item 14 exhibits financial statement schedules reports form 8k 1 financial statements financial statements required item submitted separate section beginning page report 2 financial statement schedules financial statement schedule required item submitted separate section page s1 report schedules included page s1 report omitted absence conditions required information included financial statements notes thereto 3 exhibits see c b reports form 8k none c exhibits incorporated reference registration statement form s1 registration 33351845 portions omitted pursuant request confidential treatment financial statement schedules see a2 american bank note holographics inc independent auditors report board directors stockholders american bank note holographics inc elmsford new york audited accompanying balance sheets american bank note holographics inc december 31 1998 1997 related statements income stockholders equity cash flows three years period ended december 31 1998 audits also included financial statement schedule listed accompanying table contents financial statements financial statement schedule responsibility companys management responsibility express opinion financial statements financial statement schedule based audits conducted audits accordance generally accepted auditing standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audits provide reasonable basis opinion financial statements present fairly material respects financial position american bank note holographics inc december 31 1998 1997 results operations cash flows three years period ended december 31 1998 conformity generally accepted accounting principles also opinion financial statement schedule considered relation basic financial statements taken whole presents fairly material respects information set forth therein discussed note 10 financial statements company involved certain litigation potential litigation discussed note 11 financial statements accompanying 1997 1996 financial statements restated deloitte touche llp new york new york november 11 1999 except paragraph 7 note 10 date november 16 1999 paragraph 6 note 10 date december 1 1999 american bank note holographics inc balance sheets december 31 1998 1997 thousands except share data see notes financial statements american bank note holographics inc statements income years ended december 31 1998 1997 1996 thousands except per share data see notes financial statements american bank note holographics inc statements stockholders equity years ended december 31 1998 1997 1996 thousands see notes financial statements american bank note holographics inc statements cash flows years ended december 31 1998 1997 1996 thousands see notes financial statements american bank note holographics inc notes financial statements years ended december 31 1998 1997 1996 1 basis presentation summary significant accounting policies american bank note holographics inc company july 20 1998 offering date whollyowned subsidiary american banknote corporation former parent offering date former parent completed sale 13636000 shares companys common stock public offering representing entire investment company receive proceeds offering additionally connection offering amounts due former parent affiliates approximately 339 million cancelled deemed dividend see note 7 immediately following offering company approximately 52 million secured bank debt nominal cash financial reporting purposes amounts due former parent affiliates prior offering date classified within stockholders equity june 11 1998 company declared 13636 one stock split effective july 2 1998 form stock dividend common stock increased authorized common stock 30000000 shares authorized preferred stock 5000000 shares accompanying financial statements give retroactive effect consummation stock split whollyowned subsidiary company provided certain corporate administrative services former parent including financial reporting treasury functions tax planning compliance risk management human resources legal services additionally former parent managed cash financing requirements centrally interest expense financing requirements prior offering date based existing capital structure financial position operations company may differ results may achieved company operated independent entity company originates massproduces markets secure holograms used security packaging promotional applications company operates one reportable industry segment use estimates preparation financial statements conformity generally accepted accounting principles requires management make estimates assumptions affect reported amounts assets liabilities disclosure contingent assets liabilities date financial statements reported amounts sales expenses reporting period actual results may differ materially estimates cash equivalents highly liquid investments maturity three months less purchased considered cash equivalents concentrations credit risk significant portion companys accounts receivable due credit card issuers related credit card manufacturers located throughout united states europe company establishes credit polices based ongoing evaluation customers creditworthiness competitive market conditions require collateral company establishes allowance doubtful accounts based assessment exposures credit losses balance sheet date believes allowance doubtful accounts sufficient based credit exposures outstanding december 31 1998 inventories sales recognition inventories stated lower cost market cost determined firstin firstout fifo method hologram originations represent costs unique master hologram made customer specifications integral part production process capitalized charged cost goods sold estimated production period sales related cost goods sold generally recognized latter time shipment title passes customers situations company shipped product right return company unable reasonably estimate level returns andor sale contingent upon customers use product situations company recognize sales upon product american bank note holographics inc notes financial statements years ended december 31 1998 1997 1996 continued 1 basis presentation summary significant accounting policies continued shipment rather buyer product informs company product used additionally pursuant terms certain customer completed items stored behalf customer companys onsite secured facility instance sales recognized following occurred customer ordered goods manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order december 31 1997 accounts receivable customer totaled 16 million amounts receivable customer december 31 1998 first quarter 1998 company recorded sales approximately 65 million arrangement december 31 1998 customer advances approximating 15 million represent payments received customers products yet shipped 12 million products shipped right return 03 million company unable reasonably estimate level returns customer advances classified current liabilities accompanying balance sheets royalty income company enters licensing agreements certain manufacturers company receives royalty payments royalty payments due licensing agreements recognized income either based upon shipment reports licensees available estimated shipments licensees depreciation amortization machinery equipment recorded cost depreciated straightline method estimated useful lives 5 22 years amortization leasehold improvements computed straightline method based upon remaining term applicable lease estimated useful life asset whichever shorter longlived assets company reviews longlived assets impairment changes circumstances indicate carrying amount asset may recoverable changes circumstances may include among factors significant change technology may render asset group obsolete noncompetitive significant change extent manner asset used evidence physical defect asset group operating loss changes circumstances indicate carrying amount asset may recoverable company estimates future cash flows undiscounted without interest charges expected result use asset eventual disposition records impairment loss equal amount carrying amount asset exceeds fair value asset estimated cash flows less carrying amount asset assets disposed assets expected provide future service potential company recorded lower carrying amount fair value less costs sell intangible assets excess cost net assets acquired amortized 30 years straightline method company reviews enterprise level goodwill impairment changes circumstances similar described longlived assets indicate carrying value may recoverable circumstances company estimates future cash flows using recoverability method undiscounted including related interest charges basis recording impairment loss impairment loss recorded adjust carrying value goodwill recoverable amount impairment loss taken greater amount carrying value net assets business exceeds fair value deferred financing costs incurred connection obtaining financing deferred amortized charge interest expense term related borrowing using interest method american bank note holographics inc notes financial statements years ended december 31 1998 1997 1996 continued 1 basis presentation summary significant accounting policies continued warranty costs company provides warranty costs amounts estimates needed cover future warranty obligations products sold year estimates warranty costs periodically reviewed adjusted necessary consider actual experience research development research development costs expensed incurred 1998 03 million 1997 05 million 1996 06 million income taxes company accounts income taxes liability method accordance statement financial accounting standards sfas 109 accounting income taxes provision income taxes includes deferred income taxes resulting items reported different periods income tax financial statement purposes deferred tax assets liabilities represent expected future tax consequences differences financial statement carrying amounts existing assets liabilities respective tax basis stockbased compensation plans sfas 123 accounting stockbased compensation allows either adoption fair value method accounting stockbased compensation plans continuation accounting stockbased compensation plans accounting principles board apb opinion 25 accounting stock issued employees related interpretations supplemental disclosures company chosen account stock options using intrinsic value based method prescribed apb opinion 25 accordingly recognize compensation expense stock option grants made exercise price equal excess fair market value stock date grant pro forma net income net income per share amounts fair value method adopted presented note 8 sfas 123 impact companys results operations financial position cash flows basic diluted net income per share basic net income per share computed based weighted average number outstanding shares common stock giving retroactive effect stock split basic weighted average number shares outstanding 13636000 years ended december 31 1998 1997 1996 diluted net income per share computed dividing net income weighted average number shares common stock outstanding dilutive potential shares common stock related outstanding stock options 1998 year ended december 31 1998 dilutive effect approximately 65000 equivalent shares related stock options used determining diluted weighted average shares outstanding years ended december 31 1998 1997 1996 diluted weighted average number shares outstanding 13701000 13636000 respectively business information sales mastercard approximately 30 35 23 sales years ended december 31 1998 1997 1996 respectively approximately 75 1998 mastercard sales recorded first quarter 1998 december 31 1997 accounts receivable mastercard approximated 16 million company exclusive supplier holograms mastercard pursuant agreement amended extends february 2003 agreement provides automatic twoyear renewal periods terminated either party 1999 company informed mastercard believes company breached certain terms agreement 1998 1997 company working closely mastercard address issues raised mastercard believes relationship mastercard good loss substantial portion sales mastercard however would material adverse effect financial position results operations cash flows company american bank note holographics inc notes financial statements years ended december 31 1998 1997 1996 continued 1 basis presentation summary significant accounting policies continued sales manufacturers visa credit cards approximately 50 customers approximately 26 27 31 sales years ended december 31 1998 1997 1996 respectively loss substantial portion sales customers would material adverse effect financial position results operations cash flows company december 31 1998 1997 accounts receivable customers approximated 10 million 25 million respectively company historically purchased certain key materials used manufacture holograms single suppliers supply contracts problems occur respect delivery quality cost materials could material adverse effect financial position results operations cash flows company export sales us export sales 28 25 32 sales years ended december 31 1998 1997 1996 respectively export sales denominated united states dollars december 31 1998 1997 accounts receivable customers approximated 12 million 08 million respectively comprehensive income 1998 company adopted sfas 130 reporting comprehensive income establishes rules reporting comprehensive income components years ended december 31 1998 1997 1996 difference companys net income comprehensive income reclassifications certain prior year amounts reclassified conform current years presentation new accounting standards march 1998 american institute certified public accountants aicpa issued statement position 981 accounting costs computer software developed obtained internal use sop 981 sop 981 requires computer software costs associated internal use software expensed incurred certain capitalization criteria met company adopted sop 981 january 1 1999 adoption statement material impact companys financial position results operations cash flows april 1998 aicpa issued statement position 985 reporting cost startup activities sop 985 sop 985 requires costs associated preopening preoperating organization activities expensed incurred company adopted sop 985 january 1 1999 adoption statement material impact companys financial position results operations cash flows june 1998 financial accounting standards board issued sfas 133 accounting derivative instruments hedging activities amended effective fiscal years beginning june 15 2000 sfas 133 requires recognition derivatives balance sheets either assets liabilities measured fair value company adopt sfas 133 2001 fiscal year company currently evaluating impact sfas 133 financial position results operations cash flows american bank note holographics inc notes financial statements years ended december 31 1998 1997 1996 continued 2 inventories includes approximately 08 million costs december 31 1997 relating work customers anticipation orders ordinary course business costs december 31 1998 3 machinery equipment leasehold improvements 4 accrued expenses 5 taxes income accordance tax allocation agreement effect offering date company included consolidated us federal income tax return certain instances consolidated combined state local income tax returns former parent made payments former parent based amounts would payable federal state local income taxes consolidated american bank note holographics inc notes financial statements years ended december 31 1998 1997 1996 continued 5 taxes income continued combined returns filed company computed federal state local income tax provision filing separate income tax returns without regard tax allocation agreement october 1999 affiliate former parent received assessment approximately 09 million taxes interest city new york relating years ended december 31 1990 1991 1992 company included combined city new york income tax returns former parent periods covered assessment previously made payments former parent based amounts would payable combined income tax returns filed company contingently liable jointly severally us federal state local income taxes periods included consolidated combined income tax returns former parent see note 10 amounts paid former parent excess amounts would payable company filed separate income tax returns charged due former parent affiliates periods subsequent offering date company file us federal state income tax returns deferred income taxes arise temporary differences tax bases assets liabilities reported amounts financial statements taxes income benefit follows reconciliation taxes income amount computed applying federal income tax statutory rate 35 1998 1997 1996 follows american bank note holographics inc notes financial statements years ended december 31 1998 1997 1996 continued 5 taxes income continued tax effects items comprising companys deferred income tax assets liabilities follows 6 revolving credit agreement july 20 1998 contemporaneously offering company entered 300 million credit facility agreement credit agreement consisting 200 million acquisition facility 100 million working capital facility maturing july 20 2004 replaced facility company entered affiliate former parent substantially companys assets secured terms credit agreement time offering approximately 52 million due owing credit agreement december 31 1998 56 million outstanding credit agreement exceeded maximum permitted borrowings defined pursuant borrowing base formula defined credit agreement february 1999 lenders notified company default credit agreement march 31 1999 credit agreement amended credit agreement whereby maximum permitted borrowings reduced lesser 45 million maximum permitted borrowings borrowing base formula defined borrowings amended credit agreement bore interest lenders alternate base rate defined plus 05 july 20 1999 amended credit agreement amended second amended credit agreement whereby existing events default waived ii latest maturity date loans outstanding changed january 20 2000 iii maximum permitted borrowings reduced 40 million decline monthly december 31 1999 maximum permitted borrowings 26 million second amended credit agreement provided borrowings revolving credit line bearing interest lenders alternate base rate defined plus 2 80 december 31 1998 subject borrowing base formula defined consideration second amended credit agreement company paid fee 40000 issued warrants purchase 781645 shares common stock subject antidilution rights 450 per share warrants terminated september 29 1999 pursuant second amended credit agreement amounts outstanding second amended credit agreement repaid described american bank note holographics inc notes financial statements years ended december 31 1998 1997 1996 continued 6 revolving credit agreement continued september 29 1999 amounts outstanding second amended credit agreement repaid company entered loan security agreement foothill capital corporation subsidiary wells fargo bank loan security agreement maturing september 29 2004 loan security agreement secured substantially companys assets provides borrowings aggregate amount 100 million may increased 150 million consent parties subject borrowing base formula revolving credit facility term loan capital expenditure loan borrowings loan security agreement bear interest lenders reference rate defined plus 15 may decrease 125 100 05 certain circumstances terms loan security agreement maximum amounts term capital expenditure loans approximately 10 million 20 million respectively repayable sixty equal monthly installments loan security agreement contains covenants customary credit facilities similar nature including limitations ability company among things declare dividends repurchase redeem stock ii prepay redeem repurchase debt incur liens engage saleleaseback transactions iii make loans investments iv incur additional debt v amend otherwise alter material agreements enter restrictive agreements vi make capital expenditures fiscal year excess 25 million vii engage mergers acquisitions asset sales viii engage certain transactions affiliates ix materially alter nature business additionally terms loan security agreement company required achieve year 2000 compliance december 31 1999 company also required comply specified financial covenants ratios must provide lender march 31 june 30 1999 unaudited financial statements december 15 1999 september 30 1999 unaudited financial statements december 31 1999 loan security agreement provides events default customary transactions type including nonpayment misrepresentation breach covenant crossdefaults bankruptcy adverse judgments excess 02 million change ownership control result amended credit agreement first quarter 1999 company write unamortized deferred financing costs approximately 04 million relating credit agreement result second amended credit agreement third quarter 1999 company write unamortized deferred financing costs approximately 59000 relating amended credit agreement result loan security agreement third quarter 1999 company write remaining unamortized deferred financing costs approximately 31000 relating second amended credit agreement 1998 1997 weighted average interest rate outstanding borrowings approximately 84 90 respectively average aggregate borrowings 1998 1997 approximately 52 million 09 million respectively december 31 1998 company notes payable totaling approximately 377000 304000 due 1999 18000 2000 19000 2001 21000 2002 15000 2003 notes bear interest rates ranging 585 836 7 related party transactions financial statements reflect allocated readily determinable actual expenses services provided companys former parent affiliates allocations utilized company former parent affiliates recorded transactions based upon systematic reasonable methods including limited sales asset values headcount percent total american bank note holographics inc notes financial statements years ended december 31 1998 1997 1996 continued 7 related party transactions continued amounts major category historical transactions former parent affiliates follow 1 primarily medical life disability insurance premiums 2 includes legal fees allocated portion audit fees 3 included balances 53 million note receivable former parent bore interest 575 per annum 4 includes value restricted stock former parent amount deemed dividend former parent subject adjustment based companys taxable income offering date see note 5 financial reporting purposes amounts due former parent affiliates periods prior offering date classified within stockholders equity addition company sold 06 million 04 million 07 million holograms 1998 1997 1996 respectively former parent affiliates normal course business purchases company former parent affiliates normal course business 01 million 03 million 1997 1996 respectively purchases 1998 december 31 1998 1997 trade accounts receivable former parent affiliates 02 million 06 million respectively additionally company acted subcontractor affiliate former parent government contract sales subcontract billed affiliate former parent approximated 03 million 82000 1998 1997 respectively december 31 1998 trade accounts receivable affiliate former parent subcontract approximated 01 million december 31 1998 accounts payable accrued expenses include approximately 03 million 02 million respectively due former parent affiliates american bank note holographics inc notes financial statements years ended december 31 1998 1997 1996 continued 7 related party transactions continued 1997 1996 employees company received stock options former parents stockbased compensation plans options granted 1998 compensation cost stock option plans determined based fair value grant award dates 1996 1997 consistent provisions sfas 123 accounting stockbased compensation net income would reduced approximately 13000 22000 respectively connection offering company former parent entered number agreements relating transition period defining ongoing relationships following offering follows see note 10 separation agreement provides company generally indemnify former parent including officers directors employees affiliates costs liabilities expenses relating offering conduct company business including result guarantees former parent obligations company ii former parent indemnify company costs liabilities expenses relating conduct former parent business including result guarantees company obligations former parent iii immediately prior closing offering company nominal amount unrestricted cash former parent shall entitled unrestricted cash hand iv former parent indemnify hold harmless company federal foreign state local franchise income sales use transfer tax liabilities obligations including interest penalties attributable former parents consolidated group activities company periods v company indemnify hold harmless former parent federal foreign state local franchise income sales use transfer tax liabilities obligations including interest penalties attributable activities company periods vi company former parent crossindemnify certain matters license agreement provides company right use american bank note name oneyear term automatically renewable consecutive oneyear periods annual fee 1 additionally company former parent granted perpetual paidup royaltyfree licenses patents trademarks proprietary technology used respective business company agreed use name american bank note variation thereof connection business enterprise venture outside holography industry sublicense name third parties transitional services agreement former parent agreed provide cause provided company certain specified corporate administrative services oneyear transitional period offering agreement provides services provided fees greater former parents costs services provided agreement employee benefits allocation agreement governs allocation responsibilities costs regarding employee benefit plans related matters agreement provides company shall establish new benefit insurance plans employees cooperate former parent respect certain shared responsibilities transitional period former parent solely responsible contributions may required following offering respect service prior thereto employees company covered former parent defined benefit retirement plan american bank note holographics inc notes financial statements years ended december 31 1998 1997 1996 continued 8 1998 stock incentive plan subsequent offering date company adopted 1998 stock incentive plan 1998 plan purpose granting various stock incentives key employees board directors committee appointed board directors discretionary authority subject certain restrictions administer 1998 plan total number shares reserved issuance 1998 plan 1363000 shares common stock exercise price options granted 1998 plan may less 100 fair market value common stock date option granted options granted 1998 plan generally would become vested exercisable 33 13 total optioned shares upon succeeding anniversary date grant generally unexercised portion option automatically terminates upon termination optionees employment company unless otherwise determined board directors provided however extension shall extend beyond expiration option generally ten years upon change control outstanding options generally become fully vested may exercised immediately summary status companys outstanding stock options december 31 1998 changes year ended follows included outstanding options companys former chairman chief executive officer 400000 former president 200000 former vice presidentfinance 40000 former vice president operations 40000 cancelled upon resignations 1999 additionally 1998 company issued 45000 options members board directors reflected table exercise price 850 per share representing fair market value companys common stock grant date 1999 company issued options newly appointed chairman 175000 shares 250 per share president 250000 shares 175 per share 100000 shares 250 per share executive vice president 150000 shares 275 per share chief financial officer 100000 shares 250 per share exercise prices equal fair market value companys common stock dates respective grants following table summarizes information stock options outstanding december 31 1998 company applies apb opinion 25 related interpretations accounting stock options accordingly compensation cost recognized outstanding stock options compensation cost companys outstanding stock options determined based fair value grant dates american bank note holographics inc notes financial statements years ended december 31 1998 1997 1996 continued 8 1998 stock incentive plan continued options consistent sfas 123 companys 1998 net income basic diluted net income per share would differed reflected pro forma amounts indicated thousands except per share amounts fair value option grant estimated date grant using blackscholes optionpricing model following weightedaverage assumptions 9 employee benefits plans certain employees company rights benefits former parents defined benefit retirement plan eligible additional benefits contributions currently required order provide benefits pursuant employee benefits allocation agreement see note 7 contributions required future including contributions fully fund plan benefits termination plan amount contributions required paid former parent see note 10 postretirement health care life insurance plans prior offering date company participated benefit plans affiliates former parent provided certain postretirement health care life insurance benefits certain eligible employees terms plans companys employees could become eligible benefits reached normal retirement age certain service requirements period company participated plans company accrued estimated cost retiree benefit payments pensions years employee provided services former parents plans funded terms employee benefits allocation agreement see note 7 company responsible benefits provided employees retired company prior offering date qualified benefits offering date currently assessing whether continue plan current employees accordingly disclosures regarding status obligation relates company provided years ended december 31 1998 1997 1996 costs relating plans approximated 21000 58000 56000 respectively retirement plans retirement benefits provided former parent eligible employees defined contribution retirement plan former parent aggregate contributions plan charged companys operations approximately 02 million years ended 1998 1997 1996 respectively company continues participating employer plan although plans terminate participation plan start defined contribution plan american bank note holographics inc notes financial statements years ended december 31 1998 1997 1996 continued 9 employee benefits plans continued certain employees company participate affiliate former parents defined benefit pension plan benefits plan frozen 1992 based years service average final compensation liability benefits plan substantially funded responsibility affiliate former parent total pension expense relating companys employees aggregate past three years less 10000 1997 1996 company participated former parents noncontributory supplemental executive retirement plan serp certain senior management employees former parent affiliates benefits noncontributory plan based years service average final compensation plan unfunded following offering companys participants ceased eligible serp benefits accordingly companys obligation plan 56000 credited due former parent affiliates aggregate contribution plan charged operations approximately 28000 1997 1996 contribution plan made year ended december 31 1998 10 commitments contingencies sec us attorney investigations february 9 1999 division enforcement sec issued formal order directing private investigation designating officers take testimony requiring production certain documents connection matters giving rise need restate companys previously issued financial statements see note 11 company provided numerous documents continues cooperate fully sec staff management company cannot predict duration investigation potential outcome us attorneys office southern district new york commenced investigation connection matters giving rise need restate companys previously issued financial statements see note 11 well possible violation 1998 foreign corrupt practices act company advised target investigation company provided numerous documents continues cooperate fully us attorneys office management company cannot predict duration investigation potential outcome litigation consolidated class action complaint company certain former officers directors former parent four colead underwriters offering auditors filed united states district court southern district new york complaint alleges violations federal securities laws seeks recover damages behalf purchasers companys common stock class period july 15 1998 february 1 1999 complaint seeks rescission purchase shares companys common stock alternatively unspecified compensatory damages along costs expenses including attorneys fees company certain defendants separately moved dismiss complaint plaintiffs discovery requests well motion class certification stayed pending resolution respective motions dismiss company commenced settlement discussions plantiffs counsel management company believe feasible predict determine outcome resolution proceedings estimate amounts potential range loss respect thereto addition timing resolution proceedings uncertain range possible resolutions could include judgements company settlements could require substantial payments company including costs defending suits could material adverse effect companys financial position results operations cash flows february 14 1997 james rigby trustee bankruptcy holosonics inc holotron corp meadow games inc fire diamond inc commenced adversary proceeding united states american bank note holographics inc notes financial statements years ended december 31 1998 1997 1996 continued 10 commitments contingencies continued bankruptcy court western district washington seattle international banknote company inc former parent company complaint alleged defendants indebted bankruptcy estate royalty payments 1981 license company liable unpaid royalties 1990 amount 226322 1991 amount 853582 july 1992 amount 568762 plus attorneys fees interest unpaid amounts defendants trustee entered settlement agreement approved order bankruptcy court september 10 1999 whereby defendants agreed pay trustee 150000 120000 paid balance payable two equal monthly installments 15000 payable ninety onehundred twenty days respectively following entry order full amount settlement accrued december 31 1998 1994 plaintiffs kah company inc kenneth haines filed suit company former parent abnh research co inc supreme court state new york county new york judgement entered march 19 1999 175639 attorneys fees still assessed plaintiffs counsel stated would seek excess 300000 attorneys fees judgement entered former parent contends company contribute payment judgement defendants appealed plaintiffs filed crossappeal still pending plaintiffs defendants currently engaged settlement discussions august 17 1999 company commenced action supreme court state new york county westchester seeking recovery approximately 350000 claim arising amounts owed company holographic materials sold delivered july 1999 defendant removed action united states district court southern district new york currently pending december 1 1999 company received defendants answers complaint counterclaims alleging millions dollars damages arising companys alleged breach 1993 agreement pursuant company sold holographic material defendant alleged failure fulfill may 1998 purchase order management company believe outcome resolution proceedings material adverse effect companys financial position results operations cash flows 1998 company fulfilled order holograms approximately 600000 1999 customer alleged company breached contract customer based problems ultimate user experiencing holograms claimed potential damages excess 6 million management company believe agreement breached discussions customer attempt resolve dispute amicably assurance however matter resolved amicably dispute lead litigation customer company currently time involved litigation plaintiff defendant incidental conduct business however shareholder litigation described company party lawsuit proceeding opinion management company likely material impact companys financial position results operations cash flows amounts accrued litigation matters represent anticipated costs damages andor settlement amounts connection pending litigation claims costs accrued probable asset impaired liability incurred amount reasonably estimated accruals based upon companys assessment consultation counsel probable loss based facts circumstances case legal issues involved nature claim made nature damages sought relevant information plaintiffs significant factors vary case possible estimate specific expected cost incurred company evaluates range probable loss records minimum end range december 31 1998 accruals american bank note holographics inc notes financial statements years ended december 31 1998 1997 1996 continued 10 commitments contingencies continued litigation matters approximated 500000 accruals recorded december 31 1997 anticipated 500000 accrual paid follows 135000 1999 365000 2000 company believes based information known december 31 1998 anticipated probable costs litigation matters december 31 1998 adequately provided extent determinable indemnifications former parent described notes 5 7 9 connection offering company former parent entered number agreements among matters provide indemnification certain circumstances company former parent 1999 former parent experienced significant financial difficulty may result inability perform terms indemnifications provided could material adverse effect companys financial position results operations cash flows product liability matters company provides holograms connection wide range customers products case possible company subject product liabilities association products connection holograms used products although company maintains product liability insurance assurance insurance would available cover claim available amounts sufficient cover potential liabilities result product liability claims could material adverse effect companys business financial condition results operations cash flows leases company longterm operating leases offices manufacturing facilities equipment expire 2007 company renewal options locations provide renewal rents based upon increases tied consumer price index net rental expense approximately 12 million years ended december 31 1998 1997 1996 december 31 1998 future minimum lease payments noncancelable operating leases follows 12 million 1999 11 million 2000 09 million 2001 09 million 2002 08 million 2003 27 million thereafter employment agreements 1999 company entered employment agreements certain officers provide among matters minimum compensation approximately 474000 1999 552000 2000 65000 2001 agreements also provide discretionary bonuses connection agreements company granted options acquire 775000 shares common stock prices ranging 175 275 per share representing fair market value companys common stock dates grant new york stock exchange suspension trading august 3 1999 new york stock exchange suspended trading companys common stock failure company deliver annual report form 10k year ended december 31 1998 quarterly report form 10q three months ended march 31 1999 timely basis following suspension new york stock exchange notified company intent apply delisting companys common stock company expect resume trading new york stock exchange company intends seek security traded another stock exchange national association securities dealers automated quotation system 11 restatement subsequent issuance companys financial statements years ended december 31 1997 1996 determined certain sales improperly recorded result restatement previously reported sales year ended december 31 1996 reduced approximately 11 million resulting corresponding increase previously reported sales year ended december 31 1997 american bank note holographics inc notes financial statements years ended december 31 1998 1997 1996 continued 11 restatement continued additionally previously reported sales year ended december 31 1997 reduced prior impact increase relating 1996 reduction discussed approximately 90 million resulting increase sales year ended december 31 1998 principally first quarter approximately 75 million result accompanying financial statements december 31 1997 years ended december 31 1997 1996 present restated results summary effects restatement follows thousands except per share data american bank note holographics inc notes financial statements years ended december 31 1998 1997 1996 continued 11 restatement continued additionally january 1 1996 retained earnings reduced approximately 278000 net applicable income taxes effects certain overbillings 1991 1994 schedule ii american bank note holographics inc valuation qualifying accounts years ended december 31 1998 1997 1996 1 accounts deemed uncollectible net recoveries 2 amount recoveries exceeded amounts deemed uncollectible year s1 signatures pursuant requirements section 13 15d securities exchange act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized american bank note holographics inc kenneth h traub kenneth h traub president chief operating officer december 21 1999 pursuant requirements securities exchange act 1934 report signed following persons behalf registrant capacities dates indicateditem 14 exhibits financial statement schedules reports form 8k 1 financial statements financial statements required item submitted separate section beginning page report 2 financial statement schedules financial statement schedule required item submitted separate section page s1 report schedules included page s1 report omitted absence conditions required information included financial statements notes thereto 3 exhibits see c b reports form 8k none c exhibits incorporated reference registration statement form s1 registration 33351845 incorporated reference annual report form 10k 1998 portions omitted pursuant request confidential treatment financial statement schedules see a2 american bank note holographics inc independent auditors report board directors stockholders american bank note holographics inc elmsford new york audited accompanying balance sheets american bank note holographics inc december 31 1999 1998 related statements operations stockholders equity cash flows three years period ended december 31 1999 audits also included financial statement schedule listed accompanying table contents financial statements financial statement schedule responsibility companys management responsibility express opinion financial statements financial statement schedule based audits conducted audits accordance generally accepted auditing standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audits provide reasonable basis opinion financial statements present fairly material respects financial position american bank note holographics inc december 31 1999 1998 results operations cash flows three years period ended december 31 1999 conformity generally accepted accounting principles also opinion financial statement schedule considered relation basic financial statements taken whole presents fairly material respects information set forth therein discussed note 10 financial statements company involved certain litigation deloitte touche llp new york new york march 29 2000 american bank note holographics inc balance sheets december 31 1999 1998 thousands except share data see notes financial statements american bank note holographics inc statements operations years ended december 31 1999 1998 1997 thousands except per share data see notes financial statements american bank note holographics inc statements stockholders equity years ended december 31 1999 1998 1997 thousands see notes financial statements american bank note holographics inc statements cash flows years ended december 31 1999 1998 1997 thousands see notes financial statements american bank note holographics inc notes financial statements years ended december 31 1999 1998 1997 1 basis presentation summary significant accounting policies american bank note holographics inc company july 20 1998 offering date whollyowned subsidiary american banknote corporation former parent offering date former parent completed sale 13636000 shares companys common stock public offering representing entire investment company receive proceeds offering additionally connection offering amounts due former parent affiliates approximately 339 million canceled deemed dividend see note 7 immediately following offering company approximately 52 million secured bank debt nominal cash financial reporting purposes amounts due former parent affiliates prior offering date classified within stockholders equity june 11 1998 company declared 13636 one stock split effective july 2 1998 form stock dividend common stock increased authorized common stock 30000000 shares authorized preferred stock 5000000 shares accompanying financial statements give retroactive effect consummation stock split whollyowned subsidiary company provided certain corporate administrative services former parent including financial reporting treasury functions tax planning compliance risk management human resources legal services additionally former parent managed cash financing requirements centrally interest expense financing requirements prior offering date based existing capital structure financial position operations company prior offering may differ results may achieved company operated independent entity company originates massproduces markets secure holograms used security packaging promotional applications company operates one reportable industry segment use estimates preparation financial statements conformity generally accepted accounting principles requires management make estimates assumptions affect reported amounts assets liabilities disclosure contingent assets liabilities date financial statements reported amounts sales expenses reporting period actual results may differ materially estimates cash equivalents highly liquid investments maturity three months less purchased considered cash equivalents american bank note holographics inc notes financial statements 1 basis presentation summary significant accounting policies continued concentrations credit risk significant portion companys accounts receivable due credit card issuers related credit card manufacturers located throughout united states europe company establishes credit policies based ongoing evaluation customers creditworthiness competitive market conditions require collateral company establishes allowance doubtful accounts based assessment exposures credit losses balance sheet date believes allowance doubtful accounts sufficient based credit exposures outstanding december 31 1999 inventories sales recognition inventories stated lower cost market cost determined firstin firstout fifo method hologram originations represent costs unique master hologram made customer specifications integral part production process capitalized charged cost goods sold estimated production period sales related cost goods sold generally recognized latter time shipment title passes customers situations company shipped product right return company unable reasonably estimate level returns andor sale contingent upon customers use product situations company recognize sales upon product shipment rather buyer product informs company product used additionally pursuant terms certain customer completed items stored behalf customer companys onsite secured facility instance sales recognized following occurred customer ordered goods manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order december 31 1999 accounts receivable customer totaled 05 million amounts receivable customer december 31 1998 first quarter 1998 company recorded sales approximately 65 million arrangement december 31 1999 1998 customer advances approximating 06 million 15 million respectively represent payments received customers products yet shipped 05 million 12 million respectively products shipped right return 01 million 03 million respectively company unable reasonably estimate level returns customer advances classified current liabilities accompanying balance sheets royalty income company enters licensing agreements certain manufacturers company receives royalty payments royalty payments due licensing agreements recognized income either based upon shipment reports licensees available estimated shipments licensees american bank note holographics inc notes financial statements 1 basis presentation summary significant accounting policies continued depreciation amortization machinery equipment recorded cost depreciated straightline method estimated useful lives 5 22 years amortization leasehold improvements computed straightline method based upon remaining term applicable lease estimated useful life asset whichever shorter longlived assets company reviews longlived assets impairment changes circumstances indicate carrying amount asset may recoverable changes circumstances may include among factors significant change technology may render asset group obsolete noncompetitive significant change extent manner asset used evidence physical defect asset group operating loss changes circumstances indicate carrying amount asset may recoverable company estimates future cash flows undiscounted without interest charges expected result use asset eventual disposition records impairment loss equal amount carrying amount asset exceeds fair value asset estimated cash flows less carrying amount asset assets disposed assets expected provide future service potential company recorded lower carrying amount fair value less costs sell intangible assets excess cost net assets acquired amortized 30 years straightline method company reviews enterprise level goodwill impairment changes circumstances similar described longlived assets indicate carrying value may recoverable circumstances company estimates future cash flows using recoverability method undiscounted including related interest charges basis recording impairment loss impairment loss recorded adjust carrying value goodwill recoverable amount impairment loss taken greater amount carrying value net assets business exceeds fair value deferred financing costs incurred connection obtaining financing deferred amortized charge interest expense term related borrowing using interest method warranty costs company provides warranty costs amounts estimates needed cover future warranty obligations products sold year estimates warranty costs periodically reviewed adjusted necessary consider actual experience american bank note holographics inc notes financial statements 1 basis presentation summary significant accounting policies continued research development research development costs expensed incurred 1999 03 million 1998 03 million 1997 05 million income taxes company accounts income taxes liability method accordance statement financial accounting standards sfas 109 accounting income taxes provision income taxes includes deferred income taxes resulting items reported different periods income tax financial statement purposes deferred tax assets liabilities represent expected future tax consequences differences financial statement carrying amounts existing assets liabilities respective tax basis stockbased compensation plans sfas 123 accounting stockbased compensation allows either adoption fair value method accounting stockbased compensation plans continuation accounting stockbased compensation plans accounting principles board apb opinion 25 accounting stock issued employees related interpretations supplemental disclosures company chosen account stock options using intrinsic value based method prescribed apb opinion 25 accordingly recognize compensation expense stock option grants made exercise price equal excess fair market value stock date grant pro forma net income net income per share amounts fair value method adopted presented note 8 sfas 123 impact companys results operations financial position cash flows basic diluted net income per share basic net income per share computed based weighted average number outstanding shares common stock giving retroactive effect stock split basic weighted average number shares outstanding 13636000 years ended december 31 1999 1998 1997 diluted net income per share computed dividing net income weighted average number shares common stock outstanding dilutive potential shares common stock related outstanding stock options 1998 year ended december 31 1999 options purchase 1420000 shares companys common stock excluded calculation diluted net income per share effect inclusion options would antidilutive year ended december 31 1998 dilutive effect approximately 65000 equivalent shares related stock options used determining diluted weighted average shares outstanding years ended december 31 1999 1998 1997 diluted weighted average number shares outstanding 13636000 13701000 13636000 respectively american bank note holographics inc notes financial statements 1 basis presentation summary significant accounting policies continued business information sales mastercard approximately 27 30 35 sales years ended december 31 1999 1998 1997 respectively approximately 75 1998 mastercard sales recorded first quarter 1998 december 31 1999 accounts receivable mastercard approximated 05 million amounts due mastercard december 31 1998 company exclusive supplier holograms mastercard pursuant agreement amended extends february 2003 agreement provides automatic twoyear renewal periods terminated either party 1999 company informed mastercard believes company breached certain terms agreement 1998 1997 company working closely mastercard address issues raised mastercard believes relationship mastercard good beginning january 2000 company agreed lower selling price mastercard approximately 12 loss substantial portion sales mastercard however would material adverse effect financial position results operations cash flows company sales manufacturers visa credit cards approximately 50 customers approximately 18 26 27 sales years ended december 31 1999 1998 1997 respectively loss substantial portion sales customers would material adverse effect financial position results operations cash flows company december 31 1999 1998 accounts receivable customers approximated 05 million 10 million respectively company historically purchased certain key materials used manufacture holograms single suppliers supply contracts problems occur respect delivery quality cost materials could material adverse effect financial position results operations cash flows company export sales us export sales approximately 32 28 25 sales years ended december 31 1999 1998 1997 respectively export sales denominated united states dollars december 31 1999 1998 accounts receivable customers approximated 05 million 12 million respectively reclassifications certain prior year amounts reclassified conform current years presentation american bank note holographics inc notes financial statements 1 basis presentation summary significant accounting policies continued new accounting standards march 1998 american institute certified public accountants aicpa issued statement position 981 accounting costs computer software developed obtained internal use sop 981 sop 981 requires computer software costs associated internal use software expensed incurred certain capitalization criteria met company adopted sop 981 january 1 1999 adoption statement material impact companys financial position results operations cash flows april 1998 aicpa issued statement position 985 reporting cost startup activities sop 985 sop 985 requires costs associated preopening preoperating organization activities expensed incurred company adopted sop 985 january 1 1999 adoption statement material impact companys financial position results operations cash flows june 1998 financial accounting standards board issued sfas 133 accounting derivative instruments hedging activities amended effective fiscal years beginning june 15 2000 sfas 133 requires recognition derivatives balance sheets either assets liabilities measured fair value company adopt sfas 133 2001 fiscal year company currently evaluating impact sfas 133 financial position results operations cash flows 2 inventories american bank note holographics inc notes financial statements 3 machinery equipment leasehold improvements 4 accrued expenses 5 taxes income accordance tax allocation agreement effect offering date company included consolidated us federal income tax return certain instances consolidated combined state local income tax returns former parent made payments former parent based amounts would payable federal state local income taxes consolidated combined returns filed company computed federal state local income tax provision filing separate income tax returns without regard tax american bank note holographics inc notes financial statements 5 taxes income continued allocation agreement october 1999 affiliate former parent received assessment approximately 09 million taxes interest city new york relating years ended december 31 1990 1991 1992 company included combined city new york income tax returns former parent periods covered assessment previously made payments former parent based amounts would payable combined income tax returns filed company contingently liable jointly severally us federal state local income taxes periods included consolidated combined income tax returns former parent see note 10 amounts paid former parent excess amounts would payable company filed separate income tax returns charged due former parent affiliates periods subsequent offering date company file us federal state income tax returns company filed income tax returns new york state year ended december 31 1998 deferred income taxes arise temporary differences tax bases assets liabilities reported amounts financial statements taxes income benefit follows american bank note holographics inc notes financial statements 5 taxes income continued reconciliation taxes income amount computed applying federal income tax statutory rate 35 follows tax effects items comprising companys deferred income tax assets liabilities follows december 31 1999 company net operating loss carryforwards available offset future federal income taxes 11 million expire 2017 net operating loss carryforwards available offset future state income taxes 11 million expire 2017 american bank note holographics inc notes financial statements 6 revolving credit agreement july 20 1998 contemporaneously offering company entered 300 million credit facility agreement credit agreement consisting 200 million acquisition facility 100 million working capital facility maturing july 20 2004 replaced facility company entered affiliate former parent substantially companys assets secured terms credit agreement december 31 1998 56 million outstanding credit agreement exceeded maximum permitted borrowings defined pursuant borrowing base formula defined credit agreement february 1999 lenders notified company default credit agreement march 31 1999 credit agreement amended credit agreement whereby maximum permitted borrowings reduced lesser 45 million maximum permitted borrowings borrowing base formula defined borrowings amended credit agreement bore interest lenders alternate base rate defined plus 05 july 20 1999 amended credit agreement amended second amended credit agreement whereby existing events default waived ii latest maturity date loans outstanding changed january 20 2000 iii maximum permitted borrowings reduced 40 million decline monthly december 31 1999 maximum permitted borrowings 26 million second amended credit agreement provided borrowings revolving credit line bearing interest lenders alternate base rate defined plus 2 80 december 31 1998 subject borrowing base formula defined consideration second amended credit agreement company paid fee 40000 issued warrants purchase 781645 shares common stock subject antidilution rights 450 per share warrants terminated september 29 1999 pursuant second amended credit agreement amounts outstanding second amended credit agreement repaid described september 29 1999 amounts outstanding second amended credit agreement repaid company entered loan security agreement foothill capital corporation subsidiary wells fargo bank amended loan security agreement maturing september 29 2004 loan security agreement secured substantially companys assets provides borrowings aggregate amount 100 million may increased 150 million consent parties subject borrowing base formula revolving credit facility term loan capital expenditure loan borrowings loan security agreement bear interest lenders reference rate defined plus 15 10 december 31 1999 may decrease 125 100 05 certain circumstances terms loan security agreement maximum amounts term capital expenditure loans approximately 10 million 20 million respectively repayable sixty equal monthly installments december 31 1999 company 74000 outstanding revolving credit facility 10 million outstanding term loan payable monthly installments 16667 beginning january 2000 december 31 1999 loans outstanding capital expenditure line addition company 03 million availability revolving credit facility december 31 1999 american bank note holographics inc notes financial statements 6 revolving credit agreement continued loan security agreement contains covenants customary credit facilities similar nature including limitations ability company among things declare dividends repurchase redeem stock ii prepay redeem repurchase debt incur liens engage saleleaseback transactions iii make loans investments iv incur additional debt v amend otherwise alter material agreements enter restrictive agreements vi make capital expenditures fiscal year excess 25 million vii engage mergers acquisitions asset sales viii engage certain transactions affiliates ix materially alter nature business additionally terms loan security agreement company required comply specified financial covenants ratios loan security agreement also provides events default customary transactions type including nonpayment misrepresentation breach covenant crossdefaults bankruptcy adverse judgments excess 02 million change ownership control 1999 company wroteoff unamortized deferred financing costs approximately 06 million relating amendments repayment credit agreement 1999 1998 weighted average interest rate outstanding borrowings approximately 84 average aggregate borrowings 1999 1998 approximately 33 million 52 million respectively december 31 1999 company notes payable totaling approximately 194000 139000 due 2000 19000 2001 21000 2002 15000 2003 notes bear interest rates ranging 585 836 american bank note holographics inc notes financial statements 7 related party transactions financial statements reflect allocated readily determinable actual expenses services provided companys former parent affiliates allocations utilized company former parent affiliates recorded transactions based upon systematic reasonable methods including limited sales asset values headcount percent total amounts major category historical transactions former parent affiliates follow 1 primarily medical life disability insurance premiums 2 includes legal fees allocated portion audit fees 3 included balances 53 million note receivable former parent bore interest 575 per annum 4 includes value restricted stock former parent amount deemed dividend former parent subject adjustment based companys taxable income offering date see note 5 american bank note holographics inc notes financial statements 7 related party transactions continued financial reporting purposes amounts due former parent affiliates periods prior offering date classified within stockholders equity addition company sold 10 million 06 million 04 million products services 1999 1998 1997 respectively former parent affiliates normal course business purchases company former parent affiliates normal course business 01 million 1997 purchases 1999 1998 december 31 1999 1998 trade accounts receivable former parent affiliates 02 million 02 million respectively included transactions company acted subcontractor affiliate former parent government contract sales subcontract billed affiliate former parent approximated 02 million 03 million 01 million 1999 1998 1997 respectively december 31 1999 1998 trade accounts receivable affiliate former parent subcontract approximated 02 million 01 million respectively december 31 1999 1998 accounts payable accrued expenses include approximately 03 million 02 million respectively due former parent affiliates 1997 employees company received stock options former parents stockbased compensation plans options granted 1999 1998 compensation cost stock option plans determined based fair value grant award dates 1997 consistent provisions sfas 123 accounting stockbased compensation net income would reduced approximately 13000 1997 connection offering company former parent entered number agreements relating transition period defining ongoing relationships following offering follows see note 10 separation agreement provides company generally indemnify former parent including officers directors employees affiliates costs liabilities expenses relating offering conduct company business including result guarantees former parent obligations company ii former parent indemnify company costs liabilities expenses relating conduct former parent business including result guarantees company obligations former parent iii immediately prior closing offering company nominal amount unrestricted cash former parent shall entitled unrestricted cash hand iv former parent indemnify hold harmless company federal foreign state local franchise income sales use transfer tax liabilities obligations american bank note holographics inc notes financial statements 7 related party transactions continued including interest penalties attributable former parents consolidated group activities company periods v company indemnify hold harmless former parent federal foreign state local franchise income sales use transfer tax liabilities obligations including interest penalties attributable activities company periods vi company former parent crossindemnify certain matters license agreement provides company right use american bank note name oneyear term automatically renewable consecutive oneyear periods annual fee 1 additionally company former parent granted perpetual paidup royaltyfree licenses patents trademarks proprietary technology used respective business company agreed use name american bank note variation thereof connection business enterprise venture outside holography industry sublicense name third parties transitional services agreement former parent agreed provide cause provided company certain specified corporate administrative services oneyear transitional period offering agreement provides services provided fees greater former parents costs services provided agreement employee benefits allocation agreement governs allocation responsibilities costs regarding employee benefit plans related matters agreement provides company shall establish new benefit insurance plans employees cooperate former parent respect certain shared responsibilities transitional period former parent solely responsible contributions may required following offering respect service prior thereto employees company covered former parent defined benefit retirement plan indemnifications former parent described notes 5 10 connection offering company former parent entered number agreements among matters provide indemnification certain circumstances company former parent described 1999 former parent experienced significant financial difficulty may result inability perform terms indemnifications provided could material adverse effect companys financial position results operations