** **

### **UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 
| **(Mark One)** |
|----------------|
| **ý**     | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|           | **For the quarterly period ended September 30, 2003** |   |   |
| **or**         |
| **o**          | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|           | **For the transition period from                        to                        ** |
|           |   |
|           | **Commission file number 33-97090** |

 

| **ACG HOLDINGS, INC.**                                                                                                      |
|-----------------------------------------------------------------------------------------------------------------------------|
| (Exact name of registrant as specified in its charter)                                                                      |
|                                                                                                                        |
| **Delaware**                                                                                                                |   | **62-1395968** |
| (State or other jurisdiction of incorporation or organization)                                                              |   | (I.R.S. Employer Identification Number) |
|                                                                                                                        |   |   |
| **100 Winners Circle  Brentwood, Tennessee 37027  (615) 377-0377**                                                          |
| (Address, including zip code, and telephone number, including area  code, of registrant’s principal executive offices) |
|                                                                                                                        |
|                                                                                                                        |
| **AMERICAN COLOR GRAPHICS, INC.**                                                                                           |
| (Exact name of registrant as specified in its charter)                                                                      |
|                                                                                                                        |
| **New York**                                                                                                                |   | **16-1003976** |
| (State or other jurisdiction of incorporation or organization)                                                              |   | (I.R.S. Employer Identification Number) |
|                                                                                                                        |   |   |
| **100 Winners Cirlce****Brentwood, Tennessee 37027  (615) 377-0377**                                                        |
| (Address, including zip code, and telephone number, including area  code, of registrant’s principal executive offices) |
|                                                                                                                             |  |  |  |  |

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

Yesý No o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2) of the Exchange Act.

Yeso No ý

 

ACGHoldings, Inc. has 163,929 shares outstanding of its Common Stock, $.01 ParValue, as of October 31, 2003 (all of which are privately owned and not tradedon a public market).

 

 

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**INDEX**

 
| **Part I.**  | **Financial Information**                                                                               | **Page No.** |
|--------------|---------------------------------------------------------------------------------------------------------|--------------|
|         |                                                                                                    |         |
| Item 1.      | Financial Statements                                                                                    |         |
|         |                                                                                                    |         |
|         | Condensed Consolidated Balance Sheets as of  September 30, 2003 and March 31, 2003                      | 3            |
|         |                                                                                                    |         |
|         | Condensed Consolidated Statements of  Operations for the Three Months Ended September 30, 2003 and 2002 | 5            |
|         |                                                                                                    |         |
|         | Condensed Consolidated Statements of  Operations for the Six Months Ended September 30, 2003 and 2002   | 6            |
|         |                                                                                                    |         |
|         | Condensed Consolidated Statements of Cash  Flows for the Six Months Ended September 30, 2003 and 2002   | 7            |
|         |                                                                                                    |         |
|         | Notes to Condensed Consolidated Financial  Statements                                                   | 8            |
|         |                                                                                                    |         |
| Item 2.      | Management’s Discussion and Analysis of  Financial Condition and Results of Operations             | 18           |
|         |                                                                                                    |         |
| Item 3.      | Quantitative and Qualitative Disclosures  About Market Risk                                             | 28           |
|         |                                                                                                    |         |
| Item 4.      | Controls and Procedures                                                                                 | 28           |
|         |                                                                                                    |         |
| **Part II.** | **Other Information**                                                                                   |         |
|         |                                                                                                    |         |
| Item 1.      | Legal Proceedings                                                                                       | 29           |
|         |                                                                                                    |         |
| Item 2.      | Changes in Securities and Use of Proceeds                                                               | 29           |
|         |                                                                                                    |         |
| Item 6.      | Exhibits and Reports on Form 8-K                                                                        | 29           |
|         |                                                                                                    |         |
|         | Signatures                                                                                              | 30           |
|         |                                                                                                    |         |
|         | Exhibit  Index                                                                                          | 31           |

 

2

----

 

**ACGHOLDINGS, INC.**

CondensedConsolidated Balance Sheets

(In thousands)

 
|                                                                                                                               |   | **September   30, 2003** |       | **March 31, 2003** |       |
|------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------|------------|--------------------|------------|
|                                                                                                                               |   | **(Unaudited)**               |       |               |       |
| **Assets**                                                                                                                         |   |                          | ** ** |               | ** ** |
|                                                                                                                               |   |                          |       |               |       |
| Current assets:                                                                                                                    |   |                          |       |               |       |
| Cash                                                                                                                               |   | $                             | —     |               | —     |   |
| Receivables:                                                                                                                       |   |                          |       |               |       |
| Trade accounts, less allowance for doubtful  accounts of $3,165 and $2,544 at September 30, 2003 and March 31, 2003,  respectively |   | 48,032                        |       | 49,402             |       |
| Income tax receivable                                                                                                              |   | 185                           |       | 233                |       |
| Other                                                                                                                              |   | 2,921                         |       | 2,227              |       |
| Total receivables                                                                                                                  |   | 51,138                        |       | 51,862             |       |
|                                                                                                                               |   |                          |       |               |       |
| Inventories                                                                                                                        |   | 10,523                        |       | 10,203             |       |
| Deferred income taxes                                                                                                              |   | 2,442                         |       | 6,246              |       |
| Prepaid expenses and other current assets                                                                                          |   | 4,560                         |       | 4,296              |       |
| Current assets of discontinued operations                                                                                          |   | —                        |       | 866                |       |
| Total current assets                                                                                                               |   | 68,663                        |       | 73,473             |       |
|                                                                                                                               |   |                          |       |               |       |
| Property, plant and equipment                                                                                                      |   | 312,258                       |       | 310,180            |       |
| Less accumulated depreciation                                                                                                      |   | (183,953                      | )          | (183,167           | )          |
| Net property, plant and equipment                                                                                                  |   | 128,305                       |       | 127,013            |       |
|                                                                                                                               |   |                          |       |               |       |
| Excess of cost over net assets acquired                                                                                            |   | 66,548                        |       | 66,548             |       |
|                                                                                                                               |   |                          |       |               |       |
| Deferred financing costs                                                                                                           |   | 12,687                        |       | 3,335              |       |
| Other assets                                                                                                                       |   | 7,535                         |       | 7,790              |       |
| Long-term assets of discontinued operations                                                                                        |   | —                        |       | 282                |       |
|                                                                                                                               |   |                          |       |               |       |
| Total assets                                                                                                                       |   | $                             | 283,738    |               | 278,441    |   |

 

See accompanying notes to condensed consolidated financial statements.

 

3

----

 

**ACGHOLDINGS, INC.**

CondensedConsolidated Balance Sheets

(Dollars inthousands, except par values and liquidation preference)

 
|                                                                                                                                                                                                                                                                                                                                                                         |   | **September   30, 2003** |    | **March 31, 2003** |    |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------|---------|--------------------|---------|
|                                                                                                                                                                                                                                                                                                                                                                         |   | **(Unaudited)**               |    |               |    |
| **Liabilities and  Stockholders’ Deficit**                                                                                                                                                                                                                                                                                                                              |   |                          |    |               |    |
|                                                                                                                                                                                                                                                                                                                                                                         |   |                          |    |               |    |
| Current liabilities:                                                                                                                                                                                                                                                                                                                                                         |   |                          |    |               |    |
| Current installments of long-term debt and  capitalized leases                                                                                                                                                                                                                                                                                                               |   | $                             | 5,729   |               | 31,698  |   |
| Trade accounts payable                                                                                                                                                                                                                                                                                                                                                       |   | 39,363                        |    | 39,044             |    |
| Accrued expenses                                                                                                                                                                                                                                                                                                                                                             |   | 35,732                        |    | 32,302             |    |
| Current liabilities of discontinued  operations                                                                                                                                                                                                                                                                                                                              |   | —                        |    | 249                |    |
| Total current liabilities                                                                                                                                                                                                                                                                                                                                                    |   | 80,824                        |    | 103,293            |    |
|                                                                                                                                                                                                                                                                                                                                                                         |   |                          |    |               |    |
| Long-term debt and capitalized leases,  excluding current installments                                                                                                                                                                                                                                                                                                       |   | 295,570                       |    | 200,059            |    |
| Deferred income taxes                                                                                                                                                                                                                                                                                                                                                        |   | 11,069                        |    | 2,023              |    |
| Other liabilities                                                                                                                                                                                                                                                                                                                                                            |   | 79,332                        |    | 80,765             |    |
| Total liabilities                                                                                                                                                                                                                                                                                                                                                            |   | 466,795                       |    | 386,140            |    |
|                                                                                                                                                                                                                                                                                                                                                                         |   |                          |    |               |    |
| Commitments and contingencies (Note 7)                                                                                                                                                                                                                                                                                                                                       |   |                          |    |               |    |
|                                                                                                                                                                                                                                                                                                                                                                         |   |                          |    |               |    |
| Stockholders’ deficit:                                                                                                                                                                                                                                                                                                                                                  |   |                          |    |               |    |
| Common stock, voting, $.01 par value,  5,852,223 shares authorized, 163,929 shares issued and outstanding                                                                                                                                                                                                                                                                    |   | 2                             |    | 2                  |    |
| Preferred stock, $.01 par value, 15,823  shares authorized, none issued and outstanding as of September 30, 2003, as  of March 31, 2003, 3,617 shares Series AA convertible preferred stock issued  and outstanding, $39,442,500 liquidation preference, and 1,606 shares Series  BB convertible preferred stock issued and outstanding, $17,500,000  liquidation preference |   | —                        |    | —             |    |
| Additional paid-in capital                                                                                                                                                                                                                                                                                                                                                   |   | 1,988                         |    | 58,816             |    |
| Accumulated deficit                                                                                                                                                                                                                                                                                                                                                          |   | (160,234                      | )       | (140,655           | )       |
| Other accumulated comprehensive loss, net  of tax                                                                                                                                                                                                                                                                                                                            |   | (24,813                       | )       | (25,862            | )       |
|                                                                                                                                                                                                                                                                                                                                                                         |   |                          |    |               |    |
| Total stockholders’ deficit                                                                                                                                                                                                                                                                                                                                             |   | (183,057                      | )       | (107,699           | )       |
|                                                                                                                                                                                                                                                                                                                                                                         |   |                          |    |               |    |
| Total liabilities and stockholders’ deficit                                                                                                                                                                                                                                                                                                                             |   | $                             | 283,738 |               | 278,441 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

4

----

 

**ACGHOLDINGS, INC.**

CondensedConsolidated Statements of Operations

(In thousands)

