UNITED
STATESSECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) |X|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT           OF 1934  For the Quarterly
Period Ended September 30, 2004 or |_|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  For
the transition period from ___________ to ___________  Commission File No.
333-50995 PHOENIX COLOR CORP.(Exact name of Registrant as specified in its charter) Delaware
(State or other jurisdiction of
incorporation or organization)
22-2269911
(I.R.S. Employer Identification No.)  540
      Western Maryland ParkwayHagerstown, Maryland(Address of principal executive offices)
    21740(Zip Code)  Registrants telephone number,
including area code:     (301) 733-0018 Indicate
by X whether the Registrant (1) has filed all reports required to be filed by Section 13
or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the Registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes |X|   No |_| Indicate
by X whether the Registrant is an accelerated filer (as defined in Exchange Act Rule
12b-2). Yes |_|   No |X| As
of November 12, 2004, there were 11,100 shares of the Registrants Class A Common
Stock issued and outstanding and 7,794 of the Registrants Class B Common Stock
issued and outstanding.   PART I  FINANCIAL
INFORMATION


Item 1. Financial
Statements.


Index to Financial
Statements




Page No.Consolidated
      Balance SheetsSeptember
      30, 2004 (Unaudited) and December 31, 2003
    
    1Consolidated
      Statements of OperationsThree
      and Nine Months Ended September 30, 2004 (Unaudited) and 2003 (Unaudited)
    
    2Consolidated
      Statements of Cash FlowsNine
      Months Ended September 30, 2004 (Unaudited) and 2003 (Unaudited)
    
    3Notes
      to Consolidated Financial Statements
    
    4
PHOENIX COLOR CORP.
AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS




September
      30,
      2004
      (Unaudited)
    
    December 31,
      2003
      (Audited)ASSETSCurrent
      assets:Cash
      and cash equivalents
    
    
    $
    80,877
    
    $
    63,714Accounts
      receivable, net of allowance for doubtful accounts and rebates of$2,622,386
      in 2004 and $2,345,715 in 2003
    
    
    
    17,357,691
    
    
    18,846,859Inventory
    
    
    
    6,530,219
    
    
    5,642,108Prepaid
      expenses and other current assets
    
    
    
    2,930,182
    
    
    3,045,703Total
      current assets
    
    
    
    26,898,969
    
    
    27,598,384Property,
      plant and equipment, net
    
    
    
    51,008,275
    
    
    57,799,341Goodwill
    
    
    
    13,302,809
    
    
    13,302,809Deferred
      financing costs, net
    
    
    
    2,123,020
    
    
    2,443,698Other
      assets
    
    
    
    9,496,144
    
    
    10,635,423Total
      assets
    
    
    $
    102,829,217
    
    $
    111,779,655LIABILITIES
      & STOCKHOLDERS DEFICITCurrent
      liabilities:Notes
      payable
    
    
    $
    
    
    $
    409,194Capital
      lease obligations
    
    
    
    900,219
    
    
    831,169Revolving
      line of credit
    
    
    
    7,353,894
    
    
    6,827,929Accounts
      payable
    
    
    
    6,998,737
    
    
    8,556,760Accrued
      expenses
    
    
    
    6,106,823
    
    
    9,064,919Total
      current liabilities
    
    
    
    21,359,673
    
    
    25,689,97110
      3/8% Senior subordinated notes
    
    
    
    105,000,000
    
    
    105,000,000MICRF
      Loan
    
    
    
    500,000
    
    
    500,000Capital
      lease obligations
    
    
    
    1,849,778
    
    
    2,533,018Other
      liabilities
    
    
    
    526,426
    
    
    105,447Total
      liabilities
    
    
    
    129,235,877
    
    
    133,828,436Commitments
      and contingencies (Note 6)Stockholders
      deficitCommon
      Stock, Class A, voting, par value $0.01 per share, authorized20,000
      shares, 14,560 issued shares, 11,100 outstanding shares
    
    
    
    146
    
    
    146Common
      Stock, Class B, non-voting, par value $0.01 per share, authorized200,000
      shares, 9,794 issued shares, 7,794 outstanding shares
    
    
    
    98
    
    
    98Additional
      paid in capital
    
    
    
    2,126,804
    
    
    2,126,804Accumulated
      deficit
    
    
    
    (26,764,478
    )
    
    (22,392,167
    )Stock
      subscriptions receivable
    
    
    
    
    
    
    (14,432
    )Treasury
      stock, at cost: Class A, 3,460 shares and Class B, 2,000 shares
    
    
    
    (1,769,230
    )
    
    (1,769,230
    )Total
      stockholders deficit
    
    
    
    (26,406,660
    )
    
    (22,048,781
    )Total
      liabilities & stockholders deficit
    
    
    $
    102,829,217
    
    $
    111,779,655The accompanying notes
are an integral part of these consolidated financial statements.
1


PHOENIX COLOR CORP.
AND SUBSIDIARIES



CONSOLIDATED
STATEMENTS OF OPERATIONS


(Unaudited)
      Three Months Ended September 30,
    
    (Unaudited)
      Nine Months Ended September 30,2004
    
    2003
    
    2004
    
    2003Net
      sales
    
    
    $
    31,733,055
    
    $
    38,091,952
    
    $
    97,463,676
    
    $
    105,982,425Cost
      of sales
    
    
    