cash flows december 8 1999 former parent filed petition plan reorganization federal bankruptcy court pursuant chapter 11 us bankruptcy code proposed plan seeks approval financial restructuring resulting cancellation certain former parents outstanding indebtedness exchange equity former parent well amendment repayment terms certain outstanding indebtedness former parent proposed plan seek affect former parents trade obligations payables ordinary course company objected disclosure statement describing abns proposed bankruptcy plan reorganization company also submitted substantial claim proceeding certain american bank note holographics inc notes financial statements 7 related party transactions continued amounts company claims former parent owes company former parents financial difficulties may difficult company collect claims future liabilities former parent company recorded amounts financial statements related claim 8 1998 stock incentive plan subsequent offering date company adopted 1998 stock incentive plan amended 1998 plan purpose granting various stock incentives key employees board directors committee appointed board directors discretionary authority subject certain restrictions administer 1998 plan total number shares reserved issuance 1998 plan 1863000 shares common stock options purchase 1240000 shares common stock outstanding plan december 31 1999 options purchase additional 180000 shares common stock outstanding outside plan december 31 1999 exercise price options granted 1998 plan may less 100 fair market value common stock date option granted options granted 1998 plan generally would become vested exercisable 33 13 total optioned shares upon succeeding anniversary date grant terms options granted outside plan terms options granted plan generally unexercised portion option automatically terminates upon termination optionees employment company unless otherwise determined board directors provided however extension shall extend beyond expiration option generally ten years upon change control outstanding options generally become fully vested may exercised immediately summary status companys outstanding stock options december 31 1999 1998 changes years ended follows american bank note holographics inc notes financial statements 8 1998 stock incentive plan continued 1999 company issued options newly appointed chairman 175000 shares 250 per share president 250000 shares 175 per share 100000 shares 250 per share executive vice president 150000 shares 275 per share chief financial officer 100000 shares 250 per share exercise prices equal fair market value companys common stock dates respective grants included outstanding options december 31 1998 options companys former chairman chief executive officer 400000 former president 200000 former vice presidentfinance 40000 former vice president operations 40000 canceled upon resignations 1999 additionally 1998 company issued 45000 options members board directors reflected table exercise price 850 per share representing fair market value companys common stock grant date following table summarizes information stock options outstanding december 31 1999 company applies apb opinion 25 related interpretations accounting stock options accordingly compensation cost recognized outstanding stock options compensation cost companys outstanding stock options determined based fair value grant dates options consistent sfas 123 companys 1999 1998 net loss income basic diluted net loss income per share would differed reflected pro forma amounts indicated thousands except per share amounts fair value option grant estimated date grant using blackscholes optionpricing model following weightedaverage assumptions american bank note holographics inc notes financial statements 9 employee benefits plans certain employees company rights benefits former parents defined benefit retirement plan eligible additional benefits contributions currently required order provide benefits pursuant employee benefits allocation agreement see note 7 contributions required future including contributions fully fund plan benefits termination plan amount contributions required paid former parent see note 10 postretirement health care life insurance plans prior offering date company participated benefit plans affiliates former parent provided certain postretirement health care life insurance benefits certain eligible employees terms plans companys employees could become eligible benefits reached normal retirement age certain service requirements period company participated plans company accrued estimated cost retiree benefit payments pensions years employee provided services former parents plans funded terms employee benefits allocation agreement see note 7 company responsible benefits provided employees retired company prior offering date qualified benefits offering date years ended december 31 1998 1997 costs relating plans approximated 21000 58000 respectively 1999 company determined would continue plan current employees included selling administrative expenses approximately 04 million relating reversal unfunded obligation retirement plans retirement benefits provided former parent eligible employees defined contribution retirement plan former parent aggregate contributions plan charged companys operations approximately 02 million years ended 1998 1997 respectively company continued participating employer plan september 30 1999 time implemented defined contribution plan contributions year ended december 31 1999 aggregated 01 million certain employees company participate affiliate former parents defined benefit pension plan benefits plan frozen 1992 based years service average final compensation liability benefits plan substantially funded responsibility affiliate former parent total pension expense relating companys employees aggregate 1998 1997 less 10000 american bank note holographics inc notes financial statements 9 employee benefits plans continued 1997 company participated former parents noncontributory supplemental executive retirement plan serp certain senior management employees former parent affiliates benefits noncontributory plan based years service average final compensation plan unfunded following offering companys participants ceased eligible serp benefits accordingly companys obligation plan 56000 credited due former parent affiliates aggregate contribution plan charged operations approximately 28000 1997 10 commitments contingencies sec us attorney investigations february 9 1999 division enforcement sec issued formal order directing private investigation designating officers take testimony requiring production certain documents connection matters giving rise need restate companys previously issued financial statements company provided numerous documents continues cooperate fully sec staff management company cannot predict duration investigation potential outcome us attorneys office southern district new york commenced investigation connection matters giving rise need restate companys previously issued financial statements well possible violation 1998 foreign corrupt practices act company advised target investigation company provided numerous documents continues cooperate fully us attorneys office management company cannot predict duration investigation potential outcome january 20 2000 former parent announced sec filing advised us attorneys office southern district new york target investigation relating revenue recognition issues involving company addition former parent announced connection issues staff sec prepared recommend sec enforcement proceedings commenced former parent us district court seeking injunctive relief monetary disgorgement former parent also announced advised counsel morris weissman chairman board chief executive officer companys former chairman board chief executive officer counsel received similar notification us attorneys office southern district new york staff sec respect mr weissman litigation consolidated class action complaint company certain former officers directors former parent four colead underwriters offering auditors filed united states district court southern district new york complaint alleges violations federal securities laws seeks recover damages behalf purchasers companys common stock class period july 15 1998 february 1 1999 complaint seeks rescission purchase shares companys common stock alternatively unspecified compensatory damages along costs expenses including attorneys fees american bank note holographics inc notes financial statements 10 commitments contingencies continued company certain defendants separately moved dismiss complaint plaintiffs discovery requests well motion class certification stayed pending resolution respective motions dismiss company commenced settlement discussions plantiffs counsel management company believe feasible predict determine outcome resolution proceedings estimate amounts potential range loss respect thereto addition timing resolution proceedings uncertain range possible resolutions could include judgments company settlements could require substantial payments company including costs defending suits could material adverse effect companys financial position results operations cash flows february 14 1997 james rigby trustee bankruptcy holosonics inc holotron corp meadow games inc fire diamond inc commenced adversary proceeding united states bankruptcy court western district washington seattle international banknote company inc former parent company complaint alleged defendants indebted bankruptcy estate royalty payments 1981 license company liable unpaid royalties period january 1 1990 july 1992 amount approximately 16 million plus attorneys fees interest unpaid amounts defendants trustee entered settlement agreement approved order bankruptcy court september 10 1999 whereby defendants agreed pay trustee 150000 paid full amount settlement accrued december 31 1998 1994 plaintiffs kah company inc kenneth haines filed suit company former parent abnh research co inc supreme court state new york county new york judgment entered march 19 1999 175639 attorneys fees still assessed judgment entered former parent contended company contribute payment judgment february 2 2000 plaintiffs defendants settled claims including attorneys fees 300000 110000 paid march 15 2000 remaining 190000 paid march 31 2000 full amount settlement accrued december 31 1998 august 17 1999 company commenced action supreme court state new york county westchester seeking recovery approximately 350000 claim arising amounts owed company holographic materials sold delivered july 1999 defendant removed action united states district court southern district new york december 1 1999 company received defendants answers complaint counterclaims alleging millions dollars damages arising companys alleged breach 1993 agreement pursuant company sold holographic material defendant alleged failure fulfill may 1998 purchase order january 7 2000 court granted companys motion summary judgment respect claim march 15 2000 company entered settlement agreement defendant paid 346000 parties exchanged general releases claims company also agreed resume shipments may 1998 purchase order american bank note holographics inc notes financial statements 10 commitments contingencies continued 1998 company fulfilled order holograms approximately 600000 1999 customer alleged company breached contract customer based problems ultimate user experiencing holograms claimed potential damages excess 6 million management company believe agreement breached discussions customer attempt resolve dispute amicably assurance however matter resolved amicably dispute lead litigation customer company begun settlement negotiations customer based settlement negotiations company reserved 775000 1999 breach contract claim relating warranties company currently time involved litigation plaintiff defendant incidental conduct business however shareholder litigation described company party lawsuit proceeding opinion management company likely material impact companys financial position results operations cash flows amounts accrued litigation matters represent anticipated costs damages andor settlement amounts connection pending litigation claims costs accrued probable asset impaired liability incurred amount reasonably estimated accruals based upon companys assessment consultation counsel probable loss based facts circumstances case legal issues involved nature claim made nature damages sought relevant information plaintiffs significant factors vary case possible estimate specific expected cost incurred company evaluates range probable loss records minimum end range december 31 1999 1998 accruals litigation matters approximated 315000 500000 respectively anticipated 315000 accrual paid 2000 company believes based information known december 31 1999 anticipated probable costs litigation matters december 31 1999 adequately provided extent determinable american bank note holographics inc notes financial statements 10 commitments contingencies continued product liability matters company provides holograms connection wide range customers products case possible company subject product liabilities association products connection holograms used products although company maintains product liability insurance assurance insurance would available cover claim available amounts sufficient cover potential liabilities result product liability claims could material adverse effect companys business financial condition results operations cash flows leases company longterm operating leases offices manufacturing facilities equipment expire 2007 company renewal options locations provide renewal rents based upon increases tied consumer price index net rental expense approximately 13 million year ended december 31 1999 12 million years ended december 31 1998 1997 december 31 1999 future minimum lease payments noncancelable operating leases follows 11 million 2000 09 million 2001 09 million 2002 08 million 2003 08 million 2004 19 million thereafter employment agreements 1999 company entered employment agreements certain officers provide among matters minimum compensation approximately 658000 2000 115000 2001 agreements also provide discretionary bonuses connection agreements company granted options acquire 775000 shares common stock prices ranging 175 275 per share representing fair market value companys common stock dates grant new york stock exchange delisting august 3 1999 new york stock exchange suspended trading companys common stock failure company deliver annual report form 10k year ended december 31 1998 quarterly report form 10q three months ended march 31 1999 timely basis following suspension new york stock exchange delisted companys common stock company expect resume trading new york stock exchange company intends seek security traded another stock exchange national association securities dealers automated quotation system american bank note holographics inc notes financial statements 11 1999 audit committee companys board directors commenced special investigation events resulted need restate companys financial statements years ended december 31 1997 1996 first three quarters 1998 costs special investigation related restatement effort legal defense approximated 35 million net insurance reimbursements 06 million included within selling administrative expenses accompanying statements operations schedule ii american bank note holographics inc valuation qualifying accounts years ended december 31 1999 1998 1997 1 accounts deemed uncollectible net recoveries s1 signatures pursuant requirements section 13 15d securities exchange act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized american bank note holographics inc kenneth h traub kenneth h traub president chief executive officer march 30 2000 pursuant requirements securities exchange act 1934 report signed following persons behalf registrant capacities dates indicateditem 14 exhibits financial statement schedules reports form 8k 1 financial statements financial statements required item submitted separate section beginning page report 2 financial statement schedules financial statement schedule required item submitted separate section page s1 report schedules included page s1 report omitted absence conditions required information included financial statements notes thereto 3 exhibits see c b reports form 8k none c exhibits 31 amended restated certificate incorporation1 32 amended restated bylaws1 33 amendment amended restated certificate incorporation2 41 form common stock certificate1 42 stock purchase agreement crane co inc american bank note holographics inc dated june 29 20003 43 warrant agreement american bank note holographics inc american stock transfer company dated december 18 20004 44 form warrant certificate4 45 form option agreement american bank note holographics inc 1998 stock incentive plan amended5 46 form option agreement american bank note holographics inc 2000 stock incentive plan5 47 option agreement dr stephen benton american bank note holographics inc dated july 20 19985 48 option agreement mr russell lacoste american bank note holographics inc dated october 11 19995 101 form separation agreement american bank note corporation american bank note holographics inc dated july 20 19981 102 form license agreement1 103 form transitional services agreement1 104 form employee benefits allocation agreement1 105 form 1998 stock incentive plan1 106 form 2000 stock incentive plan6 107 form defined contribution plan1 108 production agreement mastercard international incorporated american bank note holographics inc dated february 1 19961 109 letter agreement dated june 29 1998 mastercard international incorporated american bank note holographics inc amending production agreement dated february 1 19967 1010 letter agreement dated march 3 1999 mastercard international incorporated american bank note holographics inc amending production agreement dated february 1 19967 1011 loan security agreement dated september 29 1999 foothill capital corporation american bank note holographics inc together amendment 1 dated december 31 1999 letter dated january 4 20008 1012 employment agreement dated april 20 1999 salvatore f damato american bank note holographics inc7 1013 employment agreement dated february 3 1999 kenneth h traub american bank note holographics inc amended march 20 2000 1014 employment agreement dated april 30 1999 alan goldstein american bank note holographics inc7 1015 employment agreement dated september 15 1999 russell lacoste american bank note holographics inc7 1016 standard form loft lease dated july 23 1992 robert martin company american bank holographics inc 1017 lease agreement dated august 13 1984 mark hankin hanmar associates xv tenantsincommon american bank note company addenda thereto 1018 lease agreement dated january 19 2001 crane co inc american bank note holographics inc 231 consent deloitte touche llp 232 consent arthur andersen llp 991 letter commission pursuant temporary note 3t 1 incorporated reference registration statement form s1 registration 333 51845 2 incorporated reference proxy statement schedule 14a filed july 3 2001 3 incorporated reference form 10q filed august 14 2000 4 incorporated reference annual report form 10k 2000 5 incorporated reference registration statement form s8 registration 33361602 6 incorporated reference proxy statement schedule 14a filed august 11 2000 7 incorporated reference annual report form 10k 1998 8 incorporated reference annual report form 10k 1999 portions omitted pursuant request confidential treatment financial statement schedules see a2 signatures pursuant requirements section 13 15d securities exchange act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized american bank note holographics inc kenneth h traub kenneth h traub president chief executive officer march 29 2002 pursuant requirements securities exchange act 1934 report signed following persons behalf registrant capacities dates indicated american bank note holographics inc report independent public accountants board directors stockholders american bank note holographics inc audited accompanying balance sheets american bank note holographics inc delaware corporation december 31 2001 2000 related statements operations stockholders equity cash flows years ended financial statements schedule referred responsibility companys management responsibility express opinion financial statements schedule based audits conducted audits accordance auditing standards generally accepted united states standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audits provide reasonable basis opinion financial statements referred present fairly material respects financial position american bank note holographics inc december 31 2001 2000 results operations cash flows years ended conformity accounting principles generally accepted united states audits made purpose forming opinion basic financial statements taken whole supplemental schedule page s1 presented purposes additional analysis required part basic financial statements information subjected auditing procedures applied audits basic financial statements opinion fairly stated material respects relation basic financial statements taken whole sarthur andersen llp new york new york march 1 2002 independent auditors report board directors stockholders american bank note holographics inc elmsford new york audited accompanying statements operations stockholders equity cash flows american bank note holographics inc year ended december 31 1999 audit also included financial statement schedule listed accompanying table contents financial statements financial statement schedule responsibility companys management responsibility express opinion financial statements financial statement schedule based audit conducted audit accordance auditing standards generally accepted united states america standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audit provides reasonable basis opinion financial statements present fairly material respects results operations cash flows american bank note holographics inc year ended december 31 1999 conformity accounting principles generally accepted united states america also opinion financial statement schedule considered relation basic financial statements taken whole presents fairly material respects information set forth therein discussed note 11 financial statements company involved certain litigation potential litigation deloitte touche llp new york new york march 29 2000 american bank note holographics inc balance sheets december 31 2001 2000 thousands except share data accompanying notes integral part financial statements american bank note holographics inc statements operations years ended december 31 2001 2000 1999 thousands except per share data accompanying notes integral part financial statements american bank note holographics inc statements stockholders equity years ended december 31 2001 2000 1999 thousands accompanying notes integral part financial statements american bank note holographics inc statements cash flows years ended december 31 2001 2000 1999 thousands accompanying notes integral part financial statements american bank note holographics inc notes financial statements years ended december 31 2001 2000 1999 1 basis presentation summary significant accounting policies american bank note holographics inc company incorporated state delaware august 1985 company july 20 1998 offering date whollyowned subsidiary american banknote corporation former parent company originates massproduces markets secure holograms used security packaging promotional applications company operates one reportable industry segment use estimates preparation financial statements conformity generally accepted accounting principles requires management make estimates assumptions affect reported amounts assets liabilities disclosure contingent assets liabilities date financial statements reported amounts sales expenses reporting period actual results may differ materially estimates cash equivalents highly liquid investments primarily government bonds maturity three months less purchased considered cash equivalents stated cost approximates market concentrations credit risk significant portion companys accounts receivable due credit card issuers related credit card manufacturers located throughout united states europe company establishes credit polices based ongoing evaluation customers creditworthiness competitive market conditions require collateral inventories stated lower cost market cost determined firstin firstout fifo method hologram originations represent costs unique master hologram made customer specifications integral part production process capitalized charged cost goods sold production period revenue recognition company recognizes revenue accordance provisions security exchange commissions sec staff accounting bulletin sab 101 revenue recognition specifically sales related cost goods sold generally recognized latter time shipment title passes customers situations company shipped product right return company unable reasonably estimate level returns andor sale contingent upon customers use product situations company recognize sales upon product shipment rather buyer product informs company product used additionally pursuant terms certain customer completed items stored behalf customer companys onsite secured facility instance sales recognized following occurred customer ordered goods manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order december 31 2001 2000 accounts receivable customer approximated 10 million 04 million respectively december 31 2001 2000 customer advances approximating 01 02 million respectively represent payments received customers products yet shipped customer advances classified current liabilities accompanying balance sheets effective october 1 2000 company adopted emerging issues task force eitf 0010 accounting shipping handling fees costs provisions eitf 0001 shipping handling amounts billed customers included revenues shipping handling costs included selling administrative expenses amounted 370000 377000 499000 years ended december 31 2001 2000 1999 respectively comparative prior period financial statements reclassified reflect change adoption eitf impact determination net income loss royalty income company enters licensing agreements certain manufacturers company receives royalty payments royalty payments due licensing agreements recognized income either based upon shipment reports licensees available estimated shipments licensees american bank note holographics inc notes financial statements years ended december 31 2001 2000 1999 1 basis presentation summary significant accounting policies continued depreciation amortization machinery equipment recorded cost depreciated using straightline method estimated useful lives ranging 5 22 years amortization leasehold improvements computed using straightline method based upon remaining term applicable lease estimated useful life asset whichever shorter longlived assets accordance statement financial accounting standards sfas 121 accounting impairment longlived assets longlived assets disposed company reviews longlived assets impairment changes circumstances indicate carrying amount asset may recoverable changes circumstances may include among factors significant change technology may render asset group obsolete noncompetitive significant change extent manner asset used evidence physical defect asset group operating loss changes circumstances indicate carrying amount asset may recoverable company estimates future cash flows undiscounted without interest charges expected result use asset eventual disposition records impairment loss equal amount carrying amount asset exceeds fair value asset estimated cash flows less carrying amount asset july 2001 financial accounting standards board fasb issued sfas 143 accounting asset retirement obligations requires obligations associated retirement longlived assets recorded increases costs related asset also october 3 2001 fasb issued sfas 144 accounting impairment disposal longlived assets sfas 144 supercedes sfas 121 accounting impairment disposal longlived assets longlived assets disposed sfas 144 develops one accounting model determining impairment based model sfas 121 longlived assets disposed sale requires disposed lower book value fair value less cost sell addition sfas 144 expands scope discontinued operations new rules applied prospectively beginning january 1 2002 management expect adoption statements material impact financial position goodwill excess cost net assets acquired amortized 30 years using straightline method company reviews enterprise level goodwill impairment changes circumstances similar described longlived assets indicate carrying value may recoverable circumstances company estimates future cash flows using recoverability method undiscounted including related interest charges basis recording impairment loss impairment loss recorded adjust carrying value goodwill recoverable amount july 2001 fasb issued sfas 141 business combinations sfas 142 goodwill intangible assets sfas 141 requires business combinations initiated june 30 2001 accounted using purchase method defines criteria recognition acquired intangible assets sfas 142 goodwill intangible assets indefinite lives longer amortized reviewed annually frequently impairment indicators arise impairment separable intangible assets deemed indefinite lives continue amortized useful lives maximum life amortization provisions sfas 142 apply goodwill intangible assets acquired june 30 2001 respect goodwill intangible assets acquired prior july 1 2001 company required adopt sfas 142 effective january 1 2002 company process performing required transitional fair value impairment test goodwill reviewing separable intangible assets january 1 2002 company recorded 345000 002 per share goodwill amortization 2001 result adoption sfas 142 company longer record goodwill amortization warranty costs company provides warranty costs amounts estimates needed cover future warranty obligations products sold year estimates warranty costs periodically reviewed adjusted necessary consider actual experience research development research development costs expensed incurred income taxes company accounts income taxes liability method accordance sfas 109 accounting income taxes provision income taxes includes deferred income taxes resulting items reported american bank note holographics inc notes financial statements years ended december 31 2001 2000 1999 1 basis presentation summary significant accounting policies continued different periods income tax financial statement purposes deferred tax assets liabilities represent expected future tax consequences differences financial statement carrying amounts existing assets liabilities respective tax basis stockbased compensation plans sfas 123 accounting stockbased compensation allows either adoption fair value method accounting stockbased compensation plans continuation accounting stockbased compensation plans accounting principles board apb opinion 25 accounting stock issued employees related interpretations supplemental disclosures company chosen account stock options using intrinsic value based method prescribed apb opinion 25 accordingly recognize compensation expense stock option grants made exercise price equal excess fair market value stock date grant pro forma net income loss net income loss per share amounts fair value method adopted presented note 9 sfas 123 impact companys results operations financial position cash flows basic diluted net income loss per share basic net income loss per share computed based weighted average number outstanding shares common stock giving retroactive effect stock split basic weighted average number shares outstanding 18483720 15421064 13636000 years ended december 31 2001 2000 1999 respectively diluted net income loss per share computed dividing net income loss weighted average number shares common stock outstanding dilutive potential shares common stock years ended december 31 2001 2000 1999 effect options purchase 2509500 shares 2472500 shares 1420000 shares respectively companys common stock excluded calculation diluted net income loss per share effect inclusion options would antidilutive years ended december 31 2001 2000 1999 diluted weighted average number shares outstanding 18483720 15421064 13636000 respectively business concentration risks sales mastercard approximately 37 28 27 sales years ended december 31 2001 2000 1999 respectively december 31 2001 2000 accounts receivable mastercard approximated 10 04 million respectively company provides holograms mastercard pursuant agreement amended expires february 2003 subject automatic renewal terminated either party loss substantial portion sales mastercard however would material adverse effect financial position results operations cash flows company sales manufacturers visa credit cards approximately 50 customers approximately 23 19 18 sales years ended december 31 2001 2000 1999 respectively loss substantial portion sales customers would material adverse effect financial position results operations cash flows company december 31 2001 2000 accounts receivable customers approximated 10 million 06 million respectively company historically purchased certain key materials used manufacture holograms single suppliers supply contracts problems occur respect delivery quality cost materials could material adverse effect financial position results operations cash flows company export sales export sales 28 31 32 sales years ended december 31 2001 2000 1999 respectively export sales denominated united states dollars december 31 2001 2000 accounts receivable customers approximated 06 million 09 million respectively comprehensive income 1998 company adopted sfas 130 reporting comprehensive income establishes rules reporting comprehensive income components years ended december 31 2001 2000 1999 difference companys net income loss comprehensive income loss reclassifications certain prior year amounts reclassified conform current years presentation american bank note holographics inc notes financial statements years ended december 31 2001 2000 1999 2 inventories 3 machinery equipment leasehold improvements depreciation amortization machinery equipment leasehold improvements years ended december 31 2001 2000 1999 752000 732000 681000 respectively 4 accrued expenses 5 income taxes accordance tax allocation agreement effect offering date company included consolidated us federal income tax return certain instances consolidated combined state local income tax returns former parent made payments former parent based amounts would payable federal state local income taxes consolidated combined returns filed company computed federal state local income tax provision filing separate income tax returns without regard tax allocation agreement 2000 company former parent reached agreement subject consummation former parents chapter 11 plan see note 7 related party transactions agreement provides among things former parent responsible shall pay asserted unasserted income franchise similar tax liabilities company period january 1 1990 july 20 1998 indemnify company respect liabilities amounts paid former parent excess amounts would payable company filed separate income tax returns charged due former parent affiliates periods subsequent offering date company filing us federal state income tax returns american bank note holographics inc notes financial statements years ended december 31 2001 2000 1999 5 income taxes continued deferred income taxes arise temporary differences tax bases assets liabilities reported amounts financial statements provision benefit income taxes follows reconciliation taxes income amount computed applying federal income tax statutory rate 35 2001 2000 1999 follows tax effects items comprising companys deferred income tax assets liabilities follows american bank note holographics inc notes financial statements years ended december 31 2001 2000 1999 5 income taxes continued december 31 2001 company net operating loss carryforwards approximately 15 million expire 2021 available offset future federal taxable income current future changes ownership could limit availability use net operating loss carryforwards 6 revolving credit agreement august 23 2000 company terminated repaid outstanding amounts loan security agreement company foothill capital corporation amended foothill loan entered september 29 1999 borrowings foothill loan bore interest lenders reference rate defined plus 15 result terminating foothill loan 2000 company incurred early termination fee 01 million wroteoff approximately 02 million unamortized deferred financing costs related loans 1999 company wroteoff unamortized deferred financing costs approximately 06 million relating amendments repayment companys previous credit facility years ended december 31 2000 1999 weighted average interest rate outstanding borrowings approximately 98 84 respectively average aggregate borrowings 2000 1999 approximately 09 million 33 million respectively december 8 2000 company terminated repaid 59000 notes payable bore interest 585 7 related party transactions company former parent related parties april 4 1999 time former parents chairman chief executive officer resigned companys chairman chief executive officer december 8 1999 former parent filed petition plan reorganization chapter 11 federal bankruptcy code connection negotiations chapter 11 plan company reached agreement former parent subject among things definitive documentation ii court approval settlement shareholder litigation iii approval united states bankruptcy court former parents plan reorganization pending agreement subject consummation chapter 11 plan also provides parties exchange mutual general releases obligations may pursuant separation agreement abnh former parent dated july 20 1998 sums allegedly owing abnh former parent affiliates ii company receive 25000 shares stock reorganized former parent iii former parent responsible shall pay asserted unasserted income franchise similar tax liabilities company period january 1 1990 july 20 1998 indemnify company respect liabilities iv company withdraw claim former parent chapter 11 case object former parents chapter 11 plan long comports terms agreement company former parent described settlement company former parent made part chapter 11 plan bankruptcy court confirmed november 3 2000 result separation agreement company included accompanying statement operations 2000 approximately 05 million relating reversal accounts payable accrued expenses due former parent affiliates understand abns bankruptcy plan consummated abn indicated public sec filings give assurance bankruptcy plan consummated expects propose bankruptcy court certain amendments bankruptcy plan would require approval bankruptcy court solicitation affected creditors addition company sold 10 million products services 1999 former parent affiliates normal course business purchases company former parent affiliates normal course business 1999 company acted subcontractor affiliate former parent government contract sales subcontract billed affiliate former parent approximated 02 million 1999 american bank note holographics inc notes financial statements years ended december 31 2001 2000 1999 8 stockholders equity june 11 1998 company increased authorized common stock 30000000 shares authorized preferred stock 5000000 shares july 20 1998 former parent completed sale 13636000 shares companys common stock public offering representing entire investment company regard class action litigation settlement discussed note 11 financial statements company committed issue distribute 1460000 shares common stock well warrants purchase 863647 shares companys common stock exercise price 600 per share shares 365000 distributed included shares outstanding accompanying financial statements august 10 2001 companys stockholders approved amendment companys amended restated articles incorporation increasing number authorized shares common stock 40000000 shares june 30 2000 company entered stock purchase agreement crane co inc crane agreement company sold 3387720 shares companys common stock crane aggregate purchase price 9316230 agreement also provides board directors company audit committee board directors expanded one position filled douglas crane representative crane agreement crane right purchase proportionate share new issuance companys securities issued connection acquisition securities issued connection stock option plan agreement securities issued replacement outstanding securities issued holders shares common stock pro rata basis securities issued connection strategic investment also event company issues shares common stock securities convertible exercisable shares common stock connection settlement litigation outstanding june 29 2000 crane allowed purchase proportionate share companys common stock price 335 per share march 1 2002 proportionate purchase made agreement also contains standstill provision whereby crane agreed among things neither affiliates except otherwise provided agreement acquire current proportionate share outstanding securities company standstill provision also provides crane offer sell transfer voting securities company tender exchange offer opposed companys board directors 2000 company entered additional agreements crane company rents factory space leases employees companys facility dalton years ended december 31 2001 2000 company paid crane agreements 72000 12000 respectively rental factory space 116000 11000 respectively leased employees addition company paid crane 5700 50000 leasehold improvements rental space years ended december 31 2001 2000 respectively 9 stock incentive plans august 4 2000 company adopted american bank note holographics inc 2000 stock incentive plan amended 2000 plan subsequently approved companys stockholders annual meeting september 12 2000 july 20 1998 company adopted 1998 stock incentive plan amended 1998 plan collectively 2000 plan plans adopted purpose granting various stock incentives officers directors employees consultants company board directors committee appointed board directors discretionary authority subject certain restrictions administer plans total number shares reserved issuance plans 3213000 shares common stock options purchase 868500 shares common stock available future grants december 31 2001 plans options purchase 2344500 shares common stock outstanding plans december 31 2001 options purchase additional 165000 shares common stock outstanding outside plans december 31 2001 exercise price options granted plans may less 100 fair market value common stock date option granted options granted plans generally become vested exercisable 33 13 total optioned shares upon succeeding anniversary date grant generally unexercised portion option american bank note holographics inc notes financial statements years ended december 31 2001 2000 1999 9 stock incentive plans continued automatically terminates upon termination optionees employment company unless otherwise determined board directors provided however extension shall extend beyond expiration option generally ten years upon change control outstanding options generally become fully vested summary status companys outstanding stock options december 31 2001 2000 1999 changes years ended follows following table summarizes information stock options outstanding december 31 2001 company applies apb opinion 25 related interpretations accounting stock options accordingly compensation cost recognized outstanding stock options stock options granted exercise price equal excess fair value stock compensation cost companys outstanding stock options determined based fair value grant dates options consistent sfas 123 companys 2001 2000 1999 net income loss basic diluted net income loss per share would differed reflected pro forma amounts indicated thousands except per share amounts fair value option grant estimated date grant using blackscholes optionpricing model following weightedaverage assumptions american bank note holographics inc notes financial statements years ended december 31 2001 2000 1999 10 employee benefits plans retirement plans october 1 1999 company implemented defined contribution plans employees prior october 1 1999 company participated defined contribution plan former parent aggregate contributions plans charged companys operations approximately 48000 46000 77000 years ended december 31 2001 2000 1999 respectively postretirement health care life insurance plans prior offering date company participated benefit plans affiliates former parent provided certain postretirement health care life insurance benefits certain eligible employees terms plans companys employees could become eligible benefits reached normal retirement age certain service requirements period company participated plans company accrued estimated cost retiree benefit payments pensions years employee provided services former parents plans funded company responsible benefits provided employees retired company prior offering date qualified benefits offering date 1999 company determined would continue plan current employees included selling administrative expenses year ended december 31 1999 approximately 04 million relating reversal unfunded obligation 11 commitments contingencies sec investigation february 9 1999 division enforcement sec issued formal order directing private investigation connection matters giving rise need restate companys previously issued financial statements years ended december 31 1997 1996 first three quarters 1998 filed former management sec concluded investigation company accepted companys offer settlement march 16 2001 commissioners sec approved order making findings imposing cease desist order future violations section 17a securities act sections 10b 13a 13b2a b 30a exchange act exchange act rules 10b5 12b20 13a13 without admitting denying liability company paid 75000 fine sec certain former senior officers company allegedly violated provisions foreign corrupt practices act fine recorded charge statement operations fourth quarter 2000 order approved filed secretary sec july 18 2001 litigation consolidated class action complaint company certain former officers directors former parent four colead underwriters offering previous auditors filed united states district court southern district new york court complaint alleges violations federal securities laws seeks recover damages behalf purchasers companys common stock class period july 15 1998 february 1 1999 complaint seeks rescission purchase shares companys common stock alternatively unspecified compensatory damages along costs expenses including attorneys fees october 2000 company defendants plaintiffs entered definitive agreement settle claims subject class action well claims asserted former parent defendants separate class action settlement agreement received final approval court december 15 2000 approval bankruptcy court southern district new york chapter 11 proceeding former parent pending already given settlement insurance carrier company former parent paid escrow 12500000 previous auditors paid escrow 2350000 company committed issue distribute 1460000 shares common stock well warrants purchase 863647 shares companys common stock exercise price 600 per share shares 365000 distributed included shares outstanding accompanying financial statements warrants 215910 issued exercisable 30 month period commencing december 18 2000 february 8 2002 plaintiffs filed motion requesting distribution class settlement funds securities motion pending court former parent also issue distribute certain securities part settlement regard settlement company recorded charge statement operations fourth quarter 2000 3356000 charge comprised cost companys common stock issued closing price stock day final settlement value warrants issued value determined using blackscholes option pricing model related costs american bank note holographics inc notes financial statements years ended december 31 2001 2000 1999 11 commitments contingencies continued august 17 1999 company commenced action seeking recovery approximately 350000 claim arising amounts owed company holographic materials sold delivered july 1999 december 1 1999 company received defendants answers complaint counterclaims alleging millions dollars damages arising companys alleged breach 1993 agreement pursuant company sold holographic material defendant alleged failure fulfill may 1998 purchase order january 7 2000 court granted companys motion summary judgment respect claim march 15 2000 company entered settlement agreement defendant agreed pay 346000 parties exchanged general releases claims company also agreed would resume shipments may 1998 purchase order 1998 company fulfilled order holograms approximately 600000 1999 customer alleged company breached contract customer based problems ultimate user experiencing holograms claimed potential damages excess 6 million may 29 2000 company entered settlement customer company provide product credit customer may apply future invoices certain products sold company parties also exchanged general releases claims company recorded 775000 warranty reserve first quarter 1999 regard matter company considers reasonable estimate cost settlement third quarter 2000 companys insurance carriers agreed pay 750000 company product liability reimbursement matter company currently time involved litigation plaintiff defendant incidental conduct business however shareholder litigation described company party lawsuit proceeding opinion management company likely material impact companys financial position results operations cash flows amounts accrued litigation matters represent anticipated costs damages andor settlement amounts connection pending litigation claims costs accrued probable asset impaired liability incurred amount reasonably estimated accruals based upon companys assessment consultation counsel probable loss based facts circumstances case legal issues involved nature claim made nature damages sought relevant information plaintiffs significant factors vary case possible estimate specific expected cost incurred company evaluates range probable loss records minimum end range december 31 2001 accruals litigation matters december 31 2000 accruals litigation matters approximated 40000 company believes based information known december 31 2001 anticipated probable costs litigation matters december 31 2001 adequately provided extent determinable indemnification former parent described notes 5 7 2000 company former parent entered agreement among matters provide indemnification certain circumstances company former parent former parent experienced significant financial difficulty may result inability perform terms indemnification provided could material adverse effect companys financial position results operations cash flows product liability matters company provides holograms connection wide range customers products case possible company subject product liabilities association products connection holograms used products although company maintains product liability insurance assurance insurance would available cover claim available amounts sufficient cover potential liabilities result product liability claims could material adverse effect companys business financial condition results operations cash flows leases company longterm operating leases offices manufacturing facilities equipment expire 2007 company renewal options locations provide renewal rents based upon increases tied consumer price index net rental expense approximately 13 million 12 million 13 million years ended december 31 2001 american bank note holographics inc notes financial statements years ended december 31 2001 2000 1999 11 commitments contingencies continued 2000 1999 respectively december 31 2001 future minimum lease payments noncancelable operating leases follows 10 million 2002 08 million 2003 08 million 2004 08 million 2005 07 million 2006 04 million thereafter employment agreements 1999 company entered employment agreements certain officers provide among matters minimum compensation approximately 553000 2002 77000 2003 agreements also provide bonuses connection agreements company granted options acquire 1448000 shares common stock prices ranging 175 288 per share representing fair market value companys common stock dates grant 12 special investigation related restatement expenses 1999 audit committee companys board directors commenced special investigation events resulted need restate companys financial statements years ended december 31 1997 1996 first three quarters 1998 costs special investigation related restatement effort legal defense approximated 35 million net insurance reimbursements 06 million included within selling administrative expenses 1999 accompanying statements operations schedule american bank note holographics inc valuation qualifying accounts years ended december 31 2001 2000 1999 1 accounts deemed uncollectible net recoveries s1item 14 controls procedures evaluation disclosure controls procedures within 90 days prior date report carried evaluation supervision participation chief executive officer chief financial officer effectiveness design operation disclosure controls procedures based evaluation chief executive officer chief financial officer concluded disclosure controls procedures effective timely alerting material information required included periodic filings securities exchange commission noted design system controls based part upon certain assumptions likelihood future events assurance design succeed achieving stated goals potential future conditions regardless remote b changes internal controls significant changes internal controls factors could significantly affect controls subsequent date last evaluation part iv item 15item 14 principal accountant fees services june 6 2002 upon recommendation audit committee board directors dismissed arthur andersen llp served previous independent auditors engaged ernst young llp fees paid arthur andersen 2002 audit services rendered set forth addition ernst young llp independent auditors 2002 2003 paid audit services rendered set forth 2002 2003 audit fees audit committee concluded provision services compatible maintaining principal accountants independence preapproval policies audit committee preapproves audit nonaudit services provided independent auditors prior engagement independent auditors respect services respect audit services permissible nonaudit services previously approved audit committee authorized chairman audit committee approve audit services permissible nonaudit services provided chairman informs audit committee approval next regularly scheduled meeting audit fees tax fees set forth preapproved audit committee accordance preapproval policy abnh incur auditrelated fees 2002 2003 part iv item 15item 14 principal accountant fees services ernst young llp independent registered public accounting firm 2004 2003 paid audit services rendered set forth audit fees tax fees 2004 2003 pertained reviews federal state tax returns audit committee concluded provision services compatible maintaining principal accountants’ independence preapproval policies audit committee preapproves audit nonaudit services provided independent registered public accounting firm prior engagement independent registered public accounting firm respect services respect audit services permissible nonaudit services previously approved audit committee authorized chairman audit committee approve audit services permissible nonaudit services provided chairman informs audit committee approval next regularly scheduled meeting “audit fees” “tax fees” set forth preapproved audit committee accordance preapproval policy part iv item 15item 14 principal accountant fees services pricewaterhousecoopers llp independent registered public accounting firm 2005 ernst young llp independent registered public accounting firm 2004 paid audit services rendered set forth audit fees tax fees 2005 2004 pertained reviews federal state tax returns audit committee concluded provision services compatible maintaining principal accountants’ independence preapproval policies audit committee preapproves audit nonaudit services provided independent registered public accounting firm prior engagement independent registered public accounting firm respect services respect audit services permissible nonaudit services previously approved audit committee authorized chairman audit committee approve audit services permissible nonaudit services provided chairman informs audit committee approval next regularly scheduled meeting “audit fees” “tax fees” set forth preapproved audit committee accordance preapproval policy part iv item 15item 14 exhibits financial statement schedules reports form 8k 1 financial statements financial statements required item submitted separate section beginning page report 2 financial statement schedules financial statement schedule required item submitted separate section page s1 report schedules included page s1 report omitted absence conditions required information included financial statements notes thereto 3 exhibits see c b reports form 8k none c exhibits 31 amended restated certificate incorporation 32 amended restated bylaws 41 form common stock certificate 42 stock purchase agreement crane co inc american bank note holographics inc dated june 29 2000 incorporated reference form 10q filed august 14 2000 43 warrant agreement american bank note holographics inc american stock transfer company dated december 18 2000 44 form warrant certificate 101 form separation agreement 102 form license agreement 103 form transitional services agreement 104 form employee benefits allocation agreement 105 form 1998 stock incentive plan 106 form 2000 stock incentive plan incorporated reference proxy schudule def 14a filed august 11 2000 107 form defined contribution plan 108 production agreement mastercard international incorporated american bank note holographics inc dated february 1 1996 109 letter agreement dated june 29 1998 mastercard international incorporated american bank note holographics inc amending production agreement dated february 1 1996 1010 letter agreement dated march 3 1999 mastercard international incorporated american bank note holographics inc amending production agreement dated february 1 1996 1011 loan security agreement dated september 29 1999 foothill capital corporation american bank note holographics inc together amendment 1 dated december 31 1999 letter dated january 4 2000 incorporated reference annual report form 10k 1999 1012 employment agreement dated april 20 1999 salvatore f damato american bank note holographics inc 1013 employment agreement dated february 3 1999 kenneth h traub american bank note holographics inc 1014 employment agreement dated april 30 1999 alan goldstein american bank note holographics inc 1015 employment agreement dated september 15 1999 russell lacoste american bank note holographics inc incorporated reference registration statement form s1 registration 33351845 incorporated reference annual report form 10k 1998 portions omitted pursuant request confidential treatment financial statement schedules see a2 american bank note holographics inc report independent public accountants board directors stockholders american bank note holographics inc audited accompanying balance sheet american bank note holographics inc delaware corporation december 31 2000 related statements operations stockholders equity cash flows year ended financial statements schedule referred responsibility companys management responsibility express opinion financial statements schedule based audit conducted audit accordance auditing standards generally accepted united states standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audit provides reasonable basis opinion financial statements referred present fairly material respects financial position american bank note holographics inc december 31 2000 results operations cash flows year ended conformity accounting principles generally accepted united states audit made purpose forming opinion basic financial statements taken whole supplemental schedule page s1 presented purposes additional analysis required part basic financial statements information subjected auditing procedures applied audit basic financial statements opinion fairly stated material respects relation basic financial statements taken whole arthur andersen llp new york new york march 16 2001 independent auditors report board directors stockholders american bank note holographics inc elmsford new york audited accompanying balance sheet american bank note holographics inc december 31 1999 related statements operations stockholders equity cash flows two years period ended december 31 1999 audits also included financial statement schedule listed accompanying table contents financial statements financial statement schedule responsibility companys management responsibility express opinion financial statements financial statement schedule based audits conducted audits accordance generally accepted auditing standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audits provide reasonable basis opinion financial statements present fairly material respects financial position american bank note holographics inc december 31 1999 results operations cash flows two years period ended december 31 1999 conformity generally accepted accounting principles also opinion financial statement schedule considered relation basic financial statements taken whole presents fairly material respects information set forth therein discussed note 11 financial statements company involved certain litigation potential litigation deloitte touche llp new york new york march 29 2000 american bank note holographics inc balance sheets december 31 2000 1999 thousands except share data accompanying notes integral part financial statements american bank note holographics inc statements operations years ended december 31 2000 1999 1998 thousands except per share data accompanying notes integral part financial statements american bank note holographics inc statements stockholders equity years ended december 31 2000 1999 1998 thousands accompanying notes integral part financial statements american bank note holographics inc statements cash flows years ended december 31 2000 1999 1998 thousands accompanying notes integral part financial statements american bank note holographics inc notes financial statements years ended december 31 2000 1999 1998 1 basis presentation summary significant accounting policies american bank note holographics inc company incorporated state delaware august 1985 company july 20 1998 offering date whollyowned subsidiary american banknote corporation former parent company originates massproduces markets secure holograms used security packaging promotional applications company operates one reportable industry segment use estimates preparation financial statements conformity generally accepted accounting principles requires management make estimates assumptions affect reported amounts assets liabilities disclosure contingent assets liabilities date financial statements reported amounts sales expenses reporting period actual results may differ materially estimates cash equivalents highly liquid investments maturity three months less purchased considered cash equivalents stated cost approximates market american bank note holographics inc notes financial statements 1 basis presentation summary significant accounting policies continued concentrations credit risk significant portion companys accounts receivable due credit card issuers related credit card manufacturers located throughout united states europe company establishes credit polices based ongoing evaluation customers creditworthiness competitive market conditions require collateral inventories stated lower cost market cost determined firstin firstout fifo method hologram originations represent costs unique master hologram made customer specifications integral part production process capitalized charged cost goods sold production period revenue recognition sales related cost goods sold generally recognized latter time shipment title passes customers situations company shipped product right return company unable reasonably estimate level returns andor sale contingent upon customers use product situations company recognize sales upon product shipment rather buyer product informs company product used additionally pursuant terms certain customer completed items stored behalf customer companys onsite secured facility instance sales recognized following occurred customer ordered goods manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order december 31 2000 1999 accounts receivable customer totaled 04 million 05 million respectively first quarter 1998 company recorded sales approximately 65 million arrangement december 31 2000 1999 customer advances approximating 02 06 million respectively represent payments received customers products yet shipped 02 million 01 million respectively products shipped right return none 05 million respectively company unable reasonably estimate level returns customer advances classified current liabilities accompanying balance sheets royalty income company enters licensing agreements certain manufacturers company receives royalty payments royalty payments due licensing agreements recognized income either based upon shipment reports licensees available estimated shipments licensees american bank note holographics inc notes financial statements 1 basis presentation summary significant accounting policies continued depreciation amortization machinery equipment recorded cost depreciated straightline method estimated useful lives ranging 5 22 years amortization leasehold improvements computed straightline method based upon remaining term applicable lease estimated useful life asset whichever shorter longlived assets accordance statement financial accounting standards sfas 121 accounting impairment longlived assets longlived assets disposed company reviews longlived assets impairment changes circumstances indicate carrying amount asset may recoverable changes circumstances may include among factors significant change technology may render asset group obsolete noncompetitive significant change extent manner asset used evidence physical defect asset group operating loss changes circumstances indicate carrying amount asset may recoverable company estimates future cash flows undiscounted without interest charges expected result use asset eventual disposition records impairment loss equal amount carrying amount asset exceeds fair value asset estimated cash flows less carrying amount asset goodwill excess cost net assets acquired amortized 30 years straightline method company reviews enterprise level goodwill impairment changes circumstances similar described longlived assets indicate carrying value may recoverable circumstances company estimates future cash flows using recoverability method undiscounted including related interest charges basis recording impairment loss impairment loss recorded adjust carrying value goodwill recoverable amount deferred financing costs incurred connection obtaining financing deferred amortized charge interest expense term related borrowing using interest method company deferred financing costs capitalized december 31 2000 warranty costs company provides warranty costs amounts estimates needed cover future warranty obligations products sold year estimates warranty costs periodically reviewed adjusted necessary consider actual experience american bank note holographics inc notes financial statements 1 basis presentation summary significant accounting policies continued research development research development costs expensed incurred income taxes company accounts income taxes liability method accordance sfas 109 accounting income taxes provision income taxes includes deferred income taxes resulting items reported different