UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

ACG HOLDINGS, INC.

(615) 377-0377
(Registrant’s Telephone Number, Including Area Code)

AMERICAN COLOR GRAPHICS, INC.

(615) 377-0377
(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark 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 check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes [  ]  No [X]

ACG Holdings, Inc. has 160,067 shares outstanding of its Common Stock, $.01 Par Value, as of October 31, 2004 (all of which are privately owned and not traded on a public market).

INDEX

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ACG HOLDINGS, INC.

     See accompanying notes to condensed consolidated financial statements.

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ACG HOLDINGS, INC.
Condensed Consolidated Balance Sheets
(Dollars in thousands, except par values and liquidation preference)

     See accompanying notes to condensed consolidated financial statements.

4

ACG HOLDINGS, INC.

     See accompanying notes to condensed consolidated financial statements.

5

ACG HOLDINGS, INC.

     See accompanying notes to condensed consolidated financial statements.

6

ACG HOLDINGS, INC.

     See accompanying notes to condensed consolidated financial statements.

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ACG HOLDINGS, INC.

Description of the Company

ACG Holdings, Inc. (“Holdings”) has no operations or significant assets other than its investment in American Color Graphics, Inc. (“Graphics”), (collectively the “Company”). Holdings owns 100% of the outstanding voting shares of Graphics. The two business segments of the commercial printing industry in which the Company operates are (i) print and (ii) premedia services.

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and are in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The operating results for the three and six-month periods ended September 30, 2004 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 2005. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company’s Form 10-K for the fiscal year ended March 31, 2004 and the Company’s Post-Effective Amendment No. 1 to Registration Statement No. 333-110291 on Form S-1.

The preparation of the financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

2. Discontinued Operations

In June 2003, the Company sold its digital visual effects business, Digiscope, for a de minimis amount, which resulted in a loss of approximately $0.4 million, which is net of zero income tax benefit. As a result of this sale, Digiscope has been accounted for as a discontinued operation, and accordingly, Digiscope’s operations are segregated and reported within discontinued operations in the accompanying condensed consolidated financial statements.

3. Inventories

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

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ACG HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

4. July 3, 2003 Refinancing Transactions

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

•

the repayment of all amounts outstanding under the old bank credit agreement, and the concurrent termination of all related commitments thereunder;

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

•

effective August 3, 2003, the redemption of all of the 12¾% Senior Subordinated Notes Due 2005 (the “12¾% Notes”), at a redemption price equal to 100% of their aggregate principal amount, plus accrued and unpaid interest thereon.

In addition, the Company repurchased, and concurrently retired, all 5,223 outstanding shares of preferred stock of Holdings, and canceled all outstanding options to purchase shares of preferred stock of Holdings held by certain key officers, for an aggregate purchase price of $56.9 million. The canceled options would have been exercisable for 582 shares of preferred stock of Holdings.

In connection with the 2003 Refinancing, the Company has incurred $14.4 million of deferred financing fees. Of the total deferred financing fees, $4.9 million was paid to affiliates of Morgan Stanley for the services they performed in conjunction with the Revolving Credit Facility and the original private placement of the 10% Notes. The Company also incurred a charge of approximately $3.2 million in the quarter ended September 30, 2003 related to the write-off of deferred financing costs associated with the old bank credit agreement and the 12¾% Notes. In addition, the Company recorded incremental interest expense of approximately $1.7 million in the quarter ended September 30, 2003 as a result of the 30 day call provision related to the 12¾% Notes.

The Revolving Credit Facility provides for maximum borrowings of $70 million, including a letter of credit sub-facility of up to $40 million. Borrowings under this facility, as amended, are subject to a borrowing base limitation based on certain percentages of eligible accounts receivable, eligible inventory and the appraised value of eligible machinery and equipment and real estate, subject to certain limitations. The borrowing base arrangement includes a provision whereby proceeds from collection of substantially all of the Company’s accounts receivable are deposited into bank accounts which are applied daily toward repayment of borrowings outstanding, if any, under the Revolving Credit Facility. At September 30, 2004, the Company had borrowings outstanding under the Revolving Credit Facility of $15.4 million and had letters of credit outstanding of approximately $28.7 million. The Company had additional borrowing availability under the Revolving Credit Facility of approximately $25.9 million.

The Revolving Credit Facility is secured by substantially all of the assets of Graphics. Holdings has guaranteed Graphics’ indebtedness under the Revolving Credit Facility, which guarantee is secured by a pledge of all of Graphics’ and Graphics’ subsidiaries’ stock.

