 1999 he served as ourconsultant. Previously, Mr. Traub co-founded Voxware, Inc., a developer ofdigital speech processing technologies, and served on its board of directorsfrom February 1995 to January 1998 and as its Executive VicePresident, 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 holdsan M.B.A. from the Harvard Graduate School of Business Administration and aB.A. from Emory University.

 

*SalvatoreF. D’Amato* has served as our Chairman of the Boardsince April 1999 and as a director since March 1999. He was also ourChairman of the Board and President from 1983 to 1990 and was a consultant forus from time to time between 1990 and April 1999. Mr. D’Amato wasPresident and a director of ABN, our former parent corporation, from 1977 to1983. Prior thereto, he served as Vice President, Engineering and Senior VicePresident, Operations with ABN. Mr. D’Amato holds a masters degree inEngineering from Columbia University.

 

*Fred J.Levin* has served as a director since February 2000.Mr. Levin has been the President and Chief Executive Officer of the LGI NetworkLLC, a market research and information service company, since February 2002.  Previously, Mr. Levin was the President ofthe Concord Watch Division of Movado Group, Inc., a manufacturer and marketerof watches, from March 1998 to January 2002. Mr. Levin also servedwith Movado Group, Inc. as Senior Vice President, International from April 1995to February 1998 and as Vice President, Distribution from February 1994to March 1995. Prior thereto, Mr. Levin was a management consultant withMcKinsey & Company. Mr. Levin holds a B.S. in Industrial Engineering fromNorthwestern University and an M.B.A. from the Harvard Graduate School ofBusiness Administration.

 

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*Douglas A.Crane* has served as a director since June 2000.Mr. Crane has been the Vice President and General Manager of U.S. CurrencyProducts for Crane & Co., Inc., a manufacturer of paper products, since2004. Previously, Mr. Crane was Manager of Currency Paper Manufacturing andU.S. Currency Contract for Crane & Co. from 2001 to 2004. Mr. Crane alsoserved with Crane & Co., Inc. as Manager of Corporate Strategic Planningfrom 1998 to 2001, as Manager of Manufacturing Technology from 1995 to 1998,and as production manager, project engineer from 1990 to 1995. Mr. Crane holdsa B.S. in Biomedical Engineering/Materials Science from Brown University, anM.S. in Paper Chemistry from the Institute of Paper Science and Technology andan M.B.A. from the Massachusetts Institute of Technology. Mr. Crane wasappointed to the Board of Directors pursuant to the Stock Purchase Agreement,dated June 30, 2000, with Crane & Co., Inc. pursuant to which Crane& Co., Inc. has the right to designate one director to the Board ofDirectors for so long as it owns at least 51% of the shares of common stock itpurchased under the Stock Purchase Agreement.

 

*Mark J.Bonney* has served as a director since February 2003.Mr. Bonney has been the Managing Partner of Endeavour Advisors, LLC, astrategic management-consulting firm since April 2004. Previously, Mr.Bonney was the Chief Executive Officer of MJB Consulting, a strategicmanagement-consulting firm, since March 2002.  Prior thereto, Mr. Bonney was the Presidentand Chief Operating Officer of Axsys Technologies, a leading supplier ofoptical components and subsystems from August 1999 through March 2002.  Prior thereto, Mr. Bonney held variouspositions, including Vice President of Operations, Vice President of Financeand Chief Financial Officer of Zygo Corporation, a manufacturer of measurementsystems and optical products, from March 1993 through July 1999.  Mr. Bonney holds a B.S. in BusinessAdministration and Economics from Central Connecticut State University and anM.B.A. in Finance from the University of Hartford.

 

*AlanGoldstein* has served as our Vice President and ChiefFinancial Officer since April 1999. Mr. Goldstein served as our consultantfrom February 1999 through April 1999. Mr. Goldstein was VicePresident and Chief Accounting Officer of Complete Management, Inc., aphysician management company, from June 1997 to July 1998, and VicePresident and Chief Financial Officer of RF International, Inc., amultinational 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 anM.S. in Accounting from Long Island University. Mr. Goldstein is a CertifiedPublic Accountant.

 

**Audit Committee**

 

Our Board of Directors has established an AuditCommittee in accordance with Section 3(a)(58)(A)of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Themembers of the Audit Committee are currently Mark J. Bonney (Chairman) and FredJ. Levin.  Our Board of Directors hasdetermined that Mark J. Bonney is an audit committee financial expert asdefined by Item 401(h) of Regulation S-K of the Exchange Act.  All of the members of our Audit Committee areindependent within the meaning of Item 7(d)(3)(iv) of Schedule 14Aapplying the definition of independence set forth in Rule 4200(a)(15) of theNational Association of Securities Dealers’ listing standards. The AuditCommittee’s amended and restated charter provides that the Audit Committeeshall be comprised of no more than five and no less than three members. Dr.Stephen Benton who served as a member of our Audit Committee passed away during2003 resulting in our Audit Committee being comprised of only two members. Weare currently searching for a qualified candidate to serve on our Auditcommittee.

 

**Compliance with Section 16(a)of the Securities Exchange Act of 1934**

 

Section 16(a)of the Securities Exchange Act of 1934, as amended, requires our directors andexecutive officers, and persons who beneficially own more than 10% of ourcommon stock, to file with the Securities and Exchange Commission reports oftheir ownership and changes in their ownership of

 

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commonstock. Based upon a review of the copies of the filings with the Securities andExchange Commission and written representations from our executive officers,directors and persons who beneficially own more than 10% of our common stock,we believe that the Section 16(a) filing requirements applicable to ourexecutive officers, directors and persons who beneficially own more than 10% ofour common stock in fiscal 2004 were complied with on a timely basis.

 

**Code of Ethics**

 

We have adopted a Code ofEthics for Senior Financial Officers applicable to our Chief Executive Officer,Chief Financial Officer, treasurer, controller, principal accounting officerand other employees performing similar functions.  The Code of Ethics for Senior FinancialOfficers is available on our website.  Wewill satisfy the disclosure requirement under Item 10 of Form 8-K relating toamendments or waivers from any provision of the Code of Ethics for SeniorFinancial Officers by either filing a Form 8-K or posting this information onour website within five days business days following the date of amendment orwaiver.  Our website address is www.abnh.com.

 

**Item 11.****EXECUTIVECOMPENSATION.**

 

The followingtable provides information concerning compensation paid to or earned during2002, 2003 and 2004 by each individual who served as our chief executiveofficer or in a similar capacity during 2004 and our other two executiveofficers during 2004 (the “Named Executive Officers”).

 

**Summary Compensation Table**

 
| **Name**                        | ** ** | ** **      | ** ** | **Long-Term  Compensation  Shares of  Common Stock  Underlying  Options  (#)** | ** ** | **All  Other  Compensation  (2) ($)**    | ** ** |
|---------------------------------|------------|-----------------|------------|--------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                      |
| ** **                      |
| **Annual  Compensation**        |
| **Year**                        | ** ** | **Salary  ($)** | ** ** | **Bonus  ($)**                                                                 | ** ** | **Other  Annual  Compensation  (1) ($)** |
| Kenneth H. Traub                |       | 2004            |       | 327,818                                                                        |       | 190,000                                  |       | 10,560 |   | — |   | 6,584 |   |
| President and Chief             |       | 2003            |       | 318,270                                                                        |       | 140,000                                  |       | 9,609 |   | 200,000 |   | 5,973 |   |
| Executive Officer               |       | 2002            |       | 309,000                                                                        |       | 145,000                                  |       | 9,312 |   | — |   | 5,050 |   |
|                            |       |            |       |                                                                           |       |                                     |       |   |   |   |   |   |   |
| Salvatore F. D’Amato       |       | 2004            |       | 196,691                                                                        |       | 85,000                                   |       | 13,788 |   | — |   | 2,226 |   |
| Chairman of the Board           |       | 2003            |       | 190,962                                                                        |       | 70,000                                   |       | 13,788 |   | 40,000 |   | 2,348 |   |
|                            |       | 2002            |       | 185,400                                                                        |       | 70,000                                   |       | 42,502 |   | — |   | 2,449 |   |
|                            |       |            |       |                                                                           |       |                                     |       |   |   |   |   |   |   |
| Alan Goldstein                  |       | 2004            |       | 185,761                                                                        |       | 55,000                                   |       | 5,820 |   | — |   | 3,538 |   |
| Vice President, Chief           |       | 2003            |       | 180,350                                                                        |       | 45,000                                   |       | 5,820 |   | 40,000 |   | 3,248 |   |
| Financial Officer and Secretary |       | 2002            |       | 175,100                                                                        |       | 40,000                                   |       | 6,835 |   | — |   | 3,248 |   |

 

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(1)          Other Annual Compensation in 2003 and 2004for Mr. D’Amato and 2002, 2003 and 2004 for Messrs. Traub and Goldsteinconsisted of the use of automobiles paid for by us. Other Annual Compensationin 2002 for Mr. D’Amato consisted of $12,447 for the use of an automobile paidfor by us and $30,055 resulting from our purchase, on his behalf, of theautomobile formally leased by us for his benefit.

 

(2)          All other compensation in 2004 includes termlife insurance premiums and employer contributions to our 401(k) retirementplan paid by us for Mr. Traub of $4,534 and $2,050, respectively, for Mr. D’Amatoof $176 and $2,050, respectively and for Mr. Goldstein of $1,488 and $2,050,respectively.

 

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**Option Grants for 2004**

 

Wedid not grant any options during 2004 to the Named Executive Officers and nooptions were exercised in 2004 by them.

 

**2004Year-End Option Values**

 

The followingtable provides information concerning the number and value of unexercisedoptions held by each of the Named Executive Officers on December 31, 2004.No options were exercised in 2004 by the Named Executive Officers.

 
| ** **                | ** ** | **Shares of Common Stock  Underlying  Unexercised Options  (#)** | ** ** | **Value of Unexercised In-the-Money  Options at December 31, 2004   ($) (1)** |
|---------------------------|------------|------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|
| **Name**                  | ** ** | **Exercisable**                                                  | ** ** | **Unexercisable**                                                                  | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Kenneth H. Traub          |       | 847,917                                                          |       | 127,083                                                                            |   | $ | 1,076,949 |   | $ | 282,958 |   |
| Salvatore F. D’Amato |       | 365,000                                                          |       | —                                                                             |   | $ | 376,394 |   | — |   |
| Alan Goldstein            |       | 187,375                                                          |       | 25,625                                                                             |   | $ | 182,081 |   | $ | 56,138 |   |

 

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(1)          Based on the difference between $3.15, whichwas the closing price per share on December 31, 2004, and the exerciseprice per share of the options.

 

**StockIncentive Plans**

 

On August 4,2000, we adopted the American Bank Note Holographics, Inc. 2000 Stock IncentivePlan (as amended, the “2000 Plan”), which was subsequently approved by ourstockholders at our annual meeting on September 12, 2000. In August 2001,our stockholders approved an amendment to the 2000 Plan increasing the sharesavailable for issuance thereunder by 600,000 to 1,350,000 shares. On July 20,1998, we adopted the 1998 Stock Incentive Plan (as amended, the “1998 Plan”,and collectively with the 2000 Plan, the “Plans”). The Plans were adopted forthe purpose of granting various stock incentives to officers, directors,employees and consultants of ABNH. The board of directors (or a committeeappointed by the board of directors) has discretionary authority, subject tocertain restrictions, to administer the Plans. The total numberof shares reserved for issuance under the Plans are 3,213,000 shares ofcommon stock. Options to purchase 2,729,000 shares of common stock wereoutstanding under the Plans at December 31, 2004. The exercise price ofoptions granted under the Plans may not be less than 100% of the fair marketvalue of the common stock on the date such option was granted. Options grantedunder the Plans generally become vested and exercisable for up to either 25% or33 1/3% of the total optioned shares upon each succeeding anniversary of thedate of grant. Generally, the unexercised portion of any option automaticallyterminates upon the termination of the optionee’s employment with us, unlessotherwise determined by the board of directors; provided however, that anyextension shall not extend beyond the expiration of the option, generally tenyears. Upon a change in control, outstanding options will generally becomefully vested. On January 7, 2005, we granted options to purchase anaggregate of 95,000 shares of common stock to our executive officers anddirectors and 110,000 shares of common stock to our employees at an exerciseprice equal to the fair value of the common stock at the date of the grant.