periods income tax financial statement purposes deferred tax assets liabilities represent expected future tax consequences differences financial statement carrying amounts existing assets liabilities respective tax basis stockbased compensation plans sfas 123 accounting stockbased compensation allows either adoption fair value method accounting stockbased compensation plans continuation accounting stockbased compensation plans accounting principles board apb opinion 25 accounting stock issued employees related interpretations supplemental disclosures company chosen account stock options using intrinsic value based method prescribed apb opinion 25 accordingly recognize compensation expense stock option grants made exercise price equal excess fair market value stock date grant pro forma net income net income per share amounts fair value method adopted presented note 9 sfas 123 impact companys results operations financial position cash flows basic diluted net income loss per share basic net income per share computed based weighted average number outstanding shares common stock giving retroactive effect stock split basic weighted average number shares outstanding 15421064 13636000 years ended december 31 2000 1999 1998 respectively diluted net income loss per share computed dividing net income loss weighted average number shares common stock outstanding dilutive potential shares common stock related outstanding stock options 1998 years ended december 31 2000 1999 options purchase 2472500 shares 1420000 shares respectively companys common stock excluded calculation diluted net income loss per share effect inclusion options would antidilutive year ended december 31 1998 dilutive effect approximately 65000 equivalent shares related stock options used determining diluted weighted average shares outstanding years ended december 31 2000 1999 1998 diluted weighted average number shares outstanding 15421064 13636000 13701000 respectively american bank note holographics inc notes financial statements 1 basis presentation summary significant accounting policies continued business concentration risks sales mastercard approximately 28 27 30 sales years ended december 31 2000 1999 1998 respectively approximately 75 1998 mastercard sales recorded first quarter 1998 december 31 2000 1999 accounts receivable mastercard approximated 04 05 million respectively company exclusive supplier holograms mastercard pursuant agreement amended extends february 2003 agreement provides automatic twoyear renewal periods terminated either party 1999 company informed mastercard believes company breached certain terms agreement 1998 1997 company working closely mastercard address issues raised mastercard believes relationship mastercard good loss substantial portion sales mastercard however would material adverse effect financial position results operations cash flows company sales manufacturers visa credit cards approximately 50 customers approximately 19 18 26 sales years ended december 31 2000 1999 1998 respectively loss substantial portion sales customers would material adverse effect financial position results operations cash flows company december 31 2000 1999 accounts receivable customers approximated 06 million 05 million respectively company historically purchased certain key materials used manufacture holograms single suppliers supply contracts problems occur respect delivery quality cost materials could material adverse effect financial position results operations cash flows company export sales export sales 31 32 28 sales years ended december 31 2000 1999 1998 respectively export sales denominated united states dollars december 31 2000 1999 accounts receivable customers approximated 09 million 05 million respectively comprehensive income 1998 company adopted sfas 130 reporting comprehensive income establishes rules reporting comprehensive income components years ended december 31 2000 1999 1998 difference companys net income comprehensive income reclassifications certain prior year amounts reclassified conform current years presentation american bank note holographics inc notes financial statements 1 basis presentation summary significant accounting policies continued impact recent accounting pronouncements june 1998 financial accounting standards board fasb issued sfas 133 accounting derivative instruments hedging activities sfas 133 amended sfas 137 sfas 138 establishes accounting reporting standards derivative instruments including certain derivative instruments embedded contracts collectively referred derivatives hedging activities effective quarters fiscal years beginning june 15 2000 management believes implementation sfas 133 material impact companys results operations securities exchange commission issued staff accounting bulletin sab 101 revenue recognition december 1999 sab 101 expresses views sec staff applying generally accepted accounting principles certain revenue recognition issues june 2000 sec issued sab 101b defer effective date implementation sab 101 fourth quarter fiscal 2000 management implemented sab fourth quarter 2000 adoption sab 101 material impact companys financial position results operations march 2000 fasb issued interpretation fin 44 accounting certain transactions involving stock compensation interpretation apb opinion 25 fin 44 clarifies definition employees criteria determining whether plan qualifies noncompensatory plan accounting consequences various modifications terms previously fixed stock option award accounting exchange stock compensation awards business combination fin 44 effective july 1 2000 certain conclusions interpretation cover specific events occurred either december 15 1998 january 12 2000 company adopted fin 44 july 2000 adoption interpretation material impact companys current historical financial position results operations cash flows september 2000 emerging issues task force eitf issued eitf 0010 accounting shipping handling fees costs provisions eitf 0010 amounts billed customer sales transaction related shipping handling classified revenues eitf 0010 also requires disclosure statement operations classification shipping handling costs material unless costs included cost goods sold effective october 1 2000 company adopted eitf 0010 shipping handling amounts billed customers included revenues shipping handling costs included selling administrative expenses amounted 377000 499000 534000 years ended december 31 2000 1999 1998 respectively comparative prior period financial statements reclassified reflect change adoption eitf impact determination net income loss american bank note holographics inc notes financial statements 2 inventories reduction reserve obsolescence 2000 primarily due destruction nonsalable products reserved 1998 1999 3 machinery equipment leasehold improvements depreciation amortization machinery equipment leasehold improvements years ended december 31 2000 1999 1998 732000 681000 729000 respectively 4 accrued expenses american bank note holographics inc notes financial statements 5 income taxes accordance tax allocation agreement effect offering date company included consolidated us federal income tax return certain instances consolidated combined state local income tax returns former parent made payments former parent based amounts would payable federal state local income taxes consolidated combined returns filed company computed federal state local income tax provision filing separate income tax returns without regard tax allocation agreement 2000 company former parent reached agreement subject consummation former parents chapter 11 plan exchange mutual general releases obligations may pursuant separation agreement dated july 20 1998 including sums allegedly owing company former parent affiliates agreement provides among things former parent responsible shall pay asserted unasserted income franchise similar tax liabilities company period january 1 1990 july 20 1998 indemnify company respect liabilities amounts paid former parent excess amounts would payable company filed separate income tax returns charged due former parent affiliates periods subsequent offering date company filing us federal state income tax returns deferred income taxes arise temporary differences tax bases assets liabilities reported amounts financial statements provision benefit income taxes follows american bank note holographics inc notes financial statements 5 income taxes continued reconciliation taxes income amount computed applying federal income tax statutory rate 35 2000 1999 1998 follows tax effects items comprising companys deferred income tax assets liabilities follows december 31 2000 company net operating loss carryforwards approximately 55 million expire 2020 available offset future federal taxable income current future changes ownership could limit availability use net operating loss carryforwards american bank note holographics inc notes financial statements 6 revolving credit agreement august 23 2000 company terminated repaid outstanding amounts loan security agreement company foothill capital corporation amended foothill loan foothill loan maturity date september 29 2004 secured substantially companys assets provided borrowings aggregate amount 100 million subject borrowing base formula revolving credit facility term loan capital expenditure loan borrowings foothill loan bore interest lenders reference rate defined plus 15 foothill loan contained restrictive covenants customary credit facilities similar nature well specific financial covenants ratios december 31 1999 company 74000 outstanding revolving credit facility 10 million outstanding term loan payable monthly installments 16667 beginning january 2000 december 31 1999 loans outstanding capital expenditure line september 29 1999 contemporaneously foothill loan company terminated repaid outstanding amounts previous credit facility agreement credit facility originally entered july 20 1998 subsequently amended permitted maximum borrowing 40 million decline 26 million december 31 1999 amended credit facility matured january 2000 provided borrowings revolving credit line bearing interest lenders alternative base rate defined plus 2 subject borrowing base formula defined result terminating foothill loan company incurred 2000 early termination fee 01 million wrote approximately 02 million unamortized deferred financing costs related loans 1999 company wroteoff unamortized deferred financing costs approximately 06 million relating amendments repayment companys previous credit facility years ended december 31 2000 1999 weighted average interest rate outstanding borrowings approximately 98 84 respectively average aggregate borrowings 2000 1999 approximately 09 million 33 million respectively december 8 2000 company terminated repaid 59000 notes payable bore interest 585 american bank note holographics inc notes financial statements 7 related party transactions company former parent related parties april 4 1999 time former parents chairman chief executive officer resigned companys chairman chief executive officer december 31 1999 accounts payable accrued expenses include approximately 03 million 02 million respectively due former parent affiliates december 8 1999 former parent filed petition plan reorganization chapter 11 federal bankruptcy code 2000 company submitted substantial claim former parent bankruptcy proceedings connection negotiations chapter 11 plan company reached agreement former parent exchange mutual general releases obligations may pursuant separation agreement company former parent dated july 20 1998 sums allegedly owing company former parent affiliates agreement subject consummation chapter 11 plan also provides company receive 25000 shares stock reorganized former parent ii former parent responsible shall pay asserted unasserted income franchise similar tax liabilities company period january 1 1990 july 20 1998 indemnify company respect liabilities iii company withdraw claim former parent chapter 11 case described settlement company former parent made part chapter 11 plan bankruptcy court approved november 3 2000 connection agreement company included accompanying statement operations 2000 approximately 05 million relating reversal accounts payable accrued expenses due former parent affiliates addition company sold 10 million 06 million products services 1999 1998 respectively former parent affiliates normal course business purchases company former parent affiliates normal course business 1999 1998 december 31 1999 trade accounts receivable former parent affiliates 31000 included company acted subcontractor affiliate former parent government contract sales subcontract billed affiliate former parent approximated 02 million 03 million 1999 1998 respectively december 31 1999 trade accounts receivable affiliate former parent subcontract 135000 reclassified accrued expenses reduce reserves royalties accordance agreement former parent former parent used proceeds sales settle certain litigation involving royalties company former parent joint defendants 1998 financial statements reflect allocated readily determinable actual expenses services provided companys former parent affiliates allocations utilized company former parent affiliates recorded transactions based upon systematic american bank note holographics inc notes financial statements 7 related party transactions continued reasonable methods including limited sales asset values headcount percent total amounts major category historical transactions former parent affiliates year ended december 31 1998 follow 1 primarily medical life disability insurance premiums 2 includes legal fees allocated portion audit fees 3 included balances 53 million note receivable former parent bore interest 575 per annum 4 includes value restricted stock former parent american bank note holographics inc notes financial statements 8 stockholders equity june 11 1998 company declared 13636 one stock split effective july 2 1998 form stock dividend former parent common stock increased authorized common stock 30000000 shares authorized preferred stock 5000000 shares july 20 1998 former parent completed sale 13636000 shares companys common stock public offering representing entire investment company connection offering amounts due former parent affiliates approximately 339 million canceled deemed dividend see note 7 financial reporting purposes amounts due former parent affiliates prior offering date classified within stockholders equity june 30 2000 company entered stock purchase agreement crane co inc crane agreement company sold 3387720 shares companys common stock crane aggregate purchase price 9316230 agreement also provides board directors company audit committee board directors expanded one position taken douglas crane affiliate crane agreement crane right purchase proportionate share new issuance companys securities issued connection acquisition securities issued connection stock option plan agreement securities issued replacement outstanding securities issued holders shares common stock pro rata basis securities issued connection strategic investment also event company issues shares common stock securities convertible exercisable shares common stock connection settlement litigation outstanding june 29 2000 crane allowed purchase proportionate share companys common stock price 335 per share march 15 2001 proportionate purchase made agreement also contains standstill provision whereby crane agreed among things neither affiliates except otherwise provided agreement acquire current proportionate share outstanding securities company standstill provision also provides crane offer sell transfer voting securities company tender exchange offer opposed companys board directors 2000 company entered agreements crane company rents factory space leases employees companys facility dalton agreements company paid crane 12000 rental factory space 11000 leased employees addition company paid crane 50000 leasehold improvements rental space american bank note holographics inc notes financial statements 9 stock incentive plans august 4 2000 company adopted american bank note holographics inc 2000 stock incentive plan 2000 plan subsequently approved companys stockholders annual meeting september 12 2000 subsequent offering date company adopted 1998 stock incentive plan amended 1998 plan collectively 2000 plan plans adopted purpose granting various stock incentives officers directors employees consultants company board directors committee appointed board directors discretionary authority subject certain restrictions administer plans total number shares reserved issuance plans 2613000 shares common stock options purchase 2472500 shares common stock outstanding plans december 31 2000 options purchase additional 165000 shares common stock outstanding outside plans december 31 2000 exercise price options granted plans may less 100 fair market value common stock date option granted options granted plans generally become vested exercisable 33 13 total optioned shares upon succeeding anniversary date grant generally unexercised portion option automatically terminates upon termination optionees employment company unless otherwise determined board directors provided however extension shall extend beyond expiration option generally ten years upon change control outstanding options generally become fully vested summary status companys outstanding stock options december 31 2000 1999 1998 changes years ended follows american bank note holographics inc notes financial statements 9 stock incentive plans continued following table summarizes information stock options outstanding december 31 2000 company applies apb opinion 25 related interpretations accounting stock options accordingly compensation cost recognized outstanding stock options compensation cost companys outstanding stock options determined based fair value grant dates options consistent sfas 123 companys 2000 1999 1998 net income loss basic diluted net income loss per share would differed reflected pro forma amounts indicated thousands except per share amounts fair value option grant estimated date grant using blackscholes optionpricing model following weightedaverage assumptions american bank note holographics inc notes financial statements 10 employee benefits plans retirement plans october 1 1999 company implemented defined contribution plans employees prior october 1 1999 company participated defined contribution plan former parent aggregate contributions plans charged companys operations approximately 46000 77000 200000 years ended december 31 2000 1999 1998 respectively postretirement health care life insurance plans prior offering date company participated benefit plans affiliates former parent provided certain postretirement health care life insurance benefits certain eligible employees terms plans companys employees could become eligible benefits reached normal retirement age certain service requirements period company participated plans company accrued estimated cost retiree benefit payments pensions years employee provided services former parents plans funded company responsible benefits provided employees retired company prior offering date qualified benefits offering date year ended december 31 1998 costs relating plans approximated 21000 1999 company determined would continue plan current employees included selling administrative expenses year ended december 31 1999 approximately 04 million relating reversal unfunded obligation american bank note holographics inc notes financial statements 11 commitments contingencies sec us attorney investigations february 9 1999 division enforcement sec issued formal order directing private investigation connection matters giving rise need restate companys previously issued financial statements years ended december 31 1997 1996 first three quarters 1998 filed former management sec concluded investigation company accepted companys offer settlement march 16 2001 commissioners sec approved order making findings imposing cease desist order future violations section 17a securities act sections 10b 13a 13b2a b 30a exchange act exchange act rules 10b5 12b20 13a13 without admitting denying liability company agreed pay 75000 fine company recorded charge statement operations fourth quarter 2000 former senior officers company allegedly violated provisions foreign corrupt practices act anticipated order approved filed secretary sec near future us attorneys office southern district new york also commenced investigation 1999 connection matters giving rise need restate companys previously issued financial statements well possible violation 1998 foreign corrupt practices act certain former senior officers company advised target investigation management therefore anticipate action taken company united states attorneys office litigation consolidated class action complaint company certain former officers directors former parent four colead underwriters offering previous auditors filed united states district court southern district new york court complaint alleges violations federal securities laws seeks recover damages behalf purchasers companys common stock class period july 15 1998 february 1 1999 complaint seeks rescission purchase shares companys common stock alternatively unspecified compensatory damages along costs expenses including attorneys fees october 2000 company defendants plaintiffs entered definitive agreement settle claims subject class action well claims asserted former parent defendants separate class action settlement agreement received final approval court december 15 2000 approval bankruptcy court southern district new york chapter 11 proceeding former parent pending already given settlement insurance carrier company former parent pay 12500000 previous auditors pay 2350000 company issue distribute 1460000 shares common stock well warrants purchase 863647 shares companys common stock exercise price 600 per share shares issued 2001 365000 issued march 15 2001 included shares outstanding accompanying financial statements warrants exercisable 30 month period commencing december 15 2000 american bank note holographics inc notes financial statements 11 commitments contingencies continued former parent also issue distribute certain securities part settlement regard settlement company recorded charge statement operations fourth quarter 2000 3356000 charge comprised cost companys common stock issued closing price stock day final settlement value warrants issued value determined using blackscholes option pricing model related costs 1994 plaintiffs kah company inc kenneth haines filed suit company former parent abnh research co inc supreme court state new york county new york judgment entered march 19 1999 175639 attorneys fees still assessed february 2 2000 plaintiffs defendants settled claims including attorneys fees 300000 paid full amount settlement accrued december 31 1998 august 17 1999 company commenced action seeking recovery approximately 350000 claim arising amounts owed company holographic materials sold delivered july 1999 december 1 1999 company received defendants answers complaint counterclaims alleging millions dollars damages arising companys alleged breach 1993 agreement pursuant company sold holographic material defendant alleged failure fulfill may 1998 purchase order january 7 2000 court granted companys motion summary judgment respect claim march 15 2000 company entered settlement agreement defendant agreed pay 346000 parties exchanged general releases claims company also agreed would resume shipments may 1998 purchase order american bank note holographics inc notes financial statements 11 commitments contingencies continued 1998 company fulfilled order holograms approximately 600000 1999 customer alleged company breached contract customer based problems ultimate user experiencing holograms claimed potential damages excess 6 million may 29 2000 company entered settlement customer company provide product credit customer may apply future invoices certain products sold company parties also exchanged general releases claims company recorded 775000 warranty reserve first quarter 1999 regard matter company considers reasonable estimate cost settlement third quarter 2000 companys insurance carriers agreed pay 750000 company product liability reimbursement matter company currently time involved litigation plaintiff defendant incidental conduct business however shareholder litigation described company party lawsuit proceeding opinion management company likely material impact companys financial position results operations cash flows amounts accrued litigation matters represent anticipated costs damages andor settlement amounts connection pending litigation claims costs accrued probable asset impaired liability incurred amount reasonably estimated accruals based upon companys assessment consultation counsel probable loss based facts circumstances case legal issues involved nature claim made nature damages sought relevant information plaintiffs significant factors vary case possible estimate specific expected cost incurred company evaluates range probable loss records minimum end range december 31 2000 1999 accruals litigation matters approximated 40000 315000 respectively anticipated 40000 accrual paid 2001 company believes based information known december 31 2000 anticipated probable costs litigation matters december 31 2000 adequately provided extent determinable indemnification former parent described notes 5 7 2000 company former parent entered agreement among matters provide indemnification certain circumstances company former parent former parent experienced significant financial difficulty may result inability perform terms indemnification provided could material adverse effect companys financial position results operations cash flows american bank note holographics inc notes financial statements 11 commitments contingencies continued product liability matters company provides holograms connection wide range customers products case possible company subject product liabilities association products connection holograms used products although company maintains product liability insurance assurance insurance would available cover claim available amounts sufficient cover potential liabilities result product liability claims could material adverse effect companys business financial condition results operations cash flows leases company longterm operating leases offices manufacturing facilities equipment expire 2007 company renewal options locations provide renewal rents based upon increases tied consumer price index net rental expense approximately 12 million 13 million 12 million years ended december 31 2000 1999 1998 respectively december 31 2000 future minimum lease payments noncancelable operating leases follows 11 million 2001 09 million 2002 08 million 2003 08 million 2004 08 million 2005 12 million thereafter employment agreements 1999 company entered employment agreements certain officers provide among matters minimum compensation approximately 627000 2001 75000 2002 agreements also provide bonuses connection agreements company granted options acquire 1448000 shares common stock prices ranging 175 288 per share representing fair market value companys common stock dates grant american bank note holographics inc notes financial statements 12 special investigation related restatement expenses 1999 audit committee companys board directors commenced special investigation events resulted need restate companys financial statements years ended december 31 1997 1996 first three quarters 1998 costs special investigation related restatement effort legal defense approximated 35 million net insurance reimbursements 06 million included within selling administrative expenses 1999 accompanying statements operations schedule ii american bank note holographics inc valuation qualifying accounts years ended december 31 2000 1999 1998 1 accounts deemed uncollectible net recoveries signatures pursuant requirements section 13 15d securities exchange act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized american bank note holographics inc kenneth h traub kenneth h traub president chief executive officer march 30 2001 pursuant requirements securities exchange act 1934 report signed following persons behalf registrant capacities dates indicateditem 14 principal accountant fees services information required item set forth herein filed sec within 120 days fiscal year ended december 31 2006 part iv item 15 item 7 managements discussion analysis financial condition results operations following discussion analysis read conjunction item 6 selected financial data financial statements including notes thereto appearing elsewhere report january 19 1999 abnh announced audit committee board directors initiated investigation circumstances gave rise need restate prior period financial statements audit committees investigation since completed result findings abnh restated previously issued financial statements 1996 1997 see note 11 financial statements first three quarters 1998 effects restatement presented note 11 financial statements reflected herein overview abnh july 20 1998 whollyowned subsidiary abn date abn completed sale 13636000 shares common stock public offering representing abns entire investment abnh receive proceeds ipo additionally connection ipo amounts due abn affiliates approximately 339 million cancelled deemed dividend immediately following ipo approximately 52 million secured bank debt nominal cash whollyowned subsidiary provided certain corporate administrative services abn including financial reporting treasury functions tax planning compliance risk management human resources legal services additionally abn managed cash financing requirements centrally interest expense financing requirements prior ipo based existing capital structure results prior ipo might differed results might achieved operated independent entity abnh originates massproduces markets holograms used primarily security applications counterfeiting protection credit transaction cards identification cards documents value well tamper resistance authentication highvalue consumer industrial products ability control diffraction light origination using proprietary processes secure controlled manufacturing environment enabled us become market leader security holography products used 200 companies worldwide also produce nonsecure holograms packaging promotional applications sales holograms credit card security applications generally carry higher gross margins sales applications concerns regarding counterfeiting piracy infractions result lost sales lost goodwill product liability claims drive use product authentication holograms companies various industries utilized holograms authentication devices reduce potential losses also concerns counterfeiting copying led increased use holograms documents value including currency passports business cheques gift certificates vouchers certificates deposit stamps postage revenue tickets financial instruments sales derived sale security commercial holograms 1998 derived approximately 95 sales security applications approximately 5 commercial applications significant portion business derived orders placed limited number large customers variations timing orders cause significant fluctuations sales currently dependent certain credit card companies substantial portion business including mastercard manufacturers visa brand credit cards sales mastercard approximately 30 35 23 respectively sales visa card manufacturers approximately 26 27 31 respectively sales years ended december 31 1998 1997 1996 exclusive supplier holograms mastercard pursuant agreement amended extends february 2003 agreement provides automatic twoyear renewal periods terminated either party 1999 informed mastercard believes breached certain terms agreement 1998 1997 working closely mastercard address issues raised mastercard believe relationship mastercard good longterm purchase contracts visa supply holograms approximately 50 visa authorized card manufacturers pursuant purchase orders currently one two companies authorized manufacture sell visa brand holograms manufacturers visa brand credit cards either mastercard visa terminate respective relationship us substantially reduce orders would material adverse effect business financial condition results operations cash flows holograms sold purchase orders contracts customers sales related cost goods sold generally recognized latter time shipment title passes customers situations shipped product right return unable reasonably estimate level returns andor sale contingent upon customers use product situations recognize sales upon product shipment rather buyer product informs us product used additionally pursuant terms certain customer completed items stored behalf customer onsite secured facility instance sales recognized following occurred customer ordered goods manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order first quarter 1998 recorded sales approximately 65 million arrangement historically purchased certain key materials used manufacture holograms single suppliers supply contracts problems occur respect delivery quality cost materials could material adverse effect financial position results operations cash flows 1998 1997 1996 export sales accounted approximately 28 25 32 respectively total sales export sales presently denominated us dollars cost goods sold includes raw materials nickel foils films adhesives labor costs manufacturing overhead hologram origination costs represent costs unique master hologram made customer specifications integral part production process result costs goods sold affected product mix manufacturing yields costs hologram originations changes cost raw materials labor selling administrative expenses primarily consist salaries benefits commissions corporate sales marketing administrative personnel marketing advertising expenses services products sales may fluctuate quarter due changes customers ordering patterns customers typically provide us precise forecasts future order quantities quarterly demand holograms may materially influenced customers promotions inventory replenishment card expiration patterns delivery schedules factors may difficult us anticipate accordance tax allocation agreement effect date ipo included consolidated us federal income tax return certain instances consolidated combined state local income tax returns abn made payments abn based amounts would payable federal state local income taxes consolidated combined returns filed computed federal state local income tax provision filing separate income tax returns without regard tax allocation agreement october 1999 affiliate abn received assessment approximately 09 million taxes interest city new york relating years ended december 31 1990 1991 1992 included combined city new york income tax returns abn periods covered assessment previously made payments abn based amounts would payable combined income tax returns filed contingently liable jointly severally us federal state local income taxes periods included consolidated combined income tax returns abn amounts paid abn excess amounts would payable filed separate tax returns charged due former parent affiliates periods subsequent ipo file us federal state income tax returns comparison year ended december 31 1998 year ended december 31 sales increased 56 million 242 231 million 1997 287 million 1998 increase sales due primarily increase sales security holograms credit cards 29 million security holograms 27 million sales fourth quarter 1998 impacted approximately 30 million sales including sale goods originally shipped consignment discounts normal selling prices exchange immediate payment believe absence discounts portion sales would occurred 1999 therefore anticipated sales related gross margins net income adversely affected first quarter 1999 contractual net unit sales price applicable mastercard reduced september 1998 approximately 5 december 31 1998 customer advances approximating 15 million represented payments received customers products discount normal sales price exchange immediate payment yet shipped 12 million products shipped right return 03 million unable reasonably estimate level returns anticipate sales recognized 1999 transactions cost goods sold cost goods sold increased 69 million 566 122 million 1997 191 million 1998 percentage sales cost goods sold increased 528 1997 666 1998 increase reflects increases amortization origination costs charged costs goods sold based total number holographic images estimated produced due lower volumes sales originally estimated 5 increases origination costs incurred anticipation orders materialize 5 increased provisions obsolete excess inventory due primarily quality considerations lower cost market adjustments 7 effects gross margin sales discounts referred 1 increase warranty expense 1 increases royalty expenses 2 offset increase gross margins sales mix 7 selling administrative expenses selling administrative expenses increased 05 million 58 million 1997 63 million 1998 percentage sales selling administrative expenses decreased 251 1997 220 1998 increase expenses primarily attributable increased sales commissions 04 million relating increase sales increased administrative salaries 02 million relating new hires salary increases increased costs relating shareholder communications costs associated public ownership 04 million offset decrease provisions bad debts 04 million depreciation amortization depreciation amortization remained relatively unchanged 1998 compared 1997 percentage sales depreciation amortization decreased 49 1997 38 1998 income decreased 02 million 08 million 1997 06 million 1998 decrease income primarily due change 1997 estimate 1996 royalties resulting information reported licensee 1997 interest net interest net decreased 05 million 01 million net income 1997 04 million net expense 1998 decrease due increased interest expense revolving credit facility 04 million reduction interest income abn 01 million result cancellation 53 million note receivable abn bore interest 575 per annum included deemed dividend discussed income taxes income taxes periods prior ipo based taxes would paid operated standalone basis income taxes decreased 08 million 21 million 1997 13 million 1998 result lower taxable income due factors described reconciliation income taxes federal statutory rate effective rate see note 5 financial statements net income result foregoing net income decreased 17 million 607 28 million 1997 11 million 1998 comparison year ended december 31 1997 year ended december 31 sales decreased 44 million 160 275 million 1996 231 million 1997 decrease sales due primarily decrease commercial hologram sales 22 million decrease 22 million sales security holograms credit cards cost goods sold cost goods sold decreased 25 million 170 147 million 1996 122 million 1997 percentage sales cost goods sold decreased 535 1996 528 1997 selling administrative expenses selling administrative expenses increased 11 million 234 47 million 1996 58 million 1997 percentage sales selling administrative expenses increased 171 1996 251 1997 increase selling administrative expenses due primarily bad debt charge 800000 associated product development project addition approximately 300000 expenses incurred 1997 connection iso 9000 certification depreciation amortization depreciation amortization remained relatively unchanged 1996 1997 percentage sales depreciation amortization increased 41 1996 49 1997 income increased 06 million 02 million 1996 08 million 1997 increase primarily due change 1997 estimate 1996 royalties resulting information reported licensee 1997 interest net interest net decreased 02 million 03 million 1996 01 million 1997 result interest revolving credit facility interest income years represents interest note due abn income taxes income taxes periods prior ipo based taxes would paid operated standalone basis income taxes decreased 10 million 31 million 1996 21 million 1997 result lower taxable income due factors described reconciliation income taxes federal statutory rate effective rate see note 5 financial statements net income result foregoing net income decreased 15 million 349 43 million 1996 28 million 1997 seasonality sales generally exhibited substantial seasonality however sales operating results date future sales therefore operating results may continue fluctuate quarter degree fluctuation depend number factors including timing level sales change pricing products mix products sold significant portion business expected derived orders placed limited number large customers variations timing orders could cause significant fluctuations operating results customers typically provide us precise forecasts future order quantities quarterly demand holograms may materially influenced customers promotions inventory replenishment card expiration patterns delivery schedules factors may difficult us anticipate factors may result fluctuations operating results include timing new product announcements introduction new products new technologies us competitors delays research development new products increased rd expenses availability cost materials suppliers competitive pricing pressures financing costs liquidity capital resources december 31 1998 43 million cash equivalents working capital 20 million cash balance included cash generated sales fourth quarter 1998 discount normal sales price exchange immediate payment customer advances well effects increase accounts payable substantial portion cash subsequently utilized repayments revolving credit agreement payment trade payables costs relating audit committee investigation discussed estimate total amount expended connection audit committee investigation related restatement efforts approximate 40 million costs charged operations incurred adversely impact 1999 operating results cash flows september 30 1999 10 million cash equivalents 23 million payable revolving credit agreement foothill capital corporation availability borrowing base formula revolving credit agreement july 20 1998 contemporaneously ipo entered 300 million credit facility agreement consisting 200 million acquisition facility 100 million working capital facility maturing july 20 2004 replaced facility entered affiliate abn substantially assets secured terms credit agreement time ipo approximately 52 million due owing credit agreement december 31 1998 56 million outstanding credit agreement exceeded maximum permitted borrowings defined pursuant borrowing base formula defined credit agreement february 1999 lenders notified us default credit agreement march 31 1999 credit agreement amended whereby maximum permitted borrowings reduced lesser 45 million maximum permitted borrowings borrowing base formula defined borrowings amended credit agreement bore interest lenders alternate base rate defined plus 05 july 20 1999 amended credit agreement amended whereby 1 existing events default waived 2 latest maturity date loans outstanding changed january 20 2000 3 maximum permitted borrowings reduced 40 million decline monthly december 31 1999 maximum permitted borrowings 26 million second amended credit agreement provided borrowings revolving credit line bearing interest lenders alternate base rate defined plus 2 80 december 31 1998 subject borrowing base formula defined consideration second amended credit agreement paid fee 40000 issued warrants purchase 781645 shares common stock subject antidilution rights 450 per share warrants terminated september 29 1999 pursuant second amended credit agreement amounts outstanding second amended credit agreement repaid described september 29 1999 amounts outstanding second amended credit agreement repaid entered loan security agreement foothill capital corporation subsidiary wells fargo bank maturing september 29 2004 loan security agreement secured substantially assets provides borrowings aggregate amount 100 million may increased 150 million consent parties subject borrowing base formula revolving credit facility term loan capital expenditure loan borrowings loan security agreement bear interest lenders reference rate defined plus 15 may decrease 125 100 05 certain circumstances terms loan security agreement maximum amounts term capital expenditure loans approximately 10 million 20 million respectively repayable sixty equal monthly installments loan security agreement contains covenants customary credit facilities similar nature including limitations ability among things 1 declare dividends repurchase redeem stock 2 prepay redeem repurchase debt incur liens engage saleleaseback transactions 3 make loans investments 4 incur additional debt 5 amend otherwise alter material agreements enter restrictive agreements 6 make capital expenditures fiscal year excess 25 million 7 engage mergers acquisitions asset sales 8 engage certain transactions affiliates 9 materially alter nature business additionally terms loan security agreement required achieve year 2000 compliance december 31 1999 also required comply specified financial covenants ratios must provide lender march 31 june 30 1999 unaudited financial statements december 15 1999 september 30 1999 unaudited financial statements december 31 1999 loan security agreement provides events default customary transactions type including nonpayment misrepresentation breach covenant crossdefaults bankruptcy adverse judgments excess 02 million change ownership control result amended credit agreement first quarter 1999 write unamortized deferred financing costs approximately 04 million relating credit agreement result second amended credit agreement third quarter 1999 write unamortized deferred financing costs approximately 59000 relating amended credit agreement result loan security agreement third quarter 1999 write remaining unamortized deferred financing costs approximately 31000 relating second amended credit agreement 1998 1997 weighted average interest rate outstanding borrowings approximately 84 90 respectively average aggregate borrowings 1998 1997 approximately 52 million 09 million respectively prior ipo cash accounts controlled centralized basis abn accordingly cash receipts disbursements received made abn recorded due abn affiliates subsequent ipo maintain centralized cash management system prior ipo cash provided abn ordinary course business way intercompany advances service debt obligations general corporate purposes upon consummation ipo intercompany advances cancelled included deemed dividend abn 339 million immediately following ipo approximately 52 million secured bank debt nominal cash year ended december 31 1998 operating activities provided cash flow 74 million compared 40 million 46 million cash flow provided operating activities 1997 1996 respectively increase cash flows primarily due sales fourth quarter 1998 discount normal sales price exchange immediate payment customer advances discussed well increase amounts owed vendors investing activities years ended december 31 1998 1997 1996 used cash flows approximately 04 million 05 million 04 million respectively activities primarily reflected capital expenditures respective years anticipate capital expenditures 1999 2000 approximately 06 million 07 million respectively amounts include approximately 04 million 1999 new systems year 2000 compliant balance relating capital expenditures required improve production capabilities financing activities years ended december 31 1998 1997 1996 used cash flows 30 million 34 million 74 million respectively activity 1998 comprised advances abn affiliates 78 million deferred financing costs 05 million offset borrowings revolving credit agreement borrowings 53 million activity 1997 1996 comprised principally advances abn affiliates 41 million 74 million respectively 1997 offset 07 million borrowings existing revolving credit facility believe cash flows operations together cash balances availability funds loan security agreement sufficient meet working capital needs service debt fund capital expenditures next twelve months party certain legal proceedings may affect financial position description proceedings see item 3 legal proceedings august 3 1999 new york stock exchange suspended trading common stock failure deliver annual report form 10k year ended december 31 1998 quarterly report form 10q three months ended march 31 1999 timely basis following suspension nyse notified us intent apply delisting common stock common stock resume trading nyse intend seek common stock traded another stock exchange quoted nasdaq new accounting standards march 1998 american institute certified public accountants aicpa issued statement position 981 accounting costs computer software developed obtained internal use sop 981 sop 981 requires computer software costs associated internal use software expensed incurred certain capitalization criteria met adopted sop 981 january 1 1999 adoption statement material impact financial position results operations cash flows april 1998 aicpa issued statement position 985 reporting cost startup activities sop 985 sop 985 requires costs associated preopening preoperating organization activities expensed incurred adopted sop 985 january 1 1999 adoption statement material impact financial position results operations cash flows june 1998 financial accounting standards board issued sfas 133 accounting derivative instruments hedging activities amended effective fiscal years beginning june 15 2000 sfas 133 requires recognition derivatives balance sheets either assets liabilities measured fair value adopt sfas 133 2001 fiscal year currently evaluating impact sfas 133 financial position results operations cash flows year 2000 readiness disclosure year 2000 issue result computer programs using last two digits refer year therefore computer programs properly recognize year begins 20 instead familiar 19 corrected computer applications could fail create erroneous results global extent potential impact year 2000 problem yet known timely corrected could adversely affect economy us use computer information systems manufacturing equipment may affected also rely suppliers customers also dependent systems equipment use date sensitive software recognize importance year 2000 issue given high priority late 1997 began review production equipment used manufacture products well systems related infrastructure manufacturing office facilities inventoried verified year 2000 readiness computer controlled manufacturing equipment computer controls manufacturing office facilities equipment included air conditioning heating systems elevator manufacturing equipment process validated equipment manufacturers completed december 1998 december 1998 began evaluating testing internal computer information systems effort involved plans creating purchasing replacement systems computer information systems developed internally well obtaining versions software purchased third parties year 2000 compliant expect converted replaced computer information systems entire business operations end fourth quarter 1999 estimated total cost approximately 425000 include internal costs associated year 2000 remediation internal costs associated year 2000 remediation expensed incurred material past performance expected material relative future performance funds expended relating year 2000 remediation 1998 october 31 1999 approximately 380000 expended approximately 45000 expended november december 1999 current estimates amount costs time necessary remediate test computer systems based facts circumstances existing known time estimates made using assumptions future events including continued availability certain resources implementation success key third parties factors process implementing new financial manufacturing software comply year 2000 issues improve management reporting capabilities mission critical portions software pilot tested insure correct operation hardware software begun testing parallel new financial manufacturing software expect testing include data november 30 1999 expected completion date december 15 1999 parallel testing completed consider mission critical hardware software year 2000 compliant new financial manufacturing software implemented tested year 2000 contingency plan also modified include year 2000 compliant capabilities new portions software also late 1998 began assess year 2000 remediation efforts suppliers including providers services utilities customers significant business relationship efforts however provide assurances affected year 2000 problems organizations process completed march 1999 date however information received suppliers customers indicate respective year 2000 remediation efforts target achieve year 2000 compliance december 31 1999 unsuccessful remediation efforts key suppliers customers unsuccessful regard year 2000 remediation may material adverse impact results financial condition worst case scenario would include loss utility service rendering us unable manufacture distribute contingency plan includes precautionary measures managing inventory levels deployment manual systems use alternate computer software currently use outside contractors time however unable quantify potential adverse impact continue monitor evaluate situation impact inflation recent years inflation significant impact historical operations assurance inflation adversely affect operations future particularly emerging markets inflationary conditions tend prevalent unaudited quarterly results operations years ended december 31 1998 1997 financial statements quarters period ended september 30 1998 year ended december 31 1997 restated see note 11 financial statements b first quarter 1998 abnh recorded sales 65 million related customer order transferred abnhs onsite secured facility see note 1 financial statements item 7aitem 7 managements discussion analysis financial condition results operations following discussion analysis read conjunction item 6 selected financial data financial statements including notes thereto appearing elsewhere report year ended december 31 1999 confronted many significant issues impact business early 1999 notified commercial bankers default bank debt result operated limited liquidity year devoted great deal effort expense refinance debt also replaced key members management team including chairman president vp finance controller reorganized workforce 1999 also named defendant class action litigation sec us attorneys office initiated investigations nyse delisted common stock addressing issues costly distraction new management furthermore result issues great deal scrutiny concerned customers suppliers employees creditors stockholders others factors negative impact 1999 operating performance expect factors continue smaller negative impact 2000 operating performance overview abnh july 20 1998 whollyowned subsidiary abn date abn completed sale 13636000 shares common stock public offering representing abns entire investment abnh receive proceeds ipo additionally connection ipo amounts due abn affiliates approximately 339 million cancelled deemed dividend immediately following ipo approximately 52 million secured bank debt nominal cash whollyowned subsidiary provided certain corporate administrative services abn including financial reporting treasury functions tax planning compliance risk management human resources legal services additionally abn managed cash financing requirements centrally interest expense financing requirements prior ipo based existing capital structure results prior ipo might differed results might achieved operated independent entity abnh originates massproduces markets holograms used primarily security applications counterfeiting protection credit transaction cards identification cards documents value well tamper resistance authentication highvalue consumer industrial products ability control diffraction light origination using proprietary processes secure controlled manufacturing environment enabled us become market leader security holography products used 200 companies worldwide also produce nonsecure holograms packaging promotional applications sales holograms credit card security applications generally carry higher gross margins sales applications concerns regarding counterfeiting piracy infractions result lost sales lost goodwill product liability claims drive use product authentication holograms companies various industries utilized holograms authentication devices reduce potential losses also concerns counterfeiting copying led increased use holograms documents value including currency passports business cheques gift certificates vouchers certificates deposit stamps postage revenue tickets financial instruments significant portion business derived orders placed certain credit card companies including mastercard manufacturers visa brand credit cards variations timing orders cause significant fluctuations sales mastercard years ended december 31 1999 1998 1997 approximately 27 30 35 respectively exclusive supplier holograms mastercard pursuant agreement amended extends february 2003 agreement provides automatic twoyear renewal periods terminated either party 1999 informed mastercard believes breached certain terms agreement 1998 1997 working closely mastercard address issues raised mastercard believe relationship mastercard good beginning january 2000 agreed lower selling price mastercard approximately 12 reduction negative impact sales gross margins sales visa card manufacturers approximately 18 26 27 respectively sales years ended december 31 1999 1998 1997 longterm purchase contracts visa supply holograms approximately 50 visa authorized card manufacturers pursuant purchase orders currently one two companies authorized manufacture sell visa brand holograms manufacturers visa brand credit cards either mastercard visa terminate respective relationship us substantially reduce orders would material adverse effect business financial condition results operations cash flows holograms sold purchase orders contracts customers sales related cost goods sold generally recognized latter time shipment title passes customers situations shipped product right return unable reasonably estimate level returns andor sale contingent upon customers use product situations recognize sales upon product shipment rather buyer product informs us product used additionally pursuant terms certain customer completed items stored behalf customer onsite secured facility instance sales recognized following occurred customer ordered goods manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order first quarter 1998 recorded sales approximately 65 million arrangement december 31 1999 accounts receivable customer totaled 05 million accounts receivable customer december 31 1998 historically purchased certain key materials used manufacture holograms single suppliers supply contracts problems occur respect delivery quality cost materials could material adverse effect financial position results operations cash flows 1999 1998 1997 export sales accounted approximately 32 28 25 respectively total sales export sales presently denominated us dollars sales may fluctuate quarter due changes customers ordering patterns customers typically provide us precise forecasts future order quantities quarterly demand holograms may materially influenced customers promotions inventory replenishment card expiration patterns delivery schedules factors may difficult us anticipate cost goods sold includes raw materials nickel foils films adhesives labor costs manufacturing overhead hologram origination costs represent costs unique master hologram made customer specifications integral part production process result costs goods sold affected product mix manufacturing yields costs hologram originations changes cost raw materials labor selling administrative expenses primarily consist salaries benefits commissions corporate sales marketing administrative personnel marketing advertising expenses services products accordance tax allocation agreement effect date ipo included consolidated us federal income tax return certain instances consolidated combined state local income tax returns abn made payments abn based amounts would payable federal state local income taxes consolidated combined returns filed computed federal state local income tax provision filing separate income tax returns without regard tax allocation agreement october 1999 affiliate abn received assessment approximately 09 million taxes interest city new york relating years ended december 31 1990 1991 1992 included combined city new york income tax returns abn periods covered assessment previously made payments abn based amounts would payable combined income tax returns filed contingently liable jointly severally us federal state local income taxes periods included consolidated combined income tax returns abn amounts paid abn excess amounts would payable filed separate tax returns charged due former parent affiliates filed us federal pennsylvania state income tax returns 1998 new york state income tax return 1998 filed comparison year ended december 31 1999 year ended december 31 sales decreased 80 million 278 287 million 1998 207 million 1999 decrease sales primarily due decrease sales security holograms credit cards 57 million result 30 million sales fourth quarter 1998 discount normal selling prices exchange immediate payment generally lower purchases security holograms credit cards card manufacturers due higher purchases customers 1998 due concerns regarding potential year 2000 issues distractions impact business associated need restate prior financial statements royalty income royalty income remained relatively unchanged 1998 1999 percentage sales royalty income increased 19 1998 26 1999 cost goods sold cost goods sold decreased 76 million 398 191 million 1998 115 million 1999 percentage sales cost goods sold decreased 666 1998 556 1999 decrease reflects decreases amortization origination costs 10 relating 1998 amortization origination costs due lower volumes sales originally estimated amortization costs incurred anticipation orders materialize decreased provisions obsolete excess inventory 2 due improved product quality decrease royalty expenses 2 related royalty litigation settlement reserved 1998 offset increase warranty expense 3 primarily resulting 08 million provision settlement breach contract claim relating warranties selling administrative expenses selling administrative expenses increased 30 million 476 63 million 1998 93 million 1999 percentage sales selling administrative expenses increased 219 1998 450 1999 increase selling administrative expenses due primarily costs incurred related audit committee investigation related restatement efforts defense litigation 35 million net insurance reimbursements 06 million increase administrative salaries benefits 04 million offset decrease sales expenses 05 million due lower remuneration travel transportation expenses reversal liability postretirement health care benefits 04 million since decided establish plan depreciation amortization depreciation amortization remained relatively unchanged 1998 1999 percentage sales depreciation amortization increased 38 1998 50 1999 income remained relatively unchanged 1998 1999 interest net interest net increased 06 million 04 million 1998 10 million 1999 increase due increase interest expense due write deferred financing costs 06 million related amendments repayment credit agreement chase manhattan bank offset reduction interest expense resulted decrease revolving loan balances 02 million decrease interest income 02 million result cancellation 53 million note receivable abn bore interest 775 per annum included deemed dividend discussed taxes income benefit taxes income benefit periods prior ipo based taxes would paid operated standalone basis income taxes decreased 18 million 13 million 1998 05 million 1999 result loss incurred due factors described reconciliation income taxes federal statutory rate effective rate see note 5 financial statements net loss income result foregoing net loss income decreased 22 million net income 11 million 1998 net loss 11 million 1999 comparison year ended december 31 1998 year ended december 31 sales increased 56 million 242 231 million 1997 287 million 1998 increase sales due primarily increase sales security holograms credit cards 29 million security holograms 27 million sales fourth quarter 1998 impacted approximately 30 million sales including sale goods originally shipped consignment discounts normal selling prices exchange immediate payment believe absence discounts portion sales would occurred 1999 contractual net unit sales price applicable mastercard reduced september 1998 approximately 5 december 31 1998 customer advances approximating 15 million represented payments received customers products discount normal sales price exchange immediate payment yet shipped 12 million products shipped right return 03 million unable reasonably estimate level returns royalty income royalty income decreased 02 million 294 08 million 1997 06 million 1998 decrease due lower reported licensee revenue 1998 1997 cost goods sold cost goods sold increased 69 million 566 122 million 1997 191 million 1998 percentage sales cost goods sold increased 528 1997 666 1998 increase reflects increases amortization origination costs charged costs goods sold based total number holographic images estimated produced due lower volumes sales originally estimated 5 increases origination costs incurred anticipation orders materialize 5 increased provisions obsolete excess inventory due primarily quality considerations lower cost market adjustments 7 effects gross margin sales discounts referred 1 increase warranty expense 1 increases royalty expenses 2 offset increase gross margins sales mix 7 selling administrative expenses selling administrative expenses increased 05 million 58 million 1997 63 million 1998 percentage sales selling administrative expenses decreased 251 1997 220 1998 increase expenses primarily attributable increased sales commissions 04 million relating increase sales increased administrative salaries 02 million relating new hires salary increases increased costs relating shareholder communications costs associated public ownership 04 million offset decrease provisions bad debts 04 million depreciation amortization depreciation amortization remained relatively unchanged 1998 compared 1997 percentage sales depreciation amortization decreased 49 1997 38 1998 income remained relatively unchanged 1998 compared 1997 interest net interest net decreased 05 million 01 million net income 1997 04 million net expense 1998 decrease due increased interest expense revolving credit facility 04 million reduction interest income abn 01 million result cancellation 53 million note receivable abn bore interest 575 per annum included deemed dividend discussed income taxes income taxes periods prior ipo based taxes would paid operated standalone basis income taxes decreased 08 million 21 million 1997 13 million 1998 result lower taxable income due factors described reconciliation income taxes federal statutory rate effective rate see note 5 financial statements net income result foregoing net income decreased 17 million 607 28 million 1997 11 million 1998 seasonality sales generally exhibited substantial seasonality however sales operating results date future sales therefore operating results may continue fluctuate quarter degree fluctuation depend number factors including timing level sales change pricing products mix products sold significant portion business expected derived orders placed limited number large customers variations timing orders could cause significant fluctuations operating results customers typically provide us precise forecasts future order quantities quarterly demand holograms may materially influenced customers promotions inventory replenishment card expiration patterns delivery schedules factors may difficult us anticipate factors may result fluctuations operating results include timing new product announcements introduction new products new technologies