** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

** **

**FORM 10-K**

 

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

** **

**For the fiscal year ended December 31, 2005**

 

**OR**

 

**o****TRANSITION REPORT PURSUANT TO SECTION13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For the transition period of             to             **

 

**Commission File No. 1-14227**

 

**AMERICANBANK NOTE HOLOGRAPHICS, INC.**

(Exact Name of Registrant as Specified in Its Charter)

 

| **DELAWARE**                                                    |   | **13-3317668**                           |
|-----------------------------------------------------------------|--------|------------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization) |   | (I.R.S. Employer  Identification Number) |
|                                                            |   |                                     |
| **2 APPLEGATE DRIVE  ROBBINSVILLE, NJ**                         |   | **08691**                                |
| (Address of Principal Executive Offices)                        |   | (Zip Code)                               |

 

**(609) 632-0800**

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

**NONE**

 

Securities registered pursuant to Section 12(g) of the Act:

**COMMON STOCK, $.01 PAR VALUE PER SHARE**

(Title of Class)

 

Indicate by check mark if the registrant is awell know seasoned issuer, as defined in Rule 405 of the Securities Act. YES  o    NO  ý

 

Indicate by check mark if the registrant isnot required to file reports pursuant to Section 13 or Section 15(d) ofthe Act. YES  o    NO  ý

 

Indicate by check mark whether the registrant:(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports, and (2) hasbeen subject to such filing requirements 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 orany amendment to this Form 10-K. ý

 

Indicate by checkmark whether the registrant is alarge accelerated filer, an accelerated filer or a non-accelerated filer. (Seedefinition of accelerated filer and large accelerated filer in Rule 12b-2of the Exchange Act). Large accelerated filer o     Acceleratedfiler o    Non-accelerated filer ý

 

Indicate by check mark whether the registrant is a shell company (asdefined in Exchange Act Rule 12b-2). YES  o    NO  ý

 

The aggregate market value of the common stock, $0.01 par value, held bynon-affiliates of the registrant, based upon the closing sale price of thecommon stock on June 30, 2005, was approximately $53,235,421. Shares ofcommon stock held by each officer and director and by each person who controls10% or more of the outstanding voting power of the registrant have beenexcluded in that such persons may be deemed to be affiliates. This determinationof affiliate status is not necessarily a conclusive determination for otherpurposes.

 

The aggregate number of shares of common stock, $.01 par value,outstanding on March 15, 2006 was 18,888,144.

 

DOCUMENTS INCORPORATED BY REFERENCE

NONE

 

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AMERICAN BANK NOTEHOLOGRAPHICS, INC.

 

2005 Form 10-K

 

### **Tableof Contents**

### ** **

| Part I                    |                                                                                                                |   |
|--------------------------------|---------------------------------------------------------------------------------------------------------------------|--------|
|                           |                                                                                                                |   |
| Item 1.                        | Business                                                                                                            | 3      |
| Item 1A.                       | Risk Factors                                                                                                        | 12     |
| Item 1B.                       | Unresolved  Staff Comments                                                                                          | 18     |
| Item 2.                        | Properties                                                                                                          | 18     |
| Item 3.                        | Legal  Proceedings                                                                                                  | 19     |
| Item 4.                        | Submission  of Matters to a Vote of Security Holders                                                                | 19     |
|                           |                                                                                                                |   |
| Part II                   |                                                                                                                |   |
|                           |                                                                                                                |   |
| Item 5.                        | Market  for Registrant’s Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities | 20     |
| Item 6.                        | Selected  Financial Data                                                                                            | 21     |
| Item 7.                        | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         | 22     |
| Item 7A.                       | Quantitative  and Qualitative Disclosures About Market Risk                                                         | 31     |
| Item 8.                        | Financial  Statements and Supplementary Data                                                                        | 31     |
| Item 9.                        | Changes In  and Disagreements With Accountants on Accounting and Financial Disclosure                               | 32     |
| Item 9A.                       | Control  Procedures                                                                                                 | 32     |
| Item 9B.                       | Other Information                                                                                                   | 32     |
|                           |                                                                                                                |   |
| Part III                  |                                                                                                                |   |
|                           |                                                                                                                |   |
| Item 10.                       | Directors  and Executive Officers of Registrant                                                                     | 33     |
| Item 11.                       | Executive  Compensation                                                                                             | 36     |
| Item 12.                       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                    | 43     |
| Item 13.                       | Certain  Relationships and Related Transactions                                                                     | 46     |
| Item 14.                       | Principal  Accountant Fees and Services                                                                             | 47     |
|                           |                                                                                                                |   |
| Part IV                   |                                                                                                                |   |
|                           |                                                                                                                |   |
| Item 15.                       | Exhibits and  Financial Statement Schedules                                                                         | 48     |
|                           |                                                                                                                |   |
| Index to Financial  Statements | F-1                                                                                                                 |

 

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**Part I.**

 

**Item 1. BUSINESS.**

 

American Bank Note Holographics, Inc. (“ABNH” or the “Company”) originates, produces, markets and sellsholograms and products incorporating holograms. The Company’s products are usedprimarily in security applications including authentication of transactioncards, identity documents, documents of value and various consumer products. TheCompany operates in one reportable industry segment. 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,Sears, Nordstrom, Quaker State, Sony, Nike, Eli Lilly, and Janssen-Cilag aswell as the United States government and other governments and companies. Wealso produce non-secure holograms for design and promotional applications.

 

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

 

•                  our reputation as a quality supplierof secure holograms with over 20 years of experience in the industry,

 

•                  our expertise in  holographic technology and productiontechniques which enables us to offer effective security solutions for a varietyof end use markets and application environments,

 

•                  our secure production and distributionprocesses and capabilities which qualify us to meet the stringent requirementsof security conscious customers,

 

•                  our origination laboratories, whichenable us to produce distinctive holograms with a variety of security featuresthat make them difficult to counterfeit, and

 

•                  our integrated manufacturingfacilities, which allow us to mass produce our products in accordance with thehighest quality standards.

 

**TheHolography Industry**

 

A hologram is aunique type of image that is created through the diffraction of light atpre-determined angles to create various visual effects. Holograms are createdwith special laser configurations and do not use ink, thereby enabling aholographic image to be easily distinguished from a traditionally printed orcopied image. When a hologram is viewed from different angles, the viewer isable to see features such as depth and movement, which would not typically bepossible in most two-dimensional images. Holograms can also include informationthat is detectable 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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•                  difficult to copy - holograms cannotbe copied with conventional copying equipment such as color copiers orscanners. The unique properties and high resolution of a security hologram makeit extremely difficult to replicate even with specialized equipment andexpertise.

 

•                  overt features - the unique visualaspects of a hologram are easily recognizable, making authentication ofproducts and documents practical for the general public without specialmachinery, equipment or training. Overt features that we offer include:

 

•                  3-D Imagery - animage that has three dimensions and gives the illusion of depth or varyingdistances.

 

•                  TrueColor- aholographic image that gives the illusion of color.

 

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

 

•                  Secondary FlipImage - an image that appears and disappears when viewed at certain angles.

 

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

 

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

 

•                  covert features - hidden featuresthat can only be detected with high-powered microscopes or specialized readerscan be incorporated into a hologram to make it more difficult to counterfeit,facilitate verification in the field and support forensic investigation. Covertfeatures that we offer include:

 

•                  Hidden LatentImage - a hidden element within a holographic image that is machine-readableonly with a proprietary reader.

 

•                  HoloScanTM - ABNH’shidden machine readable code within a holographic image that can be read withspecial readers.

 

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

 

•                  Nano Imagery -microscopic text or a logo within a holographic image that is visible only withhigh-powered magnification.

 

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

 

•                  HoloMagTM – an integrated hologram andmagnetic stripe.

 

•                  Micro-demetallization- a feature whereby a designed portion of the vacuum deposited aluminum materialsare removed from the holographic film to create additional unique features thatcan be used to differentiate and authenticate the materials. This can be usedto create see through screens, additional micro text in the metallizationlayer, and images that are only visible under magnification.

 

•                  Tamper Apparent- an invisible feature used in labels which when combined with the holographicimage will act as a self destructive layer and produce a predictable releasepattern that indicates that a product has been tampered with or altered. Thisrelease pattern can be in the form of a customized or generic design.

 

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•                  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 ofsecurity, authentication and design features. Based on customer specific needsand applications, we can combine these techniques creating a unique set ofeffects in a well-constructed and effective holographic security product.

 

***Non-Security***

 

The non-securitysector of the holography industry includes design, packaging and otherdecorative applications.

 

The unique visualappeal 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 are generallynot as complex, secure or proprietary as security holograms. Since there aremore 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:

 

***TransactionCards***. In the early 1980’s, we began marketing our secureholograms for use on transaction cards and, as a result, helped to create andexpand the security sector of the holography market. Since that time, hologramshave been established as an important fraud prevention device on transactioncards. They are also commonly used to enhance the brand image of a transactioncard issuer. Our products include:

 

HolographicHot-Stamp Patch. Our largest source of revenue since ourinception has been security holograms embossed into hot-stamp foil, fortransaction card authentication. Holographic hot-stamp patches can also enhancethe design and branding of a card. Our customers for this product include theissuers or manufacturers of MasterCard, VISA, American Express, Diners Club,Sears and various other retail and payment cards. We are the market leader inthis segment and have developed a secure, global distribution system for secureholograms to the payment card industry.

 

HoloMagTM.HoloMag is an integrated holographic magnetic stripe. HoloMag significantlyenhances the security of a card with overt, covert and machine readablesecurity features. HoloMag also supports the branding objectives of cardissuers with attractive imagery on the magnetic stripe while freeing up spaceon the front of cards.

 

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HoloCardTM. HoloCardincorporates 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.

 

***IdentificationDocuments.*** We provide secure holographic laminates andpatches for identity documents such as national ID cards, passports, governmentcredentials, military credentials and drivers’ licenses. We have patents ondemetallized holograms which are transparent and used to see printedinformation under the holograms.

 

We believe thereare significant security advantages for demetallized holograms used on ID cardsand other documents. We currently supply demetallized laminates for certainsecure U.S. government credentials as well as national IDs for certain foreigncountries. We believe there is a need to improve the security of many identitydocuments used in the United States and other countries, and we are proposingsecurity holograms as a component of the security enhancements that are beingconsidered by major issuers of identification documents.

 

***ProductAuthentication and Security Packaging.*** The use ofholograms for product authentication and security packaging is driven byconcerns regarding counterfeiting, piracy, pilfering, diversion and otherinfractions that can result in lost sales, lost goodwill and product liabilityclaims. Holograms are used as authentication devices in, among others,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 with abroad 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 innovativeapproach to sealing bottles or containers with a higher level of security.Utilizing an induction seal process, this application provides forauthentication, tamper-resistance and branding. A holographic layer becomes part ofthe seal itself. HoloCap can be combined with other security features to createan effective approach for the security needs of a wide range of sealedproducts.

 

Holographic ShrinkSleeves. ABNH has developed a heat-shrink seal with anintegrated holographic stripe that can be applied to the lids of bottles todeter product fraud and tampering. By including overt and covert securityfeatures within the hologram, a customized tamper-apparent break pattern and anembedded black light verification system, ABNH’s holographic shrink sleevesprovide manufacturers of bottled goods with a tool to combat criminals that, atthe same time, can be easily integrated into a customer’s existing manufacturingoperations.

 

***Documentsof Value.*** Concerns over counterfeiting and copying haveled to an increased use of holograms produced by international suppliers forinternational markets for currency, checks, gift certificates, tax stamps andother financial instruments. While this market may provide a future growthopportunity for the Company, we have had minimal sales in this market to date.Holographic products for 

 

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paper documents ofvalue include:

 

HolographicThread. A holographic thread is a security device made up ofa 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 produce holographic material for security threadswith our proprietary process, which we believe provides significant advantagesfor brighter and more durable holographic threads compared to other methods ofholographic replication.

 

HolographicRibbons. A holographic ribbon is an anti-counterfeitingdevice that can be used on documents of value such as checks and currency. Thesystem is comprised of a narrow strip hologram made of hot-stamp foil and slitinto ribbons that are applied on security paper by either the paper maker orthe printer.

 

HolographicPatch. A holographic patch is created by embossing a holograminto hot-stamp foil, and is used for authenticating currency and other securedocuments. 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 holographic imagery for decorative and promotional purposes.Our products for this market include pressure sensitive labels with a richarray of designs and wide web holographic patterns for flexible packagingapplications.

 

**Strategy**

 

*Protectand Enhance 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 leading transaction card companies andmany of the major security card manufacturers. We intend to maintain ourleadership position in the card industry and grow through excellent customerservice and the distribution of new products that address the security needsand design objectives of this market.

 

*FocusSales and Marketing.*We have narrowed the focus of our salesand marketing efforts to those specific applications within our target marketsin which we can establish and sustain competitive advantages through acombination of product differentiation, intellectual property and marketposition.

 

*Broadenand Enhance Our Security Offerings*. We are developing bettersecurity solutions for our target markets which incorporate innovativeapplications of holography and other complementary technologies.

 

*ControlCosts*. We have invested in and intend to continue to investin more efficient operations and prudently manage our expenses to strengthenour competitive position and enhance profitability.

 

*StrengthenOperational Capabilities*. We have made significantinvestments in our facilities and our manufacturing capabilities and intend tocontinue to invest in enhancing our production and operational capabilities tobroaden our product range, improve the products and services we provide to ourcustomers, become more vertically integrated in our manufacturing operationsand to gain operational efficiencies.

 

**ProductionProcesses**

 

We are one of themost experienced security production companies in the holographic industry. Ournew facility in Robbinsville, New Jersey combines the operations that werepreviously conducted in our

 

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facilities inElmsford, New York and Huntingdon Valley, Pennsylvania while expanding andbroadening our production capabilities. In this facility, we operate aholographic design studio, six holographic origination laboratories, arecombining operation, electroforming, plate making, eighteen mass replicationlines, converting and finishing operations as well as extensive quality controland security procedures. Additionally we have high security warehouse andshipping and receiving areas.

 

Our productionprocess is integrated to handle most aspects of production, including materialssourcing, processing, finishing, packaging, storage and logistics. We generallydesign and originate our own holograms in our facility in Robbinsville NewJersey. We subcontract certain production functions or products, includingHoloMag, to third parties. The production process for holograms produced by theCompany consists of the following steps:

 

***Design***

 

The first step ofthe 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 the designhas been completed, various laser-ready components (magnetic disc,three-dimensional sculpture, flat art, etc., referred to as “information”) aredelivered to our holographic 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 object beamthen 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.

 

***PlateMaking***

 

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. Webelieve that our plate making process is an important component of our abilityto mass-produce our

 

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secure hologramswith high precision.

 

The electrolyticprocess creates different “generations” of plates prior to the productionphase. Each generation, identical to the last, creates a more wear resistantplate for use in a mass production environment, thereby extending the usefullife of the plate. The production plate will have varying degrees of hardness,depending upon the processes used in production.

 

***MassProduction***

 

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 employ threemethods of mass-production of holograms. Hard embossing transfers images to analuminum foil/polyester substrate through heat and pressure. Heat and pressureon the holographic plate force the holographic image into the foil, which isthen converted into the final product. Soft or compliant embossing permitsembossing into pre-metallized and other films and allows for embossing onwider-web materials.

 

The other methodof mass production we employ is casting. We developed a proprietary castingmethod involving ultraviolet curing, which we refer to as In-Situ PolymericReplication. Using this method, a polymer is transferred to a substrate(polyester, polypropylene, etc.) which is then put in contact with theholographic plate so that holographic imagery is replicated. The material isthen metallized using a vacuum deposition process.

 

Finishing for eachof 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.

 

**Procurement of Key Materials and Products**

 

We purchasecertain key materials used in the manufacture of our products, and subcontractcertain production functions or products from third parties some of which aresole suppliers. In some cases, we do not have supply contracts with oursuppliers, and operate on a purchase order basis. In the case of HoloMag, wehave a single supplier, CFC International, Inc., with whom we have asupply contract. We may not be able to find alternative sources in atimely manner if our suppliers or subcontractors become unwilling or unable tosupply us, or if they increase their prices. Our inability to obtain keyproduct components or to have certain processes performed on our behalf couldcause delays or reduce product shipments, which could cause our relationshipwith customers to suffer and materially and adversely affect our financialcondition, results of operations and cash flows.

 

**Quality**

 

Through anextensive quality assurance program, we continually make improvements to ourprocesses through the use of an effective and efficient business managementsystem.

 

In 2005, we movedand consolidated our facilities from Elmsford, New York and Huntingdon Valley,Pennsylvania into a new facility in Robbinsville, New Jersey. (See “ManufacturingFacilities” below and “Item 2. Properties”). We began the ISO 9001-2000certification process for this facility during 2005.

 

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**InformationTechnology**

 

We have implemented an integrated enterprise resource planning systemthat provides information for management decision making. We made improvementsto this system in 2005 and we intend to make additional improvements in 2006.

 

**Researchand Product Development**

 

We have devotedsignificant attention to research and product development to continue toenhance our origination, replication and mass production capabilities as wellas the features and performance of our products. Our research and developmenthas enabled us to create new technologies and proprietary production processesand to deliver innovative products to the marketplace. We intend to continue tomake on-going investments in research and development in order to:

 

•                  Develop better solutions for our customers’ problems.

•                  Create features which differentiate our products fromthose of our competitors.

•                  Develop and improve processing techniques to improvethe quality and reduce the costs of 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. During 2005,substantial construction was completed within this facility to meet ourspecialized operational and security requirements and this facility has becomethe site for our primary operations. The new facility provides substantial room forexpansion as we consolidated our operations that were conducted within a 58,000square foot facility in Elmsford, New York and a 30,000 square foot facility inHuntingdon Valley, Pennsylvania into the new facility. We are currentlyevaluating the possible use of the Huntingdon Valley facility for certainmanufacturing and secure storage. We have also acquired  and installed additionalequipment and technology in the Robbinsville facility in order to broaden ourcapabilities to serve our target customers, expand capacity, become morevertically integrated and improve efficiency. See “Item 2. Properties.”

 

**Sales and Marketing**

** **

In 2005, we provided holographic products to over 200 customersworldwide. The majority of these customers are manufacturers of securetransaction cards. We are the exclusive supplier of holograms to MasterCard andwe are one of two authorized manufacturers of VISA Dove holograms for sale toapproved manufacturers of VISA cards. In 2005, we supplied holographic magneticstripes for VISA, MasterCard, American Express and Diners Club cards. See Item1A. “Risk Factors–*VISA’s decision to discontinue the use of the current version of HoloMag willhave a material adverse effect on our results of operations and financialcondition*”. In addition, we supply holograms to Sears, Nordstrom,Quaker State, Sony, Nike, Exxon Mobil, Janssen-Cilag and Eli Lilly, as well asthe United States government and other governments and companies.

 

In the salesdepartment we currently employ a Vice President of Sales, a Vice President ofCorporate Development, and two full-time, incentive-compensated salespeople. Wealso utilize incentive-based international sales agents around the world.During 2005, as a result of the roll-out of our HoloMag product we reorganizedand expanded our Customer Service group by adding a Director of CustomerService and four customer service personnel.

 

Our sales processgenerally involves identifying a customer need, designing a solution for thecustomer

 

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need, creatingsamples for customer evaluation and testing. Most of our target customers aretransaction card issuers, government agencies and large corporations that areexperiencing counterfeiting or other security problems. The sales process isgenerally at least three months, and in some cases, the sales process can lastseveral years.

 

Pricing decisionsare generally made centrally by our operating executives. We focus some of ourmarketing efforts on trade shows such as the Card Tech/SecureTech trade show,Cartes and a number of other security industry conferences around the world.

 

**Competition**

** **

The holographic,magnetic tape and product security industries are highly competitive and highlyfragmented. A number of our competitors are larger, and have greater financialresources, than us. Our industry has become increasingly competitive over thepast several years as low cost foreign producers have entered our targetmarkets, and low cost holographic producers that previously focused onnon-security applications are increasingly competing in security applications.The holographic industry has also experienced consolidation, which hasincreased the breadth and scale of some of our competitors. In the holographicindustry, competition is generally based on technology, price, product qualityand customer service. We also compete with other non-holographic methods ordevices.

 

**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 cannot assureyou that the degree of protection offered by our patents is sufficient; thesuccess of any of our enforcement actions or the likelihood that patents willbe issued for pending applications. Competitors in the U.S. and foreigncountries may have applied for or obtained, or may in the futureapply for and obtain, patents that will prevent, limit or interfere with ourability to make and sell some of our products.

 

**Employees**

** **

As of March 15,2006, we employed 120 persons of which 57 are covered by collective bargainingagreements. We consider our relations with our employees to be good. We areparty to a collective bargaining agreement with Paper, Allied-Industrial,Chemical & Energy Workers International Union Local 286 (“Local 286”).Prior to our consolidation in Robbinsville, New Jersey we also had employeescovered by an agreement with PACE International Union Local 1-0318. Inconnection with our****move toRobbinsville, New Jersey, we  enteredinto a closure agreement with Local 1-0318, dated March 19, 2005, thatprovided for the termination of the contract with Local 1-0318. The agreementwith Local 286 has a five-year term, which will expire on January 28,2010.

 

**Available Information**

 

Our investor relations website is accessable through www.abnh.com. Wemake available on this website under the caption “Investor Relations (SECFilings)” free of charge, our annual reports on Form 10-K, quarterlyreports on Form 10-Q, current reports on Form 8-K and amendments tothose reports as soon as reasonably practicable after we electronically file orsubmit such materials to the Securities and Exchange Commission.

 

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**Item 1A.**                                                  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 madepursuant to the provisions of the Private Securities Litigation Reform Actof 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.

 

*VISA’s decision to discontinuethe use of the current version of HoloMag had a material adverse effect on our results of operations and financialcondition in the quarter ended December 31, 2005 and will continue toimpact our results of operations and financial condition in 2006.*

 

Sales to manufacturers ofVISA transaction cards were approximately 37%, 31% and 30% of sales for theyears ended December 31, 2005, 2004 and 2003, respectively. Currently weare one of two companies authorized to manufacture and sell the VISA Dove hotstamp holograms to manufacturers of VISA brand transaction cards.****OnMarch 15, 2005, VISA announced its intention to phase out the Dove hotstamp hologram that we supply for the front of the VISA card, and to replace itwith an integrated holographic magnetic stripe. On April 8, 2005, weentered into an Agreement with VISA, pursuant to which we are authorized tosupply HoloMag to VISA approved card manufacturers. Sales of HoloMag to VISAauthorized card manufacturers amounted to $2.3 million and $3.8 in the threemonths ended September 30, 2005 and December 31, 2005, respectively. Wepreviously reported that we had learned of a small number of incidents in whichcertain card terminals had been affected by electro-static discharge (“ESD”)from static electricity carried on cards incorporating HoloMag. On March 14,2006, we were informed by VISA that, as a result of the ESD issue, VISA isinforming its member financial institutions and authorized card manufacturersthat (i) VISA will no longer approve VISA card designs which incorporatethe current version of HoloMag, (ii) VISA strongly recommends that theirmembers attempt to avoid further issuance of cards incorporating the currentversion of HoloMag and (iii) VISA recommends that their members follow analternate card design incorporating a conventional magnetic stripe and Dovehologram and VISA also provided notice to us that it was revoking our right toproduce HoloMag under its agreement (the “VISA Decision”). VISA’s decision todiscontinue the use of the current version of HoloMag and the resulting cessationof sales has had, and will continue to have a material adverse effect on ourresults of operations and financial condition.