(Unaudited)

 
|                                                          |   | **Three Months Ended  September 30,** |    |
|---------------------------------------------------------------|--------|---------------------------------------|---------|
|                                                          |   | **2003**                              |    | **2002** |   |
|                                                          |   |                                  |    |   |   |
| Sales                                                         |   | $                                     | 115,280 |   | 130,076 |   |
| Cost of sales                                                 |   | 100,606                               |    | 112,321 |   |
| Gross profit                                                  |   | 14,674                                |    | 17,755 |   |
| Selling, general and administrative  expenses                 |   | 8,954                                 |    | 8,941 |   |
| Restructuring costs                                           |   | 2,000                                 |    | — |   |
| Operating income                                              |   | 3,720                                 |    | 8,814 |   |
| Other expense (income):                                       |   |                                  |    |   |   |
| Interest expense                                              |   | 10,110                                |    | 7,096 |   |
| Interest income                                               |   | (6                                    | )       | (21 | ) |
| Loss on early extinguishment of debt                          |   | 3,196                                 |    | — |   |
| Other, net                                                    |   | 175                                   |    | 179 |   |
| Total other expense                                           |   | 13,475                                |    | 7,254 |   |
|                                                          |   |                                  |    |   |   |
| Income (loss) from continuing operations  before income taxes |   | (9,755                                | )       | 1,560 |   |
|                                                          |   |                                  |    |   |   |
| Income tax expense:                                           |   |                                  |    |   |   |
| Current                                                       |   | 102                                   |    | 150 |   |
| Deferred                                                      |   | 12,823                                |    | 148 |   |
| Total income tax expense                                      |   | 12,925                                |    | 298 |   |
|                                                          |   |                                  |    |   |   |
| Income (loss) from continuing operations                      |   | (22,680                               | )       | 1,262 |   |
| Discontinued operations:                                      |   |                                  |    |   |   |
| Loss from operations, net of $0 tax                           |   | —                                |    | 140 |   |
|                                                          |   |                                  |    |   |   |
| Net income (loss)                                             |   | $                                     | (22,680 | ) | 1,122 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

5

----

 

**ACGHOLDINGS, INC.**

CondensedConsolidated Statements of Operations

(In thousands)

(Unaudited)

** **
|                                                          |   | **Six Months Ended  September 30,** |    |
|---------------------------------------------------------------|--------|-------------------------------------|---------|
|                                                          |   | **2003**                            |    | **2002** |   |
|                                                          |   |                                |    |   |   |
| Sales                                                         |   | $                                   | 236,967 |   | 257,531 |   |
| Cost of sales                                                 |   | 203,592                             |    | 218,803 |   |
| Gross profit                                                  |   | 33,375                              |    | 38,728 |   |
| Selling, general and administrative  expenses                 |   | 16,323                              |    | 17,020 |   |
| Restructuring costs                                           |   | 2,000                               |    | — |   |
| Operating income                                              |   | 15,052                              |    | 21,708 |   |
| Other expense (income):                                       |   |                                |    |   |   |
| Interest expense                                              |   | 17,301                              |    | 14,305 |   |
| Interest income                                               |   | (7                                  | )       | (77 | ) |
| Loss on early extinguishment of debt                          |   | 3,196                               |    | — |   |
| Other, net                                                    |   | 211                                 |    | 482 |   |
| Total other expense                                           |   | 20,701                              |    | 14,710 |   |
|                                                          |   |                                |    |   |   |
| Income (loss) from continuing operations  before income taxes |   | (5,649                              | )       | 6,998 |   |
| Income tax expense:                                           |   |                                |    |   |   |
| Current                                                       |   | 624                                 |    | 726 |   |
| Deferred                                                      |   | 12,850                              |    | 189 |   |
| Total income tax expense                                      |   | 13,474                              |    | 915 |   |
|                                                          |   |                                |    |   |   |
| Income (loss) from continuing operations                      |   | (19,123                             | )       | 6,083 |   |
| Discontinued operations:                                      |   |                                |    |   |   |
| Loss from operations, net of $0 tax                           |   | 12                                  |    | 502 |   |
| Loss on sale, net of $0 tax                                   |   | 444                                 |    | — |   |
|                                                          |   |                                |    |   |   |
| Net income (loss)                                             |   | $                                   | (19,579 | ) | 5,581 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

6

----

 

**ACG HOLDINGS, INC.**

#### CondensedConsolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 
|                                                                                      |   | **Six Months Ended  September 30,** |    |
|-------------------------------------------------------------------------------------------|--------|-------------------------------------|---------|
|                                                                                      |   | **2003**                            |    | **2002** |   |
|                                                                                      |   |                                |    |   |   |
| *Cash flows provided (used) by  operating activities:*                                    |   |                                |    |   |   |
|                                                                                      |   |                                |    |   |   |
| Net income (loss)                                                                         |   | $                                   | (19,579 | ) | 5,581 |   |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |   |                                |    |   |   |
| Depreciation                                                                              |   | 11,829                              |    | 11,187 |   |
| Depreciation related to discontinued operations                                           |   | 26                                  |    | 237 |   |
| Amortization of other assets                                                              |   | 313                                 |    | 269 |   |
| Amortization of deferred financing costs                                                  |   | 1,037                               |    | 769 |   |
| Write-off of deferred financing costs                                                     |   | 3,196                               |    | — |   |
| Deferred income tax expense                                                               |   | 12,850                              |    | 189 |   |
| Discontinued operations, net of tax                                                       |   | 430                                 |    | 365 |   |
| Decrease in working capital and other                                                     |   | 2,858                               |    | 2,351 |   |
| Net cash provided by operating activities                                                 |   | 12,960                              |    | 20,948 |   |
|                                                                                      |   |                                |    |   |   |
| *Cash flows provided (used) by  investing activities:*                                    |   |                                |    |   |   |
|                                                                                      |   |                                |    |   |   |
| Purchases of property, plant and equipment                                                |   | (10,105                             | )       | (20,845 | ) |
| Proceeds from sales of property, plant and  equipment                                     |   | 24                                  |    | 11 |   |
| Other                                                                                     |   | 271                                 |    | 40 |   |
| Net cash used by investing activities                                                     |   | (9,810                              | )       | (20,794 | ) |
|                                                                                      |   |                                |    |   |   |
| *Cash flows provided (used) by  financing activities:*                                    |   |                                |    |   |   |
|                                                                                      |   |                                |    |   |   |
| Repayment of long-term debt, net                                                          |   | (39,185                             | )       | (8,066 | ) |
| Net increase in revolver borrowings                                                       |   | —                              |    | 9,290 |   |
| Repayment of 123⁄4% senior subordinated notes                                          |   | (170,055                            | )       | (1,700 | ) |
| Proceeds from issuance of 10% senior second  secured notes                                |   | 280,000                             |    | — |   |
| Repayment of capital lease obligations                                                    |   | (3,253                              | )       | (3,859 | ) |
| Repayment of capital lease obligations –  discontinued operations                    |   | —                              |    | (100 | ) |
| Payment of deferred financing costs                                                       |   | (13,585                             | )       | (264 | ) |
| Repurchase and retire preferred stock and cancel  preferred stock options                 |   | (56,942                             | )       | — |   |
| Other, net                                                                                |   | —                              |    | (2 | ) |
| Net cash used by financing activities                                                     |   | (3,020                              | )       | (4,701 | ) |
|                                                                                      |   |                                |    |   |   |
| Effect of exchange rates on cash                                                          |   | (130                                | )       | — |   |
| Net change in cash                                                                        |   | —                              |    | (4,547 | ) |
|                                                                                      |   |                                |    |   |   |
| Cash:                                                                                     |   |                                |    |   |   |
| Beginning of period                                                                       |   | —                              |    | 4,547 |   |
|                                                                                      |   |                                |    |   |   |
| End of period                                                                             |   | $                                   | —  |   | — |   |
|                                                                                      |   |                                |    |   |   |
| Non-cash investing activity:                                                              |   |                                |    |   |   |
| Equipment purchases under capital leases                                                  |   | $                                   | 2,035   |   | 725 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

7

----

 

**ACG HOLDINGS, INC.**

#### Notes toCondensed Consolidated Financial Statements

(Unaudited)

 

***Description of theCompany***

 

ACG Holdings, Inc. (“Holdings”) has no operations or significant assetsother than its investment in American Color Graphics, Inc. (“Graphics”),(collectively the “Company”).  Holdingsowns 100% of the outstanding voting shares of Graphics.  The two business segments of the commercialprinting industry in which the Company operates are (i) print and (ii) premediaservices.

 

**1.**     **Basis of Presentation**

 

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States for interim financial information and are in accordancewith the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States for complete financial statements.  In the opinion of management, alladjustments (consisting of normal recurring adjustments) considered necessaryfor a fair presentation have been included. The operating results for the three and six-month periods endedSeptember 30, 2003 are not necessarily indicative of the results that may beexpected for the fiscal year ending March 31, 2004. These unaudited condensedconsolidated financial statements should be read in conjunction with theconsolidated financial statements and footnotes thereto included in theCompany’s Form 10-K for the fiscal year ended March 31, 2003 and the Company’sPost-Effective Amendment No. 9 to Registration Statement No. 33-97090 on FormS-1.

 

The preparation of the financial statements in conformity withaccounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions that affect the amounts reportedin the financial statements and accompanying notes.  Actual results could differ from those estimates.  Certain prior period information has beenreclassified to conform to current period presentation.

 

**2.****     Discontinued Operations**

 

In June 2003, the Company sold its digital visual effects business,(“Digiscope”), for a de minimis amount, which resulted in a net loss ofapproximately $0.4 million, which is net of zero income tax benefits.  The sale of Digiscope has been accounted foras a discontinued operation, and accordingly, Digiscope’s operations aresegregated and reported within discontinued operations in the accompanyingcondensed consolidated financial statements. Sales, cost of sales and selling, general and administrative expensesattributable to Digiscope for the three and six months ended September 30, 2002have been reclassified and presented within discontinued operations.

 

**3.**     **Inventories**

 

The components of inventories are as follows (in thousands):

 
|               |   | **September 30,  2003** |   | **March 31,  2003** |   |
|--------------------|--------|-------------------------|--------|---------------------|--------|
| Paper              |   | $                       | 8,422  |                | 7,973  |   |
| Ink                |   | 154                     |   | 164                 |   |
| Supplies and other |   | 1,947                   |   | 2,066               |   |
| Total inventories  |   | $                       | 10,523 |                | 10,203 |   |

 

8

----

 

**4.****   July 3, 2003 RefinancingTransactions**

 

On July 3, 2003, the Company sold $280 million aggregate principalamount of its 10% Senior Second Secured Notes Due 2010 (the “10% Notes”) aspart of a recapitalization involving Graphics, Holdings and certain affiliatesof the Company and also entered into a $70 million senior secured revolvingcredit facility maturing on July 3, 2008, with a syndicate of lenders (the“Revolving Credit Facility”), (collectively the “2003 Refinancing”).  Graphics repaid substantially all existingindebtedness (excluding capital leases) through:

 

•      the repayment of all amountsoutstanding under the old bank credit agreement, and the concurrent terminationof all related commitments thereunder;

•      the issuance of letters ofcredit under the Revolving Credit Facility to replace outstanding letters ofcredit; and

•      effective August 3, 2003,the redemption of all of the 123⁄4% Senior Subordinated Notes Due 2005 (the “123⁄4%Notes”), at a redemption price equal to 100% of their aggregate principalamount, plus accrued and unpaid interest thereon.