us competitors delays research development new products increased rd expenses availability cost materials suppliers competitive pricing pressures financing costs liquidity capital resources december 31 1999 03 million cash equivalents working capital 21 million december 31 1998 43 million cash equivalents working capital 20 million 1998 cash balance included cash generated sales fourth quarter 1998 discount normal sales price exchange immediate payment customer advances well effects increase accounts payable substantial portion cash subsequently utilized repayments revolving credit agreement payment trade payables costs relating audit committee investigation discussed total amount incurred connection audit committee investigation related restatement efforts defense litigation approximated 35 million net insurance reimbursements 06 million costs charged operations incurred adverse impact 1999 operating results cash flows july 20 1998 contemporaneously ipo entered 300 million credit facility agreement consisting 200 million acquisition facility 100 million working capital facility maturing july 20 2004 replaced facility entered affiliate abn substantially assets secured terms credit agreement time ipo approximately 52 million due owing credit agreement december 31 1998 56 million outstanding credit agreement exceeded maximum permitted borrowings defined pursuant borrowing base formula defined credit agreement february 1999 lenders notified us default credit agreement march 31 1999 credit agreement amended whereby maximum permitted borrowings reduced lesser 45 million maximum permitted borrowings borrowing base formula defined borrowings amended credit agreement bore interest lenders alternate base rate defined plus 05 july 20 1999 amended credit agreement amended whereby 1 existing events default waived 2 latest maturity date loans outstanding changed january 20 2000 3 maximum permitted borrowings reduced 40 million decline monthly december 31 1999 maximum permitted borrowings 26 million second amended credit agreement provided borrowings revolving credit line bearing interest lenders alternate base rate defined plus 2 80 december 31 1998 subject borrowing base formula defined consideration second amended credit agreement paid fee 40000 issued warrants purchase 781645 shares common stock subject antidilution rights 450 per share warrants terminated september 29 1999 pursuant second amended credit agreement amounts outstanding second amended credit agreement repaid described september 29 1999 amounts outstanding second amended credit agreement repaid entered loan security agreement foothill capital corporation subsidiary wells fargo bank maturing september 29 2004 loan security agreement secured substantially assets provides borrowings aggregate amount 100 million may increased 150 million consent parties subject borrowing base formula revolving credit facility term loan capital expenditure loan borrowings loan security agreement bear interest lenders reference rate defined plus 15 100 december 31 1999 may decrease 125 100 05 certain circumstances terms loan security agreement maximum amounts term capital expenditure loans approximately 10 million 20 million respectively repayable sixty equal monthly installments december 31 1999 74000 outstanding revolving credit facility 10 million outstanding term loan payable monthly installments 16667 beginning january 2000 loans outstanding capital expenditure loan december 31 1999 addition 03 million availability revolving credit facility december 311999 loan security agreement contains covenants customary credit facilities similar nature including limitations ability among things 1 declare dividends repurchase redeem stock 2 prepay redeem repurchase debt incur liens engage saleleaseback transactions 3 make loans investments 4 incur additional debt 5 amend otherwise alter material agreements enter restrictive agreements 6 make capital expenditures fiscal year excess 25 million 7 engage mergers acquisitions asset sales 8 engage certain transactions affiliates 9 materially alter nature business additionally terms loan security agreement required comply specified financial covenants ratios loan security agreement also provides events default customary transactions type including nonpayment misrepresentation breach covenant crossdefaults bankruptcy adverse judgments excess 02 million change ownership control 1999 wroteoff unamortized deferred financing costs approximately 06 million relating amendments repayment credit agreement chase 1999 1998 weighted average interest rate outstanding borrowings 84 average aggregate borrowings 1999 1998 approximately 33 million 52 million respectively prior ipo cash accounts controlled centralized basis abn accordingly cash receipts disbursements received made abn recorded due abn affiliates subsequent ipo maintain centralized cash management system prior ipo cash provided abn ordinary course business way intercompany advances service debt obligations general corporate purposes upon consummation ipo intercompany advances cancelled included deemed dividend abn 339 million immediately following ipo approximately 52 million secured bank debt nominal cash year ended december 31 1999 operating activities provided cash flow 15 million compared 74 million 40 million cash flow provided operating activities 1998 1997 respectively decrease cash flows primarily due decreased earnings 22 million decrease cash provided reductions accounts payable accrued expenses customer advances 73 million offset increases cash provided accounts receivable inventory prepaid expenses 23 million adjustments reconcile net income net cash provided operations 13 investing activities years ended december 31 1999 1998 1997 used cash flows approximately 05 million 04 million 05 million respectively activities primarily reflected capital expenditures respective years anticipate capital expenditures 2000 2001 approximately 07 million 10 million respectively amounts relating capital expenditures required improve production capabilities financing activities years ended december 31 1999 1998 1997 used cash flows 51 million 30 million 34 million respectively activity 1999 comprised repayment revolving credit notes payable 57 million incurring deferred financing costs 04 million offset borrowings term loan 10 million activity 1998 1997 comprised principally advances abn affiliates 78 million 41 million respectively borrowings revolving credit agreement 49 million 07 million respectively 1998 included 04 million borrowings notes payable 05 million deferred financing costs believe cash flows operations together cash balances availability funds loan security agreement sufficient meet working capital needs service debt fund capital expenditures next twelve months party certain legal proceedings may affect financial position description proceedings see item 3 legal proceedings august 3 1999 new york stock exchange suspended trading common stock failure deliver annual report form 10k year ended december 31 1998 quarterly report form 10q three months ended march 31 1999 timely basis following suspension nyse notified us delisted common stock common stock resume trading nyse intend seek common stock traded another stock exchange quoted nasdaq year 2000 disclosure year 2000 issue result computer systems programs using two digits rather four identify given year result computer systems programs year 2000 compliant may able distinguish whether 00 means 1900 2000 could result variety failures errors preparation year 2000 tested software hardware performed remedial work software ensure year 2000 compliance date experienced material difficulties associated year 2000 knowledge third party upon depend experienced material year 2000 problem vendors material hardware software components infrastructure systems indicated products use year 2000 compliant however still possible errors defects may remain undetected dates january 1 2000 may trigger year 2000 problems occurs respect software computer systems third parties rely reputation business operating results financial condition could suffer new accounting standards june 1998 financial accounting standards board issued sfas 133 accounting derivative instruments hedging activities amended effective fiscal years beginning june 15 2000 sfas 133 requires recognition derivatives balance sheets either assets liabilities measured fair value adopt sfas 133 2001 fiscal year currently evaluating impact sfas 133 financial position results operations cash flows impact inflation recent years inflation significant impact historical operations assurance inflation adversely affect operations future particularly emerging markets inflationary conditions tend prevalent unaudited quarterly results operations years ended december 31 1999 1998 year ended december 31 1999 incurred costs 35 million net 06 million insurance reimbursements connection audit committee investigation related restatement effort defense litigation also 1999 determined would establish postretirement health care plan reversed 404000 accrued liability regard costs reversal included selling administrative expenses b first quarter 1998 abnh recorded sales 65 million related customer order transferred abnhs onsite secured facility see note 1 financial statements item 7aitem 7 managements discussion analysis financial condition results operations following discussion analysis read conjunction item 6 selected financial data financial statements including notes thereto appearing elsewhere report overview abnh july 20 1998 whollyowned subsidiary abn date abn completed sale 13636000 shares common stock initial public offering representing abns entire investment abnh receive proceeds offering abnh originates massproduces markets holograms used primarily security applications counterfeiting protection credit transaction cards identification cards documents value well tamper resistance authentication highvalue consumer industrial products also produce nonsecure holograms packaging promotional applications sales holograms security applications generally carry higher gross margins sales nonsecurity applications concerns regarding counterfeiting piracy infractions result lost sales lost goodwill product liability claims drive use product authentication holograms companies various industries utilized holograms authentication devices reduce potential losses also concerns counterfeiting copying led increased use holograms documents value including currency passports business checks gift certificates vouchers certificates deposit stamps postage revenue tickets financial instruments significant portion business derived orders placed credit card companies including mastercard manufacturers visa brand credit cards variations timing orders cause significant fluctuations sales mastercard years ended december 31 2001 2000 1999 approximately 37 28 27 respectively provide holograms mastercard pursuant agreement amended expires february 2003 subject automatic renewal terminated either party sales visa card manufacturers approximately 23 19 18 respectively sales years ended december 31 2001 2000 1999 longterm purchase contracts visa supply holograms approximately 50 visa authorized card manufacturers pursuant purchase orders currently one two companies authorized manufacture sell visa brand holograms manufacturers visa brand credit cards either mastercard visa terminate respective relationship us substantially reduce orders would material adverse effect business financial condition results operations cash flows holograms sold purchase orders contracts customers sales related cost goods sold generally recognized latter time shipment title passes customers situations shipped product right return unable reasonably estimate level returns andor sale contingent upon customers use product situations recognize sales upon product shipment rather buyer product informs us product used additionally pursuant terms certain customer completed items stored behalf customer onsite secured facility instance sales recognized following occurred customer ordered goods manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order december 31 2001 2000 accounts receivable customer totaled 10 million 04 million respectively purchase certain key materials used manufacture holograms outsource certain key processes third party suppliers sole source relationships supply contracts problems occur respect delivery quality cost materials processes could material adverse effect financial position results operations cash flows 2001 2000 1999 export sales accounted approximately 28 31 32 respectively total sales export sales presently denominated us dollars sales may fluctuate quarter due changes customers ordering patterns customers typically provide us precise forecasts future order quantities quarterly demand holograms may materially influenced customers promotions inventory replenishment card expiration patterns delivery schedules factors may difficult us anticipate cost goods sold includes raw materials nickel foils films adhesives labor costs manufacturing overhead hologram origination costs represent costs unique master hologram made customer specifications integral part production process result costs goods sold affected product mix manufacturing yields costs hologram originations changes cost raw materials labor selling administrative expenses primarily consist salaries benefits commissions corporate sales marketing administrative personnel marketing promotion expenses legal accounting expenses associated public company accordance tax allocation agreement effect date offering included consolidated federal income tax return certain instances consolidated combined state local income tax returns abn made payments abn based amounts would payable federal state local income taxes consolidated combined returns filed computed federal state local income tax provision filing separate income tax returns without regard tax allocation agreement 2000 abnh former parent reached agreement subject consummation former parents chapter 11 plan see item 13 certain relationships related transactions agreement provides among things former parent responsible shall pay asserted unasserted income franchise similar tax liabilities abnh period january 1 1990 july 20 1998 indemnify abnh respect liabilities amounts paid former parent excess amounts would payable abnh filed separate income tax returns charged due former parent affiliates periods subsequent date offering abnh filing federal state income tax returns march 1 2002 abns bankruptcy plan consummated abn indicated public sec filings expects propose bankruptcy court certain amendments bankruptcy plan would require approval bankruptcy court solicitation affected creditors results operations comparison year ended december 31 2001 year ended december 31 2000 sales increased 10 million 52 190 million 2000 200 million 2001 increase sales due primarily increase sales security holograms credit cards 16 million partially offset decrease security holograms 06 million royalty income royalty income remained relatively unchanged cost goods sold cost goods sold increased 11 million 122 89 million 2000 100 million 2001 percentage sales cost goods sold increased 466 2000 498 2001 increase cost goods sold percentage sales 3 primarily due one time insurance settlement 750000 2000 related product liability matter expensed 1999 recur 2001 4 increase reserve obsolescence 2 offset decrease production costs 3 selling administrative expenses selling administrative expenses decreased 08 million 81 million 2000 73 million 2001 percentage sales selling administrative expenses decreased 425 2000 365 2001 decrease selling administrative expenses primarily due lower professional fees 08 million resulting resolution prior legal accounting matters reduction administration expenses 01 million offset partially increases sales salaries benefits expenses 01 million research development research development expenses increased 09 million 2000 12 million 2001 percentage sales research development expenses increased 49 2000 61 2001 increase reflects companys increased emphasis development testing new products target markets income expense income expense changed net expense 35 million 2000 income 03 million 2001 increase primarily due expenses recorded 2000 associated settling shareholder litigation prepayment debt partially offset gain settlement former parent recur 2001 income taxes income tax expense increased benefit 11 million 37 pretax loss 2000 expense 05 million 48 pretax income 2001 effective tax rate 2001 increased due difference treatment amortization goodwill book tax purposes occur 2002 since accordance provisions statement financial accounting standards sfas 142 goodwill intangible assets cease amortization goodwill effective january 1 2002 comparison year ended december 31 2000 year ended december 31 1999 sales decreased 22 million 102 212 million 1999 190 million 2000 decrease sales due primarily decrease sales security holograms credit cards 17 million due believe effect high inventory levels transaction card market since many banks acquired extra inventory cards 1998 1999 anticipation potential problems year 2000 transition decrease security holograms 04 million decrease freight billings 01 million royalty income royalty income decreased 01 million 170 05 million 1999 04 million 2000 decrease due lower reported licensee revenue 2000 cost goods sold cost goods sold decreased 23 million 211 112 million 1999 89 million 2000 percentage sales cost goods sold decreased 531 1999 466 2000 decrease comprised decrease provision obsolete excess inventory 5 decrease warranty expense 7 primarily resulting 08 million provision settlement breach contract claim relating warranties 1999 related insurance reimbursement recorded 2000 partially offset increase product cost due changes product mix 6 selling administrative expenses selling administrative expenses decreased 17 million 98 million 1999 81 million 2000 percentage sales selling administrative expenses decreased 463 1999 425 2000 decrease expenses primarily due costs incurred related audit committee investigation related restatement efforts 35 million recur 2000 decrease bad debt expense 02 million offset partially increases selling salaries benefits 02 million due addition personnel selling expenses 06 million principally due higher costs incurred travel shows marketing samples administrative salaries benefits 06 million principally due reversal accrued retirement benefits 1999 recur 2000 administrative expenses 06 million principally due professional public company expenses interest net interest net decreased 05 million 10 million net expense 1999 05 million net expense 2000 decrease due greater write deferred financing costs associated repayment existing credit facility 1999 write deferred financing costs associated repayment foothill loans 2000 03 million increase interest income 02 million settlement shareholder litigation shareholder litigation amounted 35 million 2000 comprised 34 million regarding settlement shareholder litigation 01 million connection costs incurred regarding sec us attorney investigations settlement former parent settlement former parent amounted 05 million comprised 03 million accounts payable 02 million accrued expenses reversed fourth quarter 2000 resulting settlement entered former parent seasonality sales generally exhibited substantial seasonality however sales operating results date future sales therefore operating results may continue fluctuate quarter degree fluctuation depend number factors including timing level sales change pricing products mix products sold significant portion business expected derived orders placed limited number large customers variations timing orders could cause significant fluctuations operating results customers typically provide us precise forecasts future order quantities quarterly demand holograms may materially influenced customers promotions inventory replenishment card expiration patterns delivery schedules factors may difficult us anticipate factors may result fluctuations operating results include timing new product announcements introduction new products new technologies us competitors delays research development new products increased research development expenses availability cost materials suppliers competitive pricing pressures financing costs liquidity capital resources december 31 2001 74 million cash equivalents working capital 119 million august 23 2000 terminated repaid outstanding amounts foothill loan entered september 29 1999 borrowings foothill loan bore interest lenders reference rate defined plus 15 result terminating foothill loan incurred 2000 early termination fee 01 million wrote approximately 02 million unamortized deferred financing costs related loans years ended december 31 2000 1999 weighted average interest rate outstanding borrowings approximately 98 84 respectively average aggregate borrowings 2000 1999 approximately 09 million 33 million respectively june 30 2000 entered stock purchase agreement crane co inc crane agreement sold 3387720 shares common stock crane aggregate purchase price 9316230 agreement also provides board directors audit committee board directors expanded one position filled douglas crane representative crane agreement also provides long crane owns least 51 shares common stock purchased agreement crane shall entitled designate one director management slate nominees board directors board directors expanded number greater six board directors shall expanded another seat crane shall entitled nominate additional director agreement crane right purchase proportionate share new issuance securities issued connection acquisition securities issued connection stock option plan agreement securities issued replacement outstanding securities issued holders shares common stock pro rata basis securities issued connection strategic investment also event issue shares common stock andor securities convertible exercisable shares common stock connection settlement litigation outstanding june 29 2000 crane allowed purchase proportionate share common stock price 335 per share agreement also contains standstill provision whereby crane agreed among things neither affiliates except otherwise provided agreement acquire current proportionate share outstanding securities standstill provision also provides crane offer sell transfer voting securities abnh tender exchange offer opposed board directors connection transaction crane also received right cause us register cranes shares public resale right include shares future registration securities subject certain exceptions year ended december 31 2001 operating activities provided cash flow 02 million compared 04 million 15 million cash flow provided operating activities 2000 1999 respectively decrease cash flows 2000 2001 primarily due decrease adjustments reconcile net income net cash provided operations 18 million decrease cash provided changes operating assets liabilities 09 million offset increase earnings 25 million investing activities years ended december 31 2000 1999 1998 used cash flows approximately 07 million 07 million 05 million respectively activities primarily reflected capital expenditures respective years anticipate capital expenditures 2002 2003 approximately 15 million year amounts relating capital expenditures required improve production capabilities reduce costs financing activities year ended december 31 2001 years ended december 31 2000 1999 financing activities provided cash flows 79 million used cash flows 51 million respectively activity 2000 consisted equity financing net costs 91 million offset partially repayment debt 12 million activity 1999 comprised repayment revolving credit notes payable 57 million incurred deferred financing costs 04 million offset borrowings term loan 10 million believe cash flows operations cash balances sufficient meet working capital needs fund capital expenditures next twelve months new accounting standards july 2001 financial accounting standards board fasb issued sfas 143 accounting asset retirement obligations requires obligations associated retirement longlived assets recorded increases costs related asset also october 3 2001 fasb issued sfas 144 accounting impairment disposal longlived assets sfas 144 supercedes sfas 121 accounting impairment disposal longlived assets longlived assets disposed sfas 144 develops one accounting model determining impairment based model sfas 121 longlived assets disposed sale requires disposed lower book value fair value less cost sell sfas 144 expands scope discontinued operations new rules applied prospectively beginning january 1 2002 expect adoption statements material impact financial statements sec issued staff accounting bulletin sab 101 revenue recognition december 1999 sab 101 expresses views sec staff applying generally accepted accounting principles certain revenue recognition issues june 2000 sec issued sab 101b defer effective date implementation sab 101 fourth quarter fiscal 2000 concluded implementation sab material impact financial position results operations september 2000 emerging issues task force eitf issued eitf 0010 accounting shipping handling fees costs provisions eitf 0010 amounts billed customer sales transaction related shipping handling classified revenues eitf 0010 also requires disclosure statement operations classification shipping handling costs material unless costs included cost goods sold effective october 1 2000 adopted eitf 0010 shipping handling amounts billed customers included revenues shipping handling costs included selling administrative expenses amounted 370000 377000 499000 years ended december 31 2001 2000 1999 respectively comparative prior period financial statements reclassified reflect change adoption eitf impact determination net income loss impact inflation recent years inflation significant impact historical operations assurance inflation adversely affect operations future particularly emerging markets inflationary conditions tend prevalent unaudited quarterly results operations years ended december 31 2001 2000 year ended december 31 2000 incurred costs 34 million regarding settlement shareholder litigation 01 million connection settlements sec us attorney investigations addition reversed 05 million accounts payable accrued expenses resulting settlement entered former parent items included income expense accompanying statement operations additionally third quarter 2000 insurance carriers agreed pay 750000 us product liability reimbursement included cost sales b quarterly sales year ended december 31 2000 adjusted amounts originally reported include shipping charges billed customers previously netted general administrative expenses required provisions eitf 0010 item 7aitem 7 management’s discussion analysis financial condition results operations following discussion analysis read conjunction “item 6 selected financial data” financial statements including notes thereto appearing elsewhere report overview abnh july 20 1998 whollyowned subsidiary abn date abn completed sale 13636000 shares common stock initial public offering “offering” representing abn’s entire investment abnh receive proceeds offering abnh originates massproduces markets holograms used primarily security applications counterfeiting protection credit transaction cards identification cards documents value well tamper resistance authentication highvalue consumer industrial products also produce nonsecure holograms packaging promotional applications sales holograms security applications generally carry higher gross margins sales nonsecurity applications concerns regarding counterfeiting piracy infractions result lost sales lost goodwill product liability claims drive use product authentication holograms companies various industries utilized holograms authentication devices reduce potential losses also concerns counterfeiting copying prompted use holograms documents value including currency passports business checks gift certificates vouchers certificates deposit stamps postage revenue tickets financial instruments significant portion business derived orders placed credit card companies including mastercard manufacturers visa brand credit cards variations timing orders cause significant fluctuations sales mastercard years ended december 31 2002 2001 2000 approximately 41 37 28 respectively entered agreement mastercard dated february 28 2003 replaces agreement dated february 1 1996 amended new agreement expires february 2008 subject automatic renewal terminated either party terms new agreement mastercard obligated purchase least 80 holograms us right utilize crane co produce 20 mastercard’s annual hologram requirements coordination us new agreement provides mastercard receive three sequential price reductions approximately 3 effective beginning 2003 2004 2006 currently exclusive supplier mastercard sales visa card manufacturers approximately 26 23 19 respectively sales years ended december 31 2002 2001 2000 longterm purchase contracts visa supply holograms approximately 50 visa authorized card manufacturers pursuant purchase orders currently one two companies authorized manufacture sell visa brand holograms manufacturers visa brand credit cards either mastercard visa terminate respective relationship us substantially reduce orders would material adverse effect business financial condition results operations cash flows holograms sold purchase orders contracts customers sales related cost goods sold generally recognized latter time shipment title passes customers situations shipped product right return unable reasonably estimate level returns andor sale contingent upon customers’ use product situations recognize sales upon product shipment rather buyer product informs us product used additionally pursuant terms certain customer completed items stored behalf customer onsite secured facility instance sales recognized following occurred customer ordered goods manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order december 31 2002 2001 accounts receivable customer totaled 16 million 10 million respectively purchase certain key materials used manufacture holograms outsource certain key processes third party suppliers sole source relationships supply contracts problems occur respect delivery quality cost materials processes could material adverse effect financial position results operations cash flows 2002 2001 2000 export sales accounted approximately 27 28 31 respectively total sales export sales presently denominated us dollars sales may fluctuate quarter due changes customers’ ordering patterns customers typically provide us precise forecasts future order quantities quarterly demand holograms may materially influenced customers’ promotions inventory replenishment card expiration patterns delivery schedules factors may difficult us anticipate cost goods sold includes raw materials nickel foils films adhesives labor costs manufacturing overhead hologram origination costs represent costs unique master hologram made customer specifications integral part production process result costs goods sold affected product mix manufacturing yields costs hologram originations changes cost raw materials labor selling administrative expenses primarily consist salaries benefits commissions corporate sales marketing administrative personnel marketing promotion expenses legal accounting expenses associated public company accordance tax allocation agreement effect date offering included consolidated federal income tax return certain instances consolidated combined state local income tax returns abn made payments abn based amounts would payable federal state local income taxes consolidated combined returns filed computed federal state local income tax provision filing separate income tax returns without regard tax allocation agreement 2000 reached agreement abn provided among things abn responsible pay asserted unasserted income franchise similar tax liabilities period january 1 1990 july 20 1998 indemnify us respect liabilities periods subsequent date offering filing federal state income tax returns critical accounting policies make use estimates assumptions impact reported amounts assets liabilities date financial statements reported amounts revenue expenses reporting period ongoing basis evaluate estimates including related bad debts inventories intangible assets estimates assumptions based historical results trends well forecasts might change future believe following critical accounting policies among others impact significant judgments estimates use preparation financial statements revenue recognition recognize revenue accordance provisions securities exchange commission’s “sec” staff accounting bulletin “sab” 101 “revenue recognition” specifically sales related cost goods sold generally recognized latter time shipment title passes customers situations shipped product right return unable reasonably estimate level returns andor sale contingent upon customers’ use product situations recognize sales upon product shipment rather buyer product informs us product used additionally pursuant terms certain customer completed items stored behalf customer onsite secured facility instance sales recognized following occurred customer ordered goods manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order allowance doubtful accounts maintain allowances doubtful accounts estimated losses resulting inability customers make required payments recognize allowance doubtful accounts based length time receivables past due current business environment historical experience financial condition customers deteriorate economic conditions worsen additional allowances may required future inventory valuation inventories stated lower cost market cost determined firstin firstout fifo method balance sheet date evaluate ending inventory excess quantities obsolescence provide reserves estimated obsolescence equal difference cost inventory estimated market value fully reserve inventories deemed obsolete future demand market conditions less favorable projections additional inventory writedowns may required impairment goodwill longlived assets account goodwill longlived assets accordance sfas 142 “goodwill intangible assets” sfas 144 “accounting impairment disposal longlived assets” sfas 142 provides goodwill amortized instead tested impairment annual basis adopted us january 1 2002 impairment testing performed two steps determination impairment based fair value compared carrying value ii indication impairment step measures amount impairment loss comparing implied fair value goodwill carrying amount goodwill accordance sfas 142 completed transitional impairment test quarter ended march 31 2002 testing indicated adjustment required upon adoption pronouncement performed annual test impairment required sfas 142 quarter ended december 31 2002 time fair value based quoted market prices found less carrying amount accordingly recorded 74 million impairment charge year ended december 31 2002 charge represents full impairment goodwill balance sheet sfas 144 requires longlived assets certain identifiable intangibles reviewed impairment whenever events changes circumstances indicate carrying amount asset may recoverable recoverability assets held used measured comparison carrying amount asset future net cash flows expected generated asset assets considered impaired impairment recognized measured amount carrying amount assets exceeds fair value assets disposed reported lower carrying amount fair value less costs sell quarter ended december 31 2002 recorded charge impairment longlived assets 19 million write fixed assets consisting master plates longer used charge represents full impairment longlived asset balance sheet goodwill longlived assets arose purchase accounting former parent related us connection former parent’s 1990 merger results operations comparison year ended december 31 2002 year ended december 31 2001 sales decreased 13 million 67 200 million 2001 187 million 2002 decrease sales due primarily decrease sales noncredit card security holograms due conclusion certain lower margin programs 2001 2003 anticipate sales adversely affected price reductions certain existing accounts reduced volume shipments certain older accounts believe factors least partially offset sales new accounts 2003 royalty income royalty income increased 01 million 191 05 million 2001 06 million 2002 increase due higher reported licensee revenue 2002 anticipate expiration certain patents cause royalty income decrease materially 2003 cost goods sold cost goods sold decreased 11 million 104 100 million 2001 89 million 2002 percentage sales cost goods sold decreased 498 2001 478 2002 decrease comprised decrease production costs 3 primarily resulting effect cost reductions put place 2002 elimination lower margin sales decrease 2 resulting settlement vendor dispute offset increase provision inventory obsolescence 1 increase warranty expense 1 increase royalty expense 1 related settlement patent license matter 2003 anticipate cost goods sold percentage sales adversely impacted price reductions believe least partially offset cost reductions implemented selling administrative expenses selling administrative expenses decreased 02 million 73 million 2001 71 million 2002 percentage sales selling administrative expenses increased 365 2001 382 2002 decrease expenses primarily due decrease selling salaries benefits 02 million primarily resulting decrease personnel decrease selling expenses 02 million primarily related reductions travel show expenses offset increases administration expenses 01 million related increases general insurance relocation expenses increase bad debt expense 01 million due increase allowance doubtful accounts due increase aging accounts receivable research development research development expenses decreased 01 million 12 million 2001 11 million 2002 percentage sales research development expenses decreased 62 2001 61 2002 decrease primarily due decrease research development testing expense 2002 impairment goodwill fixed assets performed annual impairment test goodwill sfas 142 quarter ended december 31 2002 upon completion test determined goodwill impaired result decrease market capitalization accordingly recorded impairment charge 74 million quarter ended december 31 2002 reflecting writedown carrying value goodwill addition quarter ended december 31 2002 recorded asset impairment charge 19 million write fixed assets consisting master plates longer used impairment recorded requirements sfas 144 “accounting impairment disposal longlived assets” income expense income expense increased 05 million 03 million 2001 08 million 2002 increase due patent settlement agreement entered third quarter 2002 06 million settlement dispute former agent fourth quarter 2002 01 million offset decrease interest income 02 million resulting lower interest rates effect 2002 income taxes income tax expense increased 03 million 58 06 million 2001 09 million 2002 increase primarily due increase taxable income 2002 giving effect impairment goodwill fixed assets permanent differences tax purposes comparison year ended december 31 2001 year ended december 31 2000 sales increased 10 million 52 190 million 2000 200 million 2001 increase sales due primarily increase sales security holograms credit cards 16 million partially offset decrease security holograms 06 million royalty income royalty income remained relatively unchanged cost goods sold cost goods sold increased 11 million 122 89 million 2000 100 million 2001 percentage sales cost goods sold increased 466 2000 498 2001 increase cost goods sold percentage sales 3 primarily due one time insurance settlement 750000 2000 related product liability matter expensed 1999 recur 2001 4 increase reserve obsolescence 2 offset decrease production costs 3 selling administrative expenses selling administrative expenses decreased 08 million 81 million 2000 73 million 2001 percentage sales selling administrative expenses decreased 425 2000 365 2001 decrease selling administrative expenses primarily due lower professional fees 08 million resulting resolution prior legal accounting matters reduction administration expenses 01 million offset partially increases sales salaries benefits expenses 01 million research development research development expenses increased 09 million 2000 12 million 2001 percentage sales research development expenses increased 49 2000 61 2001 increase reflects increased emphasis development testing new products target markets income expense income expense changed net expense 35 million 2000 income 03 million 2001 increase primarily due expenses recorded 2000 associated settling shareholder litigation prepayment debt partially offset gain settlement former parent recur 2001 income taxes income tax expense increased benefit 11 million 37 pretax loss 2000 expense 05 million 48 pretax income 2001 effective tax rate 2001 increased due difference treatment amortization goodwill book tax purposes seasonality sales generally exhibited substantial seasonality however sales operating results date future sales therefore operating results may continue fluctuate quarter degree fluctuation depend number factors including timing level sales change pricing products mix products sold significant portion business expected derived orders placed limited number large customers variations timing orders could cause significant fluctuations operating results customers typically provide us precise forecasts future order quantities quarterly demand holograms may materially influenced customers’ promotions inventory replenishment card expiration patterns delivery schedules factors may difficult us anticipate factors may result fluctuations operating results include timing new product announcements introduction new products new technologies us competitors delays research development new products increased research development expenses availability cost materials suppliers competitive pricing pressures financing costs liquidity capital resources december 31 2002 87 million cash equivalents working capital 141 million august 23 2000 terminated repaid outstanding amounts loan security agreement abnh foothill capital corporation amended “foothill loan” entered september 29 1999 borrowings foothill loan bore interest lender’s reference rate defined plus 15 result terminating foothill loan incurred 2000 early termination fee 01 million wrote approximately 02 million unamortized deferred financing costs related loans year ended december 31 2000 weighted average interest rate outstanding borrowings approximately 98 average aggregate borrowings 2000 approximately 09 million june 30 2000 entered stock purchase agreement “agreement” crane co inc “crane” agreement sold 3387720 shares common stock crane aggregate purchase price 9316230 agreement also provides board directors audit committee board directors expanded one position filled douglas crane representative crane agreement also provides long crane owns least 51 shares common stock purchased agreement crane shall entitled designate one director management slate nominees board directors board directors expanded number greater six board directors shall expanded another seat crane shall entitled nominate additional director agreement also contains standstill provision whereby crane agreed among things neither affiliates except otherwise provided agreement acquire current proportionate share outstanding securities standstill provision also provides crane offer sell transfer voting securities abnh tender exchange offer opposed board directors connection transaction crane also received right cause us register crane’s shares public resale right include shares future registration securities subject certain exceptions net cash provided operating activities increased 14 million 16 million year ended december 31 2002 compared 02 million cash provided operating activities prior year ended december 31 2002 net loss adjusted noncash charges provided cash 30 million compared 23 million cash provided net income adjusted noncash charges prior year ended december 31 2002 cash used changes operating assets liabilities 14 million compared 21 million cash used changes operating assets liabilities prior year investing activities years ended december 31 2002 2001 used cash flows approximately 04 million 07 million respectively activities primarily reflected capital expenditures respective years anticipate capital expenditures 2003 2004 approximately 15 million year amounts relating capital expenditures intended improve production capabilities reduce costs financing activities years ended december 31 2002 2001 believe cash flows operations cash balances sufficient meet working capital needs fund capital expenditures next twelve months march 17 2003 board directors authorized repurchase 20 million outstanding common stock terms repurchase plan authorized make purchases timetotime either open market privately negotiated transactions conditions warrant period twelve months stock repurchase commence prior release first quarter 2003 financial results depending market conditions factors purchases may suspended resumed time timetotime without prior notice following table quantifies future obligations consist primarily lease obligations thousands new accounting standards december 2002 financial accounting standards boards “fasb” issued sfas 148 “accounting stock based compensationtransition disclosurean amendment fasb statement 123” sfas 148 provides alternative methods transition voluntary change fair value based method accounting stockbased employee compensation intrinsic valuebased method accounting prescribed accounting principles board “apb” opinion 25 “accounting stock issued employees” addition sfas 148 amends disclosure requirements sfas 123 “accounting stockbased compensation” adopted disclosure requirements sfas 148 effective december 31 2002 allowed sfas 123 company elected continue apply intrinsic valuebased method accounting accordingly recognize compensation expense stock option grants made exercise price equal excess fair market value stock date grant impact inflation recent years inflation significant impact historical operations assurance inflation adversely affect operations future particularly emerging markets inflationary conditions tend prevalent unaudited quarterly results operations years ended december 31 2002 2001 item 7aitem 7 managements discussion analysis financial condition results operations following discussion analysis read conjunction item 6 selected financial data financial statements including notes thereto appearing elsewhere report overview abnh july 20 1998 whollyowned subsidiary abn date abn completed sale 13636000 shares common stock initial public offering representing abns entire investment abnh receive proceeds offering abnh originates massproduces markets holograms used primarily security applications counterfeiting protection credit transaction cards identification cards documents value well tamper resistance authentication highvalue consumer industrial products also produce nonsecure holograms packaging promotional applications sales holograms security applications generally carry higher gross margins sales nonsecurity applications concerns regarding counterfeiting piracy infractions result lost sales lost goodwill product liability claims drive use product authentication holograms companies various industries utilized holograms authentication devices reduce potential losses also concerns counterfeiting copying prompted use holograms documents value including currency passports gift certificates vouchers stamps tickets financial instruments significant portion business derived orders placed credit card companies including mastercard manufacturers visa brand credit cards variations timing orders cause significant fluctuations sales mastercard years ended december 31 2003 2002 2001 approximately 33 41 37 respectively entered agreement mastercard dated february 28 2003 replaced agreement dated february 1 1996 amended entered amendment agreement september 29 2003 mastercard retained us produce new hologram debit mastercard extended agreement february 2011 subject automatic renewal terminated either party new agreement provides mastercard receive three sequential price reductions approximately 3 effective beginning 2003 2004 2006 currently exclusive supplier mastercard sales visa card manufacturers approximately 30 26 23 respectively sales years ended december 31 2003 2002 2001 longterm purchase contracts visa supply holograms approximately 50 visa authorized card manufacturers pursuant purchase orders currently one two companies authorized manufacture sell visa brand holograms manufacturers visa brand credit cards either mastercard visa terminate respective relationship us substantially reduce orders would material adverse effect business financial condition results operations cash flows holograms sold purchase orders contracts customers sales related cost goods sold generally recognized latter time shipment title passes customers situations shipped product sale contingent upon customers use product situations recognize sales upon product shipment rather buyer product informs us product used additionally pursuant terms certain customer completed items stored behalf customer onsite secured facility instance sales recognized following occurred customer ordered goods manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order december 31 2003 2002 accounts receivable customer totaled 10 million 16 million respectively purchase certain key materials used manufacture holograms outsource certain key processes third party suppliers sole source relationships supply contracts problems occur respect delivery quality cost materials processes could material adverse effect financial position results operations cash flows 2003 2002 2001 export sales accounted approximately 28 27 28 respectively total sales export sales presently denominated us dollars sales may fluctuate quarter due changes customers ordering patterns customers typically provide us precise forecasts future order quantities quarterly demand holograms may materially influenced customers promotions inventory replenishment card expiration patterns delivery schedules factors may difficult us anticipate cost goods sold includes raw materials nickel foils films adhesives labor costs manufacturing overhead hologram origination costs represent costs unique master hologram made customer specifications integral part production process result costs goods sold affected product mix manufacturing yields costs hologram originations changes cost raw materials labor selling administrative expenses primarily consist salaries benefits commissions corporate sales marketing administrative personnel marketing promotion expenses legal accounting expenses associated public company accordance tax allocation agreement effect date offering included consolidated federal income tax return certain instances consolidated combined state local income tax returns abn made payments abn based amounts would payable federal state local income taxes consolidated combined returns filed computed federal state local income tax provision filing separate income tax returns without regard tax allocation agreement 2000 reached agreement abn provided among things abn responsible pay asserted unasserted income franchise similar tax liabilities period january 1 1990 july 20 1998 indemnify us respect liabilities periods subsequent date offering filing federal state income tax returns critical accounting policies make use estimates assumptions impact reported amounts assets liabilities date financial statements reported amounts revenue expenses reporting period ongoing basis evaluate estimates including related bad debts inventories intangible assets estimates assumptions based historical results trends well forecasts might change future believe following critical accounting policies among others impact significant judgments estimates use preparation financial statements revenue recognition recognize revenue accordance provisions securities exchange commissions sec staff accounting bulletin sab 101 revenue recognition specifically sales related cost goods sold generally recognized latter time shipment title passes customers situations shipped product sale contingent upon customers use product situations recognize sales upon product shipment rather buyer product informs us product used additionally pursuant terms certain customer completed items stored behalf customer onsite secured facility instance sales recognized following occurred customer ordered goods manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order allowance doubtful accounts maintain allowances doubtful accounts estimated losses resulting inability customers make required payments recognize allowance doubtful accounts based length time receivables past due current business environment historical experience financial condition customers deteriorate economic conditions worsen additional allowances may required future inventory valuation inventories stated lower cost market cost determined firstin firstout fifo method balance sheet date evaluate ending inventory excess quantities obsolescence provide reserves estimated obsolescence equal difference cost inventory estimated market value fully reserve inventories deemed obsolete future demand market conditions less favorable projections additional inventory writedowns may required impairment goodwill longlived assets account goodwill longlived assets accordance sfas 142 goodwill intangible assets sfas 142 sfas 144 accounting impairment disposal longlived assets sfas 144 sfas 142 provides goodwill amortized instead tested impairment annual basis adopted us january 1 2002 impairment testing performed two steps determination impairment based fair value compared carrying value ii indication impairment step measures amount impairment loss comparing implied fair value goodwill carrying amount goodwill accordance sfas 142 completed transitional impairment test quarter ended march 31 2002 testing indicated adjustment required upon adoption pronouncement performed annual test impairment required sfas 142 quarter ended december 31 2002 time fair value based quoted market prices found less carrying amount accordingly recorded 74 million impairment charge year ended december 31 2002 charge represents full impairment goodwill balance sheet sfas 144 requires longlived assets certain identifiable intangibles reviewed impairment whenever events changes circumstances indicate carrying amount asset may recoverable recoverability assets held used measured comparison carrying amount asset future net cash flows expected generated asset assets considered impaired impairment recognized measured amount carrying amount assets exceeds fair value assets disposed reported lower carrying amount fair value less costs sell quarter ended december 31 2002 recorded charge impairment longlived assets 19 million write fixed assets consisting master plates longer used charge represents full impairment longlived asset balance sheet goodwill longlived assets arose purchase accounting former parent related us connection former parents 1990 merger results operations comparison year ended december 31 2003 year ended december 31 2002 sales decreased 04 million 20 187 million 2002 183 million 2003 decrease due decrease sales mastercard original mastercard hologram 24 discontinuation europay hologram 04 million partially offset sales 08 million new debit mastercard hologram increase sales identification products 08 million net increase sales products 08 million royalty income royalty income year ended december 31 2003 decreased 05 million year ended december 31 2002 due expiration patent license agreement cost goods sold cost goods sold decreased 06 million 73 89 million 2002 83 million 2003 percentage sales cost goods sold decreased 478 2002 453 2003 decrease cost goods sold percentage sales 3 primarily due decreases provisions warranty obsolescence royalties 3 lower production costs 2 offset 2002 vendor reimbursement 2 recur 2003 selling administrative expenses selling administrative expenses decreased 06 million 71 million 2002 65 million 2003 percentage sales selling administrative expenses decreased 382 2002 356 2003 decrease selling administrative expenses primarily due decrease selling administrative expenses 05 million primarily due decreases expenses insurance telephone travel show sales samples bad debt expenses decrease salaries benefits 01 million primarily due lower headcount commissions research development research development expenses remained relatively unchanged impairment goodwill fixed assets 2002 impairment charges 74 million write goodwill recorded requirements sfas 142 19 million write fixed assets recorded requirements sfas 144 recur 2003 income decreased 07 million 08 million 2002 01 million 2003 decrease primarily due income settlement agreements 2002 recur 2003 income taxes income tax expense decreased 01 million 09 million 2002 08 million 2003 decrease primarily due decrease taxable income 2003 giving effect impairments goodwill fixed assets permanent differences tax purposes comparison year ended december 31 2002 year ended december 31 2001 sales decreased 13 million 67 200 million 2001 187 million 2002 decrease sales due primarily decrease sales noncredit card security holograms due conclusion certain lower margin programs 2001 royalty income royalty income increased 01 million 191 05 million 2001 06 million 2002 increase due higher reported licensee revenue 2002 cost goods sold cost goods sold decreased 11 million 104 100 million 2001 89 million 2002 percentage sales cost goods sold decreased 498 2001 478 2002 decrease comprised decrease production costs 3 primarily resulting effect cost reductions put place 2002 elimination lower margin sales decrease 2 resulting settlement vendor dispute offset increase provision inventory obsolescence 1 increase warranty expense 1 increase royalty expense 1 related settlement patent license matter selling administrative expenses selling administrative expenses decreased 02 million 73 million 2001 71 million 2002 percentage sales selling administrative expenses increased 365 2001 382 2002 decrease expenses primarily due decrease selling salaries benefits 02 million primarily resulting decrease personnel decrease selling expenses 02 million primarily related reductions travel show expenses offset increases administration expenses 01 million related increases general insurance relocation expenses increase bad debt expense 01 million due increase allowance doubtful accounts due increase aging accounts receivable research development research development expenses decreased 01 million 12 million 2001 11 million 2002 percentage sales research development expenses decreased 62 2001 61 2002 decrease primarily due decrease research development testing expense 2002 impairment goodwill fixed assets performed annual impairment test goodwill sfas 142 quarter ended december 31 2002 upon completion test determined goodwill impaired result decrease market capitalization accordingly recorded impairment charge 74 million quarter ended december 31 2002 reflecting writedown carrying value goodwill addition quarter ended december 31 2002 recorded asset impairment charge 19 million write fixed assets consisting master plates longer used impairment recorded requirements sfas 144 accounting impairment disposal longlived assets income expense income expense increased 05 million 03 million 2001 08 million 2002 increase due patent settlement agreement entered third quarter 2002 06 million settlement dispute former agent fourth quarter 2002 01 million offset decrease interest income 02 million resulting lower interest rates effect 2002 income taxes income tax expense increased 03 million 58 06 million 2001 09 million 2002 increase primarily due increase taxable income 2002 giving effect impairment goodwill fixed assets permanent differences tax purposes seasonality sales generally exhibited substantial seasonality however sales operating results date future sales therefore operating results may continue fluctuate quarter degree fluctuation depend number factors including timing level sales change pricing products mix products sold significant portion business expected derived orders placed limited number large customers variations timing orders could cause significant fluctuations operating results customers typically provide us precise forecasts future order quantities quarterly demand holograms may materially influenced customers promotions inventory replenishment card expiration patterns delivery schedules factors may difficult us anticipate factors may result fluctuations operating results include timing new product announcements introduction new products new technologies us competitors delays research development new products increased research development expenses availability cost materials suppliers competitive pricing pressures financing costs liquidity capital resources december 31 2003 113 million cash equivalents working capital 161 million june 30 2000 entered stock purchase agreement crane co inc crane agreement sold 3387720 shares common stock crane aggregate purchase price 9316230 agreement also provides board directors audit committee board directors expanded one position filled douglas crane representative crane agreement also provides long crane owns least 51 shares common stock purchased agreement crane shall entitled designate one director management slate nominees board directors board directors expanded number greater six board directors shall expanded another seat crane shall entitled nominate additional director agreement also contains standstill provision whereby crane agreed among things neither affiliates except otherwise provided agreement acquire current proportionate share outstanding securities standstill provision also provides crane offer sell transfer voting securities abnh tender exchange offer opposed board directors connection transaction crane also received right cause us register cranes shares public resale right include shares future registration securities subject certain exceptions net cash provided operating activities 31 million year ended december 31 2003 compared 16 million cash provided operating activities prior year ended december 31 2003 net income adjusted noncash charges provided cash 25 million compared 30 million cash provided net loss adjusted noncash charges prior year ended december 31 2003 cash provided changes operating assets liabilities 06 million compared cash used changes operating assets liabilities 14 million prior year investing activities years ended december 31 2003 2002 used cash flows approximately 05 million 04 million respectively activities primarily reflected capital expenditures respective years anticipate capital expenditures 2004 2005 approximately 35 million year amounts relating capital expenditures intended improve production capabilities expand product line reduce future operating costs financing activities years ended december 31 2003 2002 believe cash flows operations cash balances sufficient meet working capital needs fund capital expenditures next twelve months march 17 2003 board directors authorized repurchase 20 million outstanding common stock terms repurchase plan authorized make purchases timetotime either open market privately negotiated transactions conditions warrant period twelve months stock repurchase plan terminated december 15 2003 without shares repurchased plan following table quantifies future obligations consist primarily lease obligations thousands impact inflation recent years inflation significant impact historical operations assurance inflation adversely affect operations future particularly emerging markets inflationary conditions tend prevalent unaudited quarterly results operations years ended december 31 2003 2002 item 7aitem 7 management’s discussion analysis financial condition results operations note 1 notes financial statements item 7 management’s discussion analysis financial condition results operations following discussion analysis read conjunction “item 6 selected financial data” financial statements including notes thereto appear elsewhere report overview abnh july 20 1998 whollyowned subsidiary american banknote corporation “abn” “former parent” date abn completed sale 13636000 shares common stock initial public offering “offering” representing abn’s entire investment abnh receive proceeds offering abnh originates massproduces markets holograms used primarily security applications counterfeiting protection credit transaction cards identification cards documents value well tamper resistance authentication highvalue consumer industrial products also produce nonsecure holograms packaging promotional applications sales holograms security applications generally carry higher gross margins sales nonsecurity applications concerns regarding counterfeiting piracy infractions result lost sales lost goodwill product liability claims drive use product authentication holograms companies various industries utilize holograms authentication devices reduce potential losses significant portion business derived orders placed credit card companies including mastercard manufacturers visa brand credit cards variations timing orders cause significant fluctuations sales mastercard years ended december 31 2004 2003 2002 approximately 35 33 41 respectively entered agreement mastercard dated february 28 2003 replaced agreement dated february 1 1996 amended entered amendment agreement september 29 2003 mastercard retained us produce new hologram debit mastercard extended agreement february 2011 subject automatic renewal terminated either party new agreement provides mastercard receive three sequential price reductions approximately 3 effective beginning 2003 2004 2006 currently exclusive supplier mastercard sales visa card manufacturers approximately 31 30 26 respectively sales years ended december 31 2004 2003 2002 currently one two companies authorized manufacture sell visa dove holograms manufacturers visa brand credit cards march 15 2005 visa announced intention phase dove hologram supply front visa card replace integrated holographic magnetic stripe expect supply holomagnetic stripe product holomag visa cards cannot assure future sales holomag visa’s authorized card manufacturers successful profitable historical sales visa dove hologram contract visa commits authorized card manufacturers purchase dove holograms holomag us lose substantial portion business either mastercard visa without replacing new product sales business operating results financial condition would materially adversely affected addition fail obtain anticipated orders customers experience delays cancellations orders customers business financial performance materially adversely affected holograms sold purchase orders contracts customers sales related cost goods sold generally recognized latter time shipment title passes customers situations shipped product sale contingent upon customers’ use product situations recognize sales upon product shipment rather buyer product informs us product used additionally pursuant terms certain customer completed items stored behalf customer onsite secured facility instance sales recognized following occurred customer ordered goods manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order december 31 2004 2003 accounts receivable customer totaled 11 million 10 million respectively purchase certain key materials used manufacture holograms outsource certain key processes third party suppliers sole source relationships supply contracts problems occur respect delivery quality cost materials processes could material adverse effect financial position results operations cash flows 2004 2003 2002 export sales accounted approximately 21 28 27 respectively total sales export sales presently denominated us dollars