 

As a result of the VISA Decision, the Company’s results of operationsfor the quarter and year ended December 31, 2005 have been materiallyaffected. In the quarter ended December 31, 2005, as a result of the VISADecision, we recorded a pre-tax charge amounting to approximately $5.0 millionof which $4.8 million was recorded in cost of goods sold and was principallyrelated to the value of our HoloMag inventory. Also included in the charge wereincreases in our provisions for accounts receivable and potential non-ESDrelated warranty claims. We will review the valuation of these accounts on anongoing basis as part of our closing process and make appropriate changesto our reserve levels based upon the facts at the time. Sales of HoloMag toVISA authorized transaction card manufacturers began in the quarter endedSeptember 30, 2005 and amounted $2.3 million in that quarter. In thequarter ended December 31, 2005 HoloMag sales to VISA authorized cardmanufacturers amounted to $3.8 million. Sales of VISA HoloMag continued to growin the first quarter of 2006 compared to the prior quarter until theannouncement by VISA on March 14, 2006. Accordingly, our sales in thequarter ending March 31, 2006 are expected to be higher than the level ofthe quarter ended December 31, 2005 and are expected to decline thereafteras a result of the VISA Decision.

 

We are currently working on the developmentof a second generation of holographic magnetic tape, but there can be noassurance that we will be successful in developing such a product, or that anysuch product will be acceptable to our customers. Further there can be noassurance that a competitor of ours will not develop an acceptable product thatis adopted by our customers.

 

12

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*We may be subject to claimsarising from the suspension of sales of HoloMag for VISA transaction cards.*

 

In its correspondence to us relating toHoloMag, VISA has stated to us its view that “a remediation program forimpacted stakeholders may be necessary” and that VISA would seekindemnification from us for such costs and/or claims. We have been evaluatingVISA’s actions and claims and have submitted our initial response to VISA. VISAhas recommended to its members that cards bearing the HoloMag product alreadyin the market be replaced as soon as practical. Additionally, as a result ofVISA’s notification to financial institutions and authorized cardmanufacturers, we have received communications from customers seeking toaddress the status and disposition of their HoloMag inventory and orders.

 

In the event that VISA or other third partiesassert claims against us, our financial condition and results of operations maybe adversely affected.

 

*We depend on sales to transaction card companies for asubstantial portion of our revenue, the loss of which would have a materialadverse effect on our business.*

* *

A significant portion of the Company’sbusiness is derived from orders placed by certain transaction card companiesand manufacturers of transaction cards, and variations in the timing of suchorders can cause significant fluctuations in the Company’s sales. Salesto transaction card companies and manufacturers of transaction cards accountedfor approximately 86% of our total sales in 2005 and 84% of our total sales in2004. The traditional hot stamp patch hologram on many transaction cards isbeing phased out by some of our major customers and is being replaced by anintegrated holographic magnetic stripe. We previously reported that we hadlearned of a small number of incidents in which certain card terminals had beenaffected by electro-staticdischarge (“ESD”) from static electricity carried on cards incorporating thecurrent version of HoloMag. We have been advised by customers that there is aneed to develop a second generation holographic magnetic tape product thataddresses ESD and we have commenced such development. There can be no assurancethat we will be successful in developing such a product that will be acceptableto our customers. Further there can be no assurance that a competitor of ourswill not develop an acceptable product that is adopted by our customers. To theextent that we experience declining sales of HoloMag or traditional hot stamp patchholograms to our transaction card customers, without replacing such sales withsales of new products, our business, operating results and financial condition wouldbe materially and adversely affected.

 

*We depend on sales to MasterCard for a substantial portion of ourrevenue, the loss of which would have a material adverse effect on ourbusiness.*

 

Sales to MasterCard were approximately 31% and 35% of sales for theyears ended December 31, 2005 and 2004, respectively. The Company has anagreement with MasterCard, as amended, pursuant to which the Company is theexclusive supplier of MasterCard holograms and holographic magnetic stripes,HoloMagTM. In the quarter ended September 30, 2005, MasterCard advised itsmember financial institutions around the world that it will allow them tochoose among card designs that incorporate either the traditional hot stamppatch hologram or HoloMag, both of which are supplied by the Company. Theagreement with MasterCard was amended on August 24, 2005, and expires on February 28,2013, subject to automatic renewal thereafter.

 

If we were to lose a substantial portion of our business withMasterCard without replacing it with new product sales, our business, operatingresults and financial condition would be materially and adversely affected. Inaddition, if we fail to obtain anticipated orders from MasterCard or if weexperience delays or cancellations of orders from MasterCard, our business andfinancial performance will be materially and adversely affected.

* *

* *

*13*

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* *

*Our quarterly and annual operating results may fluctuateand the price of our common stock may change in response to those fluctuations.*

* *

Our quarterly andannual operating results have varied in the past and may varysignificantly in the future depending on factors such as:

 

•                  theimpact of the VISA Decision on our business,

•                  timing of customer orders,

•                  customer business cycles,

•                  cancellation or expiration ofcustomer contracts or programs,

•                  card expiration patterns,

•                  inventory replenishment,

•                  increased competition,

•                  changes in our and our competitors’pricing policies,

•                  changes in the cost of materials orlabor,

•                  cost and availability of the servicesof subcontractors,

•                  costs of recruiting or relocatingpersonnel,

•                  increased research and developmentexpenses,

•                  expenses associated with litigation,

•                  market acceptance of our products,

•                  the time required for customertesting and evaluation,

•                  costs associated with implementingchanges in operations,

•                  investments in new technology andequipment,

•                  changes in facility requirements,

•                  changes in our business strategy, and

•                  general economic 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 are in a competitive, highly-fragmented industrywith many companies competing to deliver a highly-specialized product, which may leadto declining sales or reduced prices for our products.*

* *

The holographic,magnetic tape and product security industries are highly competitive and highlyfragmented. A number of our competitors are larger, and have greater financialresources, than us. Our competitors, which are numerous and may have moreresources than us, may take away market share or compete with us on thebasis of price, which may erode our prices and margins. Our industry hasbecome

 

14

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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. The holographic industry has also experienced consolidation,which has increased the breadth and scale of some of our competitors. Increasingcompetition in the market for our security holograms has resulted in decliningsales prices for certain products. Competitive pressures may force us toreduce prices, which can adversely affect our results of operations.

 

Competition isbased on a number of factors, such as:

 

•                  price,

•                  technology,

•                  product quality, and

•                  customer service.

 

In addition, anincreased 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.

 

We have been advised by customers that there is a need to develop asecond generation holographic magnetic tape product that addresses ESD fromstatic electricity carried on cards incorporating the current version ofHoloMag, and we have commenced such development. There can be no assurance thatwe will be successful in developing such a product that will be acceptable toour customers. We are aware that competitors are working to develop productsthat would compete with our current and potential future offerings including asecond generation of holographic magnetic tape that does not give rise to ESDissues.

 

*If we are not able to successfully protect ourintellectual property our business could be materially and 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. We can notassure you that we will be able to maintain the confidentiality of our tradesecrets or that our confidentiality agreements will provide meaningfulprotection of our trade secrets or other proprietary information. In addition,litigation may be necessary in the future to enforce our intellectualproperty rights or to determine the validity and scope of our patents or of theproprietary rights of others. Such litigation might result in substantial costsand diversion of resources and management attention.

 

*If our products infringe on the intellectual propertyrights of third-parties, our business may suffer if we are sued forinfringement or cannot obtain licenses to these rights on commerciallyacceptable terms.*

* *

We are subject tothe 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. Anysuch claims, with or without merit, could result in significant litigationcosts and diversion of management attention, and could require us to enter intoroyalty and license agreements that may be disadvantageous to us or causeother harm to our business. If litigation is successful against us, it

 

15

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could result ininvalidation of our proprietary rights and liability for damages, which couldhave a material adverse effect on our business and financial condition.

 

*We depend on third-party suppliers and subcontractorsfor some key products and processes, and we may not be able to findalternative sources in a timely manner if those suppliers or subcontractorsfail to supply us.*

* *

We purchase certain key materials used in the manufacture of ourproducts, and subcontract certain production functions or products from thirdparties some of which are sole suppliers. In some cases, we do not have supplycontracts with our suppliers, and operate on a purchase order basis. In thecase of HoloMag, we have a single supplier, CFC International, Inc., withwhom we have a supply contract. We may not be able to find alternativesources in a timely manner if our suppliers or subcontractors become unwillingor unable to supply us, or if they increase their prices. Our inability toobtain key product components or to have certain processes performed on ourbehalf could cause delays or reduce product shipments, which could cause ourrelationship with customers to suffer and materially and adversely affect ourfinancial condition, results of operations and cash flows.

 

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

* *

Our common stocktrades on the over-the-counter bulletin board (OTCBB), an electronic quotationservice. The OTCBB does not impose listing standards or requirements, does notprovide automatic trade executions and does not maintain relationships withquoted issuers. Stocks traded on the OTCBB may experience:

 

•                  a loss of market makers,

•                  a lack of readily available bid andask prices,

•                  a greater spread between the bid andask prices of its stock, and

•                  a general loss of liquidity comparedto established stock exchanges or the NASDAQ National Market.

 

In addition, manyinvestors have policies against purchasing or holding OTCBB securities. Bothtrading volume and the market value of our stock have been, and will continueto be, affected by trading on the OTCBB, which may adversely affect theprice of our stock and make it difficult for our stockholders to resell theirshares.

 

*If we were unable to continue to attract and retainqualified employees, our business, operating results and financial conditioncould be materially and adversely affected.*

* *

While we haveadded significantly to our talent pool in 2005 our future success continues todepend on our ability to attract and retain qualified:

 

•                  management,

•                  engineering,

•                  manufacturing,

•                  research and development,

•                  sales and marketing, and

•                  customer support personnel.

 

Competition forthese individuals is intense, and we cannot assure you that we will be able toretain our existing personnel or attract and retain additional personnel.

 

16

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*We may be subject to significant productliability in connection with the products which we provide to our customers.*

* *

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 significant percentage of our sales arederived from overseas customers, our exports and business may be subject tosome risks related to doing business internationally.*

* *

Sales derived fromcustomers outside the United States were 34% of our total sales in 2005 and 21%of our total sales in 2004. Our international sales are subject to risks,including:

 

•                  U.S. and international regulatoryrequirements and policy changes,

•                  exchange rate fluctuations,

•                  political and economic instability,

•                  difficulties in accounts receivablecollection,

•                  tariffs and other barriers, and

•                  difficulty in attracting, retainingand managing international representatives.

 

These factors may havea material adverse effect on our future international sales, and consequentlyour business, financial condition or results of operations.

 

*Our business is subject to environmental regulationand is always subject to environmental liability.*

* *

Our operations aresubject to federal, state and local environmental laws and regulations. If wefail to comply with applicable rules and regulations, we could be subjectto monetary 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 of our common stock uponexercise of outstanding options, together with the potential sales of suchshares in the public market, could result in substantial dilution of yourinvestment, a detrimental effect on our liquidity and ability to raiseadditional capital, and a significant decline in the market value of our commonstock.*

* *

As of March 15,2006, we had 18,888,144 shares of our common stock issued and outstanding and3,151,263 additional shares of common stock reserved for issuance upon exerciseof outstanding stock options. If the holders of shares of common stock acquiredupon the exercise of outstanding options or the lapse of the sale restrictionson restricted stock grants were to sell a significant amount of their sharesinto the open market, the market price of our common stock could be adverselyaffected. The sales might also make it more difficult for us to sell equity orequity-related securities in the future at a price we deem appropriate.

 

*Crane & Co. Inc. has certain rights whichcould adversely affect the market price of our common stock.*

* *

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. Thisstock is not currently registered for

 

17

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public resale, butmay be sold (i) in privately negotiated transactions, (ii) pursuantto Rule 144 in the public market, and subject to the volume restrictionsof Rule 144, or (iii) pursuant to a registration statement filed bythe Company. Crane has the right to demand registration on Form S-3 in theevent Form S-3 is available to the Company. Since our stock trades on theOTC Bulletin Board the Form S-3 is not currently available to the Company.Crane also has piggy-back registration rights which require us to register itsstock in the event the Company files a registration statement to sell commonstock. On November 30, 2005 we were informed by Crane & Co., Inc.of their intention to sell a portion or all of their shares in an orderlymanner. If the sale of these shares is not conducted in an orderly fashion itcould have a negative impact on the price of our common stock. If we arerequired to register Crane’s common stock, the Company will incur legal,accounting and other expenses associated with the registration and sale, andthe registration and sale of Crane’s common stock may have an impact on themarket for our common stock. To date, we are not aware that Crane has sold anyshares.

 

*Our principal stockholders, executive officers anddirectors have substantial influence over all matters requiring stockholderapproval, including a change of control that you might otherwise approve.*

* *

Our principalstockholders, executive officers and directors and entities related to them, inthe aggregate, beneficially own approximately 48% of our common stock as of March 15,2006. These stockholders acting together have the ability to exert substantialinfluence over all matters requiring approval by our stockholders. Thesematters include the election and removal of directors and any merger,consolidation or sale of all or substantially all of our assets. Such aconcentration of ownership could have the effect of delaying, deferring orpreventing a change in control, or impeding a merger or consolidation, takeoveror other business combination.

 

*Effects of anti-takeover provisions could inhibit theacquisition of ABNH.*

* *

Our certificate ofincorporation permits our board of directors to issue up to 5,000,000 shares ofpreferred stock and to fix the rights, preferences, privileges and restrictionsof such shares without any further vote or action by our stockholders. Althoughwe have no current plans to issue shares of preferred stock, the potentialissuance of preferred stock may have the effect of:

 

•                  discouraging potential acquisitionsproposals,

•                  delaying or preventing a change incontrol, and

•                  limiting the price that investorsmight be willing to pay in the future for shares of our common stock.

 

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 1B. UNRESOLVED STAFFCOMMENTS.**

 

Not applicable.

 

**Item 2. PROPERTIES.**

 

We maintain securehologram manufacturing facilities in Robbinsville, New Jersey, HuntingdonValley, Pennsylvania and Dalton, Massachusetts. During 2005 we moved ourheadquarters and substantially all of our principal operations, including ourdesign, engineering, research and development, holographic

 

18

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origination, platemaking, manufacturing, distribution and quality control for numerousholographic products to our 134,000 square foot leased facility atRobbinsville, New Jersey. The initial lease term for the new facility isthrough May 2017 and at the expiration of the lease, we have options torenew the lease for three consecutive five year periods and we also have anoption to make an offer to purchase the building.

 

Our 30,000 squarefoot leased facility at Huntingdon Valley, Pennsylvania was vacated as part ofthe move and consolidation of operations in 2005. We are currently evaluatingthe possible use of this facility for certain manufacturing and secure storage.The lease on this facility expires in July 2007.

 

Our 2,400 squarefoot leased facility at Dalton, Massachusetts was opened in 2000 and has beendedicated to the production of security holograms.

 

Our 57,200 squarefoot leased facility at Elmsford, New York was vacated and all operationspreviously conducted in the facility were transferred to Robbinsville in 2005. Thelease on the facility expires in December 2007. We have the right tosublease and have been attempting to do so since the building was vacated. Weare currently negotiating a settlement of our obligations for the remainder ofthe lease term with the landlord.

 

Each of ourfacilities is constantly monitored for security, and has uniformed securitypersonnel on site, 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.

 

**Item 3. LEGAL PROCEEDINGS.**

 

We currently, andfrom time to time, are involved in litigation (as both plaintiff and defendant)incidental to the conduct of our business; however, we are not a party to anylawsuit or proceeding which, in our opinion, is likely to have a materialimpact on our financial position, results of operations or cash flows.

 

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

 

None.

 

19

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**Part II**

 

**Item 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES.**

 

Our common stockhas been quoted on the NASD’s Over-the-Counter Bulletin Board quotation serviceunder the symbol “ABHH,” since March 31, 2000. Our securities are notlisted or quoted on any exchange or other quotation system.

 

The followingtable sets forth the high and low closing prices of our common stock for eachquarter of 2004, 2005 and the period from January 1 to March 28 of2006.

 
| ** **                                   | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------------------------------------|------------|----------|------------|---------|------------|
| **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                                |       | $        | 3.62       |    | $          | 2.75 |   |
| Second Quarter                               |       | 4.13     |       | 3.60    |       |
| Third Quarter                                |       | 5.92     |       | 3.87    |       |
| Fourth Quarter                               |       | 6.95     |       | 5.05    |       |
|                                         |       |     |       |    |       |
| **2006**                                     |       |     |       |    |       |
| First Quarter (through March 28,  2006) |       | $        | 6.40       |    | $          | 2.00 |   |

 

As of March 28,2006, there were approximately 550 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 not paidcash dividends during the past two fiscal years. We have no plans or intentionsof paying dividends in the foreseeable future.

 

20

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**Item 6. SELECTED FINANCIAL DATA.**

 
| ** **                                                          | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                          | ** ** | **2001**                                   | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| STATEMENT OF INCOME  DATA:                                          |       |                                       |       |   |   |   |   |   |   |   |   |
| Revenue:                                                            |       |                                       |       |   |   |   |   |   |   |   |   |
| Sales                                                               |       | $                                          | 20,016     |   | $ | 18,665 |   | $ | 18,284 |   | $ | 21,263 |   | $ | 32,299 |   |
| Royalty income                                                      |       | 466                                        |       | 555 |   | 48 |   | 13 |   | 20 |   |
|                                                                |       | 20,482                                     |       | 19,220 |   | 18,332 |   | 21,276 |   | 32,319 |   |
| Costs and expenses:                                                 |       |                                       |       |   |   |   |   |   |   |   |   |
| Cost of goods sold,  exclusive of depreciation and amortization (a) |       | 9,962                                      |       | 8,926 |   | 8,279 |   | 9,161 |   | 19,368 |   |
| Selling and  administrative                                         |       | 7,314                                      |       | 7,136 |   | 6,518 |   | 7,070 |   | 8,850 |   |
| Research and  development                                           |       | 1,233                                      |       | 1,143 |   | 1,142 |   | 1,270 |   | 1,263 |   |
| Depreciation and  amortization                                      |       | 1,097                                      |       | 800 |   | 739 |   | 830 |   | 1,297 |   |
| Facility consolidation                                              |       |                                       |       |   |   |   |   | 242 |   | 2,769 |   |
| Impairment of goodwill  and fixed assets (b)                        |       | —                                     |       | 9,298 |   | — |   | — |   | — |   |
|                                                                |       | 19,606                                     |       | 27,303 |   | 16,678 |   | 18,573 |   | 33,547 |   |
|                                                                |       |                                       |       |   |   |   |   |   |   |   |   |
| Operating income (loss)                                             |       | 876                                        |       | (8,083 | ) | 1,654 |   | 2,703 |   | (1,228 | ) |
|                                                                |       |                                       |       |   |   |   |   |   |   |   |   |
| Other income:                                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Interest, net                                                       |       | 258                                        |       | 113 |   | 97 |   | 121 |   | 259 |   |
| Patent settlement and  other                                        |       | —                                     |       | 691 |   | — |   | 178 |   | — |   |
|                                                                |       | 258                                        |       | 804 |   | 97 |   | 299 |   | 259 |   |
| Income (loss) before  provision (benefit) for income taxes          |       | 1,134                                      |       | (7,279 | ) | 1,751 |   | 3,002 |   | (969 | ) |
| Provision (benefit) for  income taxes                               |       | 543                                        |       | 858 |   | 744 |   | 1,201 |   | (388 | ) |
| Net income (loss)                                                   |       | $                                          | 591        |   | $ | (8,137 | ) | $ | 1,007 |   | $ | 1,801 |   | $ | (581 | ) |
|                                                                |       |                                       |       |   |   |   |   |   |   |   |   |
| Net income (loss) per  share: (c)                                   |       |                                       |       |   |   |   |   |   |   |   |   |
| Basic                                                               |       | $                                          | 0.03       |   | $ | (0.44 | ) | $ | 0.05 |   | $ | 0.10 |   | $ | (0.03 | ) |
| Diluted                                                             |       | $                                          | 0.03       |   | $ | (0.44 | ) | $ | 0.05 |   | $ | 0.10 |   | $ | (0.03 | ) |
|                                                                |       |                                       |       |   |   |   |   |   |   |   |   |
| Weighted average shares  outstanding: (c)                           |       |                                       |       |   |   |   |   |   |   |   |   |
| Basic                                                               |       | 18,484                                     |       | 18,484 |   | 18,484 |   | 18,489 |   | 18,593 |   |
| Diluted                                                             |       | 18,484                                     |       | 18,484 |   | 18,526 |   | 18,907 |   | 18,593 |   |

 
| ** **                       | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2001**              | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| BALANCE SHEET DATA:              |       |                  |       |   |   |   |   |   |   |   |   |
| Working capital                  |       | $                     | 11,884     |   | $ | 14,091 |   | $ | 16,054 |   | $ | 17,243 |   | $ | 13,556 |   |
| Total assets                     |       | 28,586                |       | 20,130 |   | 21,020 |   | 25,211 |   | 29,484 |   |
| Total debt                       |       | —                |       | — |   | — |   | — |   | — |   |
| Total stockholders’  equity |       | 24,579                |       | 16,442 |   | 17,449 |   | 19,314 |   | 19,310 |   |
|                                  |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(a) *In the quarter ended December 31, 2005,as a result of the VISA Decision, we recorded a pre-tax charge amounting toapproximately $5.0 million relating primarily to the value of our HoloMag inventory.Also included in the charge were increases in our provisions for accountsreceivable and warranty.*

 

(b) *As a result of our annual test forimpairment of goodwill, we recorded an impairment charge of $7.4 million duringthe quarter ended December 31, 2002. As a result of our review oflong-lived assets for impairment during the quarter ended December 31,2002, we recorded an impairment charge of $1.9 million (see Note 1 of the Notesto the Financial Statements).*

 

(c) *Diluted earnings (loss) per share would havebeen anti-dilutive for the years ended December 31, 2002 and 2005, ifbased on fully diluted shares adjusted to reflect stock options exercised.*

 

21

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**Item 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS.**

 

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

 

**Overview**

** **

ABNH was, until July 20,1998, a wholly-owned subsidiary of American Banknote Corporation (“ABN”). Onthat date, ABN completed the sale of 13,636,000 shares of our common stock inan initial public offering (the “Offering”), representing ABN’s entireinvestment in ABNH. We did not receive any proceeds from the Offering.