 

**Retirement Plans**

 

On October 1,1999, we implemented defined contribution plans for our employees. Aggregatecontributions to such plans, which have been charged to our operations, wereapproximately $59,000, $56,000 and $51,000 for the years endedDecember 31, 2004, 2003 and 2002, respectively.

 

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**Director Compensation**

 

Each member ofthe board of directors who is not an employee of ABNH will receive compensationof $12,000 per year for serving on the board of directors. Each of thesedirectors will also receive $1,000 for each board meeting attended in person,$500 for each telephonic board meeting attended and $500 for each committeemeeting attended. We also will reimburse directors for any expenses incurred inattending meetings of the board of directors and the committees thereof. Upontheir initial election to the board of directors, each non-employee boardmember is granted options to purchase 25,000 shares of our common stock. Suchoptions are exercisable at the fair market value of the common stock at thedate of grant. These options become vested and exercisable for up to 20% of thetotal option shares upon the first anniversary of the grant of the options andfor an additional 20% of the total option shares upon each succeedinganniversary until the option is fully exercisable at the end of the fifth year.In addition, directors may, from time to time, receive additional grants ofoptions to purchase shares of our common stock as determined by our board ofdirectors.

 

On January 7, 2005 theboard of directors adopted a policy to increase the compensation paid todirectors who are not employees of ABNH. Under the new policy, in addition to the compensation described above,each director who is not an employee of ABNH will automatically receive anoption to purchase 5,000 shares of our common stock at the first meeting of theboard of directors of each calendar year. Such options are exercisable at the fair market value on the date of thegrant and will become vested and exercisable over a period of three years.  In addition, the chairman of each committeeof the Board of Directors will receive an additional annual fee of $6,000.

 

**Employment Agreements**

 

We enteredinto an amended employment agreement with Kenneth H. Traub in March 2005for an initial term of one year, which renews automatically for successive oneyear terms, unless we give at least 60 days written notice prior to the end ofthe current term. The agreement provides for an annual base salary of $400,000in 2005, to be increased by not less than 3% per year upon renewal and furtherprovides that, if we do not renew his employment agreement, Mr. Traub willreceive severance equal to two times his annual salary and bonus.  Additionally, Mr. Traub is eligible toreceive annual bonuses based on the Compensation Committee’s assessment of Mr.Traub’s performance for the prior year based on agreed-upon performanceobjectives. The target annual bonus is $100,000 although any actual bonus maybe more or less than such amount. In the event of Mr. Traub’s termination by usfor any reason other than for cause, as defined in the agreement, or hisresignation for good reason, as defined in the agreement, we are generallyrequired to (1) pay him his salary then in effect with any bonus which may havebeen accrued or which otherwise would have been granted by the board to him fora period of two years following such termination, (2) continue to provideemployee benefits to Mr. Traub, and (3) accelerate vesting on any unvestedoptions granted to him. Upon the termination of Mr. Traub’s employment by usfollowing a change of control, as defined in the agreement, or Mr. Traub’sresignation for good reason following a change in control, we are required to(1) pay him a severance amount equal to two times his annual salary and bonusthen in effect (or, if such termination or resignation for good reason is morethan one year after such change of control, an amount equal to three times hissalary and annual bonus then in effect), (2) accelerate vesting on any unvestedoptions granted under the Plans (as defined in the agreement) and any shares ofrestricted stock purchased by Mr. Traub, and (3) to the extent such amounts aresubject to excise taxes under Section 4999 of the Internal Revenue Code,provide a tax gross up to him for any additional amounts due. In connectionwith his employment agreement, Mr. Traub has agreed not to compete with, orsolicit from, us during his term of employment and for one year thereafter andhas agreed not to disclose or use our confidential information.

 

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We enteredinto an employment agreement with Salvatore F. D’Amato in April 1999 foran initial term of two years, which renews upon mutual agreement for successiveone year terms. As amended, the agreement provides for a base salary of$180,000 per year. Pursuant to the Agreement Mr. D’Amato is eligible to receivebonuses at the discretion of our board of directors, with a target bonus of$10,000 per quarter. The quarterly bonus is required to be paid unless theboard determines otherwise based on certain factors. In the event of Mr. D’Amato’stermination 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 theagreement, we are required to continue to pay his salary then in effect,together with any bonus that may have accrued, for the remainder of hisemployment term. Upon termination of Mr. D’Amato’s employment following achange of control, or Mr. D’Amato’s resignation for good reason within one yearof a change of control, we are required to pay him an amount equal to hisannual salary and bonus. In connection with his employment agreement, Mr. D’Amatoagreed not to compete with us during his term of employment and for one yearthereafter.

 

We enteredinto an employment agreement with Alan Goldstein in April 1999 for aninitial term of one year which renews automatically for successive one yearterms, unless we give at least 60 days written notice prior to the end of thecurrent term. As amended, the agreement provides for an annual base salary of$170,000, to be increased by not less than 3% per year upon renewal and furtherprovides that, if we do not renew his employment agreement, Mr. Goldstein willreceive severance equal to one-half of his annual salary and bonus. Pursuant tothe agreement Mr. Goldstein is eligible to receive bonuses at the discretion ofour board of directors, with a target bonus of $10,000 per quarter. In the eventof Mr. Goldstein’s termination by us for any reason other than for cause, asdefined in the agreement, or his resignation for good reason, as defined in theagreement, we are required to (1) pay him his salary then in effect with anybonus which may have been accrued or which otherwise would have been granted bythe board to him for a period of six months following such termination orresignation for good reason, (2) continue to provide employee benefits to Mr.Goldstein and (3) accelerate vesting on any unvested options granted to himunder the 1998 Plan and permit the exercise of vested options under such planfor a period of two years thereafter. Upon termination of Mr. Goldstein’semployment following a change of control, or Mr. Goldstein’s resignation for agood reason, as defined in the agreement, following a change in control, we arerequired to pay him as severance an amount equal to nine months of his salaryand bonus then in effect. In connection with his employment agreement, Mr.Goldstein agreed not to compete with us during his term of employment and forone year thereafter.

 

**Compensation CommitteeInterlocks and Insider Participation**

 

TheCompensation Committee currently consists of Messrs. Levin, Crane and Bonney.Mr. Crane is an employee and representative of Crane & Co., Inc. See “Item13. Certain Relationships and Related Transactions.”None of the members of our Compensation Committee is or has been an officer oremployee of ABNH. No interlocking relationships exist between the board of directorsor Compensation Committee and the board of directors or compensation committeeof any other company, nor has any such interlocking relationship existed in thepast. None of our executive officers or directors serves on the board ofdirectors or compensation committee of any entity which has one or moreexecutive officers serving as a member of our board of directors orCompensation Committee.

 

**Compensation Committee Report on ExecutiveCompensation**

 

TheCompensation Committee of the board of directors advises our board of directorson compensation matters, determines the compensation of the Chief ExecutiveOfficer, reviews and takes action on the recommendation of the Chief ExecutiveOfficer as to the appropriate compensation of other officers and key personneland approves the grants of bonuses to officers and key personnel. TheCompensation Committee is also responsible for the administration of our StockIncentive Plans. This report of the Compensation Committee shall not be deemedincorporated by reference by any general statement

 

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incorporatingby reference this Annual Report on Form 10-K into any filing under theSecurities Act of 1933, as amended, or the Securities Exchange Act of 1934, asamended, except to the extent that we specifically incorporate this informationby reference, and shall not otherwise be deemed filed under such acts.

 

**Chief Executive OfficerCompensation**

 

TheCompensation Committee reviews the compensation arrangements for our ChiefExecutive Officer at least annually, typically in the fourth and/or firstquarter of the fiscal year. In March 2005, we entered into an Amended andRestated Employment Agreement with Mr. Traub, which is described above. Indetermining whether to enter into the Amended and Restated Employment Agreementwith Mr. Traub, and the compensation arrangements thereunder, the CompensationCommittee considered the terms of his original employment agreement, asamended, his leadership of the Company, our financial and operationalperformance during the preceding year, competitive pay practices, and Mr. Traub’sindividual performance and contributions to us. The Compensation Committeebelieves that Mr. Traub provides strong leadership to us and has beeninstrumental in improving our financial, operating and strategic position.

 

In making itscompensation decisions with respect to Mr. Traub for 2004, the CompensationCommittee exercised its discretion and judgment based on the above factors,relying on both qualitative and quantitative criteria and results.  As part of its review of executivecompensation, the Compensation Committee periodically reviews data on CEOcompensation provided by independent compensation consultants.  In fiscal 2004, Mr. Traub’s salary was $327,818.Mr. Traub was also paid the $25,000 quarterly bonus contemplated under hisemployment agreement and an additional year-end discretionary bonus of $90,000based on the Compensation Committee’s evaluation of his performance for theyear. Pursuant to the Amended and Restated Employment Agreement, Mr. Traub’ssalary has been increased to $400,000 and the $25,000 quarterly bonus has beeneliminated. Mr. Traub is also entitled to an annual bonus based on theCompensation Committee’s assessment of Mr. Traub’s and the Company’sperformance against objectives to be reasonably determined by the CompensationCommittee.

 

**ABNH’S GeneralCompensation Policy for Executive Officers**

 

Thefundamental policy of the Compensation Committee is to provide our executive officerswith competitive compensation packages that are designed to retain keypersonnel, motivate executives to advance our objectives and rewardcontributions to our operational and financial performance. It is theCompensation Committee’s objective to have a portion of each executive officer’scompensation contingent upon our performance as well as upon each executiveofficer’s own level of performance. Therefore, the compensation package foreach executive officer is comprised of three different elements: (1) basesalary which is designed primarily to be competitive with salary levels in theindustry; (2) cash bonuses which reflect the achievement of qualitative andquantitative objectives and goals; and (3) long-term stock-based incentiveawards which strengthen the mutuality of interest between the executiveofficers and our stockholders.

 

***Factors***.The principal factors (together with the factors specified above with respectto Mr. Traub) that the Compensation Committee considered with respect to each executiveofficer’s compensation for fiscal 2004 are summarized below. The CompensationCommittee may, however, in its discretion, apply entirely different factors forexecutive compensation in future years.

 

***Base Salary***.The base salary for each executive officer is specified in his respectiveemployment agreement and was determined on the basis of the following factors:experience, expected personal performance, the salary levels in effect forcomparable positions within and outside the industry and internal and externalbase salary comparability considerations. The weight given to each of thesefactors differed from individual to individual, as the Compensation Committeeand the board of directors believed appropriate.

 

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***Bonus.***Bonus represents the variable component of the executive compensation programthat is tied to our performance and individual achievement. In determiningbonuses, the Compensation Committee considers factors such as relativeperformance of ABNH during the year and the individual’s contribution to ourperformance, the need to attract, retain and motivate high quality executivesas well as the degree to which the executive officer met or exceeded certainobjectives established for him.

 

***Long-Term Incentive Compensation***.Long-term incentives are provided through grants of stock options. The grantsare designed to align the interests of each executive officer with those of thestockholders and provide each individual with a significant incentive to manageABNH from the perspective of an owner with an equity stake. Each option grantallows the individual to acquire shares of our common stock at a fixed priceper share over a specified period of time up to ten years. Each optiongenerally becomes exercisable in installments over a three or four-year period.Therefore, the option grant will provide a return to the executive officer onlyif the executive officer remains employed by ABNH during the vesting period,and then only if the market price of the underlying shares appreciates. Thenumber of shares subject to each option grant is set at a level intended tocreate meaningful opportunity for appreciation based on the executive officer’scurrent position with ABNH, the size of comparable awards made to individualsin similar positions and the individual’s personal performance in recentperiods. The Compensation Committee also considers the number of unvestedoptions held by the executive officer in order to maintain an appropriate levelof equity incentive for that individual. However, the Compensation Committeedoes not adhere to any specific guidelines as to the relative option holdingsof our executive officers.