Amounts outstanding under the Revolving Credit Facility, as amended, bear interest at a rate equal to, at the Company’s option, (a) an alternate base rate, plus an applicable margin of 2.00% or (b) a reserve adjusted LIBOR rate, plus an applicable margin of 3.00%. The applicable margins under both rate structures are subject to periodic downward adjustment based upon the attainment of certain fixed charge coverage ratio levels.

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ACG HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

The Revolving Credit Facility, as amended, contains customary affirmative and negative covenants, including but not limited to:

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minimum fixed charge coverage ratio requirements; and

•

limitations on acquisitions and investments, new subsidiaries, uses of proceeds, indebtedness, liens, dividends and distributions, prepayments of certain indebtedness, affiliate transactions, loans, asset dispositions and Holdings’ business operations.

The Company was in compliance with all such covenant requirements at September 30, 2004.

5. Comprehensive Loss

Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income,” requires foreign currency translation adjustments, minimum pension liability adjustments and unrealized gains or losses on available-for-sale securities to be included in comprehensive loss.

Total comprehensive loss for the three and six months ended September 30, 2004 and 2003 are as follows (in thousands):

6. Income Taxes

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

The Company recorded income tax benefit of $1.3 million and $1.0 million for the three and six months ended September 30, 2004, respectively, compared to expense of $12.9 million and $13.5 million for the three and six months ended September 30, 2003, respectively.

The income tax expense for both the three and six months ended September 30, 2003 primarily relates to an adjustment, recorded in the three months ended September 30, 2003, to increase the deferred tax asset valuation allowance by $12.8 million. This adjustment reflected a change in circumstances which resulted in a judgment that, based on the provisions in SFAS 109 that restrict the Company’s ability to consider forecasts of future income, a corresponding amount of deferred tax assets may not be realized. The change in circumstances arose from an assessment of the economic climate, particularly the continuance of competitive pricing pressures in the industry, and the expected increase in annual interest costs arising from the issuance of the 10% Notes that provided negative evidence about the Company’s ability to realize certain deferred tax assets. The Company will reverse its valuation allowance into income when and to the extent sufficient

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ACG HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

positive evidence arises to support the realization of the related deferred tax assets. Tax benefit from U.S. losses in the three and six months ended September 30, 2003 was primarily offset by an increase in the valuation allowance and foreign tax expense.

The income tax benefit in the three and six months ended September 30, 2004 relates primarily to tax benefit in foreign jurisdictions. Tax benefit from U.S. losses in the three and six months ended September 30, 2004 was primarily offset by an increase in the valuation allowance.

7. Employee Benefit Plans

Components of Net Periodic Benefit Cost (in thousands)

In December 2003, the Medicare Prescription Drug Improvement and Modernization Act of 2003 (the “Act”) was enacted. The Act introduces a prescription drug benefit under Medicare (“Medicare Part D”) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. Due to uncertainties in determining the impact the Act could have on the Company’s accumulated postretirement benefit obligation and net periodic postretirement benefit cost, the condensed consolidated financial statements do not reflect the effect the Act may have on the Company’s

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ACG HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

postretirement plan. Upon resolution of such uncertainties, which are substantially beyond the Company’s control, the Company’s postretirement plan will recognize the effects of the Act, which are not likely to be material.

8. Commitments and Contingencies

The Company has employment agreements with one of its principal officers and two other employees. Such agreements provide for minimum salary levels as well as for incentive bonuses, which are payable if specified management goals are attained. The aggregate commitment for future compensation at September 30, 2004, excluding bonuses, is approximately $2.8 million.

In the quarter ended December 31, 1997, the Company entered into multi-year contracts to purchase a portion of the Company’s raw materials to be used in its normal operations. In connection with such purchase agreements, pricing for a portion of the Company’s raw materials is adjusted for certain movements in market prices, changes in raw material costs and other specific price increases while purchase quantity levels are variable based upon certain contractual requirements and conditions. The Company is deferring certain contractual provisions over the life of the contracts, which are being recognized as the purchase commitments are achieved and the related inventory is sold. The amount deferred at September 30, 2004 is $47.7 million and is included within Other liabilities in the Company’s condensed consolidated balance sheet.

Graphics, together with over 300 other persons, has been designated by the U. S. Environmental Protection Agency as a potentially responsible party (a “PRP”) under the Comprehensive Environmental Response Compensation and Liability Act (“CERCLA”, also known as “Superfund”) at a solvent recovery operation that closed in 1989. Although liability under CERCLA may be imposed on a joint and several basis and the Company’s ultimate liability is not precisely determinable, the PRPs have agreed in writing that Graphics’ share of removal costs is approximately 0.583%; therefore Graphics believes that its share of the anticipated remediation costs at such site will not be material to its business or the Company’s condensed consolidated financial statements as a whole.