 

ABNH originates, produces, markets and sellssecure holograms and products incorporating secure holograms. The Company’sproducts are used primarily in security applications including authenticationof transaction cards, identity documents, value documents and various consumerproducts. The Company operates in one reportable industry segment. Ourability to create distinctive, secure optically variable devices, to reproducethem with high quality and to distribute them securely has enabled us to becomea market leader in security holography. Our products are sold to over 200companies worldwide, including MasterCard, VISA, American Express, Discover,Diners Club, Sears, Nordstrom, Quaker State, Nike, Janssen-Cilag and Eli Lilly,as well as agencies of the United States government and certain foreigngovernments. We also produce non-secure holograms for design and promotionalapplications.

 

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.

 

A significant portion of the Company’s business is derived from ordersplaced by certain transaction card companies, and variations in the timing ofsuch orders can cause significant fluctuations in the Company’s sales. Salesto transaction card companies accounted for approximately 86% of our totalsales in 2005 and 84% of our total sales in 2004.

 

Sales to MasterCard (which includes HoloMagTM starting in the threemonth period ended December 31, 2005) were approximately 31% and 35% ofsales for the years ended December 31, 2005 and 2004, respectively. TheCompany has an agreement with MasterCard, as amended, pursuant to which theCompany is the exclusive supplier of MasterCard holograms and holographicmagnetic stripes, HoloMag. In the quarter ended September 30, 2005,MasterCard advised its member financial institutions around the world that itwill allow them to choose among card designs that incorporate either thetraditional hot stamp patch hologram or HoloMag, both of which are supplied bythe Company. The agreement with MasterCard was amended on August 24, 2005,and expires on February 28, 2013, subject to automatic renewal thereafter.

 

If we were to lose a substantial portion of our business withMasterCard without replacing it with new product sales, our business, operatingresults and financial condition would be materially and adversely affected. Inaddition, if we fail to obtain anticipated orders from MasterCard or if weexperience delays or cancellations of orders from MasterCard, our business,operating results and financial performance will be materially and adverselyaffected.

 

*Sales of VISA holograms (which includes HoloMag starting inthe three month period ended September 30, 2005) to manufacturers of VISAtransaction cards were approximately 37%, 31% and 30% of sales for the yearsended December 31, 2005, 2004 and 2003, respectively. Currently we are oneof two companies*

* *

*22*

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* *

*authorized to manufacture and sell the VISA Dove hot stampholograms to manufacturers of VISA brand transaction cards.****OnMarch 15, 2005, VISA announced its intention to phase out the Dove hotstamp hologram that we supply for the front of the VISA card, and to replace itwith an integrated holographic magnetic stripe. On April 8, 2005, weentered into an Agreement with VISA, pursuant to which we were authorized tosupply HoloMag to VISA-approved card manufacturers. We previously reported thatwe had learned of a small number of incidents in which certain card terminalshad been affected by electro-static discharge (“ESD”) from static electricitycarried on cards incorporating HoloMag. On March 14, 2006, we wereinformed by VISA that, as a result of the ESD issue, VISA is informing itsmember financial institutions and authorized card manufacturers that (i) VISAwill no longer approve VISA card designs which incorporate the current versionof HoloMag, (ii) VISA strongly recommends that their members attempt toavoid further issuance of cards incorporating the current version of HoloMagand (iii) VISA recommends that their members follow an alternate carddesign incorporating a conventional magnetic stripe and Dove hologram and VISAprovided notice to us that it was revoking our right to produce HoloMag underits agreement (the “VISA Decision”). We are continuing to evaluate VISA’sactions and claims and have submitted an initial response to VISA. We believethat we are in compliance with our agreement with VISA and that the HoloMagproduct complies with all standards and specifications contained in our agreement.*

* *

Our products are sold on a fixed price basisunder purchase orders and contracts with customers. Sales and the related costof goods sold are generally recognized at the latter of the time of shipment orwhen title passes to customers. In some situations, the Company has shippedproduct where the sale is contingent upon the customers’ use of the product. Inthese situations, the Company does not recognize sales upon product shipment,but rather when the buyer of the product informs the Company that the producthas been used. Additionally, pursuant to the request of and agreement with acertain customer, completed items are stored on behalf of this customer at theCompany’s on-site secured facility, and in that instance, sales are recognizedwhen all of the following have occurred: the customer has ordered the goodspursuant to a fixed price purchase order, 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, thecustomer has been billed for the order and collection of the invoice isconsidered probable. At December 31, 2005 and 2004, accounts receivablefrom this customer totaled $1.5 million and $1.1 million, respectively. In certaincases the Company has agreed to maintain an inventory of products for acustomer to ensure quick turn around of deliveries. The Company only acceptsreturns of product sold to customers when the product is determined to not bein conformance with the specifications previously agreed upon with suchcustomers in accordance with the terms of its warranty policy and generallyreplaces the product. The Company generally provides replacement product for upto 180 days from original shipment as a warranty for defective product.Shipping and handling amounts billed to customers are included in sales andamounted to $0.9 million, $0.4 million and $0.4 million in 2005, 2004 and 2003,respectively.

 

We purchase certain key materials used in the manufacture of ourproducts, and subcontract certain production functions or products from thirdparties some of which are sole suppliers. In some cases, we do not have supplycontracts with our suppliers, and operate on a purchase order basis.

 

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In the case of HoloMag, we have a single supplier, CFC International, Inc.,with whom we have a supply contract. We may not be able to findalternative 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.

 

During 2005, 2004 and 2003, export sales accounted for approximately34%, 21% and 28%, respectively, of total sales. All of our export sales are presentlydenominated in U.S. dollars.

 

Sales may fluctuate from quarter to quarter due to changes incustomers’ ordering patterns. Customers do not typically provide us withprecise forecasts of future order quantities. Quarterly demand for our productsmay be materially influenced by customers’ promotions, inventoryreplenishment, card expiration patterns, delivery schedules and other factors,such as the VISA Decision, which may be difficult for us to anticipate.

 

Cost of goods sold includes raw materialssuch as nickel, foils, films and adhesives; labor costs; manufacturingoverhead; and hologram origination costs (which represent costs of a uniquemaster hologram that is made to customer specifications and is an integral part ofthe production process). Cost of goods sold also includes the cost of certainprocesses that the Company outsources to third parties. As a result, costs ofgoods sold are affected by product mix, manufacturing yields, supplier pricesand changes in the cost of raw materials and labor.

 

Selling and administrative expenses primarilyconsist of salaries, benefits and commissions for the Company’s corporate,sales, customer service, marketing and administrative personnel, marketing andpromotion expenses, legal and accounting expenses and expenses associated withbeing a public company. The Company also includes the cost of shipping andhandling product deliveries that are billed to customers in selling andadministrative expenses. These costs amounted to $1.0 million, $0.5 million and$0.4 million in 2005, 2004 and 2003, respectively.

 

**CriticalAccounting Policies**

** **

The preparation ofour financial statements in conformity with generally accepted accountingprinciples requires management to make use of estimates and assumptions thatimpact the reported amounts of assets and liabilities at the date of thefinancial statements and the reported amounts of revenue and expenses duringthe reporting period. On an ongoing basis, we evaluate our estimates, includingthose related to bad debts, inventories and intangible assets. These estimatesand assumptions are based on historical results and trends as well as ourforecasts as to how these might change in the future. In addition, theseestimates and assumptions have been influenced by our current knowledge of thepotential impact of the VISA Decision. Actual results may differmaterially from these estimates.

 

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

 

**RevenueRecognition**

 

The Company recognizes revenue in accordancewith the provisions of the SEC’s Staff Accounting Bulletin (“SAB”) No. 104,“Revenue Recognition (an amendment of SAB 101, “Revenue Recognition inFinancial Statements”).”  Specifically,sales and the related cost of goods sold are generally recognized at the latterof the time of shipment or when title passes to customers. In some situations,the Company has shipped product where the sale is contingent upon the customers’use of the product. In these situations, the Company does not recognize salesupon product shipment, but rather when the buyer of the product 

 

24

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informs the Company that the product has beenused. Additionally, pursuant to the request of and agreement with a certaincustomer, completed items are stored on behalf of the customer at the Company’son-site secured facility and, in that instance, sales are recognized when allof the following have occurred: the customer has ordered the goods pursuant toa fixed price purchase order, the manufacturing process is complete, the goodshave been transferred to the on-site secured facility and are ready forshipment, the risk of ownership has passed to the customer, the customer hasbeen billed for the order and collection of the invoice is considered probable.The Company only accepts returnsof product sold to customers when the product is determined to not be inconformance with the specifications previously agreed upon with such customersin accordance with the terms of its warranty policy and generally replaces theproduct.

 

Customer advances represent payments receivedfrom customers for products which have not yet been shipped. These customeradvances are classified as current liabilities on the Company’s balance sheets.

 

Shipping and handling amounts billed tocustomers are included in sales. Shipping and handling costs are included inselling and administrative expenses.

 

**Allowance forDoubtful Accounts**

** **

We maintainallowances for doubtful accounts for estimated losses resulting from theinability of our customers to make the required payments. We recognize an allowancefor doubtful accounts based on the length of time the receivables are past due,the current business environment and our historical experience. If thefinancial condition of our customers were to deteriorate or if economicconditions were to worsen, additional allowances may be required in thefuture.

 

**InventoryValuation**

** **

Inventories are stated at the lower of cost or market with cost beingdetermined on the first-in, first-out (FIFO) method. At each balance sheetdate, we evaluate our ending inventory for excess quantities and obsolescence. Weprovide reserves for estimated obsolescence equal to the difference between thecost of the inventory and its estimated market value. We fully reserve forinventories deemed obsolete. If future demand or market conditions are lessfavorable than our projections, additional inventory write-downs may berequired.

 

**Impairment of Long-lived Assets**

 

We account for long-lived assets in accordance with SFAS No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*(“SFAS No. 144”). 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 bedisposed of are reported at the lower of the carrying amount or fair value lesscosts to sell.

 

**Recent Accounting Pronouncements**

 

In December 2004, the Financial Accounting Standards Board issuedStatement No. 123(R) (FAS 123R), *Share-Based Payment*,revising FAS 123 and requiring that all share-based payments to employees berecognized in the financial statements. Generally, the approach to accountingfor share-based payments in FAS 123R is similar to the approach described inFAS 123, however, pro forma footnote disclosure will no longer be analternative to financial statement recognition. This statement, as amended,becomes

 

25

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effective in the first annual periodbeginning after June 15, 2005. The Company has adopted the new statementeffective January 1, 2006, using the modified-prospective transitionmethod described in the statement. Under this method, the Company will be requiredto recognize compensation expense over the remaining vesting period for allawards that remain unvested as of January 1, 2006. As permitted by FAS123, the Company currently accounts for share-based payments to employees usingAPB 25’s intrinsic value method and, as such, generally recognized nocompensation cost for employee stock options. For an approximate impact on 2006results refer to the pro-forma results shown in Note 1.,”Stock-basedCompensation”, in the Financial Statements.

 

In November 2004, the FinancialAccounting Standards Board (“FASB”) issued Statement No. 151 (“FAS 151”), *Inventory Costs*, an amendment of ARB No. 43, Chapter 4.FAS 151 clarifies that abnormal amounts of idle facility expense, freight,handling costs and wasted materials should be recognized as current periodcharges. In addition, FAS 151 requires that allocation of fixed productionoverhead to inventory be based on the normal capacity of the productionfacilities. FAS 151 is effective for inventory costs incurred during fiscalyears beginning after June 15, 2005. The Company currently believes thatthe adoption of FAS 151 will not have a material impact on its financialstatements.

 

In March 2005, the FASB issuedinterpretation No. 47, *Accounting for ConditionalAsset Retirement Obligations*, an interpretation of SFAS No. 143.This interpretation clarifies that the term of *conditionalasset retirement obligation* refers to a legal obligation to perform anasset retirement activity in which the timing and/or method of settlement areconditional on a future event that may or may not be within thecontrol of the entity. The obligation to perform the asset retirementactivity is unconditional even though uncertainty exists about the timingand/or method of settlement. Accordingly, an entity is required to recognize aliability for the fair value of a conditional asset retirement obligation ifthe fair value of the liability can be reasonably estimated. The provisions ofInterpretation 47 are effective for fiscal years ending after December 15,2005. The adoption of this statement will not have an impact to the Company’sfinancial statement presentation since there have been no conditional assetretirement obligations.

 

In December 2004, the FASB issuedStatement of Financial Accounting Standards (“SFAS”) No. 154, *Accounting Changes and Error Corrections*, a replacement ofAPB Opinion No. 20 and SFAS No. 3. This statement changes therequirements for the accounting for and the reporting of a change in accountingprinciple. This statement requires retrospective application to prior periodfinancial statements of changes in accounting principle, unless it isimpracticable to determine either the period-specific effects of the cumulativeeffect of the change. Indirect effects of a change in accounting principleshould be recognized in the period of the accounting change. The provisions ofSFAS No. 154 are effective for fiscal years beginning after December 15,2005. The Company has adopted this Statement beginning January 1, 2006.

 

**Impact of the VISA Decision**

 

*As aresult of the VISA Decision, the Company’s results of operations for thequarter and year ended December 31, 2005 have been materially affected. Inthe quarter ended December 31, 2005, as a result of the VISA Decision, werecorded a pre-tax charge amounting to approximately $5.0 million of which $4.8million was recorded in cost of goods sold and was principally related to thevalue of our HoloMag inventory. Also included in the charge were increases inour provisions for accounts receivable and potential non-ESD related warrantyclaims. We will review the valuation of these accounts on an ongoing basis as apart of our closing process and make appropriate changes to our reservelevels based upon the facts at the time. Sales of HoloMag to VISA authorizedtransaction card manufacturers began in the quarter ended September 30,2005 and amounted to $2.3 million in that quarter. In the quarter ended December 31,2005 HoloMag sales to VISA authorized card manufacturers amounted to $3.8million. Sales of VISA*

* *

*26*

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* *

*HoloMagcontinued to grow in the first quarter of 2006 compared to the prior quarter untilthe announcement by VISA on March 15, 2006. Accordingly, sales in thequarter ending March 31, 2006 are expected to be higher than the level ofthe quarter ended December 31, 2005 and are expected to decline thereafteras a result of the VISA Decision.*

* *

**Results of Operations**

** **

**Comparisonof the Year Ended December 31, 2005 to the Year Ended December 31,2004**

 

*Sales.* Sales increased by $11.0 million,or 52%, from $21.3 million in 2004 to $32.3 million in 2005. The increase was primarily due to the roll-outof the HoloMag program in the transaction card market. HoloMag sales accountedfor approximately $8.4 million of the increase from 2004 to 2005 and included salesof approximately $6.1 million to manufacturers of VISA transaction cards whichsales began in the second half of the year. HoloMag was also sold tomanufacturers of American Express and Diners Club cards throughout the entireyear and to MasterCard beginning in the fourth quarter. Sales growth was alsoaffected by the value of the HoloMag product which sells for substantiallyhigher prices than a conventional hot stamp hologram due to its unique designand high security features. We also created new product solutions in theidentity document and product authentication markets and expanded existingcustomer relationships in each of our markets.

 

*RoyaltyIncome.* Royalty income remained relatively unchanged.

 

*Cost of Goods Sold, excluding Depreciation andAmortization.* Cost ofgoods sold, excluding depreciation and amortization increased by $10.2 million,from $9.2 million in 2004 to $19.4 million in 2005 primarily as a result of thevolume increase due to the ramp up of HoloMag in the second half of 2005 andincreases in inventory and warranty reserves for HoloMag. As a percentage ofsales, cost of goods sold excluding depreciation and amortization increasedfrom 43.1% in 2004 to 60.0% in 2005. As a result of the VISA Decision, in thefourth quarter of 2005, we recorded a charge to cost of goods sold of $4.8million to reserve the value of the HoloMag inventory and provide foradditional, non-ESD related warranty claims for products sold in 2005.

 

*Selling and Administrative Expenses.*Selling and administrative expensesincreased $1.8 million from $7.1 million in 2004 to $8.9 million in 2005. As apercentage of sales, selling and administrative expenses decreased from 33.3%in 2004 to 27.4% in 2005. The increase in expenses was primarily due to higherprofessional fees, salaries and wages in support of the growth of the businessand the facility consolidation and shipping charges which increased due tohigher product shipments as well as an increase in the allowance for doubtfulaccounts relating to the VISA Decision. The decrease in percentage of sales wasprimarily due to the volume increase in sales, partially offset by highergeneral and administrative costs.

 

*Research and Development.*Research and development expenses amounted to$1.3 million in both 2004 and 2005 as lower testing expenses in 2005 werepartially offset by higher salaries and wages due to manpower additions andconsulting costs in connection with the HoloMag program.

 

*Depreciation and Amortization.*Depreciation and amortization increased $0.5million from $0.8 million in 2004 to $1.3 million in 2005. The increase wasprimarily due to the acceleration of depreciation on equipment and leaseholdimprovements from the Company’s abandoned facility in Elmsford, New York of$0.4 million and the increase in fixed assets in connection with the leaseholdimprovements and new equipment in the Company’s new facility in Robbinsville,New Jersey.

 

*Facility Consolidation Expenses.*Facility consolidation expenses of $2.8million were recorded in 2005 as compared to $0.2 million recorded in 2004. Allamounts recorded in facilities consolidation expenses pertain to expensesincurred for the Company’s move and consolidation into its new facility in

 

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Robbinsville, New Jersey and in 2005 consist primarily of futureamounts of rent due on the abandoned facility in Elmsford, New York, movingcosts for equipment and inventory and employee severance costs, while expensesincurred in 2004 consist primarily of legal fees, real estatecommissions and employee relocation and severance expenses.

 

*Interest Income*. Interest income increased $0.2 million from$0.1 million in 2004 to $0.3 million in 2005 primarily as a result of higherinterest rates in effect during 2005.

 

*OtherIncome.* Other income decreased $0.2 million from $0.2 millionin 2004 to $0 million in 2005. The decrease was primarily due to income from apatent settlement agreement with a competitor in 2004 which did not recur in2005.

 

*IncomeTaxes*. The Company recorded a benefit from income taxes of $.4million in 2005 as a result of the pre-tax loss as compared to income taxexpense of $1.3 million in 2004.

 

**Comparison of 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 inpharmaceutical product protection which offset a continued reduction in lowermargin label sales.

 

*RoyaltyIncome.* Royalty income remained relatively unchanged.

 

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

 

*Sellingand Administrative Expenses.* Selling and administrativeexpenses increased by $0.6 million, from $6.5 million in 2003 to $7.1 millionin 2004. As a percentage of sales, selling and administrative expensesdecreased from 35.6% in 2003 to 33.3% in 2004. The increase in selling andadministrative expenses is primarily due to an increase in sales salaries of$0.1 million, an increase in other selling expenses of $0.1 million primarilydue 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 development expenses increased$0.1 million from $1.2 million in 2003 to $1.3 million in 2004. The increasewas primarily due to the development and testing of new products.

 

*Depreciationand Amortization.*Depreciation and amortization expenseincreased $0.1 million from $0.7 million in 2003 to $0.8 million in 2004primarily due to new assets in 2004.

 

*FacilityConsolidation Expenses.* Facility consolidation expenses of$0.2 million pertain to expenses

 

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incurred for ournew facility in Robbinsville, New Jersey and consist primarily of legal fees,real estate commissions and employee relocation and severance expenses.

 

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

 

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

 

**Seasonality**

 

Our sales have notgenerally exhibited substantial seasonality. However, our sales and operatingresults to date have, and future sales and therefore operating results may,continue to fluctuate from quarter to quarter. The degree of fluctuation willdepend on a number of factors, including the timing and level of sales, and anychange in the pricing of our products and the mix of products sold. Because asignificant portion of our business is expected to be derived from ordersplaced by a limited number of large customers, variations in the timing of suchorders could cause significant fluctuations in our operating results. Customersdo not typically provide us with precise forecasts of future order quantities.Quarterly demand for our products may be materially influenced bycustomers’ promotions, inventory replenishment, transaction card expirationpatterns, delivery schedules and other factors which may be difficult forus to anticipate. Other factors that may result in fluctuations inoperating results include the impact of the VISA Decision, the timing of newproduct announcements and the introduction of new products and new technologiesby us or our competitors, delays in research and development of new products,increased research and development expenses, availability and cost of materialsfrom our suppliers, and competitive pricing pressures.

 

**Liquidity and CapitalResources**

** **

At December 31,2005, we had $9.1 million of cash and cash equivalents and working capital of$13.6 million.

 

The Company’s operating activities providedcash of $0.3 million in 2005, compared to $3.4 million of cash provided in2004. The decrease was primarily due to an increase in accounts receivable andinventories in connection with the increase in sales partially offset by anincrease in accounts payable due to the growth of the business. Investingactivities in 2005 used cash of $3.1 million including $5.1 million as a resultof capital expenditures, primarily associated with leasehold improvements andnew equipment in the new facility partially offset by sales of short-terminvestments of $2.0 million. Financing activities in 2005 provided cash of $0.6million due to the exercise of stock options. Financing activities in 2004provided cash of $0.1 million due to the exercise of options.

 

On December 14, 2004, the Company entered into agreements to leasea 134,000 square foot modern manufacturing and office building in Robbinsville,New Jersey, which is the site of its primary operations following the closure,relocation and consolidation of its operations in Elmsford, New York andHuntingdon Valley, Pennsylvania into the Robbinsville site. The Companycompleted the relocation and consolidation of its operations during 2005. TheRobbinsville facility provides substantial room for expansion as theCompany consolidated its operations that were being conducted within a 58,000square foot facility in Elmsford, New York and a 30,000 square foot facility inHuntingdon Valley, Pennsylvania into the new facility. We are currentlyevaluating the possible use of the Huntingdon Valley facility for certainmanufacturing and secure storage. The Company has also acquired and installedadditional 

 

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equipment and technology in the new facility to broaden itscapabilities to serve its target customers, expand capacity, become morevertically integrated and improve efficiency.