 

**Internal Revenue CodeLimits on the Deductibility of Compensation**

 

Section 162(m)of the Internal Revenue Code of 1986, as amended, generally deniespublicly-held corporations a federal income tax deduction for compensationexceeding $1,000,000 paid to the Chief Executive Officer or any of the fourother highest paid executive officers, excluding performance-basedcompensation. Through December 31, 2003, this provision has not limitedour ability to deduct executive compensation, but the Compensation Committeewill continue to monitor the potential impact of Section 162(m) on ourability to deduct executive compensation. We believe that our compensationphilosophy of paying our executive officers with competitive salaries, cashbonuses and long-term incentives, as described in this report, serves the bestinterest of ABNH and its stockholders.

 

THECOMPENSATION COMMITTEE

 

Fred J. Levin

Douglas A.Crane

Mark J. Bonney

 

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**Item 12.****SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT AND RELATED STOCKHOLDER MATTERS.**

 

The followingtable sets forth as of March 15, 2005 certain information regardingbeneficial ownership of our common stock by (1) each person who is known to usto be the beneficial owner of more than 5% of the outstanding shares of ourcommon stock, (2) each director, (3) each of the Named Executive Officers and(4) all directors and executive officers as a group. All persons listed havesole voting and investment power with respect to their shares unless otherwiseindicated. The address of all persons listed is c/o American Bank NoteHolographics, Inc., 399 Executive Boulevard, Elmsford, NY 10523, unlessotherwise indicated.

 
| **Name and Address**                                               | ** ** | **Number (1)** | ** ** | **Percentage (1)** | ** ** |
|--------------------------------------------------------------------|------------|----------------|------------|--------------------|------------|
| Crane & Co., Inc                                               |       | 3,387,720      |       | 18.3               | %          |
| 30 South Street                                                    |       |           |       |               |       |
| Dalton, MA 01226                                                   |       |           |       |               |       |
|                                                               |       |           |       |               |       |
| Libra Advisors, LLC (2)                                            |       | 2,156,000      |       | 11.7               | %          |
| Libra Associates, LLC                                              |       |           |       |               |       |
| Libra Fund, L.P.                                                   |       |           |       |               |       |
| Ranjan Tandon                                                      |       |           |       |               |       |
| 909 Third Avenue, 29th Floor                                       |       |           |       |               |       |
| New York, NY 10022                                                 |       |           |       |               |       |
|                                                               |       |           |       |               |       |
| Levy, Harkins & Co., Inc. (3)                                  |       | 1,803,650      |       | 9.7                | %          |
| The Gracy Fund, L.P.                                               |       |           |       |               |       |
| Edwin A. Levy                                                      |       |           |       |               |       |
| Michael J. Harkins                                                 |       |           |       |               |       |
| 570 Lexington Avenue                                               |       |           |       |               |       |
| New York, NY 10022                                                 |       |           |       |               |       |
|                                                               |       |           |       |               |       |
| Kenneth H. Traub (4)                                               |       | 847,917        |       | 4.4                | %          |
|                                                               |       |           |       |               |       |
| Salvatore F. D’Amato (5)                                      |       | 367,000        |       | 1.9                | %          |
|                                                               |       |           |       |               |       |
| Alan Goldstein (6)                                                 |       | 187,375        |       | 1.0                | %          |
|                                                               |       |           |       |               |       |
| Fred J. Levin (7)                                                  |       | 76,200         |       |               | *          |
|                                                               |       |           |       |               |       |
| Douglas A. Crane (8)                                               |       | 3,408,520      |       | 18.4               | %          |
|                                                               |       |           |       |               |       |
| Mark J. Bonney (9)                                                 |       | 10,000         |       |               | *          |
|                                                               |       |           |       |               |       |
| All executives officers and directors as a  group (6 persons) (10) |       | 4,897,012      |       | 24.5               | %          |

 

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* Less than 1%.

 

(1) Beneficialownership is determined in accordance with the rules of the SEC, and includesgeneral voting power and/or investment power with respect to securities. At March 15,2005, we had 18,517,907 shares of common stock outstanding. These percentageswere calculated based on the total of shares of common stock outstanding andshares of common stock subject to options currently exercisable or exercisablewithin 60 days of March 15, 2005, which are deemed outstanding forcomputing the percentage beneficially owned by the person holding such options.

 

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(2) Theinformation provided is based solely on a Schedule 13G, as amended, filedwith the SEC on February 14, 2005. Libra Advisors, LLC, the general partnerof Libra Fund, LP owns 1,832,516 shares of common stock. Libra Advisors, LLC isalso the investment adviser of an offshore fund that owns 323,484 shares of ourcommon stock. Libra Advisors, LLC has the power to vote and to direct thevoting of and the power to dispose and direct the disposition of these2,156,000 shares. Ranjon Tandon is the sole voting member and manager of LibraAdvisors, LLC and may be deemed to have the power to vote and to direct thevoting of and the power to dispose and direct the disposition of the 2,156,000shares of common stock beneficially owned by Libra Advisors, LLC.

 

(3) Theinformation provided is based solely on a Schedule 13G, as amended, filedwith the SEC on January 24, 2005. Levy, Harkins & Co., Inc. (“LHC”) is the beneficial owner of 12,500shares of common stock held in LHC’s pension and profit sharing plans and maybe deemed the beneficial owner of 1,379,550 shares of common stock held inindividual accounts of investment advisory clients of LHC.  The Gracy Fund, L.P., a private investmentcompany, is the beneficial owner of 294,500 of common stock.  Edwin A. Levy and Michael J. Harkins are thesole shareholders of LHC and the sole general partners of the Gracy Fund, L.P.and have shared power to vote or direct the vote of, and dispose or to directthe disposition of the 1,686,550 shares beneficially owned or deemedbeneficially owned by LHC and beneficially owned by The Gracy Fund, L.P.  Mr. Levy,individually is the beneficial owner of 117,100 of common stock.

 

(4) Consistsof 847,917 shares of common stock subject to options currently exercisable orexercisable within 60 days of March 15, 2005.

 

(5) Includes365,000 shares of common stock subject to options currently exercisable orexercisable within 60 days of March 15, 2005.

 

(6) Consistsof 187,375 shares of common stock subject to options currently exercisable orexercisable within 60 days of March 15, 2005.

 

(7) Includes25,000 shares of common stock subject to options currently exercisable orexercisable within 60 days of March 15, 2005.

 

(8) Includes20,000 shares of common stock subject to options currently exercisable orexercisable within 60 days of March 15, 2005 and 3,387,720 shares ofcommon stock owned by Crane & Co., Inc., a privately owned corporation thatMr. Crane and his family own. Mr. Crane disclaimsbeneficial ownership of the shares held by Crane & Co., Inc.

 

(9) Consistsof 10,000 shares of common stock subject to options currently exercisable orexercisable within 60 days of March 15, 2005.

 

(10) Includes1,455,292 shares of common stock subject to options currently exercisable orexercisable within 60 days of March 15, 2005.

 

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**EquityCompensation Plan Information**

 

The followingtable sets forth information as of December 31, 2004 with respect toshares of our common stock which may be issued under our equity compensationplans.

 
| **Plan Category**                                               | ** ** | **Number of securities  to be issued upon  exercise of  outstanding options,  warrants and rights** | ** ** | **Weighted-average  exercise price  of outstanding  options,  warrants and rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation plans  (excluding securities  reflected in column (a))** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                      | ** ** | **(a)**                                                                                             | ** ** | **(b)**                                                                             | ** ** | **(c)**                                                                                                                                              | ** ** |
| ** **                                                      | ** ** | ** **                                                                                          | ** ** | ** **                                                                          | ** ** | ** **                                                                                                                                           | ** ** |
| Equity compensation plans approved by  security holders (1)     |       | 1,073,000                                                                                           |       | $                                                                                   | 1.41       |                                                                                                                                                 | 274,813    |   |
|                                                            |       |                                                                                                |       |                                                                                |       |                                                                                                                                                 |       |   |
| Equity compensation plans not approved by  security holders (2) |       | 1,656,000                                                                                           |       | $                                                                                   | 2.63       |                                                                                                                                                 | 177,000    |   |
|                                                            |       |                                                                                                |       |                                                                                |       |                                                                                                                                                 |       |   |
| Total:                                                          |       | 2,729,000                                                                                           |       |                                                                                |       | 451,813                                                                                                                                              |       |

 

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(1)          Represents our 2000 StockIncentive Plan.

(2)          Represents our 1998Stock Incentive Plan.

 

**Material Terms of the 1998 Plan**

 

OnJuly 20, 1998, we adopted the 1998 Stock Incentive Plan (as amended, the “1998Plan”). The 1998 Plan was adopted for the purpose of granting various stockincentives to officers, directors, employees and consultants of ABNH. The boardof directors (or a committee appointed by the board of directors) hasdiscretionary authority, subject to certain restrictions, to administer the1998 Plan. The total number of shares reserved for issuanceunder the 1998 Plan are 1,863,000 shares of common stock. Options topurchase 1,656,000 shares of common stock were outstanding under the 1998 Planat December 31, 2004. The exercise price of options granted under the 1998Plan may not be less than 100% of the fair market value of the common stock onthe date such option was granted. Options granted under the 1998 Plan generallybecome vested and exercisable for up to either 25% or 33 1/3% of the totaloptioned shares upon each succeeding anniversary of the date of grant.Generally, the unexercised portion of any option automatically terminates uponthe termination of the optionee’s employment with us, unless otherwisedetermined by the board of directors; provided however, that any extensionshall not extend beyond the expiration of the option, generally ten years. Upona change in control, outstanding options will generally become fully vested.

 

**MaterialTerms of the 2000 Plan**

 

On August 4,2000, we adopted the American Bank Note Holographics, Inc. 2000 Stock IncentivePlan (as amended, the “2000 Plan”), which was subsequently approved by ourstockholders at our annual meeting on September 12, 2000. In August 2001, ourstockholders approved an amendment to the 2000 Plan increasing the sharesavailable for issuance thereunder by 600,000 to 1,350,000 shares. The 2000 Planwas adopted for the purpose of granting various stock incentives to officers,directors, employees and consultants of ABNH. The board of directors (or acommittee appointed by the board of directors) has discretionary authority,subject to certain restrictions, to administer the 2000 Plan. The total numberof shares reserved for issuance under the 2000 Plan is 1,350,000 shares ofcommon stock. Options to purchase 1,073,000 shares of common stock wereoutstanding under the 2000 Plan at December 31, 2004. The exercise price ofoptions granted under the 2000 Plan may not be less than 100% of the fairmarket value of the common stock on the date such option was granted. Optionsgranted under the 2000 Plan generally become vested and exercisable for up toeither 25% or 33 1/3% of the total optioned shares upon each succeedinganniversary of the date of grant. Generally, the unexercised portion of anyoption automatically terminates upon the termination of the optionee’semployment with us, unless otherwise determined by the board of directors;provided however, that any extension shall not extend beyond the expiration ofthe option, generally ten years. Upon a change in control, outstanding optionswill generally become fully vested.

 

40

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**Item 13.****CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.**

 

OnJune 30, 2000, we entered into a Stock Purchase Agreement (the “Agreement”)with Crane & Co., Inc. (“Crane”). Under the Agreement, we sold 3,387,720shares of our common stock to Crane for an aggregate purchase price of$9,316,230. The Agreement also provides that our Board of Directors and our auditcommittee of our Board of Directors each be expanded by one position, which wasfilled by Douglas A. Crane, a representative of Crane. The Agreement alsoprovides that, for as long as Crane owns at least 51% of the shares of commonstock purchased under the Agreement, Crane shall be entitled to designate onedirector on the management slate of nominees to our Board, and that, should ourBoard be expanded to a number greater than six, then our Board shall beexpanded by another seat, and Crane shall be entitled to nominate an additionaldirector.