 

In addition, the Company repurchased, and concurrently retired, all5,223 outstanding shares of preferred stock of Holdings, and canceled alloutstanding options to purchase shares of preferred stock of Holdings held bycertain key officers, for an aggregate purchase price of $56.9 million.  The canceled options would have beenexercisable for 582 shares of preferred stock of Holdings.

 

In connection with the 2003 Refinancing, the Company incurred $13.2million of deferred financing fees through September 30, 2003.  Of the total deferred financing fees, $4.9million was paid to affiliates of Morgan Stanley for the services theyperformed in conjunction with the Revolving Credit Facility and the originalprivate placement of the 10% Notes.  TheCompany also incurred a charge of approximately $3.2 million in the quarterended September 30, 2003 related to the write-off of deferred financing costsassociated with the old bank credit agreement and the 123⁄4% Notes.  In addition, the Company recordedincremental interest expense of approximately $1.7 million in the quarter endedSeptember 30, 2003 as a result of the 30 day call provision related to the 123⁄4%Notes.

 

The Revolving Credit Facility provides for maximum borrowings of $70million, including a letter of credit sub-facility of up to $40 million.  Borrowings under the Revolving CreditFacility are subject to a borrowing base limitation based on certainpercentages of eligible accounts receivable and eligible inventory and a $35million sublimit based upon the appraised value of eligible machinery andequipment and real estate.

 

The Revolving Credit Facility is secured by substantially all of theassets of Graphics.  Holdings hasguaranteed Graphics’ indebtedness under the Revolving Credit Facility, whichguarantee is secured by a pledge of all of Graphics’ and Graphics’subsidiaries’ stock.

 

Amounts outstanding under the Revolving Credit Facility bear interestat an initial rate equal to, at the Company’s option, (a) an alternate baserate, plus an applicable margin of 1.50% or (b) a reserve adjusted LIBOR rate,plus an applicable margin of 2.50%.  Theapplicable margins under both rate structures are subject to periodic downwardadjustment based upon the attainment of certain fixed charge coverage ratiolevels.

 

The Revolving Credit Facility contains customary affirmative andnegative covenants, including but not limited to:

•**     **a minimum fixed chargecoverage ratio requirement; and

•**     **limitations onacquisitions and investments, new subsidiaries, uses of proceeds, indebtedness,liens, dividends and distributions, prepayments of certain indebtedness,affiliate transactions, loans, asset dispositions and Holdings’ businessoperations.

 

9

----

 

**5.****   Comprehensive Income (Loss)**

 

Statement of Financial Accounting Standards No. 130, “ReportingComprehensive Income,” requires foreign currency translation adjustments,minimum pension liability adjustments and unrealized gains or losses onavailable-for-sale securities to be included in comprehensive income (loss).

 

Total comprehensive income (loss) for the three and six months endedSeptember 30, 2003 and 2002 are as follows (in thousands):

 
|                                                 |   | **Three Months Ended  September 30,** |    | **Six Months Ended  September 30,** |   |
|------------------------------------------------------|--------|---------------------------------------|---------|-------------------------------------|--------|
|                                                 |   | **2003**                              |    | **2002**                            |   | **2003** |   | **2002** |   |
|                                                 |   |                                  |    |                                |   |   |   |   |   |
| Net income (loss)                                    |   | $                                     | (22,680 | )                                   | 1,122  |   | (19,579 | ) | 5,581 |   |
| Foreign currency translation adjustment, net of  tax |   | (7                                    | )       | (462                                | )      | 1,049 |   | 186 |   |
|                                                 |   |                                  |    |                                |   |   |   |   |   |
| Total comprehensive income (loss)                    |   | $                                     | (22,687 | )                                   | 660    |   | (18,530 | ) | 5,767 |   |

 

**6.****   Income Taxes**

 

Income taxes have been provided using the liability method inaccordance with Statement of Financial Accounting Standards No. 109,“Accounting for Income Taxes” (“SFAS 109”). Deferred income taxes reflect the net tax effects of temporarydifferences between the carrying amounts of assets and liabilities forfinancial reporting purposes and the amounts as measured by tax laws andregulations.

 

The Company recorded income tax expense of $12.9 million and $13.5million for the three and six months ended September 30, 2003, respectivelycompared to $0.3 million and $0.9 million for the three and six months endedSeptember 30, 2002, respectively.  Theincrease in income tax expense in both the three and six months ended September30, 2003 is primarily due to an adjustment to increase the deferred tax assetvaluation allowance by $12.8 million. This adjustment reflected a change in circumstances which resulted in ajudgment that, based on the provisions in SFAS 109 that restrict the Company’sability to consider forecasts of future income, a corresponding amount ofdeferred tax assets may not be realized. The change in circumstances arises from an assessment of the currenteconomic climate, particularly the continuance of competitive pricing pressuresin the industry, and the expected increase in annual interest costs arisingfrom the issuance of the 10% Notes that have provided negative evidence aboutthe Company’s ability to realize certain deferred tax assets.  The Company will reverse its valuationallowance into income when and to the extent sufficient positive evidencearises to support the realization of the related deferred tax assets.

 

**7.****   Commitments and Contingencies**

 

The Company has employment agreements with one of its principalofficers and two other employees. Such agreements provide for minimum salarylevels as well as for incentive bonuses, which are payable if specifiedmanagement goals are attained.  Inaddition, the Company has a consulting agreement with one former employee.  The aggregate commitment for future compensationat September 30, 2003, excluding bonuses, was approximately $1.8 million.

 

In the quarter ended December 31, 1997, the Company entered intomulti-year contracts to purchase a portion of the Company’s raw materials to beused in its normal operations.  Inconnection with such purchase agreements, pricing for a portion of theCompany’s raw materials is adjusted for certain movements in market prices,changes in raw material costs and other specific price increases.  The Company is deferring certain

 

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contractual provisions over the life of the contracts, which are beingrecognized as the purchase commitments are achieved. The amount deferred atSeptember 30, 2003 is $47.0 million and is included within Other liabilities inthe Company’s condensed consolidated balance sheet.

 

Graphics, together with over 300 other persons, has been designated bythe U.S. Environmental Protection Agency as a potentially responsible party (a“PRP”) under the Comprehensive Environmental Response Compensation andLiability Act (“CERCLA,” also known as “Superfund”) at a solvent recoveryoperation that closed in 1989.  Althoughliability under CERCLA may be imposed on a joint and several basis and theCompany’s ultimate liability is not precisely determinable, the PRPs haveagreed in writing that Graphics’ share of removal costs is approximately 0.583%and therefore Graphics believes that its share of the anticipated remediationcosts at such site will not be material to its business or financialcondition.  Based upon an analysis ofGraphics’ volumetric share of waste contributed to the site and the agreementamong the PRPs, the Company maintains a reserve of approximately $0.1 millionin connection with this liability on its condensed consolidated balance sheetat September 30, 2003. The Company believes this amount is adequate to coversuch liability.

 

The Company has been named as a defendant in several legal actionsarising from its normal business activities. In the opinion of management, any liabilities that may arise from suchactions will not, individually or in the aggregate, have a material adverseeffect on the condensed consolidated financial statements of the Company.

 

**8.****   Restructuring Costs**

 

***Fiscal Year 2004 RestructuringCosts***

 

In July 2003, the Company implemented a restructuring plan for theprint and premedia services segments to further reduce its selling, general andadministrative expenses. This plan resulted in the termination of fouradministrative employees.

 

As a result of this plan, the Company recorded a pre-tax restructuringcharge of approximately $1.8 million in the quarter ended September 30,2003.  This charge was classified withinrestructuring costs in the accompanying condensed consolidated statements ofoperations in the three and six month periods ended September 30, 2003.  The cost of this restructuring plan wasaccounted for in accordance with the guidance set forth in Statement ofFinancial Accounting Standards No. 146, “Accounting for Costs Associated withExit or Disposal Activities” (“SFAS 146”). The restructuring charge is composed of severance and relatedtermination benefits.

 

The following table summarizes the activity related to thisrestructuring plan for the six months ended September 30, 2003 (in thousands):

 
|                               |   | **Restructuring  Reserve** |   | **Activity** |   | **09/30/03  Restructuring  Reserve Balance** |   |
|------------------------------------|--------|----------------------------|--------|--------------|--------|----------------------------------------------|--------|
|                               |   |                       |   |         |   |                                         |   |
| Severance and other employee costs |   | $                          | 1,775  |         | (168   | )                                            | 1,607  |   |
|                                    |        |                            |        |              |        |                                              |        |  |

 

As of September 30, 2003, the Company believes the restructuringreserve of approximately $1.6 million is adequate.  The Company anticipates that approximately $0.5 million of therestructuring balance will be paid by March 31, 2004, approximately $0.7million will be paid by March 31, 2005, approximately $0.3 million will be paidby March 31, 2006 and the remaining $0.1 million will be paid by March 31,2007.  These costs will be fundedthrough cash generated from operations and borrowings under the RevolvingCredit Facility.

 

11

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***Fiscal Year 2003Restructuring Costs***

 

In the fourth quarter of the fiscal year ended March 31, 2003, theCompany’s Board of Directors approved a restructuring plan for the print andpremedia services segments designed to improve operating efficiency and profitability.This plan included the closing of a premedia services facility in Nashville,Tennessee, a reduction of personnel in both the print and premedia servicessegments and the elimination of certain administrative personnel.  These combined actions resulted in theelimination of 30 positions within the Company.

 

As a result of this plan, the Company recorded a pre-tax restructuringcharge of approximately $1.2 million in the fourth quarter of the fiscal yearended March 31, 2003.  This charge was classifiedwithin restructuring costs and other special charges in the consolidatedstatements of operations in the fiscal year ended March 31, 2003.  The cost of this restructuring plan wasaccounted for in accordance with the guidance set forth in SFAS 146.  The restructuring charge is primarilycomposed of severance and related termination benefits.

 

The following table summarizes the activity related to thisrestructuring plan for the six months ended September 30, 2003 (in thousands):

 
|                               |   | **03/31/03  Restructuring  Reserve Balance** |   | **Activity** |   | **09/30/03  Restructuring  Reserve Balance** |   |
|------------------------------------|--------|----------------------------------------------|--------|--------------|--------|----------------------------------------------|--------|
| Severance and other employee costs |   | $                                            | 979    |         | (657   | )                                            | 322    |   |
| Other costs                        |   | 103                                          |   | (87          | )      | 16                                           |   |
|                               |   | $                                            | 1,082  |         | (744   | )                                            | 338    |   |

 

The process of closing a premedia services facility, and the eliminationof certain personnel within the Company was completed by March 31, 2003.  During the fiscal year ended March 31, 2003,$0.1 million of these costs were paid. As of September 30, 2003, the Company believes the restructuring reserveof approximately $0.3 million is adequate. The Company anticipates that theremaining costs will be paid before March 31, 2004.  These costs will be funded through cash generated from operationsand borrowings under the Revolving Credit Facility.