Graphics received written notice, dated May 10, 2004, of its potential liability in connection with the Gibson Environmental Site at 2401 Gibson Street, Bakersfield, California. Gibson Environmental, Inc. operated the six acre site as a storage and treatment facility for used oil and contaminated soil from June 1987 through October 1995. Graphics received the notice and a settlement offer from LECG, a consultant representing approximately 60 companies comprising the Gibson Group Trust. Graphics has begun its investigation into this matter but it believes its potential liability in connection with this site will not be material to its business or the Company’s condensed consolidated financial statements as a whole.

Based upon an analysis of Graphics’ volumetric share of waste contributed to the sites, the Company maintains a reserve of approximately $0.1 million in connection with these liabilities in its condensed consolidated balance sheet at September 30, 2004. The Company believes this amount is adequate to cover such liabilities.

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

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ACG HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

9. Restructuring Costs

Fiscal Year 2004 Restructuring Costs

January 2004 Plan

In January 2004, the Company approved a restructuring plan for the print and premedia services segments designed to improve operating efficiency and profitability. This plan included a consolidation of capacity and the related downsizing of a print facility in Stevensville, Ontario, a reduction of personnel in certain of the Company’s other print and premedia facilities and the elimination of certain selling and administrative positions. These actions included the elimination of 208 positions within the Company.

As a result, the Company recorded a pre-tax restructuring charge of approximately $5.7 million in the quarter ended March 31, 2004 associated with this plan. This charge was classified within restructuring costs and other charges in the consolidated statement of operations for the fiscal year ended March 31, 2004. The cost of this restructuring plan was accounted for in accordance with the guidance set forth in Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”). This restructuring charge was composed primarily of severance and related termination benefits.

The following table summarizes the activity related to this restructuring plan for the six months ended September 30, 2004 (in thousands):

During the fiscal year ended March 31, 2004, $1.8 million of these costs were paid. As of September 30, 2004, the Company believes the restructuring reserve of approximately $2.2 million is adequate. The Company anticipates that approximately $1.0 million of the restructuring balance will be paid by March 31, 2005 and the remaining $1.2 million will be paid during the fiscal year ending March 31, 2006. These costs will be funded through cash generated from operations and borrowings under the Revolving Credit Facility, as amended.

July 2003 Plan

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

As a result of this plan, the Company recorded a pre-tax restructuring charge of approximately $1.8 million in the quarter ended September 30, 2003. This charge was classified within restructuring costs in the condensed consolidated statements of operations in the quarter ended September 30, 2003. The cost of this restructuring plan was accounted for in accordance with the guidance set forth in SFAS 146. The restructuring charge was composed of severance and related termination benefits.

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ACG HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

The following table summarizes the activity related to this restructuring plan for the six months ended September 30, 2004 (in thousands):

During the fiscal year ended March 31, 2004, $0.7 million of these costs were paid. As of September 30, 2004, the Company believes the restructuring reserve of approximately $0.7 million is adequate. The Company anticipates that approximately $0.3 million of the restructuring balance will be paid by March 31, 2005, approximately $0.3 million will be paid during the fiscal year ending March 31, 2006 and the remaining $0.1 million will be paid during the fiscal year ending March 31, 2007. These costs will be funded through cash generated from operations and borrowings under the Revolving Credit Facility, as amended.

Fiscal Year 2003 Restructuring Costs

In the fourth quarter of the fiscal year ended March 31, 2003, the Company’s Board of Directors approved a restructuring plan for the print and premedia 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 services segments and the elimination of certain administrative personnel. These combined actions resulted in the elimination of 30 positions within the Company.

As a result of this plan, the Company recorded a pre-tax restructuring charge of approximately $1.2 million in the fourth quarter of the fiscal year ended March 31, 2003. This charge was classified within restructuring costs and other charges in the consolidated statements of operations in the fiscal year ended March 31, 2003. The cost of this restructuring plan was accounted for in accordance with the guidance set forth in SFAS 146. The restructuring charge was composed primarily of severance and related termination benefits. The Company reduced the restructuring reserve related to this plan by approximately $0.2 million in the quarter ended March 31, 2004. This reduction was primarily the result of lower than anticipated severance and other employee costs due to the terminated employees obtaining other employment during their severance periods.

The following table summarizes the activity related to this restructuring plan for the six months ended September 30, 2004 (in thousands):