 

The Agreementalso contains a standstill provision, whereby Crane agreed, that, among otherthings, neither it nor its affiliates, except as otherwise provided for in theAgreement, will acquire more than its current proportionate share of the outstandingsecurities of ABNH. The standstill provision also provides that Crane will notoffer, sell or transfer any of its voting securities of ABNH during a tender orexchange offer if such offer is opposed by our Board of Directors. Inconnection with the transaction, Crane also received the right to cause us toregister Crane’s shares for public resale and the right to include such sharesin any future registration of our securities, subject to certain exceptions.

 

During 2000,we entered into agreements with Crane under which we rent factory space andlease employees for our facility in Dalton, MA. For the years ended December 31,2004, 2003 and 2002, we paid Crane under these agreements $72,000 each year,for the rental of the factory space and $169,000, $162,000 and $151,000,respectively, for the leased employees.

 

**Item 14.**** PRINCIPAL ACCOUNTANT FEES AND SERVICES.**

 

Ernst& Young LLP, our independent registered public accounting firm for 2004 and2003, were paid for audit and other services rendered as set forth below.

 

**Audit Fees**

 
| **2004 Fiscal Year**                                  | ** ** | ** ** | ** ** |
|-------------------------------------------------------|------------|------------|------------|
| Audit Fees                                            |       | $          | 245,400    |   |
| Audit-Related Fees                                    |       | —     |       |
| Tax Fees                                              |       | 2,000      |       |
| All Other Fees                                        |       | —     |       |
|                                                  |       |       |       |
| Total Fees for the Year Ended  December 31, 2004 |       | $          | 247,400    |   |

 
| **2003 Fiscal Year**                                  | ** ** | ** ** | ** ** |
|-------------------------------------------------------|------------|------------|------------|
| Audit Fees                                            |       | $          | 245,700    |   |
| Audit-Related Fees                                    |       | —     |       |
| Tax Fees                                              |       | 1,250      |       |
| All Other Fees                                        |       | —     |       |
|                                                  |       |       |       |
| Total Fees for the Year Ended  December 31, 2003 |       | $          | 246,950    |   |

 

Taxfees for 2004 and 2003 pertained to reviews of our federal and state taxreturns.

 

TheAudit Committee concluded that provision of these services is compatible withmaintaining the principal accountants’ independence.

 

41

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**Pre-Approval Policies**

 

TheAudit Committee pre-approves all audit and non-audit services provided by ourindependent registered public accounting firm prior to the engagement of theindependent registered public accounting firm with respect to suchservices.  With respect to audit servicesand permissible non-audit services not previously approved, the Audit Committeehas authorized the Chairman of the Audit Committee to approve such auditservices and permissible non-audit services, provided the Chairman informs theAudit Committee of such approval at its next regularly scheduled meeting.  All “Audit Fees” and “Tax Fees” set forthabove were pre-approved by the Audit Committee in accordance with itspre-approval policy.

 

**Part IV**

 

**Item 15.****EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**

 

(a)                                  The followingdocuments are filed as part of this report:

 

(1)                                  Financial Statements

 

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

 

(2)                                  Financial StatementSchedules

 

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

 

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

 

(3)                                  Exhibits

 

The following exhibits are filed as part of this report or areincorporated herein by reference. Exhibit Nos. 10.4, 10.5, 10.6, 10.7, 10.8, 10.9, and 10.10 aremanagement contracts, compensatory plans or arrangements.

 
| 3.1    |   | Amended and  Restated Certificate of Incorporation. (1)                                                                                       |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                          |
| 3.2    |   | Amended and  Restated By-Laws. (1)                                                                                                            |
|   |   |                                                                                                                                          |
| 3.3    |   | Amendment to  the Amended and Restated Certificate of Incorporation. (2)                                                                      |
|   |   |                                                                                                                                          |
| 4.1    |   | Form of  Common Stock Certificate. (1)                                                                                                        |
|   |   |                                                                                                                                          |
| 4.2    |   | Stock  Purchase Agreement by and between Crane & Co., Inc. and American Bank  Note Holographics, Inc. dated as of June 29, 2000. (3) |
|   |   |                                                                                                                                          |
| 4.3    |   | Form of  Option Agreement for American Bank Note Holographics, Inc. 1998 Stock  Incentive Plan as amended. (5)                                |

 

42

----

 
| 4.4    |   | Form of  Option Agreement for American Bank Note Holographics, Inc. 2000 Stock  Incentive Plan. (5)                                                                                                                |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                    |
| 10.1   |   | Form of  Separation Agreement, by and between American Bank Note Corporation and  American Bank Note Holographics, Inc. dated July 20, 1998. (1)                                                                   |
|   |   |                                                                                                                                                                                                                    |
| 10.2   |   | Form of  License Agreement. (1)                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                    |
| 10.3   |   | Form of  Transitional Services Agreement. (1)                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                    |
| 10.4   |   | Form of  Employee Benefits Allocation Agreement. (1)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                    |
| 10.5   |   | Form of 1998  Stock Incentive Plan. (1)                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                    |
| 10.6   |   | Form of 2000  Stock Incentive Plan. (6)                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                    |
| 10.7   |   | Form of  Defined Contribution Plan. (1)                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                    |
| 10.8   |   | Employment  Agreement, dated April 20, 1999, between Salvatore F. D’Amato and  American Bank Note Holographics, Inc. (7)                                                                                      |
|   |   |                                                                                                                                                                                                                    |
| 10.9   |   | Amended and  Restated Employment Agreement, between Kenneth Traub and American Bank Note  Holographics, Inc., dated March 29, 2005.                                                                                |
|   |   |                                                                                                                                                                                                                    |
| 10.10  |   | Employment  Agreement, dated April 30, 1999, between Alan Goldstein and American  Bank Note Holographics, Inc. (7)                                                                                                 |
|   |   |                                                                                                                                                                                                                    |
| 10.11  |   | Standard  Form of Loft Lease, dated as of July 23, 1992, by and between Robert Martin  Company and American Bank Note Holographics, Inc. (9)                                                                       |
|   |   |                                                                                                                                                                                                                    |
| 10.12  |   | Lease  Agreement, dated as of January 19, 2001 by and between Crane & Co.,  Inc. and American Bank Note Holographics, Inc. (9)                                                                                 |
|   |   |                                                                                                                                                                                                                    |
| 10.13  |   | Lease  Agreement, dated August 11, 2002, by and between Mark Hankin and HanMar  Associates MLP, tenants-in-common and American Bank Note Holographics, Inc.  with Addenda thereto. (11)                            |
|   |   |                                                                                                                                                                                                                    |
| 10.14  |   | Settlement  Agreement, dated July 1, 2002, by and between American Bank Note Holgraphics,  Inc. and Leonhard Kurz GmbH & Co. KG (10)                                                                                |
|   |   |                                                                                                                                                                                                                    |
| 10.15  |   | Patent  License Agreement, dated July 1, 2002, by and between American Bank Note  Holographics, Inc. and Leonhard Kurz GmbH & Co. KG (10)(+)                                                                        |
|   |   |                                                                                                                                                                                                                    |
| 10.16  |   | Substitute  Cross License Agreement, dated July 1, 2002, by and between American Bank  Note Holographics, Inc. and Leonhard Kurz & Co. KG (10)                                                                      |
|   |   |                                                                                                                                                                                                                    |
| 10.17  |   | Hologram  Agreement, dated February 28, 2003, by and between MasterCard International  Incorporated and American Bank Note Holograhics, Inc. (11)(+)                                                                    |
|   |   |                                                                                                                                                                                                                    |
| 10.18  |   | Form of  Indemnification Agreement between the Company and its directors and officers.  (12)                                                                                                                            |
|   |   |                                                                                                                                                                                                                    |
| 10.19  |   | Amendment  No. 1 to the Hologram Agreement, dated February 28, 2003, by and between  MasterCard International Incorporated and American Bank Note Holographics,  Inc., made as of September 29, 2003. (13)(+) |

 

43

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| 10.20  |   | Sublease  Agreement by and between APW North America Inc. and American Bank Note  Holographics, Inc., dated December 14, 2004. (14)                                                                                                                                                                                                                                                |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.21  |   | Subordination,  Non-Disturbance, Attornment, Renewal and Option to Purchase Agreement by and  between American Bank Note Holographics, Inc. and More Applied Four (DE) LLC,  dated December 14, 2004. (14)                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.22  |   | Subordination,  Non-Disturbance and Attornment Agreement by and between American Bank Note  Holographics, Inc. and LaSalle Bank National Association, formerly known as  LaSalle National Bank, as Trustee for Morgan Stanley Capital I Inc.,  Commercial Mortgage Securities Inc., Commercial Mortgage Pass-Through  Certificates, Series 1999-WF1, dated December 14, 2004. (14) |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.23  |   | Escrow  Agreement by and between APW North America Inc., American Bank Note  Holographics, Inc. and Chicago Title Insurance Company, dated  December 14, 2004. (14)                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                    |
| 23.1   |   | Consent of  Ernst & Young LLP.                                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                    |
| 31.1   |   | Certification  of Kenneth H. Traub pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a),  as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                    |
| 31.2   |   | Certification  of Alan Goldstein pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                    |
| 32.1   |   | Certification  of Kenneth H. Traub pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes – Oxley Act of 2002.                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                    |
| 32.2   |   | Certification  of Alan Goldstein pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes – Oxley Act of 2002.                                                                                                                                                                                                                            |

 

----

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

 

(2)                                  Incorporated byreference from the Proxy Statement on Schedule 14A filed on July 3,2001.

 

(3)                                  Incorporated byreference from the Quarterly Report on Form 10-Q filed on August 14, 2000.

 

(4)                                  Incorporated byreference from the Annual Report on Form 10-K for 2000.

 

(5)                                  Incorporated byreference from the Registration Statement on Form S-8 (Registration No.333-61602).

 

(6)                                  Incorporated byreference from the Proxy Statement on Schedule 14A filed on August 11,2000.

 

(7)                                  Incorporated byreference from the Annual Report on Form 10-K for 1998.

 

(8)                                  Incorporated byreference from the Annual Report on Form 10-K for 1999.

 

(9)                                  Incorporated byreference from the Annual Report on Form 10-K for 2001.

 

44

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(10)                            Incorporated by referencefrom the Quarterly Report on Form 10-Q filed on August 13, 2002.

 

(11)                            Incorporated by referencefrom the Annual Report on Form 10-K for 2002.

 

(12)                            Incorporated by referencefrom the Quarterly Report on Form 10-Q filed on August 12, 2003.

 

(13)                            Incorporated by referencefrom the Quarterly Report on Form 10-Q filed on November 13, 2003.

 

(14)                            Incorporated by referencefrom the Current Report on Form 8-K filed on December 20, 2004.

 

(+)                                 Portions have beenomitted pursuant to a request for confidential treatment.

 

45

----

 

SIGNATURES

 

Pursuant tothe requirements of section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
|                 | AMERICAN  BANK NOTE HOLOGRAPHICS, INC. |
|----------------------|----------------------------------------|
|                 |                                   |
|                 |                                   |
|                 | By:                                    | /s/ Kenneth  H. Traub |   |
|                 |                                   | Kenneth H.  Traub |
|                 |                                   | President  and Chief Executive Officer |
|                 |                                   |
| March 31,  2005 |                                   |

 

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

 
| **Signature**                       | ** ** | **Title**                                      | ** **                              | ** ** | **Date**   |
|-------------------------------------|------------|------------------------------------------------|-----------------------------------------|------------|------------|
|                                | ** ** | ** **                                     | ** **                              | ** ** | ** ** |
| /s/ Kenneth  H. Traub          |       |                                           | President,  Chief Executive Officer and |       |       | March 31,  2005 |
| Kenneth H.  Traub                   |       | Director  (Principal Executive Officer)        |                                    |       |       |
|                                |       |                                           |                                    |       |       |
|                                |       |                                           |                                    |       |       |
| /s/ Alan  Goldstein            |       |                                           | Chief  Financial Officer                |       |       | March 31,  2005 |
| Alan  Goldstein                     |       | (Principal  Financial and  Accounting Officer) |                                    |       |       |
|                                |       |                                           |                                    |       |       |
|                                |       |                                           |                                    |       |       |
| /s/ Salvatore  F. D’Amato |       |                                           | Chairman of  the Board                  |       |       | March 31,  2005 |
| Salvatore F.  D’Amato          |       |                                           |                                    |       |       |
|                                |       |                                           |                                    |       |       |
|                                |       |                                           |                                    |       |       |
| /s/ Fred  J. Levin             |       |                                           | Director                                |       |       | March 31,  2005 |
| Fred J.  Levin                      |       |                                           |                                    |       |       |
|                                |       |                                           |                                    |       |       |
|                                |       |                                           |                                    |       |       |
| /s/ Douglas  A. Crane          |       |                                           | Director                                |       |       | March 31,  2005 |
| Douglas A.  Crane                   |       |                                           |                                    |       |       |
|                                |       |                                           |                                    |       |       |
|                                |       |                                           |                                    |       |       |
| /s/ Mark  J. Bonney            |       |                                           | Director                                |       |       | March 31,  2005 |
| Mark J.  Bonney                     |       |                                           |                                    |       |       |

 

46

----

 

AMERICAN BANK NOTEHOLOGRAPHICS, INC.