 

The base rent on the lease for theRobbinsville, New Jersey facility is $555,000 per year, increasing by 1.9% peryear, and the first seven months of the lease were rent-free. We recordeddeferred rent of $0.4 million in 2004 and 2005. The term of the lease for theRobbinsville facility extends through May 31, 2017, and at the expirationof the term, we have options to renew the lease for three consecutive five yearperiods at the then fair market value and also have an option to purchase thebuilding after the end of the original lease term for the adjusted fair marketvalue as defined in the lease agreement. The base rent on the lease inHuntingdon Valley, Pennsylvania is $144,000 per year. The lease on thisfacility expires on June 30, 2007. The base rent on the lease in Elmsford,New York is $746,000 per year. The lease on this facility expires on December 31,2007. As this facility was abandoned as part of our move and consolidationin 2005 the remaining rent, net of estimated sublease income, through the endof the lease term has been charged to Facility Consolidation Expense in 2005.

 

We invested approximately $6.0 millionthrough 2005 in capital additions at the Robbinsville, New Jersey facility inconjunction with the consolidation of our operations, of which approximately$5.1 million was expended in 2005 and $.9 million was expended in 2004. Theseexpenditures were for facility upgrades to customize the Robbinsville, NewJersey facility for the Company’s operational and security requirements as wellas the acquisition of new equipment to upgrade and expand our productioncapabilities.

 

We believe that cash flows from operations and cash balances will besufficient to meet working capital needs and fund capital expenditures for theforeseeable future after considering the potential impact of the VISA Decision.

 

The following table illustrates the costs incurred in the relocationand consolidation of facilities through December 31, 2005 and anticipatedin 2006 and 2007.

 
| ** **                                | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                | ** ** | **Actual**                                                    | ** ** | **Estimated** | ** ** |
| ** **                                | ** ** | **2004**                                                      | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** |
| ** **                                | ** ** | **(In Thousands)**                                       | ** ** |
| Rent on abandoned  facilities, net        |       | $                                                             | —     |   | $ | 1,905 |   | $ | — |   | $ | — |   |
| Accretion on abandoned  facilities rental |       | —                                                        |       | 45 |   | 140 |   | 83 |   |
| Employee severance  costs                 |       | 15                                                            |       | 107 |   | 9 |   | — |   |
| Employee relocation  costs                |       | 56                                                            |       | 116 |   | 170 |   | 240 |   |
| Moving costs                              |       | —                                                        |       | 590 |   | — |   | — |   |
| Legal expenses and  commissions           |       | 171                                                           |       | 6 |   | — |   | — |   |
|                                      |       | $                                                             | 242        |   | $ | 2,769 |   | $ | 319 |   | $ | 323 |   |

 

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 |       | $         | 9,020      |                       | $          | 1,576          |       | $              | 2,033      |                        | $          | 1,216 |   | $ | 4,195 |   |
|                   |            |           |            |                            |            |                |            |                |            |                             |            |  |  |  |  |  |

 

**Impact ofInflation**

 

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

 

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**Off-BalanceSheet Arrangements**

 

The Company has nooff-balance sheet arrangements.

 

**UnauditedQuarterly Results of Operations for the Years Ended December 31, 2005 and2004.**

 
| ** **                                                   | ** ** | **Year Ended December 31, 2005**               | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **First  Quarter**                                                 | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter(1)(2)** | ** ** |
| ** **                                                   | ** ** | **(In Thousands, Except Per Share Data)** | ** ** |
| Sales                                                        |       | $                                                                  | 6,400      |   | $ | 6,857 |   | $ | 8,959 |   | $ | 10,083 |   |
|                                                         |       |                                                               |       |   |   |   |   |   |   |
| Cost of goods sold,  excluding depreciation and amortization |       | $                                                                  | 2,799      |   | $ | 3,161 |   | $ | 4,227 |   | $ | 9,181 |   |
|                                                         |       |                                                               |       |   |   |   |   |   |   |
| Net income (loss)                                            |       | $                                                                  | 610        |   | $ | 450 |   | $ | 1,116 |   | $ | (2,757 | ) |
|                                                         |       |                                                               |       |   |   |   |   |   |   |
| Net income (loss) per  share-basic and diluted               |       | $                                                                  | 0.03       |   | $ | 0.02 |   | $ | 0.06 |   | $ | (0.15 | ) |

 
| ** **                                                      | ** ** | **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,  exclusive of depreciation and amortization |       | $                                         | 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 |   |

 

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(1)                                  Thequarter ended December 31, 2005 includes $5.0 million of additional chargesfor the VISA Decision. Net Income (loss) in the quarter was also impacted byfacility consolidation expense of $2.2 million.

 

(2)                                  Dilutedincome (loss) per share would have been anti-dilutive for the quarter ended December 31,2005 if based on fully diluted shares adjusted to reflect stock optionexercises.

 

**Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

We do not engagein significant activity with respect to market risk sensitive instruments.Accordingly, our risk with respect to market risk sensitive instruments isimmaterial.

 

**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 thisForm 10-K.

 

31

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**Item 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE.**

 

On April 27, 2005, Ernst & Young LLP (“Ernst &Young”) notified us that it would be resigning as our independent auditors uponcompletion of their SAS No. 100 review for the quarter ended March 31,2005. Ernst & Young subsequently completed its SAS No. 100 reviewand by letter dated May 17, 2005 confirmed its resignation. Ernst &Young advised the Company that it was resigning because of Ernst &Young’s resource constraints, and that its resignation was not related to any matterconcerning the Company including the Company’s selection or application ofaccounting policies or judgments, the scope of audit, internal controls orintegrity of management.

 

Ernst & Young audited our financialstatements for our two most recent fiscal years ended December 31, 2004.

 

During our two most recent fiscal years ended December 31,2004 and for the period from January 1, 2005 through the date ofresignation, there were no disagreements with Ernst & Young on anymatters of accounting principles or practices, financial statement disclosure,or auditing scope or procedure, which disagreements, if not resolved to thesatisfaction of Ernst & Young would have caused them to make referenceto the subject matter of their disagreement in their report.

 

During our two most recent fiscal years ended December 31,2004 and for the period from January 1, 2005 through the date ofresignation, there were no reportable events as such term is defined byparagraph (a)(1)(iv) of Item 304 of Regulation S-K promulgatedby the Securities and Exchange Commission.

 

The report of Ernst & Young accompanyingthe audit for our two most recent fiscal years ended December 31, 2004 didnot contain any adverse opinion or disclaimer or opinion, nor was it qualifiedor modified as to uncertainty, audit scope or accounting principles.

 

The Company provided Ernst & Young with acopy of the above disclosures on May 18, 2005, and requested that Ernst &Young furnish a letter addressed to the Securities and Exchange Commissionstating whether it agrees with the statements made by the Company and, if not,stating the respects in which it does not agree. A copy of such letter isattached as exhibit 16.1 to the Form 8-K filed by the Company on May 20,2005.

 

On, August 1, 2005 we engagedPricewaterhouseCoopers, LLP as our independent registered public accountingfirm for 2005. During our fiscal years ended December 31, 2004 and 2003,and through August 1, 2005, neither we, nor anyone acting on our behalf,consulted with PricewaterhouseCoopers, LLP with respect to the application ofaccounting principles to a specified transaction, either completed or proposed,or the type of audit opinion that might be rendered on our financialstatements, or any other matters or events set forth in Item 304(a)(2)(i) and(ii) of Regulation S-K.

 

**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, ourchief executive officer and chief financial officer concluded that ourdisclosure controls and procedures were effective in timely alerting them tomaterial information relating to ABNH required to be included in our periodicSecurities and Exchange Commission filings. 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**

 

None.

 

32

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**Part III**

 

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

 

The following table sets forth certain information concerning ourdirectors, executive officers and other key employees. All directors holdoffice until the next annual meeting of stockholders or until their successorshave been elected and qualified.

 

 

| **Name**                            | ** ** | **Age**    | ** ** | **Position(s)**                                                  |
|-------------------------------------|------------|------------|------------|------------------------------------------------------------------|
| **Directors,  Executive Officers:** | ** ** | ** ** | ** ** | ** **                                                       |
|                                |       |       |       |                                                             |
| Kenneth H. Traub                    |       | 44         |       | President, Chief  Executive Officer and Director                 |
|                                |       |       |       |                                                             |
| Salvatore F. D’Amato           |       | 77         |       | Chairman of the  Board                                           |
|                                |       |       |       |                                                             |
| Mark J. Bonney                      |       | 52         |       | Executive Vice  President, Chief Financial Officer and Secretary |
|                                |       |       |       |                                                             |
| Jordan Davis *                      |       | 44         |       | Director                                                         |
|                                |       |       |       |                                                             |
| Fred J. Levin*                      |       | 43         |       | Director                                                         |

 

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*    Member of the audit and compensationcommittees.

 

*KennethH. 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 ChiefOperating Officer, and from January 1999 through February 1999 heserved as our consultant. Previously, Mr. Traub co-founded Voxware, Inc.,a developer of digital speech processing technologies, and served on its boardof directors from February 1995 to January 1998 and as its ExecutiveVice President, Chief Financial Officer and Secretary from February 1995to April 1998. Prior thereto, Mr. Traub was Vice President ofTrans-Resources, Inc., a diversified multinational holding company. Mr. Traubholds an M.B.A. from the Harvard Graduate School of Business Administration anda B.A. from Emory University.

 

*SalvatoreF. D’Amato* has served as our Chairman of the Board since April 1999and as a director since March 1999. He was also our Chairman of the Boardand President from 1983 to 1990 and was a consultant for us from time to timebetween 1990 and April 1999. Mr. D’Amato was President and a directorof American Banknote, our former parent corporation, from 1977 to 1983. Priorthereto, he served as Vice President, Engineering and Senior Vice President,Operations with ABN. Mr. D’Amato holds a masters degree in Engineeringfrom Columbia University.

 

*Mark J.Bonney* has served as our Executive Vice President, ChiefFinancial Officer and Secretary since June 2005. Prior to joining theCompany in these capacities Mr. Bonney served as a director of the Companyfrom February 2003. Previously, Mr. Bonney had been the ManagingPartner of Endeavour Advisors, LLC, a strategic management-consulting firm fromApril 2004. Previously, Mr. Bonney was the Chief Executive Officer ofMJB Consulting, a strategic management-consulting firm, since March 2002. Priorthereto, Mr. Bonney was the President and Chief Operating Officer of AxsysTechnologies, a leading supplier of optical components and subsystems from August 1999through March 2002. Prior thereto, Mr. Bonney held various positions,including Vice President of Operations, Vice President of Finance and ChiefFinancial Officer of Zygo Corporation, a manufacturer of measurement systemsand optical products, from March 1993 through July 1999. Mr. Bonneyholds a B.S. in Business Administration and Economics from Central ConnecticutState University and an M.B.A. in Finance from the University of Hartford.

 

33

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*Jordan S. Davis* has served as a director since May 2005.Mr. Davis has been a Managing Partner of Radius Ventures, a venturecapital firm since 1996. Mr. Davis also serves on the boards of directorsof Health Language, Inc., Impliant, Inc. and Zettacore, Inc.,each portfolio companies of Radius Ventures. Mr. Davis earned an M.B.A.from the J.L. Kellogg Graduate School of Management at Northwestern Universityin 1986 and a B.A. in Economics from The State University of New York atBinghamton in 1983.

 

*Fred J.Levin* has served as a director since February 2000. Mr. Levinhas been the President and Chief Executive Officer of the LGI Network LLC, amarket research and information service company, since February 2002. Previously,Mr. Levin was the President of the Concord Watch Division of Movado Group, Inc.,a manufacturer and marketer of watches, from March 1998 to January 2002.Mr. Levin also served with Movado Group, Inc. as Senior VicePresident, International from April 1995 to February 1998 and as VicePresident, Distribution from February 1994 to March 1995. Priorthereto, Mr. Levin was a management consultant with McKinsey &Company. Mr. Levin holds a B.S. in Industrial Engineering fromNorthwestern University and an M.B.A. from the Harvard Graduate School ofBusiness Administration.

 

**Other Key Management Personnel**

 

*****Michael T. Banahan***** is our VicePresident of Sales. Mr. Banahan has been a senior sales executive with thecompany since 1989 and has been Vice President of Sales since 1999. Mr. Banahanis currently a member of the International Association of Financial CrimesInvestigators (IAFCI) and serves as the chairman of the ethics committee of theDocument Security Alliance (DSA). Mr. Banahan was previously a salesexecutive at Burlington Industries, Tension Envelope and West Point Pepperel. Mr. Banahanholds a B.A. in Marketing from the University of Rhode Island.

 

*****George Condos***** is ourController and has been in this role since joining ABNH in April 1999.Prior to ABNH, Mr. Condos was Controller of PSR Logistics. He also servedas District Controller and Office Manager at Browning-Ferris Industries and wasController of United Carting Company. Mr. Condos holds a B.S. inAccounting from Fairleigh Dickinson University.

 

*****Alan Goldstein***** is our VicePresident of Finance. Mr. Goldstein joined the company in April 1999and served as Vice President and Chief Financial Officer until June 2005. Mr. Goldsteinwas previously Vice President and Chief Accounting Officer of CompleteManagement Inc. He also served as Vice President and Chief Financial Officer ofRF International, Inc., a multi-national transportation services holdingcompany. Mr. Goldstein holds an M.S. in Accounting from Long IslandUniversity and a B.S. in Business Administration from Boston University. Mr. Goldsteinwill be leaving ABNH effective March 31, 2006.

 

*****Dr. John Hynes***** is our VicePresident and Chief Technology Officer. Prior to joining ABNH in 2005, Dr. Hyneswas President of Card Based Information Technologies, Inc., a leadingconsulting firm to the card industry since 1990. Dr. Hynes holds adoctorate in magnetic physics from Florida State University and has worked inthe transaction card and related industries for over 25 years. Dr. Hynesholds several patents on magnetic stripes, card security and other fields. Dr. Hyneshas served on numerous standards committees including American NationalStandards Institute, International Standards Organization and AutomaticIdentification Manufacturers. Dr. Hynes has also chaired Card TechnologySeminars, Card Tech/Secure Tech and International Card ManufacturersAssociation annual conferences covering magnetic stripe performance, cardproduction and emerging technologies.

 

*****Ron G. McClenny***** is our VicePresident of Operations. Mr. McClenny is responsible for managing theCompany’s manufacturing, engineering and quality assurance operations.Previously, Mr. McClenny was Vice President, and General Manager of JVCMagnetics America, where he was responsible for

 

34

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managing a $100 million video tape manufacturingfacility with 250 staff members. Mr. McClenny holds a B.S. in ElectricalEngineering from Auburn University and is a Six Sigma Black Belt.

 

*****William C. Morwald***** is our VicePresident of Quality & Product Management. Mr. Morwald joinedABNH in 1984 and has served in his current role since January 2003. Mr. Morwaldhas served in numerous capacities with ABNH including manufacturing, qualityand product management and was responsible for establishing our operation inDalton, Massachusetts.

 

*****Adam L.A. Scheer***** is our VicePresident of Corporate Development and Marketing. Mr. Scheer joined ABNHin 2001 and his responsibilities at ABNH include oversight of marketing,business development, international sales and strategic planning. Prior tojoining ABNH, Mr. Scheer served as a senior officer with companies in thetechnology and chemicals industries and as an investment banking analyst. Mr. Scheerholds a B.A. in history, cum laude, from Williams College and an M.B.A. inManagement, earned with distinction, from New York University’s Stern School ofBusiness where he was named a Stern Scholar.

 

**Audit Committee**

 

Our Board of Directors has established an AuditCommittee in accordance with Section 3(a)(58)(A) of the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”). The members of the AuditCommittee are currently Jordan S. Davis (Chairman) and Fred J. Levin. The AuditCommittee recommends to the Board of Directors the appointment of ourindependent auditors. The Audit Committee also discusses and reviews, with ourindependent auditors, the scope and results of the annual audit. All of themembers of our Audit Committee are independent within the meaning of Section 7(d)(3)(iv) ofSchedule 14A applying the definition of independence set forth in Rule 4200(a)(15)of the National Association of Securities Dealers’ listing standards. Our Boardof Directors has determined that there is no audit committee financial expertas defined by Item 401(h) of Regulation S-K of the Exchange Act. MarkJ. Bonney served as our audit committee financial expert until June 9,2005 at which time he resigned from our Board of Directors and became our ChiefFinancial Officer. Our Board of Directors believes that the current members ofour Audit Committee are qualified to serve based on their collective experienceand background. Our Board of Directors originally adopted a written charter forour Audit Committee on August 4, 2000, and adopted an amended and restatedwritten charter on April 28, 2003. The Audit Committee’s amended andrestated charter provides that the Audit Committee shall be comprised of nomore than five and no less than three members. Our Audit Committee is currentlycomprised of only two members. We are currently searching for a qualifiedcandidate and financial expert to serve on our Audit Committee as its thirdmember.

 

**Compensation Committee**

 

 Our Board ofDirectors has established a Compensation Committee. The Compensation Committeeadvises our Board of Directors on compensation matters, determines thecompensation of the Chief Executive Officer, reviews and takes action on therecommendation of the Chief Executive Officer as to the appropriatecompensation of other officers and key personnel and approves the grants ofbonuses to officers and key personnel. The Compensation Committee is alsoresponsible for the administration of our 1998 Stock Incentive Plan, 2000 StockIncentive Plan and 2005 Stock Incentive Plan. The Compensation Committee iscurrently composed of Messrs. Levin (Chairman) and Davis.

 

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

** **

Section 16(a) ofthe Securities Exchange Act of 1934, as amended, requires our directors andexecutive officers, and persons who beneficially own more than 10% of our commonstock, to file with the Securities and Exchange Commission reports of theirownership and changes in their ownership of common stock. Based upon a reviewof the copies of the filings with the Securities and Exchange

 

35

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Commission andwritten representations from our executive officers, directors and persons whobeneficially own more than 10% of our common stock, we believe that the Section 16(a) filingrequirements applicable to our executive officers, directors and persons whobeneficially own more than 10% of our common stock in fiscal 2005 were compliedwith on a timely basis.

 

**Code of Ethics**

 

We have adopted a Code of Ethics for Senior Financial Officersapplicable to our Chief Executive Officer, Chief Financial Officer, treasurer,controller, principal accounting officer and other employees performing similarfunctions. The Code of Ethics for Senior Financial Officers is available on ourwebsite. We will satisfy the disclosure requirement under Item 10 of Form 8-Krelating to amendments or waivers from any provision of the Code of Ethics forSenior Financial Officers by either filing a Form 8-K or posting thisinformation on our website within four business days following the date ofamendment or waiver. Our website address is www.abnh.com.

 

**Item 11. EXECUTIVE COMPENSATION.**

 

The followingtable provides information concerning compensation paid to or earned during2003, 2004 and 2005 by our (i) chief executive officer during 2005, (ii) twoexecutive officers who were serving as executive officers of the Company at December 31,2005 and (iii) our former Chief Financial Officer (collectively, the “NamedExecutive Officers”).

 

**SummaryCompensation Table**

 
| ** **                                         | ** ** | ** ** | ** ** | ** **                   | ** ** | **Long-Term  Compensation  Shares of  Common Stock  Underlying  Options  (#)** | ** ** | ** **                                    | ** ** |
|----------------------------------------------------|------------|------------|------------|------------------------------|------------|------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                         | ** ** | ** ** | ** ** | ** **                   | ** ** | ** **                                                                               | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                         | ** ** | ** ** | ** ** | **Annual Compensation** | ** ** | ** **                                                                               | ** ** | ** **                                    | ** ** | ** ** |
| **Name**                                           | ** ** | **Year**   | ** ** | **Salary  ($)**              | ** ** | **Bonus  ($)**                                                                           | ** ** | **Other  Annual  Compensation  (1) ($)** | ** ** | **Restricted  Stock  Awards  ($)** | ** ** | ** ** | **All Other  Compensation  (2) (4)($)** | ** ** |
| Kenneth H. Traub                                   |       | 2005       |       | 400,000                      |       | 225,000                                                                                  |       | 10,343                                        |       | — |   | 50,000 |   | 6,930 |   |
| President and Chief                                |       | 2004       |       | 327,818                      |       | 190,000                                                                                  |       | 10,560                                        |       | — |   | — |   | 6,584 |   |
| Executive Officer                                  |       | 2003       |       | 318,270                      |       | 140,000                                                                                  |       | 9,609                                         |       | — |   | 200,000 |   | 5,973 |   |
|                                               |       |       |       |                         |       |                                                                                     |       |                                          |       |   |   |   |   |   |   |
| Salvatore F. D’Amato                          |       | 2005       |       | 202,592                      |       | 95,000                                                                                   |       | 13,000                                        |       | — |   | 15,000 |   | 2,219 |   |
| Chairman of the Board                              |       | 2004       |       | 196,691                      |       | 85,000                                                                                   |       | 13,788                                        |       | — |   | — |   | 2,226 |   |
|                                               |       | 2003       |       | 190,962                      |       | 70,000                                                                                   |       | 13,788                                        |       | — |   | 40,000 |   | 2,348 |   |
|                                               |       |       |       |                         |       |                                                                                     |       |                                          |       |   |   |   |   |   |   |
| Mark J. Bonney (3) (4)                        |       | 2005       |       | 126,244                      |       | 92,000                                                                                   |       | 4,900                                         |       | 31,000 | (5) | 152,500 |   | 108,087 |   |
| Executive Vice  President, Chief Financial Officer |       | 2004       |       | —                       |       | —                                                                                   |       | —                                        |       | — |   | — |   | — |   |
| and Secretary                                      |       | 2003       |       | —                       |       | —                                                                                   |       | —                                        |       | — |   | — |   | — |   |
|                                               |       |       |       |                         |       |                                                                                     |       |                                          |       |   |   |   |   |   |   |
| Alan Goldstein                                     |       | 2005       |       | 228,225                      |       | 10,000                                                                                   |       | 5,820                                         |       | — |   | 15,000 |   | 3,588 |   |
| Vice President  Finance(6)                         |       | 2004       |       | 185,761                      |       | 55,000                                                                                   |       | 5,820                                         |       | — |   | — |   | 3,538 |   |
|                                               |       | 2003       |       | 180,350                      |       | 45,000                                                                                   |       | 5,820                                         |       | — |   | 40,000 |   | 3,248 |   |

 

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(1)          Other AnnualCompensation in 2003, 2004 and 2005 for Messrs. Traub, D’Amato andGoldstein consisted of the use of automobiles paid for by us. Mr. Bonneyreceives a car allowance of $700.00 per month.

 

(2)          All other compensationin 2003, 2004 and 2005 includes term life insurance premiums and employercontributions to our 401(k) retirement plan paid by us for Mr. Traub of$4,830, $4,534 and $3,973,

 

36

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respectivelyand $2,100, $2,050 and $2,000, respectively; for Mr. D’Amato of $119, $176and $348, respectively and $2,100, $2,050 and $2,000, respectively, and for Mr. Goldsteinof $1,488, $1,488 and $1,248, respectively and $2,100, $2,050 and $2,000,respectively.