    25,979,379
    
    
    28,961,597
    
    
    79,606,528
    
    
    83,592,281Gross
      profit
    
    
    
    5,753,676
    
    
    9,130,355
    
    
    17,857,148
    
    
    22,390,144Operating
      expenses:Selling
      and marketing expenses
    
    
    
    1,502,603
    
    
    1,495,958
    
    
    5,109,298
    
    
    5,242,773General
      and administrative expenses
    
    
    
    2,503,040
    
    
    3,042,985
    
    
    8,358,409
    
    
    9,264,086(Gain)
      loss on sale of assets
    
    
    
    (87,666
    )
    
    403,321
    
    
    (76,655
    )
    
    422,679Restructuring
      credit
    
    
    
    
    
    
    (2,180,946
    )
    
    
    
    
    (2,180,946
    )Total
      operating expenses
    
    
    
    3,917,977
    
    
    2,761,318
    
    
    13,391,052
    
    
    12,748,592Income
      from operations
    
    
    
    1,835,699
    
    
    6,369,037
    
    
    4,466,096
    
    
    9,641,552Other
      expenses:Interest
      expense
    
    
    
    2,399,691
    
    
    3,051,602
    
    
    8,918,658
    
    
    9,185,569Other
      income
    
    
    
    (19,402
    )
    
    (25,034
    )
    
    (80,250
    )
    
    (81,356
    )Income
      (loss) before income taxes
    
    
    
    (544,590
    )
    
    3,342,469
    
    
    (4,372,312
    )
    
    537,339Income
      tax benefit
    
    
    
    
    
    
    
    
    
    
    
    
    Net
      income (loss)
    
    
    
    ($ 544,590
    )
    $
    3,342,469
    
    
    ($
      4,372,312
    )
    $
    537,339The accompanying notes
are an integral part of these consolidated financial statements.
2


PHOENIX COLOR CORP.
AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS





Nine
      Months Ended September 30,(Unaudited)
      2004
    
    (Unaudited)
      2003Operating
      activitiesNet
      (loss) income
    
    
    
    ($4,372,312
    )
    $
    537,339Adjustments
      to reconcile net (loss) income to net cash provided by operating activities:Depreciation
      and amortization of property, plant and equipment
    
    
    
    8,173,126
    
    
    7,738,847Amortization
      of deferred financing costs
    
    
    
    380,679
    
    
    417,334Provision
      for uncollectible accounts
    
    
    
    486,979
    
    
    399,305Recapture
      of restructuring charge
    
    
    
    
    
    
    (2,180,946
    )Change
      in fair value of interest rate swap
    
    
    
    420,979
    
    
    (Gain)
      loss on disposal of assets
    
    
    
    (76,655
    )
    
    422,679Increase
      (decrease) in cash resulting from changes in operating assets and liabilities:Accounts
      receivable
    
    
    
    1,002,189
    
    
    (1,587,648
    )Inventory
    
    
    
    (888,111
    )
    
    240,509Prepaid
      expenses and other assets
    
    
    
    1,373,169
    
    
    1,342,264Accounts
      payable
    
    
    
    323,728
    
    
    (1,382,571
    )Accrued
      expenses
    
    
    
    (2,988,096
    )
    
    (1,721,678
    )Net
      cash provided by operating activities
    
    
    
    3,835,675
    
    
    4,225,434Investing
      activities:Proceeds
      from sale of equipment
    
    
    
    1,040,816
    
    
    200,067Capital
      expenditures
    
    
    
    (4,346,342
    )
    
    (2,654,614
    )Net
      cash used in investing activities
    
    
    
    (3,305,526
    )
    
    (2,454,547
    )Financing
      activities:Net
      receipts from (payments to) revolving line of credit
    
    
    
    525,965
    
    
    (819,501
    )Principal
      payments on long term borrowings and capital leases
    
    
    
    (1,023,383
    )
    
    (942,587
    )Payment
      of deferred financing costs
    
    
    
    (30,000
    )
    
    (40,000
    )Proceeds
      from the payment of stock subscriptions
    
    
    
    14,432
    
    
    10,800Net
      cash used in financing activities
    
    
    
    (512,986
    )
    
    (1,791,288
    )Net
      increase (decrease) in cash
    
    
    
    17,163
    
    
    (20,401
    )Cash
      and cash equivalents at beginning of period
    
    
    
    63,714
    
    
    109,297Cash
      and cash equivalents at end of period
    
    
    $
    80,877
    
    $
    88,896Non-cash
      investing activities:Equipment
      included in accounts payable
    
    
    $
    108,321
    
    $
    1,067,943The accompanying notes
are an integral part of these consolidated financial statements.