 

INDEX TO FINANCIAL STATEMENTS

 

ITEM 15(a)

 

 
| REPORT  OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM                                      |   |
|-----------------------------------------------------------------------------------------------|--------|
| FINANCIAL STATEMENTS:                                                                         |   |
| Balance Sheets, December 31, 2004 and  2003                                                   |   |
| Statements of Operations for  the Years Ended December 31, 2004, 2003 and   2002         |   |
| Statements of  Stockholders’ Equity for the Years Ended December 31, 2004, 2003 and 2002 |   |
| Statements of Cash Flows for  the Years Ended December 31, 2004, 2003 and 2002                |   |
| Notes to Financial  Statements                                                                |   |
| Schedule II -  Valuation and Qualifying Accounts                                              |   |

 

----

 

Report of IndependentRegistered Public Accounting Firm

 

To the Board ofDirectors

American Bank NoteHolographics, Inc.

 

We have auditedthe accompanying balance sheets of American Bank Note Holographics, Inc. (the “Company”)as of December 31, 2004 and 2003 and the related statements of operations,stockholders’ equity, and cash flows for each of the three years in the periodended December 31, 2004. Our audits also included the financial statementschedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of theCompany’s management.  Our responsibilityis to express an opinion on these financial statements and schedule based onour audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement.  Wewere not engaged to perform an audit of the Company’s internal control overfinancial reporting.  Our auditincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly we express nosuch opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management,and evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion,the financial statements referred to above present fairly, in all materialrespects, the financial position of the Company at December 31, 2004 and 2003and the results of its operations and its cash flows for each of the threeyears in the period ended December 31, 2004 in conformity with U.S. generallyaccepted accounting principles. Also, in our opinion, the related financialstatement schedule, when considered in relation to the basic financialstatements taken as a whole, presents fairly in all material respects theinformation set forth therein.

 
|                | /s/ Ernst & Young  LLP |   |
|---------------------|----------------------------|--------|
|                |
| New York, New  York |
| March 10, 2005      |

 

F-2

----

 

AMERICAN BANK NOTEHOLOGRAPHICS, INC.

 

BALANCE SHEETSDECEMBER 31, 2004 AND 2003(In Thousands, Except Share Data)

 
| ** **                                                                                                                                | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                                                                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| ASSETS                                                                                                                                    |       |       |       |       |       |
| CURRENT ASSETS:                                                                                                                           |       |       |       |       |       |
| Cash and cash equivalents                                                                                                                 |       | $          | 11,357     |       | $          | 7,340 |   |
| Short-term investments                                                                                                                    |       | 1,989      |       | 4,001      |       |
| Accounts receivable, net of allowance for doubtful  accounts of $180 and $180                                                             |       | 3,889      |       | 3,174      |       |
| Inventories                                                                                                                               |       | 3,394      |       | 2,386      |       |
| Deferred income taxes                                                                                                                     |       | 983        |       | 981        |       |
| Prepaid expenses                                                                                                                          |       | 317        |       | 385        |       |
| Other                                                                                                                                     |       | —     |       | 150        |       |
| Total current assets                                                                                                                      |       | 21,929     |       | 18,417     |       |
| MACHINERY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS— Net  of accumulated depreciation and amortization of $10,062 and $9,238             |       | 3,172      |       | 2,490      |       |
| OTHER ASSETS                                                                                                                              |       | 110        |       | 113        |       |
| TOTAL ASSETS                                                                                                                              |       | $          | 25,211     |       | $          | 21,020 |   |
|                                                                                                                                      |       |       |       |       |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                 |       |       |       |       |       |
| CURRENT LIABILITIES:                                                                                                                      |       |       |       |       |       |
| Accounts payable                                                                                                                          |       | $          | 1,519      |       | $          | 687 |   |
| Accrued expenses                                                                                                                          |       | 2,065      |       | 1,627      |       |
| Customer advances                                                                                                                         |       | 69         |       | 49         |       |
| Income taxes payable                                                                                                                      |       | 1,058      |       | —     |       |
| Total current liabilities                                                                                                                 |       | 4,711      |       | 2,363      |       |
| DEFERRED INCOME TAXES                                                                                                                     |       | 1,186      |       | 1,208      |       |
| Total liabilities                                                                                                                         |       | 5,897      |       | 3,571      |       |
|                                                                                                                                      |       |       |       |       |       |
| COMMITMENTS AND CONTINGENCIES                                                                                                             |       |       |       |       |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                |       |       |       |       |       |
| Preferred Stock, authorized, 5,000,000 shares; no  shares issued or outstanding                                                           |       | —     |       | —     |       |
| Common Stock, par value $0.01 per share, authorized,  40,000,000 shares; issued and outstanding, 18,515,907 shares and 18,483,720  shares |       | 185        |       | 185        |       |
| Additional paid-in capital                                                                                                                |       | 24,058     |       | 23,994     |       |
| Accumulated deficit                                                                                                                       |       | (4,929     | )          | (6,730     | )          |
| Total stockholders’ equity                                                                                                           |       | 19,314     |       | 17,449     |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                           |       | $          | 25,211     |       | $          | 21,020 |   |

 

The accompanying notesare an integral part of these financial statements.

 

F-3

----

 

AMERICAN BANK NOTEHOLOGRAPHICS, INC.

 

STATEMENTS OF OPERATIONSYEARS ENDED DECEMBER 31, 2004, 2003 AND 2002(In Thousands, Except Per Share Data)

 
| ** **                                      | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| REVENUE:                                        |       |     |       |     |       |     |       |
| Sales                                           |       | $        | 21,263     |     | $          | 18,284   |       | $ | 18,665 |   |
| Royalty income                                  |       | 13       |       | 48       |       | 555      |       |
| Total revenue                                   |       | 21,276   |       | 18,332   |       | 19,220   |       |
|                                            |       |     |       |     |       |     |       |
| COSTS AND EXPENSES:                             |       |     |       |     |       |     |       |
| Cost of goods sold                              |       | 9,161    |       | 8,279    |       | 8,926    |       |
| Selling and administrative                      |       | 7,070    |       | 6,518    |       | 7,136    |       |
| Research and development                        |       | 1,270    |       | 1,142    |       | 1,143    |       |
| Depreciation and amortization                   |       | 830      |       | 739      |       | 800      |       |
| Facility consolidation                          |       | 242      |       | —   |       | —   |       |
| Impairment of goodwill and fixed assets         |       | —   |       | —   |       | 9,298    |       |
| Total costs and expenses                        |       | 18,573   |       | 16,678   |       | 27,303   |       |
|                                            |       |     |       |     |       |     |       |
| Operating income (loss)                         |       | 2,703    |       | 1,654    |       | (8,083   | )          |
|                                            |       |     |       |     |       |     |       |
| OTHER INCOME:                                   |       |     |       |     |       |     |       |
| Interest                                        |       | 121      |       | 97       |       | 113      |       |
| Patent and other settlements                    |       | 178      |       | —   |       | 691      |       |
| Total other income                              |       | 299      |       | 97       |       | 804      |       |
|                                            |       |     |       |     |       |     |       |
| INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES |       | 3,002    |       | 1,751    |       | (7,279   | )          |
|                                            |       |     |       |     |       |     |       |
| PROVISION FOR INCOME TAXES                      |       | 1,201    |       | 744      |       | 858      |       |
|                                            |       |     |       |     |       |     |       |
| NET INCOME (LOSS)                               |       | $        | 1,801      |     | $          | 1,007    |       | $ | (8,137 | ) |
|                                            |       |     |       |     |       |     |       |
| NET INCOME (LOSS) PER SHARE:                    |       |     |       |     |       |     |       |
| Basic and diluted                               |       | $        | 0.10       |     | $          | 0.05     |       | $ | (0.44 | ) |
|                                                 |            |          |            |          |            |          |            |  |  |  |  |  |

 

The accompanying notesare an integral part of these financial statements.

 

F-4

----

 

AMERICAN BANK NOTEHOLOGRAPHICS, INC.

 

STATEMENTS OF STOCKHOLDERS’ EQUITYYEARS ENDED DECEMBER 31, 2004, 2003 AND 2002(In Thousands)

 
| ** **                                        | ** ** | ** **       | ** ** | **Additional** | ** ** | **Retained**  | ** ** | ** **   | ** ** |
|---------------------------------------------------|------------|------------------|------------|----------------|------------|---------------|------------|--------------|------------|
| ** **                                        | ** ** | **Common Stock** | ** ** | **Paid-In**    | ** ** | **(Deficit)** | ** ** | ** **   | ** ** |
| ** **                                        | ** ** | **Shares**       | ** ** | **Amount**     | ** ** | **Capital**   | ** ** | **Earnings** | ** ** | **Total** | ** ** |
| BALANCE, JANUARY 1, 2002                          |       | 18,484           |       | $              | 185        |          | $          | 23,994       |       | $ | 400 |   | $ | 24,579 |   |
| Net loss                                          |       | —           |       | —         |       | —        |       | (8,137       | )          | (8,137 | ) |
| BALANCE, DECEMBER 31, 2002                        |       | 18,484           |       | 185            |       | 23,994        |       | (7,737       | )          | 16,442 |   |
| Net income                                        |       | —           |       | —         |       | —        |       | 1,007        |       | 1,007 |   |
| BALANCE, DECEMBER 31, 2003                        |       | 18,484           |       | 185            |       | 23,994        |       | (6,730       | )          | 17,449 |   |
| Issuance of shares from exercise of stock options |       | 32               |       |           |       | 64            |       |         |       | 64 |   |
| Net income                                        |       | —           |       | —         |       | —        |       | 1,801        |       | 1,801 |   |
| BALANCE, DECEMBER 31, 2004                        |       | 18,516           |       | $              |  185  |          | $          |  24,058 |       | $ |  (4,929 | ) | $ |  19,314 |   |

 

The accompanying notesare an integral part of these financial statements.

 

F-5

----

 

AMERICAN BANK NOTEHOLOGRAPHICS, INC.

