Old Point.360 10-Q 2005 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

___________

FORM 10-Q

(Mark One)

XQuarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the quarterly period ended September 30, 2005 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 number 0-21917

                                            Point.360                                           

(Exact Name of Registrant as Specified in Its Charter)

California (State of or other jurisdiction of incorporation or organization)	95-4272619 (I.R.S. Employer Identification No.)
2777 North Ontario Street, Burbank, CA (Address of principal executive offices)	91504 (Zip Code)

                                      (818) 565-1400                                     

(Registrant’s Telephone Number, Including Area Code)

(Former Name, Former Address and Former Fiscal Year,

if Changed Since Last Report)

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 XNo         

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes No X 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes No X 

As of September 30, 2005, there were 9,368,857 shares of the registrant’s common stock outstanding.

PART I - FINANCIAL INFORMATION

ITEM 1.FINANCIAL STATEMENTS

POINT.360

CONSOLIDATED BALANCE SHEETS

ASSETS
	December 31, 2004		September 30, 2005
			(unaudited)
Current assets:
Cash and cash equivalents	$	668,000	$	431,000
Accounts receivable, net of allowances for doubtful accounts of $531,000 and $588,000 (unaudited), respectively		12,468,000		13,305,000
Inventories		932,000		812,000
Prepaid expenses and other current assets		1,788,000		2,056,000
Deferred income taxes		1,310,000		1,310,000
Total current assets		17,166,000		17,914,000
Property and equipment, net		31,451,000		28,809,000
Other assets, net		742,000		625,000
Goodwill and other intangibles, net		27,288,000		27,473,000
Total assets	$	76,647,000	$	74,821,000
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	4,898,000	$	4,775,000
Accrued wages and benefits		1,751,000		1,099,000
Accrued earn-out payments		1,000,000		-
Other accrued expenses		1,249,000		1,003,000
Income taxes payable		1,148,000		1,202,000
Borrowings under revolving line of credit		4,323,000		5,988,000
Current portion of borrowings under notes payable		2,849,000		3,051,000
Current portion of capital lease and other obligations		67,000		63,000
Total current liabilities		17,285,000		17,181,000
Deferred income taxes		5,788,000		5,008,000
Bank notes payable, less current portion		14,494,000		13,149,000
Capital lease and other obligations, less current portion		136,000		68,000
Total long-term liabilities		20,418,000		18,225,000
Total liabilities		37,703,000		35,406,000
Contingencies (Note 4 and 6)		-		-
Shareholders’ equity
Preferred stock - no par value; 5,000,000 authorized; none outstanding		-		-
Common stock - no par value; 50,000,000 authorized; 9,236,132
and 9,368,857 (unaudited) shares issued and outstanding, respectively		17,903,000		18,358,000
Additional paid-in capital		675,000		675,000
Retained earnings		20,366,000		20,382,000
Total shareholders’ equity		38,944,000		39,415,000
Total liabilities and shareholders’ equity	$	76,647,000	$	74,821,000

See accompanying notes to consolidated financial statements.

2

POINT.360

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2005			2004			2005
Revenues	$	16,465,000		$	16,748,000		$	45,846,000		$	49,821,000
Cost of goods sold		(10,729,000	)		(10,783,000	)		(29,657,000	)		(32,813,000	)
Gross profit		5,736,000			5,965,000			16,189,000			17,008,000
Selling, general and administrative expense		(4,689,000	)		(5,229,000	)		(13,785,000	)		(15,984,000	)
Write-off of deferred acquisition and financing costs		(988,000	)		-			(1,050,000	)		-
Operating income		59,000			736,000			1,354,000			1,024,000
Interest expense, net		(196,000	)		(379,000	)		(530,000	)		(999,000	)
Income (loss) before income taxes		(137,000	)		357,000			824,000			25,000
(Provision for) benefit from income taxes		56,000			(143,000	)		(338,000	)		(10,000	)
Net income (loss)	$	(81,000	)	$	214,000		$	486,000		$	15,000
Earnings(loss) per share:
Basic:
Net income (loss)	$	(0.01	)	$	0.02		$	0.05		$	-
Weighted average number of shares		9,211,321			9,364,345			9,188,095			9,338,960
Diluted:
Net income (loss)	$	(0.01	)	$	0.02		$	0.05		$	-
Weighted average number of shares including the dilutive effect of stock options		9,501,338			9,709,515			9,655,834			9,813,250

See accompanying notes to consolidated financial statements.

3

POINT.360

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine Months Ended September 30,
	2004			2005
Cash flows from operating activities:
Net income	$	486,000		$	15,000
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		4,138,000			4,652,000
Provision for doubtful accounts		(48,000	)		71,000
Other non cash items		181,000			183,000
Changes in assets and liabilities:
(Increase) decrease in accounts receivable		417,000			(766,000	)
(Increase) decrease in inventories		9,000			120,000
(Increase) decrease in prepaid expenses and other current assets		208,000			(179,000	)
(Increase) in goodwill and other tangibles		-			(185,000	)
Decrease in other assets		619,000			117,000
Increase (decrease) in accounts payable		315,000			(123,000	)
Increase in accrued settlement		575,000			-
(Decrease) in accrued expenses		(1,131,000	)		(1,898,000	)
Increase (decrease) in income taxes		(24,000	)		143,000
(Decrease) in deferred taxes		-			(780,000	)
Net cash provided by operating activities		5,745,000			1,370,000
Cash used in investing activities:
Capital expenditures		(4,083,000	)		(1,688,000	)
Proceeds from sale of equipment		40,000			-
Amount paid for acquisitions		(3,159,000	)		(25,000	)
Net cash used in investing activities		(7,202,000	)		(1,713,000	)
Cash flows used in financing activities:
Exercise of stock options		244,000			55,000
Change in revolving credit agreement		2,876,000			1,666,000
Proceeds from bank note		8,000,000			1,007,000
Change in note payable		163,000			-
Shares issued for an acquisition		-			(400,000	)
Repayment of notes payable		(16,951,000	)		(2,150,000	)
Repayment of capital lease obligations		(81,000	)		(72,000	)
Net cash provided by (used) in financing activities		(5,749,000	)		106,000
Net decrease in cash		(7,206,000	)		(237,000	)
Cash and cash equivalents at beginning of period		7,206,000			668,000
Cash and cash equivalents at end of period	$	-		$	431,000
Supplemental disclosure of cash flow information - Cash paid for:
Interest	$	418,000		$	999,000
Income tax	$	362,000		$	866,000

See accompanying notes to consolidated financial statements.