sales may fluctuate quarter due changes customers’ ordering patterns customers typically provide us precise forecasts future order quantities quarterly demand holograms may materially influenced customers’ promotions inventory replenishment card expiration patterns delivery schedules factors may difficult us anticipate cost goods sold includes raw materials nickel foils films adhesives labor costs manufacturing overhead hologram origination costs represent costs unique master hologram made customer specifications integral part production process result costs goods sold affected product mix manufacturing yields costs materials services suppliers labor selling administrative expenses primarily consist salaries benefits commissions corporate sales marketing administrative personnel marketing promotion expenses legal accounting expenses associated public company critical accounting policies make use estimates assumptions impact reported amounts assets liabilities date financial statements reported amounts revenue expenses reporting period ongoing basis evaluate estimates including related bad debts inventories intangible assets estimates assumptions based historical results trends well forecasts might change future believe following critical accounting policies among others impact significant judgments estimates use preparation financial statements revenue recognition recognize revenue accordance provisions securities exchange commission’s “sec” staff accounting bulletin “sab” 104 “revenue recognition” specifically sales related cost goods sold generally recognized latter time shipment title passes customers situations shipped product sale contingent upon customers’ use product situations recognize sales upon product shipment rather buyer product informs us product used additionally pursuant terms certain customer completed items stored behalf customer onsite secured facility instance sales recognized following occurred customer ordered goods manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order allowance doubtful accounts maintain allowances doubtful accounts estimated losses resulting inability customers make required payments recognize allowance doubtful accounts based length time receivables past due current business environment historical experience financial condition customers deteriorate economic conditions worsen additional allowances may required future inventory valuation inventories stated lower cost market cost determined firstin firstout fifo method balance sheet date evaluate ending inventory excess quantities obsolescence provide reserves estimated obsolescence equal difference cost inventory estimated market value fully reserve inventories deemed obsolete future demand market conditions less favorable projections additional inventory writedowns may required impairment goodwill longlived assets account goodwill longlived assets accordance sfas 142 “goodwill intangible assets” “sfas 142” sfas 144 “accounting impairment disposal longlived assets” “sfas 144” sfas 142 provides goodwill amortized instead tested impairment annual basis adopted us january 1 2002 impairment testing performed two steps determination impairment based fair value compared carrying value ii indication impairment step measures amount impairment loss comparing implied fair value goodwill carrying amount goodwill performed annual test impairment required sfas 142 year ended december 31 2002 time fair value based quoted market prices found less carrying amount accordingly recorded 74 million impairment charge year ended december 31 2002 charge represents full impairment goodwill balance sheet prior december 31 2002 sfas 144 requires longlived assets certain identifiable intangibles reviewed impairment whenever events changes circumstances indicate carrying amount asset may recoverable recoverability assets held used measured comparison carrying amount asset future net cash flows expected generated asset assets considered impaired impairment recognized measured amount carrying amount assets exceeds fair value assets disposed reported lower carrying amount fair value less costs sell year ended december 31 2002 recorded charge impairment longlived assets 19 million write fixed assets consisting master plates longer used charge represents full impairment longlived asset balance sheet prior december 31 2002 goodwill longlived assets arose purchase accounting former parent related us connection former parent’s 1990 merger results operations comparison year ended december 31 2004 year ended december 31 2003 sales increased 30 million 163 183 million 2003 213 million 2004 increase due increase sales holograms transaction cards existing customers 30 million creation new programs transaction cards 09 million 2004 creation new programs identification products 04 million 2004 partially offset sales 13 million identification products 2003 recur 2004 addition commenced new programs pharmaceutical consumer product protection offset reduction lower margin international label sales royalty income royalty income remained relatively unchanged cost goods sold cost goods sold increased 09 million 107 83 million 2003 92 million 2004 percentage sales cost goods sold decreased 453 2003 431 2004 decrease cost goods sold percentage sales 2 primarily due greater sales volumes higher margin products current period selling administrative expenses selling administrative expenses increased 06 million 65 million 2003 71 million 2004 percentage sales selling administrative expenses decreased 356 2003 333 2004 increase selling administrative expenses primarily due increase sales salaries 01 million increase selling expenses 01 million primarily due higher trade show travel sample expenses increase administrative salaries benefits 03 million increase administrative expenses 01 million primarily related higher professional fees recruitment expenses research development research development expenses increased 01 million 12 million 2003 13 million 2004 increase primarily due development testing new products depreciation amortization depreciation amortization expense increased 01 million 07 million 2003 08 million 2004 primarily due new assets 2004 facility consolidation expenses facility consolidation expenses 02 million pertain expenses incurred new facility robbinsville new jersey consist primarily legal fees real estate commissions employee relocation severance expenses income increased 02 million 01 million 2003 03 million 2004 increase primarily due income patent settlement agreement competitor 2004 income taxes income tax expense increased 05 million 07 million 2003 12 million 2004 increase primarily due increase taxable income 2004 comparison year ended december 31 2003 year ended december 31 2002 sales decreased 04 million 20 187 million 2002 183 million 2003 decrease due decrease sales mastercard original mastercard hologram 24 million discontinuation europay hologram 04 million partially offset sales 08 million new debit mastercard hologram increase sales identification products 08 million net increase sales products 08 million royalty income royalty income year ended december 31 2003 decreased 05 million year ended december 31 2002 due expiration patent license agreement cost goods sold cost goods sold decreased 06 million 73 89 million 2002 83 million 2003 percentage sales cost goods sold decreased 478 2002 453 2003 decrease cost goods sold percentage sales 3 primarily due decreases provisions warranty obsolescence royalties 3 lower production costs 2 offset 2002 vendor reimbursement 2 recur 2003 selling administrative expenses selling administrative expenses decreased 06 million 71 million 2002 65 million 2003 percentage sales selling administrative expenses decreased 382 2002 356 2003 decrease selling administrative expenses primarily due decrease selling administrative expenses 05 million primarily due decreases expenses insurance telephone travel show sales samples bad debt expenses decrease salaries benefits 01 million primarily due lower headcount commissions research development research development expenses remained relatively unchanged impairment goodwill fixed assets 2002 impairment charges 74 million write goodwill recorded requirements sfas 142 19 million write fixed assets recorded requirements sfas 144 recur 2003 income decreased 07 million 08 million 2002 01 million 2003 decrease primarily due income settlement agreements 2002 recur 2003 income taxes income tax expense decreased 01 million 09 million 2002 08 million 2003 decrease primarily due decrease taxable income 2003 giving effect impairments goodwill fixed assets permanent differences tax purposes seasonality sales generally exhibited substantial seasonality however sales operating results date future sales therefore operating results may continue fluctuate quarter degree fluctuation depend number factors including timing level sales change pricing products mix products sold significant portion business expected derived orders placed limited number large customers variations timing orders could cause significant fluctuations operating results customers typically provide us precise forecasts future order quantities quarterly demand holograms may materially influenced customers’ promotions inventory replenishment card expiration patterns delivery schedules factors may difficult us anticipate factors may result fluctuations operating results include timing new product announcements introduction new products new technologies us competitors delays research development new products increased research development expenses availability cost materials suppliers competitive pricing pressures liquidity capital resources december 31 2004 114 million cash equivalents shortterm investments 20 million working capital 172 million june 30 2000 entered stock purchase agreement “agreement” crane co inc “crane” agreement sold 3387720 shares common stock crane aggregate purchase price 9316230 agreement also provides board directors audit committee board directors expanded one position filled douglas crane representative crane agreement also provides long crane owns least 51 shares common stock purchased agreement crane shall entitled designate one director management slate nominees board directors board directors expanded number greater six board directors shall expanded another seat crane shall entitled nominate additional director agreement also contains standstill provision whereby crane agreed among things neither affiliates except otherwise provided agreement acquire current proportionate share outstanding securities standstill provision also provides crane offer sell transfer voting securities abnh tender exchange offer opposed board directors connection transaction crane also received right cause us register crane’s shares public resale right include shares future registration securities subject certain exceptions net cash provided operating activities 34 million year ended december 31 2004 compared 31 million cash provided operating activities prior year ended december 31 2004 net income adjusted noncash charges provided cash 26 million compared 25 million cash provided net income adjusted noncash charges prior year ended december 31 2004 cash provided changes operating assets liabilities 08 million compared cash provided changes operating assets liabilities 06 million prior year investing activities year ended december 31 2004 provided cash flows 05 million compared 44 million cash used 2003 activities primarily reflected decrease investments shortterm securities 20 million capital expenditures 15 million 2004 investments shortterm securities 40 million capital expenditures 04 million 2003 capital expenditures 2004 included 10 million leasehold improvements equipment installed new facility robbinsville new jersey anticipate capital expenditures 2005 2006 approximately 65 30 million respectively capital expenditures directed building high quality secure manufacturing facility robbinsville new jersey enhancing production capabilities expanding product line improving operating efficiencies financing activities year ended december 31 2004 provided cash 01 million primarily due issuance common stock due exercise stock options financing activities year ended december 31 2003 december 14 2004 entered agreements lease 134000 square foot modern manufacturing office building robbinsville new jersey future site primary operations construction within facility meet specialized operational security requirements approximately may 2005 new facility provides substantial room expansion consolidate operations currently conducted within 58000 square foot facility elmsford new york 30000 square foot facility huntingdon valley pennsylvania new facility robbinsville new jersey also acquiring additional equipment technology installed new facility order broaden capabilities serve target customers expand capacity improve efficiency leases elmsford new york huntingdon valley pennsylvania facilities expire december 2007 july 2007 respectively company seeking identify subtenants portion leases upon vacating premises base rent new lease robbinsville new jersey facility 555000 per year increasing 19 per year first seven months lease rentfree currently pay combined base rent 933000 per year two existing smaller facilities elmsford new york huntingdon valley pennsylvania term new lease may 31 2017 expiration term options renew lease three consecutive five year periods option purchase building currently anticipate investing approximately 74 million 2005 approximately 1 million expended 2004 facility upgrades customize robbinsville new jersey facility operational security requirements well acquisition new equipment upgrade expand production capabilities believe cash flows operations cash balances sufficient meet working capital needs fund capital expenditures including expenditures relating robbinsville new jersey facility next twelve months also currently expect incur expenses totaling approximately 42 million incurred 02 million 2004 associated existing leases vacating current facilities elmsford new york huntingdon valley pennsylvania relocating terminating certain employees moving equipment related expenses expect substantially complete third quarter 2005 costs presented facility consolidation expense financial statements approximately 29 million expenses paid cash ratably fourth quarter 2007 approximately 13 million expenses paid cash incurred fourth quarter 2005 following table quantifies future obligations consist primarily lease obligations thousands impact inflation recent years inflation significant impact historical operations assurance inflation adversely affect operations future particularly emerging markets inflationary conditions tend prevalent unaudited quarterly results operations years ended december 31 2004 2003 item 7aitem 7 management’s discussion analysis financial condition results operations following discussion analysis read conjunction “item 6 selected financial data” financial statements including notes thereto appear elsewhere report overview abnh july 20 1998 whollyowned subsidiary american banknote corporation “abn” date abn completed sale 13636000 shares common stock initial public offering “offering” representing abn’s entire investment abnh receive proceeds offering abnh originates produces markets sells secure holograms products incorporating secure holograms company’s products used primarily security applications including authentication transaction cards identity documents value documents various consumer products company operates one reportable industry segment ability create distinctive secure optically variable devices reproduce high quality distribute securely enabled us become market leader security holography products sold 200 companies worldwide including mastercard visa american express discover diners club sears nordstrom quaker state nike janssencilag eli lilly well agencies united states government certain foreign governments also produce nonsecure holograms design promotional applications concerns regarding counterfeiting piracy infractions result lost sales lost goodwill product liability claims drive use product authentication holograms companies various industries utilize holograms authentication devices significant portion company’s business derived orders placed certain transaction card companies variations timing orders cause significant fluctuations company’s sales transaction card companies accounted approximately 86 total sales 2005 84 total sales 2004 sales mastercard includes holomag™ starting three month period ended december 31 2005 approximately 31 35 sales years ended december 31 2005 2004 respectively company agreement mastercard amended pursuant company exclusive supplier mastercard holograms holographic magnetic stripes holomag quarter ended september 30 2005 mastercard advised member financial institutions around world allow choose among card designs incorporate either traditional hot stamp patch hologram holomag supplied company agreement mastercard amended august 24 2005 expires february 28 2013 subject automatic renewal thereafter lose substantial portion business mastercard without replacing new product sales business operating results financial condition would materially adversely affected addition fail obtain anticipated orders mastercard experience delays cancellations orders mastercard business operating results financial performance materially adversely affected sales visa holograms includes holomag starting three month period ended september 30 2005 manufacturers visa transaction cards approximately 37 31 30 sales years ended december 31 2005 2004 2003 respectively currently one two companies authorized manufacture sell visa dove hot stamp holograms manufacturers visa brand transaction cards march 15 2005 visa announced intention phase dove hot stamp hologram supply front visa card replace integrated holographic magnetic stripe april 8 2005 entered agreement visa pursuant authorized supply holomag visaapproved card manufacturers previously reported learned small number incidents certain card terminals affected electrostatic discharge “esd” static electricity carried cards incorporating holomag march 14 2006 informed visa result esd issue visa informing member financial institutions authorized card manufacturers visa longer approve visa card designs incorporate current version holomag ii visa strongly recommends members attempt avoid issuance cards incorporating current version holomag iii visa recommends members follow alternate card design incorporating conventional magnetic stripe dove hologram visa provided notice us revoking right produce holomag agreement “visa decision” continuing evaluate visa’s actions claims submitted initial response visa believe compliance agreement visa holomag product complies standards specifications contained agreement products sold fixed price basis purchase orders contracts customers sales related cost goods sold generally recognized latter time shipment title passes customers situations company shipped product sale contingent upon customers’ use product situations company recognize sales upon product shipment rather buyer product informs company product used additionally pursuant request agreement certain customer completed items stored behalf customer company’s onsite secured facility instance sales recognized following occurred customer ordered goods pursuant fixed price purchase order manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order collection invoice considered probable december 31 2005 2004 accounts receivable customer totaled 15 million 11 million respectively certain cases company agreed maintain inventory products customer ensure quick turn around deliveries company accepts returns product sold customers product determined conformance specifications previously agreed upon customers accordance terms warranty policy generally replaces product company generally provides replacement product 180 days original shipment warranty defective product shipping handling amounts billed customers included sales amounted 09 million 04 million 04 million 2005 2004 2003 respectively purchase certain key materials used manufacture products subcontract certain production functions products third parties sole suppliers cases supply contracts suppliers operate purchase order basis case holomag single supplier cfc international inc supply contract may able find alternative sources timely manner suppliers subcontractors become unwilling unable supply us increase prices inability obtain key product components certain processes performed behalf could cause delays reduce product shipments could cause relationship customers suffer materially adversely affect financial condition results operations cash flows 2005 2004 2003 export sales accounted approximately 34 21 28 respectively total sales export sales presently denominated us dollars sales may fluctuate quarter due changes customers’ ordering patterns customers typically provide us precise forecasts future order quantities quarterly demand products may materially influenced customers’ promotions inventory replenishment card expiration patterns delivery schedules factors visa decision may difficult us anticipate cost goods sold includes raw materials nickel foils films adhesives labor costs manufacturing overhead hologram origination costs represent costs unique master hologram made customer specifications integral part production process cost goods sold also includes cost certain processes company outsources third parties result costs goods sold affected product mix manufacturing yields supplier prices changes cost raw materials labor selling administrative expenses primarily consist salaries benefits commissions company’s corporate sales customer service marketing administrative personnel marketing promotion expenses legal accounting expenses associated public company also includes cost shipping handling product deliveries billed customers selling administrative expenses costs amounted 10 million 05 million 04 million 2005 2004 2003 respectively critical accounting policies preparation financial statements conformity generally accepted accounting principles requires management make use estimates assumptions impact reported amounts assets liabilities date financial statements reported amounts revenue expenses reporting period ongoing basis evaluate estimates including related bad debts inventories intangible assets estimates assumptions based historical results trends well forecasts might change future addition estimates assumptions influenced current knowledge potential impact visa decision actual results may differ materially estimates believe following critical accounting policies among others impact significant judgments estimates use preparation financial statements revenue recognition company recognizes revenue accordance provisions sec’s staff accounting bulletin “sab” 104 “revenue recognition amendment sab 101 “revenue recognition financial statements”” specifically sales related cost goods sold generally recognized latter time shipment title passes customers situations company shipped product sale contingent upon customers’ use product situations company recognize sales upon product shipment rather buyer product informs company product used additionally pursuant request agreement certain customer completed items stored behalf customer company’s onsite secured facility instance sales recognized following occurred customer ordered goods pursuant fixed price purchase order manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order collection invoice considered probable company accepts returns product sold customers product determined conformance specifications previously agreed upon customers accordance terms warranty policy generally replaces product customer advances represent payments received customers products yet shipped customer advances classified current liabilities company’s balance sheets shipping handling amounts billed customers included sales shipping handling costs included selling administrative expenses allowance doubtful accounts maintain allowances doubtful accounts estimated losses resulting inability customers make required payments recognize allowance doubtful accounts based length time receivables past due current business environment historical experience financial condition customers deteriorate economic conditions worsen additional allowances may required future inventory valuation inventories stated lower cost market cost determined firstin firstout fifo method balance sheet date evaluate ending inventory excess quantities obsolescence provide reserves estimated obsolescence equal difference cost inventory estimated market value fully reserve inventories deemed obsolete future demand market conditions less favorable projections additional inventory writedowns may required impairment longlived assets account longlived assets accordance sfas 144 accounting impairment disposal longlived assets “sfas 144” sfas 144 requires longlived assets certain identifiable intangibles reviewed impairment whenever events changes circumstances indicate carrying amount asset may recoverable recoverability assets held used measured comparison carrying amount asset future net cash flows expected generated asset assets considered impaired impairment recognized measured amount carrying amount assets exceeds fair value assets disposed reported lower carrying amount fair value less costs sell recent accounting pronouncements december 2004 financial accounting standards board issued statement 123r fas 123r sharebased payment revising fas 123 requiring sharebased payments employees recognized financial statements generally approach accounting sharebased payments fas 123r similar approach described fas 123 however pro forma footnote disclosure longer alternative financial statement recognition statement amended becomes effective first annual period beginning june 15 2005 company adopted new statement effective january 1 2006 using modifiedprospective transition method described statement method company required recognize compensation expense remaining vesting period awards remain unvested january 1 2006 permitted fas 123 company currently accounts sharebased payments employees using apb 25’s intrinsic value method generally recognized compensation cost employee stock options approximate impact 2006 results refer proforma results shown note 1”stockbased compensation” financial statements november 2004 financial accounting standards board “fasb” issued statement 151 “fas 151” inventory costs amendment arb 43 chapter 4 fas 151 clarifies abnormal amounts idle facility expense freight handling costs wasted materials recognized current period charges addition fas 151 requires allocation fixed production overhead inventory based normal capacity production facilities fas 151 effective inventory costs incurred fiscal years beginning june 15 2005 company currently believes adoption fas 151 material impact financial statements march 2005 fasb issued interpretation 47 accounting conditional asset retirement obligations interpretation sfas 143 interpretation clarifies term conditional asset retirement obligation refers legal obligation perform asset retirement activity timing andor method settlement conditional future event may within control entity obligation perform asset retirement activity unconditional even though uncertainty exists timing andor method settlement accordingly entity required recognize liability fair value conditional asset retirement obligation fair value liability reasonably estimated provisions interpretation 47 effective fiscal years ending december 15 2005 adoption statement impact company’s financial statement presentation since conditional asset retirement obligations december 2004 fasb issued statement financial accounting standards “sfas” 154 accounting changes error corrections replacement apb opinion 20 sfas 3 statement changes requirements accounting reporting change accounting principle statement requires retrospective application prior period financial statements changes accounting principle unless impracticable determine either periodspecific effects cumulative effect change indirect effects change accounting principle recognized period accounting change provisions sfas 154 effective fiscal years beginning december 15 2005 company adopted statement beginning january 1 2006 impact visa decision result visa decision company’s results operations quarter year ended december 31 2005 materially affected quarter ended december 31 2005 result visa decision recorded pretax charge amounting approximately 50 million 48 million recorded cost goods sold principally related value holomag inventory also included charge increases provisions accounts receivable potential nonesd related warranty claims review valuation accounts ongoing basis part closing process make appropriate changes reserve levels based upon facts time sales holomag visa authorized transaction card manufacturers began quarter ended september 30 2005 amounted 23 million quarter ended december 31 2005 holomag sales visa authorized card manufacturers amounted 38 million sales visa holomag continued grow first quarter 2006 compared prior quarter announcement visa march 15 2006 accordingly sales quarter ending march 31 2006 expected higher level quarter ended december 31 2005 expected decline thereafter result visa decision results operations comparison year ended december 31 2005 year ended december 31 sales increased 110 million 52 213 million 2004 323 million 2005 increase primarily due rollout holomag program transaction card market holomag sales accounted approximately 84 million increase 2004 2005 included sales approximately 61 million manufacturers visa transaction cards sales began second half year holomag also sold manufacturers american express diners club cards throughout entire year mastercard beginning fourth quarter sales growth also affected value holomag product sells substantially higher prices conventional hot stamp hologram due unique design high security features also created new product solutions identity document product authentication markets expanded existing customer relationships markets royalty income royalty income remained relatively unchanged cost goods sold excluding depreciation amortization cost goods sold excluding depreciation amortization increased 102 million 92 million 2004 194 million 2005 primarily result volume increase due ramp holomag second half 2005 increases inventory warranty reserves holomag percentage sales cost goods sold excluding depreciation amortization increased 431 2004 600 2005 result visa decision fourth quarter 2005 recorded charge cost goods sold 48 million reserve value holomag inventory provide additional nonesd related warranty claims products sold 2005 selling administrative expensesselling administrative expenses increased 18 million 71 million 2004 89 million 2005 percentage sales selling administrative expenses decreased 333 2004 274 2005 increase expenses primarily due higher professional fees salaries wages support growth business facility consolidation shipping charges increased due higher product shipments well increase allowance doubtful accounts relating visa decision decrease percentage sales primarily due volume increase sales partially offset higher general administrative costs research development research development expenses amounted 13 million 2004 2005 lower testing expenses 2005 partially offset higher salaries wages due manpower additions consulting costs connection holomag program depreciation amortization depreciation amortization increased 05 million 08 million 2004 13 million 2005 increase primarily due acceleration depreciation equipment leasehold improvements company’s abandoned facility elmsford new york 04 million increase fixed assets connection leasehold improvements new equipment company’s new facility robbinsville new jersey facility consolidation expenses facility consolidation expenses 28 million recorded 2005 compared 02 million recorded 2004 amounts recorded facilities consolidation expenses pertain expenses incurred company’s move consolidation new facility robbinsville new jersey 2005 consist primarily future amounts rent due abandoned facility elmsford new york moving costs equipment inventory employee severance costs expenses incurred 2004 consist primarily legal fees real estate commissions employee relocation severance expenses interest income interest income increased 02 million 01 million 2004 03 million 2005 primarily result higher interest rates effect 2005 income decreased 02 million 02 million 2004 0 million 2005 decrease primarily due income patent settlement agreement competitor 2004 recur 2005 income taxes company recorded benefit income taxes 4 million 2005 result pretax loss compared income tax expense 13 million 2004 comparison year ended december 31 2004 year ended december 31 2003 sales increased 30 million 163 183 million 2003 213 million 2004 increase due increase sales holograms transaction cards existing customers 30 million creation new programs transaction cards 09 million 2004 creation new programs identification products 04 million 2004 partially offset sales 13 million identification products 2003 recur 2004 addition commenced new programs pharmaceutical product protection offset continued reduction lower margin label sales royalty income royalty income remained relatively unchanged cost goods sold excluding depreciation amortization cost goods sold excluding depreciation amortization increased 09 million 107 83 million 2003 92 million 2004 percentage sales cost goods sold excluding depreciation amortization decreased 453 2003 431 2004 decrease cost goods sold excluding depreciation amortization percentage sales 2 primarily due greater sales volumes higher margin products current period selling administrative expenses selling administrative expenses increased 06 million 65 million 2003 71 million 2004 percentage sales selling administrative expenses decreased 356 2003 333 2004 increase selling administrative expenses primarily due increase sales salaries 01 million increase selling expenses 01 million primarily due higher trade show travel sample expenses increase administrative salaries benefits 03 million increase administrative expenses 01 million primarily related higher professional fees recruitment expenses research development research development expenses increased 01 million 12 million 2003 13 million 2004 increase primarily due development testing new products depreciation amortization depreciation amortization expense increased 01 million 07 million 2003 08 million 2004 primarily due new assets 2004 facility consolidation expenses facility consolidation expenses 02 million pertain expenses incurred new facility robbinsville new jersey consist primarily legal fees real estate commissions employee relocation severance expenses income increased 02 million 01 million 2003 03 million 2004 increase primarily due income patent settlement agreement competitor 2004 income taxes income tax expense increased 05 million 07 million 2003 12 million 2004 increase primarily due increase taxable income 2004 seasonality sales generally exhibited substantial seasonality however sales operating results date future sales therefore operating results may continue fluctuate quarter degree fluctuation depend number factors including timing level sales change pricing products mix products sold significant portion business expected derived orders placed limited number large customers variations timing orders could cause significant fluctuations operating results customers typically provide us precise forecasts future order quantities quarterly demand products may materially influenced customers’ promotions inventory replenishment transaction card expiration patterns delivery schedules factors may difficult us anticipate factors may result fluctuations operating results include impact visa decision timing new product announcements introduction new products new technologies us competitors delays research development new products increased research development expenses availability cost materials suppliers competitive pricing pressures liquidity capital resources december 31 2005 91 million cash equivalents working capital 136 million company’s operating activities provided cash 03 million 2005 compared 34 million cash provided 2004 decrease primarily due increase accounts receivable inventories connection increase sales partially offset increase accounts payable due growth business investing activities 2005 used cash 31 million including 51 million result capital expenditures primarily associated leasehold improvements new equipment new facility partially offset sales shortterm investments 20 million financing activities 2005 provided cash 06 million due exercise stock options financing activities 2004 provided cash 01 million due exercise options december 14 2004 company entered agreements lease 134000 square foot modern manufacturing office building robbinsville new jersey site primary operations following closure relocation consolidation operations elmsford new york huntingdon valley pennsylvania robbinsville site company completed relocation consolidation operations 2005 robbinsville facility provides substantial room expansion company consolidated operations conducted within 58000 square foot facility elmsford new york 30000 square foot facility huntingdon valley pennsylvania new facility currently evaluating possible use huntingdon valley facility certain manufacturing secure storage company also acquired installed additional equipment technology new facility broaden capabilities serve target customers expand capacity become vertically integrated improve efficiency base rent lease robbinsville new jersey facility 555000 per year increasing 19 per year first seven months lease rentfree recorded deferred rent 04 million 2004 2005 term lease robbinsville facility extends may 31 2017 expiration term options renew lease three consecutive five year periods fair market value also option purchase building end original lease term adjusted fair market value defined lease agreement base rent lease huntingdon valley pennsylvania 144000 per year lease facility expires june 30 2007 base rent lease elmsford new york 746000 per year lease facility expires december 31 2007 facility abandoned part move consolidation 2005 remaining rent net estimated sublease income end lease term charged facility consolidation expense 2005 invested approximately 60 million 2005 capital additions robbinsville new jersey facility conjunction consolidation operations approximately 51 million expended 2005 9 million expended 2004 expenditures facility upgrades customize robbinsville new jersey facility company’s operational security requirements well acquisition new equipment upgrade expand production capabilities believe cash flows operations cash balances sufficient meet working capital needs fund capital expenditures foreseeable future considering potential impact visa decision following table illustrates costs incurred relocation consolidation facilities december 31 2005 anticipated 2006 2007 following table quantifies future obligations consist primarily lease obligations thousands impact inflation recent years inflation significant impact historical operations assurance inflation adversely affect operations future particularly emerging markets inflationary conditions tend prevalent offbalance sheet arrangements company offbalance sheet arrangements unaudited quarterly results operations years ended december 31 2005 2004 1 quarter ended december 31 2005 includes 50 million additional charges visa decision net income loss quarter also impacted facility consolidation expense 22 million 2 diluted income loss per share would antidilutive quarter ended december 31 2005 based fully diluted shares adjusted reflect stock option exercises item 7aitem 7 managements discussion analysis financial condition results operations following discussion analysis read conjunction item 6 selected financial data financial statements including notes thereto appearing elsewhere report overview abnh july 20 1998 whollyowned subsidiary abn date abn completed sale 13636000 shares common stock public offering representing abns entire investment abnh receive proceeds ipo abnh originates massproduces markets holograms used primarily security applications counterfeiting protection credit transaction cards identification cards documents value well tamper resistance authentication highvalue consumer industrial products also produce nonsecure holograms packaging promotional applications sales holograms credit card security applications generally carry higher gross margins sales applications concerns regarding counterfeiting piracy infractions result lost sales lost goodwill product liability claims drive use product authentication holograms companies various industries utilized holograms authentication devices reduce potential losses also concerns counterfeiting copying led increased use holograms documents value including currency passports business cheques gift certificates vouchers certificates deposit stamps postage revenue tickets financial instruments significant portion business derived orders placed credit card companies including mastercard manufacturers visa brand credit cards variations timing orders cause significant fluctuations sales mastercard years ended december 31 2000 1999 1998 approximately 28 27 30 respectively exclusive supplier holograms mastercard pursuant agreement amended extends february 2003 agreement provides automatic twoyear renewal periods terminated either party 1999 informed mastercard believes breached certain terms agreement 1998 1997 working closely mastercard address issues raised mastercard believe relationship mastercard good sales visa card manufacturers approximately 19 18 26 respectively sales years ended december 31 2000 1999 1998 longterm purchase contracts visa supply holograms approximately 50 visa authorized card manufacturers pursuant purchase orders currently one two companies authorized manufacture sell visa brand holograms manufacturers visa brand credit cards either mastercard visa terminate respective relationship us substantially reduce orders would material adverse effect business financial condition results operations cash flows holograms sold purchase orders contracts customers sales related cost goods sold generally recognized latter time shipment title passes customers situations shipped product right return unable reasonably estimate level returns andor sale contingent upon customers use product situations recognize sales upon product shipment rather buyer product informs us product used additionally pursuant terms certain customer completed items stored behalf customer onsite secured facility instance sales recognized following occurred customer ordered goods manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order december 31 2000 1999 accounts receivable customer totaled 04 million 05 million respectively historically purchased certain key materials used manufacture holograms single suppliers supply contracts problems occur respect delivery quality cost materials could material adverse effect financial position results operations cash flows 2000 1999 1998 export sales accounted approximately 31 32 28 respectively total sales export sales presently denominated us dollars sales may fluctuate quarter due changes customers ordering patterns customers typically provide us precise forecasts future order quantities quarterly demand holograms may materially influenced customers promotions inventory replenishment card expiration patterns delivery schedules factors may difficult us anticipate cost goods sold includes raw materials nickel foils films adhesives labor costs manufacturing overhead hologram origination costs represent costs unique master hologram made customer specifications integral part production process result costs goods sold affected product mix manufacturing yields costs hologram originations changes cost raw materials labor selling administrative expenses primarily consist salaries benefits commissions corporate sales marketing administrative personnel marketing advertising expenses services products accordance tax allocation agreement effect date ipo included consolidated us federal income tax return certain instances consolidated combined state local income tax returns abn made payments abn based amounts would payable federal state local income taxes consolidated combined returns filed computed federal state local income tax provision filing separate income tax returns without regard tax allocation agreement 2000 abnh former parent reached agreement subject consummation former parents chapter ii plan exchange mutual general releases obligations may pursuant separation agreement dated july 20 1998 including sums allegedly owing abnh former parent affiliates agreement provides among things former parent responsible shall pay asserted unasserted income franchise similar tax liabilities abnh period january 1 1990 july 20 1998 indemnify abnh respect liabilities amounts paid former parent excess amounts would payable abnh filed separate income tax returns charged due former parent affiliates periods subsequent offering date abnh filing us federal state income tax returns comparison year ended december 31 2000 year ended december 31 sales decreased 22 million 102 212 million 1999 190 million 2000 decrease sales due primarily decrease sales security holograms credit cards 17 million due believe effect high inventory levels transaction card market since many banks acquired extra inventory cards 1998 1999 anticipation potential problems year 2000 transition decrease security holograms 04 million decrease freight billings 01 million royalty income royalty income decreased 01 million 170 05 million 1999 04 million 2000 decrease due lower reported licensee revenue 2000 cost goods sold cost goods sold decreased 23 million 211 112 million 1999 89 million 2000 percentage sales cost goods sold decreased 531 1999 466 2000 decrease comprised decrease provision obsolete excess inventory 5 decrease warranty expense 7 primarily resulting 08 million provision settlement breach contract claim relating warranties 1999 related insurance reimbursement recorded 2000 partially offset increase product cost due changes product mix 6 selling administrative expenses selling administrative expenses decreased 17 million 98 million 1999 81 million 2000 percentage sales selling administrative expenses decreased 463 1999 425 2000 decrease expenses primarily due costs incurred related audit committee investigation related restatement efforts 35 million reoccur 2000 decrease bad debt expense 02 million offset partially increases selling salaries benefits 02 million due addition personnel selling expenses 06 million principally due higher costs incurred travel shows marketing samples administrative salaries benefits 06 million principally due reversal accrued retirement benefits 1999 reoccur 2000 administrative expenses 06 million principally due professional public company expenses interest net interest net decreased 05 million 10 million net expense 1999 05 million net expense 2000 decrease due greater write deferred financing costs associated repayment existing credit facility 1999 write deferred financing costs associated repayment foothill loans 2000 03 million increase interest income 02 million settlement shareholder litigation shareholder litigation amounted 35 million 2000 comprised 34 million regarding settlement shareholder litigation 01 million connection costs incurred regarding sec us attorney investigations settlement former parent settlement former parent amounted 05 million comprised 03 million accounts payable 02 million accrued expenses reversed fourth quarter 2000 resulting settlement entered former parent comparison year ended december 31 1999 year ended december 31 sales decreased 80 million 274 292 million 1998 212 million 1999 decrease sales primarily due decrease sales security holograms credit cards 57 million result 30 million sales fourth quarter 1998 discount normal selling prices exchange immediate payment generally lower purchases security holograms credit cards card manufacturers due higher purchases customers 1998 due concerns regarding potential year 2000 issues distractions impact business associated need restate prior financial statements cost goods sold cost goods sold decreased 75 million 399 187 million 1998 112 million 1999 percentage sales cost goods sold decreased 641 1998 531 1999 decrease reflects decreases amortization origination costs 11 relating 1998 amortization origination costs due lower volumes sales originally estimated amortization costs incurred anticipation orders materialize decreased provisions obsolete excess inventory 2 due improved product quality decrease royalty expenses 2 related royalty litigation settlement reserved 1998 offset increase warranty expense 3 primarily resulting 08 million provision settlement breach contract claim relating warranties increase product cost 1 selling administrative expenses selling administrative expenses increased 30 million 436 68 million 1998 98 million 1999 percentage sales selling administrative expenses increased 234 1998 463 1999 increase selling administrative expenses due primarily costs incurred related audit committee investigation related restatement efforts defense litigation 35 million net insurance reimbursements 06 million increase administrative salaries benefits 04 million offset decrease sales expenses 05 million due lower remuneration travel transportation expenses reversal liability postretirement healthcare benefits 04 million since decided establish plan interest net interest net increased 06 million 04 million 1998 10 million 1999 increase due increase interest expense due write deferred financing costs 06 million related amendments repayment credit agreement chase manhattan bank offset reduction interest expense resulted decrease revolving loan balances 02 million decrease interest income 02 million result cancellation 53 million note receivable former parent bore interest 775 per annum included deemed dividend discussed seasonality sales generally exhibited substantial seasonality however sales operating results date future sales therefore operating results may continue fluctuate quarter degree fluctuation depend number factors including timing level sales change pricing products mix products sold significant portion business expected derived orders placed limited number large customers variations timing orders could cause significant fluctuations operating results customers typically provide us precise forecasts future order quantities quarterly demand holograms may materially influenced customers promotions inventory replenishment card expiration patterns delivery schedules factors may difficult us anticipate factors may result fluctuations operating results include timing new product announcements introduction new products new technologies us competitors delays research development new products increased research development expenses availability cost materials suppliers competitive pricing pressures financing costs liquidity capital resources december 31 2000 79 million cash equivalents working capital 104 million 79 million cash balance includes proceeds generated equity investment abnh crane co inc june 30 2000 net repayment amounts outstanding loan security agreement foothill capital corporation amended foothill loan august 23 2000 terminated repaid outstanding amounts foothill loan foothill loan maturity date september 29 2004 secured substantially assets provided borrowings aggregate amount 100 million subject borrowing base formula revolving credit facility term loan capital expenditure loan borrowings foothill loan bore interest lenders reference rate defined plus 15 foothill loan contained restrictive covenants customary credit facilities similar nature well specific financial covenants ratios result terminating foothill loan incurred 2000 early termination fee 01 million wrote approximately 02 million unamortized deferred financing costs related loans years ended december 31 2000 1999 weighted average interest rate outstanding borrowings approximately 98 84 respectively average aggregate borrowings 2000 1999 approximately 09 million 33 million respectively june 30 2000 entered stock purchase agreement crane co inc crane agreement sold 3387720 shares common stock crane aggregate purchase price 9316230 agreement also provides board directors audit committee board directors expanded one position taken douglas crane affiliate crane agreement crane right purchase proportionate share new issuance securities issued connection acquisition securities issued connection stock option plan agreement securities issued replacement outstanding securities issued holders shares common stock pro rata basis securities issued connection strategic investment also event issue shares common stock securities convertible exercisable shares common stock connection settlement litigation outstanding june 29 2000 crane allowed purchase proportionate share common stock price 335 per share agreement also contains standstill provision whereby crane agreed among things neither affiliates except otherwise provided agreement acquire current proportionate share outstanding securities standstill provision also provides crane offer sell transfer voting securities abnh tender exchange offer opposed board directors year ended december 31 2000 operating activities provided cash flow 04 million compared 15 million 74 million cash flow provided operating activities 1999 1998 respectively decrease cash flows 2000 primarily due decreased earnings 08 million decrease cash provided changes accounts receivable inventories prepaid expenses 39 million offset increases cash provided changes accounts payable accrued expenses customer advances 13 million adjustments reconcile net income net cash provided operations 23 million investing activities years ended december 31 2000 1999 1998 used cash flows approximately 07 million 05 million 04 million respectively activities primarily reflected capital expenditures respective years anticipate capital expenditures 2001 2002 approximately 15 million year amounts relating capital expenditures required improve production capabilities financing activities years ended december 31 2000 1999 1998 provided cash flow 79 million used cash flows 51 million 30 million respectively activity 2000 consisted equity financing net costs 91 million offset partially repayment debt 12 million activity 1999 comprised repayment revolving credit notes payable 57 million incurred deferred financing costs 04 million offset borrowings term loan 10 million activity 1998 comprised principally advances former parent affiliates 78 million deferred financing fees incurred 05 million offset partially revolving credit borrowings 49 million borrowings notes payable 04 million believe cash flows operations cash balances sufficient meet working capital needs service debt fund capital expenditures next twelve months new accounting standards june 1998 financial accounting standards board fasb issued sfas 133 accounting derivative instruments hedging activities sfas 133 amended sfas 137 sfas 138 establishes accounting reporting standards derivative instruments including certain derivative instruments embedded contracts collectively referred derivatives hedging activities effective quarters fiscal years beginning june 15 2000 believe implementation sfas 133 material impact results operations securities exchange commission issued staff accounting bulletin sab 101 revenue recognition december 1999 sab 101 expresses views sec staff applying generally accepted accounting principles certain revenue recognition issues june 2000 sec issued sab 101b defer effective date implementation sab 101 fourth quarter fiscal 2000 concluded implementation sab material impact financial position results operations march 2000 fasb issued interpretation fin 44 accounting certain transactions involving stock compensation interpretation apb opinion 25 fin 44 clarifies definition employees criteria determining whether plan qualifies noncompensatory plan accounting consequences various modifications terms previously fixed stock option award accounting exchange stock compensation awards business combination fin 44 effective july 1 2000 certain conclusions interpretation cover specific events occurred either december 15 1998 january 12 2000 adopted fin 44 july 2000 adoption interpretation material impact current historical financial position results operations cash flows september 2000 emerging issues task force eitf issued eitf 0010 accounting shipping handling fees costs provisions eitf 0010 amounts billed customer sales transaction related shipping handling classified revenues eitf 0010 also requires disclosure statement operations classification shipping handling costs material unless costs included cost goods sold effective october 1 2000 adopted eitf 0010 shipping handling amounts billed customers included revenues shipping handling costs included selling administrative expenses amounted 377000 499000 534000 years ended december 31 2000 1999 1998 respectively comparative prior period financial statements reclassified reflect change adoption eitf impact determination net income loss impact inflation recent years inflation significant impact historical operations assurance inflation adversely affect operations future particularly emerging markets inflationary conditions tend prevalent unaudited quarterly results operations years ended december 31 2000 1999 year ended december 31 2000 incurred costs 34 million regarding settlement shareholder litigation 01 million connection settlements sec us attorney investigations addition reversed 05 million accounts payable accrued expenses resulting settlement entered former parent items included income expense accompanying statement operations additionally third quarter 2000 insurance carriers agreed pay 750000 us product liability reimbursement included cost sales b quarterly sales years ended december 31 2000 1999 adjusted amounts originally reported include shipping charges billed customers previously netted general administrative expenses required securities exchange commission c quarterly cost goods sold years ended december 31 2000 1999 adjusted amounts previously reported due reclassification research development costs cost sales separate expense line item accompanying statement operations year ended december 31 1999 incurred costs 35 million net 06 million insurance reimbursements connection audit committee investigation related restatement effort defense litigation also 1999 determined would establish postretirement health care plan reversed 404000 accrued liability regard costs reversal included selling administrative expenses item 7aitem 7 management’s discussion analysis financial condition results operations following discussion analysis read conjunction “item 6 selected financial data” financial statements including notes thereto appear elsewhere report overview abnh july 20 1998 whollyowned subsidiary american banknote corporation “abn” date abn completed sale 13636000 shares common stock initial public offering “offering” representing abn’s entire investment abnh receive proceeds offering originate produce market sell secure holograms products incorporating secure holograms products used primarily security applications including authentication transaction cards identity documents value documents various consumer products operate one reportable industry segment ability create distinctive secure optically variable devices reproduce high quality distribute securely enabled us become market leader security holography products sold 200 companies worldwide including mastercard visa american express discover diners club citicorp sears nordstrom janssencilag eli lilly genomma quaker state roshfrans sony oki data raytheon nike reebok prince well united states government governments companies also produce nonsecure holograms design promotional applications concerns regarding counterfeiting piracy infractions result lost sales lost goodwill product liability claims drive use product authentication holograms companies various industries utilize holograms authentication devices significant portion business derived orders placed certain transaction card companies manufacturers transaction cards variations timing orders cause significant fluctuations sales transaction card companies manufacturers transaction cards accounted approximately 84 86 total sales 2006 2005 respectively traditional hot stamp hologram supplied many transaction cards primary source revenue twenty years certain customers began transition hot stamp hologram integrated holographic magnetic stripe “holomag” supply cancelled plans make transition reverting back traditional hot stamp hologram due small number incidents certain card terminals affected electrostatic discharge “esd” static electricity carried cards incorporating first generation holomag result advised esd issue response requests customers developed second generation holomag product addresses esd currently offering customers second generation version holomag began shipping product limited quantities early 2007 sales manufacturers visa transaction cards approximately 35 37 sales years ended december 31 2006 2005 respectively currently authorized supplier visa dove hot stamp holograms manufacturers visa brand transaction cards march 15 2005 visa announced intention phase dove hot stamp hologram supply visa card replace integrated holographic magnetic stripe april 8 2005 entered agreement visa pursuant authorized supply holomag visa approved card manufacturers began shipping holomag visa authorized card manufacturers second half 2005 march 14 2006 informed visa result esd issue visa effectively ceasing holomag program “visa decision” visa moved include either dove hot stamp hologram mini dove hot stamp hologram supply security device visa cards letter dated november 7 2006 advised visa terminating visa holomag agreement sales visa products visa authorized card manufacturers 2006 2005 follows sales holomag visa authorized card manufacturers expected continue 2007 sales hot stamp holograms visa authorized card manufacturers expected continue 2007 lose substantial portion hot stamp hologram business visa without replacing new product sales business operating results financial condition would materially adversely affected addition fail obtain anticipated orders visa authorized card manufactures experience delays cancellations orders card manufacturers business financial performance materially adversely affected sales mastercard approximately 35 31 sales years ended december 31 2006 2005 respectively agreement mastercard amended pursuant company exclusive supplier mastercard holograms holographic magnetic stripes holomag™ quarter ended september 30 2005 mastercard advised member financial institutions around world allow choose among card designs incorporate either traditional hot stamp patch hologram holomag supplied company sales holomag mastercard significant 2006 february 9 2007 mastercard advised certified card manufacturers us effective immediately suspending use first generation holomag product due decrease demand product date mastercard approved second generation holomag product mastercard informed us continuing test second generation holomag product agreement mastercard expires february 28 2013 subject automatic renewal thereafter lose substantial portion business mastercard without replacing new product sales business operating results financial condition would materially adversely affected addition fail obtain anticipated orders mastercard experience delays cancellations orders mastercard business financial performance materially adversely affected products sold fixed price basis purchase orders contracts customers sales related cost goods sold generally recognized latter time shipment title passes customers situations shipped product sale contingent upon customers’ use product situations recognize sales upon product shipment rather buyer product informs us product used additionally pursuant request agreement certain customer completed items stored behalf customer onsite secured facility instance sales recognized following occurred customer ordered goods pursuant fixed price purchase order manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order collection invoice considered reasonably assured december 31 2006 2005 accounts receivable customer totaled 24 million 15 million respectively certain cases agreed maintain inventory products customer ensure quick turn around deliveries accept returns product sold customers product determined conformance specifications previously agreed upon customers accordance terms warranty policy generally replaces product generally provide replacement product 180 days original shipment warranty defective product shipping handling amounts billed customers included sales amounted 09 million 09 million 04 million 2006 2005 2004 respectively purchase certain key materials used manufacture products subcontract certain production functions products third parties sole suppliers cases supply contracts suppliers operate purchase order basis case holomag single supplier cfc international inc itw company supply contract amended july 26 2006 also time negotiated settlement cfc international inc resulted reduction payable approximately 10 million may able find alternative sources timely manner suppliers subcontractors become unwilling unable supply us increase prices inability obtain key product components certain processes performed behalf could cause delays reduce product shipments could cause relationship customers suffer materially adversely affect financial condition results operations cash flows 2006 2005 2004 export sales accounted approximately 35 34 21 respectively total sales export sales presently denominated us dollars sales may fluctuate quarter due changes customers’ ordering patterns customers typically provide us precise forecasts future order quantities quarterly demand products may materially influenced customers’ promotions inventory replenishment card expiration patterns delivery schedules factors visa decision may difficult us anticipate cost goods sold includes raw materials nickel foils films adhesives labor costs manufacturing overhead hologram origination costs represent costs unique master hologram made customer specifications integral part production process cost goods sold also includes cost certain processes outsource third parties result costs goods sold affected product mix manufacturing yields supplier prices changes cost raw materials labor selling administrative expenses primarily consist salaries benefits commissions corporate sales customer service marketing administrative personnel marketing promotion expenses legal accounting expenses associated public company also include cost shipping handling product deliveries billed customers selling administrative expenses costs amounted 11 million 10 million 05 million 2006 2005 2004 respectively critical accounting policies preparation financial statements conformity accounting principles generally accepted united states america requires management make use estimates assumptions impact reported amounts assets liabilities date financial statements reported amounts revenue expenses reporting period ongoing basis evaluate estimates including related bad debts stockbased compensation inventories intangible assets taxes estimates assumptions based historical results trends well forecasts estimates assumptions might change future believe following critical accounting policies impact significant judgments estimates use preparation financial statements revenue recognition recognize revenue accordance provisions