 

(3)          Mr. Bonney joinedthe Company on June 9, 2005 at an annual salary of $215,000.

 

(4)          All Other Compensationincludes director’s fees of $16,462 paid to Mr. Bonney prior to hisresignation from the Board in May 2005, $744 paid for term life insurancepremiums and $90,881 paid to Mr. Bonney in December 2005 inconnection with a cash buyout of the value of certain stock options granted tohim while a director of the Company and forwhich he would have been subject to adverse tax consequences under Section 409Aof the Internal Revenue Code of 1986, as amended. The cash payment representedthe difference between the aggregate fair market value on December 15,2005 of the shares of the Company’s common stock subject to the cancelledoptions, being $6.45 per share, and the aggregate exercise price of thecancelled options and was subject to applicable withholdings.

 

(5)          Representsa restricted stock grant of 5,000 shares on November 15, 2005 at a valueof $6.40. The restricted stock vests in full on November 15, 2008. At December 31,2005, Mr. Bonney held 5,000 shares of restricted stock at an aggregatedollar value of $31,000 based on the Company’s closing stock price on that dateof $6.20. The restricted stock is eligible to receive dividends when and ifdeclared.

 

(6)          Effective June 9, 2005, Mr. Goldstein became the Vice President ofFinance and resigned from his executive officer position as Chief FinancialOfficer and Secretary.

 

**Option Grants for 2005**

 

During 2005 the Named Executive Officersreceived certain stock awards under the Company’s 1998 Stock Incentive Plan,2000 Stock Incentive Plan and 2005 Stock Incentive Plan. The following tablesets forth information with respect to option grants in 2005 to each of theNamed Executive Officers.

 

**Executive Option Grants in LastFiscal Year**

 
| **Name**                  | ** ** | **Number of  Securities  Underlying  Options  Granted (1) (#)** | ** ** | **% of Total  Options  Granted to  Employees in  Fiscal Year(2)** | ** ** | **Exercise or  Base Price  ($/share)** | ** ** | **Expiration  Date** | ** ** | **Potential Realizable Value  At Assumed Annual Rates of  Stock Price Appreciation For  Option Term (3)** | ** ** |
|---------------------------|------------|--------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|----------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                | **5%($)**  | ** **                                                                     | **10%($)** | ** **                                                                            |
| Kenneth H. Traub          |       | 50,000                                                                         |       | 12.16                                                                                 | %          | 2.95                                             |       | 1/7/15               |       | 93,000                                                                                                                                                           |       | 235,000 |   |
| Salvatore F. D’Amato |       | 15,000                                                                         | (a)        | 3.65                                                                                  | %          | 2.95                                             |       | 1/7/15               |       | 27,900                                                                                                                                                           |       | 70,500 |   |
| Mark Bonney               |       | 3,334                                                                          |       | 0.81                                                                                  | %          | 2.95                                             |       | 1/7/15               |       | 6,201                                                                                                                                                            |       | 15,670 |   |
|                      |       | 15,500                                                                         |       | 3.77                                                                                  | %          | 3.80                                             |       | 6/9/15               |       | 37,045                                                                                                                                                           |       | 93,930 |   |
|                      |       | 97,000                                                                         |       | 23.59                                                                                 | %          | 3.80                                             |       | 6/9/15               |       | 231,830                                                                                                                                                          |       | 587,820 |   |
|                      |       | 20,000                                                                         |       | 4.86                                                                                  | %          | 5.65                                             |       | 9/22/15              |       | 71,000                                                                                                                                                           |       | 180,000 |   |
|                      |       | 16,666                                                                         | (b)        | 4.05                                                                                  | %          | 6.45                                             |       | 12/15/15             |       | 67,664                                                                                                                                                           |       | 78,330 |   |
| Alan Goldstein            |       | 15,000                                                                         |       | 3.65                                                                                  | %          | 2.95                                             |       | 1/7/15               |       | 27,900                                                                                                                                                           |       | 70,500 |   |

 

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(1)          Options vest over three years with 33.3%vesting on the first anniversary of the grant date and the remaining 66.7%vesting at the rate of 8.34% on the last day of each of the following eightquarters. Exceptions include:

(a)  Vest in full on January 7,2006

(b) Fully vested atdate of grant.

(2)          Based on options to purchase 411,166 sharesgranted in 2005 under the 1998, 2000 and 2005 Stock Incentive Plans.

 

37

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(3)          These amounts represent assumed rates ofappreciation in the price of the Company’s common stock during the terms of theoptions in accordance with rates specified in applicable federal securitiesregulations. Actual gains, if any, on stock option exercises will depend on thefuture price of the common stock and overall stock market conditions. The 5%rate of appreciation over the term of the $2.95, $3.80, $5.65 and the $6.45stock prices on the dates of the respective grants would result in a stockprice of $4.81, $6.19, $9.20 and $10.51, respectively. The 10% rate ofappreciation over the term of the $2.95, $3.80, $5.65 and the $6.45 stock priceon the date of the respective grants would result in a stock price of $7.65,$9.86, $14.65 and $16.73, respectively. There is no representation that therates of appreciation reflected in this table will be achieved.

 

**2005Year-End Option Values**

 

The following tableprovides information concerning the number and value of unexercised optionsheld by each of the Named Executive Officers on December 31, 2005. Nooptions were exercised in 2005 by the Named Executive Officers.

 
| ** **                | ** ** | **Shares of Common Stock  Underlying Unexercised Options  (#)** | ** ** | **Value of Unexercised In-the-Money  Options at December 31, 2005  ($) (1)** | ** ** |
|---------------------------|------------|------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|
| **Name**                  | ** ** | **Exercisable**                                                                          | ** ** | **Unexercisable**                                                                                                    | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Kenneth H. Traub          |       | 902,084                                                                                  |       | 122,916                                                                                                              |       | $ | 3,948,222 |   | $ | 385,434 |   |
| Salvatore F. D’Amato |       | 365,000                                                                                  |       | 15,000                                                                                                               |       | $ | 1,489,644 |   | $ | 48,750 |   |
| Mark J. Bonney            |       | 16,666                                                                                   |       | 145,834                                                                                                              |       | — |   | $ | 243,800 |   |
| Alan Goldstein            |       | 198,625                                                                                  |       | 29,375                                                                                                               |       | $ | 812,363 |   | $ | 75,506 |   |

 

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(1)          Based on the differencebetween $6.20, which was the closing price per share on December 31, 2005,and the exercise price per share of the options.

 

**Director Compensation**

** **

Each member of theboard of directors who is not an employee of ABNH will receive compensation of$12,000 per year for serving on the board of directors. Each of these directorswill also receive $1,000 for each board meeting attended in person, $500 foreach telephonic board meeting attended and $500 for each committee meetingattended. 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 the board of directors adopted a policy toincrease the compensation paid to directors who are not employees of ABNH. Underthe new policy, in addition to the compensation described above, each directorwho is not an employee of ABNH will automatically receive an option to purchase5,000 shares of our common stock at the first meeting of the board of directorsof each calendar year. Such options are exercisable at the fair market value onthe date of the grant and will become vested and

 

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exercisable over a period of three years. In addition, the chairman ofeach committee of the Board of Directors will receive an additional annual feeof $6,000.

 

**Employment Agreements**

** **

We entered into anamended employment agreement with Kenneth H. Traub in March 2005 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 agreement provides for an annual base salary of $400,000 in2005, 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 to receive annual bonuses based on the CompensationCommittee’s assessment of Mr. Traub’s performance for the prior year basedon agreed-upon performance objectives. The target annual bonus is $100,000although any actual bonus may be more or less than such amount. In theevent of Mr. Traub’s termination by us for any reason other than forcause, as defined in the agreement, or his resignation for good reason, asdefined in the agreement, we are generally required to (1) pay him hissalary then in effect with any bonus which may have been accrued or whichotherwise would have been granted by the board to him for a period of two yearsfollowing such termination, (2) continue to provide employee benefits to Mr. Traub,and (3) accelerate vesting on any unvested options granted to him. Uponthe termination of Mr. Traub’s employment by us following a change ofcontrol, as defined in the agreement, or Mr. Traub’s resignation for goodreason following a change in control, we are required to (1) pay him aseverance amount equal to two times his annual salary and bonus then in effect(or, if such termination or resignation for good reason is more than one yearafter such change of control, an amount equal to three times his salary andannual bonus then in effect), (2) accelerate vesting on any unvestedoptions and any shares of restricted stock granted to Mr. Traub, and (3) tothe extent such amounts are subject to excise taxes under Section 4999 ofthe Internal Revenue Code, provide a tax gross up to him for any additionalamounts due. In connection with his employment agreement, Mr. Traub hasagreed not to compete with, or solicit from, us during his term of employmentand for one year thereafter and has agreed not to disclose or use ourconfidential information.

 

We entered into anemployment agreement with Salvatore F. D’Amato in April 1999 for aninitial 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 toreceive bonuses at the discretion of our board of directors, with a targetbonus of $10,000 per quarter. The quarterly bonus is required to be paid unlessthe board 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 oneyear of 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 entered into an employmentagreement with Mark Bonney in June 2005 for an initial term of one year,which renews automatically for successive one-year terms, unless we give atleast 60 days written notice prior to the end of the current term. Theagreement provides for an annual base salary of $215,000 and further providesthat, if we do not renew his employment agreement, Mr. Bonney will receiveseverance equal to six months of his current salary payable over the six-monthperiod in accordance with customary payroll practices and we shall continue hisemployee benefits for such six-month period. Pursuant to the agreement, Mr. Bonneyis eligible to receive bonuses at the discretion of our Board of Directors orcompensation committee in consultation with our Chief Executive Officer. Inconnection with the agreement, we granted to Mr. Bonney options topurchase up to 112,500 shares of our common

 

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stock at an exercise priceof $3.80 per share and extended the terms of options to purchase 30,000 sharesof our common stock previously granted to Mr. Bonney in connection withhis service as member of our board of directors. The agreement also providesthat we will reimburse Mr. Bonney up to $100,000 in connection with therelocation of his residence in connection with his employment by us. In theevent of Mr. Bonney’s termination by us for any reason other than forcause, as defined in the agreement, or his resignation for good reason, asdefined in the agreement and upon his execution and delivery to us of a generalrelease, we are required to (1) pay him his salary then in effect for aperiod of six months following such termination or resignation for good reason,(2) continue to provide employee benefits to Mr. Bonney and (3) permitthe exercise of options granted under any of our stock option plans or otherequity incentive plans which were vested on the termination date for a periodof nine months thereafter. Upon termination of Mr. Bonney’s employmentfollowing a change of control, or Mr. Bonney’s resignation for goodreason, as defined in the agreement, following a change of control, we arerequired to (1) pay him a severance amount equal to one and one-half timeshis annual salary and bonus then in effect (2) accelerate vesting on any unvestedoptions or common stock granted under any of our stock option plans or otherequity incentive plans, and (3) to the extent such amounts are subject toexcise taxes under Section 4999 of the Internal Revenue Code, provide atax gross up to him for any additional amounts due. In connection with hisemployment agreement, Mr. Bonney agreed not to compete with us during histerm of employment and for one year thereafter.

 

We entered into an amendedemployment agreement with Alan Goldstein in June 2005 for a term ending onMarch 31, 2006 (unless terminated earlier in accordance with theagreement). Pursuant to the amended agreement Mr. Goldstein became ourVice President of Finance and resigned as our Chief Financial Officer andSecretary. As amended, the agreement provides for an annual base salary of$240,000, to be increased by not less than 3% per year in the event the term ofMr. Goldstein’s employment is extended beyond March 31, 2006. In theevent that (i) prior to March 31, 2006, Mr. Goldstein is terminatedby us for any reason other than for cause, as defined in the agreement, (ii) Mr. Goldsteinresigns for good reason, as defined in the agreement prior to March 31,2006 or (iii) the employment term expires on March 31, 2006 (and Mr. Goldsteinhas not been terminated for cause or resigned other than for good reason), uponexecution and delivery to the Company of a general release, Mr. Goldsteinshall be entitled to receive his salary and employee benefits for a period ofnine months following the end of his employment and Mr. Goldstein’soptions shall vest immediately upon the expiration of his employment and shallremain exercisable for a two year period. In connection with his employmentagreement, Mr. Goldstein agreed not to compete with us during his term ofemployment and for one year thereafter.

 

**Compensation CommitteeInterlocks and Insider Participation**

** **

The CompensationCommittee currently consists of Messrs. Levin and Davis. None of themembers of our Compensation Committee is or has been an officer or employee ofABNH. No interlocking relationships exist between the board of directors orCompensation Committee and the board of directors or compensation committee ofany other company, nor has any such interlocking relationship existed in the past.None of our executive officers or directors serves on the board of directors orcompensation committee of any entity which has one or more executive officersserving as a member of our board of directors or Compensation Committee.

 

**Compensation Committee Report on ExecutiveCompensation**

 

The CompensationCommittee of the board of directors advises our board of directors oncompensation 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

 

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CompensationCommittee shall not be deemed incorporated by reference by any generalstatement incorporating by reference this Annual Report on Form 10-K intoany filing under the Securities Act of 1933, as amended, or the SecuritiesExchange Act of 1934, as amended, except to the extent that we specificallyincorporate this information by reference, and shall not otherwise be deemedfiled under such acts.

 

**Chief Executive OfficerCompensation**

** **

The CompensationCommittee reviews the compensation arrangements for our Chief Executive Officerat least annually, typically in the fourth and/or first quarter of the fiscalyear. In March 2005, we entered into an Amended and Restated EmploymentAgreement with Mr. Traub, which is described above. In determining whetherto enter into the Amended and Restated Employment Agreement with Mr. Traub,and the compensation arrangements thereunder, the Compensation Committeeconsidered the terms of his original employment agreement, as amended, hisleadership of the Company, our financial and operational performance during thepreceding year, competitive pay practices, and Mr. Traub’s individualperformance and contributions to us. The Compensation Committee believes that Mr. Traubprovides strong leadership to us and has been instrumental in improving ourfinancial, operating and strategic position.

 

In making itscompensation decisions with respect to Mr. Traub for 2005, theCompensation Committee exercised its discretion and judgment based on the abovefactors, relying both on qualitative and quantitative criteria and results. TheCompensation Committee, together with Mr. Traub, established bothquantifiable and qualitative objectives at the beginning of 2005 and weightedeach of these objectives according to their importance to 2005 and futureyears. As part of its review of executive compensation, the CompensationCommittee periodically reviews data on CEO compensation provided by independentcompensation consultants. In fiscal 2005, Mr. Traub’s salary was $400,000.The Amended and Restated Employment Agreement with Mr. Traub provides for atarget annual bonus of $100,000, and further provides that the actual bonus maybe more or less than the target based on the Compensation Committee'sreasonable assessment of the Executive's performance against the agreed uponobjectives. Mr. Traub was paid a total year-end discretionary bonus of$225,000 based on the Compensation Committee’s evaluation of his and theCompany’s performance for the year as compared to the objectives set at thebeginning of the year.

 

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

** **

The fundamentalpolicy of the Compensation Committee is to provide our executive officers withcompetitive compensation packages that are designed to retain key personnel,motivate executives to advance our objectives and reward contributions to ouroperational and financial performance. It is the Compensation Committee’sobjective to have a portion of each executive officer’s compensation contingentupon our performance as well as upon each executive officer’s own level ofperformance. Therefore, the compensation package for each executive officer iscomprised of three different elements: (1) base salary which is designedprimarily to be competitive with salary levels in the industry; (2) cashbonuses which reflect the achievement of qualitative and quantitativeobjectives and goals which are established at the beginning of each year; and (3) long-termstock-based incentive awards which strengthen the mutuality of interest betweenthe executive officers and our stockholders.

 

***Factors***. The principal factors (together with thefactors specified above with respect to Mr. Traub) that the CompensationCommittee considered with respect to each executive officer’s compensation forfiscal 2005 are summarized below. The Compensation Committee may, however, inits discretion, apply entirely different factors for executive compensation infuture years.

 

***Base Salary***. The base salary for each executiveofficer is specified in his respective employment agreement and was determinedon the basis of the following factors: experience, expected personalperformance, the salary levels in effect for comparable positions within andoutside the industry and internal and external base salary comparabilityconsiderations. The weight given to each of these factors differed fromindividual to individual, as the Compensation Committee and the board ofdirectors

 

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believedappropriate.

 

***Bonus.*** Bonus represents the variable component ofthe executive compensation program that is tied to our performance andindividual achievement. In determining bonuses, the Compensation Committeeconsiders factors such as relative performance of ABNH during the year and theindividual’s contribution to our performance, the need to attract, retain andmotivate high quality executives as well as the degree to which the executiveofficer met or exceeded certain objectives established for him.

 

***Long-Term Incentive Compensation***. Long-termincentives are provided through grants of stock options and restricted shares.The grants are designed to align the interests of each executive officer withthose of the stockholders and provide each individual with a significantincentive to manage ABNH from the perspective of an owner with an equity stake.Each stock option grant allows the individual to acquire shares of our commonstock at a fixed price per share over a specified period of time up to tenyears. Each option generally becomes exercisable in installments over a threeor four-year period. Restricted shares are immediately issued and outstandingwith full voting rights as of the grant date but may not be sold orotherwise transferred by the executive until the restriction lapses three yearsfrom the grant date, Therefore, the option or restricted share grant willprovide a return to the executive officer only if the executive officer remainsemployed by ABNH during the vesting period of the options or restriction periodof the restricted shares. Additionally, stock options will only provide areturn to the executive if the market price of the underlying sharesappreciates. The number of shares subject to each option grant is set at alevel intended to create meaningful opportunity for appreciation based on theexecutive officer’s current position with ABNH, the size of comparable awardsmade to individuals in similar positions and the individual’s personal performancein recent periods. The Compensation Committee also considers the number ofunvested stock options held by the executive officer in order to maintain anappropriate level of equity incentive for that individual. However, theCompensation Committee does not adhere to any specific guidelines as to therelative option or restricted stock holdings of 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, 2005, 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

Jordan S. Davis

 

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**Item 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATEDSTOCKHOLDER MATTERS.**

 

The followingtable sets forth as of March 15, 2006 certain information regardingbeneficial ownership of our common stock by (1) each person who is knownto us to be the beneficial owner of more than 5% of the outstanding shares ofour common stock, (2) each director, (3) each of the Named ExecutiveOfficers and (4) all directors and executive officers as a group. Allpersons listed have sole voting and investment power with respect to theirshares unless otherwise indicated. The address of all persons listed is c/oAmerican Bank Note Holographics, Inc., 2 Applegate Drive, Robbinsville, NJ08691, unless otherwise indicated.

 
| **Name and Address**                                   | ** ** | **Number (1)** | ** ** | **Percentage (1)** | ** ** |
|------------------------------------------------------------------|------------|---------------------|------------|-------------------------|------------|
| Crane & Co.,  Inc                                       |       | 3,387,720           |       | 17.9                    | %          |
| 30 South Street                                                  |       |                |       |                    |       |
| Dalton, MA 01226                                                 |       |                |       |                    |       |
|                                                             |       |                |       |                    |       |
| Libra Advisors, LLC (2)                                          |       | 2,156,000           |       | 11.4                    | %          |
| Libra Associates, LLC                                            |       |                |       |                    |       |
| Libra Fund, L.P.                                                 |       |                |       |                    |       |
| Ranjan Tandon                                                    |       |                |       |                    |       |
| 909 Third Avenue, 29th  Floor                                    |       |                |       |                    |       |
| New York, NY 10022                                               |       |                |       |                    |       |
|                                                             |       |                |       |                    |       |
| Levy, Harkins &  Co., Inc. (3)                     |       | 1,910,981           |       | 10.1                    | %          |
| The Gracy Fund, L.P.                                             |       |                |       |                    |       |
| Edwin A. Levy                                                    |       |                |       |                    |       |
| Michael J. Harkins                                               |       |                |       |                    |       |
| 570 Lexington Avenue                                             |       |                |       |                    |       |
| New York, NY 10022                                               |       |                |       |                    |       |
|                                                             |       |                |       |                    |       |
| Kenneth H. Traub (4)                                             |       | 981,458             |       | 5.0                     | %          |
|                                                             |       |                |       |                    |       |
| Salvatore F. D’Amato  (5)                                   |       | 387,000             |       | 2.0                     | %          |
|                                                             |       |                |       |                    |       |
| Mark J. Bonney (6)                                               |       | 51,666              |       | *                       |       |
|                                                             |       |                |       |                    |       |
| Fred J. Levin (7)                                                |       | 90,252              |       | *                       |       |
|                                                             |       |                |       |                    |       |
| Jordan S. Davis                                                  |       | 20,000              |       | *                       |       |
|                                                             |       |                |       |                    |       |
| Alan Goldstein (8)                                               |       | 207,688             |       | 1.1                     | %          |
|                                                             |       |                |       |                    |       |
| All executive officers  and directors as a group (5 persons) (9) |       | 1,530,376           |       | 7.6                     | %          |

 

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* Less than 1%.

 

(1) Beneficialownership is determined in accordance with the rules of the SEC, andincludes general voting power and/or investment power with respect tosecurities. At March 15, 2006, we had 18,888,144 shares of common stockoutstanding. These percentages were calculated based on the total of shares ofcommon stock outstanding and shares of common stock subject to optionscurrently exercisable or exercisable within 60 days of March 15, 2006,which are deemed outstanding for computing the percentage beneficially owned bythe 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 13, 2006. Libra Advisors, LLC, the generalpartner of Libra Fund, LP owns 1,817,516 shares of common stock. LibraAdvisors, LLC is also the investment adviser of an offshore fund that owns338,484 shares of our common stock. Libra Advisors, LLC has the power to voteand to direct the voting of and the power to dispose and direct the dispositionof these 2,156,000 shares. Ranjon Tandon is the sole voting member and managerof Libra Advisors, LLC and may be deemed to have the power to vote and todirect the voting of and the power to dispose and direct the disposition of the2,156,000 shares 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 12, 2006. Levy, Harkins & Co., Inc.(“LHC”) is the beneficial owner of 12,700 shares of common stock held in LHC’spension and profit sharing plans and may be deemed the beneficial owner of1,486,681 shares of common stock held in individual accounts of investmentadvisory clients of LHC. The Gracy Fund, L.P., a private investment company, isthe beneficial owner of 294,500 of common stock. Edwin A. Levy and Michael J.Harkins are the sole shareholders of LHC and the sole general partners of theGracy Fund, L.P. and have shared power to vote or direct the vote of, anddispose or to direct the disposition of the 1,793,881 shares beneficially ownedor deemed beneficially owned by LHC and beneficially owned by The Gracy Fund,L.P. Mr. Levy, individually is the beneficial owner of 117,100 of commonstock.