 

***Fiscal Year 2002Restructuring Costs***

 

In January 2002, the Company’s Board of Directors approved arestructuring plan for the print and premedia services segments designed toimprove asset utilization, operating efficiency and profitability. This planincluded the closing of a print facility in Hanover, Pennsylvania, and apremedia services facility in West Palm Beach, Florida, the downsizing of aBuffalo, New York premedia services facility and the elimination of certainadministrative personnel.  This actionresulted in the elimination of 189 positions within the Company.

 

As a result of this plan, the Company recorded a pre-tax restructuringcharge of approximately $8.6 million in the fourth quarter of the fiscal yearended March 31, 2002.  This charge wasclassified within restructuring costs and other special charges in theconsolidated statements of operations in the fiscal year ended March 31,2002.  The cost of this restructuringplan was accounted for in accordance with the guidance set forth in EmergingIssues Task Force Issue 94-3, “Liability Recognition for Certain EmployeeTermination Benefits and Other Costs to Exit an Activity (Including CertainCosts Incurred in a Restructuring)” (“EITF 94-3”).  The restructuring charge included severance and relatedtermination benefits, lease termination costs primarily related to future leasecommitments, equipment deinstallation costs directly associated with thedisassembly of certain printing presses and other equipment, and other costsprimarily including legal fees, site clean-up costs and the write-off ofcertain press related parts that provide no future use or functionality.** **TheCompany 

 

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recorded an additional $0.2 million of restructuring charges related tothis plan in the quarter ended September 30, 2003.  This charge relates to future lease commitments and is classifiedwithin restructuring costs in the accompanying condensed consolidatedstatements of operations for the three and six months ended September 30, 2003.

 

The following table summarizes the activity related to thisrestructuring plan for the six months ended September 30, 2003 (in thousands):

 
|                               |   | **03/31/03  Restructuring  Reserve  Balance** |   | **Activity** |   | **Additional  Reserve** |   | **09/30/03  Restructuring  Reserve  Balance** |   |
|------------------------------------|--------|-----------------------------------------------|--------|--------------|--------|-------------------------|--------|-----------------------------------------------|--------|
| Severance and other employee costs |   | $                                             | 498    |         | (107   | )                       | — |                                          | 391    |   |
| Lease termination costs            |   | 1,311                                         |   | (347         | )      | 225                     |   | 1,189                                         |   |
| Other costs                        |   | 70                                            |   | 9            |   | —                  |   | 79                                            |   |
|                               |   | $                                             | 1,879  |         | (445   | )                       | 225    |                                          | 1,659  |   |

 

The process of closing two facilities and downsizing one facility,including equipment deinstallation and relocation of that equipment to otherfacilities within the Company was completed by March 31, 2002.  During the fiscal years ended March 31, 2003and March 31, 2002, $3.3 million and $3.4 million of these costs were paid, respectively.As of September 30, 2003, the Company believes the restructuring reserve ofapproximately $1.7 million is adequate. The Company anticipates that $0.6million of the restructuring reserve balance will be paid by March 31, 2004 andthe remaining $1.1 million will be paid by March 31, 2005.  These costs will be funded through cashgenerated from operations and borrowings under the Revolving Credit Facility.

 

**9.****   Industry Segment Information**

 

The Company has significant operations principally in two industrysegments: (1) print and****(2)premedia services.  All of the Company’sprint business and assets are attributed to the print division and all of theCompany’s premedia services business and assets are attributed to the premediaservices division.  The Company’scorporate expenses have been segregated and do not constitute a reportablesegment.

 

The Company has two reportable segments: (1) print and (2) premediaservices.  The print business producesadvertising inserts, comics (Sunday newspaper comics, comic insert advertisingand comic books), and other publications. The Company’s premedia services business assists customers in thecapture, manipulation, transmission and distribution of images.  The majority of the premedia services workleads to the production of four-color separations in a format appropriate foruse by printers.

 

The accounting policies of each of the segments are the same as thoseused by the Company in its condensed consolidated financial statements.  The Company evaluates performance based onsegment EBITDA as calculated by management, which is defined as earnings beforenet interest expense, income tax expense, depreciation, amortization,restructuring costs, loss on early extinguishment of debt, other expense(income) and discontinued operations. This calculation differs from the EBITDA disclosed in Management’sDiscussion and Analysis of Financial Condition and Results of Operations asthat definition includes the impact of restructuring costs, loss on earlyextinguishment of debt, other expense (income) and discontinuedoperations.  The Company generallyaccounts for intersegment revenues and transfers as if the revenues ortransfers were to third parties, that is, at current market prices.  Certain reclassifications have been made toprior period balances to conform with the current period presentation.

 

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In June 2003, the Company sold its digital visual effects business,Digiscope, for a de minimis amount and recorded a net loss of approximately$0.4 million, which is net of zero income tax benefits.  Segment operating results for the three andsix months ended September 30, 2002 have been reclassified to presentDigiscope’s operating results as a discontinued operation.  In addition, the three and six months endedSeptember 30, 2002 reflect a reclassification to the print segment of certainpremedia revenues and expenses performed in the print facilities previouslypresented within the premedia services segment.  We revised and reclassified the segment reporting to reflect thecurrent approach used by the Chief Operating Decision Maker in evaluatingsegment operating results.  Thesereclassifications do not impact the Company’s previously reported consolidatedresults.

 

The Company’s reportable segments are business units that offerdifferent products and services.  Theyare managed separately because each segment requires different technology andmarketing strategies.  A substantialportion of the revenue, long-lived assets and other assets of the Company’sreportable segments are attributed to or located in the United States.

 
| **(In thousands)**                             |   | **Print** |    | **Premedia  Services** |   | **Corporate  and Other** |    | **Total** |    |
|------------------------------------------------|--------|-----------|---------|------------------------|--------|--------------------------|---------|-----------|---------|
|                                           |   |      |    |                   |   |                     |    |      |    |
| **Six Months Ended September 30,  2003**       |   |      |    |                   |   |                     |    |      |    |
| Segment revenues                               |   | $         | 210,508 |                   | 26,459 |                     | —  |      | 236,967 |   |
|                                           |   |      |    |                   |   |                     |    |      |    |
| EBITDA as calculated by management             |   | $         | 25,834  |                   | 5,077  |                     | (1,717  | )         | 29,194  |   |
|                                           |   |      |    |                   |   |                     |    |      |    |
| Depreciation and amortization                  |   | (10,278   | )       | (1,864                 | )      | —                   |    | (12,142   | )       |
| Restructuring costs                            |   | (1,716    | )       | (284                   | )      | —                   |    | (2,000    | )       |
| Operating income (loss)                        |   | 13,840    |    | 2,929                  |   | (1,717                   | )       | 15,052    |    |
|                                           |   |      |    |                   |   |                     |    |      |    |
| Interest expense                               |   | —    |    | —                 |   | (17,301                  | )       | (17,301   | )       |
| Interest income                                |   | —    |    | —                 |   | 7                        |    | 7         |    |
| Loss on early extinguishment of debt           |   | —    |    | —                 |   | (3,196                   | )       | (3,196    | )       |
| Other, net                                     |   | (31       | )       | (24                    | )      | (156                     | )       | (211      | )       |
| Income tax expense                             |   | —    |    | —                 |   | (13,474                  | )       | (13,474   | )       |
| Depreciation from discontinued operations      |   | —    |    | —                 |   | (26                      | )       | (26       | )       |
| Discontinued operations excluding depreciation |   | —    |    | —                 |   | (430                     | )       | (430      | )       |
| Net income (loss)                              |   | $         | 13,809  |                   | 2,905  |                     | (36,293 | )         | (19,579 | ) |
|                                           |   |      |    |                   |   |                     |    |      |    |
| Total assets                                   |   | $         | 253,881 |                   | 14,517 |                     | 15,340  |      | 283,738 |   |
| Total goodwill                                 |   | $         | 64,656  |                   | 1,892  |                     | —  |      | 66,548  |   |
| Total capital expenditures                     |   | $         | 11,461  |                   | 679    |                     | —  |      | 12,140  |   |

 

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| **(In thousands)**                             |   | **Print** |    | **Premedia  Services** |   | **Corporate  and Other** |    | **Total** |    |
|------------------------------------------------|--------|-----------|---------|------------------------|--------|--------------------------|---------|-----------|---------|
| **Six Months Ended September 30,  2002**       |   |      |    |                   |   |                     |    |      |    |
| Segment revenues                               |   | $         | 230,486 |                   | 27,045 |                     | —  |      | 257,531 |   |
|                                           |   |      |    |                   |   |                     |    |      |    |
| EBITDA as calculated by management             |   | $         | 31,463  |                   | 3,482  |                     | (1,781  | )         | 33,164  |   |
|                                           |   |      |    |                   |   |                     |    |      |    |
| Depreciation and amortization                  |   | (9,349    | )       | (2,107                 | )      | —                   |    | (11,456   | )       |
| Operating income (loss)                        |   | 22,114    |    | 1,375                  |   | (1,781                   | )       | 21,708    |    |
|                                           |   |      |    |                   |   |                     |    |      |    |
| Interest expense                               |   | —    |    | —                 |   | (14,305                  | )       | (14,305   | )       |
| Interest income                                |   | —    |    | —                 |   | 77                       |    | 77        |    |
| Other, net                                     |   | (201      | )       | (184                   | )      | (97                      | )       | (482      | )       |
| Income tax expense                             |   | —    |    | —                 |   | (915                     | )       | (915      | )       |
| Depreciation from discontinued operations      |   | —    |    | —                 |   | (237                     | )       | (237      | )       |
| Discontinued operations excluding depreciation |   | —    |    | —                 |   | (265                     | )       | (265      | )       |
| Net income (loss)                              |   | $         | 21,913  |                   | 1,191  |                     | (17,523 | )         | 5,581   |   |
|                                           |   |      |    |                   |   |                     |    |      |    |
| Total assets                                   |   | $         | 261,314 |                   | 20,784 |                     | 13,365  |      | 295,463 |   |
| Total goodwill                                 |   | $         | 64,656  |                   | 1,892  |                     | —  |      | 66,548  |   |
| Total capital expenditures                     |   | $         | 20,456  |                   | 1,114  |                     | —  |      | 21,570  |   |
|                                           |
|                                           |
| **Three Months Ended September 30,  2003**     |   |      |    |                   |   |                     |    |      |    |
| Segment revenues                               |   | $         | 102,132 |                   | 13,148 |                     | —  |      | 115,280 |   |
|                                           |   |      |    |                   |   |                     |    |      |    |
| EBITDA as calculated by management             |   | $         | 10,426  |                   | 2,362  |                     | (1,007  | )         | 11,781  |   |
|                                           |   |      |    |                   |   |                     |    |      |    |
| Depreciation and amortization                  |   | (5,140    | )       | (921                   | )      | —                   |    | (6,061    | )       |
| Restructuring costs                            |   | (1,716    | )       | (284                   | )      | —                   |    | (2,000    | )       |
| Operating income (loss)                        |   | 3,570     |    | 1,157                  |   | (1,007                   | )       | 3,720     |    |
|                                           |   |      |    |                   |   |                     |    |      |    |
| Interest expense                               |   | —    |    | —                 |   | (10,110                  | )       | (10,110   | )       |
| Interest income                                |   | —    |    | —                 |   | 6                        |    | 6         |    |
| Loss on early extinguishment of debt           |   | —    |    | —                 |   | (3,196                   | )       | (3,196    | )       |
| Other, net                                     |   | (37       | )       | (17                    | )      | (121                     | )       | (175      | )       |
| Income tax expense                             |   | —    |    | —                 |   | (12,925                  | )       | (12,925   | )       |
| Net income (loss)                              |   | $         | 3,533   |                   | 1,140  |                     | (27,353 | )         | (22,680 | ) |
|                                           |   |      |    |                   |   |                     |    |      |    |
| Total assets                                   |   | $         | 253,881 |                   | 14,517 |                     | 15,340  |      | 283,738 |   |
| Total goodwill                                 |   | $         | 64,656  |                   | 1,892  |                     | —  |      | 66,548  |   |
| Total capital expenditures                     |   | $         | 5,307   |                   | 522    |                     | —  |      | 5,829   |   |