3



PHOENIX COLOR CORP.
AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.
Basis
of Presentation.The
accompanying interim consolidated financial statements of Phoenix Color Corp. and its
subsidiaries (the Company) do not include all of the information and
disclosures generally required for annual consolidated financial statements and are
unaudited. In the opinion of management, the accompanying unaudited consolidated
financial statements contain all material adjustments (consisting of normal recurring
accruals), necessary to present fairly the Companys financial position as of
September 30, 2004, and the results of its operations for the three month and nine month
periods ended September 30, 2004 and 2003. The unaudited interim consolidated financial
statements should be read in conjunction with the Companys audited consolidated
financial statements for the year ended December 31, 2003, included in the Companys
Annual Report filed on Form 10-K.


2.
Inventory.Inventory
consists of the following:



September
      30, 2004
    
    December 31,
      2003Raw
      materials
    
    
    $
    4,695,276
    
    $
    4,121,000Work in process
    
    
    
    1,834,943
    
    
    1,521,108$
    6,530,219
    
    $
    5,642,1083.
Other
Assets.Other
assets at September 30, 2004 and December 31, 2003 include equipment deposits of
$1,988,230 and $1,869,861, respectively.


4.
Accrued
Expenses.Accrued
expenses at September 30, 2004 and December 31, 2003 include accrued interest payable of
$1,824,383 and $4,433,471, respectively.


5.
Debt.The
Company issued $105.0 million of 10-3/8% Senior Subordinated Notes due 2009 under an
indenture (the Indenture) in a private offering. The Senior Subordinated
Notes are uncollateralized senior subordinated obligations of the Company with interest
payable semiannually on February 1 and August 1 of each year. Although not due until
2009, the Senior Subordinated Notes are redeemable, at the option of the Company, on or
after February 1, 2004, at declining premiums through January 2007 and at their principal
amount thereafter. If a third party acquires control of the Company, the Senior
Subordinated Note holders have the right to require the Company to repurchase the Senior
Subordinated Notes at a price equal to 101% of the principal amount of the notes plus
accrued and unpaid interest to the date of purchase. All current and future restricted
subsidiaries, as defined in the Indenture, are guarantors of the Senior
Subordinated Notes on an uncollateralized senior subordinated basis. The Indenture
prohibits the Company from incurring more than $5 million of debt for the acquisition of
equipment unless the required consolidated coverage ratio is achieved and contains other
non-financial covenants. As of September 30, 2004 and December 31, 2003 the Company
failed to meet the required consolidated coverage ratio. The Company has incurred $2.7
million of the $5 million permitted for equipment indebtedness pursuant to the Indenture.
4


On
October 27, 2003, the Company entered into an Interest Rate Swap Agreement (the Swap
Agreement) to manage interest rate costs relating to its Senior Subordinated Notes.
The Swap Agreement effectively converts $50 million of the Companys $105 million of
debt under the Senior Subordinated Notes into variable rate debt. Pursuant to the Swap
Agreement, the Company receives payments based on a 10-3/8% rate and makes payments based
on a LIBOR-based variable rate plus 7.42% adjusted semiannually in arrears. For the
period beginning October 27, 2003 and ending July 31, 2004, the Company received payments
under Swap at a fixed rate of 10 3/8% and made payments at a fixed rate of 8.64%. The
interest rate swap does not qualify for hedge accounting and therefore any change in the
interest rate swaps value is recorded as a component of interest expense on the
Companys consolidated statement of operations. As of September 30, 2004 and
December 31, 2003, the fair value of the interest rate swap was ($526,426) and
($105,447), respectively, which were included in other long term liabilities on the
consolidated balance sheet. Interest expense for the three month period ended September
30, 2004, decreased by $516,152, which represents the change in the valuation of the
interest rate swap on June 30, 2004 and September 30, 2004. Interest expense for the nine
month period ended September 30, 2004, increased by $420,979, which represents the change
in the valuation of the interest rate swap on September 30, 2004 and December 31, 2003.


In
May 2000, the Company entered into a five year $500,000 loan agreement with the Maryland
Industrial and Commercial Redevelopment Fund (MICRF) bearing interest at 4.38% per annum.
Pursuant to its terms, if the Company employs 543 people in Maryland in each of the years
of the loan, then the loan and all accrued interest thereon shall be forgiven. If the
Company does not meet the employment requirements, it will be required to repay the loan
and accrued interest thereon in quarterly installments until repaid in full. As of
September 30, 2004, the Company employed over 575 people in the State of Maryland. The
Company has included the principal amount of this loan in long term debt on the Companys
consolidated balance sheet at September 30, 2004.


On
September 30, 2003, the Company entered into an Amended and Restated Loan and Security
Agreement (the Senior Credit Facility) with a commercial bank providing for
the continuance of a $20,000,000 revolving credit facility through August 31, 2006.
Borrowings under the Senior Credit Facility are subject to a borrowing base as defined in
the agreement and are collateralized by substantially all of the assets of the Company.
The Companys availability under the Senior Credit Facility was $4.3 million as of
September 30, 2004. The Senior Credit Facility contains, without limitation, prohibitions
against the payment of dividends, distributions and the redemption of stock; limitations
on sales of assets, compensation of executives, and additional debt; and other financial
and non-financial covenants, including a requirement that the Company maintain a defined
fixed coverage charge ratio, as defined in the Senior Credit Facility. As of December 31,
2003 the Company was in compliance with fixed coverage charge ratio. As of September 30,
2004, the Company was in compliance with its fixed coverage charge ratio. The Company
executed a second amendment (Exhibit 10.1 attached hereto) to the Senior Credit Facility
which clarified the definition of fixed charges in the first amendment to the Senior
Credit Facility.