 

(4) Includes936,458 shares of common stock subject to options currently exercisable orexercisable within 60 days of March 15, 2006. Includes 45,000 sharesof restricted stock that fully vest on January 26, 2009.

 

(5) Includes380,000 shares of common stock subject to options currently exercisable orexercisable within 60 days of March 15, 2006. Includes 5,000 sharesof restricted stock that fully vest on May 15, 2006.

 

(6) Includes16,666 shares of common stock subject to options currently exercisable orexercisable within 60 days of March 15, 2006. Includes 15,000 shares ofrestricted stock, 5,000 of which fully vest on November 15, 2008 and thebalance of which fully vest on January 26, 2009.

 

(7) Includes26,666 shares of common stock subject to options currently exercisable orexercisable within 60 days of March 15, 2006.

 

(8) Consistsof 207,688 shares of common stock subject to options currently exercisable orexercisable within 60 days of March 15, 2006. Effective June 9,2005 Mr. Goldstein became the Vice President Finance and resigned from hisexecutive officer position as Chief Financial Officer and Secretary.

 

(9) Includes1,530,376 shares of common stock subject to options currently exercisable orexercisable within 60 days of March 15, 2006. Does not includeoptions to purchase 207,688 shares of common stock which are currentlyexercisable or exercisable within 60 days of March 15, 2006 by Mr. Goldstein,our former Chief Financial Officer and Secretary.

 

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**EquityCompensation Plan Information**

 

The followingtable sets forth information as of December 31, 2005 with respect toshares of our common stock which may be issued under our equitycompensation plans.

 
| **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)     |       | 1,293,938                                                                                                                                        |       | $                                                                                                       | 1.95       |                                                                                                                                                                                                            | 1,562,813  |   |
|                                                            |       |                                                                                                                                             |       |                                                                                                    |       |                                                                                                                                                                                                            |       |
| Equity compensation  plans not approved by security holders (2) |       | 1,678,000                                                                                                                                        |       | $                                                                                                       | 2.73       |                                                                                                                                                                                                            | 46,500     |   |
|                                                            |       |                                                                                                                                             |       |                                                                                                    |       |                                                                                                                                                                                                            |       |
| Total:                                                          |       | 2,971,938                                                                                                                                        |       |                                                                                                    |       | 1,609,313                                                                                                                                                                                                       |       |

 

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(1)          Represents our 2000 and2005 Stock Incentive Plans.

(2)          Represents our 1998Stock Incentive Plan.

 

**Material Terms of the 1998 StockIncentive Plan**

 

On July 20, 1998, we adopted the 1998Stock Incentive Plan (as amended, the “1998 Plan”). The 1998 Plan was adoptedfor the 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 1998 Plan. The total number of sharesreserved for issuance under the 1998 Plan are 1,863,000 shares of common stock.Options to purchase 1,678,000 shares of common stock were outstanding under the1998 Plan at December 31, 2005. The exercise price of options granted underthe 1998 Plan may not be less than 100% of the fair market value of thecommon stock on the date such option was granted. Options granted under the1998 Plan generally become vested and exercisable for up to either 25% or 331/3% of the total optioned shares upon each succeeding anniversary of the dateof 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.

 

**MaterialTerms of the 2000 Stock Incentive Plan**

 

On August 4,2000, we adopted the American Bank Note Holographics, Inc. 2000 StockIncentive Plan

 

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(as amended, the “2000Plan”), which was subsequently approved by our stockholders at our annualmeeting on September 12, 2000. In August 2001, our stockholdersapproved an amendment to the 2000 Plan increasing the shares available forissuance thereunder by 600,000 to 1,350,000 shares. The 2000 Plan was adoptedfor the 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 2000 Plan. The total number of sharesreserved for issuance under the 2000 Plan is 1,350,000 shares of common stock.Options to purchase 1,257,272 shares of common stock were outstanding under the2000 Plan at December 31, 2005. The exercise price of options grantedunder the 2000 Plan may not be less than 100% of the fair market value ofthe common stock on the date such option was granted. Options granted under the2000 Plan generally become vested and exercisable for up to either 25% or 331/3% of the total optioned shares upon each succeeding anniversary of the dateof 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.

 

**MaterialTerms of the 2005 Stock Incentive Plan**

 

On August 8,2005, we adopted the American Bank Note Holographics, Inc. 2005 StockIncentive Plan (the “2005 Plan”), which was subsequently approved by ourstockholders at our annual meeting on September 22, 2005. The 2005 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 2005 Plan. The total numberof shares reserved for issuance under the 2005 Plan is 1,600,000 shares ofcommon stock. Options to purchase 36,666 shares of common stock wereoutstanding under the 2005 Plan at December 31, 2005. During 2005, weissued 15,000 shares of restricted stock, which were all outstanding under the2005 Plan at December 31, 2005. The exercise price of options grantedunder the 2005 Plan may not be less than 100% of the fair market value ofthe common stock on the date such option was granted. Options granted under the2005 Plan generally become vested and exercisable for up to 33 1/3% of thetotal optioned 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.

 

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

 

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 our 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, and that, should our Board beexpanded to a number greater than six, then our Board shall be expanded byanother seat, and Crane shall be entitled to nominate an additional director.

 

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 ouroutstanding securities. The standstill provision also provides that Crane willnot offer, sell or transfer any of its voting securities of ABNH during atender or exchange offer if

 

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such offer isopposed by our board of directors. In connection with the transaction, Cranealso received the right to cause us to register Crane’s shares for publicresale and the right to include such shares in any future registration of oursecurities, subject to certain exceptions. On November 30, 2005 we wereinformed by Crane & Co., Inc. of their intention to sell aportion or all of their shares in an orderly manner to institutional buyers. OnNovember 29, 2005, Douglas Crane resigned from the Company’s Board ofDirectors and Crane has not appointed a replacement.

 

During 2000, weentered into agreements with Crane under which we rent factory space and leaseemployees for our facility in Dalton, MA. For the years ended December 31,2005, 2004 and 2003, we paid Crane under these agreements $72,000 each year,for the rental of the factory space and $153,000, $169,000 and $162,000,respectively, for the leased employees.

 

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

 

PricewaterhouseCoopers, LLP, our independentregistered public accounting firm for 2005 and Ernst & Young LLP, ourindependent registered public accounting firm for 2004 were paid for audit andother services rendered as set forth below.

 

**Audit Fees**

 
| **2005 Fiscal Year**                                  | ** ** | **PricewaterhouseCoopers,  LLP** | ** ** | **Ernst &  Young LLP** | ** ** |
|-------------------------------------------------------|------------|----------------------------------|------------|--------------------------------------|------------|
| Audit Fees                                            |       | $                                | 253,000    |                                 | $          | 25,000 |   |
| Audit-Related Fees                                    |       | —                           |       | —                               |       |
| Tax Fees                                              |       | —                           |       | —                               |       |
| All Other Fees                                        |       | —                           |       | 13,000                               |       |
| Total Fees for the Year  Ended December 31, 2005 |       | $                                | 253,000    |                                 | $          | 38,000 |   |

 
| **2004 Fiscal Year**                         | ** ** | **Ernst &  Young LLP** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------|------------|
| 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    |   |

 

Tax fees for 2005 and 2004 pertained toreviews of our federal and state tax returns.

 

The Audit Committee concluded that provisionof these services is compatible with maintaining the principal accountants’independence.

 

**Pre-Approval Policies**

 

The Audit Committee pre-approves all auditand non-audit services provided by our independent registered public accountingfirm prior to the engagement of the independent registered public accountingfirm with respect to such services. With respect to audit services andpermissible non-audit services not previously approved, the Audit Committee hasauthorized the Chairman of the Audit Committee to approve such audit

 

47

----

 

services and permissible non-audit services,provided the Chairman informs the Audit Committee of such approval at its nextregularly scheduled meeting. All “Audit Fees” and “Tax Fees” set forth abovewere pre-approved by the Audit Committee in accordance with its pre-approvalpolicy.

 

**Part IV**

 

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

 

(a)                      Thefollowing documents are filed as part of this report:

 

(1)                                  FinancialStatements

 

Thefinancial statements required by this item are submitted in a separate section beginningon page F-1 of this report.

 

(2)                                  FinancialStatement Schedules

 

Thefinancial statement schedule required by this item is submitted in aseparate section on page S-1 of this report.

 

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

 

(3)                                  Exhibits

 

Thefollowing exhibits are filed as part of this report or are incorporatedherein by reference. Exhibit Nos. 10.4, 10.5, 10.6, 10.7, 10.8, 10.9,10.10, 10.11, 10.12, 10.13, 10.30, 10.33, 10.34, 10.35 and 10.36 are managementcontracts, 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)    |
|   |   |                                                                                                                                                            |
|   | 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)                                                                                                                    |

 

48

----

 
|   | 10.6   | Form of  2000 Stock Incentive Plan. (6)                                                                                                                                                                                                    |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                            |
|   | 10.8   | Amendment to the  2000 Stock Incentive Plan. (15)                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                            |
|   | 10.9   | Form of  2005 Stock Incentive Plan. (17)                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                            |
|   | 10.10  | Form of  Defined Contribution Plan. (1)                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                            |
|   | 10.11  | Employment  Agreement, dated April 20, 1999, between Salvatore F. D’Amato and  American Bank Note Holographics, Inc. (7)                                                                                                         |
|   |   |                                                                                                                                                                                                                                            |
|   | 10.12  | Amended and  Restated Employment Agreement between Kenneth Traub and American Bank Note  Holographics, Inc., dated March 29, 2005. (16)                                                                                               |
|   |   |                                                                                                                                                                                                                                            |
|   | 10.13  | Amended and  Restated Employment Agreement, dated June 9, 2005, between Alan  Goldstein and American Bank Note Holographics, Inc. (15)                                                                                                |
|   |   |                                                                                                                                                                                                                                            |
|   | 10.14  | Standard Form of  Loft Lease, dated as of July 23, 1992, by and between Robert Martin  Company and American Bank Holographics, Inc. (9)                                                                                          |
|   |   |                                                                                                                                                                                                                                            |
|   | 10.15  | Lease Agreement,  dated as of January 19, 2001 by and between Crane & Co., Inc.  and American Bank Note Holographics, Inc. (9)                                                                                          |
|   |   |                                                                                                                                                                                                                                            |
|   | 10.16  | 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)                                               |
|   |   |                                                                                                                                                                                                                                            |
|   | 10.17  | Settlement Agreement, dated July 1,  2002, by and between American Bank Note Holographics, Inc. and Leonhard  Kurz GmbH & Co. KG (10)                                                                                        |
|   |   |                                                                                                                                                                                                                                            |
|   | 10.18  | Patent License Agreement, dated July 1,  2002, by and between American Bank Note Holographics, Inc. and Leonhard  Kurz GmbH & Co. KG (10)(+)                                                                                 |
|   |   |                                                                                                                                                                                                                                            |
|   | 10.19  | Substitute Cross License Agreement,  dated July 1, 2002, by and between American Bank Note Holographics, Inc.  and Leonhard Kurz & Co. KG (10)                                                                               |
|   |   |                                                                                                                                                                                                                                            |
|   | 10.20  | Hologram Agreement, dated February 28,  2003, by and between MasterCard International Incorporated and American Bank  Note Holograhics, Inc. (11)(+)                                                                                  |
|   |   |                                                                                                                                                                                                                                            |
|   | 10.21  | Amendment No. 1  to the Hologram Agreement, dated February 28, 2003, by and between  MasterCard International Incorporated and American Bank Note Holoographics, Inc.  (13) (+)                                                  |
|   |   |                                                                                                                                                                                                                                            |
|   | 10.22  | Amendment No. 2  to Hologram Agreement, dated March 25, 2005 to the Hologram Agreement,  dated February 28, 2003, by and between MasterCard International  Incorporated and American Bank Note Holographics, Inc. (18) (+)  |
|   |   |                                                                                                                                                                                                                                            |
|   | 10.23  | Amendment No. 3  to Hologram Agreement, dated August 24, 2005 to the Hologram Agreement,  dated February 28, 2003, by and between MasterCard International  Incorporated and American Bank Note Holographics, Inc. (18) (+) |
|   |   |                                                                                                                                                                                                                                            |
|   | 10.24  | VISA  International Holographic Magnetic Stripe Tape Manufacturing Approval  Association and American Bank Note Holographics, Inc. (18) (+)                                                                                                |
|   |   |                                                                                                                                                                                                                                            |
|   | 10.25  | Form of  Indemnification Agreement between the Company and its directors and officers.  (12)                                                                                                                                               |

 

49

----

 
| 10.26  |   | Sublease Agreement by  and between APW North America Inc. and American Bank Note Holographics, Inc.,  dated December 14, 2004. (14)                                                                                                                                                                                                                                                |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.27  |   | 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)                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.28  |   | 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) |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.29  |   | Escrow Agreement by and  between APW North America Inc., American Bank Note Holographics, Inc. and  Chicago Title Insurance Company, dated December 14, 2004. (14)                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.30  |   | Employment Agreement,  dated June 9, 2005, by and between American Bank Note Holographics, Inc. and  Mark Bonney. (15)                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.31  |   | Development, Supply and  Subcontracting Agreement, dated May 30, 2001, by and between American Bank  Note Holographics, Inc. and CFC International, Inc. (+)                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.32  |   | Amendment No. 1 to  Development, Supply and Subcontracting Agreement, dated May 30, 2001, by and  between American Bank Note Holographics, Inc. and CFC International, Inc.,  made as of January 4, 2006. (+)                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.33  |   | Form of Option  Agreement for American Bank Note Holographics, Inc. 1998                                                                                                                                                                                                                                                                                                           |
|   |   | Stock Incentive Plan as  amended. (5)                                                                                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.34  |   | Form of Option  Agreement for American Bank Note Holographics, Inc. 2000                                                                                                                                                                                                                                                                                                           |
|   |   | Stock Incentive Plan.  (5)                                                                                                                                                                                                                                                                                                                                                         |
| 10.35  |   | Form of Option  Agreement for American Bank Note Holographics, Inc. 2005 Stock Incentive  Plan. (16)                                                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 10.36  |   | Form of Restricted  Stock Agreement for American Bank Note Holographics, Inc. 2005 Stock  Incentive Plan. (16)                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 23.1   |   | Consent of  PricewaterhouseCoopers, LLP.                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 23.2   |   | Consent of Ernst &  Young LLP.                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 24.1   |   | Power of Attorney of  Jordan S. Davis, dated March 28, 2006.                                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 24.2   |   | Power of Attorney of  Fred Levin, dated March 25, 2006                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                               |
| 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 Mark  Bonney 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.                                                                                                                                                                                                                       |

 

50

----

 
|   |   |                                                                                                                                                 |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|
| 32.1   |   | Certification of  Kenneth H. Traub pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes – Oxley Act of 2002. |
|   |   |                                                                                                                                                 |
| 32.2   |   | Certification of Mark  Bonney 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.

 

(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.

 

(15)         Incorporated by referencefrom the Quarterly Report on Form 10-Q filed on August 15, 2005.

 

(16)         Incorporated by referencefrom the Current Report on Form 8-K filed on September 22, 2005.

 

(17)         Incorporated by referencefrom the Registration Statement on Form S-8 (Registration No. 333- 129686).

 

(18)         Incorporated by referencefrom the Quarterly Report on Form 10-Q filed on November 13, 2005.

 

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

 

51

----

 

SIGNATURES

 

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

 

 
|           | AMERICAN BANK NOTE  HOLOGRAPHICS, INC. |
|----------------|----------------------------------------|
|           |                                   |
|           |                                   |
|           | By:                                    | /s/ Kenneth H. Traub |   |
|           |                                   | Kenneth H. Traub |
|           |                                   | President and Chief  Executive Officer |
|           |                                   |
| March 31, 2006 |                                   |

 

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

 
| **Signature**                 | ** ** | **Title**                                     | ** **                              | **Date**   |
|-------------------------------|------------|-----------------------------------------------|-----------------------------------------|------------|
| ** **                    | ** ** | ** **                                    | ** **                              | ** ** |
| /s/ Kenneth H. Traub          |       |                                          | President, Chief  Executive Officer and |       | March 31, 2006 |
| Kenneth H. Traub              |       | Director (Principal  Executive Officer)       |                                    |       |
|                          |       |                                          |                                    |       |
|                          |       |                                          |                                    |       |
|                          |       |                                          |                                    |       |
| /s/ Mark J. Bonney            |       |                                          | Chief Financial Officer                 |       | March 31, 2006 |
| Mark J. Bonney                |       | (Principal Financial  and Accounting Officer) |                                    |       |
|                          |       |                                          |                                    |       |
|                          |       |                                          |                                    |       |
| /s/ Salvatore F. D’Amato |       |                                          | Chairman of the Board                   |       | March 31, 2006 |
| Salvatore F. D’Amato     |       |                                          |                                    |       |
|                          |       |                                          |                                    |       |
|                          |       |                                          |                                    |       |
|  *                       |       |                                          | Director                                |       | March 31, 2006 |
| Jordan S. Davis               |       |                                          |                                    |       |
|                          |       |                                          |                                    |       |
|                          |       |                                          |                                    |       |
|  *                       |       |                                          | Director                                |       | March 31, 2006 |
| Fred J. Levin                 |       |                                          |                                    |       |
|                          |       |                                          |                                    |       |
|                               |            |                                               |                                         |            |  |  |  |

 
| * /s/ Kenneth H. Traub         |   |
|--------------------------------|--------|
|   Kenneth H. Traub   |
|   *Attorney-in fact* |

 

52

----

 

AMERICAN BANK NOTEHOLOGRAPHICS, INC.

 

INDEX TO FINANCIAL STATEMENTS

 

ITEM 15(a)

 
| REPORT OF INDEPENDENT  REGISTERED PUBLIC ACCOUNTING FIRM                                      |   |
|-----------------------------------------------------------------------------------------------|--------|
| REPORT OF INDEPENDENT  REGISTERED PUBLIC ACCOUNTING FIRM                                      |   |
| FINANCIAL STATEMENTS:                                                                         |   |
| Balance  Sheets, December 31, 2005 and 2004                                                   |   |
| Statements  of Operations for the Years Ended December 31, 2005, 2004 and 2003                |   |
| Statements  of Stockholders’ Equity for the Years Ended December 31, 2005, 2004 and 2003 |   |
| Statements  of Cash Flows for the Years Ended December 31, 2005, 2004 and 2003                |   |
| Notes  to Financial Statements                                                                |   |
| Schedule II - Valuation  and Qualifying Accounts                                              |   |

 

----

 

### **Reportof Independent Registered Public Accounting Firm**

 

 

To the Board of Directors

Of American Bank NoteHolographics, Inc.

 

 

Inour opinion, the financial statements listed in the accompanying index presentfairly, in all material respects, the financial position of American Bank NoteHolographics, Inc. at December 31, 2005, and the results of its****operations and its****cash flows forthe year in the period ended December 31, 2005 in conformity with accountingprinciples generally accepted in the United States of America. In addition, inour opinion, the financial statement schedules listed in the accompanying index****present fairly, in all materialrespects, the information set forth therein when read in conjunction with therelated financial statements. These financial statements and financialstatement schedules are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements andfinancial statement schedules based on our audit. We conducted our audit ofthese statements in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation. We believe that ouraudit provides a reasonable basis for our opinion.

 

 
|   | /s/  PricewaterhouseCoopers, LLP |
|--------|----------------------------------|

 

 

FlorhamPark, New Jersey

March 31, 2006

 

F-2

----

 

Report of IndependentRegistered Public Accounting Firm

 

To the Board of Directors and Shareholders of

American Bank Note Holographics, Inc.

 

We have audited the accompanying balance sheet of American Bank NoteHolographics, Inc. (the “Company”) as of December 31, 2004 and the relatedstatements of operations, stockholders’ equity, and cash flows for each of thetwo years in the period ended December 31, 2004. Our audits also included theinformation for each of the two years in the period ended December 31, 2004included in the financial statement schedule listed in the Index at Item 15(a).These financial statements and schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements and schedule based on our 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. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above presentfairly, in all material respects, the financial position of the Company as ofDecember 31, 2004 and the results of its operations and its cash flows for eachof the two years in the period ended December 31, 2004 in conformity with U.S.generally accepted accounting principles. Also, in our opinion, the informationfor each of the two years in the period ended December 31, 2004 in the relatedfinancial statement schedule when considered in relation to the basic financialstatements taken as a whole, present fairly in all material respects theinformation set forth therein.

 

 
|   | /s/  Ernst & Young LLP |   |
|--------|----------------------------|--------|

 

New York, New York

March 10, 2005

 

F-3

----

 

AMERICAN BANK NOTEHOLOGRAPHICS, INC.

 

BALANCE SHEETS

DECEMBER 31, 2005AND 2004

(In Thousands, ExceptShare Data)

 
| ** **                                                                                                                                | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                                                                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| ASSETS                                                                                                                                    |       |       |       |       |       |
| CURRENT ASSETS:                                                                                                                           |       |       |       |       |       |
| Cash and cash equivalents                                                                                                                 |       | $          | 9,114      |       | $          | 11,357 |   |
| Short-term investments                                                                                                                    |       | —     |       | 1,989      |       |
| Accounts receivable, net of allowance for doubtful  accounts of $500 and $180                                                             |       | 6,019      |       | 3,889      |       |
| Inventories, net                                                                                                                          |       | 2,940      |       | 3,394      |       |
| Deferred income taxes, net                                                                                                                |       | 2,968      |       | 983        |       |
| Prepaid expenses and other                                                                                                                |       | 331        |       | 317        |       |
| Income tax receivable                                                                                                                     |       | 401        |       | —     |       |
| Total current assets                                                                                                                      |       | 21,773     |       | 21,929     |       |
| MACHINERY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS— Net  of accumulated depreciation and amortization of $8,852 and $10,062             |       | 7,224      |       | 3,172      |       |
| DEFERRED INCOME TAXES, NET                                                                                                                |       | 411        |       | —-    |       |
| OTHER ASSETS                                                                                                                              |       | 76         |       | 110        |       |
| TOTAL ASSETS                                                                                                                              |       | $          | 29,484     |       | $          | 25,211 |   |
|                                                                                                                                      |       |       |       |       |       |
| LIABILITIES AND STOCKHOLDERS’  EQUITY                                                                                                |       |       |       |       |       |
| CURRENT LIABILITIES:                                                                                                                      |       |       |       |       |       |
| Accounts payable                                                                                                                          |       | $          | 3,820      |       | $          | 1,519 |   |
| Accrued expenses                                                                                                                          |       | 3,834      |       | 2,040      |       |
| Customer advances                                                                                                                         |       | 204        |       | 69         |       |
| Income taxes payable                                                                                                                      |       | 359        |       | 1,058      |       |
| Total current liabilities                                                                                                                 |       | 8,217      |       | 4,686      |       |
| LONG-TERM LIABILITIES                                                                                                                     |       | 1,957      |       | 1,211      |       |
| Total liabilities                                                                                                                         |       | 10,174     |       | 5,897      |       |
|                                                                                                                                      |       |       |       |       |       |
| 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, 18,715,469 shares and 18,515,907  shares |       | 187        |       | 185        |       |
| Additional paid-in capital                                                                                                                |       | 24,729     |       | 24,058     |       |
| Unearned compensation on restricted stock                                                                                                 |       | (96        | )          | —     |       |
| Accumulated deficit                                                                                                                       |       | (5,510     | )          | (4,929     | )          |
| Total stockholders’ equity                                                                                                           |       | 19,310     |       | 19,314     |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                           |       | $          | 29,484     |       | $          | 25,211 |   |

 

The accompanying notesare an integral part of these financial statements.