4

POINT.360

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

September 30, 2005

NOTE 1-THE COMPANY

Point.360 (“Point.360” or the “Company”) provides video and film asset management services to owners, producers and distributors of entertainment and advertising content. The Company provides the services necessary to edit, master, reformat, archive and distribute its clients’ video content, including television programming, spot advertising and movie trailers. The Company provides worldwide electronic distribution, using fiber optics and satellites. The Company delivers commercials, movie trailers, electronic press kits, infomercials and syndicated programming, by both physical and electronic means, to thousands of broadcast outlets worldwide. The Company operates in one reportable segment.

The Company seeks to capitalize on growth in demand for the services related to the distribution of advertising and entertainment content, without assuming the production or ownership risk of any specific television program, feature film or other form of content. The primary users of the Company’s services are entertainment studios and advertising agencies that choose to outsource such services due to the sporadic demand of any single customer for such services and the fixed costs of maintaining a high-volume physical plant.

Since January 1, 1997, the Company has successfully completed nine acquisitions of companies providing similar services. The Company will continue to evaluate acquisition opportunities to enhance its operations and profitability. As a result of these acquisitions, the Company believes it is one of the largest and most diversified providers of technical and distribution services to the entertainment and advertising industries, and is therefore able to offer its customers a single source for such services at prices that reflect the Company’s scale economies.

The accompanying unaudited financial statements have been prepared in accordance with generally accepted accounting principles and the Securities and Exchange Commission’s rules and regulations for reporting interim financial statements and footnotes. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three- and nine-month periods ended September 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. These financial statements should be read in conjunction with the financial statements and related notes contained in the Company’s Form 10-K for the year ended December 31, 2004.

NOTE 2-ACCOUNTING PRONOUNCEMENTS

In May 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003. This statement does not affect the Company at this time.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs”. SFAS No. 151 amends the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) under the guidance in ARB No. 43, Chapter 4, "Inventory Pricing”. Paragraph 5 of ARB No. 43, Chapter 4, previously stated that “. . . under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal as to require treatment as current period charges. . . .”This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of "so abnormal." In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Management does not expect adoption of SFAS No. 151 to affect the Company’s financial statements.

In December 2004, the FASB issued SFAS No. 152, “Accounting for Real Estate Time-Sharing Transactions”. The FASB issued this Statement as a result of the guidance provided in AICPA Statement of Position (SOP) 04-2, “Accounting for Real Estate Time-Sharing Transactions”. SOP 04-2 applies to all real estate time-sharing transactions. Among other items, the SOP provides guidance on the recording of credit losses and the treatment of selling costs, but does not change the revenue recognition guidance in SFAS No. 66,”Accounting for Sales of Real Estate”, for real estate time-sharing transactions. SFAS No. 152 amends Statement No. 66 to reference the guidance provided in SOP 04-2. SFAS No. 152 also amends SFAS No. 67, “Accounting for Costs and Initial Rental Operations of Real Estate Projects”, to state that SOP 04-2 provides the relevant guidance on accounting for incidental operations and costs related to the sale of real estate time-sharing transactions. SFAS No. 152 is effective for years beginning after June 15, 2005, with restatements of previously issued financial statements prohibited. This statement is not applicable to the Company.

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In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets,” an amendment to Opinion No. 29, “Accounting for Nonmonetary Transactions”. Statement No. 153 eliminates certain differences in the guidance in Opinion No. 29 as compared to the guidance contained in standards issued by the International Accounting Standards Board. The amendment to Opinion No. 29 eliminates the fair value exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. Such an exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occuring in periods beginning after December 16, 2004. Management does not expect adoption of SFAS No. 153 to have a material impact on the Company’s financial statements.

In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment.” SFAS 123(R) amends SFAS No. 123, “Accounting for Stock-Based Compensation”, and APB Opinion 25, “Accounting for Stock Issued to Employees.” SFAS No.123(R) requires that the cost of share-based payment transactions (including those with employees and non-employees) be recognized in the financial statements. SFAS No. 123(R) applies to all share-based payment transactions in which an entity acquires goods or services by issuing (or offering to issue) its shares, share options, or other equity instruments (except for those held by an ESOP) or by incurring liabilities (1) in amounts based (even in part) on the price of the entity’s shares or other equity instruments, or (2) that require (or may require) settlement by the issuance of an entity’s shares or other equity instruments. This statement is effective (1) for public companies qualifying as SEC small business issuers, as of the first interim period or fiscal year beginning after December 15, 2005, or (2) for all other public companies, as of the first fiscal year beginning after June 15, 2005, or (3) for all nonpublic entities, as of the first fiscal year beginning after December 15, 2005. Management is currently assessing the effect of SFAS No. 123(R) on the Company’s financial statements.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”, an amendment to Accounting Principles Bulletin (APB) Opinion No. 20, “Accounting Changes”, and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.” Although SFAS No. 154 carries forward the guidance in APB No. 20 and SFAS No. 3 with respect to accounting for changes in estimates, changes in reporting entity, and the correction of errors, SFAS No. 154 establishes new standards on accounting for changes in accounting principles, whereby all such changes must be accounted for by retrospective application to the financial statements of prior periods unless it is impracticable to do so. SFAS No. 154 is effective for accounting changes and error corrections made in fiscal years beginning after December 15, 2005, with early adoption permitted for changes and corrections made in years beginning after May 2005.