5



6.
Commitments
and Contingencies.The
Company is not a party to any legal proceedings, other than claims and lawsuits arising
in the normal course of its business. Although the outcome of claims and lawsuits against
the Company can not be accurately predicted, the Company does not believe that any of the
claims or lawsuits will have a material adverse effect on its business, financial
condition, results of operations and cash flows for any quarterly or annual period.


7.
Guarantor
Subsidiaries.Phoenix
Color Corp. (Parent) currently has no independent operations, and the
guarantees made by all of its subsidiaries, which are all 100% owned, are full and
unconditional and joint and several. The Company currently does not have any direct or
indirect non-guarantor subsidiaries. All consolidated amounts in the Parents
financial statements would be representative of the combined guarantors.


8.
Income
Taxes.The
Company did not record an income tax provision for the three or nine months ended
September 30, 2004 and 2003 due to the uncertainty of the utilization of its deferred tax
assets generated primarily as a result of its net operating losses.


9.
Stock
OptionsThe
Company has one stock-based employee compensation plan, which was established in 2002.
The Company accounts for the plan under the recognition and measurement provisions of APB
Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations.
Under APB No. 25, compensation cost is measured as the excess, if any, of the fair market
value of the Companys common stock at the date of the grant over the exercise price
of the option granted. Compensation cost is recognized over the vesting period. Prior to
August 2003, no options were issued or outstanding. On August 16, 2003, options to
purchase an aggregate of 657 shares of the Companys Class A common stock were
issued to key executives of the Company. The options vest ratably over a three year
vesting period. As of September 30, 2004, one third of the options are exercisable and
2,178 shares are available for future grants under the terms of the Companys
Amended and Restated Stock Incentive Plan.
6


The
following table illustrates the effect on net (loss) income if the Company had applied
the fair value recognition provisions of SFAS Statement No. 123, Accounting for
Stock-Based Compensation, as amended by SFAS No. 148 to stock-based employee
compensation for the three and nine month periods ended September 30:





Three Months
      Ended
      September 30
    
    Nine Months
      Ended
      September 302004
    
    2003
    
    2004
    
    2003Net
      (loss) income, reported
    
    
    
    ($
      544,590
    )
    $
    3,342,469
    
    
    ($4,372,312
    )
    $
    537,339Add: Stock-based
      employee compensationexpense included
      in reported net loss,net of related
      tax effects
    
    
    
    
    
    
    
    
    
    
    
    
    Deduct: Total
      stock-based employeecompensation
      expense determined underfair value
      based methods for stockoptions,
      net of related tax effects
    
    
    
    ($ 10,777
    )
    
    
    
    
    ($ 32,331
    )
    
    Pro forma
      net (loss) income
    
    
    
    ($ 555,367
    )
    $
    3,342,469
    
    
    ($4,404,643
    )
    $
    537,339The
effect of applying SFAS No. 123 on the nine month period ended September 30, 2004 pro
forma net loss, as stated above, is not necessarily representative of the effects on
reported net loss for future years due to, among other things, (i) the vesting period of
the stock options and (ii) the fair value of additional option grants in future years.


Item 2.  Managements
Discussion and Analysis of Financial Condition and Results of Operations.


Our
results of operations for the three and nine months ended September 30, 2004 reflect the
fact that we continue to operate in an environment where our customers, book publishers,
are under intense competitive pressure. While trade publishers have experienced an
increase in sales in the current year, educational publishers in elementary, secondary
and higher education have experienced declines and are under intense pressure to reduce
costs. Small and medium sized publishers have been expanding but do not have the budgets
or capitalization to use special effects on their book components. This has caused
publishers to seek price concessions from their vendors, and over capacity in
manufacturing has resulted in lower prices. Retailers have the right to return unsold
books to publishers. As a result, publishers have reduced the quantities of orders to
avoid having to take back unsold books resulting in lower sales by book and book
component manufacturers.


During
the nine month period ended September 30, 2004, we continued to look for ways to reduce
costs of manufacture and overhead to remain competitive in this highly aggressive
environment. Our net sales decreased $8.5 million to $97.5 million for the nine months
ended September 30, 2004 from $106.0 million for the same period in 2003, and our income
from operations, declined $3.0 million to $4.5 million from $7.5 million for the nine
months ended September 30, 2004 and 2003, respectively after excluding the recapture of a
prior year restructuring charge in 2003. We have instituted cost saving measures in
several areas including disbanding our aviation department and implementing a new
employee health benefit plan, the two of which we estimate should save $3.0 million
annually.