 

F-4

----

 

AMERICAN BANK NOTEHOLOGRAPHICS, INC.

 

STATEMENTS OF OPERATIONS

YEARS ENDEDDECEMBER 31, 2005, 2004 AND 2003

(In Thousands, Except PerShare Data)

 
| ** **                                                   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| REVENUE:                                                     |       |     |       |     |       |     |       |
| Sales                                                        |       | $        | 32,299     |     | $          | 21,263   |       | $ | 18,284 |   |
| Royalty income                                               |       | 20       |       | 13       |       | 48       |       |
| Total revenue                                                |       | 32,319   |       | 21,276   |       | 18,332   |       |
|                                                         |       |     |       |     |       |     |       |
| COSTS AND EXPENSES:                                          |       |     |       |     |       |     |       |
| Cost of goods sold, excluding depreciation and  amortization |       | 19,368   |       | 9,161    |       | 8,279    |       |
| Selling and administrative                                   |       | 8,850    |       | 7,070    |       | 6,518    |       |
| Research and development                                     |       | 1,263    |       | 1,270    |       | 1,142    |       |
| Depreciation and amortization                                |       | 1,297    |       | 830      |       | 739      |       |
| Facility consolidation                                       |       | 2,769    |       | 242      |       | —   |       |
| Total costs and expenses                                     |       | 33,547   |       | 18,573   |       | 16,678   |       |
|                                                         |       |     |       |     |       |     |       |
| Operating (loss) income                                      |       | (1,228   | )          | 2,703    |       | 1,654    |       |
|                                                         |       |     |       |     |       |     |       |
| OTHER INCOME:                                                |       |     |       |     |       |     |       |
| Interest                                                     |       | 259      |       | 121      |       | 97       |       |
| Patent and other settlements                                 |       | —   |       | 178      |       | —   |       |
| Total other income                                           |       | 259      |       | 299      |       | 97       |       |
|                                                         |       |     |       |     |       |     |       |
| (LOSS) INCOME BEFORE (BENEFIT) PROVISION FOR INCOME  TAXES   |       | (969     | )          | 3,002    |       | 1,751    |       |
|                                                         |       |     |       |     |       |     |       |
| (BENEFIT) PROVISION FOR INCOME TAXES                         |       | (388     | )          | 1,201    |       | 744      |       |
|                                                         |       |     |       |     |       |     |       |
| NET (LOSS) INCOME                                            |       | $        | (581       | )        | $          | 1,801    |       | $ | 1,007 |   |
|                                                         |       |     |       |     |       |     |       |
| NET (LOSS) INCOME PER SHARE:                                 |       |     |       |     |       |     |       |
| Basic                                                        |       | $        | (0.03      | )        | $          | 0.10     |       | $ | 0.05 |   |
| Diluted                                                      |       | $        | (0.03      | )        | $          | 0.10     |       | $ | 0.05 |   |

 

The accompanying notesare an integral part of these financial statements.

 

F-5

----

 

AMERICAN BANK NOTEHOLOGRAPHICS, INC.

 

STATEMENTS OFSTOCKHOLDERS’ EQUITY

YEARS ENDEDDECEMBER 31, 2005, 2004 AND 2003

(In Thousands)

 
| ** **                                        | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional** | ** ** | ** **       | ** ** | ** **  | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|-------------|------------|----------------|------------|------------------|------------|-------------|------------|------------|------------|
| ** **                                        | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Unearned**   | ** ** | **Accumulated**  | ** ** | ** **  | ** ** |
| ** **                                        | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Compensation** | ** ** | **Deficit** | ** ** | **Total**  | ** ** |
| BALANCE, JANUARY 1, 2003                          |       | 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     |       |
| Issuance of shares from exercise of stock options |       | 184                   |       | 2           |       | 575            |       | —           |       | —      |       | 577        |       |
| Issuance of restricted stock                      |       | 15                    |       |        |       | 96             |       | (96              | )          | —      |       | —     |       |
| Net (loss)                                        |       | —                |       | —      |       | —         |       | —           |       | (581        | )          | (581       | )          |
| BALANCE, DECEMBER 31, 2005                        |       | 18,715                |       | $           | 187        |           | $          | 24,729           |       | $           | (96        | )          | $          | (5,510 | ) | $ | 19,310 |   |

 

The accompanying notesare an integral part of these financial statements.

 

F-6

----

 

AMERICAN BANK NOTEHOLOGRAPHICS, INC.

 

STATEMENTS OF CASH FLOWS

YEARS ENDEDDECEMBER 31, 2005, 2004 AND 2003

(In Thousands)

 
| ** **                                                                                | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                     |       |       |       |       |       |       |       |
| Net (loss) income                                                                         |       | $          | (581       | )          | $          | 1,801      |       | $ | 1,007 |   |
| Adjustments to reconcile net (loss) income to net  cash provided by operating activities: |       |       |       |       |       |       |       |
| Depreciation and amortization                                                             |       | 1,297      |       | 830        |       | 739        |       |
| Deferred income taxes, net                                                                |       | (2,864     | )          | 1          |       | 744        |       |
| Increase (decrease) in allowance for doubtful  accounts                                   |       | 320        |       | —     |       | (30        | )          |
| Increase (decrease) in provision for inventories                                          |       | 3,728      |       | 141        |       | (760       | )          |
| Changes in operating assets and liabilities:                                              |       |       |       |       |       |       |       |
| Accounts receivable                                                                       |       | (2,450     | )          | (715       | )          | 517        |       |
| Inventories                                                                               |       | (3,274     | )          | (1,149     | )          | 915        |       |
| Prepaid expenses and other                                                                |       | 14         |       | 215        |       | 486        |       |
| Income tax receivable                                                                     |       | (401       | )          | —     |       | —     |       |
| Accounts payable                                                                          |       | 2,090      |       | 832        |       | (279       | )          |
| Accrued expenses                                                                          |       | 1,794      |       | 413        |       | (176       | )          |
| Customer advances                                                                         |       | 135        |       | 20         |       | (40        | )          |
| Income taxes payable                                                                      |       | (699       | )          | 1,058      |       | —     |       |
| Long-term liabilities                                                                     |       | 1,214      |       | —     |       | —     |       |
| Net cash provided by operating activities                                                 |       | 323        |       | 3,447      |       | 3,123      |       |
|                                                                                      |       |       |       |       |       |       |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                     |       |       |       |       |       |       |       |
| Decrease (increase) in short-term investments                                             |       | 1,989      |       | 2,012      |       | (4,001     | )          |
| Capital expenditures                                                                      |       | (5,132     | )          | (1,506     | )          | (441       | )          |
| Net cash (used in) provided by investing activities                                       |       | (3,143     | )          | 506        |       | (4,442     | )          |
|                                                                                      |       |       |       |       |       |       |       |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                     |       |       |       |       |       |       |       |
| Proceeds from exercise of stock options                                                   |       | 577        |       | 64         |       | —     |       |
| Net cash provided by financing activities                                                 |       | 577        |       | 64         |       | —     |       |
|                                                                                      |       |       |       |       |       |       |       |
| (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                                          |       | (2,243     | )          | 4,017      |       | (1,319     | )          |
| CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR                                              |       | 11,357     |       | 7,340      |       | 8,659      |       |
| CASH AND CASH EQUIVALENTS, END OF YEAR                                                    |       | $          | 9,114      |       | $          | 11,357     |       | $ | 7,340 |   |
|                                                                                      |       |       |       |       |       |       |       |
| SUPPLEMENTAL CASH FLOW INFORMATION:                                                       |       |       |       |       |       |       |       |
| Income taxes paid                                                                         |       | $          | 3,359      |       | $          | 184        |       | $ | 5 |   |
| Capital expenditures included in accounts payable                                         |       | $          | 211        |       | $          | —     |       | $ | — |   |

 

The accompanying notesare an integral part of these financial statements.

 

F-7

----

 

NOTES TO FINANCIAL STATEMENTS

YEARS ENDED DECEMBER 31,2005, 2004 AND 2003

 

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”).

 

ABNHoriginates, produces, markets and sells holograms and products incorporatingholograms. The Company’s products are used primarily in security applicationsincluding authentication of transaction cards, identity documents, valuedocuments and various consumer products. 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. On anongoing basis, we evaluate our estimates, including those related to bad debts,inventories and intangible assets. These estimates and assumptions are based onhistorical results and trends as well as our forecasts as to how these mightchange in the future. In addition, theses estimates and assumptions have beeninfluenced by our current knowledge of the impact of the VISA Decision. (seeNote 11. Subsequent Event). Actual results may differ materially from ourestimates.

 

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 –Short-term investments consists of a government bond which matured February 22,2005. In accordance with Statement of Financial Accounting Standard (“SFAS”)No. 115, “Accounting for Certain Investments in Debt and Equity Securities,”management determines the appropriate classification of marketable securitiesat the time of purchase and reevaluates such designations as of each balancesheet date. This investment was classified as held to maturity and carried atits amortized cost until its maturity date.

 

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, 2005 two customerseach accounted for 22% of the Company’s accounts receivable and 30% and 11%,respectively of its sales for the year then ended. At December 31, 2004 each ofthree customers accounted for 28%, 19% and 11%, respectively, of the Company’saccounts receivable and 35%, 9% and 6%, respectively, of its sales for the yearthen ended. 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.

 

RevenueRecognition — The Companyrecognizes revenue in accordance with the provisions of the SEC’s StaffAccounting Bulletin (“SAB”) No. 104, “Revenue Recognition (an amendment of SAB101, “Revenue Recognition in Financial Statements”).”  Specifically, sales and the related cost ofgoods sold are generally recognized at the latter of the time of shipment orwhen title passes to customers. In some

 

F-8

----

 

situations, the Company has shipped product where the sale iscontingent upon the customers’ use of the product. In these situations, theCompany does not recognize sales upon product shipment, but rather when thebuyer of the product informs the Company that the product has been used.Additionally, pursuant to the request of and agreement with a certain customer,completed items are stored on behalf of the customer at the Company’s on-sitesecured facility and, in that instance, sales are recognized when all of thefollowing have occurred: the customer has ordered the goods pursuant to a fixedprice purchase order, the manufacturing process is complete, the goods havebeen transferred to the on-site secured facility and are ready for shipment,the risk of ownership has passed to the customer, the customer has been billedfor the order and collection of the invoice is considered probable. The Company only accepts returns of productsold to customers when the product is determined to not be in conformance withthe specifications previously agreed upon with such customers in accordancewith the terms of its warranty policy and generally replaces the product.

 

Shipping and handlingamounts billed to customers are included in revenues and amounted to $867,000,$433,000 and $358,000 for the years ended December 31, 2005, 2004 and 2003,respectively. Shipping and handling costs are included in selling andadministrative expenses.

 

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 life of the asset.Estimated useful lives are generally as follows: Machinery and productionequipment - 5 to 15 years; Furniture and fixtures – 5 to 7 years and  Computer equipment - 3 to 5 years.Amortization of leasehold improvements is computed using the straight-linemethod based upon the remaining term of the applicable lease, or the estimateduseful life of the asset, whichever is shorter, currently 13 years.

 

Long-Lived Assets —Long-lived assets used in operations are reviewed for impairment wheneverevents or changes in circumstances indicate that the carrying amount of theassets might not be recoverable. For long-lived assets to be held and used, theCompany recognizes an impairment loss only if its carrying amount is notrecoverable through its undiscounted cash flows and measures the impairmentloss based on the difference between the carrying amount and fair value.

 

Warranty Costs — TheCompany provides for warranty costs in amounts it estimates will be needed tocover future warranty obligations for products sold. Estimates of warrantycosts are based on historical experience and are periodically reviewed andadjusted, when necessary. The Company’s product warranty provision is includedin accrued expenses in the accompanying balance sheets. Changes in the Company’swarranty provision during the years ended December 31, 2005, 2004 and 2003 aredisplayed in the following table. The significant change in warranties providedin 2005 is principally due to increased volume in the quarter ended December31, 2005 and an additional provision recorded in the quarter ended December 31,2005 for potential non-ESD related warranty claims as a result of the VISADecision. (see Note 11. Subsequent Event)

 
| ** **                   | ** ** | **2005**            | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------|------------|---------------------|------------|----------|------------|----------|------------|
| ** **                   |       | **(In  Thousands)** |       |
| Balance at beginning of year |       | $                   | 510        |     | $          | 510      |       | $ | 605 |   |
| Warranties provided          |       | 890                 |       | 160      |       | 160      |       |
| Settlements made             |       | (260                | )          | (160     | )          | (255     | )          |
| Balance at end of year       |       | $                   | 1,140      |     | $          | 510      |       | $ | 510 |   |

 

F-9

----

 

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 Compensation –The Company accounts for stock options granted to employees and directors usingthe intrinsic value method in accordance with APB Opinion No. 25, “Accountingfor Stock Issued to Employees”, and its related interpretations. The Companyadopted the disclosure requirements of SFAS No. 123, “Accounting forStock-Based Compensation”, and accordingly the Company does not recognizecompensation expense for stock option grants made at an exercise price equal toor in excess of the fair market value of the stock at the date of 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 net(loss) income and basic and diluted net (loss) income per share would havediffered as reflected by the pro forma amounts, calculated using theBlack-Scholes model to estimate the fair value of the options at grant date,indicated below:

 
| ** **                                                                                                               | ** ** | **2005**                                                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                                               | ** ** | **((In Thousands, Except Per Share Data)** | ** ** |
| Net (loss) income, as reported                                                                                           |       | $                                                                   | (581       | )        | $          | 1,801    |       | $ | 1,007 |   |
|                                                                                                                     |       |                                                                |       |     |       |     |       |
| 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 |       | 208                                                                 |       | 77       |       | 81       |       |
| Pro forma, net (loss) income                                                                                             |       | $                                                                   | (789       | )        | $          | 1,724    |       | $ | 926 |   |
|                                                                                                                     |       |                                                                |       |     |       |     |       |
| Basic and diluted net (loss)income per share, as  reported                                                               |       | $                                                                   | (0.03      | )        | $          | 0.10     |       | $ | 0.05 |   |
| Basic and diluted net (loss)income per share, pro  forma                                                                 |       | $                                                                   | (0.04      | )        | $          | 0.09     |       | $ | 0.05 |   |

 

Basic and Diluted Net(Loss) Income per Share — Basic net (loss) income per share is computed basedon the weighted average number of outstanding shares of common stock. The basicweighted average number of shares outstanding were 18,593,000 for the yearended December 31, 2005, 18,489,000 for the year ended December 31, 2004 and18,484,000 for the year ended December 31, 2003. Diluted net income (loss) pershare is computed by dividing net income (loss) by the weighted average numberof shares of common stock outstanding and dilutive potential shares of commonstock. As the Company was in a loss position for the year ended December 31,2005 dilutive stock options were excluded from the calculation of dilutiveearnings per share as the shares would have had an anti-dilutive effect. Forthe year ended December 31, 2004 the diluted number of weighted sharesoutstanding was 18,907,000 which included dilutive stock options of 418,000.For the year ended December 31, 2003, the diluted weighted average number ofshares outstanding was 18,526,000 which included dilutive stock options of42,000.

 

Business Concentration Risks — A significant portion of the Company’s business is derived from ordersplaced by certain transaction card companies and manufacturers of transactioncards, and variations in the timing of such orders can cause significantfluctuations in the Company’s sales. Sales to transaction card companiesand manufacturers of transaction cards accounted for approximately 86% of ourtotal sales in 2005 and 84% of our total sales in 2004. The traditional hotstamp patch hologram on many transaction

 

F-10

----

 

cards is beingphased out by some of our major customers and is being replaced by anintegrated holographic magnetic stripe. We previously reported that we hadlearned of a small number of incidents in which certain card terminals had beenaffected byelectro-static discharge (“ESD”) from static electricity carried on cardsincorporating the current version of HoloMag. We have been advised by customersthat there is a need to develop a second generation holographic magnetic tapeproduct that addresses ESD and we have commenced such development. There can beno assurance that we will be successful in developing such a product that willbe acceptable to our customers. Further there can be no assurance that acompetitor of ours will not develop an acceptable product that is adopted byour customers.

 

Salesto MasterCard for the years ended December 31, 2005, 2004 and 2003 wereapproximately 31%, 35%, and 33%, respectively. At December 31, 2005 and 2004,accounts receivable from MasterCard approximated $1.5 million and $1.1 million,respectively. We entered into an agreement with MasterCard dated February 28,2003, which replaced the agreement dated 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. This agreement provided for MasterCard to receivethree sequential price reductions of approximately 3% each, effective at thebeginning of 2003, 2004 and 2006. We entered into an additional amendment tothe agreement with MasterCard on August 24, 2005 in which MasterCard named theCompany as its supplier of holographic magnetic stripes (“HoloMagTM”) andextended the agreement through February 28, 2013, subject to automatic renewal.The Company is the exclusive supplier of holograms and holographic magneticstripes to MasterCard.

 

*Sales ofVISA holograms (which includes HoloMag starting in the three month period endedSeptember 30, 2005) to manufacturers of VISA transaction cards wereapproximately 37%, 31% and 30% of sales for the years ended December 31, 2005,2004 and 2003, respectively. Currently we are one of two companies authorizedto manufacture and sell the VISA Dove hot stamp holograms to manufacturers ofVISA brand transaction cards. On March 15, 2005, VISA announced its intentionto phase out the Dove hot stamp hologram that we supply for the front of theVISA card, and to replace it with an integrated holographic magnetic stripe. OnApril 8, 2005, we entered into an Agreement with VISA, pursuant to which wewere authorized to supply HoloMag to VISA-approved card manufacturers. Wepreviously reported that we had learned of a small number of incidents in whichcertain card terminals had been affected by electro-static discharge (“ESD”)from static electricity carried on cards incorporating HoloMag. On March 14,2006, we were informed by VISA that, as a result of the ESD issue, VISA isinforming its member financial institutions and authorized card manufacturersthat (i) VISA will no longer approve VISA card designs which incorporatethe current version of HoloMag, (ii) VISA strongly recommends that theirmembers attempt to avoid further issuance of cards incorporating the currentversion of HoloMag and (iii) VISA recommends that their members follow analternate card design incorporating a conventional magnetic stripe and Dovehologram and VISA provided notice to us that it was revoking our right toproduce HoloMag under its agreement (the “VISA Decision”). We are continuing toevaluate VISA’s actions and claims and have submitted an initial response toVISA.*In the quarter ended December 31, 2005, as a result of the VISADecision, we recorded a pre-tax charge amounting to approximately $5.0 millionof which $4.8 million was recorded in cost of goods sold and was principallyrelated to the value of our HoloMag inventory. Also included in the charge wereincreases in our provisions for accounts receivable and potential non-ESDrelated warranty claims. We will review the valuation of these accounts on anongoing basis as part of our closing process and make appropriate changes toour reserve levels based upon the facts at the time.

 

F-11

----

 

We purchase certain key materials used in the manufacture of ourproducts, and subcontract certain production functions or productsfrom third parties some of which are solesuppliers. In some cases, we do not have supply contracts with our suppliers,and operate on a purchase order basis. In the case of HoloMag, we have a single supplier, CFC International,Inc., with whom we have a supply contract. We may not be able to findalternative 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 products or product components or to have certainprocesses performed on our behalf could cause delays or reduce productshipments, which could cause our relationship with customers to suffer andmaterially and adversely affect our financial condition, results of operationsand cash flows.

 

ExportSales — During2005, 2004 and 2003, export sales accounted for approximately 34%, 21% and 28%,respectively, of total sales. All of our export sales are presently denominatedin U.S. dollars. At December 31, 2005and 2004, accounts receivable from these customers approximated $2.0 and $.5million, respectively.

 

FairValue of Financial Instruments – The Company’s financial instruments consist ofcash and cash equivalents, short-term investments, accounts receivables,accounts payable and accrued expenses. The carrying amounts reported in thebalance sheets approximate their fair value at both December 31, 2005 and 2004.

 

Comprehensive Income –Comprehensive income is equal to net income in all periods.

 

Reclassifications – Certain prior year amounts have been reclassifiedto conform with the current year’s presentation.

 

Impact of Recently Issued Accounting Standards — In December 2004, the Financial AccountingStandards Board issued Statement No. 123(R) (FAS 123R), *Share-BasedPayment*, revising FAS 123 and requiring that all share-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 statement, asamended, becomes effective in the first annual period beginning after June 15,2005. The Company has adopted the new statement effective January 1, 2006,using the modified-prospective transition method described in the statement.Under this method, the Company will be required to recognize compensationexpense over the remaining vesting period for all awards that remain unvestedas of January 1, 2006. As permitted by FAS 123, the Company currently accountsfor share-based payments to employees using APB 25’s intrinsic value methodand, as such, generally recognized no compensation cost for employee stockoptions. For an approximate impact on 2006 results refer to the pro-formaresults shown above in Note 1. “Stock-based Compensation”.

 

In November 2004, the Financial Accounting Standards Board issuedStatement No. 151 (FAS 151), *Inventory Costs*,an amendment of ARB No. 43, Chapter 4. FAS 151 clarifies that abnormal amountsof idle facility expense, freight, handling costs and wasted materials shouldbe recognized as current period charges. In addition, FAS 151 requires thatallocation of fixed production overhead to inventory be based on the normalcapacity of the production facilities. FAS 151 is effective for inventory costsincurred during fiscal years beginning after June 15, 2005. The Companycurrently believes that the adoption of FAS 151 will not have a material impacton its financial statements.

 

In March 2005, the Financial Accounting Standards Board (“FASB”) issuedinterpretation No. 47, *Accounting for ConditionalAsset Retirement Obligations*, an interpretation of SFAS No. 143.This interpretation clarifies that the term of *conditionalasset retirement obligation* refers to a legal obligation

 

F-12

----

 

to perform an asset retirement activity in which the timing and/ormethod of settlement are conditional on a future event that may or may not bewithin the control of the entity. The obligation to perform the assetretirement activity is unconditional even though uncertainty exists about thetiming and/or method of settlement. Accordingly, an entity is required torecognize a liability for the fair value of a conditional asset retirementobligation if the fair value of the liability can be reasonably estimated. Theprovisions of Interpretation 47 are effective for fiscal years ending afterDecember 15, 2005. The adoption of this statement will not have an impact tothe Company’s financial statement presentation since there have been no conditionalasset retirement obligations.