NOTE 3-LONG TERM DEBT AND NOTES PAYABLE

In May 2002, the Company and its banks entered into a term loan agreement amending a previous credit arrangement and having a maturity date of December 31, 2004. Pursuant to the agreement, the Company made a $2 million principal payment and made additional principal payments of $3.5 million and $7.0 million in 2002 and 2003, respectively. The agreement provided for interest at the banks’ reference rate plus 1.25% and required the Company to maintain certain financial covenant ratios. The term loan was secured by substantially all of the Company’s assets. Certain legal and other costs associated with the new term loan, including fees of $50,000 and $250,000 paid in May 2002 and June 2003, respectively, were capitalized to be amortized over the remaining life of the loan.

On March 12, 2004, the Company entered into a new credit agreement which provided up to $10 million of revolving credit availability for two years and a five-year $8 million term loan. For the first two years of the term loan, the Company could re-borrow all principal payments to finance up to 80% of capital equipment purchases. The agreement provided for interest at the banks’ prime rate or LIBOR plus 2.25% for the revolver, prime rate plus 0.25% or LIBOR plus 2.50% for the term loan, and required the Company to maintain certain financial covenant ratios. The facilities are secured by all of the Company’s assets. The term loan required principal payments of $1.6 million annually. The $15,866,000 outstanding term loan as of December 31, 2003 was repaid by $1,000,000 of scheduled principal payments made in January and February 2004 and, on March 12, 2004, by new term loan borrowings of $8,000,000 and cash payment of $6,866,000.

In July and August 2004, the term loan and revolving portions of the Company’s bank facility were increased by $4.7 million and $1.9 million, respectively.

As of June 30, 2005, the credit agreement was changed with respect to the following: (i) the due date of the revolving portion of loans outstanding was changed from March 12, 2006 to January 31, 2006; (ii) the re-borrowing commitment under the term loan was eliminated; (iii) the interest rate for both the LIBOR and prime rate options was increased by 0.5%; and (iv) certain financial covenants were changed. The Company intends to replace the existing credit agreement before January 31, 2006.

In August 2004, the Company entered into a Standing Loan Agreement and Swap Commitment with a bank (the “Mortgage”) in order to purchase land and a building (see below). Pursuant to the Mortgage, the Company borrowed $6,435,000 payable in monthly installments of principal and interest on a fully amortized basis over 15 years. The mortgage debt is secured by the land and building.

6

In connection with the Mortgage, the Company entered into a one-year interest rate swap contract to economically hedge the Mortgage debt. Under the terms of the swap agreement, the amount hedged was $6,435,000 at a fixed 4.35% interest rate for the first year. Prior to the end of the first year, by August 2005, the Company was obligated to “fix” the interest rate with respect to the remaining 14 years of the Mortgage debt term based on a fixed rate quoted by the banks or LIBOR plus 1.85% for that period. In December 2004, the rate was fixed at 6.83% for the remaining term of the mortgage through a new hedge agreement.

NOTE 4-ISSUANCE OF WARRANT, POSSIBLE ACQUISITION AND WRITE-OFF OF DEFERRED COSTS, RELATED LEGAL ACTIONS AND SETTLEMENT

In July 2002, the Company acquired an option to purchase three subsidiaries (the “Subsidiaries”) of Alliance Atlantis Communications Inc. (“Alliance”) engaged in businesses directly related to those of the Company. In consideration for the option, the Company issued to Alliance a warrant to acquire 500,000 shares of the Company’s common stock at $2.00 per share. The warrant was to expire five years from the closing date of the transaction, or July 3, 2005 if the Company did not purchase the Subsidiaries. In connection therewith, the Company capitalized the fair value of the warrant ($619,000 determined by using the Black-Scholes valuation model) as an other asset on the balance sheet.

In December 2002, the option was extended to March 10, 2003. In connection with the extension, the Company made a $300,000 deposit toward the purchase price of the Subsidiaries, which deposit was nonrefundable except in very limited circumstances. The deposit was capitalized as an other asset. Additionally, the Company capitalized approximately $700,000 of due diligence and other expenses associated with the proposed acquisition during the six months ended June 30, 2003.

The Company did not exercise its option to purchase the Subsidiaries by the March 10, 2003 termination date; however, Alliance agreed to continue negotiations with the Company to complete the transaction.

In connection with the possible acquisition of the Subsidiaries, the Company entered discussions with several possible lenders to provide financing for the purchase of the Subsidiaries and to pay off the Company’s then existing term loan with a group of banks. A provision in the Company’s term loan agreement prohibited acquisitions unless approved by the banks, which permission had been denied.

In June 2003, discussions with Alliance and the new lenders were terminated. As a result, the Company wrote off the above mentioned deposit, due diligence costs and approximately $400,000 of legal and other costs associated with the proposed new financing. The $619,000 value of the warrant was reversed against Additional Paid-in Capital because, in management’s opinion, Alliance had breached certain provisions of the option agreement resulting in a termination event according to the provisions of the warrant. In July 2003, Alliance filed a complaint in the United States District Court, Central District of California, seeking a judicial determination that Alliance has full right of legal ownership to the warrant as well as the $300,000 deposit. If the Company was not successful in this defense, the warrant value would have to be expensed.

On July 18, 2003, Alliance filed a complaint against the Company in the Superior Court of Justice, Ontario, Canada, alleging that the Company breached a non-disclosure agreement between Alliance and the Company by issuing a press release with respect to termination of negotiations to purchase the Subsidiaries without obtaining the required prior written consent of Alliance. Alliance maintained that the press release impaired its ability to extract value from the Subsidiaries and negatively affected its ability to sell the Subsidiaries to a third party. The complaint sought breach of contract and punitive damages of approximately $4.4 million, expenses and a permanent order enjoining further such statements by the Company.

On August 11, 2003, the Company filed a counterclaim in the United States District Court, Central District of California against Alliance for, among other things, misrepresentation and breach of contract seeking cancellation of the warrant and general damages of at least $1.2 million.