7


Forward Looking
Statements


Some
of the statements in this Quarterly Report on Form 10-Q are forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended.
These statements include our indications regarding our intent, beliefs or current
expectations. In some cases, you can identify forward-looking statements by terminology
such as may, estimates, anticipates,intends, will, should, could,expects, believes, continues or
predicts.These statements involve a variety of known and unknown risks,
uncertainties, and other factors that may cause our actual results to differ materially
from intended or expected results. These factors include (i) the risk factors and other
information presented in our Registration Statement filed with the Securities and
Exchange Commission, File No. 333-50995, which became effective May 13, 1999, (ii) the
risk that we will not have the funds we anticipated or will require more funds than we
anticipated to finance our current operations, remaining capital expenditures and
internal growth for the year 2004, (iii) the risk that any claims and lawsuits filed,
threatened to be filed or pending against us might have a material adverse effect on our
business or results of operations, (iv) the risk that cost savings measures we have
instituted will not yield the savings we anticipate, (v) the risk that we will not
receive the net payments we anticipate pursuant to our interest rate swap or that we will
incur a net liability pursuant to our interest rate swap, (vi) the risk that our
allowance for doubtful accounts and rebates will not be adequate and (vii) the risk that
there has been an impairment in the value of our physical assets. You should not place
undue reliance on these forward-looking statements, which speak only as of the date
hereof. We expressly decline any obligation to publicly release the results of any
revisions to these forward-looking statements that may be made to reflect events or
circumstances after the date hereof or to reflect the occurrence of unanticipated events.


The
following discussion and analysis should be read in conjunction with our unaudited
Consolidated Financial Statements and the Notes thereto included elsewhere in this Form
10-Q.


Critical Accounting
Policies


Our
discussion and analysis of financial condition and results of operations are based upon
our Consolidated Financial Statements, which were prepared in accordance with accounting
principles generally accepted in the United States of America. To prepare our financial
statements, we must make certain judgments and estimates which affect the reporting of
assets and liabilities, both real and contingent, and income and expenses. Assets and
liabilities which are continually re-evaluated include, but are not limited to,
allowances for doubtful accounts, inventories, goodwill, income taxes, restructuring,
contingencies and litigation. We use our best judgment when making estimates, based on
the current facts and historical experience with respect to numerous factors that are
difficult to predict and beyond managements control. Because we are making
judgments when we make estimates, actual results may differ materially from these
estimates. We believe our estimates are reasonable under the circumstances based on our
critical accounting policies used in preparing our financial statements.


Management
believes that the following policies are critical accounting policies, as defined by the
Securities and Exchange Commission (the SEC). The SEC defines critical
accounting policies as those that are both most important to the portrayal of a companys
financial condition and results of operations and require managements most
difficult, subjective or complex judgment, often as a result of the need to make
estimates about the effect of matters that are inherently uncertain and might change in
subsequent periods. We discuss our significant accounting policies, including those that
do not require management to make difficult, subjective or complex judgments or
estimates, in the Notes to the Consolidated Financial Statements.

8



Revenue Recognition


We
recognize revenue upon shipment of our products to or on behalf of our customers. No
sales are made on consignment.


Allowance for Doubtful
Accounts and Rebates


We
maintain allowances for doubtful accounts for estimated losses resulting from the
inability of our customers to make payments for products shipped. All accounts are
regularly reviewed to determine if the allowance is adequate, and if not, additional
allowances are made. If the financial condition of our customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional allowances might
be required. We also provide rebates to certain customers if they attain certain sales
levels. The rebates are in the form of a credit, which is established as an allowance
against accounts receivable. As of September 30, 2004, our accounts receivable balance,
net of allowances for doubtful accounts and rebates of $2.6 million, was $17.4 million.
We believe the allowance is reasonable.


Inventory


Our
inventory, which is physically counted monthly, is stated at the lower of cost or market
value, as determined under the first-in, first-out (FIFO) method. We do not
maintain an inventory of finished goods as all product manufactured is for a specific
order and is shipped upon completion.


Intangible Assets


Our
goodwill represents the excess of the purchase price over the fair value of identifiable
net tangible assets acquired. Our total goodwill of $13.3 million consists of $4.7
million and $8.6 million associated with the 1996 and 1999 acquisitions of New England
Book Holding Corporation, and Mid-City Lithographers, Inc., respectively. In January
2002, we adopted the Statement of Financial Accounting Standards No. 142 Goodwill
and Other Intangible Assets. We test the value of goodwill based on a comparison of
undiscounted cash flow to the recorded value at least annually but more often if needed.
In 2004, we performed the required annual test and determined that goodwill was not
impaired, but if market conditions deteriorate, we may be required to recognize an
impairment charge to the asset.


Long Lived Assets


We
regularly evaluate the value of property, equipment and tangible assets recorded on our
balance sheet for impairment and record any impairment loss when the value of the assets
is less than the sum of the expected cash flows from those assets. As of September 30,
2004, we do not believe there was any impairment to the value of our physical assets.


Deferred Tax Valuation
Allowance


As
of September 30, 2004, we recorded a valuation allowance of $6.4 million against our
total net deferred tax asset of $6.4 million. Statement of Financial Accounting Standards
No. 109 (SFAS No. 109) requires us to evaluate the likely realization of the
tax asset, and if evidence exists that would create doubt as to the realization of the
tax asset, to provide an allowance against it. Our results over the past three years
created a large cumulative loss and represented sufficient negative evidence to require
us to provide for a valuation allowance against the tax asset. We intend to maintain this
valuation allowance until such time as sufficient positive evidence exists to support its
reversal.