 

In December 2004, the Financial Accounting Standards Board (“FASB”)issued Statement of Financial Accounting Standards (“SFAS”) No. 154, *Accounting Changes and Error Corrections*, a replacement ofAPB Opinion No. 20 and SFAS No. 3. This statement changes the requirements forthe accounting for and the reporting of a change in accounting principle. Thisstatement requires retrospective application to prior period financialstatements of changes in accounting principle, unless it is impracticable todetermine either the period-specific effects of the cumulative effect of thechange. Indirect effects of a change in accounting principle should berecognized in the period of the accounting change. The provisions of SFAS No.154 are effective for fiscal years beginning after December 15, 2005. TheCompany has adopted this Statement beginning January 1, 2006.

 

2.               INVENTORIES,NET

 

| ** **                                   | ** ** | **December 31,**   | ** ** |
|----------------------------------------------|------------|-------------------------|------------|
| ** **                                   | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                                   | ** ** | **(In Thousands)** | ** ** |
| Finished goods                               |       | $                       | 5,802      |   | $ | 2,050 |   |
| Finished goods on consignment with customers |       | 158                     |       | 231 |   |
| Work in process                              |       | 644                     |       | 1,192 |   |
| Raw materials                                |       | 616                     |       | 473 |   |
| Subtotal                                     |       | 7,220                   |       | 3,946 |   |
| Less: Inventory reserves                     |       | 4,280                   |       | 552 |   |
|                                         |       |                    |       |   |   |
| Inventories                                  |       | $                       | 2,940      |   | $ | 3,394 |   |

 

Inventoriesare stated at the lower of cost or market (first-in, first-out method). As aresult of the VISA Decision (see Note 12, Subsequent Event) in the quarterended December 31, 2005, we adjusted the value of HoloMag inventory by$4,018,000 reflecting the lower of cost or market value at December 31, 2005.

 

3.               MACHINERY,EQUIPMENT AND LEASEHOLD IMPROVEMENTS

 

| ** **                                           | ** ** | **December 31,**   | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|
| ** **                                           | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                                           | ** ** | **(In Thousands)** | ** ** |
| Machinery and equipment                              |       | $                       | 9,760      |   | $ | 8,832 |   |
| Furniture and fixtures                               |       | 318                     |       | 164 |   |
| Purchased Software and computers                     |       | 1,762                   |       | 1,354 |   |
| Construction in progress                             |       | 729                     |       | 846 |   |
| Leasehold improvements                               |       | 3,369                   |       | 1,131 |   |
| Other                                                |       | 138                     |       | 907 |   |
|                                                 |       | 16,076                  |       | 13,234 |   |
| Accumulated depreciation and amortization            |       | 8,852                   |       | 10,062 |   |
| Machinery, equipment and leasehold improvements, net |       | $                       | 7,224      |   | $ | 3,172 |   |

 

F-13

----

 

Depreciation andamortization of machinery and equipment and leasehold improvements for theyears ended December 31, 2005, 2004 and 2003 were $1,291,000, $824,000 and$733,000, respectively.

 

4.               ACCRUEDEXPENSES

 

| ** **                 | ** ** | **December 31,**   | ** ** |
|----------------------------|------------|-------------------------|------------|
| ** **                 | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                 | ** ** | **(In Thousands)** | ** ** |
| Accrued contract liability |       | $                       | 357        |   | $ | 357 |   |
| Warranty reserves          |       | 1,140                   |       | 510 |   |
| Salaries and wages         |       | 796                     |       | 642 |   |
| Accrued professional fees  |       | 112                     |       | 121 |   |
| Facility consolidation     |       | 1,182                   |       | 190 |   |
| Other                      |       | 247                     |       | 220 |   |
|                       |       | $                       | 3,834      |   | $ | 2,040 |   |

 

5.     INCOME TAXES

 

Provision for incometaxes are as follows:

 

| ** **      | ** ** | **For the Years Ended  December 31,** | ** ** |
|-----------------|------------|-----------------------------------------------------------|------------|
| ** **      | ** ** | **2005**                                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **      | ** ** | **(In Thousands)**                                   | ** ** |
| Current:        |       |                                                      |       |   |   |   |   |
| Federal         |       | $                                                         | 2,027      |   | $ | 962 |   | $ | — |   |
| State and local |       | 449                                                       |       | 263 |   | — |   |
|            |       | 2,476                                                     |       | 1,225 |   | — |   |
| Deferred:       |       |                                                      |       |   |   |   |   |
| Federal         |       | (2,311                                                    | )          | (19 | ) | 573 |   |
| State and local |       | (553                                                      | )          | (5 | ) | 171 |   |
|            |       | (2,864                                                    | )          | (24 | ) | 744 |   |
|            |       | $                                                         | (388       | ) | $ | 1,201 |   | $ | 744 |   |

 

F-14

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A reconciliation of thetaxes on income in 2005, 2004 and 2003 is as follows:

 
| ** **                                    | ** ** | **For the Years Ended  December 31,** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                    | ** ** | **2005**                                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                    | ** ** | **(Amounts In Thousands)**                      | ** ** |
| ** **                                    | ** ** | ** **                                                | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** |
| ** **                                    | ** ** | **Amount**                                                | ** ** | **Pretax** | ** ** | **Amount** | ** ** | **Pretax** | ** ** | **Amount** | ** ** | **Pretax** | ** ** |
| Tax at statutory rate                         |       | $                                                         | (329       | ) | 34.0 | % | $ | 1,051 |   | 35.0 | % | $ | 613 |   | 35.0 | % |
| State and local taxes, net of Federal benefit |       | (83                                                       | )          | 8.6 |   | 167 |   | 5.5 |   | 111 |   | 6.3 |   |
| Other                                         |       | 24                                                        |       | (2.5 | ) | (17 | ) | (0.5 | ) | 20 |   | 1.2 |   |
|                                          |       | $                                                         | (388       | ) | 40.1 | % | $ | 1,201 |   | 40.0 | % | $ | 744 |   | 42.5 | % |

 

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

 
| ** **                                     | ** ** | **December 31,**   | ** ** |
|------------------------------------------------|------------|-------------------------|------------|
| ** **                                     | ** ** | **2005**                | ** ** | **2004** | ** ** |
| ** **                                     | ** ** | **(In Thousands)** | ** ** |
| Current deferred tax assets:                   |       |                    |       |   |   |
| Uniform capitalization of inventory            |       | $                       | 175        |   | $ | 204 |   |
| Bad debt reserve                               |       | 195                     |       | 72 |   |
| Warranty reserve                               |       | 445                     |       | 204 |   |
| Inventory obsolescence                         |       | 1,918                   |       | 221 |   |
| Accrued vacation                               |       | 39                      |       | 87 |   |
| Other liabilities                              |       | 196                     |       | 195 |   |
| Net current deferred tax asset                 |       | $                       | 2,968      |   | $ | 983 |   |
| Non current deferred tax asset:                |       |                    |       |   |   |
| Deferred rent                                  |       | $                       | 142        |   | $ | — |   |
| Facility consolidation                         |       | 656                     |       | — |   |
|                                           |       | 798                     |       | — |   |
| Non current deferred tax liabilities:          |       |                    |       |   |   |
| Excess tax over book depreciation              |       | (387                    | )          | (468 | ) |
|                                           |       |                    |       |   |   |
| Net non current deferred tax asset (liability) |       | $                       | 411        |   | $ | (468 | ) |

 

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 the Company issued and distributed 1,460,000shares of its common stock as well as warrants to purchase 863,647 shares ofthe Company’s common stock, at an exercise price of $6.00 per share insettlement of the class action lawsuit filed against the Company in 1999. Thewarrants expired on June 18, 2003. None of the warrants were exercised. OnAugust 10, 2001, the Company’s stockholders approved an amendment to theCompany’s Amended and Restated Articles of Incorporation increasing the numberof authorized shares of its common stock to 40,000,000 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

 

F-15

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the Board of Directors ofthe Company and the audit committee of the Board of Directors each be expandedby one position, which was filled by Douglas A. Crane, a representative ofCrane. Mr. Crane resigned from our Board of Directors on November 29, 2005 andon November 30, 2005 we were informed by Crane & Co., Inc. of theirintention to sell a portion or all of their shares in an orderly manner. Cranehas not sold any of its shares as of March 15, 2006.

 

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, 2005, 2004 and 2003, the Company paid Craneunder these agreements, $72,000 each year, for the rental of factory space and$153,000, $169,000 and $162,000, respectively, for the leased employees, whichare primarily included in cost of goods sold in the accompanying statements ofoperations.

 

7.               FACILITYCONSOLIDATION

 

OnDecember 14, 2004, the Company entered into agreements to lease a 134,000square foot modern manufacturing and office building in Robbinsville, NewJersey, which is the site of its primary operations following the closure,relocation and consolidation of its operations in Elmsford, New York andHuntingdon Valley, Pennsylvania into the Robbinsville site. The Companycompleted the relocation and consolidation of its operations during 2005. TheRobbinsville facility provides substantial room for expansion as the Companyconsolidated its operations that were being conducted within a 58,000 squarefoot facility in Elmsford, New York and a 30,000 square foot facility in HuntingdonValley, Pennsylvania into the new facility. We are currently evaluating thepossible use of the Huntingdon Valley facility for certain manufacturing andsecure storage. The Company has also acquired and installed additionalequipment and technology in the new facility to broaden its capabilities toserve its target customers, expand capacity, become more vertically integratedand improve efficiency.

 

The base rent on the lease for the Robbinsville, New Jersey facility is$555,000 per year, increasing by 1.9% per year, and the first seven months ofthe lease were rent-free. We recorded a minimal amount of deferred rent in 2004and $0.4 million in 2005. The term of the lease for the Robbinsville facilityextends through May 31, 2017, and at the expiration of the term, we haveoptions to renew the lease for three consecutive five year periods at the thenfair market value and also have an option to purchase the building after theend of the original lease term for the adjusted fair market value as defined inthe lease agreement. The base rent on the lease in Huntingdon Valley,Pennsylvania is $144,000 per year. The lease on this facility expires on June30, 2007. The base rent on the lease in Elmsford, New York is $746,000 peryear. The lease on this facility expires on December 31, 2007. As the Elmsfordfacility was abandoned as part of our move and consolidation in 2005 theremaining rent through the end of the lease term has been charged to facilityconsolidation expense in 2005.

 

We invested approximately $6.1 million through 2005 in capital assetsrelating to the move and consolidation, of which approximately $5.2 million wasexpended in 2005 and $.9 million was expended in 2004. These expenditures werefor facility upgrades to customize the Robbinsville, New Jersey facility forthe Company’s operational and security requirements as well as the acquisitionof new equipment to upgrade and expand our production capabilities.

 

Thefollowing table illustrates the costs incurred in the relocation andconsolidation in the years ended

 

F-16

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December31, 2004 and 2005 and anticipated in 2006 and 2007.

 
| ** **                               | ** ** | **For the Years Ended December 31,** | ** ** |
|------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                               | ** ** | **Actual**                                               | ** ** | **Estimated** | ** ** |
| ** **                               | ** ** | **2004**                                                 | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** |
| ** **                               | ** ** | **(In Thousands)**                                  | ** ** |
| Rent on abandoned facilities, net        |       | $                                                        | —     |   | $ | 1,905 |   | $ | — |   | $ | — |   |
| Accretion on abandoned facilities rental |       | —                                                   |       | 45 |   | 140 |   | 83 |   |
| Employee severance costs                 |       | 15                                                       |       | 107 |   | 9 |   | — |   |
| Employee relocation costs                |       | 56                                                       |       | 116 |   | 170 |   | 240 |   |
| Moving costs                             |       | —                                                   |       | 590 |   | — |   | — |   |
| Legal expenses and commissions           |       | 171                                                      |       | 6 |   | — |   | — |   |
|                                     |       | $                                                        | 242        |   | $ | 2,769 |   | $ | 319 |   | $ | 323 |   |

 

8.     STOCKINCENTIVE PLANS

 

OnAugust 8, 2005, we adopted the 2005 Stock Incentive Plan (the “2005 Plan”),which was subsequently approved by our stockholders at the annual meeting onSeptember 22, 2005. The number of shares available for issuance under the 2005Stock Incentive Plan is 1,600,000. On August 4, 2000, we adopted theAmerican Bank Note Holographics, Inc. 2000 Stock Incentive Plan (as amended,the “2000 Plan”), which was subsequently approved by our stockholders at ourannual meeting on September 12, 2000. In August 2001, our stockholders approvedan amendment to the 2000 Plan increasing the shares available for issuancethereunder by 600,000 to 1,350,000 shares. On July 20, 1998, we adopted the1998 Stock Incentive Plan (as amended, the “1998 Plan”, and collectively withthe 2000 Plan and the 2005 Plan, the “Plans”). The Plans were adopted for thepurpose of granting various stock incentives to officers, directors, employeesand consultants of ABNH. The board of directors (or a committee appointed bythe board of directors) has discretionary authority, subject to certainrestrictions, to administer the Plans. The total number of shares reserved forissuance under the Plans are 4,813,000 shares of common stock. Options topurchase 2,971,938 shares of common stock were outstanding under the Plans atDecember 31, 2005. The exercise price of options granted under the Plans maynot be less than 100% of the fair market value of the common stock on the datesuch option was granted. Options granted under the Plans generally becomevested and exercisable for up to either 25% or 33 1/3% of the total optionedshares upon each succeeding anniversary of the date of grant. Generally, the unexercisedportion of any option automatically terminates upon the termination of theoptionee’s employment with us, unless otherwise determined by the board ofdirectors; provided however, that any extension shall not extend beyond theexpiration of the option, generally ten years. Upon a change in control,outstanding options will generally become fully vested. Additionally atDecember 31, 2005, 15,000 shares of restricted stock had been issued.Restricted stock will fully vest three years from the date of issuance if thegrantee is employed at that time. On January 26, 2006, we granted options topurchase an aggregate of 30,000 shares of common stock to our executiveofficers and directors and 193,000 shares of common stock to our employees atan exercise price equal to the fair value of the common stock at the date ofthe grant. Additionally we issued 60,000 restricted shares to executiveofficers and 79,000 restricted shares to employees on that date.

 

F-17

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A summary of the statusof the Company’s outstanding stock options as of December 31, 2005, 2004 and2003 and changes during the years then ended follows:

 
| ** **                                                      | ** ** | **2005**   | ** ** | **2004**                               | ** ** | **2003**   | ** ** |
|-----------------------------------------------------------------|------------|------------|------------|----------------------------------------|------------|------------|------------|
| ** **                                                      | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Outstanding, beginning of year                                  |       | 2,729,000  |       | $                                      | 2.15       |       | 2,838,000  |   | $ | 2.19 |   | 2,318,500 |   | $ | 2.55 |   |
| Granted                                                         |       | 491,166    |       | $                                      | 3.73       |       | —     |   | — |   | 586,000 |   | $ | 0.91 |   |
| Exercised                                                       |       | (184,562   | )          | $                                      | 1.96       |       | (32,187    | ) | $ | 2.01 |   | — |   | — |   |
| Forfeited                                                       |       | (63,666    | )          | $                                      | 2.86       |       | (76,813    | ) | $ | 2.10 |   | (66,500 | ) | $ | 3.61 |   |
| Outstanding, end of year                                        |       | 2,971,938  |       | $                                      | 2.41       |       | 2,729,000  |   | $ | 2.15 |   | 2,838,000 |   | $ | 2.19 |   |
| Exercisable, end of year                                        |       | 2,330,165  |       | $                                      | 2.27       |       | 2,380,578  |   | $ | 2.32 |   | 2,170,251 |   | $ | 2.54 |   |
| Weighted average fair value of options granted  during the year |       | $          | 3.07       |                                   |       |       | $          | — |   |   |   | $ | 0.78 |   |   |   |
|                                                                 |            |            |            |                                        |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thefollowing table summarizes information concerning outstanding and exercisableoptions at December 31, 2005:

 
| ** **               | ** ** | **Options Outstanding** | ** ** | ** **      | ** ** |
|--------------------------|------------|------------------------------|------------|-----------------|------------|
| ** **               | ** ** | ** **                   | ** ** | **Weighted**    | ** ** | ** ** | ** ** | **Options Exercisable** | ** ** |
| ** **               | ** ** | ** **                   | ** ** | **Average**     | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **               | ** ** | ** **                   | ** ** | **Remaining**   | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Range of**        | ** ** | **Options**                  | ** ** | **Contractual** | ** ** | **Exercise** | ** ** | **Options** | ** ** | **Exercise** | ** ** |
| **Exercise Prices** | ** ** | **Outstanding**              | ** ** | **Life**        | ** ** | **Price** | ** ** | **Exercisable** | ** ** | **Price** | ** ** |
| $0.78 - $1.18            |       | 525,938                      |       | 7.58            |       | $ | 0.95 |   | 349,999 |   | $ | 0.96 |   |
| $1.67 - $1.94            |       | 813,500                      |       | 4.49            |       | $ | 1.86 |   | 813,500 |   | $ | 1.86 |   |
| $2.03 - $2.50            |       | 1,041,000                    |       | 3.81            |       | $ | 2.32 |   | 1,041,000 |   | $ | 2.32 |   |
| $2.75 - $8.50            |       | 591,500                      |       | 8.25            |       | $ | 4.62 |   | 125,666 |   | $ | 8.23 |   |
| $0.68 - $8.50            |       | 2,971,938                    |       | 5.55            |       | $ | 2.41 |   | 2,330,165 |   | $ | 2.27 |   |

 

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:

 
| ** **              | ** ** | **2005**       | ** ** | **2004** | ** ** | **2003**       | ** ** |
|-------------------------|------------|----------------|------------|----------|------------|----------------|------------|
| Expected volatility     |       | 63.00%         |       | —   |       | 62.30%         |       |
| Risk-free interest rate |       | 4.07% to 4.60% |       | —   |       | 3.15% to 4.25% |       |
| Dividend yield          |       | —         |       | —   |       | —         |       |
| Expected life           |       | 7.5 years      |       | —   |       | 7.5 years      |       |

 

9.               EMPLOYEE BENEFITSPLANS

 

Retirement Plans — OnOctober 1, 1999, the Company implemented defined contribution plans for itsemployees. Aggregate contributions to such plans, which have been charged tothe Company’s operations, were approximately $57,000, $59,000 and $56,000 forthe years ended December 31, 2005, 2004 and 2003, respectively.

 

10.         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.

 

F-18

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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 onits Robbinsville location, which provides for renewal rents based upon theadjusted fair market rental value, as defined in the lease agreement.

 

Rental expense wasapproximately $1.3 million, $1.2 million and $1.3 million for the years endedDecember 31, 2005, 2004 and 2003, respectively.

 

At December 31, 2005,future minimum lease payments under non-cancelable operating leases, expiringthrough 2017, are as follows: $1.6 million in 2006; $1.4 million in 2007; $0.6million in 2008; $0.6 million in 2009 and $4.8 million, thereafter.

 

Employment Agreements —The Company entered into employment agreements with certain of its currentexecutive officers, which provide for, among other matters, minimumcompensation of approximately $0.8 million in 2006 and $0.8 million in 2007.The agreements also provide for bonuses. In connection with these agreements,the Company granted options to acquire 1,567,500 shares of its common stockfrom February 1999 through December 2005, at prices ranging from $0.85 to $6.40per share, representing the fair market value of the Company’s common stock onthe dates of grants.

 

11.   SubsequentEvent

 

TheCompany previously reported that it had learned that there had been a smallnumber of incidents in which certain card terminals had been affected byelectro-static discharge (“ESD”) from static electricity carried on cardsincorporating HoloMag. The Company also reported at that date that it had beenadvised by customers of a need to develop a second generation holographicmagnetic tape product that addresses the ESD issue, and that the Company hadcommenced such development, but that there can be no assurance that the Companywill be successful in developing such a product that will be acceptable to itscustomers.

 

OnMarch 14, 2006, we were informed by VISA that, as a result of the ESD issue,VISA is informing its member financial institutions and authorized cardmanufacturers that (i) VISA will no longer approve VISA card designs whichincorporate the current version of HoloMag, (ii) VISA strongly recommendsthat their members attempt to avoid further issuance of cards incorporating thecurrent version of HoloMag and (iii) VISA recommends that their membersfollow an alternate card design incorporating a conventional magnetic stripeand Dove hologram and VISA also provided notice to us that it was revoking ourright to produce HoloMag under its agreement (the “VISA Decision”). The Companycontinues to evaluate VISA’s actions and claims and has provided VISA with itsinitial response. The Company believes that it is in compliance with itsagreement with VISA and that its HoloMag product complies with all standardsand specifications therein. As a result of VISA’s notification to financialinstitutions and authorized card manufacturers, the Company has receivedcommunications from VISA authorized card manufacturers seeking to address thestatus and disposition of their HoloMag inventory and orders.

 

F-19

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*Accordingly,*in the quarter ended December 31,2005, as a result of the VISA Decision, the Company recorded a pre-tax chargeamounting to approximately $5.0 million of which $4.8 million was recorded incost of goods sold and was principally related to the value of our HoloMaginventory. Also included in the charge were increases in our provisions foraccounts receivable and potential non-ESD related warranty claims.We willreview the valuation of these accounts on an ongoing basis as part of ourclosing process and make appropriate changes to our reserve levels based uponthe facts at the time.

 

F-20

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Schedule II

 

AMERICAN BANK NOTEHOLOGRAPHICS, INC.

 

VALUATION AND QUALIFYINGACCOUNTS

YEARS ENDED DECEMBER 31,2005, 2004 AND 2003

 
| ** **                                                           | ** ** | ** **                            | ** ** | **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, 2005:                                        | ** ** | ** **                            | ** ** | ** **                                    | ** ** | ** **                           | ** ** | ** **     | ** ** | ** ** | ** ** |
| Allowance for doubtful accounts (deducted from accounts  receivable) |       | $                                     | 180        |                                          | $          | 320                                  |       | $              | —     |   | $ | — | (1) | $ | 500 |   |
| Allowance for obsolescence (deducted from inventory)                 |       | $                                     | 552        |                                          | $          | 4,102                                |       | $              | —     |   | $ | 374 | (2) | $ | 4,280 |   |
|                                                                 |       |                                  |       |                                          |       |                                 |       |           |       |   |   |
| 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 |   |

 

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(1)  Accounts deemed to be uncollectible.

(2)  Destruction of obsolete inventory.

 

S-1

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