Pursuant to a Settlement and Mutual Release Agreement executed in November 2004, Alliance and the Company agreed to settle all claims. Pursuant to the agreement, the Company paid Alliance $575,000 in cash in November 2004. All amounts deferred prior to the settlement related to possible acquisition of the Subsidiaries have been expensed. Such amounts have been shown separately in the Consolidated Statements of Income for clarity of presentation.

NOTE 5-STOCK-BASED COMPENSATION

The Company applies Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, in accounting for its stock option plans. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. SFAS No. 123 established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic value-based method of accounting described above, and has adopted the disclosure requirements of SFAS No. 123. Pro forma net income and earnings per share disclosures, as if the Company recorded compensation expense based on the fair value for stock-based awards, have been presented in accordance with the provisions of SFAS No. 148 and are as follows for the three- and nine-month periods ended September 30, 2004 and 2005.

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	Three months ended September 30						Nine months ended September 30
	2004			2005			2004			2005
Net income (loss):
As reported	$	(81,000	)	$	214,000		$	486,000		$	15,000
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(75,000	)		(61,000	)		(204,000	)		(158,000	)
Pro forma		(156,000	)		153,000			282,000			(143,000	)
Basic earnings (loss) per share of common stock:
As reported	$	(0.01	)	$	0.02		$	0.05		$	0.00
Pro forma	$	(0.02	)	$	0.02		$	0.03		$	(0.02	)
Diluted earnings (loss) per share of common stock:
As reported	$	(0.01	)	$	0.02		$	0.05		$	0.00
Pro forma	$	(0.02	)	$	0.02		$	0.03		$	(0.01	)

The fair value of each option was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

	Three months ended September 30						Nine months ended September 30
	2004			2005			2004			2005
Risk-free interest rate		1.51	%		3.54	%		1.18	%		3.02	%
Expected term (years)		5.00			5.00			5.00			5.00
Volatility		44	%		43	%		44	%		43	%
Expected annual dividends		0.0	%		0.0	%		0.0	%		0.0	%

NOTE 6-CONTINGENCIES

In addition to the legal proceedings the Company had with Alliance (see Note 4) from time to time the Company may become a party to various legal actions and complaints arising in the ordinary course of business, although it is not currently involved in any such material legal proceedings.

NOTE 7-SHAREHOLDERS’ EQUITY

During the nine months ended September 30, 2005, the number of outstanding shares of the Company’s common stock increased by 132,725 shares due to the exercise of 27,725 employee stock options for $55,000 in cash, and 105,000 shares issued for the purchase of the assets of another business (valued at approximately $400,000).

NOTE 8-ACQUISITION

On July 1, 2004, the Company acquired all of the outstanding stock of International Video Conversions, Inc. (“IVC”) for $7 million in cash. The purchase agreement requires possible additional payments of $1 million, $2 million and $2 million in 2005, 2006 and 2007, respectively, if earnings before interest, taxes, depreciation and amortization during the 30 months after the acquisition reach certain predetermined levels. As part of the transaction, the Company entered into employment and/or non competition agreements with four senior officers of IVC which fix responsibilities, salaries and other benefits and set forth limitations on the individuals’ ability to compete with the Company for the term of the earn-out period (30 months). IVC is a high definition and standard definition digital mastering and data conversion entity serving the motion picture/television production industry. In connection with the acquisition, the term loan portion of the Company’s bank facility (see Note 3) was increased by $4.7 million. To pay for the acquisition, the Company used $2.3 million of cash on hand and borrowed $4.7 million under the term loan portion of the facility. As of December 31, 2004, the first additional payment of $1 million was accrued on the balance sheet, which amount was paid on April 1, 2005. The total purchase consideration has been allocated to the assets and liabilities acquired based on their respective estimated fair values as summarized below.

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Cash and cash equivalents	$	1,205,000
Inventories		120,000
Other current assets		1,000
Accounts Receivable		2,036,000
Goodwill		242,000
Property, plant and equipment		6,009,000
Total assets acquired		9,613,000
Accounts payable		(442,000	)
Accrued		(417,000	)
Income tax payable		(72,000	)
Deferred tax liabilities		(1,682,000	)
Current and other liabilities assumed		(2,613,000	)
Net assets acquired over liabilities, and purchase price	$	7,000,000

The following table presents unaudited pro forma results of the combined operations for nine-month period ended September 30, 2004 as if the acquisition had occurred as of the beginning of such period rather than as of the acquisition date. The pro forma information presented below is for illustrative purposes only and is not indicative of results that would have been achieved or results which may be achieved in the future:

	Nine months ended September 30, 2004
Revenue	$	51,534,000
Operating Income		1,816,000
Net income		695,000
Basic earnings per share		0.08
Diluted earnings per share		0.07

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POINT.360

MANAGEMENT’S DISCUSSION AND ANALYSIS

ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements and Notes and contains forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those indicated in the forward-looking statements as a result of various factors.

We are one of the largest providers of video and film asset management services to owners, producers and distributors of entertainment and advertising content. We provide the services necessary to edit, master, reformat, archive and ultimately distribute our clients’ film and video content, including television programming, spot advertising, feature films and movie trailers using electronic and physical means. We deliver commercials, movie trailers, electronic press kits, infomercials and syndicated programming to hundreds of broadcast outlets worldwide. Our interconnected facilities in Los Angeles, New York, Chicago, Dallas and San Francisco provide service coverage in each of the major U.S. media centers. Clients include major motion picture studios, advertising agencies and corporations.

We operate in a highly competitive environment in which customers desire a broad range of service at a reasonable price. There are many competitors offering some or all of the services provided by the Company. Additionally, some of our customers are large studios, which also have in-house capabilities that may influence the amount of work outsourced to companies like Point.360. We attract and retain customers by maintaining a high service level at reasonable prices.