 

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| **(In thousands)**                             |   | **Print** |    | **Premedia  Services** |   | **Corporate  and Other** |   | **Total** |    |
|------------------------------------------------|--------|-----------|---------|------------------------|--------|--------------------------|--------|-----------|---------|
| **Three Months Ended September 30,  2002**     |   |      |    |                   |   |                     |   |      |    |
| Segment revenues                               |   | $         | 116,446 |                   | 13,630 |                     | — |      | 130,076 |   |
|                                           |   |      |    |                   |   |                     |   |      |    |
| EBITDA as calculated by management             |   | $         | 13,725  |                   | 1,778  |                     | (1,030 | )         | 14,473  |   |
|                                           |   |      |    |                   |   |                     |   |      |    |
| Depreciation and amortization                  |   | (4,626    | )       | (1,033                 | )      | —                   |   | (5,659    | )       |
| Operating income (loss)                        |   | 9,099     |    | 745                    |   | (1,030                   | )      | 8,814     |    |
|                                           |   |      |    |                   |   |                     |   |      |    |
| Interest expense                               |   | —    |    | —                 |   | (7,096                   | )      | (7,096    | )       |
| Interest income                                |   | —    |    | —                 |   | 21                       |   | 21        |    |
| Other, net                                     |   | (149      | )       | (68                    | )      | 38                       |   | (179      | )       |
| Income tax expense                             |   | —    |    | —                 |   | (298                     | )      | (298      | )       |
| Depreciation from discontinued operations      |   | —    |    | —                 |   | (114                     | )      | (114      | )       |
| Discontinued operations excluding depreciation |   | —    |    | —                 |   | (26                      | )      | (26       | )       |
| Net income (loss)                              |   | $         | 8,950   |                   | 677    |                     | (8,505 | )         | 1,122   |   |
|                                           |   |      |    |                   |   |                     |   |      |    |
| Total assets                                   |   | $         | 261,314 |                   | 20,784 |                     | 13,365 |      | 295,463 |   |
| Total goodwill                                 |   | $         | 64,656  |                   | 1,892  |                     | — |      | 66,548  |   |
| Total capital expenditures                     |   | $         | 10,749  |                   | 886    |                     | — |      | 11,635  |   |

 

**10.****  Impact of Recently IssuedAccounting Standards**

 

In April 2002, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards No. 145, “Rescission of FASBStatements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections” (“SFAS 145”).  SFAS 145rescinds Statement of Financial Accounting Standards No. 4, “Reporting Gainsand Losses from Extinguishment of Debt” (“SFAS 4”), which required all gainsand losses from extinguishment of debt to be aggregated and, if material,classified as an extraordinary item, net of the related income tax effect.  As a result, the criteria in AccountingPrinciples Board Opinion No. 30 will now be used to classify those gains andlosses.  SFAS 145 amends Statement ofFinancial Accounting Standards No. 13, “Accounting for Leases” (“SFAS 13”), torequire that certain lease modifications that have economic effects similar tosale-leaseback transactions be accounted for in the same manner assale-leaseback transactions.  SFAS 145makes various technical corrections to existing pronouncements.  While those corrections are not substantivein nature, in some instances, they may change accounting practice.  The provisions of SFAS 145 are effective forfinancial statements issued for fiscal years beginning after May 15, 2002, andinterim periods within those fiscal years. In accordance with the guidance set forth in SFAS 145, the Companyclassified the $3.2 million charge incurred in the three and six month periodsended September 30, 2003 related to the write-off of deferred financing costsassociated with the old bank credit agreement and the 123⁄4% Notes as Otherexpense in the accompanying condensed consolidated statements of operations.

 

In January 2003, the FASB issued Interpretation No. 46, “Consolidationof Variable Interest Entities” (“FIN 46”) to expand upon and strengthenexisting accounting guidance that addresses when a company should include inits financial statements the assets, liabilities and activities of anotherentity.  Until now, a company generallyhas included another entity in its consolidated financial statements only if itcontrolled the entity through voting interests.  FIN 46 changes that guidance by requiring a variable interest entity,as defined, to be consolidated by a company if that company is subject to amajority of the risk of loss from the variable interest entity’s activities oris entitled to receive a majority of the entity’s residual returns orboth.  FIN 46 also requires disclosureabout variable interest entities that the company is not required toconsolidate but in which

 

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it has a significant variable interest.  The consolidation requirements of FIN 46 apply immediately tovariable interest entities created after January 31, 2003 and to existingentities in the first fiscal year or interim period ending after December 15,2003.  Certain of the disclosurerequirements apply in all financial statements issued after January 31, 2003,regardless of when the variable interest entity was established.  The Company has evaluated the requirementsof FIN 46 and does not expect any effect on its consolidated financial positionor operating results.

 

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**ACG HOLDINGS, INC.**

Management’s Discussion and Analysis of

## Financial Condition and Results of Operations

 

**Special Note Regarding Forward LookingStatements**

 

This Quarterly Report on Form 10-Q (this “Report”) containsforward-looking statements within the meaning of Section 21E of the SecuritiesExchange Act of 1934.  Discussionscontaining such forward-looking statements may be found in this section, aswell as within this Report generally.  Inaddition, when used in this Report, the words “believes,” “intends,” “expects,”“may,” “will,” “estimates,” “should,” “could,” “anticipates,” “plans” or othercomparable terms are intended to identify forward-looking statements.  Forward-looking statements are subject to anumber of risks and uncertainties. Actual results in the future could differ materially from thosedescribed in the forward-looking statements as a result of many factors outsideof the control of ACG Holdings, Inc. (“Holdings”), together with itswholly-owned subsidiary, American Color Graphics, Inc. (“Graphics”), including,but not limited to:

 

•      a failure to achieveexpected cost reductions or to execute other key strategies,

•      fluctuations in the cost ofpaper, ink and other key raw materials,

•      changes in the advertisingand print markets,

•      actions by our competitors,particularly with respect to pricing,

•      the financial condition ofour customers,

•      downgrades of our creditratings,

•      our financial condition andliquidity and our leverage and debt service obligations,

•      the general condition of theUnited States economy,

•      interest rate and foreigncurrency exchange rate fluctuations,

•      the level of capitalresources required for our operations,

•      changes in the legal andregulatory environment,

•      the demand for our productsand services, and

•      other risks anduncertainties, including the matters set forth in this Report generally andthose described from time to time in our filings with the Securities andExchange Commission.

 

All forward-looking statements in this Report are qualified by thesecautionary statements and are made only as of the date of this Report.  We do not undertake any obligation, otherthan as required by law, to update or revise any forward-looking statements,whether as a result of new information, future events or otherwise.

 

Consequently, such forward-looking statements should be regarded solelyas our current plans, estimates and beliefs. We do not undertake, and specifically decline any obligation to publiclyrelease the results of any revisions to these forward-looking statements thatmay be made to reflect any future events or circumstances after the date ofsuch statements or to reflect the occurrence of anticipated or unanticipatedevents.

 

**Results of Operations**

 

***General***

 

In June 2003, we made a strategic decision to sell the operations ofour digital visual effects business, Digiscope, for a de minimus amount.  This resulted in a net loss of approximately$0.4 million in the six months ended September 30, 2003, which is net of zeroincome tax benefits.  The sale ofDigiscope has been accounted for as a discontinued operation, and accordingly,Digiscope’s operations are reclassified and presented within discontinuedoperations in the accompanying condensed consolidated financialstatements.  Sales, costs of sales andselling, general and administrative expenses attributable to Digiscope for thethree and six months ended September 30, 2002 have been reclassified andpresented within discontinued operations.

 

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In July 2003, we implemented a plan to further reduce our selling,general and administrative expenses. This plan resulted in the termination of four administrativeemployees.  We recorded a pre-tax restructuringcharge of approximately $1.8 million in the quarter ended September 30, 2003associated with this plan.  Thisrestructuring charge is composed of severance and related terminationbenefits.  The cost of thisrestructuring plan was accounted for in accordance with the guidance set forthin SFAS 146.  We also recorded an additional$0.2 million of restructuring charges related to the Fiscal Year 2002restructuring plan (see note 8 to our condensed consolidated financialstatements) in the quarter ended September 30, 2003.  This charge is related to future lease commitments and isclassified within restructuring costs in our condensed consolidated statementsof operations for the three and six months ended September 30, 2003.