9



Stock Based Compensation


The
Company discloses information relating to stock-based compensation awards in accordance
with SFAS No.123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148,
Accounting for Stock-Based Compensation Transition and Disclosure, and has elected to
apply the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees to such compensation awards. Under the Companys employee stock
option plans, the Company grants employee stock options at an exercise price equal to the
fair market value at the date of grant. No compensation expense has been recorded with
respect to such stock option grants.


Results of Operations


The
following table sets forth, for the periods indicated, certain information derived from
the Companys Consolidated Statements of Operations (dollars in millions):




Three Months Ended September 30,
    
    Nine
      Months Ended September 30,2004
    
    %
    
    2003
    
    %
    
    2004
    
    %
    
    2003
    
    %Net
      sales
    
    $
    31.7
    
    
    100.0
    
    $
    38.1
    
    
    100.0
    
    $
    97.5
    
    
    100.0
    
    $
    106.0
    
    
    100.0Cost of sales
    
    
    26.0
    
    
    82.0
    
    
    29.0
    
    
    76.1
    
    
    79.6
    
    
    81.6
    
    
    83.6
    
    
    78.9Gross profit
    
    
    5.7
    
    
    18.0
    
    
    9.1
    
    
    23.9
    
    
    17.9
    
    
    18.4
    
    
    22.4
    
    
    21.1Operating
      expenses
    
    
    3.9
    
    
    12.3
    
    
    2.8
    
    
    7.3
    
    
    13.4
    
    
    13.7
    
    
    12.7
    
    
    12.0Income from
      operations
    
    
    1.8
    
    
    5.7
    
    
    6.3
    
    
    16.6
    
    
    4.5
    
    
    4.7
    
    
    9.7
    
    
    9.1Interest
    
    
    2.3
    
    
    7.3
    
    
    3.0
    
    
    7.9
    
    
    8.9
    
    
    9.1
    
    
    9.2
    
    
    8.7Other income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.1
    
    
    0.1
    
    
    0.1
    
    
    0.1Loss before
      income taxes
    
    
    (0.5
    )
    
    (1.6
    )
    
    3.3
    
    
    8.7
    
    
    (4.3
    )
    
    (4.3
    )
    
    0.6
    
    
    0.6Income tax
      provision
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    (0.5
    )
    
    (1.6
    )
    
    3.3
    
    
    8.7
    
    
    (4.3
    )
    
    (4.3
    )
    
    0.6
    
    
    0.6Three Months Ended
September 30, 2004 and 2003


Net
sales decreased $6.4 million, or 16.8%, to $31.7 million for the three months ended
September 30, 2004, from $38.1 million for the same period in 2003. The decrease occurred
primarily as a result of decreased sales volume in the book component manufacturing and
Rockaway book manufacturing business units, with sales marginally increasing in the
Maryland book manufacturing business unit . The decreased sales volume in the book
component unit is a result of lower quantities per job combined with aggressive pricing
due to competitiveness in the printing industry. The decrease in the Rockaway business
unit is primarily the result of publishers seeking to maximize the benefits of off shore
pricing. However, we have developed a symbiotic relationship with an Asian printer to
assist customers to fulfill their economic needs while retaining the relationship with
the customer.


Gross
profit decreased $3.4 million, or 37.4%, to $5.7 million for the three months ended
September 30, 2004, from $9.1 million for the same period in 2003. This decrease was
primarily the result of decreased sales volumes discussed above and our inability to
reduce manufacturing costs at a rate commensurate with the decrease in sales. The gross
profit margin declined 5.9% to 18.0% for the three months ended September 30, 2004, from
23.9% for the same period in 2003, primarily due to increased material labor and overhead
costs as a percentage of sales.
10



Operating
expenses increased $1.1 million or 39.3% to $3.9 million for the three months ended
September 30, 2004, from $2.8 million for the same period in 2003. In the third quarter
of 2003, we realized a non-cash credit of $2.1 million for the recapture of a
restructuring charge recorded in a previous year and incurred a charge for loss on sale
of equipment of $0.4 million. Exclusive of the restructuring credit and loss on equipment
dispositions, operating expenses after giving effect to these amounts, for the third
quarter of 2003 amounted to $4.5 million or $0.6 million higher than the current year.
The decrease in expenses in 2004 was the result of lower administrative expenses, with
compensation and employee benefits accounting for approximately 60% of the decrease.


Interest
expense decreased $0.7 million to $2.3 million for the three months ended September 30,
2004, from $3.0 million for the same period in 2003. This decrease was primarily the
result of the difference between the fair market value of our interest rate swap on
September 30, 2004 of ($0.5) million and June 30, 2004 of ($1.0) million resulting in a
non-cash credit of $0.5 million. The additional decrease of $0.2 million was primarily
due to the difference between the interest we paid under our Senior Subordinated Notes
and the interest we received from the interest rate swap.