In recent years, electronic delivery services have grown while physical duplication and delivery have been declining. We expect this trend to continue over a long term (i.e. the next 10 years). All of our electronic, fiber optics, satellite and Internet deliveries are made using third party vendors, which eliminates our need to invest in such capability. However, the use of others to deliver our services poses the risk that costs may rise in certain situations that cannot be passed on to customers, thereby lowering gross margins. There is also the risk that third party vendors who directly compete with us will succeed in taking away business or refuse to allow us to use their distribution channels. In fact, in June 2005, one such vendor/competitor notified us that its electronic distribution channel would not be available to us except in very limited circumstances, or unless we entered certain “preferred vendor” arrangements that we believed would not be in the best long-term interests of Point.360. While curtailment of these services has not materially affected our ability to deliver commercial spots, we have not been able to pass on increased alternative delivery costs to our customers in the third quarter. While we are exploring other lower cost alternatives, gross margins related to spot delivery revenues will be lower until such alternatives become available.

The Company has an opportunity to expand its business by establishing closer relationships with our customers through excellent service at a competitive price and maintaining adequate third party distribution channels. Our success is also dependent on attracting and maintaining employees capable of maintaining such relationships. Also, growth can be achieved by acquiring similar businesses (for example, the acquisition of International Video Conversions, Inc. (“IVC”) in July 2004) which can increase revenues by adding new customers, or expanding services provided to existing customers.

Our business generally involves the immediate servicing needs of our customers. Most orders are fulfilled within several days, with occasional larger orders spanning weeks or months. At any particular time, we have little firm backlog.

We believe that our nationwide interconnected facilities provide the ability to better service national customers than single-location competitors. We will look to expand both our service offering and geographical presence through acquisition of other businesses or opening additional facilities.

During 2004, we completed the acquisition of IVC and settled all disputes related to a proposed acquisition of three subsidiaries of Alliance Atlantis Communications, Inc. (“Alliance”). The financial statement comparisons below highlight the effects of these transactions.

Statistical Analysis

The table below summarizes pro forma results for the three- and nine-month periods ended September 30, 2004 and 2005, without the effects of (1) IVC’s results of operations for the first six months of 2005 and (2) the write-off of deferred Alliance acquisition, financing and settlement costs in 2004. IVC was purchased on July 1, 2004. The Alliance write-off represents the costs of due diligence, legal, financing and the settlement of all matters related to the proposed acquisition of three subsidiaries of Alliance, which matters were finalized in 2004: (in thousands except per share amounts)

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	Quarter Ended
	September 30, 2004									September 30, 2005
	Pro forma			(2)			GAAP									GAAP
Revenues	$	16,465		$	-		$	16,465								$	16,748
Cost of goods sold		(10,729	)		-			(10,729	)								(10,783	)
Gross profit		5,736			-			5,736									5,965
Selling, general and administrative expense (3)		(4,689	)		-			(4,689	)								(5,229	)
Write-off of deferred acquisition, financing and settlement costs (3)		-			(988	)		(988	)								-
Operating income (loss)		1,047			(988	)		59									736
Interest expense, net		(196	)		-			(196	)								(379	)
Income (loss) before income taxes		851			(988	)		(137	)								357
(Provision for) benefit from income taxes		(349	)		405			56									(143	)
Net income (loss)	$	502		$	(583	)	$	(81	)							$	214
Earnings (loss) per share:
Basic:	$	0.05		$	(0.06	)	$	(0.01	)							$	0.02
Diluted:	$	0.05		$	(0.06	)	$	(0.01	)							$	0.02
	Nine Months Ended
	September 30, 2004									September 30, 2005
	Pro forma			(2)			GAAP			Pro forma			(1)			GAAP
Revenues	$	45,846		$	-		$	45,846		$	44,031		$	5,790		$	49,821
Cost of goods sold		(29,657	)		-			(29,657	)		(28,906	)		(3,907	)		(32,813	)
Gross profit		16,189			-			16,189			15,125			1,883			17,008
Selling, general and administrative expense (3)		(13,785	)		-			(13,785	)		(14,678	)		(1,306	)		(15,984	)
Write-off of deferred acquisition, financing and settlement costs (3)		-			(1,050	)		(1,050	)		-			-			-
Operating income (loss)		2,404			(1,050	)		1,354			447			577			1,024
Interest expense, net		(530	)		-			(530	)		(882	)		(117	)		(999	)
Income (loss) before income taxes		1,874			(1,050	)		824			(435	)		460			25
(Provision for) benefit from income taxes		(769	)		431			(338	)		179			(189	)		(10	)
Net income (loss)	$	1,105		$	(619	)	$	486		$	(256	)	$	271		$	15
Earnings (loss) per share:
Basic:	$	0.11		$	(0.06	)	$	0.05		$	(0.03	)	$	0.03		$	-
Diluted:	$	0.11		$	(0.06	)	$	0.05		$	(0.03	)	$	0.03		$	-

(1) Contribution of IVC for the first six months of 2005.

(2) Write-off of deferred acquisition, financing and settlement costs.

(3) Amounts have been adjusted to segregate Alliance-related expenses from Selling, General and Administrative expense for consistency of presentation among periods.

While the above presentation of pro forma income statements and adjustments do not represent the results of operations in accordance with generally accepted accounting principles (“GAAP”), we believe that this disclosure provides useful information for readers of the financial statements in analyzing the causes of operating difference from period to period. Additional comparative data is set forth below.

In total, revenues in the nine-month period were 9%, greater than in the same 2004 period. Without the inclusion of IVC for the first six months of 2005 (the comparable 2005 period to 2004 when the Company did not own IVC) , revenues in the 2005 nine-month period would have been $44.0 million, a decrease of 4% from 2004. Pro forma 2004 revenues for the nine-month period if IVC had been purchased at the beginning of 2004 would have been $51.5 million.

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The addition of IVC will not only increase revenues for all of 2005 (twelve months of operations compared to six months in 2004), but will add to the cost infrastructure of the Company in both cost of sales and selling, general and administrative (“SG&A”) areas. With the inclusion of IVC, we expect 2005 sales to be higher than experienced in 2004. We expect SG&A in 2005 to be higher as a percentage of sales than in 2004 (excluding the special charge in 2004) due to the addition of management and sales personnel and costs associated with process documentation required by Sarbanes Oxley. Interest expense is expected to be higher in 2005 because of additional debt incurred for the acquisition of IVC, mortgage debt incurred and capital expenditures made in 2004 for the Media Center storage facility and interest rate increases.