sec’s staff accounting bulletin “sab” 104 “revenue recognition amendment sab 101 “revenue recognition financial statements”” products sold fixed price basis purchase orders contracts customers sales related cost goods sold generally recognized latter time shipment title passes customers situations shipped product sale contingent upon customers’ use product situations recognize sales upon product shipment rather buyer product informs us product used additionally pursuant request agreement certain customer completed items stored behalf customer onsite secured facility instance sales recognized following occurred customer ordered goods pursuant fixed price purchase order manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order collection invoice considered reasonably assured certain cases agreed maintain inventory products customer ensure quick turn around deliveries accept returns product sold customers product determined conformance specifications previously agreed upon customers accordance terms warranty policy typically within 180 days sale generally replaces product customer advances represent payments received customers products yet shipped customer advances classified current liabilities balance sheets shipping handling amounts billed customers included sales shipping handling costs included selling administrative expenses amounted 11 million 10 million 05 million 2006 2005 2004 respectively allowance doubtful accounts maintain allowances doubtful accounts estimated losses resulting inability customers make required payments recognize allowance doubtful accounts based length time receivables past due current general business environment credit worthiness current specific business conditions customers historical experience financial condition customers deteriorate economic conditions worsen additional allowances may required future inventory valuation inventories stated lower cost market cost determined firstin firstout fifo method balance sheet date evaluate ending inventory excess quantities obsolescence provide reserves estimated obsolescence equal difference cost inventory estimated market value fully reserve inventories deemed obsolete future demand market conditions less favorable projections additional inventory writedowns may required impairment longlived assets account longlived assets accordance sfas 144 accounting impairment disposal longlived assets “sfas 144” sfas 144 requires longlived assets certain identifiable intangibles reviewed impairment whenever events changes circumstances indicate carrying amount asset may recoverable recoverability assets held used measured comparison carrying amount asset future net cash flows expected generated asset assets considered impaired impairment recognized measured amount carrying amount assets exceeds fair value assets disposed reported lower carrying amount fair value less costs sell recent accounting pronouncements september 2006 financial accounting standards board issued sfas 157 “fair value measurements” “sfas 157” sfas 157 defines fair value establishes framework measuring fair value generally accepted accounting principles expands disclosures fair value measurements sfas 157 effective fiscal years beginning december 15 2007 company currently process evaluating impact adoption sfas 157 financial position results operations cash flows september 2006 sec issued staff accounting bulletin 108 “considering effects prior year misstatements quantifying misstatements current year financial statements” “sab 108” address diversity practice quantifying financial statement misstatements sab 108 requires company quantifies misstatements based impact financial statements related disclosures adopted provisions sab 108 fourth quarter 2006 adoption effect financial statements july 2006 financial accounting standards board issued interpretation 48 “accounting uncertainty income taxes interpretation sfas 109” “fin 48” fin 48 clarifies accounting uncertainty income tax positions taken expects take respect tax return pronouncement prescribes morelikelythannot threshold recognition well measurement criteria changes tax positions financial statement purposes addition fin 48 also requires additional qualitative quantitative disclosures unrecognized tax benefits included notes financial statements adopt provisions fin 48 quarter ending march 31 2007 reviewed accounting income taxes light provisions fin 48 expect adoption materially affect consolidated financial statements december 2004 financial accounting standards board issued statement 123r fas 123r sharebased payment revising fas 123 requiring sharebased payments employees recognized financial statements generally approach accounting sharebased payments fas 123r similar approach described fas 123 however pro forma footnote disclosure longer alternative financial statement recognition adopted new statement effective january 1 2006 using modifiedprospective transition method described statement method recognize compensation expense remaining vesting period awards remain unvested january 1 2006 permitted fas 123 previously accounted sharebased payments employees using apb 25’s intrinsic value method generally recognized compensation cost employee stock options impact 2006 results shown results operations note 8”stockbased compensation” financial statements november 2004 financial accounting standards board “fasb” issued statement 151 “fas 151” inventory costs amendment arb 43 chapter 4 fas 151 clarifies abnormal amounts idle facility expense freight handling costs wasted materials recognized current period charges addition fas 151 requires allocation fixed production overhead inventory based normal capacity production facilities fas 151 effective inventory costs incurred fiscal years beginning june 15 2005 adopted fas 151 2006 result impact visa decision recorded approximately 08 million overhead expenses period expenses 2006 march 2005 fasb issued interpretation 47 accounting conditional asset retirement obligations interpretation sfas 143 interpretation clarifies term conditional asset retirement obligation refers legal obligation perform asset retirement activity timing andor method settlement conditional future event may within control entity obligation perform asset retirement activity unconditional even though uncertainty exists timing andor method settlement accordingly entity required recognize liability fair value conditional asset retirement obligation fair value liability reasonably estimated provisions interpretation 47 effective fiscal years ending december 15 2005 adopted interpretation 47 2006 adoption statement impact financial statement presentation since conditional asset retirement obligations stockbased compensation expense beginning first quarter 2006 required record expense sharebased payment transactions pursuant statement financial accounting standards 123 r “fas 123r” modified prospective method required restate prior year financial statements include current year expenses related stock option grants vested december 31 2005 use blackscholes option pricing model calculate fair value options key assumptions valuation method include expected term option stock price volatility riskfree interest rate dividend yield exercise price forfeiture rate many assumptions judgmental highly sensitive determination compensation expense first quarter 2006 modified assumption expected term used fas 123 reflect estimated reduction amount time options granted remain outstanding result historical trends increased expected volatility based recent events resulted significantly higher volatility previous periods fas 123r required estimate forfeitures rather recording forfeitures occur previously permitted estimated forfeiture rate determined reviewing historical trends fourth quarter 2006 modified assumptions expected term forfeitures based upon actual experience 2006 continue review blackscholes assumptions modify needed future changes assumptions may lead variations compensation expense record future periods 2006 operating income reduced 980000 stockbased payment compensation expense stock options restricted stock stockbased compensation 2006 affected cost goods sold 225000 selling general administrative expenses 639000 research development expenses 116000 stockbased compensation expense reduced 2006 net income 638000 basic fully diluted earnings per share 003 fas 123r also requires benefits tax deductions excess recognized compensation cost reported financing cash flow rather operating cash flow required previous accounting literature effect reducing net operating cash flows increasing financing cash flows periods adoption year ended december 31 2006 recognized financing cash flows amounting 58000 excess tax deductions fas 123r also requires computation apic pool amount excess tax benefits available offset future “shortfalls” calculated beginning apic pool using “longform” method apic pool used subsequent adoption fas 123r determining whether amounts deferred tax assets related stock options excess tax deductions realized short falls need recorded expense impact visa decision february 23 2006 reported learned small number incidents certain card terminals affected electrostatic discharge “esd” static electricity carried cards incorporating holomag also reported date advised customers need develop second generation holographic magnetic tape product addresses esd issue commenced development could assurance would successful developing product would acceptable customers march 14 2006 informed visa result esd issue visa effectively ceasing holomag program “visa decision” visa moved include either dove hot stamp hologram mini hot stamp hologram supply security device visa cards letter dated november 7 2006 advised visa terminating visa holomag agreement visa’s march 2006 correspondence us visa stated view “a remediation program impacted stakeholders may necessary” visa would seek indemnification us costs andor claims evaluating visa’s actions claims continue discuss matter visa believe complied visa holomag agreement holomag product complied standards specifications contained agreement accordingly quarter ended december 31 2005 result visa decision recorded pretax charge amounting approximately 50 million 48 million recorded cost goods sold principally related value holomag inventory also included charge increases provisions accounts receivable potential nonesd related warranty claims also shipments totaling approximately 23 million visa holomag completed invoiced quarter ended march 31 2006 recognized revenue collection amounts considered probable result visa decision 2006 subsequent completing filing financial statements quarter ended march 31 2006 substantially amounts outstanding relating prior shipments visa holomag collected accordingly revenue approximately 09 million 02 million 12 million recorded quarters ended june 30 2006 september 30 2006 december 31 2006 respectively also 2006 wroteoff value visa holomag inventory reversed reserve obsolescence recorded quarter ended december 31 2005 additionally result visa decision twelve months ended december 31 2006 wroteoff approximately 08 million idle facility costs absorbed inventory approximately 03 million costs capitalized balance sheet december 31 2005 relating terminated manufacturing project 2006 also analyzed provision levels warranty liability accounts receivable recorded necessary adjustments invented technology methods significantly reducing esd filed patent applications inventions incorporated invention holomag product testing shows second generation holomag product generally exhibits esd standard black magnetic stripe currently offering customers second generation version holomag began shipping product limited quantities early 2007 although assurance given second generation version holomag accepted customers results operations comparison year ended december 31 2006 year ended december 31 2005 sales increased 02 million 1 323 million 2005 325 million 2006 increase achieved despite cessation sales visa holomag result visa decision sales visa holomag amounted 61 million 2005 54 million 2006 excluding decline visa holomag sales 2006 sales transaction card market increased slightly result expansion existing products new customer programs 2006 also experienced sales growth product authentication security identification markets royalty income royalty income immaterial declined 2005 cost goods sold excluding depreciation amortization cost goods sold excluding depreciation amortization decreased 36 million 194 million 2005 158 million 2006 decrease primarily result increases inventory warranty reserves holomag 2005 recur 2006 recognition approximately 23 million visa holomag revenue 2006 corresponding cost goods sold recur future periods also reducing cost goods sold 2006 compared 2005 full year affect cost reductions associated consolidation facilities robbinsville new jersey occurred 2005 expect cost reductions realized future periods result efficiencies gaining facility consolidation partially offsetting decreases approximately 08 million idle facility costs absorbed inventory well approximately 02 million stockbased compensation expense percentage sales cost goods sold excluding depreciation amortization decreased 600 2005 485 2006 result visa decision fourth quarter 2005 recorded charge cost goods sold 48 million reserve value holomag inventory provide additional nonesd related warranty claims products sold 2005 believe reasonable likelihood approximately 07 million nonvisa related reserves balance sheet december 31 2006 reversed income 2007 periods potential claims programs expire selling administrative expenses selling administrative expenses increased 01 million 89 million 2005 90 million 2006 percentage sales selling administrative expenses increased 274 2005 277 2006 increase expenses primarily due higher professional fees salaries wages support growth business well addressing holomag related matters increased costs associated public company well approximately 06 million stockbased compensation expense partially offset reduction bad debt expense resulting reduction allowance doubtful accounts increase costs percentage sales primarily due higher general administrative costs research development research development expenses increased 03 million 13 million 2005 16 million 2006 primarily result higher research development costs associated invention reduce esd development second generation holomag product development complementary products well approximately 01 million stockbased compensation expense depreciation amortization depreciation amortization decreased 05 million 13 million 2005 08 million 2006 higher depreciation expenses resulting additions fixed assets year robbinsville new jersey facility offset reversal portion anticipated costs previously recorded renovation vacated facility elmsford new york result settlement buildings owner facility consolidation expenses facility consolidation expenses 01 million recorded 2006 compared 28 million recorded 2005 expense recorded 2006 resulted expenses related employee relocations additional expenses incurred abandoned facility rent partially offset impact settlement owner abandoned facility elmsford new york reduced remaining rent owed lease 10 costs recorded 2005 include majority costs incurred relocation consolidation project consist primarily future amounts rent due abandoned facility elmsford new york moving costs equipment inventory employee severance costs interest income interest income increased 02 million 03 million 2005 05 million 2006 primarily result higher average cash balances higher interest rates effect 2006 income taxes provision income taxes increased 26 million 04 million 2005 22 million 2006 percentage income taxes provision income taxes decreased 400 2005 376 2006 decrease effective tax rate due reduction permanent timing differences 2006 well adjustments provision actual deductions tax credits recorded 2006 filing 2005 income tax returns differed income tax provision september 30 2005 believe reasonable likelihood portion reserve balance sheet december 31 2006 reversed income 2007 comparison year ended december 31 2005 year ended december 31 2004 sales increased 110 million 52 213 million 2004 323 million 2005 increase primarily due rollout holomag program transaction card market holomag sales accounted approximately 84 million increase 2004 2005 included sales approximately 61 million manufacturers visa transaction cards sales began second half year holomag also sold manufacturers american express diners club cards throughout entire year mastercard beginning fourth quarter sales growth also affected value holomag product sells substantially higher prices conventional hot stamp hologram due unique design high security features also created new product solutions identity document product authentication markets expanded existing customer relationships markets royalty income royalty income remained relatively unchanged cost goods sold excluding depreciation amortization cost goods sold excluding depreciation amortization increased 102 million 92 million 2004 194 million 2005 primarily result volume increase due ramp holomag second half 2005 increases inventory warranty reserves holomag percentage sales cost goods sold excluding depreciation amortization increased 431 2004 600 2005 result visa decision fourth quarter 2005 recorded charge cost goods sold 48 million reserve value holomag inventory provide additional nonesd related warranty claims products sold 2005 selling administrative expenses selling administrative expenses increased 18 million 71 million 2004 89 million 2005 percentage sales selling administrative expenses decreased 333 2004 274 2005 increase expenses primarily due higher professional fees salaries wages support growth business facility consolidation shipping charges increased due higher product shipments well increase allowance doubtful accounts relating visa decision decrease percentage sales primarily due volume increase sales partially offset higher general administrative costs research development research development expenses amounted 13 million 2004 2005 lower testing expenses 2005 partially offset higher salaries wages due manpower additions consulting costs connection holomag program depreciation amortization depreciation amortization increased 05 million 08 million 2004 13 million 2005 increase primarily due acceleration depreciation equipment leasehold improvements company’s abandoned facility elmsford new york 04 million increase fixed assets connection leasehold improvements new equipment company’s new facility robbinsville new jersey facility consolidation expenses facility consolidation expenses 28 million recorded 2005 compared 02 million recorded 2004 amounts recorded facilities consolidation expenses pertain expenses incurred company’s move consolidation new facility robbinsville new jersey 2005 consist primarily future amounts rent due abandoned facility elmsford new york moving costs equipment inventory employee severance costs expenses incurred 2004 consist primarily legal fees real estate commissions employee relocation severance expenses interest income interest income increased 02 million 01 million 2004 03 million 2005 primarily result higher interest rates effect 2005 income decreased 02 million 02 million 2004 0 million 2005 decrease primarily due income patent settlement agreement competitor 2004 recur 2005 income taxes company recorded benefit income taxes 4 million 2005 result pretax loss compared income tax expense 12 million 2004 seasonality sales generally exhibited substantial seasonality however sales operating results date future sales therefore operating results may continue fluctuate quarter degree fluctuation depend number factors including timing level sales change pricing products mix products sold significant portion business expected derived orders placed limited number large customers variations timing orders could cause significant fluctuations operating results customers typically provide us precise forecasts future order quantities quarterly demand products may materially influenced customers’ promotions inventory replenishment transaction card expiration patterns delivery schedules factors may difficult us anticipate factors may result fluctuations operating results include impact visa decision timing new product announcements introduction new products new technologies us competitors delays research development new products increased research development expenses availability cost materials suppliers competitive pricing pressures liquidity capital resources december 31 2006 153 million cash equivalents working capital 191 million operating activities provided cash 60 million 2006 03 million 2005 substantial increase cash 2006 primarily result net income 36 million adjusted noncash costs 38 million changes operating assets liabilities 14 million 38 million noncash adjustments primarily related 18 million change net deferred taxes primarily due disposal visa holomag inventories previously reserved ii 10 million sharebased compensation expense due adoption fas 123 r iii depreciation expense totaling 08 million iv 03 million writeoff certain fixed assets result visa decision 14 million cash usage result changes asset liability accounts primarily result 16 million decrease accounts payable primarily result 10 million settlement vendor ii 08 million decrease longterm liabilities principally result accrued facility consolidation costs becoming current liability iii 06 million reduction income taxes receivablepayable result overpaying estimated income taxes 2005 iv 05 million reduction accrued liabilities partially offset 12 million reduction accounts receivable primarily result collection visa holomag receivables 08 million reduction inventories investing activities 2006 neither provided used cash primarily result return 04 million progress payments made manufacturer special machine accepted company offset capital expenditures 04 million year financing activities 2006 provided cash 02 million due exercise stock options fas 123r requires benefits tax deductions excess recognized compensation cost reported financing cash flow rather operating cash flow required previous accounting literature effect reducing net operating cash flows increasing financing cash flows periods adoption year ended december 31 2006 recognized financing cash flows amounting 01 million excess tax deductions operating activities provided cash 03 million 2005 compared 34 million cash provided 2004 decrease primarily due increase accounts receivable inventories connection increase sales partially offset increase accounts payable accrued liabilities due growth business investing activities 2005 used cash 31 million including 51 million result capital expenditures primarily associated leasehold improvements new equipment new facility partially offset sales shortterm investments 20 million financing activities 2005 provided cash 06 million due exercise stock options december 14 2004 entered agreements lease 134000 square foot modern manufacturing office building robbinsville new jersey site primary operations following closure relocation consolidation operations elmsford new york huntingdon valley pennsylvania robbinsville new jersey site completed relocation consolidation operations 2005 robbinsville facility provides substantial room expansion consolidated operations conducted within 58000 square foot facility elmsford new york 30000 square foot facility huntingdon valley pennsylvania new facility 2006 reopened huntingdon valley facility certain manufacturing secure storage also acquired installed additional equipment technology new facility broaden capabilities serve target customers expand capacity become vertically integrated improve efficiency base rent lease robbinsville new jersey facility 555000 per year increasing 19 per year first seven months lease rentfree recorded deferred rent 04 million 2004 2005 term lease robbinsville facility extends may 31 2017 expiration term options renew lease three consecutive five year periods fair market value also option purchase building end original lease term adjusted fair market value defined lease agreement base rent lease huntingdon valley pennsylvania 144000 per year lease facility expires june 30 2007 currently negotiating potential extension lease huntingdon valley pennsylvania facility base rent lease elmsford new york 746000 per year lease facility expires december 31 2007 facility abandoned part move consolidation 2005 remaining rent net estimated sublease income end lease term charged facility consolidation expense 2005 quarter ended september 30 2006 entered amendment lease elmsford new york facility terms amendment buildings owner agreed ten percent 10 reduction fixed annual rent retroactive april 1 2006 recorded reduction facility consolidation expense ii payment 100000 contribution towards cost demolition restoration facility recorded reduction depreciation expense iii provided letter credit favor owner amount 78960680 event uncured default payments lease agreement iv acceleration payments us lease agreement event facility subleased invested approximately 60 million 2005 capital additions robbinsville new jersey facility conjunction consolidation operations approximately 51 million expended 2005 9 million expended 2004 expenditures facility upgrades customize robbinsville new jersey facility operational security requirements well acquisition new equipment upgrade expand production capabilities believe cash flows operations cash balances sufficient meet working capital needs fund capital expenditures foreseeable future 2007 pursuing prospective strategic acquisitions partnerships order diversify product line customer base achieve scale efficiencies strengthen position integrated supplier products services authenticate protect enhance critical valuable documents products brands funding acquisitions partnerships determined case basis could include combination cash debt equity following table quantifies future obligations consist primarily lease obligations thousands impact inflation recent years inflation significant impact historical operations assurance inflation adversely affect operations future particularly emerging markets inflationary conditions tend prevalent offbalance sheet arrangements offbalance sheet arrangements unaudited quarterly results operations years ended december 31 2006 2005 1 adopted fas 123 r modified prospective method effective january 1 2006 resulting stock based compensation expense impacted net income 146000 178000 171000 116000 quarters ended march 31 june 30 september 30 december 31 2006 respectively modified prospective method required restate prior year financial statements 2 quarter ended december 31 2005 includes 50 million additional charges holomag inventory adjustment additional warranty provision increase allowance doubtful accounts net income loss quarter also impacted facility consolidation expense 22 million 3 diluted income loss per share would antidilutive quarter ended december 31 2005 based fully diluted shares adjusted reflect stock options item 7a item 7a quantitative qualitative disclosures market risk engage significant activity respect market risk sensitive instruments accordingly risk respect market risk sensitive instruments immaterial item 8item 7a quantitative qualitative disclosures market risk engage significant activity respect market risk sensitive instruments accordingly risk respect market risk sensitive instruments immaterial item 8item 7a quantitative qualitative disclosures market risk engage significant activity respect market risk sensitive instruments accordingly risk respect market risk sensitive instruments immaterial item 8item 7a quantitative qualitative disclosures market risk engage significant activity respect market risk sensitive instruments accordingly risk respect market risk sensitive instruments immaterial item 8item 7a quantitative qualitative disclosures market risk engage significant activity respect market risk sensitive instruments accordingly risk respect market risk sensitive instruments immaterial item 8item 7a quantitative qualitative disclosures market risk engage significant activity respect market risk sensitive instruments accordingly risk respect market risk sensitive instruments immaterial item 8item 7a quantitative qualitative disclosures market risk engage significant activity respect market risk sensitive instruments accordingly risk respect market risk sensitive instruments immaterial item 8item 7a quantitative qualitative disclosures market risk engage significant activity respect market risk sensitive instruments accordingly risk respect market risk sensitive instruments immaterial item 8item 7a quantitative qualitative disclosures market risk engage significant activity respect market risk sensitive instruments accordingly risk respect market risk sensitive instruments immaterial item 8 item 8 financial statements supplementary data financial statements supplementary data required item filed part form 10k see index financial statements page form 10k item 9item 8 financial statements supplementary data financial statements supplementary data required item filed part form 10 k see index financial statements page form 10k item 9item 8 financial statements supplementary data financial statements supplementary data required item filed part form 10k see index financial statements page form 10k item 9item 8 financial statements supplementary data financial statements supplementary data required item filed part form 10k see index financial statements page form 10k item 9item 8 financial statements supplementary data financial statements supplementary data required item filed part form 10k see index financial statements page form 10k item 9item 8 financial statements supplementary data financial statements supplementary data required item filed part form 10k see index financial statements page form 10k item 9item 8 financial statements supplementary data financial statements supplementary data required item filed part form 10k see index financial statements page form 10k item 9item 8 financial statements supplementary data financial statements supplementary data required item filed part form 10k see index financial statements page form 10k item 9item 8 financial statements supplementary data financial statements supplementary data required item filed part form 10k see index financial statements page form 10k item 9 nannannanitem 15 exhibits financial statement schedules reports form 8k 1 financial statements financial statements required item submitted separate section beginning page report 2 financial statement schedules financial statement schedule required item submitted separate section page s1 report schedules included page s1 report omitted absence conditions required information included financial statements notes thereto 3 exhibits see c see a2 signatures pursuant requirements section 13 15d securities exchange act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized american bank note holographics inc kenneth h traub kenneth h traub president chief executive officer march 31 2003 pursuant requirements securities exchange act 1934 report signed following persons behalf registrant capacities dates indicated certifications kenneth h traub certify 1 reviewed annual report form 10k american bank note holographics inc 2 based knowledge annual report contain untrue statement material fact omit state material fact necessary make statements made light circumstances statements made misleading respect period covered annual report 3 based knowledge financial statements financial information included annual report fairly present material respects financial condition results operations cash flows registrant periods presented annual report 4 registrant’s certifying officers responsible establishing maintaining disclosure controls procedures defined exchange act rules 13a14 15d14 registrant designed disclosure controls procedures ensure material information relating registrant including consolidated subsidiaries made known us others within entities particularly period annual report prepared b evaluated effectiveness registrant’s disclosure controls procedures date within 90 days prior filing date annual report “evaluation date” c presented annual report conclusions effectiveness disclosure controls procedures based evaluation date 5 registrant’s certifying officers disclosed based recent evaluation registrant’s auditors audit committee registrant’s board directors persons performing equivalent functions significant deficiencies design operation internal controls could adversely affect registrant’s ability record process summarize report financial data identified registrant’s auditors material weaknesses internal controls b fraud whether material involves management employees significant role registrant’s internal controls 6 registrant’s certifying officers indicated annual report whether significant changes internal controls factors could significantly affect internal controls subsequent date recent evaluation including corrective actions regard significant deficiencies material weaknesses date march 31 2003 kenneth h traub kenneth h traub president chief executive officer alan goldstein certify 1 reviewed annual report form 10k american bank note holographics inc 2 based knowledge annual report contain untrue statement material fact omit state material fact necessary make statements made light circumstances statements made misleading respect period covered annual report 3 based knowledge financial statements financial information included annual report fairly present material respects financial condition results operations cash flows registrant periods presented annual report 4 registrant’s certifying officers responsible establishing maintaining disclosure controls procedures defined exchange act rules 13a14 15d14 registrant designed disclosure controls procedures ensure material information relating registrant including consolidated subsidiaries made known us others within entities particularly period annual report prepared b evaluated effectiveness registrant’s disclosure controls procedures date within 90 days prior filing date annual report “evaluation date” c presented annual report conclusions effectiveness disclosure controls procedures based evaluation date 5 registrant’s certifying officers disclosed based recent evaluation registrant’s auditors audit committee registrant’s board directors persons performing equivalent functions significant deficiencies design operation internal controls could adversely affect registrant’s ability record process summarize report financial data identified registrant’s auditors material weaknesses internal controls b fraud whether material involves management employees significant role registrant’s internal controls 6 registrant’s certifying officers indicated annual report whether significant changes internal controls factors could significantly affect internal controls subsequent date recent evaluation including corrective actions regard significant deficiencies material weaknesses date march 31 2003 alan goldstein alan goldstein chief financial officer chief accounting officer american bank note holographics inc item 15a report independent auditors board directors stockholders american bank note holographics audited accompanying balance sheets american bank note holographics inc “company” december 31 2002 related statements operations stockholders’ equity cash flows year ended audit also included financial statement schedule listed index item 15a financial statements schedule responsibility company’s management responsibility express opinion financial statements schedule based audit financial statements company december 31 2001 two years period ended december 31 2001 audited auditors ceased operations whose report dated march 1 2002 expressed unqualified opinion statements conducted audit accordance auditing standards generally accepted united states standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audit provides reasonable basis opinion financial statements referred present fairly material respects financial position company december 31 2002 results operations cash flows year ended conformity accounting principles generally accepted united states also opinion related financial statement schedule year ended december 31 2002 considered relation basic financial statements taken whole presents fairly material respects information set forth therein discussed financial statements company december 31 2001 two years period ended december 31 2001 audited auditors ceased operations described note 1 financial statements revised include transitional disclosures required statement financial accounting standards “statement” 142 “goodwill intangible assets” adopted company january 1 2002 audit procedures respect disclosures note 1 respect 2001 2000 included agreeing previously reported net income loss previously issued financial statements adjustments reported net income loss representing amortization expense recognized periods related goodwill longer amortized result initially applying statement 142 company’s underlying records obtained management b testing mathematical accuracy reconciliation adjusted net income loss reported net income loss related net loss income per share amounts opinion disclosures 2001 2000 note 1 appropriate however engaged audit review apply procedures 2001 2000 financial statements company respect disclosures accordingly express opinion form assurance 2001 2000 financial statements taken whole ernst young llp new york new york march 7 2003 following copy previously issued report arthur andersen llp dated march 1 2002 related audit financial statements american bank note holographics inc twoyear period ended december 31 2001 2002 arthur andersen llp ceased operations reissued report additionally arthur andersen llp consented use audit report since american bank note holographics inc unable obtain current manually signed audit report copy arthur andersen’s recent signed dated report included satisfy filing requirements permitted rule 202e regulation sx report independent public accountants board directors stockholders american bank note holographics inc audited accompanying balance sheets american bank note holographics inc delaware corporation december 31 2001 2000 related statements operations stockholders’ equity cash flows years ended financial statements schedule referred responsibility company’s management responsibility express opinion financial statements schedule based audits conducted audits accordance auditing standards generally accepted united states standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audits provide reasonable basis opinion financial statements referred present fairly material respects financial position american bank note holographics inc december 31 2001 2000 results operations cash flows years ended conformity accounting principles generally accepted united states audits made purpose forming opinion basic financial statements taken whole supplemental schedule page s1 presented purposes additional analysis required part basic financial statements information subjected auditing procedures applied audits basic financial statements opinion fairly stated material respects relation basic financial statements taken whole arthur andersen llp new york new york march 1 2002 american bank note holographics inc balance sheets december 31 2002 2001 thousands except share data accompanying notes integral part financial statements american bank note holographics inc statements operations years ended december 31 2002 2001 2000 thousands except per share data accompanying notes integral part financial statements american bank note holographics inc statements stockholders’ equity years ended december 31 2002 2001 2000 thousands accompanying notes integral part financial statements american bank note holographics inc statements cash flows years ended december 31 2002 2001 2000 thousands accompanying notes integral part financial statements american bank note holographics inc notes financial statements years ended december 31 2002 2001 2000 1 basis presentation summary significant accounting policies american bank note holographics inc “company” “abnh” incorporated state delaware august 1985 company july 20 1998 “offering date” whollyowned subsidiary american banknote corporation “former parent” company originates massproduces markets secure holograms used security packaging promotional applications company operates one reportable industry segment use estimates preparation financial statements conformity accounting principles generally accepted united states requires management make estimates assumptions affect reported amounts assets liabilities disclosure contingent assets liabilities date financial statements reported amounts sales expenses reporting period actual results may differ materially estimates cash equivalents highly liquid investments primarily government bonds maturity three months less purchased considered cash equivalents stated cost approximates market concentrations credit risk significant portion company’s accounts receivable due credit card issuers related credit card manufacturers located throughout united states europe december 31 2002 year ended one customer accounted 40 company’s accounts receivable 41 sales second customer accounted 24 company’s accounts receivable 11 sales december 31 2001 year ended one customer accounted 31 company’s accounts receivable 37 sales company establishes credit polices based ongoing evaluation customers’ creditworthiness competitive market conditions require collateral inventories stated lower cost market cost determined firstin firstout fifo method cost hologram originations represent costs unique master hologram made customer specifications integral part production process charged cost goods sold period incurred revenue recognition company recognizes revenue accordance provisions security exchange commission’s “sec” staff accounting bulletin “sab” 101 “revenue recognition” specifically sales related cost goods sold generally recognized latter time shipment title passes customers situations company shipped product right return company unable reasonably estimate level returns andor sale contingent upon customers’ use product situations company recognize sales upon product shipment rather buyer product informs company product used additionally pursuant terms certain customer completed items stored behalf customer company’s onsite secured facility instance sales recognized following occurred customer ordered goods manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order december 31 2002 2001 accounts receivable customer approximated 16 million 10 million respectively december 31 2002 2001 customer advances approximating 01 million represent payments received customers products yet shipped customer advances classified current liabilities accompanying balance sheets effective october 1 2000 company adopted emerging issues task force “eitf” 0010 “accounting shipping handling fees costs” provisions eitf 0001 shipping handling amounts billed customers included revenues shipping handling costs included selling administrative expenses amounted 373000 370000 377000 years ended december 31 2002 2001 2000 respectively comparative prior period financial statements reclassified reflect change adoption eitf impact determination net income loss royalty income company enters licensing agreements certain manufacturers company receives royalty payments royalty payments due licensing agreements recognized income either based upon shipment reports licensees available estimated shipments licensees depreciation amortization machinery equipment recorded cost depreciated using straightline method estimated useful lives ranging 5 15 years amortization leasehold improvements computed using straightline method based upon remaining term applicable lease estimated useful life asset whichever shorter long lived assets july 2001 financial accounting standards board “fasb” issued sfas 143 “accounting asset retirement obligations” requires obligations associated retirement longlived assets recorded increases costs related asset also october 3 2001 fasb issued sfas 144 “accounting impairment disposal longlived assets” sfas 144 supercedes sfas 121 “accounting impairment disposal longlived assets” longlived assets disposed of” sfas 144 develops one accounting model determining impairment based model sfas 121 longlived assets disposed sale requires recorded lower book value fair value less cost sell addition sfas 144 expands scope “discontinued operations” new rules applied prospectively beginning january 1 2002 quarter ended december 31 2002 company recorded charge impairment longlived assets 19 million write fixed assets consisting master plates longer used impairment charge recorded requirements sfas 144 represents full impairment longlived asset balance sheet asset arose purchase accounting company’s former parent related company connection former parent’s merger 1990 goodwill july 2001 fasb issued sfas 142 “goodwill intangible assets” provides goodwill amortized instead tested impairment annual basis adopted company january 1 2002 impairment testing performed two steps determination impairment based fair value company compared carrying value ii indication impairment step measures amount impairment loss comparing implied fair value goodwill carrying amount goodwill accordance sfas 142 company completed transitional impairment test quarter ended march 31 2002 testing indicated adjustment required upon adoption pronouncement company performed annual test impairment required sfas 142 quarter ended december 31 2002 time fair value based quoted market prices company found less carrying amount result company recorded 74 million impairment charge year ended december 31 2002 charge represents full impairment goodwill company’s balance sheet asset arose purchase accounting company’s former parent related company connection former parent’s merger 1990 result adoption sfas 142 amortization goodwill ceased january 1 2002 goodwill amortization recorded 2002 goodwill amortization expense 345000 would included accompanying statement operations year ended december 31 2002 2001 2000 historical financial statements reflect provisions sfas 142 company adopted sfas 142 january 1 2000 net income loss basic diluted net income loss per share years ended december 31 2001 2000 would follows thousands warranty costs company provides warranty costs amounts estimates needed cover future warranty obligations products sold year estimates warranty costs periodically reviewed adjusted necessary consider actual experience research development research development costs expensed incurred income taxes company accounts income taxes liability method accordance sfas 109 “accounting income taxes” provision income taxes includes deferred income taxes resulting items reported different periods income tax financial statement purposes deferred tax assets liabilities represent expected future tax consequences differences financial statement carrying amounts existing assets liabilities respective tax basis stockbased compensation plans december 2002 fasb issued sfas 148 “accounting stock based compensationtransition disclosurean amendment fasb statement 123” sfas 148 provides alternative methods transition voluntary change fair value based method accounting stockbased employee compensation intrinsic valuebased method accounting prescribed accounting principles board “apb” opinion 25 “accounting stock issued employees” addition sfas 148 amends disclosure requirements sfas 123 “accounting stockbased compensation” adopted disclosure requirements sfas 148 effective december 31 2002 allowed sfas 123 company elected continue apply intrinsic valuebased method accounting prescribed apb opinion 25 accordingly recognize compensation expense stock option grants made exercise price equal excess fair market value stock date grant compensation cost company’s outstanding stock options determined based fair value grant dates options consistent sfas 123 company’s 2002 2001 2000 net income loss basic diluted net income loss per share would differed reflected pro forma amounts indicated thousands except per share amounts basic diluted net income loss per share basic net income loss per share computed based weighted average number outstanding shares common stock basic weighted average number shares outstanding 18483720 15421064 years ended december 31 2002 2001 2000 respectively diluted net income loss per share computed dividing net income loss weighted average number shares common stock outstanding dilutive potential shares common stock years ended december 31 2002 2001 2000 effect options purchase 2318500 shares 2509500 shares 2472500 shares respectively company’s common stock excluded calculation diluted net income loss per share effect inclusion options would antidilutive years ended december 31 2002 2001 effect warrants purchase 863647 shares 215912 shares respectively company’s common stock excluded calculation diluted net income loss per share effect inclusion warrants would antidilutive years ended december 31 2002 2001 2000 diluted weighted average number shares outstanding 18483720 15421064 respectively business concentration risks sales mastercard approximately 41 37 28 sales years ended december 31 2002 2001 2000 respectively december 31 2002 2001 accounts receivable mastercard approximated 16 million 10 million respectively company entered agreement mastercard dated february 28 2003 replaces agreement dated february 1 1996 amended new agreement expires february 2008 subject automatic renewal terminated either party terms new agreement mastercard obligated purchase least 80 holograms company right utilize crane co produce 20 mastercard’s annual hologram requirements coordination company new agreement provides mastercard receive three sequential price reductions approximately 3 effective beginning 2003 2004 2006 company currently exclusive supplier mastercard loss substantial portion sales mastercard however would material adverse effect financial position results operations cash flows company sales manufacturers visa credit cards approximately 50 customers approximately 26 23 19 sales years ended december 31 2002 2001 2000 respectively loss substantial portion sales customers would material adverse effect financial position results operations cash flows company december 31 2002 2001 accounts receivable customers approximated 15 million 10 million respectively company historically purchased certain key materials used manufacture holograms single suppliers supply contracts problems occur respect delivery quality cost materials could material adverse effect financial position results operations cash flows company export sales export sales 27 28 31 sales years ended december 31 2002 2001 2000 respectively export sales denominated united states dollars december 31 2002 2001 accounts receivable customers approximated 05 million 06 million respectively comprehensive income 1998 company adopted sfas 130 “reporting comprehensive income” establishes rules reporting comprehensive income components years ended december 31 2002 2001 2000 difference company’s net income loss comprehensive income loss fair value financial instruments company’s financial instruments consist cash equivalents accounts receivables accounts payable accrued expenses carrying amounts reported balance sheets approximate fair value december 31 2002 2001 reclassifications certain prior year amounts reclassified conform current year’s presentation 2 inventories 3 machinery equipment leasehold improvements depreciation amortization machinery equipment leasehold improvements years ended december 31 2002 2001 2000 794000 749000 732000 respectively quarter ended december 31 2002 company recorded asset impairment charge 19 million write fixed assets consisting master plates longer used see note 1 4 accrued expenses 5 income taxes accordance tax allocation agreement effect offering date company included consolidated us federal income tax return certain instances consolidated combined state local income tax returns former parent made payments former parent based amounts would payable federal state local income taxes consolidated combined returns filed company computed federal state local income tax provision filing separate income tax returns without regard tax allocation agreement 2000 company former parent reached agreement subject consummation former parent’s chapter 11 plan see note 7 “related party transactions” agreement provides among things former parent responsible shall pay asserted unasserted income franchise similar tax liabilities company period january 1 1990 july 20 1998 indemnify company respect liabilities periods subsequent offering date company filing us federal state income tax returns deferred income taxes arise temporary differences tax bases assets liabilities reported amounts financial statements provision benefit income taxes follows reconciliation taxes income 2002 2001 2000 follows tax effects items comprising company’s deferred income tax assets liabilities follows december 31 2002 company net operating loss carryforwards approximately 14 million expire 2021 available offset future federal taxable income current future changes ownership could limit availability use net operating loss carryforwards 6 revolving credit agreement august 23 2000 company terminated repaid outstanding amounts loan security agreement company foothill capital corporation amended “foothill loan” entered september 29 1999 borrowings foothill loan bore interest lender’s reference rate defined plus 15 result terminating foothill loan 2000 company incurred early termination fee 01 million wroteoff approximately 02 million unamortized deferred financing costs related loans year ended december 31 2000 weighted average interest rate outstanding borrowings approximately 98 average aggregate borrowings 2000 approximately 09 million december 8 2000 company terminated repaid 59000 notes payable bore interest 585 7 related party transactions company former parent related parties april 4 1999 time former parent’s chairman chief executive officer resigned company’s chairman chief executive officer december 8 1999 former parent filed petition plan reorganization chapter 11 federal bankruptcy code connection negotiations chapter 11 plan company reached agreement former parent provided among things former parent responsible pay asserted unasserted income franchise similar tax liabilities company period january 1 1990 july 20 1998 indemnify company respect liabilities result agreement company included accompanying statement operations 2000 approximately 05 million relating reversal accounts payable accrued expenses due former parent affiliates 8 stockholders’ equity june 11 1998 company increased authorized common stock 30000000 shares authorized preferred stock 5000000 shares july 20 1998 former parent completed sale 13636000 shares company’s common stock public offering “offering” representing entire investment company 2001 2002 company issued distributed 1460000 shares common stock well warrants purchase 863647 shares company’s common stock exercise price 600 per share settlement class action lawsuit filed company august 10 2001 company’s stockholders approved amendment company’s amended restated articles incorporation increasing number authorized shares common stock 40000000 shares june 30 2000 company entered stock purchase agreement “agreement” crane co inc “crane” agreement company sold 3387720 shares company’s common stock crane aggregate purchase price 9316230 agreement also provides board directors company audit committee board directors expanded one position filled douglas crane representative crane agreement also contains standstill provision whereby crane agreed among things neither affiliates except otherwise provided agreement acquire current proportionate share outstanding securities company standstill provision also provides crane offer sell transfer voting securities company tender exchange offer opposed company’s board directors 2000 company entered additional agreements crane company rents factory space leases employees company’s facility dalton years ended december 31 2002 2001 2000 company paid crane agreements 72000 12000 respectively rental factory space 151000 116000 11000 respectively leased employees addition company paid crane 5700 50000 leasehold improvements rental space years ended december 31 2001 2000 respectively february 28 2003 company entered new agreement mastercard entitles mastercard appoint crane second supplier produce 20 mastercard’s annual hologram requirements coordination company addition agreement allows mastercard appoint crane contingent supplier certain circumstances 9 settlement agreement abnh leonhard kurz gmbh co kg “kurz” entered settlement agreement dated july 1 2002 pursuant settlement agreement kurz make payments abnh totaling 900000 two years 300000 paid upon settlement remainder payable eight quarterly installments 75000 beginning october 2002 exchange release past present future infringements abnh’s demetallizing hotstamping patents except future use specific interpretation demetallizing patents subject royalty based license abnh recorded amounts income accompanying statement operations 2002 net legal expenses 280000 imputed interest 50000 10 stock incentive plans august 4 2000 company adopted american bank note holographics inc 2000 stock incentive plan amended “2000 plan” subsequently approved company’s stockholders annual meeting september 12 2000 july 20 1998 company adopted 1998 stock incentive plan amended “1998 plan” collectively 2000 plan “plans” plans adopted purpose granting various stock incentives officers directors employees consultants company board directors committee appointed board directors discretionary authority subject certain restrictions administer plans total number shares reserved issuance plans 3213000 shares common stock options purchase 909500 shares common stock available future grants december 31 2002 plans options purchase 2303500 shares common stock outstanding plans december 31 2002 options purchase additional 15000 shares common stock outstanding outside plans december 31 2002 exercise price options granted plans may less 100 fair market value common stock date option granted options granted plans generally become vested exercisable 33 13 total optioned shares upon succeeding anniversary date grant generally unexercised portion option automatically terminates upon termination optionee’s employment company unless otherwise determined board directors provided however extension shall extend beyond expiration option generally ten years upon change control outstanding options generally become fully vested summary status company’s outstanding stock options december 31 2002 2001 2000 changes years ended follows following table summarizes information concerning outstanding exercisable options december 31 2002 fair value option grant estimated date grant using blackscholes optionpricing model following weightedaverage assumptions 11 employee benefits plans retirement plans october 1 1999 company implemented defined contribution plans employees aggregate contributions plans charged company’s operations approximately 51000 48000 46000 years ended december 31 2002 2001 2000 respectively 12 commitments contingencies litigation consolidated class action complaint company certain former officers directors former parent four colead underwriters offering deloitte touche llp filed united states district court southern district new york “court” complaint alleged violations federal securities laws sought recover damages behalf purchasers company’s common stock class period july 15 1998 february 1 1999 complaint sought rescission purchase shares company’s common stock alternatively unspecified compensatory damages along costs expenses including attorney’s fees october 2000 company defendants plaintiffs entered definitive agreement settle claims subject class action well claims asserted former parent defendants separate class action settlement agreement received final approval court december 15 2000 settlement insurance carrier company former parent paid 12500000 deloitte touche llp paid 2350000 addition company issued distributed 1460000 shares common stock 365000 shares issued distributed february 2001 remaining 1095000 shares issued distributed may 2002 abnh also issued distributed warrants purchase 863647 shares company’s common stock exercise price 600 per share warrants expire june 18 2003 former parent also issued distributed certain securities part settlement regard settlement company recorded charge statement operations fourth quarter 2000 3356000 charge comprised cost company’s common stock issued closing price stock day final settlement value warrants issued value determined using blackscholes option pricing model related costs 1991 abnh entered patent license agreement “license agreement” required abnh pay royalties connection certain products abnh produces 2002 licensor license agreement filed lawsuit abnh united states district court eastern district washington alleging breach license agreement december 2002 abnh entered settlement agreement whereby abnh paid 431250 december 31 2002 payment satisfied obligations abnh pay royalties may owed past future license agreement abnh recorded 231250 royalty expense accompanying statements operations cover allegedly past due royalties 200000 amortized remaining life patents expire 2005 2007 company currently time involved litigation plaintiff defendant incidental conduct business however shareholder litigation described company party lawsuit proceeding opinion management company likely material impact company’s financial position results operations cash flows amounts accrued litigation matters represent anticipated costs damages andor settlement amounts connection pending litigation claims costs accrued probable asset impaired liability incurred amount reasonably estimated accruals based upon company’s assessment consultation counsel probable loss based facts circumstances case legal issues involved nature claim made nature damages sought relevant information plaintiffs significant factors vary case possible estimate specific expected cost incurred company evaluates range probable loss records minimum end range december 31 2002 accruals litigation matters approximated 10000 december 31 2001 accruals litigation matters company believes based information known december 31 2002 anticipated probable costs litigation matters december 31 2002 adequately provided extent determinable indemnification former parent described notes 5 7 2000 company former parent entered agreement among matters provide indemnification certain circumstances company former parent former parent experienced significant financial difficulty may result inability perform terms indemnification provided could material adverse effect company’s financial position results operations cash flows product liability matters company provides holograms connection wide range customers’ products case possible company subject product liabilities association products connection holograms used products although company maintains product liability insurance assurance insurance would available cover claim available amounts sufficient cover potential liabilities result product liability claims could material adverse effect company’s business financial condition results operations cash flows leases company longterm operating leases offices manufacturing facilities equipment expire 2007 company renewal options locations provide renewal rents based upon increases tied consumer price index net rental expense approximately 13 million 13 million 12 million years ended december 31 2002 2001 2000 respectively december 31 2002 future minimum lease payments noncancelable operating leases expiring 2007 follows 11 million 2003 09 million 2004 09 million 2005 09 million 2006 08 million 2007 employment agreements company entered employment agreements certain current officers provide among matters minimum compensation approximately 501000 2003 318000 2004 80000 2005 agreements also provide bonuses connection agreements company granted options acquire 1273000 shares common stock prices ranging 175 250 per share representing fair market value company’s common stock dates grant schedule ii american bank note holographics inc valuation qualifying accounts years ended december 31 2002 2001 2000 1 accounts deemed uncollectible net recoveries s1item 15 exhibits financial statement schedules reports form 8k a1 financial statements financial statements required item submitted separate section beginning page report 2financial statement schedules financial statement schedule required item submitted separate section page s1 report schedules included page s1 report omitted absence conditions required information included financial statements notes thereto 3exhibits see c breports form 8k current report form 8k dated november 14 2003 reporting companys results operations quarter ended september 30 2003 cexhibits following exhibits filed part report incorporated herein reference exhibit nos 104 105 106 107 108 109 1010 management contracts compensatory plans arrangements 31 amended restated certificate incorporation 1 32 amended restated bylaws 1 33 amendment amended restated certificate incorporation 2 41 form common stock certificate 1 42 stock purchase agreement crane co inc american bank note holographics inc dated june 29 2000 3 43 form option agreement american bank note holographics inc 1998 stock incentive plan amended 5 44 form option agreement american bank note holographics inc 2000 stock incentive plan 5 45 option agreement dr stephen benton american bank note holographics inc dated july 20 1998 5 101 form separation agreement american bank note corporation american bank note holographics inc dated july 20 1998 1 102 form license agreement 1 103 form transitional services agreement 1 104 form employee benefits allocation agreement 1 105 form 1998 stock incentive plan 1 106 form 2000 stock incentive plan 6 107 form defined contribution plan 1 108 employment agreement dated april 20 1999 salvatore f damato american bank note holographics inc 7 109 employment agreement dated february 3 1999 kenneth h traub american bank note holographics inc amended march 20 2000 9 1010 employment agreement dated april 30 1999 alan goldstein american bank note holographics inc 7 1011 standard form loft lease dated july 23 1992 robert martin company american bank holographics inc 9 1012 lease agreement dated january 19 2001 crane co inc american bank note holographics inc 9 1013 lease agreement dated august 11 2002 mark hankin hanmar associates mlp tenantsincommon american bank note holographics inc addenda thereto 11 1014 settlement agreement dated july 1 2002 american bank note holgraphics inc leonhard kurz gmbh co kg 10 1015 patent license agreement dated july 1 2002 american bank note holographics inc leonhard kurz gmbh co kg 10 1016 substitute cross license agreement dated july 1 2002 american bank note holographics inc leonhard kurz co kg 10 1017 hologram agreement dated february 28 2003 mastercard international incorporated american bank note holograhics inc 11 1018 form idemnification agreement company directors officers 12 1019 amendment 1 hologram agreement dated february 28 2003 mastercard international incorporated american bank note holographics inc made september 29 2003 13 231 consent ernst young llp 232 consent arthur andersen llp 311 certification kenneth h traub pursuant exchange act rules 13a15e 15d15e adopted pursuant section 302 sarbanesoxley act 2002 312 certification alan goldstein pursuant exchange act rules 13a15e 15d15e adopted pursuant section 302 sarbanesoxley act 2002 321 certification