 

The following table, including certain reclassifications in prior yearresults to conform with current year presentation, summarizes our results ofoperations for the three months ended September 30, 2003 (the “2003 Three-MonthPeriod”), the three months ended September 30, 2002 (the “2002 Three-MonthPeriod”), the six months ended September 30, 2003 (the “2003 Six-Month Period”)and the six months ended September 30, 2002 (the “2002 Six-Month Period”):

 
|                          |   | **Three Months Ended  September 30,** |    | **Six Months Ended  September 30,** |    |
|-------------------------------|--------|---------------------------------------|---------|-------------------------------------|---------|
|                          |   | **2003**                              |    | **2002**                            |    | **2003** |   | **2002** |   |
|                          |   | **(Dollars  in thousands)**           |    |
| **Sales:**                    |   |                                  |    |                                |    |   |   |   |   |
| Print                         |   | $                                     | 102,132 |                                | 116,446 |   | 210,508 |   | 230,486 |   |
| Premedia Services             |   | 13,148                                |    | 13,630                              |    | 26,459 |   | 27,045 |   |
| Total                         |   | $                                     | 115,280 |                                | 130,076 |   | 236,967 |   | 257,531 |   |
|                          |   |                                  |    |                                |    |   |   |   |   |
| **Gross Profit:**             |   |                                  |    |                                |    |   |   |   |   |
| Print                         |   | $                                     | 11,329  |                                | 14,341  |   | 26,333 |   | 32,282 |   |
| Premedia Services             |   | 3,348                                 |    | 3,413                               |    | 7,046 |   | 6,445 |   |
| Other (a)                     |   | (3                                    | )       | 1                                   |    | (4 | ) | 1 |   |
| Total                         |   | $                                     | 14,674  |                                | 17,755  |   | 33,375 |   | 38,728 |   |
|                          |   |                                  |    |                                |    |   |   |   |   |
| **Gross Margin:**             |   |                                  |    |                                |    |   |   |   |   |
| Print                         |   | 11.1                                  | %       | 12.3                                | %       | 12.5 | % | 14.0 | % |
| Premedia Services             |   | 25.5                                  | %       | 25.0                                | %       | 26.6 | % | 23.8 | % |
| Total                         |   | 12.7                                  | %       | 13.7                                | %       | 14.1 | % | 15.0 | % |
|                          |   |                                  |    |                                |    |   |   |   |   |
| **Operating Income  (Loss):** |   |                                  |    |                                |    |   |   |   |   |
| Print (b)                     |   | $                                     | 3,570   |                                | 9,099   |   | 13,840 |   | 22,114 |   |
| Premedia Services (b)         |   | 1,157                                 |    | 745                                 |    | 2,929 |   | 1,375 |   |
| Other (a)                     |   | (1,007                                | )       | (1,030                              | )       | (1,717 | ) | (1,781 | ) |
| Total                         |   | $                                     | 3,720   |                                | 8,814   |   | 15,052 |   | 21,708 |   |

 

----

(a)   Includes corporate general and administrativeexpenses.

(b)   In both the 2003 Three and Six-Month Periods, printand premedia services’ operating incomes include the impact of restructuringcosts of $1.7 million and $0.3 million, respectively.

 

19

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***Print***

 

***Sales.***  In the 2003 Six-Month Period, print salesdecreased $20.0 million to $210.5 million from $230.5 million in the 2002Six-Month Period.  The decrease in the2003 Six-Month Period includes an increase in customer supplied paper, theimpact of competitive pricing pressures and certain changes in product andcustomer mix.  These decreases wereoffset in part by increased paper prices and an approximate 3% increase inprint production volume. See “—Value Added Revenue and Print Impressions forthe Print Segment” below.

 

In the 2003 Three-Month Period, print sales decreased $14.3 million to$102.1 million from $116.4 million in the 2002 Three-Month Period.  The decrease in the 2003 Three-Month Periodincludes an increase in customer supplied paper, the impact of competitivepricing pressures, certain changes in product and customer mix and anapproximate 2% decrease in print production volume. See “—Value Added Revenue and Print Impressions for the Print Segment”below.  These decreases were offset inpart by increased paper prices.

 

***Gross Profit. ***In the 2003Six-Month Period, print gross profit decreased $6.0 million to $26.3 millionfrom $32.3 million in the 2002 Six-Month Period.  In the 2003 Six-Month Period, print gross margin decreased to12.5% from 14.0% in the 2002 Six-Month Period. The decrease in gross profit includes the impact of competitive pricingpressures, certain changes in product and customer mix and increases in certainoperating expenses. These decreases were offset in part by the increased printproduction volume.  The decrease ingross margin includes these items, coupled with the impact of increased paperprices and increased levels of customer supplied paper reflected in sales.  Our gross margin may not be comparable fromperiod to period because of the impact of changes in paper prices and levels ofcustomer supplied paper included in sales.

 

In the 2003 Three-Month Period, print gross profit decreased $3.0million to $11.3 million from $14.3 million in the 2002 Three-MonthPeriod.  In the 2003 Three-Month Period,print gross margin decreased to 11.1% from 12.3% in the 2002 Three-MonthPeriod.  The decrease in gross profitincludes the impact of competitive pricing pressures, certain changes inproduct and customer mix, increases in certain operating expenses and thedecrease in print production volume. The decrease in gross margin includes these items, coupled with theimpact of increased paper prices and increased levels of customer suppliedpaper reflected in sales.  Our grossmargin may not be comparable from period to period because of the impact ofchanges in paper prices and levels of customer supplied paper included insales.

 

***Selling, General andAdministrative Expenses.***  In the 2003 Six-Month Period, print selling, general andadministrative expenses increased $0.6 million to $10.8 million, or 5.1% ofprint sales, from $10.2 million, or 4.4% of print sales in the 2002 Six-MonthPeriod.  This increase included the impactin the 2003 Six-Month Period of the change in our estimates related to theallowance for doubtful accounts, as well as increases in certain administrativecosts.

 

In the 2003 Three-Month Period, print selling, general andadministrative expenses increased $0.8 million to $6.0 million, or 5.9% ofprint sales, from $5.2 million, or 4.5% of print sales in the 2002 Three-MonthPeriod.  This increase included theimpact in the 2003 Three-Month Period of the change in our estimates related tothe allowance for doubtful accounts, as well as increases in certainadministrative costs.

 

***Restructuring Costs.* **Restructuringcosts were $1.7 million in both the 2003 Three and Six-Month Period.  We incurred no restructuring costs in the2002 Three or Six-Month Period.  Seenote 8 to our condensed consolidated financial statements appearing elsewherein this Report.

 

***Operating Income.***  As a result of the factors discussed above,print operating income decreased to $13.8 million in the 2003 Six-Month Periodfrom $22.1 million in the 2002 Six-Month Period and decreased to $3.6 millionin the 2003 Three-Month Period from $9.1 million in the 2002 Three-MonthPeriod.

 

20

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***Premedia Services***

 

***Sales.*** In the 2003 Six-Month Period, premediaservices’ sales decreased $0.5 million to $26.5 million from $27.0 million inthe 2002 Six-Month Period.  Theseresults include competitive pricing pressures and the continuance of weakpremedia market conditions.

 

In the 2003 Three-Month Period, premedia services’ sales decreased $0.5million to $13.1 million from $13.6 million in the 2002 Three-MonthPeriod.  These results includecompetitive pricing pressures and the continuance of weak premedia market conditions.

 

***Gross Profit.***  In the 2003 Six-Month Period, premediaservices’ gross profit increased $0.6 million to $7.0 million from $6.4 millionin the 2002 Six-Month Period.  In the2003 Six-Month Period, premedia services’ gross margin increased to 26.6% from23.8% in the 2002 Six-Month Period.  Theincrease in gross profit and gross margin for the 2003 Six-Month Period isprimarily the result of reduced manufacturing costs related to various costcontainment programs and the closure of a premedia facility.

 

In the 2003 Three-Month Period, premedia services’ gross profitremained relatively unchanged at $3.3 million versus $3.4 million in the 2002Three-Month Period.  In the 2003Three-Month Period, premedia services’ gross margin increased to 25.5% from 25.0%in the 2002 Three-Month Period.

 

***Selling, General andAdministrative Expenses.***In the 2003 Six-MonthPeriod, premedia services’ selling, general and administrative expensesdecreased $1.3 million to $3.8 million, or 14.5% of premedia services’ sales,from $5.1 million, or 18.8% of premedia services’ sales in the 2002 Six-MonthPeriod.  The decrease in the 2003Six-Month Period is primarily attributable to decreased selling expenses.

 

In the 2003 Three-Month Period, premedia services’ selling, general andadministrative expenses decreased $0.8 million to $1.9 million, or 14.5% ofpremedia services’ sales, from $2.7 million, or 19.6% of premedia services’sales in the 2002 Three-Month Period. The decrease in the 2003 Three-Month Period is primarily attributable todecreased selling expenses.

 

***Restructuring Costs****.*** **Restructuring costs were $0.3million in both the 2003 Three and Six-Month Period.  We incurred no restructuring costs in the 2002 Three or Six-MonthPeriod.  See note 8 to our condensedconsolidated financial statements appearing elsewhere in this Report.

 

***Operating Income.***  As a result of the factors discussed above,premedia services’ operating income increased to $2.9 million in the 2003Six-Month Period from $1.4 million in the 2002 Six-Month Period and increasedto $1.2 million in the 2003 Three-Month Period from $0.7 million in the 2002Three-Month Period.

 

***Other Operations***

 

Other operations consist of corporate general and administrativeexpenses.  In the 2003 Six-Month Period,operating losses from other operations improved to a loss of $1.7 million froma loss of $1.8 million in the 2002 Six-Month Period.  In both the 2003 Three-Month Period and the 2002 Three-MonthPeriod, operating losses from other operations were $1.0 million.

 

***Interest Expense***

 

In the 2003 Six-Month Period, interest expense increased to $17.3million from $14.3 million in the 2002 Six-Month Period and increased to $10.1million in the 2003 Three-Month Period from $7.1 million in the 2002

 

21

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Three-Month Period.  Theseincreases include the impact of higher levels of indebtedness associated withour 2003 Refinancing (defined below). In addition, interest expense in the 2003 Three and Six-Month Periods,includes incremental interest expense of approximately $1.7 million, related tothe 30 day call provision associated with the 123⁄4% Notes.

 

***Loss on EarlyExtinguishment of Debt***

 

In the 2003 Three and Six-Month Periods, we incurred a charge ofapproximately $3.2 million, net of $0 taxes, related to the write-off ofdeferred financing costs associated with our old bank credit agreement and the123⁄4% Notes.  See note 4 to our condensedconsolidated financial statements appearing elsewhere in this Report.

 

***Income Taxes***

 

In the 2003 Six-Month Period, income tax expense increased to $13.5million from $0.9 million in the 2002 Six-Month Period. In the 2003 Three-MonthPeriod, income tax expense increased to $12.9 million****from $0.3 million in the 2002 Three-Month Period.  The increase in both the 2003 Six-MonthPeriod and the 2003 Three-Month Period is primarily due to an adjustment toincrease the deferred tax asset valuation allowance by $12.8 million.  This adjustment reflected a change incircumstances which resulted in a judgment that, based on the provisions ofSFAS 109 that restrict our ability to consider forecasts of future income, acorresponding amount of deferred tax assets may not be realized.  The change in circumstances arises from ourassessment of the current economic climate, particularly the continuance of competitivepricing pressures in our industry, and the expected increase in annual interestcosts arising from the issuance of our 10% Notes in July 2003 (see note 4 toour condensed consolidated financial statements appearing elsewhere in thisReport)****that have providednegative evidence about our ability to realize certain deferred taxassets.  We will reverse our valuationallowance into income when and to the extent sufficient positive evidencearises to support the realization of the related deferred tax assets.

 

***DiscontinuedOperations***

 

In June 2003, we sold the operations of Digiscope for a de minimisamount, which resulted in a net loss of approximately $0.4 million, which isnet of zero income tax benefits.  Thesale of Digiscope has been accounted for as a discontinued operation, andaccordingly, Digiscope’s operations for the 2002 Three and Six-Month Periodshave been reclassified and presented within discontinued operations in theaccompanying condensed consolidated statements of operations.