Please refer to Cautionary Statements and Risk Factors below with respect to forward-looking statements.

Three Months Ended September 30, 2005 Compared To Three Months Ended September 30, 2004.

Revenues.Revenues were $16.7 million for the three-month period ended September 30, 2005, compared to $16.5 million for the three-month period ended September 30, 2004.

Gross Profit.In the third quarter of 2005, gross margin was 36% of sales, compared to 35% for the quarter ended September 30, 2004.

Selling, General And Administrative Expense.SG&A expense was $5.2 million in the third quarter of 2005 as compared to $5.7 million in the same period of 2004. Without the special charge in 2004, SG&A expense in that period would have been $4.6 million. The increase in 2005 is due principally to the addition of sales personnel and related expenses.

Interest Expense.Interest expense for the three-month period ended September 30, 2005 was $0.4 million, an increase of $0.2 million over the three-month period ended September 30, 2004 because of higher debt levels due to the acquisition of real property in the third quarter of 2004 and increasing rates on variable interest debt.

Nine Months Ended September 30, 2005 Compared To Nine Months Ended September 30, 2004.

Revenues.Revenues were $49.8 million for the nine-month period ended September 30, 2005, compared to $45.8 million for the nine-month period ended September 30, 2004. The addition of IVC as of July 1, 2004 contributed $5.8 million of revenues in the 2005 period, without which sales would have declined 4% to $44.0 million when compared to the 2004 quarter.

Gross Profit.In the first nine months of 2005, gross margin was 34% of sales, compared to 35% for the nine-months ended September 30, 2004. The decline is due principally to lower sales at facilities other than IVC.

Selling, General And Administrative Expense.SG&A expense was $16.0 million in the first nine months of 2005 as compared to $14.8 million in the same period of 2004 ($13.8 million before the special charge). The increase was due principally to the addition of IVC and sales personnel.

Interest Expense.Interest expense for the nine-month period ended September 30, 2005 was $1.0 million, an increase of $0.5 million over the nine-month period ended September 30, 2004 because of higher debt levels due to the acquisition of IVC and real property in the third quarter of 2004 and increasing rates on variable interest debt.

LIQUIDITY AND CAPITAL RESOURCES

This discussion should be read in conjunction with the notes to the financial statements and the corresponding information more fully described in the Company’s Form 10-K for the year ended December 31, 2004.

In May 2002, the Company and its banks entered into a term loan agreement with a maturity date of December 31, 2004. In January and February 2004, the Company made $1 million of scheduled principal payments under the term loan. In March 2004, the Company paid off the remaining $14.9 million prior term loan principal balance with $6.9 of cash and proceeds from the new $8 million term loan pursuant to a new credit agreement. The new agreement provided up to $10 million of revolving credit availability for two years and a five-year $8 million five-year term loan. The agreement was subsequently amended to increase the revolving credit and term loan availability by $1.9 million and $4.7 million, respectively. For the first two years of the term loan, the Company could re-borrow all principal payments on $8 million of the term loan to finance up to 80% of capital equipment purchases. The agreement provided for interest at the banks’ prime rate or LIBOR plus 2.25% for the revolver, prime rate plus 0.25% or LIBOR plus 2.50% for the term loan, and requires the Company to maintain certain financial covenant ratios. The term loan requires principal payments of approximately $2.5 million annually.

During the second quarter of 2005, the Company discussed with its banks the possibility that declining margins might cause a breach as of June 30, 2005 of certain financial covenants contained in the credit agreement. As of June 2005, the credit agreement was changed with respect to the following: (i) the due date of the revolving portion of loans outstanding was shortened to January 31, 2006; (ii) the re-borrowing commitment under the term loan was eliminated; (iii) the interest rate for both the LIBOR and prime rate options was increased by 0.5%; and (iv) certain financial covenants were changed. Additionally, the banks asked the Company to find a new lender.

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While all potential breaches of covenants were eliminated, the cost of borrowing increased on July 1, 2005 as indicated above. We are currently in discussion with several banks and financial institutions to replace the existing revolving and term credit agreement, and we expect to finalize a new credit relationship prior to January 31, 2006.

In November 2003, the Company leased a new 64,600 square foot building in Los Angeles, California, for the purpose of consolidating four vault locations then occupying approximately 71,000 square feet. A provision of the lease provided that in May 2005, the Company had an option to purchase the building for approximately $8,572,000. We purchased the building in August 2004 by paying $2,137,000 in cash and borrowing the $6,435,000 million balance under a mortgage term loan payable over 15 years. We also spent approximately $3.1 million for improvements to the building during 2004.

The acquisition of IVC was completed in July 2004, for which we paid $2.3 million in cash and borrowed the $4.7 million. The IVC purchase agreement also required payments of $1 million, $2 million and $2 million in 2005, 2006 and 2007, respectively, if certain predetermined earnings levels (as defined) are met. In April 2005, $1 million was paid.

The following table summarizes the September 30, 2005 status of our revolving line of credit and term loans:

Revolving credit (excluding cash)	$	5,557,000
Current portion of term loans		3,051,000
Long-term portion of term loans		13,149,000
Total	$	21,757,000

Monthly and annual principal and interest payments due under the term debt are approximately $283,000 and $3,400,000, respectively, assuming no change in interest rates. Monthly and annual principal and interest payments due under the mortgage debt are approximately $57,000 and $700,000, respectively. We expect that remaining amounts available under the current revolving credit arrangement through January 31, 2006, the availability of bank or institutional credit from new sources and cash generated from operations will be sufficient to fund debt service, operating needs and about $2.5 - 3.5 million of capital expenditures for the next twelve months.