For
the three months ended September 30, 2004 and 2003, we did not record a tax benefit due
to the uncertainty of the realization of our deferred tax asset.


We
incurred a net loss of $0.5 million for the three months ended September 30, 2004,
compared to net income of $3.3 million for the same period in 2003. The change was due to
the factors described above.


Nine Months Ended
September 30, 2004 and 2003


Net
sales decreased $8.5 million, or 8.0%, to $97.5 million for the nine months ended
September 30, 2004, from $106.0 million for the same period in 2003. The decrease
occurred in all business units. Although the number of jobs processed remained virtually
unchanged, sales dollars declined as a result of reductions in the order quantities
combined with severe pricing pressures due to over capacity in the book and book
component manufacturing industry. Sales in the Rockaway, New Jersey business unit
declined even though our Asian initiative doubled its sales, due to major customers
seeking the benefits of off shore pricing with Asian manufacturers with whom they have
been dealing over long periods to time.


Gross
profit decreased $4.5 million, or 20.1%, to $17.9 million for the nine months ended
September 30, 2004, from $22.4 million for the same period in 2003. This decrease was
primarily the result of decreased sales volumes discussed above and our inability to
reduce manufacturing costs at a rate commensurate with the decrease in sales. The gross
profit margin declined 2.7% to 18.4% for the nine months ended September 30, 2004, from
21.1% for the same period in 2003, primarily due to increased labor and overhead costs as
a percentage of sales offset by decreased material costs as a percentage sales.


Operating
expenses increased $0.7 million or 5.5% to $13.4 million for the nine months ended
September 30, 2004, from $12.7 million for the same period in 2003. In September of 2003,
we realized a non-cash credit of $2.1 million for the recapture of a restructuring charge
recorded in a previous year and incurred a charge for loss on sale of equipment of $0.4
million. Exclusive of the restructuring credit and loss on equipment dispositions,
operating expenses for the nine months ended September 30, 2004 decreased $1.0 million to
$13.4 million from $14.4 million for the same period in the prior year. The decrease in
expenses occurred primarily in administrative expenses, with compensation, employee
benefits, professional fees and elimination of the aviation department accounting for
approximately 75% of the decrease.

11



Interest
expense decreased $0.3 million to $8.9 million for the nine months ended September 30,
2004, from $9.2 million for the same period in 2003. Included in interest expense for the
nine months ended September 30, 2004 is a non-cash charge of $0.4 million resulting from
the change in fair market value of our interest rate swap on September 30, 2004 of ($0.5)
million and December 31, 2003 of ($0.1) million. Excluding this non-cash charge, our
interest decreased $0.7 million for the nine months ended September 30, 2004 for the same
period in 2003. This decrease was due to average lower borrowing under our revolving line
of credit combined with the difference between the interest we paid under our Senior
Subordinated Notes and the interest we received from the interest rate swap.


For
the nine months ended September 30, 2004and 2003, we did not record a tax benefit due to
the uncertainty of the realization of our deferred tax asset.


We
incurred a net loss of $4.3 million for the nine months ended September 30, 2004,
compared to net income of $0.6 million for the same period in 2003. The change was due to
the factors described above.


Liquidity and Capital
Resources


During
the first nine months of 2004, our cash increased by approximately $17,000. Net cash
provided by operating activities was approximately $3.8 million, which consisted
principally of (i) a net loss of $4.4 million offset by net non-cash expenses of $9.4
million, and decreased by (ii) an increase in working capital of $1.2 million. Net cash
used in investing activities was $3.3 million due to capital and equipment expenditures.
Net cash used for financing activities was $0.5 million, resulting primarily from
repayments of long term debt and capital lease obligations of $1 million offset by
increases in borrowings under our Senior Credit Facility of $0.5 million.


Working
capital increased $3.6 million to $5.5 million as of September 30, 2004, from $1.9
million at December 31, 2003. This increase is primarily attributable to an increase in
inventory of $0.9 million, a decrease in accounts payable and accrued expenses of $4.5
million, offset by a decrease in accounts receivable of $1.5 million and an increase in
borrowing under the Senior Credit Facility of $0.5 million.


We
historically have financed our operations with internally generated funds, external short
and long-term borrowings and operating leases. We believe that funds generated from
operations, together with existing cash amounts, available credit under our Senior Credit
Facility ($4.3 million as of September 30, 2004) and other financial sources will be
sufficient to finance our current operations, remaining capital expenditure requirements
and internal growth for the year 2004. Should we experience a material decrease in demand
for our products, or an inability to reduce costs, the resulting decrease in the
availability of funds could have a material adverse effect on our business, prospects or
results of operations.


If
we were to make any significant acquisitions for cash, it may be necessary to obtain
additional debt or equity financing. There can be no assurance that such financing would
be available on satisfactory terms or at all. We have no current agreements with respect
to any acquisitions.
12


The
following is a summary of our future cash payments under contractual obligations as of
September 30, 2004. In the event of a default, many of the contracts provide for
acceleration of payments.