 

***Net Income (Loss)***

 

As a result of the factors discussed above, net income (loss) decreasedto a loss of $19.6 million in the 2003 Six-Month Period from income of $5.6million in the 2002 Six-Month Period and in the 2003 Three-Month Period, netincome (loss) decreased to a loss of $22.7 million from income of $1.1 millionin the 2002 Three-Month Period.

 

***Liquidity andCapital Resources***

 

On July 3, 2003, we refinanced all of our existing indebtedness(excluding capital leases) in connection with the 2003 Refinancing. The primaryobjectives of this refinancing included the placement of a long-term capitalstructure which (1) eliminated the near-term amortization requirements of ourold bank credit agreement and our 123⁄4% Notes, (2) provided strong liquidity andgreater operating and financial flexibility and (3) reduced our overall cost ofcapital.  As part of the 2003Refinancing, we sold $280 million aggregate principal amount 

 

22

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of our 10% Notes and also entered into the Revolving CreditFacility.  We repaid substantially allexisting indebtedness (excluding capital leases) through:

•      the repayment of all amountsoutstanding under our old bank credit agreement, and the concurrent terminationof all related commitments thereunder;

•      the issuance of letters ofcredit under the Revolving Credit Facility to replace outstanding letters ofcredit; and,

•      effective August 3, 2003,the redemption of all of the 123⁄4% Notes, at a redemption price equal to 100% oftheir aggregate principal amount, plus accrued and unpaid interest thereon.

 

In addition, we repurchased, and concurrently retired, all 5,223outstanding shares of preferred stock of Holdings, and canceled all outstandingoptions to purchase shares of preferred stock of Holdings held by certain keyofficers, for an aggregate purchase price of $56.9 million.  The canceled options would have beenexercisable for 582 shares of preferred stock of Holdings.

 

As part of the 2003 Refinancing, we incurred $13.2 million of deferredfinancing fees through September 30, 2003. Of the total deferred financing fees, $4.9 million was paid toaffiliates of Morgan Stanley for the services they performed in conjunctionwith the Revolving Credit Facility and the original private placement of the10% Notes. We also incurred a charge of approximately $3.2 million in thequarter ended September 30, 2003 related to the write-off of deferred financingcosts associated with the old bank credit agreement and the 123⁄4% Notes.  In addition, we recorded incrementalinterest expense of approximately $1.7 million in the quarter ended September30, 2003 related to the 30 day call provision associated with the 123⁄4% Notes.

 

Our primary sources of liquidity are cash provided by operatingactivities and borrowings under the Revolving Credit Facility.  The Revolving Credit Facility provides for:

 

•      maximum borrowings of $70million subject to a borrowing base limitation based on certain percentages ofeligible accounts receivable and eligible inventory and a $35 million sublimitbased on the appraised value of eligible machinery and equipment and realestate, maturing on July 3, 2008, including a letter of credit sub-facility ofup to $40 million.

 

At September 30, 2003, we had no borrowings outstanding under theRevolving Credit Facility and had letters of credit outstanding ofapproximately $31.3 million and as a result had additional borrowingavailability of approximately $38.7 million. Payments due on existing capital lease obligations during the remainderof our fiscal year ending March 31, 2004 (“Fiscal Year 2004”) are approximately$3.7 million.

 

During the 2003 Six-Month Period, we used net cash provided byoperating activities of $13.0 million (see Condensed Consolidated Statements ofCash Flows appearing elsewhere in this Report) and proceeds from the 2003Refinancing of $280 million primarily to fund the following expenditures:

 

•      $39.2 million to repayindebtedness outstanding under the old bank credit agreement,

•      $170.1 million to redeem the123⁄4% Notes,

•      $56.9 million to repurchaseand retire all outstanding shares of preferred stock of Holdings, and cancelall outstanding options to purchase shares of preferred stock of Holdings,

•      $13.2 million for fees andexpenses paid to date related to the 2003 Refinancing,

•      $10.1 million in cashcapital expenditures, and

•      $3.5 million to serviceother indebtedness (including capital lease obligations of $3.2 million anddeferred financing fees related to the old bank credit agreement and the 123⁄4%Notes of $0.3 million).

 

23

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Our cash-on-hand of approximately $3.6 million is presented net ofoutstanding checks within trade accounts payable at September 30, 2003.  Accordingly, cash is presented at a balanceof $0 million in the September 30, 2003 balance sheet.

 

We plan to continue our program of upgrading our print and premediaservices equipment.  We anticipate thattotal Fiscal Year 2004 capital expenditures, including maintenance, costreduction and customer support capital, will approximate $16 million.  This will include cash capital expendituresof approximately $13 million and capital lease spending of approximately $3million.

 

Our primary sources of liquidity have been cash provided by operatingactivities and borrowings under the Revolving Credit Facility.  We anticipate that our primary needs forliquidity will be to conduct our business, meet our debt service requirements,make capital expenditures and, if we elect, redeem, repay or repurchase outstandingindebtedness including repurchases of our 10% Notes in privately negotiatedtransactions, or in open market purchases, to the extent permitted by theRevolving Credit Facility.

 

At September 30, 2003, we had total indebtedness of $301.3****million, including capital leaseobligations of $21.3 million and $280 million of our 10% Notes. We have nooff-balance sheet financial instruments. We are currently in compliance with all financial covenants set forth inthe Revolving Credit Facility.

 

A significant portion of Graphics’ long-term obligations, includingindebtedness under the Revolving Credit Facility and the 10% Notes, has beenfully and unconditionally guaranteed by Holdings.  Holdings is subject to certain restrictions under its guaranteeof indebtedness under the Revolving Credit Facility, including among otherthings, restrictions on mergers, acquisitions, incurrence of additional debtand payment of cash dividends.

 

**EBITDA and EBITDA Margin**

** **
|                  |   | **Three Months Ended  September 30,** |       | **Six Months Ended  September 30,** |   |
|-----------------------|--------|---------------------------------------|------------|-------------------------------------|--------|
|                  |   | **2003**                              |       | **2002**                            |   | **2003** |   | **2002** |   |
|                  |   | **(Dollars  in thousands)**           | ** ** |
| **EBITDA:**           |   |                                  |       |                                |   |   |   |   |   |
| Print (a)             |   | $                                     | 8,673      |                                | 13,576 |   | 24,087 |   | 31,262 |   |
| Premedia Services (a) |   | 2,061                                 |       | 1,710                               |   | 4,769 |   | 3,298 |   |
| Other   (b)      |   | (4,324                                | )          | (1,018                              | )      | (5,499 | ) | (2,143 | ) |
| Total                 |   | $                                     | 6,410      |                                | 14,268 |   | 23,357 |   | 32,417 |   |
|                  |   |                                  |       |                                |   |   |   |   |   |
| **EBITDA Margin:**    |   |                                  |       |                                |   |   |   |   |   |
| Print                 |   | 8.5                                   | %          | 11.7                                | %      | 11.4 | % | 13.6 | % |
| Premedia Services     |   | 15.7                                  | %          | 12.5                                | %      | 18.0 | % | 12.2 | % |
| Total                 |   | 5.6                                   | %          | 11.0                                | %      | 9.9 | % | 12.6 | % |

 

----

(a)   In both the 2003 Three and Six-Month Periods, EBITDAfor the print and premedia services’ segments includes the impact ofrestructuring costs of $1.7 million and $0.3 million, respectively.

(b)   Other operations includes corporate general andadministrative expenses as well as discontinued operations.  In addition, other operations includes thewrite-off of deferred financing costs related to the 2003 Refinancing of $3.2million in both the 2003 Three and Six-Month Periods.

 

24

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EBITDA is presented and discussed because management believes thatinvestors regard EBITDA as a key measure of a leveraged company’s performanceand ability to meet its future debt service requirements. “EBITDA” is definedas earnings before net interest expense, income tax expense, depreciation andamortization.  “EBITDA Margin” isdefined as EBITDA as a percentage of net sales.  EBITDA is not a measure of financial performance under accountingprinciples generally accepted in the United States and should not be consideredan alternative to net income (or any other measure of performance underaccounting principles generally accepted in the United States) as a measure ofperformance or to cash flows from operating, investing or financing activitiesas an indicator of cash flows or as a measure of liquidity. Certain covenantsin the 10% Senior Second Secured Notes Indenture and the Revolving CreditFacility are based on, or include EBITDA, subject to certain adjustments.

 

The following table provides a reconciliation (in thousands) of EBITDAto net income (loss):

 
|                                       |   | **Print** |   | **Premedia Services** |   | **Other** |    | **Total** |    |
|--------------------------------------------|--------|-----------|--------|-----------------------|--------|-----------|---------|-----------|---------|
|                                       |   |      |   |                  |   |      |    |      |    |
| **Three Months Ended  September 30, 2003** |   |      |   |                  |   |      |    |      |    |
| EBITDA                                     |   | $         | 8,673  |                  | 2,061  |      | (4,324  | )         | 6,410   |   |
|                                       |   |      |   |                  |   |      |    |      |    |
| Depreciation and amortization              |   | (5,140    | )      | (921                  | )      | —    |    | (6,061    | )       |
| Interest expense, net                      |   | —    |   | —                |   | (10,104   | )       | (10,104   | )       |
| Income tax expense                         |   | —    |   | —                |   | (12,925   | )       | (12,925   | )       |
|                                       |   |      |   |                  |   |      |    |      |    |
| Net income (loss)                          |   | $         | 3,533  |                  | 1,140  |      | (27,353 | )         | (22,680 | ) |
|                                       |
|                                       |
| **Three Months Ended  September 30, 2002** |   |      |   |                  |   |      |    |      |    |
| EBITDA                                     |   | $         | 13,576 |                  | 1,710  |      | (1,018  | )         | 14,268  |   |
|                                       |   |      |   |                  |   |      |    |      |    |
| Depreciation and amortization              |   | (4,626    | )      | (1,033                | )      | (114      | )       | (5,773    | )       |
| Interest expense, net                      |   | —    |   | —                |   | (7,075    | )       | (7,075    | )       |
| Income tax expense                         |   | —    |   | —                |   | (298      | )       | (298      | )       |
|                                       |   |      |   |                  |   |      |    |      |    |
| Net income (loss)                          |   | $         | 8,950  |                  | 677    |      | (8,505  | )         | 1,122   |   |
|                                       |
|                                       |
| **Six Months Ended  September 30, 2003**   |   |      |   |                  |   |      |    |      |    |
| EBITDA                                     |   | $         | 24,087 |                  | 4,769  |      | (5,499  | )         | 23,357  |   |
|                                       |   |      |   |                  |   |      |    |      |    |
| Depreciation and amortization              |   | (10,278   | )      | (1,864                | )      | (26       | )       | (12,168   | )       |
| Interest expense, net                      |   | —    |   | —                |   | (17,294   | )       | (17,294   | )       |
| Income tax expense                         |   | —    |   | —                |   | (13,474   | )       | (13,474   | )       |
|                                       |   |      |   |                  |   |      |    |      |    |
| Net income (loss)                          |   | $         | 13,809 |                  | 2,905  |      | (36,293 | )         | (19,579 | ) |

 