kenneth h traub pursuant 18 usc section 1350 adopted pursuant section 906 sarbanesoxley act 2002 322 certification alan goldstein pursuant 18 usc section 1350 adopted pursuant section 906 sarbanesoxley act 2002 1incorporated reference registration statement form s1 registration 33351845 2incorporated reference proxy statement schedule 14a filed july 3 2001 3incorporated reference quarterly report form 10q filed august 14 2000 4incorporated reference annual report form 10k 2000 5incorporated reference registration statement form s8 registration 333 61602 6incorporated reference proxy statement schedule 14a filed august 11 2000 7incorporated reference annual report form 10k 1998 8incorporated reference annual report form 10k 1999 9incorporated reference annual report form 10k 2001 10incorporated reference quarterly report form 10q filed august 13 2002 11incorporated reference annual report form 10k 2002 12incorporated reference quarterly report form 10q filed august 12 2003 13incorporated reference quarterly report form 10q filed november 13 2003 portions omitted pursuant request confidential treatment dfinancial statement schedules see a2 signatures pursuant requirements section 13 15d securities exchange act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized american bank note holographics inc kenneth h traub kenneth h traub president chief executive officer march 23 2004 pursuant requirements securities exchange act 1934 report signed following persons behalf registrant capacities dates indicated signature title date kenneth h traub kenneth h traub president chief executive officer director principal executive officer march 23 2004 alan goldstein alan goldstein chief financial officer principal financial accounting officer march 23 2004 salvatore f damato salvatore f damato chairman board march 23 2004 fred j levin fred j levin director march 23 2004 douglas crane douglas crane director march 23 2004 mark j bonney mark j bonney director march 23 2004 american bank note holographics inc item 15a report independent auditors board directors american bank note holographics inc audited accompanying balance sheets american bank note holographics inc company december 31 2003 2002 related statements operations stockholders equity cash flows years ended audits also included financial statement schedule listed index item 15a financial statements schedule responsibility companys management responsibility express opinion financial statements schedule based audits financial statements company december 31 2001 year ended audited auditors ceased operations whose report dated march 1 2002 expressed unqualified opinion statements conducted audits accordance auditing standards generally accepted united states standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audits provide reasonable basis opinion 2003 2002 financial statements referred present fairly material respects financial position company december 31 2003 2002 results operations cash flows two years period ended december 31 2003 conformity accounting principles generally accepted united states also opinion related financial statement schedule years ended december 31 2003 2002 considered relation basic financial statements taken whole presents fairly material respects information set forth therein discussed financial statements company december 31 2001 year ended audited auditors ceased operations described note 1 financial statements revised include transitional disclosures required statement financial accounting standards statement 142 goodwill intangible assets adopted company january 1 2002 audit procedures respect disclosures note 1 respect 2001 included agreeing previously reported net income previously issued financial statements adjustments reported net income representing amortization expense recognized period related goodwill longer amortized result initially applying statement 142 companys underlying records obtained management b testing mathematical accuracy reconciliation adjusted net income reported net income related net income per share amounts opinion disclosures 2001 note 1 appropriate however engaged audit review apply procedures 2001 financial statements company respect disclosures accordingly express opinion form assurance 2001 financial statements taken whole ernst young llp new york new york march 5 2004 following copy previously issued report arthur andersen llp dated march 1 2002 related audit financial statements american bank note holographics inc twoyear period ended december 31 2001 2002 arthur andersen llp ceased operations reissued report additionally arthur andersen llp consented use audit report since american bank note holographics inc unable obtain current manually signed audit report copy arthur andersens recent signed dated report included satisfy filing requirements permitted rule 202e regulation sx report independent public accountants board directors stockholders american bank note holographics inc audited accompanying balance sheets american bank note holographics inc delaware corporation december 31 2001 2000 related statements operations stockholders equity cash flows years ended financial statements schedule referred responsibility companys management responsibility express opinion financial statements schedule based audits conducted audits accordance auditing standards generally accepted united states standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audits provide reasonable basis opinion financial statements referred present fairly material respects financial position american bank note holographics inc december 31 2001 2000 results operations cash flows years ended conformity accounting principles generally accepted united states audits made purpose forming opinion basic financial statements taken whole supplemental schedule page s1 presented purposes additional analysis required part basic financial statements information subjected auditing procedures applied audits basic financial statements opinion fairly stated material respects relation basic financial statements taken whole arthur andersen llp new york new york march 1 2002 american bank note holographics inc balance sheets december 31 2003 2002 thousands except share data accompanying notes integral part financial statements american bank note holographics inc statements operations years ended december 31 2003 2002 2001 thousands except per share data accompanying notes integral part financial statements american bank note holographics inc statements stockholders equity years ended december 31 2003 2002 2001 thousands accompanying notes integral part financial statements american bank note holographics inc statements cash flows years ended december 31 2003 2002 2001 thousands accompanying notes integral part financial statements american bank note holographics inc notes financial statements years ended december 31 2003 2002 2001 1 basis presentation summary significant accounting policies american bank note holographics inc company abnh incorporated state delaware august 1985 company july 20 1998 offering date whollyowned subsidiary american banknote corporation former parent abn company originates massproduces markets secure holograms used security packaging promotional applications company operates one reportable industry segment use estimatesthe preparation financial statements conformity accounting principles generally accepted united states requires management make estimates assumptions affect reported amounts assets liabilities disclosure contingent assets liabilities date financial statements reported amounts sales expenses reporting period actual results may differ materially estimates cash equivalentsall highly liquid investments primarily government bonds maturity three months less purchased considered cash equivalents stated cost approximates market concentrations credit riska significant portion companys accounts receivable due credit card issuers related credit card manufacturers located throughout united states europe december 31 2003 year ended one customer accounted 30 companys accounts receivable 33 sales second customer accounted 30 companys accounts receivable 9 sales december 31 2002 year ended one customer accounted 40 companys accounts receivable 41 sales second customer accounted 24 companys accounts receivable 11 sales company establishes credit policies based ongoing evaluation customers creditworthiness competitive market conditions require collateral inventoriesinventories stated lower cost market cost determined firstin firstout fifo method cost hologram originations represent costs unique master hologram made customer specifications integral part production process charged cost goods sold period incurred revenue recognitionthe company recognizes revenue accordance provisions securities exchange commissions sec staff accounting bulletin sab 101 revenue recognition specifically sales related cost goods sold generally recognized latter time shipment title passes customers situations company shipped product sale contingent upon customers use product situations company recognize sales upon product shipment rather buyer product informs company product used additionally pursuant terms certain customer completed items stored behalf customer companys onsite secured facility instance sales recognized following occurred customer ordered goods manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order december 31 2003 2002 accounts receivable customer approximated 10 million 16 million respectively december 31 2003 2002 customer advances approximating 01 million represent payments received customers products yet shipped customer advances classified current liabilities accompanying balance sheets effective october 1 2000 company adopted emerging issues task force eitf 0010 accounting shipping handling fees costs provisions eitf 0010 shipping handling amounts billed customers included revenues shipping handling costs included selling administrative expenses amounted 358000 373000 370000 years ended december 31 2003 2002 2001 respectively royalty incomethe company enters licensing agreements certain manufacturers company receives royalty payments royalty payments due licensing agreements recognized income either based upon shipment reports licensees available estimated shipments licensees depreciation amortizationmachinery equipment recorded cost depreciated using straightline method estimated useful lives ranging 5 15 years amortization leasehold improvements computed using straightline method based upon remaining term applicable lease estimated useful life asset whichever shorter longlived assetsin july 2001 financial accounting standards board fasb issued sfas 143 accounting asset retirement obligations requires obligations associated retirement longlived assets recorded increases costs related asset also october 3 2001 fasb issued sfas 144 accounting impairment disposal longlived assets sfas 144 supercedes sfas 121 accounting impairment disposal longlived assets longlived assets disposed sfas 144 develops one accounting model determining impairment based model sfas 121 longlived assets disposed sale requires recorded lower book value fair value less cost sell addition sfas 144 expands scope discontinued operations new rules applied prospectively beginning january 1 2002 quarter ended december 31 2002 company recorded charge impairment longlived assets 19 million write fixed assets consisting master plates longer used impairment charge recorded requirements sfas 144 represents full impairment longlived asset balance sheet asset arose purchase accounting companys former parent related company connection former parents merger 1990 impairment longlived assets 2003 goodwillin july 2001 fasb issued sfas 142 goodwill intangible assets provides goodwill amortized instead tested impairment annual basis adopted company january 1 2002 impairment testing performed two steps determination impairment based fair value company compared carrying value ii indication impairment step measures amount impairment loss comparing implied fair value goodwill carrying amount goodwill accordance sfas 142 company completed transitional impairment test quarter ended march 31 2002 testing indicated adjustment required upon adoption pronouncement company performed annual test impairment required sfas 142 quarter ended december 31 2002 time fair value based quoted market prices company found less carrying amount result company recorded 74 million impairment charge year ended december 31 2002 charge represents full impairment goodwill companys balance sheet asset arose purchase accounting companys former parent related company connection former parents merger 1990 result adoption sfas 142 amortization goodwill ceased january 1 2002 goodwill amortization recorded 2002 goodwill amortization expense 345000 would included accompanying statement operations year ended december 31 2002 2001 historical financial statements reflect provisions sfas 142 company adopted sfas 142 january 1 2001 net income basic diluted net income per share year ended december 31 2001 would follows thousands except per share data warranty coststhe company provides warranty costs amounts estimates needed cover future warranty obligations products sold year estimates warranty costs based historical experience periodically reviewed adjusted necessary companys product warranty provision included accrued expenses accompanying balance sheets changes companys warranty provision years ended december 31 2003 2002 2001 follows thousands research developmentresearch development costs expensed incurred income taxesthe company accounts income taxes liability method accordance sfas 109 accounting income taxes provision income taxes includes deferred income taxes resulting items reported different periods income tax financial statement purposes deferred tax assets liabilities represent expected future tax consequences differences financial statement carrying amounts existing assets liabilities respective tax basis stockbased compensation plansin december 2002 fasb issued sfas 148 accounting stock based compensationtransition disclosurean amendment fasb statement 123 sfas 148 provides alternative methods transition voluntary change fair value based method accounting stockbased employee compensation intrinsic valuebased method accounting prescribed accounting principles board apb opinion 25 accounting stock issued employees addition sfas 148 amends disclosure requirements sfas 123 accounting stockbased compensation company adopted disclosure requirements sfas 148 effective december 31 2002 allowed sfas 123 company elected continue apply intrinsic valuebased method accounting prescribed apb opinion 25 accordingly recognize compensation expense stock option grants made exercise price equal excess fair market value stock date grant compensation cost companys outstanding stock options determined based fair value grant dates options consistent sfas 123 companys 2003 2002 2001 net income loss basic diluted net income loss per share would differed reflected pro forma amounts indicated thousands except per share data basic diluted net income loss per sharebasic net income loss per share computed based weighted average number outstanding shares common stock basic weighted average number shares outstanding 18483720 years ended december 31 2003 2002 2001 diluted net income loss per share computed dividing net income loss weighted average number shares common stock outstanding dilutive potential shares common stock year ended december 31 2003 diluted number weighted shares outstanding 18525914 includes dilutive stock options 42194 years ended december 31 2002 2001 diluted weighted average number shares outstanding 18483720 years ended december 31 2002 2001 effect options purchase 2318500 shares 2509500 shares respectively companys common stock excluded calculation diluted net income loss per share effect inclusion options would antidilutive years ended december 31 2002 2001 effect warrants purchase 863647 shares 215912 shares respectively companys common stock excluded calculation diluted net income loss per share effect inclusion warrants would antidilutive warrants expired june 18 2003 business concentration riskssales mastercard approximately 33 41 37 sales years ended december 31 2003 2002 2001 respectively december 31 2003 2002 accounts receivable mastercard approximated 10 million 16 million respectively company entered agreement mastercard dated february 28 2003 replaced agreement dated february 1 1996 amended company mastercard entered amendment agreement september 29 2003 mastercard retained company produce new hologram debit mastercard extended agreement february 28 2011 subject automatic renewal terminated either party agreement also provides mastercard receive three sequential price reductions approximately 3 effective beginning 2003 2004 2006 company currently exclusive supplier mastercard loss substantial portion sales mastercard however would material adverse effect financial position results operations cash flows company sales manufacturers visa credit cards approximately 50 customers approximately 30 26 23 sales years ended december 31 2003 2002 2001 respectively loss substantial portion sales customers would material adverse effect financial position results operations cash flows company december 31 2003 2002 accounts receivable customers approximated 13 million 15 million respectively company historically purchased certain key materials used manufacture holograms single suppliers supply contracts problems occur respect delivery quality cost materials could material adverse effect financial position results operations cash flows company export salesexport sales 28 27 28 sales years ended december 31 2003 2002 2001 respectively export sales denominated united states dollars december 31 2003 2002 accounts receivable customers approximated 05 million comprehensive incomein 1998 company adopted sfas 130 reporting comprehensive income establishes rules reporting comprehensive income components years ended december 31 2003 2002 2001 difference companys net income loss comprehensive income loss fair value financial instrumentsthe companys financial instruments consist cash equivalents accounts receivables accounts payable accrued expenses carrying amounts reported balance sheets approximate fair value december 31 2003 2002 2 inventories 3 machinery equipment leasehold improvements depreciation amortization machinery equipment leasehold improvements years ended december 31 2003 2002 2001 733000 794000 749000 respectively quarter ended december 31 2002 company recorded asset impairment charge 19 million write fixed assets consisting master plates longer used see note 1 4 accrued expenses 5 income taxes accordance tax allocation agreement effect offering date company included consolidated us federal income tax return certain instances consolidated combined state local income tax returns former parent made payments former parent based amounts would payable federal state local income taxes consolidated combined returns filed company computed federal state local income tax provision filing separate income tax returns without regard tax allocation agreement 2000 company former parent reached agreement provides among things former parent responsible shall pay asserted unasserted income franchise similar tax liabilities company period january 1 1990 july 20 1998 indemnify company respect liabilities periods subsequent offering date company filing us federal state income tax returns deferred income taxes arise temporary differences tax bases assets liabilities reported amounts financial statements provision income taxes follows reconciliation taxes income 2003 2002 2001 follows tax effects items comprising companys deferred income tax assets liabilities follows december 31 2003 company net operating loss carryforwards approximately 03 million expire 2022 available offset future federal taxable income year ended december 31 2003 company used net operating loss carryforwards approximately 11 million offset current federal income taxes current future changes ownership could limit availability use net operating loss carryforwards 7 stockholders equity june 11 1998 company increased authorized common stock 30000000 shares authorized preferred stock 5000000 shares july 20 1998 former parent completed sale 13636000 shares companys common stock public offering representing entire investment company 2001 2002 company issued distributed 1460000 shares common stock well warrants purchase 863647 shares companys common stock exercise price 600 per share settlement class action lawsuit filed company 1999 warrants expired june 18 2003 none warrants exercised august 10 2001 companys stockholders approved amendment companys amended restated articles incorporation increasing number authorized shares common stock 40000000 shares june 30 2000 company entered stock purchase agreement crane co inc crane agreement company sold 3387720 shares companys common stock crane aggregate purchase price 9316230 agreement also provides board directors company audit committee board directors expanded one position filled douglas crane representative crane agreement also contains standstill provision whereby crane agreed among things neither affiliates except otherwise provided agreement acquire current proportionate share outstanding securities company standstill provision also provides crane offer sell transfer voting securities company tender exchange offer opposed companys board directors 2000 company entered additional agreements crane company rents factory space leases employees companys facility dalton years ended december 31 2003 2002 2001 company paid crane agreements 72000 year rental factory space 162000 151000 116000 respectively leased employees primarily included cost goods sold accompanying statements operations addition company paid crane 5700 leasehold improvements rental space year ended december 31 2001 february 28 2003 company entered new agreement mastercard entitles mastercard appoint crane second supplier produce 20 mastercards annual hologram requirements coordination company addition agreement allows mastercard appoint crane contingent supplier certain circumstances 8 settlement agreement abnh leonhard kurz gmbh co kg kurz entered settlement agreement dated july 1 2002 pursuant settlement agreement kurz make payments abnh totaling 900000 two years 300000 paid upon settlement remainder payable eight quarterly installments 75000 beginning october 2002 exchange release past present future infringements abnhs demetallizing hotstamping patents except future use specific interpretation demetallizing patents subject royalty based license abnh recorded amounts income accompanying statement operations 2002 net legal expenses 280000 imputed interest 50000 9 stock incentive plans august 4 2000 company adopted american bank note holographics inc 2000 stock incentive plan amended 2000 plan subsequently approved companys stockholders annual meeting september 12 2000 july 20 1998 company adopted 1998 stock incentive plan amended 1998 plan collectively 2000 plan plans adopted purpose granting various stock incentives officers directors employees consultants company board directors committee appointed board directors discretionary authority subject certain restrictions administer plans total number shares reserved issuance plans 3213000 shares common stock options purchase 390000 shares common stock available future grants december 31 2003 plans options purchase 2823000 shares common stock outstanding plans december 31 2003 options purchase additional 15000 shares common stock outstanding outside plans december 31 2003 exercise price options granted plans may less 100 fair market value common stock date option granted options granted plans generally become vested exercisable 25 3313 total optioned shares upon succeeding anniversary date grant generally unexercised portion option automatically terminates upon termination optionees employment company unless otherwise determined board directors provided however extension shall extend beyond expiration option generally ten years upon change control outstanding options generally become fully vested summary status companys outstanding stock options december 31 2003 2002 2001 changes years ended follows following table summarizes information concerning outstanding exercisable options december 31 2003 fair value option grant estimated date grant using blackscholes optionpricing model following weightedaverage assumptions 10 employee benefits plans retirement planson october 1 1999 company implemented defined contribution plans employees aggregate contributions plans charged companys operations approximately 56000 51000 48000 years ended december 31 2003 2002 2001 respectively 11 commitments contingencies 1991 abnh entered patent license agreement license agreement required abnh pay royalties connection certain products abnh produces 2002 licensor license agreement filed lawsuit abnh united states district court eastern district washington alleging breach license agreement december 2002 abnh entered settlement agreement whereby abnh paid 431250 december 31 2002 payment satisfied obligations abnh pay royalties may owed past future license agreement abnh recorded 231250 royalty expense 2002 accompanying statements operations cover allegedly past due royalties 200000 amortized remaining life patents expire 2005 2007 company currently time involved litigation plaintiff defendant incidental conduct business however company party lawsuit proceeding opinion management company likely material impact companys financial position results operations cash flows amounts accrued litigation matters represent anticipated costs damages andor settlement amounts connection pending litigation claims costs accrued probable asset impaired liability incurred amount reasonably estimated accruals based upon companys assessment consultation counsel probable loss based facts circumstances case legal issues involved nature claim made nature damages sought relevant information plaintiffs significant factors vary case possible estimate specific expected cost incurred company evaluates range probable loss records minimum end range december 31 2003 2002 accruals litigation matters approximated 15000 10000 respectively company believes based information known december 31 2003 anticipated probable costs litigation matters december 31 2003 adequately provided extent determinable indemnification former parentas described note 5 2000 company former parent entered agreement among matters provide indemnification certain circumstances company former parent former parent experienced significant financial difficulty may result inability perform terms indemnification provided could material adverse effect companys financial position results operations cash flows product liability mattersthe company provides holograms connection wide range customers products case possible company subject product liabilities association products connection holograms used products although company maintains product liability insurance assurance insurance would available cover claim available amounts sufficient cover potential liabilities result product liability claims could material adverse effect companys business financial condition results operations cash flows leasesthe company longterm operating leases offices manufacturing facilities equipment expire 2007 company renewal options locations provide renewal rents based upon increases tied consumer price index rental expense approximately 13 million year years ended december 31 2003 2002 2001 respectively december 31 2003 future minimum lease payments noncancelable operating leases expiring 2007 follows 10 million 2004 09 million 2005 09 million 2006 08 million 2007 employment agreementsthe company entered employment agreements certain current officers provide among matters minimum compensation approximately 421000 2004 328000 2005 agreements also provide bonuses connection agreements company granted options acquire 1553000 shares common stock february 1999 december 2003 prices ranging 085 250 per share representing fair market value companys common stock dates grants schedule ii american bank note holographics inc valuation qualifying accounts years ended december 31 2003 2002 2001 1recoveries accounts receivable 2accounts deemed uncollectible 3destruction obsolete inventory s1 american bank note holographics inc 2003 form 10k table contents part ii part iii summary compensation table option grants last fiscal year part iv signatures american bank note holographics inc index financial statements item 15a report independent auditors report independent public accountants american bank note holographics inc balance sheets december 31 2003 2002 thousands except share data american bank note holographics inc statements operations years ended december 31 2003 2002 2001 thousands except per share data american bank note holographics inc statements stockholders equity years ended december 31 2003 2002 2001 thousands american bank note holographics inc statements cash flows years ended december 31 2003 2002 2001 thousands american bank note holographics inc notes financial statements years ended december 31 2003 2002 2001 american bank note holographics inc valuation qualifying accounts years ended december 31 2003 2002 2001item 15 exhibits financial statement schedules following documents filed part report 1 financial statements financial statements required item submitted separate section beginning page report 2 financial statement schedules financial statement schedule required item submitted separate section page s1 report schedules included page s1 report omitted absence conditions required information included financial statements notes thereto 3 exhibits following exhibits filed part report incorporated herein reference exhibit nos 104 105 106 107 108 109 1010 management contracts compensatory plans arrangements 31 amended restated certificate incorporation 1 32 amended restated bylaws 1 33 amendment amended restated certificate incorporation 2 41 form common stock certificate 1 42 stock purchase agreement crane co inc american bank note holographics inc dated june 29 2000 3 43 form option agreement american bank note holographics inc 1998 stock incentive plan amended 5 44 form option agreement american bank note holographics inc 2000 stock incentive plan 5 101 form separation agreement american bank note corporation american bank note holographics inc dated july 20 1998 1 102 form license agreement 1 103 form transitional services agreement 1 104 form employee benefits allocation agreement 1 105 form 1998 stock incentive plan 1 106 form 2000 stock incentive plan 6 107 form defined contribution plan 1 108 employment agreement dated april 20 1999 salvatore f d’amato american bank note holographics inc 7 109 amended restated employment agreement kenneth traub american bank note holographics inc dated march 29 2005 1010 employment agreement dated april 30 1999 alan goldstein american bank note holographics inc 7 1011 standard form loft lease dated july 23 1992 robert martin company american bank note holographics inc 9 1012 lease agreement dated january 19 2001 crane co inc american bank note holographics inc 9 1013 lease agreement dated august 11 2002 mark hankin hanmar associates mlp tenantsincommon american bank note holographics inc addenda thereto 11 1014 settlement agreement dated july 1 2002 american bank note holgraphics inc leonhard kurz gmbh co kg 10 1015 patent license agreement dated july 1 2002 american bank note holographics inc leonhard kurz gmbh co kg 10 1016 substitute cross license agreement dated july 1 2002 american bank note holographics inc leonhard kurz co kg 10 1017 hologram agreement dated february 28 2003 mastercard international incorporated american bank note holograhics inc 11 1018 form indemnification agreement company directors officers 12 1019 amendment 1 hologram agreement dated february 28 2003 mastercard international incorporated american bank note holographics inc made september 29 2003 13 1020 sublease agreement apw north america inc american bank note holographics inc dated december 14 2004 14 1021 subordination nondisturbance attornment renewal option purchase agreement american bank note holographics inc applied four de llc dated december 14 2004 14 1022 subordination nondisturbance attornment agreement american bank note holographics inc lasalle bank national association formerly known lasalle national bank trustee morgan stanley capital inc commercial mortgage securities inc commercial mortgage passthrough certificates series 1999wf1 dated december 14 2004 14 1023 escrow agreement apw north america inc american bank note holographics inc chicago title insurance company dated december 14 2004 14 231 consent ernst young llp 311 certification kenneth h traub pursuant exchange act rules 13a14a 15d14a adopted pursuant section 302 sarbanesoxley act 2002 312 certification alan goldstein pursuant exchange act rules 13a14a 15d14a adopted pursuant section 302 sarbanesoxley act 2002 321 certification kenneth h traub pursuant 18 usc section 1350 adopted pursuant section 906 sarbanes oxley act 2002 322 certification alan goldstein pursuant 18 usc section 1350 adopted pursuant section 906 sarbanes oxley act 2002 1 incorporated reference registration statement form s1 registration 33351845 2 incorporated reference proxy statement schedule 14a filed july 3 2001 3 incorporated reference quarterly report form 10q filed august 14 2000 4 incorporated reference annual report form 10k 2000 5 incorporated reference registration statement form s8 registration 33361602 6 incorporated reference proxy statement schedule 14a filed august 11 2000 7 incorporated reference annual report form 10k 1998 8 incorporated reference annual report form 10k 1999 9 incorporated reference annual report form 10k 2001 10 incorporated reference quarterly report form 10q filed august 13 2002 11 incorporated reference annual report form 10k 2002 12 incorporated reference quarterly report form 10q filed august 12 2003 13 incorporated reference quarterly report form 10q filed november 13 2003 14 incorporated reference current report form 8k filed december 20 2004 portions omitted pursuant request confidential treatment signatures pursuant requirements section 13 15d securities exchange act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized pursuant requirements securities exchange act 1934 report signed following persons behalf registrant capacities dates indicated american bank note holographics inc item 15a report independent registered public accounting firm financial statements balance sheets december 31 2004 statements operations years ended december 31 2004 2003 statements stockholders’ equity years ended december 31 2004 2003 2002 statements cash flows years ended december 31 2004 2003 2002 notes financial statements schedule ii valuation qualifying accounts report independent registered public accounting firm board directors american bank note holographics inc audited accompanying balance sheets american bank note holographics inc “company” december 31 2004 2003 related statements operations stockholders’ equity cash flows three years period ended december 31 2004 audits also included financial statement schedule listed index item 15a financial statements schedule responsibility company’s management responsibility express opinion financial statements schedule based audits conducted audits accordance standards public company accounting oversight board united states standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement engaged perform audit company’s internal control financial reporting audit included consideration internal control financial reporting basis designing audit procedures appropriate circumstances purpose expressing opinion effectiveness company’s internal control financial reporting accordingly express opinion audit also includes examining test basis evidence supporting amounts disclosures financial statements assessing accounting principles used significant estimates made management evaluating overall financial statement presentation believe audits provide reasonable basis opinion financial statements referred present fairly material respects financial position company december 31 2004 2003 results operations cash flows three years period ended december 31 2004 conformity us generally accepted accounting principles also opinion related financial statement schedule considered relation basic financial statements taken whole presents fairly material respects information set forth therein american bank note holographics inc balance sheets december 31 2004 2003 thousands except share data accompanying notes integral part financial statements american bank note holographics inc statements operations years ended december 31 2004 2003 2002 thousands except per share data accompanying notes integral part financial statements american bank note holographics inc statements stockholders’ equity years ended december 31 2004 2003 2002 thousands accompanying notes integral part financial statements american bank note holographics inc statements cash flows years ended december 31 2004 2003 2002 thousands accompanying notes integral part financial statements american bank note holographics inc notes financial statements years ended december 31 2004 2003 2002 1 basis presentation summary significant accounting policies american bank note holographics inc “company” “abnh” incorporated state delaware august 1985 company july 20 1998 whollyowned subsidiary american banknote corporation “former parent” “abn” company originates massproduces markets secure holograms used security packaging promotional applications company operates one reportable industry segment use estimates preparation financial statements conformity us generally accepted accounting principles requires management make estimates assumptions affect reported amounts assets liabilities disclosure contingent assets liabilities date financial statements reported amounts sales expenses reporting period actual results may differ materially estimates cash equivalents highly liquid investments primarily government bonds maturity three months less purchased considered cash equivalents stated cost approximates market shortterm investments december 31 2004 shortterm investments consisted us government debt instrument matured february 22 2005 december 31 2003 shortterm investments consisted us government debt instruments matured january february 2004 accordance statement financial accounting standard “sfas” 115 “accounting certain investments debt equity securities” management determines appropriate classification marketable securities time purchase reevaluates designations balance sheet date investment classified held maturity carried amortized cost concentrations credit risk significant portion company’s accounts receivable due credit card issuers related credit card manufacturers located throughout united states europe december 31 2004 three customers accounted 28 19 11 respectively company’s accounts receivable 35 9 6 respectively sales year ended december 31 2003 year ended one customer accounted 30 company’s accounts receivable 33 sales second customer accounted 30 company’s accounts receivable 9 sales company establishes credit policies based ongoing evaluation customers’ creditworthiness competitive market conditions require collateral inventories stated lower cost market cost determined firstin firstout fifo method cost hologram originations represent costs unique master hologram made customer specifications integral part production process charged cost goods sold period incurred revenue recognition company recognizes revenue accordance provisions securities exchange commission’s “sec” staff accounting bulletin “sab” 104 “revenue recognition” specifically sales related cost goods sold generally recognized latter time shipment title passes customers situations company shipped product sale contingent upon customers’ use product situations company recognize sales upon product shipment rather buyer product informs company product used additionally pursuant terms certain customer completed items stored behalf customer company’s onsite secured facility instance sales recognized following occurred customer ordered goods manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order shipping handling amounts billed customers included revenues shipping handling costs included selling administrative expenses amounted 433000 358000 373000 years ended december 31 2004 2003 2002 respectively royalty income company enters licensing agreements certain manufacturers company receives royalty payments royalty payments due licensing agreements recognized income either based upon shipment reports licensees available estimated shipments licensees depreciation amortization machinery equipment recorded cost depreciated using straightline method estimated useful lives ranging 5 15 years amortization leasehold improvements computed using straightline method based upon remaining term applicable lease estimated useful life asset whichever shorter longlived assets longlived assets used operations reviewed impairment whenever events changes circumstances indicate carrying amount assets might recoverable longlived assets held used company recognizes impairment loss carrying amount recoverable undiscounted cash flows measures impairment loss based difference carrying amount fair value year ended december 31 2002 company recorded charge impairment longlived assets 19 million write fixed assets consisting master plates longer used impairment charge represents full impairment longlived asset arose purchase accounting company’s former parent related company connection former parent’s merger 1990 impairments longlived assets 2004 2003 goodwill july 2001 fasb issued sfas 142 “goodwill intangible assets” provides goodwill amortized instead tested impairment annual basis adopted company january 1 2002 impairment testing performed two steps determination impairment based fair value company compared carrying value ii indication impairment step measures amount impairment loss comparing implied fair value goodwill carrying amount goodwill accordance sfas 142 company completed transitional impairment test quarter ended march 31 2002 testing indicated adjustment required upon adoption pronouncement company performed annual test impairment required sfas 142 year ended december 31 2002 time fair value based quoted market prices company found less carrying amount result company recorded 74 million impairment charge year ended december 31 2002 charge represents full impairment goodwill company’s balance sheet prior december 31 2002 asset arose purchase accounting company’s former parent related company connection former parent’s merger 1990 warranty costs company provides warranty costs amounts estimates needed cover future warranty obligations products sold estimates warranty costs based historical experience periodically reviewed adjusted necessary company’s product warranty provision included accrued expenses accompanying balance sheets changes company’s warranty provision years ended december 31 2004 2003 2002 follows research development research development costs expensed incurred income taxes company accounts income taxes accordance sfas 109 “accounting income taxes” provision income taxes includes deferred income taxes resulting items reported different periods income tax financial statement purposes deferred tax assets liabilities represent expected future tax consequences differences financial statement carrying amounts existing assets liabilities respective tax basis stockbased compensation plans december 2002 fasb issued sfas 148 “accounting stock based compensationtransition disclosurean amendment fasb statement 123” sfas 148 provides alternative methods transition voluntary change fair value based method accounting stockbased employee compensation intrinsic valuebased method accounting prescribed accounting principles board “apb” opinion 25 “accounting stock issued employees” addition sfas 148 amends disclosure requirements sfas 123 “accounting stockbased compensation” company adopted disclosure requirements sfas 148 effective december 31 2002 allowed sfas 123 company uses intrinsic valuebased method accounting stock based compensation prescribed apb opinion 25 accordingly recognize compensation expense stock option grants made exercise price equal excess fair market value stock date grant compensation cost company’s outstanding stock options determined based fair value grant dates options consistent sfas 123 company’s net income loss basic diluted net income loss per share would differed reflected pro forma amounts indicated basic diluted net income loss per share basic net income loss per share computed based weighted average number outstanding shares common stock basic weighted average number shares outstanding 18488783 year ended december 31 2004 18483720 years ended december 31 2003 2002 diluted net income loss per share computed dividing net income loss weighted average number shares common stock outstanding dilutive potential shares common stock years ended december 31 2004 2003 diluted number weighted shares outstanding 18906897 18525914 respectively includes dilutive stock options 418114 42194 respectively year ended december 31 2002 diluted weighted average number shares outstanding 18483720 effect options purchase 2318500 shares company’s common stock excluded calculation diluted net income loss per share effect inclusion options would antidilutive year ended december 31 2002 effect warrants purchase 863647 shares company’s common stock excluded calculation diluted net income loss per share effect inclusion warrants would antidilutive warrants expired june 18 2003 business concentration risks sales mastercard approximately 35 33 41 sales years ended december 31 2004 2003 2002 respectively december 31 2004 2003 accounts receivable mastercard approximated 11 million 10 million respectively company entered agreement mastercard dated february 28 2003 replaced agreement dated february 1 1996 amended company mastercard entered amendment agreement september 29 2003 mastercard retained company produce new hologram debit mastercard extended agreement february 28 2011 subject automatic renewal terminated either party agreement also provides mastercard receive three sequential price reductions approximately 3 effective beginning 2003 2004 2006 company currently exclusive supplier mastercard loss substantial portion sales mastercard however would material adverse effect financial position results operations cash flows company sales manufacturers visa credit cards approximately 60 customers approximately 31 30 26 sales years ended december 31 2004 2003 2002 respectively loss substantial portion sales customers would material adverse effect financial position results operations cash flows company december 31 2004 2003 accounts receivable customers approximated 12 million 13 million respectively company historically purchased certain key materials used manufacture holograms third party suppliers problems occur respect delivery quality cost materials could material adverse effect financial position results operations cash flows company export sales export sales 21 28 27 sales years ended december 31 2004 2003 2002 respectively export sales denominated united states dollars december 31 2004 2003 accounts receivable customers approximated 05 million fair value financial instruments company’s financial instruments consist cash equivalents shortterm investments accounts receivables accounts payable accrued expenses carrying amounts reported balance sheets approximate fair value december 31 2004 2003 reclassifications certain prior year amounts reclassified conform current year’s presentation impact recently issued accounting standards december 2004 financial accounting standards board issued statement 123r fas 123r sharebased payment amending fas 123 requiring sharebased payments employees recognized financial statements generally approach accounting sharebased payments fas 123r similar approach described fas 123 however pro forma footnote disclosure longer alternative financial statement recognition statement becomes effective first interim annual period beginning june 15 2005 company expects adopt new statement effective july 1 2005 using modifiedprospective transition method described statement method company required recognize compensation expense remaining vesting period awards remain unvested july 1 2005 permitted fas 123 company currently accounts sharebased payments employees using apb 25’s intrinsic value method generally recognized compensation cost employee stock options company believes based level sharebased payments previously granted unvested adoption fas 123r material effect financial position results operations cashflows however level future equity based compensation grants could material effect amounts recorded statement operations november 2004 financial accounting standards board issued statement 151 fas 151 inventory costs amendment arb 43 chapter 4 fas 151 clarifies abnormal amounts idle facility expense freight handling costs wasted materials recognized current period charges addition fas 151 requires allocation fixed production overhead inventory based normal capacity production facilities fas 151 effective inventory costs incurred fiscal years beginning june 15 2005 company currently believes adoption fas 151 material impact financial statements 2 inventories 3 machinery equipment leasehold improvements depreciation amortization machinery equipment leasehold improvements years ended december 31 2004 2003 2002 824000 733000 794000 respectively 4 accrued expenses 5 income taxes provision income taxes follows reconciliation taxes income 2004 2003 2002 follows tax effects items comprising company’s deferred income tax assets liabilities follows deferred income taxes arise temporary differences tax bases assets liabilities reported amounts financial statements 6 stockholders’ equity june 11 1998 company increased authorized common stock 30000000 shares authorized preferred stock 5000000 shares july 20 1998 former parent completed sale 13636000 shares company’s common stock public offering “offering” representing entire investment company 2001 2002 company issued distributed 1460000 shares common stock well warrants purchase 863647 shares company’s common stock exercise price 600 per share settlement class action lawsuit filed company 1999 warrants expired june 18 2003 none warrants exercised august 10 2001 company’s stockholders approved amendment company’s amended restated articles incorporation increasing number authorized shares common stock 40000000 shares june 30 2000 company entered stock purchase agreement “agreement” crane co inc “crane” agreement company sold 3387720 shares company’s common stock crane aggregate purchase price 9316230 agreement also provides board directors company audit committee board directors expanded one position filled douglas crane representative crane agreement also contains standstill provision whereby crane agreed among things neither affiliates except otherwise provided agreement acquire current proportionate share outstanding securities company standstill provision also provides crane offer sell transfer voting securities company tender exchange offer opposed company’s board directors 2000 company entered additional agreements crane company rents factory space leases employees company’s facility dalton years ended december 31 2004 2003 2002 company paid crane agreements 72000 year rental factory space 169000 162000 151000 respectively leased employees primarily included cost goods sold accompanying statements operations 7 facility consolidation december 14 2004 company entered certain agreements lease new 134000 square foot facility located robbinsville new jersey future site company’s primary operations company consolidate existing office manufacturing facilities elmsford new york huntingdon valley pennsylvania new facility company also intends expand supplement manufacturing operations connection consolidation lease effective december 14 2004 expires may 31 2017 agreements company right renew lease three consecutive five year terms also option purchase building company currently expects incur expenses totaling approximately 42 million 02 million incurred 2004 associated existing leases vacating current facilities relocating terminating certain employees moving equipment related expenses substantially complete third quarter 2005 expenses incurred 2004 classified facility consolidation expenses accompanying statement operations approximately 29 million expenses paid cash ratably fourth quarter 2007 approximately 13 million expenses paid cash incurred fourth quarter 2005 8 settlement agreement abnh leonhard kurz gmbh co kg “kurz” entered settlement agreement dated july 1 2002 pursuant settlement agreement kurz make payments abnh totaling 900000 two years 300000 paid upon settlement remainder payable eight quarterly installments 75000 beginning october 2002 exchange release past present future infringements abnh’s demetallizing hotstamping patents except future use specific interpretation demetallizing patents subject royalty based license abnh recorded amounts income accompanying statement operations 2002 net legal expenses 280000 imputed interest 50000 9 stock incentive plans august 4 2000 company adopted american bank note holographics inc 2000 stock incentive plan amended “2000 plan” subsequently approved company’s stockholders annual meeting september 12 2000 july 20 1998 company adopted 1998 stock incentive plan amended “1998 plan” collectively 2000 plan “plans” plans adopted purpose granting various stock incentives officers directors employees consultants company board directors committee appointed board directors discretionary authority subject certain restrictions administer plans total number shares reserved issuance plans 3213000 shares common stock options purchase 451813 shares common stock available future grants december 31 2004 plans exercise price options granted plans may less fair market value common stock date options granted options granted plans generally become vested exercisable 25 33 13 total optioned shares upon succeeding anniversary date grant generally unexercised portion option automatically terminates upon termination optionee’s employment company unless otherwise determined board directors provided however extension shall extend beyond expiration option generally ten years upon change control outstanding options generally become fully vested summary status company’s outstanding stock options december 31 2004 2003 2002 changes years ended follows following table summarizes information concerning outstanding exercisable options december 31 2004 fair value option grant estimated date grant using blackscholes optionpricing model following weightedaverage assumptions 10 employee benefits plans retirement plans october 1 1999 company implemented defined contribution plans employees aggregate contributions plans charged company’s operations approximately 59000 56000 51000 years ended december 31 2004 2003 2002 respectively 11 commitments contingencies company currently time involved litigation plaintiff defendant incidental conduct business however company party lawsuit proceeding opinion management company likely material impact company’s financial position results operations cash flows product liability matters company provides holograms connection wide range customers’ products case possible company subject product liabilities association products connection holograms used products although company maintains product liability insurance assurance insurance would available cover claim available amounts sufficient cover potential liabilities result product liability claims could material adverse effect company’s business financial condition results operations cash flows leases company longterm operating leases offices manufacturing facilities equipment expire 2017 company three five year renewal options robbinsville location provides renewal rents based upon adjusted fair market rental value defined lease agreement rental expense approximately 12 million 13 million 13 million years ended december 31 2004 2003 2002 respectively december 31 2004 future minimum lease payments noncancelable operating leases expiring 2017 follows 13 million 2005 15 million 2006 14 million 2007 06 million 2008 06 million 2009 49 million thereafter employment agreements company entered employment agreements certain current officers provide among matters minimum compensation approximately 05 million 2005 04 million 2006 agreements also provide bonuses connection agreements company granted options acquire 1553000 shares common stock february 1999 december 2003 prices ranging 085 250 per share representing fair market value company’s common stock dates grants schedule ii american bank note holographics inc valuation qualifying accounts years ended december 31 2004 2003 2002 1 accounts deemed uncollectible 2 destruction obsolete inventory s1item 15 exhibits financial statement schedules following documents filed part report 1 financial statements financial statements required item submitted separate section beginning page report 2 financial statement schedules financial statement schedule required item submitted separate section page s1 report schedules included page s1 report omitted absence conditions required information included financial statements notes thereto 3 exhibits following exhibits filed part report incorporated herein reference exhibit nos 104 105 106 107 108 109 1010 1011 1012 1013 1030 1033 1034 1035 1036 management contracts compensatory plans arrangements 31 amended restated certificate incorporation 1 32 amended restated bylaws 1 33 amendment amended restated certificate incorporation 2 41 form common stock certificate 1 42 stock purchase agreement crane co inc american bank note holographics inc dated june 29 2000 3 101 form separation agreement american bank note corporation american bank note holographics inc dated july 20 1998 1 102 form license agreement 1 103 form transitional services agreement 1 104 form employee benefits allocation agreement 1 105 form 1998 stock incentive plan 1 106 form 2000 stock incentive plan 6 108 amendment 2000 stock incentive plan 15 109 form 2005 stock incentive plan 17 1010 form defined contribution plan 1 1011 employment agreement dated april 20 1999 salvatore f d’amato american bank note holographics inc 7 1012 amended restated employment agreement kenneth traub american bank note holographics inc dated march 29 2005 16 1013 amended restated employment agreement dated june 9 2005 alan goldstein american bank note holographics inc 15 1014 standard form loft lease dated july 23 1992 robert martin company american bank holographics inc 9 1015 lease agreement dated january 19 2001 crane co inc american bank note holographics inc 9 1016 lease agreement dated august 11 2002 mark hankin hanmar associates mlp tenantsincommon american bank note holographics inc addenda thereto 11 1017 settlement agreement dated july 1 2002 american bank note holographics inc leonhard kurz gmbh co kg 10 1018 patent license agreement dated july 1 2002 american bank note holographics inc leonhard kurz gmbh co kg 10 1019 substitute cross license agreement dated july 1 2002 american bank note holographics inc leonhard kurz co kg 10 1020 hologram agreement dated february 28 2003 mastercard international incorporated american bank note holograhics inc 11 1021 amendment 1 hologram agreement dated february 28 2003 mastercard international incorporated american bank note holoographics inc 13 1022 amendment 2 hologram agreement dated march 25 2005 hologram agreement dated february 28 2003 mastercard international incorporated american bank note holographics inc 18 1023 amendment 3 hologram agreement dated august 24 2005 hologram agreement dated february 28 2003 mastercard international incorporated american bank note holographics inc 18 1024 visa international holographic magnetic stripe tape manufacturing approval association american bank note holographics inc 18 1025 form indemnification agreement company directors officers 12 1026 sublease agreement apw north america inc american bank note holographics inc dated december 14 2004 14 1027 subordination nondisturbance attornment renewal option purchase agreement american bank note holographics inc applied four de llc dated december 14 2004 14 1028 subordination nondisturbance attornment agreement american bank note holographics inc lasalle bank national association formerly known lasalle national bank trustee morgan stanley capital inc commercial mortgage securities inc commercial mortgage passthrough certificates series 1999wf1 dated december 14 2004 14 1029 escrow agreement apw north america inc american bank note holographics inc chicago title insurance company dated december 14 2004 14 1030 employment agreement dated june 9 2005 american bank note holographics inc mark bonney 15 1031 development supply subcontracting agreement dated may 30 2001 american bank note holographics inc cfc international inc 1032 amendment 1 development supply subcontracting agreement dated may 30 2001 american bank note holographics inc cfc international inc made january 4 2006 1033 form option agreement american bank note holographics inc 1998 stock incentive plan amended 5 1034 form option agreement american bank note holographics inc 2000 stock incentive plan 5 1035 form option agreement american bank note holographics inc 2005 stock incentive plan 16 1036 form restricted stock agreement american bank note holographics inc 2005 stock incentive plan 16 231 consent pricewaterhousecoopers llp 232 consent ernst young llp 241 power attorney jordan davis dated march 28 2006 242 power attorney fred levin dated march 25 2006 311 certification kenneth h traub pursuant exchange act rules 13a14a 15d14a adopted pursuant section 302 sarbanesoxley act 2002 312 certification mark bonney pursuant exchange act rules 13a14a 15d14a adopted pursuant section 302 sarbanesoxley act 2002 321 certification kenneth h traub pursuant 18 usc section 1350 adopted pursuant section 906 sarbanes oxley act 2002 322 certification mark bonney pursuant 18 usc section 1350 adopted pursuant section 906 sarbanes oxley act 2002 1 incorporated reference registration statement form s1 registration 333 51845 2 incorporated reference proxy statement schedule 14a filed july 3 2001 3 incorporated reference quarterly report form 10q filed august 14 2000 4 incorporated reference annual report form 10k 2000 5 incorporated reference registration statement form s8 registration 333 61602 6 incorporated reference proxy statement schedule 14a filed august 11 2000 7 incorporated reference annual report form 10k 1998 8 incorporated reference annual report form 10k 1999 9 incorporated reference annual report form 10k 2001 10 incorporated reference quarterly report form 10q filed august 13 2002 11 incorporated reference annual report form 10k 2002 12 incorporated reference quarterly report form 10q filed august 12 2003 13 incorporated reference quarterly report form 10q filed november 13 2003 14 incorporated reference current report form 8k filed december 20 2004 15 incorporated reference quarterly report form 10q filed august 15 2005 16 incorporated reference current report form 8k filed september 22 2005 17 incorporated reference registration statement form s8 registration 333 129686 18 incorporated reference quarterly report form 10q filed november 13 2005 portions omitted pursuant request confidential treatment signatures pursuant requirements section 13 15d securities exchange act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized pursuant requirements securities exchange act 1934 report signed following persons behalf registrant capacities dates indicated american bank note holographics inc item 15a report independent registered public accounting firm report independent registered public accounting firm financial statements balance sheets december 31 2005 2004 statements operations years ended december 31 2005 2004 2003 statements stockholders’ equity years ended december 31 2005 2004 2003 statements cash flows years ended december 31 2005 2004 2003 notes financial statements schedule ii valuation qualifying accounts report independent registered public accounting firm board directors american bank note holographics inc opinion financial statements listed accompanying index present fairly material respects financial position american bank note holographics inc december 31 2005 results operations cash flows year period ended december 31 2005 conformity accounting principles generally accepted united states america addition opinion financial statement schedules listed accompanying index present fairly material respects information set forth therein read conjunction related financial statements financial statements financial statement schedules responsibility company’s management responsibility express opinion financial statements financial statement schedules based audit conducted audit statements accordance standards public company accounting oversight board united states standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements assessing accounting principles used significant estimates made management evaluating overall financial statement presentation believe audit provides reasonable basis opinion pricewaterhousecoopers llp florham park new jersey march 31 2006 report independent registered public accounting firm board directors shareholders american bank note holographics inc audited accompanying balance sheet american bank note holographics inc “company” december 31 2004 related statements operations stockholders’ equity cash flows two years period ended december 31 2004 audits also included information two years period ended december 31 2004 included financial statement schedule listed index item 15a financial statements schedule responsibility company’s management responsibility express opinion financial statements schedule based audits conducted audits accordance standards public company accounting oversight board united states standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audits provide reasonable basis opinion financial statements referred present fairly material respects financial position company december 31 2004 results operations cash flows two years period ended december 31 2004 conformity us generally accepted accounting principles also opinion information two years period ended december 31 2004 related financial statement schedule considered relation basic financial statements taken whole present fairly material respects information set forth therein new york new york march 10 2005 american bank note holographics inc balance sheets december 31 2005 2004 thousands except share data accompanying notes integral part financial statements american bank note holographics inc statements operations years ended december 31 2005 2004 2003 thousands except per share data accompanying notes integral part financial statements american bank note holographics inc statements stockholders’ equity years ended december 31 2005 2004 2003 thousands accompanying notes integral part financial statements american bank note holographics inc statements cash flows years ended december 31 2005 2004 2003 thousands accompanying notes integral part financial statements notes financial statements years ended december 31 2005 2004 2003 1 basis presentation summary significant accounting policies american bank note holographics inc “company” “abnh” incorporated state delaware august 1985 company july 20 1998 whollyowned subsidiary american banknote corporation “former parent” “abn” abnh originates produces markets sells holograms products incorporating