Payments
      Due by Period
      (in thousands of dollars)Contractual
      Obligations
    
    
    Total
    
    Less
      than
      1 year
    
    1-3
      years
    
    4-5
      Years
    
    After
      5 yearsLong-Term
      Debt (1)
    
    
    $
    105,000
    
    $
    
    
    $
    
    
    $
    105,000
    
    $
    Capital Lease
      Obligations
    
    
    
    3,165
    
    
    1,013
    
    
    2,026
    
    
    126
    
    
    Operating
      Leases
    
    
    
    21,675
    
    
    6,928
    
    
    13,947
    
    
    800
    
    
    Total Contractual
      Cash Obligations
    
    
    $
    129,840
    
    $
    7,941
    
    $
    15,973
    
    $
    105,926
    
    $
    (1)    The
amounts stated are the expected amounts of our commitments under the 10-3/8%
          Senior Subordinated Notes and assumes that no notes are tendered.


The
following is a summary of our other commercial commitments by commitment expiration date
as of September 30, 2004:



Amount
      of Commitment Expiration Per Period
      (in thousands of dollars)Other Commercial
      Commitments
    
    
    Total
    
    Less
      than
      1 year
    
    1-3
      Years
    
    4-5
      years
    
    After
      5 yearsLine
      of Credit (1)
    
    
    $
    20,000
    
    $
    
    
    $
    20,000
    
    $
    
    
    $
    Total Commercial
      Commitments
    
    
    $
    20,000
    
    $
    
    
    $
    20,000
    
    $
    
    
    $
    (1)           The line of credit is
the maximum we could borrow subject to borrowing base           limitations, and does not
represent the amount of debt outstanding under the           line of credit.


Item 3.  Quantitative
and Qualitative Disclosures about Market Risk.


On
October 27, 2003, we entered into an interest rate swap agreement to manage interest rate
costs relating to our Senior Subordinated Notes, which carry a 10-3/8% fixed rate of
interest. The interest rate swap effectively converts $50 million of our $105 million of
debt under the Senior Subordinated Notes into variable rate debt. Under our interest rate
swap agreement, we receive payments based on a 10-3/8% rate and make payments based on a
LIBOR-based variable rate plus 7.42%, adjusted semiannually in arrears. For the period
beginning October 27, 2003 and ending July 31, 2004, the Company received payments under
Swap at a fixed rate of 10 3/8% and made payments at a fixed rate of 8.64%.


Our
interest rate swap is subject to interest rate risk. Interest rates are highly sensitive
to many factors, including governmental, monetary and tax policies, domestic and
international economic and political considerations, and other factors beyond our
control. If the LIBOR-based variable rate upon which our payments under the interest rate
swap are made exceeds 2.955%, the amount we would have to pay each semiannual period
pursuant to our interest rate swap would exceed the amount we would receive each
semiannual period pursuant to the swap. The interest rate swap agreement is subject to
the risk of early termination under certain circumstances, possibly at a time unfavorable
to us. There can be no assurances that we will be able to acquire hedging instruments at
favorable prices, or at all, when the existing interest rate swap expires or is
terminated.

13






Item 4. Controls and
Procedures


Our
Chief Executive Officer and Chief Financial Officer have concluded that our disclosure
controls and procedures, (as defined in 17 CRF 240.13(a)  15(e) and 240.15(d) 15(e))
are effective based upon their evaluation of these controls and procedures as of the end
of the period covered by this report.


There
has been no change in our internal controls over financial reporting that occurred during
the second quarter of 2004 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.


PART II  OTHER
INFORMATION


Item 1. Legal
Proceedings.


We
are not a party to any legal proceedings, other than claims and lawsuits arising in the
normal course of our business. Although the outcome of claims and lawsuits against us can
not be accurately predicted, we do not believe that any of the claims and lawsuits will
have a material adverse effect on our business, financial condition, results of
operations and cash flows for any quarterly or annual period.


Item 2. Change in
Securities and Use of Proceeds.


None.


Item 3. Defaults upon
Senior Securities.


None.


Item 4. Submission of
Matters to a Vote of Security Holders.


None.


Item 5. Other
Information.


None.
14


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


(a)
Exhibits.
Exhibits filed as part of this report are listed below:10.1
Second
Amendment to the Amended and Restated Loan and Security Agreement dated as of September
30, 2003 by and among Phoenix Color Corp. and its subsidiaries, and the lenders
referenced therein and Wachovia Bank, National Association as issuer and agent.31.1
Certification
of the Chief Executive Officer pursuant to Rule 13(a)-14(a)/15(d)-14(a), as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
Certification
of the Chief Financial Officer pursuant to Rule 13(a)-14(a)/15(d)-14(a), as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(b)
Reports
on Form 8-KCurrent
Report on Form 8-K filed August 13, 2004, and furnishing under Item 15, our financial
results for the six months ended June 30, 2004.SIGNATURES


Pursuant
to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant
has duly caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.


DATE: November 12, 2004




PHOENIX COLOR
      CORP.
      By: /s/ Louis LaSorsa 
             
             Louis LaSorsa, Chairman
             and Chief Executive Officer
      By: /s/ Edward Lieberman
             
             Edward Lieberman
             Chief Financial Officer
             and Chief Accounting Officer15