We will continue to consider the acquisition of businesses complementary to its current operations. Consummation of any such acquisition or other expansion of the business conducted by the Company may be subject to the Company securing additional financing, perhaps at a cost higher than our existing term loans. Future earnings and cash flow may be negatively impacted to the extent that any acquired entities do not generate sufficient earnings and cash flow to offset the increased financing costs.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates and judgments, including those related to allowance for doubtful accounts, valuation of long-lived assets, and accounting for income taxes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Critical accounting policies are those that are important to the portrayal of the Company's financial condition and results, and which require management to make difficult, subjective and/or complex judgements. Critical accounting policies cover accounting matters that are inherently uncertain because the future resolution of such matters is unknown. We have made critical estimates in the following areas:

Revenues. We perform a multitude of services for our clients, including film-to-tape transfer, video and audio editing, standards conversions, adding effects, duplication, distribution, etc. A customer orders one or more of these services with respect to an element (commercial spot, movie, trailer, electronic press kit, etc.). The sum total of services performed on a particular element (a “package”) becomes the deliverable (i.e., the customer will pay for the services ordered in total when the entire job is completed). Occasionally, a major studio will request that package services be performed on multiple elements. Each element creates a separate revenue stream which is recognized only when all requested services have been performed on that element.

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Allowance for doubtful accounts. We are required to make judgments, based on historical experience and future expectations, as to the collectibility of accounts receivable. The allowances for doubtful accounts and sales returns represent allowances for customer trade accounts receivable that are estimated to be partially or entirely uncollectible. These allowances are used to reduce gross trade receivables to their net realizable value. The Company records these allowances as a charge to selling, general and administrative expenses based on estimates related to the following factors: i) customer specific allowances; ii) amounts based upon an aging schedule and iii) an estimated amount, based on the Company's historical experience, for issues not yet identified.

Valuation of long-lived and intangible assets. Long-lived assets, consisting primarily of property, plant and equipment and intangibles, comprise a significant portion of the Company's total assets. Long-lived assets, including goodwill and intangibles are reviewed for impairment whenever events or changes in circumstances have indicated that their carrying amounts may not be recoverable. Recoverability of assets is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by that asset. The cash flow projections are based on historical experience, management’s view of growth rates within the industry and the anticipated future economic environment.

Factors we consider important which could trigger an impairment review include the following:

lsignificant underperformance relative to expected historical or projected future operating results;

lsignificant changes in the manner of our use of the acquired assets or the strategy for our overall business;

lsignificant negative industry or economic trends;

lsignificant decline in our stock price for a sustained period; and

lour market capitalization relative to net book value.

When we determine that the carrying value of intangibles, long-lived assets and related goodwill and enterprise level goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, we measure any impairment based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model. Any amount of impairment so determined would be written off as a charge to the income statement, together with an equal reduction of the related asset. Net intangible assets, long-lived assets, and goodwill amounted to approximately $56.3 million as of September 30, 2005.

In 2002, Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”) became effective and as a result, we ceased to amortize approximately $26.3 million of goodwill beginning in 2002. In lieu of amortization, we were required to perform an initial impairment review of our goodwill in 2002 and an annual impairment review thereafter. The initial test on January 1, 2002, and the Fiscal 2002, 2003, 2004 and 2005 tests performed as of September 30, 2002, 2003, 2004 and 2005, respectively, required no goodwill impairment. The discounted cash flow method used to evaluate goodwill impairment included cash flow estimates for 2006 and subsequent years. If actual cash flow performance does not meet these expectations due to factors cited above, any resulting potential impairment could adversely affect reported goodwill asset values and earnings.

Accounting for income taxes. As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations.

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. The net deferred tax liability as of September 30, 2005 was $5 million. The Company did not record a valuation allowance against its deferred tax assets as of September 30, 2005.

RECENT ACCOUNTING PRONOUNCEMENTS

In May 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS No. 150 was effective for financial instruments entered into or modified after May 31, 2003. This statement does not affect the Company at this time.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs”. SFAS No. 151 amends the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) under the guidance in ARB No. 43, Chapter 4, "Inventory Pricing”. Paragraph 5 of ARB No. 43, Chapter 4, previously stated that “. . . under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal as to require treatment as current period charges. . . .”This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of "so abnormal." In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Management does not expect adoption of SFAS No. 151 to affect the Company’s financial statements.

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In December 2004, the FASB issued SFAS No. 152, “Accounting for Real Estate Time-Sharing Transactions.”The FASB issued this Statement as a result of the guidance provided in AICPA Statement of Position (SOP) 04-2, “Accounting for Real Estate Time-Sharing Transactions.” SOP 04-2 applies to all real estate time-sharing transactions. Among other items, the SOP provides guidance on the recording of credit losses and the treatment of selling costs, but does not change the revenue recognition guidance in SFAS No. 66, “Accounting for Sales of Real Estate”, for real estate time-sharing transactions. SFAS No. 152 amends Statement No. 66 to reference the guidance provided in SOP 04-2. SFAS No. 152 also amends SFAS No. 67, “Accounting for Costs and Initial Rental Operations of Real Estate Projects”, to state that SOP 04-2 provides the relevant guidance on accounting for incidental operations and costs related to the sale of real estate time-sharing transactions. SFAS No. 152 is effective for years beginning after June 15, 2005, with restatements of previously issued financial statements prohibited. This statement is not applicable to the Company.

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets,” an amendment to Opinion No. 29, “Accounting for Nonmonetary Transactions.” Statement No. 153 eliminates certain differences in the guidance in Opinion No. 29 as compared to the guidance contained in standards issued by the International Accounting Standards Board. The amendment to Opinion No. 29 eliminates the fair value exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. Such an exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occuring in periods beginning after December 16, 2004. Management does not expect adoption of SFAS No. 153 to have a material impact on the Company’s financial statements.