 

STATEMENTS OF CASH FLOWSYEARS ENDED DECEMBER 31, 2004, 2003 AND 2002(In Thousands)

 
| ** **                                                                                | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                     |       |       |       |       |       |       |       |
| Net income (loss)                                                                         |       | $          | 1,801      |       | $          | 1,007      |       | $ | (8,137 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |       |       |       |       |       |       |
| Depreciation and amortization                                                             |       | 830        |       | 739        |       | 800        |       |
| Deferred income taxes                                                                     |       | (24        | )          | 744        |       | 858        |       |
| (Recovery) provision for doubtful accounts                                                |       | —     |       | (30        | )          | 160        |       |
| Impairment of goodwill and fixed assets                                                   |       | —     |       | —     |       | 9,298      |       |
| Changes in operating assets and liabilities:                                              |       |       |       |       |       |       |       |
| Accounts receivable                                                                       |       | (715       | )          | 517        |       | (771       | )          |
| Inventories                                                                               |       | (1,008     | )          | 155        |       | 726        |       |
| Prepaid expenses and other                                                                |       | 215        |       | 486        |       | (140       | )          |
| Accounts payable and accrued expenses                                                     |       | 1,270      |       | (455       | )          | (1,138     | )          |
| Customer advances                                                                         |       | 20         |       | (40        | )          | (11        | )          |
| Income taxes payable                                                                      |       | 1,058      |       | —     |       | —     |       |
| Net cash provided by operating activities                                                 |       | 3,447      |       | 3,123      |       | 1,645      |       |
|                                                                                      |       |       |       |       |       |       |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                     |       |       |       |       |       |       |       |
| Decrease (increase) in short-term investments                                             |       | 2,012      |       | (4,001     | )          | —     |       |
| Capital expenditures                                                                      |       | (1,506     | )          | (441       | )          | (354       | )          |
| Net cash provided by (used in) investing activities                                       |       | 506        |       | (4,442     | )          | (354       | )          |
|                                                                                      |       |       |       |       |       |       |       |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                     |       |       |       |       |       |       |       |
| Proceeds from exercise of stock options                                                   |       | 64         |       | —     |       | —     |       |
| Net cash provided by financing activities                                                 |       | 64         |       | —     |       | —     |       |
|                                                                                      |       |       |       |       |       |       |       |
| INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                          |       | 4,017      |       | (1,319     | )          | 1,291      |       |
| CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR                                              |       | 7,340      |       | 8,659      |       | 7,368      |       |
| CASH AND CASH EQUIVALENTS, END OF YEAR                                                    |       | $          | 11,357     |       | $          | 7,340      |       | $ | 8,659 |   |
|                                                                                      |       |       |       |       |       |       |       |
| SUPPLEMENTAL CASH FLOW INFORMATION                                                        |       |       |       |       |       |       |       |
| Income taxes paid                                                                         |       | $          | 184        |       | $          | 5          |       | $ | 2 |   |

 

The accompanying notesare an integral part of these financial statements.

 

F-6

----

 

AMERICAN BANK NOTEHOLOGRAPHICS, INC.NOTES TO FINANCIAL STATEMENTSYEARS ENDED DECEMBER 31, 2004, 2003 AND 2002

 

1.      BASIS OF PRESENTATION ANDSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

American Bank NoteHolographics, Inc. (the “Company” or “ABNH”) was incorporated in the state ofDelaware in August 1985. The Company was, until July 20, 1998, a wholly-ownedsubsidiary of American Banknote Corporation (the “Former Parent” or “ABN”).

 

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

 

Use of Estimates — Thepreparation of financial statements, in conformity with U.S. generally acceptedaccounting principles, requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities, the disclosure ofcontingent assets and liabilities at the date of the financial statements, andthe reported amounts of sales and expenses during the reporting period. Actualresults may differ materially from those estimates.

 

Cash and Cash Equivalents— All highly liquid investments (primarily government bonds) with a maturity ofthree months or less, when purchased, are considered to be cash equivalents andare stated at cost, which approximates market.

 

Short-Term Investments — AtDecember 31, 2004, short-term investments consisted of a U.S. government debtinstrument which matured February 22, 2005.  At December 31, 2003, short-term investmentsconsisted of U.S. government debt instruments that matured in January andFebruary 2004.  In accordance withStatement of Financial Accounting Standard (“SFAS”) No. 115, “Accounting forCertain Investments in Debt and Equity Securities,” management determines theappropriate classification of marketable securities at the time of purchase andreevaluates such designations as of each balance sheet date. This investment isclassified as held to maturity and is carried at its amortized cost.

 

Concentrations ofCredit Risk — A significant portion of the Company’s accounts receivable aredue from credit card issuers and related credit card manufacturers locatedthroughout the United States and Europe. At December 31, 2004 each of three customersaccounted for 28%, 19% and 11%, respectively, of the Company’s accountsreceivable and 35%, 9% and 6%, respectively, of its sales for the year thenended. At December 31, 2003 and for the year then ended one customer accountedfor 30% of the Company’s accounts receivable and 33% of its sales and a secondcustomer accounted for 30% of the Company’s accounts receivable and 9% of itssales. The Company establishes its credit policies based on an ongoingevaluation of its customers’ creditworthiness and competitive market conditionsand does not require collateral.

 

Inventories — Inventoriesare stated at the lower of cost or market with cost being determined on thefirst-in, first-out (FIFO) method. The cost of hologram originations (whichrepresent costs of a unique master hologram that is made to customerspecifications and is an integral part of the production process) are chargedto cost of goods sold in the period incurred.

 

Revenue Recognition — TheCompany recognizes revenue in accordance with the provisions of the Securitiesand Exchange Commission’s (“SEC”) Staff Accounting Bulletin (“SAB”) No. 104, “RevenueRecognition.” Specifically, sales and the related cost of goods sold aregenerally recognized at the latter of the time of shipment or when title passesto customers. In some situations, the Company has shipped product where thesale is contingent upon the customers’ use of the product. In these situations,the Company does not recognize sales upon product shipment, but rather when thebuyer of the product informs the Company that the product has been used.Additionally, pursuant to terms with a certain

 

F-7

----

 

customer, completed itemsare stored on behalf of the customer at the Company’s on-site secured facilityand, in that instance, sales are recognized when all of the following haveoccurred: the customer has ordered the goods, the manufacturing process iscomplete, the goods have been transferred to the on-site secured facility andare ready for shipment, the risk of ownership has passed to the customer andthe customer has been billed for the order.

 

Shipping and handlingamounts billed to customers are included in revenues and shipping and handlingcosts are included in selling and administrative expenses and amounted to $433,000,$358,000, and $373,000 for the years ended December 31, 2004, 2003 and 2002,respectively.

 

Royalty Income — TheCompany enters into licensing agreements with certain manufacturers under whichthe Company receives royalty payments. Royalty payments due under licensingagreements are recognized as income either based upon shipment reports fromlicensees, where available, or estimated shipments by such licensees.

 

Depreciation andAmortization — Machinery and equipment are recorded at cost and are depreciatedusing the straight-line method over the estimated useful lives ranging from 5to 15 years.

 

Amortization of leaseholdimprovements is computed using the straight-line method based upon theremaining term of the applicable lease, or the estimated useful life of theasset, whichever is shorter.

 

Long-Lived Assets — Long-livedassets used in operations are reviewed for impairment whenever events orchanges in circumstances indicate that the carrying amount of the assets mightnot be recoverable. For long-lived assets to be held and used, the Companyrecognizes an impairment loss only if its carrying amount is not recoverablethrough its undiscounted cash flows and measures the impairment loss based onthe difference between the carrying amount and fair value.

 

During the year endedDecember 31, 2002, the Company recorded a charge for the impairment oflong-lived assets of $1.9 million to write off fixed assets consisting ofmaster plates which will no longer be used. The impairment charge represents the full impairment of this long-livedasset. This asset arose through purchase accounting by the Company’s FormerParent, as it related to the Company, in connection with the Former Parent’smerger in 1990. There were no impairments of long-lived assets in 2004 or 2003.

 

Goodwill — In July2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets,”which provides that goodwill should not be amortized but instead tested forimpairment on an annual basis, and which was adopted by the Company on January1, 2002.  The impairment testing isperformed in two steps: (i) the determination of impairment, based on the fairvalue of the Company compared with its carrying value, and (ii) if there is anindication of impairment, this step measures the amount of impairment loss bycomparing the implied fair value of goodwill with the carrying amount of thatgoodwill. In accordance with SFAS No. 142 the Company completed thetransitional impairment test during the quarter ended March 31, 2002, whichtesting indicated that no adjustment was required upon the adoption of thepronouncement.  The Company performed theannual test for impairment required by SFAS No. 142 during the year endedDecember 31, 2002.  At that time the fairvalue (based on quoted market prices) of the Company was found to be less thanits carrying amount and as a result, the Company recorded a $7.4 millionimpairment charge for the year ended December 31, 2002.  This charge represents the full impairment ofthe goodwill that was on the Company’s balance sheet prior to December 31, 2002.  This asset arose through purchase accountingby the Company’s Former Parent, as it related to the Company, in connectionwith the Former Parent’s merger in 1990.

 

F-8

----

 

Warranty Costs — TheCompany provides for warranty costs in amounts it estimates will be needed tocover future warranty obligations for products sold. Estimates of warranty costsare based on historical experience and are periodically reviewed and adjusted,when necessary.  The Company’s productwarranty provision is included in accrued expenses in the accompanying balancesheets.  Changes in the Company’swarranty provision during the years ended December 31, 2004, 2003 and 2002 areas follows:

 
| ** **                   | ** ** | **2004**           | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------|------------|--------------------|------------|----------|------------|----------|------------|
| ** **                   | ** ** | **(In Thousands)** | ** ** |
| Balance at beginning of year |       | $                  | 510        |     | $          | 605      |       | $ | 1,011 |   |
| Warranties provided          |       | 160                |       | 160      |       | 410      |       |
| Settlements made             |       | (160               | )          | (255     | )          | (816     | )          |
| Balance at end of year       |       | $                  | 510        |     | $          | 510      |       | $ | 605 |   |

 

Research and Development— Research and development costs are expensed as incurred.

 

Income Taxes — TheCompany accounts for income taxes in accordance with SFAS No. 109, “Accountingfor Income Taxes.” The provision for income taxes includes deferred incometaxes resulting from items reported in different periods for income tax andfinancial statement purposes. Deferred tax assets and liabilities represent theexpected future tax consequences of the differences between the financialstatement carrying amounts of existing assets and liabilities and theirrespective tax basis.

 

Stock-Based CompensationPlans — In December 2002, FASB issued SFAS No. 148, “Accounting for Stock BasedCompensation—Transition and Disclosure—an amendment of FASB Statement No. 123.”  SFAS No. 148 provides alternative methods oftransition for a voluntary change to the fair value based method of accountingfor stock-based employee compensation from the intrinsic value-based method ofaccounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees.”  Inaddition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123, “Accountingfor Stock-Based Compensation.” The Company adopted the disclosure requirementsof SFAS No. 148 effective December 31, 2002. As allowed by SFAS No. 123, theCompany uses the intrinsic value-based method of accounting for stock basedcompensation prescribed in APB Opinion No. 25, and accordingly, does notrecognize compensation expense for stock option grants made at an exerciseprice equal to or in excess of the fair market value of the stock at the dateof grant.

 

Had compensation cost forthe Company’s outstanding stock options been determined based on the fair valueat the grant dates for options consistent with SFAS No. 123, the Company’s netincome (loss) and basic and diluted net income (loss) per share would havediffered as reflected by the pro forma amounts indicated below:

 
| ** **                                                                                                               | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                                               | ** ** | **(In Thousands, Except Per Share Data)** | ** ** |
| Net income (loss), as reported                                                                                           |       | $                                         | 1,801      |     | $          | 1,007    |       | $ | (8,137 | ) |
|                                                                                                                     |       |                                      |       |     |       |     |       |
| Add: Non-cash employee compensation, as reported                                                                         |       | —                                    |       | —   |       | —   |       |
| Deduct: Stock-based employee compensation expense  determined under fair value based method for all awards, net of taxes |       | 77                                        |       | 81       |       | 346      |       |
| Pro forma, net income (loss)                                                                                             |       | $                                         | 1,724      |     | $          | 926      |       | $ | (8,483 | ) |
|                                                                                                                     |       |                                      |       |     |       |     |       |
| Basic and diluted net income (loss) per share, as  reported                                                              |       | $                                         | 0.10       |     | $          | 0.05     |       | $ | (0.44 | ) |
| Basic and diluted net income (loss) per share, pro  forma                                                                |       | $                                         | 0.09       |     | $          | 0.05     |       | $ | (0.46 | ) |

 

F-9

----

 

Basic and Diluted NetIncome (Loss) per Share — Basic net income (loss) per share is computed basedon the weighted average number of outstanding shares of common stock. The basicweighted average number of shares outstanding were 18,488,783 for the yearended December 31, 2004 and 18,483,720 for each of the years ended December 31,2003 and 2002. Diluted net income (loss) per share is computed by dividing netincome (loss) by the weighted average number of shares of common stockoutstanding and dilutive potential shares of common stock. For the years endedDecember 31, 2004 and 2003, the diluted number of weighted shares outstandingwas 18,906,897 and 18,525,914, respectively, which includes dilutive stockoptions of 418,114 and 42,194, respectively. For the year ended December 31,2002, the diluted weighted average number of shares outstanding were 18,483,720because the effect of options to purchase 2,318,500 shares of the Company’scommon stock were excluded from the calculation of diluted net income (loss)per share because the effect of inclusion of such options would have beenantidilutive. For the year ended December 31, 2002, the effect of warrants topurchase 863,647 shares of the Company’s common stock were excluded from thecalculation of diluted net income (loss) per share because the effect ofinclusion of such warrants would have been antidilutive. The warrants expiredon June 18, 2003.