holograms company’s products used primarily security applications including authentication transaction cards identity documents value documents various consumer products company operates one reportable industry segment use estimates preparation financial statements conformity us generally accepted accounting principles requires management make estimates assumptions affect reported amounts assets liabilities disclosure contingent assets liabilities date financial statements reported amounts sales expenses reporting period ongoing basis evaluate estimates including related bad debts inventories intangible assets estimates assumptions based historical results trends well forecasts might change future addition theses estimates assumptions influenced current knowledge impact visa decision see note 11 subsequent event actual results may differ materially estimates cash equivalents highly liquid investments primarily government bonds maturity three months less purchased considered cash equivalents stated cost approximates market shortterm investments shortterm investments consists government bond matured february 22 2005 accordance statement financial accounting standard “sfas” 115 “accounting certain investments debt equity securities” management determines appropriate classification marketable securities time purchase reevaluates designations balance sheet date investment classified held maturity carried amortized cost maturity date concentrations credit risk significant portion company’s accounts receivable due credit card issuers related credit card manufacturers located throughout united states europe december 31 2005 two customers accounted 22 company’s accounts receivable 30 11 respectively sales year ended december 31 2004 three customers accounted 28 19 11 respectively company’s accounts receivable 35 9 6 respectively sales year ended company establishes credit policies based ongoing evaluation customers’ creditworthiness competitive market conditions require collateral inventories stated lower cost market cost determined firstin firstout fifo method revenue recognition company recognizes revenue accordance provisions sec’s staff accounting bulletin “sab” 104 “revenue recognition amendment sab 101 “revenue recognition financial statements”” specifically sales related cost goods sold generally recognized latter time shipment title passes customers situations company shipped product sale contingent upon customers’ use product situations company recognize sales upon product shipment rather buyer product informs company product used additionally pursuant request agreement certain customer completed items stored behalf customer company’s onsite secured facility instance sales recognized following occurred customer ordered goods pursuant fixed price purchase order manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order collection invoice considered probable company accepts returns product sold customers product determined conformance specifications previously agreed upon customers accordance terms warranty policy generally replaces product shipping handling amounts billed customers included revenues amounted 867000 433000 358000 years ended december 31 2005 2004 2003 respectively shipping handling costs included selling administrative expenses royalty income company enters licensing agreements certain manufacturers company receives royalty payments royalty payments due licensing agreements recognized income either based upon shipment reports licensees available estimated shipments licensees depreciation amortization machinery equipment recorded cost depreciated using straightline method estimated useful life asset estimated useful lives generally follows machinery production equipment 5 15 years furniture fixtures 5 7 years computer equipment 3 5 years amortization leasehold improvements computed using straightline method based upon remaining term applicable lease estimated useful life asset whichever shorter currently 13 years longlived assets longlived assets used operations reviewed impairment whenever events changes circumstances indicate carrying amount assets might recoverable longlived assets held used company recognizes impairment loss carrying amount recoverable undiscounted cash flows measures impairment loss based difference carrying amount fair value warranty costs company provides warranty costs amounts estimates needed cover future warranty obligations products sold estimates warranty costs based historical experience periodically reviewed adjusted necessary company’s product warranty provision included accrued expenses accompanying balance sheets changes company’s warranty provision years ended december 31 2005 2004 2003 displayed following table significant change warranties provided 2005 principally due increased volume quarter ended december 31 2005 additional provision recorded quarter ended december 31 2005 potential nonesd related warranty claims result visa decision see note 11 subsequent event research development research development costs expensed incurred income taxes company accounts income taxes accordance sfas 109 “accounting income taxes” provision income taxes includes deferred income taxes resulting items reported different periods income tax financial statement purposes deferred tax assets liabilities represent expected future tax consequences differences financial statement carrying amounts existing assets liabilities respective tax basis stockbased compensation company accounts stock options granted employees directors using intrinsic value method accordance apb opinion 25 “accounting stock issued employees” related interpretations company adopted disclosure requirements sfas 123 “accounting stockbased compensation” accordingly company recognize compensation expense stock option grants made exercise price equal excess fair market value stock date grant compensation cost company’s outstanding stock options determined based fair value grant dates options consistent sfas 123 company’s net loss income basic diluted net loss income per share would differed reflected pro forma amounts calculated using blackscholes model estimate fair value options grant date indicated basic diluted net loss income per share basic net loss income per share computed based weighted average number outstanding shares common stock basic weighted average number shares outstanding 18593000 year ended december 31 2005 18489000 year ended december 31 2004 18484000 year ended december 31 2003 diluted net income loss per share computed dividing net income loss weighted average number shares common stock outstanding dilutive potential shares common stock company loss position year ended december 31 2005 dilutive stock options excluded calculation dilutive earnings per share shares would antidilutive effect year ended december 31 2004 diluted number weighted shares outstanding 18907000 included dilutive stock options 418000 year ended december 31 2003 diluted weighted average number shares outstanding 18526000 included dilutive stock options 42000 business concentration risks significant portion company’s business derived orders placed certain transaction card companies manufacturers transaction cards variations timing orders cause significant fluctuations company’s sales transaction card companies manufacturers transaction cards accounted approximately 86 total sales 2005 84 total sales 2004 traditional hot stamp patch hologram many transaction cards phased major customers replaced integrated holographic magnetic stripe previously reported learned small number incidents certain card terminals affected electrostatic discharge “esd” static electricity carried cards incorporating current version holomag advised customers need develop second generation holographic magnetic tape product addresses esd commenced development assurance successful developing product acceptable customers assurance competitor develop acceptable product adopted customers sales mastercard years ended december 31 2005 2004 2003 approximately 31 35 33 respectively december 31 2005 2004 accounts receivable mastercard approximated 15 million 11 million respectively entered agreement mastercard dated february 28 2003 replaced agreement dated february 1 1996 amended entered amendment agreement september 29 2003 mastercard retained us produce new hologram debit mastercard extended agreement february 2011 subject automatic renewal terminated either party agreement provided mastercard receive three sequential price reductions approximately 3 effective beginning 2003 2004 2006 entered additional amendment agreement mastercard august 24 2005 mastercard named company supplier holographic magnetic stripes “holomag™” extended agreement february 28 2013 subject automatic renewal company exclusive supplier holograms holographic magnetic stripes mastercard sales visa holograms includes holomag starting three month period ended september 30 2005 manufacturers visa transaction cards approximately 37 31 30 sales years ended december 31 2005 2004 2003 respectively currently one two companies authorized manufacture sell visa dove hot stamp holograms manufacturers visa brand transaction cards march 15 2005 visa announced intention phase dove hot stamp hologram supply front visa card replace integrated holographic magnetic stripe april 8 2005 entered agreement visa pursuant authorized supply holomag visaapproved card manufacturers previously reported learned small number incidents certain card terminals affected electrostatic discharge “esd” static electricity carried cards incorporating holomag march 14 2006 informed visa result esd issue visa informing member financial institutions authorized card manufacturers visa longer approve visa card designs incorporate current version holomag ii visa strongly recommends members attempt avoid issuance cards incorporating current version holomag iii visa recommends members follow alternate card design incorporating conventional magnetic stripe dove hologram visa provided notice us revoking right produce holomag agreement “visa decision” continuing evaluate visa’s actions claims submitted initial response visa quarter ended december 31 2005 result visa decision recorded pretax charge amounting approximately 50 million 48 million recorded cost goods sold principally related value holomag inventory also included charge increases provisions accounts receivable potential nonesd related warranty claims review valuation accounts ongoing basis part closing process make appropriate changes reserve levels based upon facts time purchase certain key materials used manufacture products subcontract certain production functions products third parties sole suppliers cases supply contracts suppliers operate purchase order basis case holomag single supplier cfc international inc supply contract may able find alternative sources timely manner suppliers subcontractors become unwilling unable supply us increase prices inability obtain key products product components certain processes performed behalf could cause delays reduce product shipments could cause relationship customers suffer materially adversely affect financial condition results operations cash flows export sales 2005 2004 2003 export sales accounted approximately 34 21 28 respectively total sales export sales presently denominated us dollars december 31 2005 2004 accounts receivable customers approximated 20 5 million respectively fair value financial instruments company’s financial instruments consist cash equivalents shortterm investments accounts receivables accounts payable accrued expenses carrying amounts reported balance sheets approximate fair value december 31 2005 2004 comprehensive income comprehensive income equal net income periods reclassifications certain prior year amounts reclassified conform current year’s presentation impact recently issued accounting standards december 2004 financial accounting standards board issued statement 123r fas 123r sharebased payment revising fas 123 requiring sharebased payments employees recognized financial statements generally approach accounting sharebased payments fas 123r similar approach described fas 123 however pro forma footnote disclosure longer alternative financial statement recognition statement amended becomes effective first annual period beginning june 15 2005 company adopted new statement effective january 1 2006 using modifiedprospective transition method described statement method company required recognize compensation expense remaining vesting period awards remain unvested january 1 2006 permitted fas 123 company currently accounts sharebased payments employees using apb 25’s intrinsic value method generally recognized compensation cost employee stock options approximate impact 2006 results refer proforma results shown note 1 “stockbased compensation” november 2004 financial accounting standards board issued statement 151 fas 151 inventory costs amendment arb 43 chapter 4 fas 151 clarifies abnormal amounts idle facility expense freight handling costs wasted materials recognized current period charges addition fas 151 requires allocation fixed production overhead inventory based normal capacity production facilities fas 151 effective inventory costs incurred fiscal years beginning june 15 2005 company currently believes adoption fas 151 material impact financial statements march 2005 financial accounting standards board “fasb” issued interpretation 47 accounting conditional asset retirement obligations interpretation sfas 143 interpretation clarifies term conditional asset retirement obligation refers legal obligation perform asset retirement activity timing andor method settlement conditional future event may within control entity obligation perform asset retirement activity unconditional even though uncertainty exists timing andor method settlement accordingly entity required recognize liability fair value conditional asset retirement obligation fair value liability reasonably estimated provisions interpretation 47 effective fiscal years ending december 15 2005 adoption statement impact company’s financial statement presentation since conditional asset retirement obligations december 2004 financial accounting standards board “fasb” issued statement financial accounting standards “sfas” 154 accounting changes error corrections replacement apb opinion 20 sfas 3 statement changes requirements accounting reporting change accounting principle statement requires retrospective application prior period financial statements changes accounting principle unless impracticable determine either periodspecific effects cumulative effect change indirect effects change accounting principle recognized period accounting change provisions sfas 154 effective fiscal years beginning december 15 2005 company adopted statement beginning january 1 2006 2 inventories net inventories stated lower cost market firstin firstout method result visa decision see note 12 subsequent event quarter ended december 31 2005 adjusted value holomag inventory 4018000 reflecting lower cost market value december 31 2005 3 machinery equipment leasehold improvements depreciation amortization machinery equipment leasehold improvements years ended december 31 2005 2004 2003 1291000 824000 733000 respectively 4 accrued expenses 5 income taxes provision income taxes follows reconciliation taxes income 2005 2004 2003 follows tax effects items comprising company’s deferred income tax assets liabilities follows deferred income taxes arise temporary differences tax bases assets liabilities reported amounts financial statements 6 stockholders’ equity june 11 1998 company increased authorized common stock 30000000 shares authorized preferred stock 5000000 shares july 20 1998 former parent completed sale 13636000 shares company’s common stock public offering “offering” representing entire investment company 2001 2002 company issued distributed 1460000 shares common stock well warrants purchase 863647 shares company’s common stock exercise price 600 per share settlement class action lawsuit filed company 1999 warrants expired june 18 2003 none warrants exercised august 10 2001 company’s stockholders approved amendment company’s amended restated articles incorporation increasing number authorized shares common stock 40000000 shares june 30 2000 company entered stock purchase agreement “agreement” crane co inc “crane” agreement company sold 3387720 shares company’s common stock crane aggregate purchase price 9316230 agreement also provides board directors company audit committee board directors expanded one position filled douglas crane representative crane mr crane resigned board directors november 29 2005 november 30 2005 informed crane co inc intention sell portion shares orderly manner crane sold shares march 15 2006 agreement also contains standstill provision whereby crane agreed among things neither affiliates except otherwise provided agreement acquire current proportionate share outstanding securities company standstill provision also provides crane offer sell transfer voting securities company tender exchange offer opposed company’s board directors 2000 company entered additional agreements crane company rents factory space leases employees company’s facility dalton years ended december 31 2005 2004 2003 company paid crane agreements 72000 year rental factory space 153000 169000 162000 respectively leased employees primarily included cost goods sold accompanying statements operations 7 facility consolidation december 14 2004 company entered agreements lease 134000 square foot modern manufacturing office building robbinsville new jersey site primary operations following closure relocation consolidation operations elmsford new york huntingdon valley pennsylvania robbinsville site company completed relocation consolidation operations 2005 robbinsville facility provides substantial room expansion company consolidated operations conducted within 58000 square foot facility elmsford new york 30000 square foot facility huntingdon valley pennsylvania new facility currently evaluating possible use huntingdon valley facility certain manufacturing secure storage company also acquired installed additional equipment technology new facility broaden capabilities serve target customers expand capacity become vertically integrated improve efficiency base rent lease robbinsville new jersey facility 555000 per year increasing 19 per year first seven months lease rentfree recorded minimal amount deferred rent 2004 04 million 2005 term lease robbinsville facility extends may 31 2017 expiration term options renew lease three consecutive five year periods fair market value also option purchase building end original lease term adjusted fair market value defined lease agreement base rent lease huntingdon valley pennsylvania 144000 per year lease facility expires june 30 2007 base rent lease elmsford new york 746000 per year lease facility expires december 31 2007 elmsford facility abandoned part move consolidation 2005 remaining rent end lease term charged facility consolidation expense 2005 invested approximately 61 million 2005 capital assets relating move consolidation approximately 52 million expended 2005 9 million expended 2004 expenditures facility upgrades customize robbinsville new jersey facility company’s operational security requirements well acquisition new equipment upgrade expand production capabilities following table illustrates costs incurred relocation consolidation years ended december 31 2004 2005 anticipated 2006 2007 8 stock incentive plans august 8 2005 adopted 2005 stock incentive plan “2005 plan” subsequently approved stockholders annual meeting september 22 2005 number shares available issuance 2005 stock incentive plan 1600000 august 4 2000 adopted american bank note holographics inc 2000 stock incentive plan amended “2000 plan” subsequently approved stockholders annual meeting september 12 2000 august 2001 stockholders approved amendment 2000 plan increasing shares available issuance thereunder 600000 1350000 shares july 20 1998 adopted 1998 stock incentive plan amended “1998 plan” collectively 2000 plan 2005 plan “plans” plans adopted purpose granting various stock incentives officers directors employees consultants abnh board directors committee appointed board directors discretionary authority subject certain restrictions administer plans total number shares reserved issuance plans 4813000 shares common stock options purchase 2971938 shares common stock outstanding plans december 31 2005 exercise price options granted plans may less 100 fair market value common stock date option granted options granted plans generally become vested exercisable either 25 33 13 total optioned shares upon succeeding anniversary date grant generally unexercised portion option automatically terminates upon termination optionee’s employment us unless otherwise determined board directors provided however extension shall extend beyond expiration option generally ten years upon change control outstanding options generally become fully vested additionally december 31 2005 15000 shares restricted stock issued restricted stock fully vest three years date issuance grantee employed time january 26 2006 granted options purchase aggregate 30000 shares common stock executive officers directors 193000 shares common stock employees exercise price equal fair value common stock date grant additionally issued 60000 restricted shares executive officers 79000 restricted shares employees date summary status company’s outstanding stock options december 31 2005 2004 2003 changes years ended follows following table summarizes information concerning outstanding exercisable options december 31 2005 fair value option grant estimated date grant using blackscholes optionpricing model following weightedaverage assumptions 9 employee benefits plans retirement plans october 1 1999 company implemented defined contribution plans employees aggregate contributions plans charged company’s operations approximately 57000 59000 56000 years ended december 31 2005 2004 2003 respectively 10 commitments contingencies company currently time involved litigation plaintiff defendant incidental conduct business however company party lawsuit proceeding opinion management company likely material impact company’s financial position results operations cash flows product liability matters company provides holograms connection wide range customers’ products case possible company subject product liabilities association products connection holograms used products although company maintains product liability insurance assurance insurance would available cover claim available amounts sufficient cover potential liabilities result product liability claims could material adverse effect company’s business financial condition results operations cash flows leases company longterm operating leases offices manufacturing facilities equipment expire 2017 company three five year renewal options robbinsville location provides renewal rents based upon adjusted fair market rental value defined lease agreement rental expense approximately 13 million 12 million 13 million years ended december 31 2005 2004 2003 respectively december 31 2005 future minimum lease payments noncancelable operating leases expiring 2017 follows 16 million 2006 14 million 2007 06 million 2008 06 million 2009 48 million thereafter employment agreements company entered employment agreements certain current executive officers provide among matters minimum compensation approximately 08 million 2006 08 million 2007 agreements also provide bonuses connection agreements company granted options acquire 1567500 shares common stock february 1999 december 2005 prices ranging 085 640 per share representing fair market value company’s common stock dates grants 11 subsequent event company previously reported learned small number incidents certain card terminals affected electrostatic discharge “esd” static electricity carried cards incorporating holomag company also reported date advised customers need develop second generation holographic magnetic tape product addresses esd issue company commenced development assurance company successful developing product acceptable customers march 14 2006 informed visa result esd issue visa informing member financial institutions authorized card manufacturers visa longer approve visa card designs incorporate current version holomag ii visa strongly recommends members attempt avoid issuance cards incorporating current version holomag iii visa recommends members follow alternate card design incorporating conventional magnetic stripe dove hologram visa also provided notice us revoking right produce holomag agreement “visa decision” company continues evaluate visa’s actions claims provided visa initial response company believes compliance agreement visa holomag product complies standards specifications therein result visa’s notification financial institutions authorized card manufacturers company received communications visa authorized card manufacturers seeking address status disposition holomag inventory orders accordingly quarter ended december 31 2005 result visa decision company recorded pretax charge amounting approximately 50 million 48 million recorded cost goods sold principally related value holomag inventory also included charge increases provisions accounts receivable potential nonesd related warranty claimswe review valuation accounts ongoing basis part closing process make appropriate changes reserve levels based upon facts time schedule ii american bank note holographics inc valuation qualifying accounts years ended december 31 2005 2004 2003 1 accounts deemed uncollectible 2 destruction obsolete inventory s1nanitem 15 exhibits financial statement schedules following documents filed part report 1 financial statements financial statements required item submitted separate section beginning page report 2 financial statement schedules financial statement schedule required item submitted separate section page s1 report schedules included page s1 report omitted absence conditions required information included financial statements notes thereto 3 exhibits following exhibits filed part report incorporated herein reference exhibit nos 104 105 106 107 108 109 1010 1011 1012 1025 1030 1034 1035 1036 1037 1038 management contracts compensatory plans arrangements 1 incorporated reference registration statement form s1 registration 33351845 2 incorporated reference proxy statement schedule 14a filed july 3 2001 3 incorporated reference quarterly report form 10q filed august 14 2000 4 incorporated reference annual report form 10k 2000 5 incorporated reference registration statement form s8 registration 33361602 6 incorporated reference proxy statement schedule 14a filed august 11 2000 7 incorporated reference annual report form 10k 1998 8 incorporated reference annual report form 10k 1999 9 incorporated reference annual report form 10k 2001 10 incorporated reference quarterly report form 10q filed august 13 2002 11 incorporated reference annual report form 10k 2002 12 incorporated reference quarterly report form 10q filed august 12 2003 13 incorporated reference quarterly report form 10q filed november 13 2003 14 incorporated reference current report form 8k filed december 20 2004 15 incorporated reference quarterly report form 10q filed august 15 2005 16 incorporated reference current report form 8k filed september 22 2005 17 incorporated reference registration statement form s8 registration 333129686 18 incorporated reference quarterly report form 10q filed november 13 2005 19 incorporated reference annual report form 10k 2005 20 incorporated reference quarterly report form 10q filed august 11 2006 21 incorporated reference quarterly report form 10q filed november 14 2006 portions omitted pursuant request confidential treatment american bank note holographics inc balance sheets december 31 2006 2005 thousands except share data accompanying notes integral part financial statements american bank note holographics inc statements operations years ended december 31 2006 2005 2004 thousands except per share data accompanying notes integral part financial statements american bank note holographics inc statements stockholders’ equity years ended december 31 2006 2005 2004 thousands accompanying notes integral part financial statements american bank note holographics inc statements cash flows years ended december 31 2006 2005 2004 thousands accompanying notes integral part financial statements american bank note holographics inc notes financial statements years ended december 31 2006 2005 2004 1 basis presentation summary significant accounting policies american bank note holographics inc “company” “abnh” incorporated state delaware august 1985 company july 20 1998 whollyowned subsidiary american banknote corporation “former parent” “abn” abnh originates produces markets sells holograms products incorporating holograms company’s products used primarily security applications including authentication transaction cards identity documents value documents various consumer products company operates one reportable industry segment use estimatesthe preparation financial statements conformity accounting principles generally accepted united states america requires management make use estimates assumptions impact reported amounts assets liabilities date financial statements reported amounts revenue expenses reporting period ongoing basis evaluate estimates including related bad debts stockbased compensation inventories taxes estimates assumptions based historical results trends well forecasts estimates assumptions might change future addition estimates assumptions influenced current assumptions potential impact visa decision see note 11 visa decision actual results may differ materially estimates cash equivalentsall highly liquid investments primarily government bonds maturity three months less purchased considered cash equivalents stated cost approximates market shortterm investmentsshortterm investments consists government bond matured february 22 2005 accordance statement financial accounting standard “sfas” 115 “accounting certain investments debt equity securities” management determines appropriate classification marketable securities time purchase reevaluates designations balance sheet date investment classified held maturity carried amortized cost maturity date inventoriesinventories stated lower cost market cost determined firstin firstout fifo method revenue recognitionthe company recognizes revenue accordance provisions sec’s staff accounting bulletin “sab” 104 “revenue recognition amendment sab 101 “revenue recognition financial statements”” products sold fixed price basis purchase orders contracts customers sales related cost goods sold generally recognized latter time shipment title passes customers situations company shipped product sale contingent upon customers’ use product situations company recognize sales upon product shipment rather buyer product informs company product used additionally pursuant request agreement certain customer completed items stored behalf customer company’s onsite secured facility instance sales recognized following occurred customer ordered goods pursuant fixed price purchase order manufacturing process complete goods transferred onsite secured facility ready shipment risk ownership passed customer billed order collection invoice considered reasonably assured december 31 2006 2005 accounts receivable customer totaled 15 million 15 million respectively certain cases company agreed maintain inventory products customer ensure quick turn around deliveries company accepts returns product sold customers product determined conformance specifications previously agreed upon customers accordance terms warranty policy generally replaces product company generally provides replacement product 180 days original shipment warranty defective product shipping handling amounts billed customers included sales amounted 09 million 09 million 04 million 2006 2005 2004 respectively shipping handling costs included selling administrative expenses royalty incomethe company enters licensing agreements certain manufacturers company receives royalty payments royalty payments due licensing agreements recognized income either based upon shipment reports licensees available estimated shipments licensees depreciation amortizationmachinery equipment recorded cost depreciated using straightline method estimated useful life asset estimated useful lives generally follows machinery production equipment5 15 years furniture fixtures5 7 years computer equipment3 5 years amortization leasehold improvements computed using straightline method based upon remaining term applicable lease estimated useful life asset whichever shorter currently 12 years longlived assetslonglived assets used operations reviewed impairment whenever events changes circumstances indicate carrying amount assets might recoverable longlived assets held used company recognizes impairment loss carrying amount recoverable undiscounted cash flows measures impairment loss based difference carrying amount fair value warranty coststhe company provides warranty costs amounts estimates needed cover future warranty obligations products sold estimates warranty costs based historical experience periodically reviewed adjusted necessary company’s product warranty provision included accrued expenses accompanying balance sheets research developmentresearch development costs expensed incurred research development expense amounted 16 million 2006 13 million 2005 2004 income taxesthe company accounts income taxes accordance sfas 109 “accounting income taxes” provision income taxes includes deferred income taxes resulting items reported different periods income tax financial statement purposes deferred tax assets liabilities represent expected future tax consequences differences financial statement carrying amounts existing assets liabilities respective tax basis july 2006 financial accounting standards board issued interpretation 48 “accounting uncertainty income taxesan interpretation sfas 109” “fin 48” fin 48 clarifies accounting uncertainty income tax positions company taken expects take respect tax return pronouncement prescribes morelikelythannot threshold recognition well measurement criteria changes tax positions financial statement purposes addition fin 48 also requires additional qualitative quantitative disclosures unrecognized tax benefits included notes financial statements adopt provisions fin 48 quarter ending march 31 2007 reviewed accounting income taxes light provisions fin 48 expect adoption materially affect consolidated financial statements stockbased compensationin december 2004 financial accounting standards board issued statement 123r fas 123r sharebased payment revising fas 123 requiring sharebased payments employees recognized financial statements adopted new statement effective january 1 2006 using modifiedprospective transition method described statement method required recognize compensation expense awards granted adoption based grant date fair value estimated accordance fas 123r unvested portion previously granted options remain outstanding adoption date based grant date fair value accordance original provisions fas 123 prior periods adjusted unearned compensation restricted shares reclassified additional paid capital beginning january 1 2006 prior adopting fas 123r applied intrinsic valuebased method accounting prescribed apb opinion 25 accordingly recognize compensation expense stock option grants made exercise price equal excess fair market value stock date grant fas 123r also requires benefits tax deductions excess recognized compensation cost reported financing cash flow rather operating cash flow required previous accounting literature effect reducing net operating cash flows increasing financing cash flows periods adoption fas 123r also requires computation apic pool amount excess tax benefits available offset future “shortfalls” calculated beginning apic pool using “longform” method apic pool used subsequent adoption fas 123r determining whether amounts deferred tax assets related stock options excess tax deductions realized short falls need recorded expense earnings per share basic diluted earnings per share calculated accordance statement financial accounting standards “sfas” 128 “earnings per share” following table sets forth reconciliation basic weighted average shares outstanding diluted weighted average shares outstanding basic diluted net loss income per sharebasic net loss income per share computed based weighted average number outstanding shares common stock company loss position year ended december 31 2005 dilutive stock options excluded calculation dilutive earnings per share shares would antidilutive effect business concentration risksa significant portion business derived orders placed certain transaction card companies manufacturers transaction cards variations timing orders cause significant fluctuations sales transaction card companies manufacturers transaction cards accounted approximately 84 86 total sales 2006 2005 respectively traditional hot stamp hologram supplied many transaction cards primary source revenue twenty years certain customers began transition hot stamp hologram integrated holographic magnetic stripe “holomag” supply cancelled plans make transition reverting back traditional hot stamp hologram due small number incidents certain card terminals affected electrostatic discharge “esd” static electricity carried cards incorporating first generation holomag result advised esd issue response requests customers developed second generation holomag product addresses esd currently offering customers second generation version holomag began shipping product limited quantities early 2007 although assurance given second generation version holomag accepted customers assurance competitor develop acceptable product adopted customers extent sales traditional hot stamp patch holograms decline without replacing sales new products business operating results financial condition would materially adversely affected concentrations credit riska significant portion company’s accounts receivable due credit card issuers related credit card manufacturers located throughout united states europe december 31 2006 three customers accounted 28 15 respectively company’s accounts receivable 35 8 5 respectively sales year ended december 31 2005 two customers accounted 22 company’s accounts receivable 30 11 respectively sales year ended company establishes credit policies based ongoing evaluation customers’ creditworthiness competitive market conditions require collateral sales manufacturers visa transaction cards approximately 35 37 sales years ended december 31 2006 2005 respectively currently authorized supplier visa dove hot stamp holograms manufacturers visa brand transaction cards march 15 2005 visa announced intention phase dove hot stamp hologram supply front visa card replace integrated holographic magnetic stripe april 8 2005 entered agreement visa pursuant authorized supply holomag visa approved card manufacturers began shipping holomag visa authorized card manufacturers second half 2005 march 14 2006 informed visa result esd issue visa effectively ceasing holomag program “visa decision” visa moved include either dove hot stamp hologram mini hot stamp hologram supply security device visa cards letter dated november 7 2006 advised visa terminating visa holomag agreement sales visa products visa authorized card manufacturers 2006 2005 follows sales holomag visa authorized card manufacturers expected continue 2007 sales hot stamp holograms visa authorized card manufacturers expected continue 2007 lose substantial portion hot stamp hologram business visa without replacing new product sales business operating results financial condition would materially adversely affected addition fail obtain anticipated orders visa authorized card manufactures experience delays cancellations orders card manufacturers business financial performance materially adversely affected visa’s march 2006 correspondence us time ceased holomag program visa stated view “a remediation program impacted stakeholders may necessary” visa would seek indemnification us costs andor claims evaluating visa’s actions claims continue discuss matter visa believe complied visa holomag agreement holomag product complied standards specifications contained agreement continuing evaluate visa’s actions claims discuss matter visa event visa third parties assert claims us financial condition results operations may adversely affected sales mastercard approximately 35 31 sales years ended december 31 2006 2005 respectively agreement mastercard amended pursuant company exclusive supplier mastercard holograms holographic magnetic stripes holomag™ quarter ended september 30 2005 mastercard advised member financial institutions around world allow choose among card designs incorporate either traditional hot stamp patch hologram holomag supplied company sales holomag mastercard significant 2006 february 9 2007 mastercard advised certified card manufacturers us effective immediately suspending use first generation holomag product due significant decrease demand product date mastercard approved second generation holomag product mastercard informed us continuing test second generation holomag product agreement mastercard expires february 28 2013 subject automatic renewal thereafter lose substantial portion business mastercard without replacing new product sales business operating results financial condition would materially adversely affected addition fail obtain anticipated orders mastercard experience delays cancellations orders mastercard business financial performance materially adversely affected export salesduring 2006 2005 2004 export sales accounted approximately 35 34 21 respectively total sales export sales presently billed us dollars december 31 2006 2005 accounts receivable customers approximated 12 million 20 million respectively purchase certain key materials used manufacture products subcontract certain production functions products third parties sole suppliers cases supply contracts suppliers operate purchase order basis case holomag single supplier cfc international inc acquired itw 2006 supply contract amended july 26 2006 also time negotiated settlement cfc international inc resulted reduction payable approximately 10 million may able find alternative sources timely manner suppliers subcontractors become unwilling unable supply us increase prices inability obtain key product components certain processes performed behalf could cause delays reduce product shipments could cause relationship customers suffer materially adversely affect financial condition results operations cash flows fair value financial instrumentsthe company’s financial instruments consist cash equivalents shortterm investments accounts receivables accounts payable accrued expenses carrying amounts reported balance sheets approximate fair value december 31 2006 2005 comprehensive incomecomprehensive income equal net income periods reclassificationscertain prior year amounts reclassified conform current year’s presentation impact recently issued accounting standards september 2006 financial accounting standards board issued sfas 157 “fair value measurements” “sfas 157” sfas 157 defines fair value establishes framework measuring fair value generally accepted accounting principles expands disclosures fair value measurements sfas 157 effective fiscal years beginning december 15 2007 company currently process evaluating impact adoption sfas 157 financial position results operations cash flows september 2006 sec issued staff accounting bulletin 108 “considering effects prior year misstatements quantifying misstatements current year financial statements” “sab 108” address diversity practice quantifying financial statement misstatements sab 108 requires company quantifies misstatements based impact financial statements related disclosures company adopted provisions sab 108 fourth quarter 2006 adoption effect company’s financial statements july 2006 financial accounting standards board issued interpretation 48 “accounting uncertainty income taxesan interpretation sfas 109” “fin 48” fin 48 clarifies accounting uncertainty income tax positions company taken expects take respect tax return pronouncement prescribes morelikelythannot threshold recognition well measurement criteria changes tax positions financial statement purposes addition fin 48 also requires additional qualitative quantitative disclosures unrecognized tax benefits included notes financial statements adopt provisions fin 48 beginning quarter ending march 31 2007 reviewed accounting income taxes light provisions fin 48 expect adoption materially affect consolidated financial statements december 2004 financial accounting standards board issued statement 123r fas 123r sharebased payment revising fas 123 requiring sharebased payments employees recognized financial statements generally approach accounting sharebased payments fas 123r similar approach described fas 123 however pro forma footnote disclosure longer alternative financial statement recognition statement amended becomes effective first annual period beginning june 15 2005 company adopted new statement effective january 1 2006 using modifiedprospective transition method described statement method company required recognize compensation expense remaining vesting period awards remain unvested january 1 2006 permitted fas 123 company currently accounts sharebased payments employees using apb 25’s intrinsic value method generally recognized compensation cost employee stock options impact 2006 results shown results operations note 8”stockbased compensation” financial statements november 2004 financial accounting standards board “fasb” issued statement 151 “fas 151” inventory costs amendment arb 43 chapter 4 fas 151 clarifies abnormal amounts idle facility expense freight handling costs wasted materials recognized current period charges addition fas 151 requires allocation fixed production overhead inventory based normal capacity production facilities fas 151 effective inventory costs incurred fiscal years beginning june 15 2005 company adopted fas 151 2006 result impact visa decision company recorded approximately 08 million overhead expenses period expenses 2006 march 2005 fasb issued interpretation 47 accounting conditional asset retirement obligations interpretation sfas 143 interpretation clarifies term conditional asset retirement obligation refers legal obligation perform asset retirement activity timing andor method settlement conditional future event may within control entity obligation perform asset retirement activity unconditional even though uncertainty exists timing andor method settlement accordingly entity required recognize liability fair value conditional asset retirement obligation fair value liability reasonably estimated provisions interpretation 47 effective fiscal years ending december 15 2005 company adopted interpretation 47 2006 adoption statement impact company’s financial statement presentation since company conditional asset retirement obligations 2 inventories net inventories stated lower cost market firstin firstout method result visa decision see note 12 visa decision quarter ended december 31 2005 adjusted value holomag inventory 4018000 reflecting lower cost market value december 31 2005 2006 following termination visa holomag program wroteoff remaining visa holomag inventory reducing finished goods inventory reserve like amount 3 machinery equipment leasehold improvements depreciation machinery equipment leasehold improvements years ended december 31 2006 2005 2004 843000 1291000 824000 respectively 4 accrued expenses significant change warranties provided 2005 principally due increased volume quarter ended december 31 2005 additional provision recorded quarter ended december 31 2005 potential nonesd related warranty claims result visa decision see note 11 visa decision changes company’s warranty provision years ended december 31 2006 2005 2004 displayed following table 5 income taxes provision income taxes follows reconciliation taxes income 2006 2005 2004 follows tax effects items comprising company’s deferred income tax assets liabilities follows deferred income taxes arise temporary differences tax bases assets liabilities reported amounts financial statements net noncurrent deferred tax liability included long term liabilities balance sheet 6 stockholders’ equity june 11 1998 company increased authorized common stock 30000000 shares authorized preferred stock 5000000 shares july 20 1998 former parent completed sale 13636000 shares company’s common stock public offering “offering” representing entire investment company 2001 2002 company issued distributed 1460000 shares common stock well warrants purchase 863647 shares company’s common stock exercise price 600 per share settlement class action lawsuit filed company 1999 warrants expired june 18 2003 none warrants exercised august 10 2001 company’s stockholders approved amendment company’s amended restated articles incorporation increasing number authorized shares common stock 40000000 shares june 30 2000 company entered stock purchase agreement “agreement” crane co inc “crane” agreement company sold 3387720 shares company’s common stock crane aggregate purchase price 9316230 agreement also provides board directors company audit committee board directors expanded one position filled douglas crane representative crane mr crane resigned board directors november 29 2005 november 30 2005 informed crane co inc intention sell portion shares orderly manner crane sold shares march 23 2007 agreement also contains standstill provision whereby crane agreed among things neither affiliates except otherwise provided agreement acquire current proportionate share outstanding securities company standstill provision also provides crane offer sell transfer voting securities company tender exchange offer opposed company’s board directors 2000 entered agreements crane rented factory space leased employees facility dalton arrangement ended october 2006 leased facilities employees turned crane time years ended december 31 2006 2005 2004 paid crane agreements 60000 72000 respectively rental factory space 62000 153000 169000 respectively leased employees 7 facility consolidation december 14 2004 company entered agreements lease 134000 square foot modern manufacturing office building robbinsville new jersey site primary operations following closure relocation consolidation operations elmsford new york huntingdon valley pennsylvania robbinsville site company completed relocation consolidation operations 2005 robbinsville facility provides substantial room expansion company consolidated operations conducted within 58000 square foot facility elmsford new york 30000 square foot facility huntingdon valley pennsylvania new facility 2006 reopened huntingdon valley facility certain manufacturing secure storage company also acquired installed additional equipment technology new facility broaden capabilities serve target customers expand capacity become vertically integrated improve efficiency base rent lease robbinsville new jersey facility 555000 per year increasing 19 per year first seven months lease rentfree recorded deferred rent 04 million 2004 2005 respectively term lease robbinsville facility extends may 31 2017 expiration term options renew lease three consecutive five year periods fair market value also option purchase building end original lease term adjusted fair market value defined lease agreement base rent lease huntingdon valley pennsylvania 144000 per year lease facility expires june 30 2007 currently negotiating extension lease facility base rent lease elmsford new york 746000 per year lease facility expires december 31 2007 facility abandoned part move consolidation 2005 remaining rent net estimated sublease income end lease term charged facility consolidation expense 2005 quarter ended september 30 2006 entered amendment lease elmsford new york facility terms amendment buildings owner agreed ten percent 10 reduction fixed annual rent retroactive april 1 2006 recorded reduction facility consolidation expense ii payment 100000 contribution towards cost demolition restoration facility recorded reduction depreciation expense iii company provided letter credit favor owner amount 78960680 event uncured default payments lease agreement iv acceleration payments company lease agreement event facility subleased invested approximately 60 million 2005 capital additions robbinsville new jersey facility conjunction consolidation operations approximately 51 million expended 2005 09 million expended 2004 expenditures facility upgrades customize robbinsville new jersey facility company’s operational security requirements well acquisition new equipment upgrade expand production capabilities following table illustrates liability balance activity related relocation consolidation 2006 2005 2004 2058000 balance december 31 2005 1182000 included accrued liabilities 876000 included longterm liabilities following table illustrates costs incurred relocation consolidation facilities december 31 2006 anticipated 2007 cash payments expenses expected completed 8 stockbased compensation plans august 8 2005 adopted 2005 stock incentive plan “2005 plan” approved stockholders annual meeting september 22 2005 number shares available issuance 2005 stock incentive plan 1600000 august 4 2000 adopted american bank note holographics inc 2000 stock incentive plan amended “2000 plan” approved stockholders annual meeting september 12 2000 august 2001 stockholders approved amendment 2000 plan increasing shares available issuance thereunder 600000 1350000 shares july 20 1998 adopted 1998 stock incentive plan amended “1998 plan” collectively 2000 plan 2005 plan “plans” number shares available issuance 1998 plan 1863000 plans adopted purpose granting various stock incentives officers directors employees consultants abnh board directors committee appointed board directors discretionary authority subject certain restrictions administer plans total number shares reserved issuance plans 4813000 shares common stock options purchase 3033722 shares common stock outstanding plans december 31 2006 exercise price options granted plans may less 100 fair market value common stock date option granted options granted plans generally become vested exercisable either 25 33 13 total optioned shares upon succeeding anniversary date grant generally unexercised portion option automatically terminates upon termination optionee’s employment us unless otherwise determined board directors provided however extension shall extend beyond expiration option generally ten years upon change control outstanding options generally become fully vested prior 2005 granted nonqualified stock options beginning 2005 began granting restricted shares addition stock options december 31 2006 133500 shares restricted stock issued restricted stock fully vest three years date issuance grantee employed time january 19 2007 granted options purchase aggregate 137500 shares common stock employees exercise price equal fair value common stock date grant additionally issued 98500 restricted shares employees date january 26 2007 granted options purchase aggregate 15000 shares common stock outside directors exercise price equal fair value common stock date grant beginning 2007 stock based compensation awards executive officers granted following release year end earnings therefore options restricted shares granted executive officers date december 2004 financial accounting standards board issued statement 123r “fas 123r” sharebased payment revising fas 123 requiring sharebased payments employees recognized financial statements adopted new statement effective january 1 2006 using modifiedprospective transition method described statement method required recognize compensation expense awards granted adoption based grant date fair value estimated accordance fas 123r unvested portion previously granted options remain outstanding adoption date based grant date fair value accordance original provisions fas 123 2006 operating income reduced 980000 stockbased payment compensation expense stock options restricted stock stockbased compensation 2006 affected cost goods sold 225000 selling general administrative expenses 639000 research development expenses 116000 stockbased compensation expense reduced 2006 net income 611000 basic fully diluted earnings per share 003 prior periods adjusted unearned compensation restricted shares reclassified additional paid capital beginning january 1 2006 fas 123r also requires benefits tax deductions excess recognized compensation cost reported financing cash flow rather operating cash flow required previous accounting literature effect reducing net operating cash flows increasing financing cash flows periods adoption year ended december 31 2006 recognized financing cash flows amounting 58000 excess tax deductions fas 123r also requires computation apic pool amount excess tax benefits available offset future “shortfalls” calculated beginning apic pool using “longform” method apic pool used subsequent adoption fas 123r determining whether amounts deferred tax assets related stock options excess tax deductions realized short falls need recorded expense prior adopting fas 123r applied intrinsic valuebased method accounting prescribed apb opinion 25 accordingly recognize compensation expense stock option grants made exercise price equal excess fair market value stock date grant following table details effect company’s net income basic diluted net income per share compensation expense stockbased awards recorded 2005 2004 based fairvalue method sfas 123 use blackscholes option pricing model calculate fair value options key assumptions valuation method include expected term option stock price volatility riskfree interest rate dividend yield exercise price forfeiture rate many assumptions judgmental highly sensitive determination compensation expense assumptions indicated weighted average fair value stock option grants 2006 2005 569 297 respectively table indicates key assumptions used valuation calculations options granted 2006 2005 discussion methodology developing assumptions used valuation model termthis period time options granted expected remain outstanding options granted maximum term ten 10 years increase expected term increase compensation expense volatilitythis measure amount stock price fluctuated expected fluctuate volatilities based historical volatility abnh’s shares factors expected volatility arising planned changes business operations increase expected volatility increase compensation expense riskfree interest ratethis us treasury rate week grant term equal expected term options granted increase riskfree interest rate increase compensation expense dividend yieldwe make dividend payments last five years plans make dividend payments foreseeable future forfeiture ratethis estimated percentage options granted expected forfeited canceled becoming vested increase forfeiture rate decrease compensation expense summary status company’s outstanding stock options december 31 2006 2005 2004 changes years ended follows following table summarizes information concerning outstanding exercisable options december 31 2006 december 31 2006 1354000 total unrecognized compensation cost net estimated forfeitures related stock options costs expected recognized weighted average period 09 years total intrinsic value stock options exercised year ended december 31 2006 238000 total intrinsic value stock options outstanding december 31 2006 1972000 total intrinsic value vested stock options december 31 2006 1884000 cash received stock option exercises year ended december 31 2006 158000 income tax benefit stock based arrangements totaled 86000 attributable stock option exercises credited additional paid capital following table summarizes information restricted stock awards 2006 restricted stock awards made 2005 stock incentive plan generally vest 100 three years grant date december 31 2006 559000 unrecognized compensation costs net estimated forfeitures related restricted stock awards costs expected recognized weighted average period 20 years december 31 2006 aggregate 1326360 shares remained available future grants awards stock incentive plans cover stock options restricted stock awards issue shares satisfy stock option exercises restricted stock awards 9 employee benefits plans retirement planson october 1 1999 company implemented defined contribution plans employees aggregate contributions plans charged company’s operations approximately 58000 57000 59000 years ended december 31 2006 2005 2004 respectively 10 commitments contingencies company currently time involved litigation plaintiff defendant incidental conduct business however company party lawsuit proceeding opinion management company likely material impact company’s financial position results operations cash flows product liability mattersthe company provides holograms connection wide range customers’ products case possible company subject product liabilities association products connection holograms used products although company maintains product liability insurance assurance insurance would available cover claim available amounts sufficient cover potential liabilities result product liability claims could material adverse effect company’s business financial condition results operations cash flows warranty contracts reservesthe company believes reasonable likelihood approximately 07 million reserves balance sheet december 31 2006 reversed income 2007 periods potential claims programs expire leasesthe company longterm operating leases offices manufacturing facilities equipment expire 2017 company three five year renewal options robbinsville location provides renewal rents based upon adjusted fair market rental value defined lease agreement company currently negotiating extension lease facility huntingdon valley pa current lease expire june 30 2007 rental expense approximately 13 million 13 million 12 million years ended december 31 2006 2005 2004 respectively december 31 2005 future minimum lease payments noncancelable operating leases expiring 2017 follows 18 million 2007 07 million 2008 08 million 2009 06 million 2010 39 million thereafter employment agreementsthe company entered employment agreements certain current executive officers provide among matters minimum compensation approximately 08 million 2007 08 million 2008 agreements also provide bonuses 11 visa decision february 23 2006 reported learned small number incidents certain card terminals affected electrostatic discharge “esd” static electricity carried cards incorporating holomag also reported date advised customers need develop second generation holographic magnetic tape product addresses esd issue commenced development could assurance would successful developing product would acceptable customers march 14 2006 informed visa result esd issue visa effectively ceasing holomag program “visa decision” visa moved include either dove hot stamp hologram mini hot stamp hologram supply security device visa cards letter dated november 7 2006 advised visa terminating visa holomag agreement visa’s march 2006 correspondence us visa stated view “a remediation program impacted stakeholders may necessary” visa would seek indemnification us costs andor claims evaluating visa’s actions claims continue discuss matter visa believe complied visa holomag agreement holomag product complied standards specifications contained agreement accordingly quarter ended december 31 2005 result visa decision recorded pretax charge amounting approximately 50 million 48 million recorded cost goods sold principally related value holomag inventory also included charge increases provisions accounts receivable potential nonesd related warranty claims also shipments totaling approximately 23 million visa holomag completed invoiced quarter ended march 31 2006 recognized revenue collection amounts considered probable result visa decision 2006 subsequent completing filing financial statements three months ended march 31 2006 approximately 09 million 02 million 12 million collected accordingly revenue recorded quarter ended june 30 2006 september 30 2006 december 31 2006 respectively also 2006 wroteoff value visa holomag inventory reversed reserve obsolescence recorded quarter ended december 31 2005 additionally result visa decision twelve months ended december 31 2006 wroteoff approximately 08 million idle facility costs absorbed inventory approximately 03 million costs capitalized balance sheet december 31 2005 relating terminated manufacturing project 2006 also analyzed provision levels warranty liability accounts receivable recorded necessary adjustments report independent registered public accounting firm board directors shareholders american bank note holographics inc opinion 2006 2005 financial statements listed accompanying index present fairly material respects financial position american bank note holographics inc december 31 2006 2005 results operations cash flows two years period ended december 31 2006 conformity accounting principles generally accepted united states america addition opinion financial statement schedules listed accompanying index two years period ended december 31 2006 present fairly material respects information set forth therein read conjunction related financial statements financial statements financial statement schedules responsibility company’s management responsibility express opinion financial statements financial statement schedules based audits conducted audits statements accordance standards public company accounting oversight board united states standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements assessing accounting principles used significant estimates made management evaluating overall financial statement presentation believe audits provide reasonable basis opinion discussed note 1 8 consolidated financial statements respectively company changed manner accounts inventory costs stockbased compensation 2006 pricewaterhousecoopers llp florham park new jersey march 26 2007 report independent registered public accounting firm board directors shareholders american bank note holographics inc audited accompanying statements operations stockholders’ equity cash flows american bank note holographics inc year ended december 31 2004 audit also included information year ended december 31 2004 included financial statement schedule listed index item 15a financial statements schedule responsibility company’s management responsibility express opinion financial statements schedule based audit conducted audit accordance standards public company accounting oversight board united states standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audit provides reasonable basis opinion financial statements referred present fairly material respects results operations cash flows american bank note holographics inc year ended december 31 2004 conformity us generally accepted accounting principles also opinion information year ended december 31 2004 related financial statement schedule considered relation basic financial statements taken whole present fairly material respects information set forth therein ernst young llp new york new york march 10 2005 signatures pursuant requirements section 13 15d securities exchange act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized american bank note holographics inc kenneth h traub kenneth h traub president chief executive officer march 30 2007 pursuant requirements securities exchange act 1934 report signed following persons behalf registrant capacities dates indicated schedule ii american bank note holographics inc valuation qualifying accounts years ended december 31 2006 2005 2004 1 accounts deemed uncollectible 2 destruction obsolete inventory