In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment.” SFAS 123(R) amends SFAS No. 123, “Accounting for Stock-Based Compensation”, and APB Opinion 25, “Accounting for Stock Issued to Employees.” SFAS No.123(R) requires that the cost of share-based payment transactions (including those with employees and non-employees) be recognized in the financial statements. SFAS No. 123(R) applies to all share-based payment transactions in which an entity acquires goods or services by issuing (or offering to issue) its shares, share options, or other equity instruments (except for those held by an ESOP) or by incurring liabilities (1) in amounts based (even in part) on the price of the entity’s shares or other equity instruments, or (2) that require (or may require) settlement by the issuance of an entity’s shares or other equity instruments. This statement is effective (1) for public companies qualifying as SEC small business issuers, as of the first interim period or fiscal year beginning after December 15, 2005, or (2) for all other public companies, as of the first fiscal year beginning after June 15, 2005, or (3) for all nonpublic entities, as of the first fiscal year beginning after December 15, 2005. Management is currently assessing the effect of SFAS No. 123(R) on the Company’s financial statements.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”, an amendment to Accounting Principles Bulletin (APB) Opinion No. 20, “Accounting Changes”, and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.” Though SFAS No. 154 carries forward the guidance in APB No. 20 and SFAS No. 3 with respect to accounting for changes in estimates, changes in reporting entity, and the correction of errors, SFAS No. 154 establishes new standards on accounting for changes in accounting principles, whereby all such changes must be accounted for by retrospective application to the financial statements of prior periods unless it is impracticable to do so. SFAS No. 154 is effective for accounting changes and error corrections made in fiscal years beginning after December 15, 2005, with early adoption permitted for changes and corrections made in years beginning after May 2005.

CAUTIONARY STATEMENTS AND RISK FACTORS

In our capacity as Company management, we may from time to time make written or oral forward-looking statements with respect to our long-term objectives or expectations which may be included in our filings with the Securities and Exchange Commission (the “SEC”), reports to stockholders and information provided in our web site.

The words or phrases “will likely,” “are expected to,” “is anticipated,” “is predicted,” “forecast,” “estimate,” “project,” “plans to continue,” “believes,” or similar expressions identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. We wish to caution you not to place undue reliance on any such forward-looking statements, which speak only as of the date made. In connection with the “Safe Harbor” provisions of the Private Securities Litigation Reform Act of 1995, we are calling to your attention important factors that could affect our financial performance and could cause actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.

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The following list of important factors may not be all-inclusive, and we specifically decline to undertake an obligation to publicly revise any forward-looking statements that have been made to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. Among the factors that could have an impact on our ability to achieve expected operating results and growth plan goals and/or affect the market price of our stock are:
 

l Recent history of losses

l Prior breach and changes in credit agreements.

l Our highly competitive marketplace.

l The risks associated with dependence upon significant customers.

l Our ability to execute our expansion strategy.

l The uncertain ability to manage growth.

l Our dependence upon and our ability to adapt to technological developments.

l Dependence on key personnel.

l Our ability to maintain and improve service quality.

l Fluctuation in quarterly operating results and seasonality in certain of our markets.

l Possible significant influence over corporate affairs by significant shareholders.

Investors are encouraged to examine the Company’s 2004 Form 10-K, which more fully describes the risks and uncertainties associated with the Company’s business. In addition, investors should consider the following:

1. During the second quarter of 2005, we entered into discussions with our banks to amend certain financial covenants contained in our credit agreement to more closely track our changing business environment which has contributed to lower sales and profits in recent quarters. As of June 30, 2005, our credit agreement was changed to shorten the due date of the outstanding revolving loan from March 12, 2006 to January 31, 2006, eliminate a re-borrowing provision of the term loan, increase interest rates on the revolver and term loans by 0.5% and revise certain financial covenants. We have also entered negotiations with several other banks and financial institutions to replace both the revolving and term credit facilities. If we are not successful in obtaining a replacement credit agreement, there is a risk that we will be in default of certain financial covenants in future quarters and/or will not be able to pay off the revolving and term loans when due. If a default condition exists in the future, all amounts outstanding under the credit agreement will be due and payable which could materially and adversely affect our business.

2. There is a risk that third party vendors who directly compete with us will succeed in taking away business or curtailing services to us. We rely on such companies principally to electronically deliver commercial spots on behalf of our advertising clients. In June 2005, one such vendor notified us that its electronic distribution channel was no longer available to us except under certain circumstances. While curtailment of these services in this instance has not materially affected our ability to deliver commercial spots, it has lowered gross margins on revenues related to electronic as we have been required to use higher-cost alternatives. Any future interruption in the supply of such services by other vendors could materially and adversely affect the Company’s financial condition, results of operations and prospects.

ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk. The Company had borrowings of $15.7 million at September 30, 2005 under a term loan and revolving credit agreement, and $6.1 million outstanding under a mortgage. Amounts outstanding under the term loan and revolving credit facility and the mortgage debt provide for interest at the banks’ prime rate plus 0.50% or LIBOR plus 2.75% for the revolver, prime plus 0.75% or LIBOR plus 2.75% for the term loan and 6.83% for the mortgage debt. The Company’s market risk exposure with respect to financial instruments is to changes in prime or LIBOR rates.

ITEM 4.CONTROLS AND PROCEDURES

Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”), the Company’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures, as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed in reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. No change in the Company’s internal control over financial reporting occurred during the Company’s most recent fiscal quarter that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Fromtime to time, the Company may become a party to various legal actions and complaints arising in the ordinary course of business, although it is not currently involved in any such material legal proceedings.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

(a)	Exhibits
	31.1	Certification of Chief Executive Officer Pursuant to 15 U.S.C. § 7241, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31.2	Certification of Chief Financial Officer Pursuant to 15 U.S.C. § 7241, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32.1	Certification of Chief Executive Officer Pursuant to 18 U.S.C. § 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2	Certification of Chief Financial Officer Pursuant to 18 U.S.C. § 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

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

	POINT.360
DATE: November 11, 2005	By:	/s/ Alan R. Steel
		Alan R. Steel Executive Vice President, Finance and Administration (duly authorized officer and principal financial officer)

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