Old Point.360 10-Q 2007 Q1 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 March 31, 2007 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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer __  Accelerated Filer __ Non-accelerated filer 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 March 31, 2007, there were 9,984,746 shares of the registrant’s common stock outstanding.

PART I - FINANCIAL INFORMATION

ITEM 1.FINANCIAL STATEMENTS

POINT.360

CONSOLIDATED BALANCE SHEETS

	December 31,		March 31,
Assets	2006		2007
Current assets:
Cash and cash equivalents	$	-	$	251,000
Accounts receivable, net of allowances for doubtful accounts of $783,000 and $772,000,
respectively		14,786,000		12,080,000
Inventories, net		750,000		730,000
Prepaid expenses and other current assets		570,000		696,000
Deferred income taxes		683,000		683,000
Total current assets		16,789,000		14,440,000
Property and equipment, net		14,138,000		13,140,000
Other assets, net		555,000		548,000
Goodwill		31,474,000		33,620,000
Total assets	$	62,956,000	$	61,748,000
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable	$	4,259,000	$	3,543,000
Accrued wages and benefits		1,861,000		1,535,000
Accrued earn-out payments		2,000,000		-
Other accrued expenses		466,000		657,000
Income tax payable		123,000		29,000
Borrowings under revolving credit agreement		3,007,000		1,892,000
Current portion of borrowings under notes payable		1,158,000		1,750,000
Current portion of capital lease obligations		16,000		48,000
Current portion of deferred gain on sale of real estate		178,000		178,000
Total current liabilities		13,068,000		9,633,000
Deferred income taxes		4,030,000		4,030,000
Notes payable, less current portion		3,474,000		5,092,000
Capital lease and other obligations, less current portion		-		-
Deferred gain on sale of real estate, less current portion		2,363,000		2,318,000
Total long-term liabilities		9,867,000		11,440,000
Total liabilities		22,935,000		21,073,000
Commitments and contingencies		-		-
Shareholders’ equity
Preferred stock - no par value; 5,000,000 shares authorized; none outstanding		-		-
Common stock - no par value; 50,000,000 shares authorized; 9,749,582 and 9,984,746
shares issued and outstanding, respectively		18,488,000		19,067,000
Additional paid-in capital		1,077,000		1,098,000
Retained earnings		20,456,000		20,510,000
Total shareholders’ equity		40,021,000		40,675,000
Total liabilities and shareholders’ equity	$	62,956,000	$	61,748,000

The accompanying notes are an integral part of these consolidated financial statements.

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POINT.360

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(Unaudited)

	Three Months Ended March 31,
	2006			2007
Revenues	$	16,039,000		$	15,482,000
Cost of services sold		(10,715,000	)		(10,424,000	)
Gross profit		5,324,000			5,058,000
Selling, general and administrative expense		(5,127,000	)		4,836,000
Operating income		197,000			222,000
Interest expense, net		(350,000	)		(132,000	)
Income (loss) before income taxes		(153,000	)		90,000
(Provision for) benefit from income taxes		61,000			(36,000	)
Net income (loss)	$	(92,000	)	$	54,000
Earnings(loss) per share:
Basic:
Net income (loss)	$	(0.01	)	$	0.01
Weighted average number of shares		9,370,724			9,947,730
Diluted:
Net income (loss)	$	(0.01	)	$	0.01
Weighted average number of shares including the dilutive effect of stock options		9,537,361			10,448,818

See accompanying notes to consolidated financial statements.