 

Business Concentration Risks— Sales to MasterCard were approximately 35%, 33% and 41% of sales for theyears ended December 31, 2004, 2003 and 2002, respectively. At December 31, 2004and 2003, accounts receivable from MasterCard approximated $1.1 million and $1.0million, respectively. The Company entered into an agreement with MasterCarddated February 28, 2003, which replaced the agreement dated February 1, 1996,as amended.  The Company and MasterCardentered into an amendment to this agreement on September 29, 2003, in whichMasterCard retained the Company to produce a new hologram for the DebitMasterCard and extended the agreement to February 28, 2011, subject toautomatic renewal if not terminated by either party.  The agreement also provides that MasterCardwill receive three sequential price reductions of approximately 3% each,effective at the beginning of 2003, 2004 and 2006.  The Company is currently the exclusivesupplier to MasterCard.  The loss of allor a substantial portion of the sales to MasterCard, however, would have amaterial adverse effect on the financial position, results of operations andcash flows of the Company.

 

Sales to manufacturers ofVISA credit cards (approximately 60 customers) were approximately 31%, 30% and 26%of sales for the years ended December 31, 2004, 2003 and 2002, respectively. Theloss of a substantial portion of the sales to these customers would have amaterial adverse effect on the financial position, results of operations andcash flows of the Company. At December 31, 2004 and 2003, accounts receivablefrom these customers approximated $1.2 million and $1.3 million, respectively.

 

The Company hashistorically purchased certain key materials used in the manufacture of itsholograms from third party suppliers. Any problems that occur with respect tothe delivery, quality or cost of any such materials could have a materialadverse effect on the financial position, results of operations and cash flowsof the Company.

 

Export Sales — Exportsales were 21%, 28% and 27% of sales for the years ended December 31, 2004, 2003and 2002, respectively. All export sales are denominated in United Statesdollars. At each of December 31, 2004 and 2003, accounts receivable from thesecustomers approximated $0.5 million.

 

Fair Value of FinancialInstruments – The Company’s financial instruments consist of cash and cashequivalents, short-term investments, accounts receivables, accounts payable andaccrued expenses.  The carrying amountsreported in the balance sheets approximate their fair value at both December31, 2004 and 2003.

 

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

 

F-10

----

 

Impact of Recently Issued Accounting Standards — In December 2004, theFinancial Accounting Standards Board issued Statement No. 123(R) (FAS 123R),Share-Based Payment, amending FAS 123 and requiring that all share-basedpayments to employees be recognized in the financial statements. Generally, theapproach to accounting for share-based payments in FAS 123R is similar to theapproach described in FAS 123, however, pro forma footnote disclosure will nolonger be an alternative to financial statement recognition. This statementbecomes effective in the first interim or annual period beginning after June15, 2005. The Company expects to adopt the new statement effective July 1,2005, using the modified-prospective transition method described in thestatement. Under this method, the Company will be required to recognizecompensation expense over the remaining vesting period for all awards thatremain unvested as of July 1, 2005. As permitted by FAS 123, the Companycurrently accounts for share-based payments to employees using APB 25’sintrinsic value method and, as such, generally recognized no compensation costfor employee stock options. The Company believes based on the level ofshare-based payments previously granted and unvested, that the adoption of FAS123R will not have a material effect on its financial position, results ofoperations or cashflows, however, the level of future equity basedcompensation grants could have a material effect on amounts recorded in ourstatement of operations.

 

In November 2004, the Financial Accounting Standards Board issued StatementNo. 151 (FAS 151), Inventory costs, an amendment of ARB No. 43, Chapter 4. FAS151 clarifies that abnormal amounts of idle facility expense, freight, handlingcosts and wasted materials should be recognized as current period charges. Inaddition, FAS 151 requires that allocation of fixed production overhead toinventory be based on the normal capacity of the production facilities. FAS 151is effective for inventory costs incurred during fiscal years beginning afterJune 15, 2005. The Company currently believes that the adoption of FAS 151 willnot have a material impact on its financial statements.

 

2.               INVENTORIES

 
| ** **                                   | ** ** | **December 31,**   | ** ** |
|----------------------------------------------|------------|--------------------|------------|
| ** **                                   | ** ** | **2004**           | ** ** | **2003** | ** ** |
| ** **                                   | ** ** | **(In Thousands)** | ** ** |
| Finished goods                               |       | $                  | 1,749      |   | $ | 800 |   |
| Finished goods on consignment with customers |       | 231                |       | 417 |   |
| Work in process                              |       | 1,044              |       | 764 |   |
| Raw materials                                |       | 370                |       | 405 |   |
| Inventories                                  |       | $                  | 3,394      |   | $ | 2,386 |   |

 

3.               MACHINERY,EQUIPMENT AND LEASEHOLD IMPROVEMENTS

 
|                                                 |   | **December 31,**   |       |
|------------------------------------------------------|--------|--------------------|------------|
|                                                 |   | **2004**           | ** ** | **2003** |   |
|                                                 |   | **(In Thousands)** |       |
| Machinery and equipment                              |   | $                  | 11,834     |   | $ | 10,583 |   |
| Leasehold improvements                               |   | 1,400              |       | 1,145 |   |
|                                                 |   | 13,234             |       | 11,728 |   |
| Accumulated depreciation and amortization            |   | 10,062             |       | 9,238 |   |
| Machinery, equipment and leasehold improvements, net |   | $                  | 3,172      |   | $ | 2,490 |   |
|                                                      |        |                    |            |  |  |  |  |  |

 

Depreciation andamortization of machinery and equipment and leasehold improvements for theyears ended December 31, 2004, 2003 and 2002 were $824,000, $733,000 and $794,000,respectively. 

 

F-11

----

 

4.               ACCRUEDEXPENSES

 
| ** **                 | ** ** | **December 31,**   | ** ** |
|----------------------------|------------|--------------------|------------|
| ** **                 | ** ** | **2004**           | ** ** | **2003** | ** ** |
| ** **                 | ** ** | **(In Thousands)** | ** ** |
| Accrued contract liability |       | $                  | 357        |   | $ | 357 |   |
| Warranty reserves          |       | 510                |       | 510 |   |
| Salaries and wages         |       | 642                |       | 527 |   |
| Accrued professional fees  |       | 121                |       | 63 |   |
| Facility consolidation     |       | 190                |       | — |   |
| Other                      |       | 245                |       | 170 |   |
|                       |       | $                  | 2,065      |   | $ | 1,627 |   |

 

 

5.      INCOMETAXES

 

Provision for incometaxes are as follows:

 
| ** **      | ** ** | **For the Years Ended  December 31,** | ** ** |
|-----------------|------------|---------------------------------------|------------|
| ** **      | ** ** | **2004**                              | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **      | ** ** | **(In Thousands)**                    | ** ** |
| Current:        |       |                                  |       |   |   |   |   |
| Federal         |       | $                                     | 962        |   | $ | — |   | $ | — |   |
| State and local |       | 263                                   |       | — |   | — |   |
|            |       | 1,225                                 |       | — |   | — |   |
| Deferred:       |       |                                  |       |   |   |   |   |
| Federal         |       | (19                                   | )          | 573 |   | 655 |   |
| State and local |       | (5                                    | )          | 171 |   | 203 |   |
|            |       | (24                                   | )          | 744 |   | 858 |   |
|            |       | $                                     | 1,201      |   | $ | 744 |   | $ | 858 |   |

 

A reconciliation of thetaxes on income in 2004, 2003 and 2002 is as follows:

 
| ** **                                                                   | ** ** | **For the Years Ended  December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                   | ** ** | **2004**                              | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                   | ** ** | **(In Thousands)**                    | ** ** |
| Tax at statutory rate                                                        |       | $                                     | 1,051      |   | $ | 613 |   | $ | (2,475 | ) |
| Amortization and impairment of nondeductible  goodwill and long-lived assets |       | —                                |       | — |   | 3,161 |   |
| State and local taxes, net of Federal benefit                                |       | 167                                   |       | 111 |   | 133 |   |
| Other                                                                        |       | (17                                   | )          | 20 |   | 39 |   |
|                                                                         |       | $                                     | 1,201      |   | $ | 744 |   | $ | 858 |   |

 

F-12

----

 

The tax effects of theitems comprising the Company’s deferred income tax assets and liabilities areas follows:

 
| ** **                             | ** ** | **December 31,**   | ** ** |
|----------------------------------------|------------|--------------------|------------|
| ** **                             | ** ** | **2004**           | ** ** | **2003** | ** ** |
| ** **                             | ** ** | **(In Thousands)** | ** ** |
| Current deferred tax assets:           |       |               |       |   |   |
| Uniform capitalization of inventory    |       | $                  | 204        |   | $ | 230 |   |
| Bad debt reserve                       |       | 72                 |       | 76 |   |
| Warranty reserve                       |       | 204                |       | 214 |   |
| Inventory obsolescence                 |       | 221                |       | 173 |   |
| Accrued vacation                       |       | 87                 |       | 83 |   |
| Other liabilities                      |       | 195                |       | 205 |   |
| Net current deferred tax asset         |       | $                  | 983        |   | $ | 981 |   |
| Non current deferred tax asset:        |       |               |       |   |   |
| Net operating loss carryforward        |       | $                  | —     |   | $ | 108 |   |
|                                   |       | —             |       | 108 |   |
| Non current deferred tax liabilities:  |       |               |       |   |   |
| Excess tax over book depreciation      |       | (1,186             | )          | (1,316 | ) |
|                                   |       |               |       |   |   |
| Net non current deferred tax liability |       | $                  | (1,186     | ) | $ | (1,208 | ) |
|                                        |            |                    |            |  |  |  |  |  |  |

 

Deferred income taxesarise from temporary differences between the tax bases of assets andliabilities and their reported amounts in the financial statements.

 

6.      STOCKHOLDERS’ EQUITY

 

On June 11, 1998, theCompany increased its authorized common stock to 30,000,000 shares and itsauthorized preferred stock to 5,000,000 shares. On July 20, 1998, the FormerParent completed the sale of 13,636,000 shares of the Company’s common stock ina public offering (the “Offering”), representing its entire investment in theCompany.  During 2001 and 2002 theCompany issued and distributed 1,460,000 shares of its common stock as well aswarrants to purchase 863,647 shares of the Company’s common stock, at anexercise price of $6.00 per share in settlement of the class action lawsuit filedagainst the Company in 1999.  Thewarrants expired on June 18, 2003.  Noneof the warrants were exercised.   On August 10, 2001, the Company’s stockholdersapproved an amendment to the Company’s Amended and Restated Articles ofIncorporation increasing the number of authorized shares of its common stock to40,000,000 shares.

 

On June 30, 2000, theCompany entered into a Stock Purchase Agreement (the “Agreement”) with Crane& Co., Inc. (“Crane”). Under the Agreement, the Company sold 3,387,720shares of the Company’s common stock to Crane for an aggregate purchase priceof $9,316,230. The Agreement also provides that the Board of Directors of theCompany and the audit committee of the Board of Directors each be expanded by oneposition, which was filled by Douglas A. Crane, a representative of Crane.