25

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|                                     |   | **Print** |   | **Premedia Services** |   | **Other** |    | **Total** |   |
|------------------------------------------|--------|-----------|--------|-----------------------|--------|-----------|---------|-----------|--------|
|                                     |   |      |   |                  |   |      |    |      |   |
| **Six Months Ended  September 30, 2002** |   |      |   |                  |   |      |    |      |   |
| EBITDA                                   |   | $         | 31,262 |                  | 3,298  |      | (2,143  | )         | 32,417 |   |
|                                     |   |      |   |                  |   |      |    |      |   |
| Depreciation and amortization            |   | (9,349    | )      | (2,107                | )      | (237      | )       | (11,693   | )      |
| Interest expense, net                    |   | —    |   | —                |   | (14,228   | )       | (14,228   | )      |
| Income tax expense                       |   | —    |   | —                |   | (915      | )       | (915      | )      |
|                                     |   |      |   |                  |   |      |    |      |   |
| Net income (loss)                        |   | $         | 21,913 |                  | 1,191  |      | (17,523 | )         | 5,581  |   |

 

**Value Added Revenue and Print Impressions forthe Print Segment**

 

We have included value-added revenue, or VAR, information to provide abetter understanding of sales activity within our print segment.  VAR is a non-GAAP measure and is defined assales less the cost of paper, ink and subcontract services.  We generally pass these expenses through toour customers.  We have also includedprint impressions because we use this as an internal measure of productionthroughput.  Although we believe printimpressions to be indicative of overall production volume, total impressionsmay not be fully comparable period to period due to (1) differences in thetype, performance and width of press equipment utilized and (2) product mixproduced.

 
|                                          |   | **Three Months Ended  September 30,** |       | **Six Months Ended  September 30,** |       |
|-----------------------------------------------|--------|---------------------------------------|------------|-------------------------------------|------------|
|                                          |   | **2003**                              |       | **2002**                            |       | **2003** |   | **2002** |   |
|                                          |   |                                  | ** ** |                                | ** ** |   | ** ** |   | ** ** |
| Print Segment VAR (in thousands)              |   | $                                     | 53,428     |                                | 54,623     |   | 110,172 |   | 111,042 |   |
|                                          |   |                                  |       |                                |       |   |   |   |   |
| Print Segment Impressions  (in millions) |   | 3,100                                 |       | 3,156                               |       | 6,423 |   | 6,231 |   |
|                                               |        |                                       |            |                                     |            |  |  |  |  |  |

 

The following table provides a reconciliation of print segment sales toprint segment VAR:

 
|                                |   | **Three Months Ended  September 30,** |    | **Six Months Ended  September 30,** |    |
|-------------------------------------|--------|---------------------------------------|---------|-------------------------------------|---------|
|                                |   | **2003**                              |    | **2002**                            |    | **2003** |   | **2002** |   |
|                                |   | **(In  thousands)**                   |    |
|                                |   |                                  |    |                                |    |   |   |   |   |
| Print Segment Sales                 |   | $                                     | 102,132 |                                | 116,446 |   | 210,508 |   | 230,486 |   |
|                                |   |                                  |    |                                |    |   |   |   |   |
| Paper, Ink and Subcontract Services |   | 48,704                                |    | 61,823                              |    | 100,336 |   | 119,444 |   |
| Print Segment VAR                   |   | $                                     | 53,428  |                                | 54,623  |   | 110,172 |   | 111,042 |   |

 

26

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**New Accounting Pronouncements**

 

In April 2002, the FASB issued SFAS 145.  SFAS 145 rescinds SFAS 4, which required all gains and lossesfrom extinguishment of debt to be aggregated and, if material, classified as anextraordinary item, net of the related income tax effect.  As a result, the criteria in AccountingPrinciples Board Opinion No. 30 will now be used to classify those gains andlosses.  SFAS 145 amends SFAS 13, torequire that certain lease modifications that have economic effects similar tosale-leaseback transactions be accounted for in the same manner assale-leaseback transactions.  SFAS 145makes various technical corrections to existing pronouncements.  While those corrections are not substantivein nature, in some instances, they may change accounting practice.  The provisions of SFAS 145 are effective forfinancial statements issued for fiscal years beginning after May 15, 2002, andinterim periods within those fiscal years. In accordance with the guidance set forth in SFAS 145, we classified the$3.2 million charge incurred in the 2003 Three-Month Period and 2003 Six-MonthPeriod related to the write-off of deferred financing costs associated with ourold bank credit agreement and the 123⁄4% Notes as Other expense in the accompanyingcondensed consolidated statements of operations.

 

In January 2003, the FASB issued FIN 46 to expand upon and strengthenexisting accounting guidance that addresses when a company should include inits financial statements the assets, liabilities and activities of anotherentity.  Until now, a company generallyhas included another entity in its consolidated financial statements only if itcontrolled the entity through voting interests.  FIN 46 changes that guidance by requiring a variable interest entity,as defined, to be consolidated by a company if that company is subject to amajority of the risk of loss from the variable interest entity’s activities oris entitled to receive a majority of the entity’s residual returns or both.  FIN 46 also requires disclosure aboutvariable interest entities that the company is not required to consolidate butin which it has a significant variable interest.  The consolidation requirements of FIN 46 apply immediately tovariable interest entities created after January 31, 2003 and to existingentities in the first fiscal year or interim period ending after December 15,2003.  Certain of the disclosurerequirements apply in all financial statements issued after January 31, 2003,regardless of when the variable interest entity was established.  We have evaluated the requirements of FIN 46and do not expect any effect on our consolidated financial position oroperating results.

 

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**ACG HOLDINGS, INC.**

Part I

 

**Item 3. Quantitative and Qualitative Disclosures About Market Risk.**

 

There have been no significant changes since March 31, 2003.  Reference is made to Item 7A (Quantitativeand Qualitative Disclosures About Market Risk) disclosure in our Form 10-Kfiled for the fiscal year ended March 31, 2003.

 

**Item4.  Controls and Procedures.**

 

As of September 30, 2003, an evaluation was performed under thesupervision and with the participation of the Company’s management, includingthe Chief Executive Officer and Chief Financial Officer, of the effectivenessof the design and operation of the Company’s disclosure controls and procedures(as defined in Rules 13a-14(c) and 15d-14(c) promulgated under the SecuritiesExchange Act of 1934, as amended). Based on that evaluation, the Company’s management, including the ChiefExecutive Officer and Chief Financial Officer, concluded that the Company’sdisclosure controls and procedures were effective as of September 30,2003.  There have been no significantchanges in the Company’s internal controls or in other factors that couldsignificantly affect internal controls subsequent to September 30, 2003.

 

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**ACG HOLDINGS, INC.**

Part II Other Information

 

**Item 1.****            Legal Proceedings.**

 

There have been no significant changes since March 31, 2003.  Reference is made to Item 3 (LegalProceedings) disclosure in our Form 10-K filed for the fiscal year ended March31, 2003.

 

**Item 2.****            Changes in Securities and Use ofProceeds.**

 

Recent Sales of Unregistered Securities

 

During the third quarter of fiscal year ended March 31, 2003, certainofficers exercised options to purchase an aggregate of 20,012 shares ofHoldings’ common stock for $.01/share. During the fourth quarter of fiscal year ended March 31, 2003, a formerofficer exercised options to purchase 518 shares of Holdings’ common stock for$.01/share.  The securities that weresold were exempt from registration on the basis that all such officers are“accredited investors” as defined by the rules of the Securities Act of 1933,as amended.

 

**Item 6.****            Exhibits and Reports on Form 8-K.**

 

(a)   Exhibits

 
| **Exhibit No.** |   | **Description**                                                                                          |
|-----------------|--------|----------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                     |
| 12.1            |   | Statement Re: Computation of Ratio of Earnings to Fixed Charges                                          |
|            |   |                                                                                                     |
| 31.1            |   | Rule 13a – 14(a)/15d-14(a) Certification of Chief Executive Officer                                 |
|            |   |                                                                                                     |
| 31.2            |   | Rule 13a – 14(a)/15d-14(a) Certification of Chief Financial Officer                                 |
|            |   |                                                                                                     |
| 32.1            |   | Certification of Chief Executive Officer and Chief Financial Officer  Pursuant to 18 U.S.C. Section 1350 |

 

(b)   Reportson Form 8-K

 

Form 8-K filed with the Securities and Exchange Commission on July 3,2003 under Item 9 announced that American Color Graphics, Inc. called forredemption on August 2, 2003, all of its outstanding 123⁄4% Senior SubordinatedNotes Due 2005.

 

Form 8-K filed with the Securities and Exchange Commission on August13, 2003 under Item 5, announced that American Color Graphics, Inc. redeemedall its outstanding 123⁄4% Senior Subordinated Notes Due 2005.

 

There were no other reports filed on Form 8-K in the quarter endedSeptember 30, 2003.

 

Form 8-K filed with the Securities and Exchange Commission on November4, 2003 under Item 5, announced American Color Graphics, Inc. will host ateleconference to discuss its financial results of the second quarter of fiscalyear ending March 31, 2004.

 

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**SIGNATURES**

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934,Holdings and Graphics have duly caused this Report to be signed on their behalfby the undersigned thereunto duly authorized.

 

 
|   |                   | ACG Holdings, Inc.                            |
|--------|------------------------|-----------------------------------------------|
|   |                   | American Color Graphics, Inc.                 |
|   |                   |                                          |
|   |                   |                                          |
| Date:  |  November 6, 2003 |                                          | By | /s/ Patrick W. Kellick |   |
|   |                   | Patrick W. Kellick                            |
|   |                   | Senior Vice President/Chief Financial Officer |
|   |                   | and Assistant Secretary                       |
|   |                   | (Authorized Officer and                       |
|   |                   | Principal Financial Officer)                  |
|   |                   |                                          |
|   |                   |                                          |
| Date:  | November 6, 2003       |                                          | By | /s/ Angela C. Marshall |   |
|   |                   | Angela C. Marshall                            |
|   |                   | Corporate Controller                          |
|   |                   | (Chief Accounting Officer)                    |
|        |                        |                                               |  |  |  |  |

 

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**EXHIBITINDEX**

 
| **Exhibit No.** |   | **Description**                                                                                          |   | **Page** |
|-----------------|--------|----------------------------------------------------------------------------------------------------------|--------|----------|
|            |   |                                                                                                     |   |     |
| 12.1            |   | Statement Re: Computation of Ratio of Earnings to Fixed Charges                                          |   | 32       |
|            |   |                                                                                                     |   |     |
| 31.1            |   | Rule 13a – 14(a)/15d-14(a) Certification of Chief Executive Officer                                 |   | 33       |
|            |   |                                                                                                     |   |     |
| 31.2            |   | Rule 13a – 14(a)/15d-14(a) Certification of Chief Financial Officer                                 |   | 34       |
|            |   |                                                                                                     |   |     |
| 32.1            |   | Certification of Chief Executive Officer and Chief Financial Officer  Pursuant to 18 U.S.C. Section 1350 |   | 35       |

 

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