 

The Agreement alsocontains a standstill provision, whereby Crane agreed, that, among otherthings, neither it nor its affiliates, except as otherwise provided for in theAgreement, will acquire more than its current proportionate share of theoutstanding securities of the Company. The standstill provision also providesthat Crane will not offer, sell or transfer any of its voting securities of theCompany during a tender or exchange offer if such offer is opposed by theCompany’s Board of Directors.

 

During 2000, the Companyentered into additional agreements with Crane under which the Company rentsfactory space and leases employees for the Company’s facility in Dalton, MA.For the years ended December 31, 2004, 2003 and 2002, the Company paid Craneunder these agreements, $72,000 each year,

 

F-13

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for the rental of factoryspace and $169,000, $162,000 and $151,000, respectively, for the leasedemployees, which are primarily included in cost of goods sold in theaccompanying statements of operations.

 

7.      FACILITY CONSOLIDATION

 

On December 14, 2004, the Company entered into certain agreements tolease a new 134,000 square foot facility located in Robbinsville, New Jerseywhich will be the future site of the Company’s primary operations.  The Company will consolidate its existingoffice and manufacturing facilities in Elmsford, New York and HuntingdonValley, Pennsylvania into the new facility. The Company also intends to expand and supplement its manufacturingoperations in connection with this consolidation.

 

The lease is effective as of December 14, 2004 and expires on May 31,2017. Under the agreements the Company has the right to renew the lease forthree consecutive five year terms and also has an option to purchase thebuilding.

 

The Company currently expects to incur expenses totaling approximately$4.2 million, of which $0.2 million was incurred in 2004,  associated with its existing leases, vacatingits current facilities, relocating and terminating certain employees, movingequipment and other related expenses which will be substantially complete bythe third quarter of 2005.  The expenses incurredin 2004 are classified as facility consolidation expenses on the accompanyingstatement of operations. Approximately $2.9 million of these expenses will bepaid in cash ratably through the fourth quarter of 2007 and approximately $1.3million of these expenses will be paid in cash as incurred through the fourthquarter of 2005.

 

8.  SETTLEMENT AGREEMENT

 

ABNH and Leonhard Kurz GmbH & Co. KG (“Kurz”) entered into aSettlement Agreement dated as of July 1, 2002. Pursuant to the Settlement Agreement, Kurz will make payments to ABNH totaling$900,000 over two years, with $300,000 paid upon settlement and the remainderpayable in eight quarterly installments of $75,000 beginning in October 2002 inexchange for a release from any past, present and future infringements of ABNH’sdemetallizing and hot-stamping patents except for a future use of a specificinterpretation of the demetallizing patents which is subject to a royalty basedlicense.  ABNH recorded such amounts asother income in the accompanying statement of operations in 2002, net of legalexpenses of $280,000 and imputed interest of $50,000.

 

9.  STOCK INCENTIVE PLANS

 

On August 4, 2000, theCompany adopted the American Bank Note Holographics, Inc. 2000 Stock IncentivePlan (as amended, the “2000 Plan”), which was subsequently approved by theCompany’s stockholders at the annual meeting on September 12, 2000. On July 20,1998, the Company adopted the 1998 Stock Incentive Plan (as amended, the “1998Plan”, and collectively with the 2000 Plan, the “Plans”). The Plans wereadopted for the purpose of granting various stock incentives to officers,directors, employees and consultants of the Company. The Board of Directors (ora committee appointed by the Board of Directors) has discretionary authority,subject to certain restrictions, to administer the Plans. The total number ofshares reserved for issuance under the Plans are 3,213,000 shares of commonstock. Options to purchase 451,813 shares of common stock are available forfuture grants at December 31, 2004

 

F-14

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under the Plans. Theexercise price of options granted under the Plans may not be less than the fairmarket value of the common stock on the date such options were granted. Optionsgranted under the Plans generally become vested and exercisable for up to 25%or 33 1/3% of the total optioned shares upon each succeeding anniversaryof the date of grant. Generally, the unexercised portion of any optionautomatically terminates upon the termination of the optionee’s employment withthe Company, unless otherwise determined by the Board of Directors; providedhowever, that any extension shall not extend beyond the expiration of theoption, generally ten years. Upon a change in control, outstanding options willgenerally become fully vested.

 

A summary of the statusof the Company’s outstanding stock options as of December 31, 2004, 2003 and2002 and changes during the years then ended follows:

 

 
| ** **                                                      | ** ** | **2004**   | ** ** | **2003**                               | ** ** | **2002**   | ** ** |
|-----------------------------------------------------------------|------------|------------|------------|----------------------------------------|------------|------------|------------|
| ** **                                                      | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Outstanding, beginning of year                                  |       | 2,838,000  |       | $                                      | 2.19       |       | 2,318,500  |   | $ | 2.55 |   | 2,509,500 |   | $ | 2.58 |   |
| Granted                                                         |       | —     |       | —                                 |       | 586,000    |       | $ | 0.91 |   | 23,000 |   | $ | 1.02 |   |
| Exercised                                                       |       | (32,187    | )          | $                                      | 2.01       |       | —     |   | — |   | — |   | — |   |
| Forfeited                                                       |       | (76,813    | )          | $                                      | 2.10       |       | (66,500    | ) | $ | 3.61 |   | (214,000 | ) | $ | 2.76 |   |
| Outstanding, end of year                                        |       | 2,729,000  |       | $                                      | 2.15       |       | 2,838,000  |   | $ | 2.19 |   | 2,318,500 |   | $ | 2.55 |   |
| Exercisable, end of year                                        |       | 2,380,578  |       | $                                      | 2.32       |       | 2,170,251  |   | $ | 2.54 |   | 1,944,124 |   | $ | 2.67 |   |
| Weighted average fair value of options granted  during the year |       | $          | —     |                                   |       |       | $          | 0.78 |   |   |   | $ | 0.84 |   |   |   |
|                                                                 |            |            |            |                                        |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thefollowing table summarizes information concerning outstanding and exercisableoptions at December 31, 2004:

 
| ** **                     | ** ** | **Options Outstanding**  | ** ** | ** **                                          | ** ** | **Options Exercisable**                | ** ** |
|--------------------------------|------------|--------------------------|------------|-----------------------------------------------------|------------|----------------------------------------|------------|
| **Range  of  Exercise Prices** | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $0.68 - $1.18                  |       | 583,000                  |       | 8.53                                                |       | $                                      | 0.95       |   | 244,578 |   | $ | 0.95 |   |
| $1.67 - $1.94                  |       | 855,000                  |       | 5.53                                                |       | $                                      | 1.86       |   | 855,000 |   | $ | 1.86 |   |
| $2.03 - $2.50                  |       | 1,171,500                |       | 4.82                                                |       | $                                      | 2.31       |   | 1,161,500 |   | $ | 2.32 |   |
| $8.50                          |       | 119,500                  |       | 3.55                                                |       | $                                      | 8.50       |   | 119,500 |   | $ | 8.50 |   |
| $0.68 - $8.50                  |       | 2,729,000                |       | 5.78                                                |       | $                                      | 2.15       |   | 2,380,578 |   | $ | 2.32 |   |

 

The fair value of eachoption grant was estimated on the date of grant using the Black-Scholesoption-pricing model with the following weighted-average assumptions:

 
| ** **              | ** ** | **2003**       | ** ** | **2002**       | ** ** |
|-------------------------|------------|----------------|------------|----------------|------------|
| Expected volatility     |       | 62.30%         |       | 63.10%         |       |
| Risk-free interest rate |       | 3.15% to 4.25% |       | 3.63% to 4.02% |       |
| Dividend yield          |       | —         |       | —         |       |
| Expected life           |       | 7.5 years      |       | 7.5 years      |       |

 

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10.       EMPLOYEE BENEFITS PLANS

 

Retirement Plans — OnOctober 1, 1999, the Company implemented defined contribution plans for itsemployees.  Aggregate contributions tosuch plans, which have been charged to the Company’s operations, wereapproximately $59,000, $56,000 and $51,000 for the years ended December 31, 2004,2003 and 2002, respectively.

 

11.       COMMITMENTS ANDCONTINGENCIES

 

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

 

Product Liability Matters— The Company provides holograms in connection with a wide range of itscustomers’ products, in which case it is possible that the Company is subjectto product liabilities in association with those products or in connection withthe holograms used with those products. Although the Company maintains productliability insurance, there can be no assurance that such insurance would beavailable to cover any such claim or available in amounts sufficient to coverall potential liabilities. As a result, product liability claims could have amaterial adverse effect on the Company’s business, financial condition, resultsof operations and cash flows.

 

Leases — The Company haslong-term operating leases for offices, manufacturing facilities and equipment,which expire through 2017. The Company has three five year renewal options on itsRobbinsville location, which provides for renewal rents based upon the adjustedfair market rental value, as defined in the lease agreement.

 

Rental expense wasapproximately $1.2 million, $1.3 million and $1.3 million for the years endedDecember 31, 2004, 2003 and 2002, respectively.

 

At December 31, 2004, futureminimum lease payments under noncancelable operating leases, expiring through2017, are as follows: $1.3 million in 2005; $1.5 million in 2006; $1.4 millionin 2007; $0.6 million in 2008; $0.6 million in 2009 and $4.9 million,thereafter.

 

Employment Agreements — TheCompany entered into employment agreements with certain of its currentofficers, which provide for, among other matters, minimum compensation ofapproximately $0.5 million in 2005 and $0.4 million in 2006. The agreementsalso provide for bonuses. In connection with these agreements, the Companygranted options to acquire 1,553,000 shares of its common stock from February1999 through December 2003, at prices ranging from $0.85 to $2.50 per share,representing the fair market value of the Company’s common stock on the datesof grants.

 

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Schedule II

 

AMERICAN BANK NOTEHOLOGRAPHICS, INC.

 

VALUATION AND QUALIFYING ACCOUNTSYEARS ENDED DECEMBER 31, 2004, 2003 AND 2002

 
| ** **                                                           | ** ** | ** **                       | ** ** | **Additions**                       | ** ** | ** **                      | ** ** | ** **     | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------|------------|-------------------------------------|------------|---------------------------------|------------|----------------|------------|
| **Description**                                                      | ** ** | **Balance,  Beginning  of Year** | ** ** | **Charged to  Costs and  Expenses** | ** ** | **Charged to  Other  Accounts** | ** ** | **Deductions** | ** ** | **Balance,  End  of Year** | ** ** |
| ** **                                                           | ** ** | **(In Thousands)**               | ** ** |
| Year ended December 31, 2004:                                        | ** ** | ** **                       | ** ** | ** **                          | ** ** | ** **                      | ** ** | ** **     | ** ** | ** ** | ** ** |
| Allowance for doubtful accounts (deducted from  accounts receivable) |       | $                                | 180        |                                | $          | 23                              |       |           |       | $ | 23 | (1) | $ | 180 |   |
| Allowance for obsolescence (deducted from inventory)                 |       | $                                | 411        |                                | $          | 216                             |       |           |       | $ | 75 | (2) | $ | 552 |   |
|                                                                 |       |                             |       |                                |       |                            |       |           |       |   |   |
| Year ended December 31, 2003:                                        |       |                             |       |                                |       |                            |       |           |       |   |   |
| Allowance for doubtful accounts (deducted from  accounts receivable) |       | $                                | 210        |                                | $          | (17                             | )          |           |       | $ | 13 | (1) | $ | 180 |   |
| Allowance for obsolescence (deducted from inventory)                 |       | $                                | 1,171      |                                | $          | 124                             |       |           |       | $ | 884 | (2) | $ | 411 |   |
|                                                                 |       |                             |       |                                |       |                            |       |           |       |   |   |
| Year ended December 31, 2002:                                        |       |                             |       |                                |       |                            |       |           |       |   |   |
| Allowance for doubtful accounts (deducted from  accounts receivable) |       | $                                | 75         |                                | $          | 160                             |       |           |       | $ | 25 | (1) | $ | 210 |   |
| Allowance for obsolescence (deducted from inventory)                 |       | $                                | 725        |                                | $          | 710                             |       |           |       | $ | 264 | (2) | $ | 1,171 |   |

 

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(1)   Accounts deemed to be uncollectible.

(2)   Destructionof obsolete inventory.

 

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