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POINT.360

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Three Months Ended March 31,
	2006			2007
Cash flows from operating activities:
Net income (loss)	$	(92,000	)	$	54,000
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		1,405,000			1,430,000
Provision for doubtful accounts		24,000			(11,000	)
Changes in assets and liabilities:
(Increase) decrease in accounts receivable		(2,384,000	)		2,717,000
Decrease in inventories		65,000			20,000
(Increase) decrease in prepaid expenses and other current assets		(360,000	)		(126,000	)
(Increase) in goodwill and other tangibles		-			-
(Increase) decrease in other assets (Increase) decrease in deferred tax asset		(33,000 (870,000	) )		27,000 -
Increase (decrease) in accounts payable		1,103,000			(716,000	)
(Decrease) in accrued expenses		(735,000	)		(2,135,000	)
Increase in income taxes Increase in other current liabilities		855,000 33,000			(94,000 (145,000	) )
Net cash provided by (used in) operating activities		(989,000	)		1,021,000
Cash used in investing activities:
Capital expenditures		(359,000	)		(431,000	)
Amount paid for acquisitions		-			(2,167,000	)
Net cash used in investing activities		(359,000	)		(2,598,000	)
Cash flows provided by (used in) financing activities:
Proceeds from sale of equipment		13,883,000			100,000
Exercise of stock options		4,000			599,000
Change in revolving credit agreement		169,000			(1,114,000	)
Proceeds from bank note		(310,000	)		2,500,000
Shares issued for an acquisition		-			-
Repayment of notes payable		(10,244,000	)		(289,000	)
Repayment of capital lease and other obligations		(23,000	)		32,000
Net cash provided by (used in) financing activities		3,479,000			1,828,000
Net increase (decrease) in cash		2,131,000			251,000
Cash and cash equivalents at beginning of period		595,000			-
Cash and cash equivalents at end of period	$	2,726,000		$	251,000
Supplemental disclosure of cash flow information - Cash paid for:
Interest	$	330,000		$	95,000
Income tax	$	-		$	19,000

See accompanying notes to consolidated financial statements.

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POINT.360

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

March 31, 2007

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 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-month period ended March 31, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007. 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, 2006.

NOTE 2- LONG TERM DEBT AND NOTES PAYABLE

On December 30, 2005, the Company entered into a new $10 million term loan agreement. The term loan provides for interest at LIBOR (5.32% as of March 31, 2007) plus 3.15% and is secured by the Company’s equipment. The term loan will be repaid in 60 equal monthly principal payments plus interest. Proceeds of the term loan were used to repay a previously existing term loan. In March 2006, the Company prepaid $4 million of the term loan with proceeds from the sale of real estate (see Note 3). Monthly principal payments were subsequently reduced pro rata.

On March 30, 2007, the Company entered into an additional $ 2.5 million term loan agreement. The loan provides for interest at 8.35% per annum and is secured by the Company’s equipment. The loan will be repaid in 45 equal monthly installments of principal and interest.

In January 2006, the due date of the then existing credit facility was extended to March 31, 2006. As of December 30, 2005, the Company did not meet certain financial covenants contained in the credit facility and received a compliance waiver from the bank.

In March 2006, the Company entered into a new credit agreement which provides up to $10 million of revolving credit. The two-year agreement provides for interest at either (i) prime (8.25% as of March 31, 2007) minus 0% - 1.00% or (ii) LIBOR plus 1.50% - 2.5%, depending on the level of the Company’s ratio of outstanding debt to fixed charges (as defined). The facility is secured by all of the Company’s assets, except for equipment securing the term loan. The revolving credit agreement requires the Company to comply with various financial and business covenants. There are cross default provisions contained in both the revolving and term loan agreements. As of March 31, 2007, the Company was in compliance with revolving and term loan agreement covenants.

NOTE 3- SALE OF REAL ESTATE

In March 2006, the Company entered into a sale and leaseback transaction with respect to its Media Center vaulting real estate. The real estate was sold for approximately $14.0 million resulting in a $1.3 million after tax gain. Additionally, the Company received $0.5 million from the purchaser for improvements. In accordance with SFAS No. 28, “Accounting for Sales with Leasebacks,” the gain will be amortized over the initial 15-year lease term as reduced rent. Net proceeds at the closing of the sale and the improvement advance (approximately $13.8 million) were used to pay off the mortgage and other outstanding debt.

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The lease is treated as an operating lease for financial reporting purposes. After the initial lease term, the Company has four five-year options to extend the lease. Minimum annual rent payments for the initial five years of the lease are $1,111,000, increasing annually thereafter based on the consumer price index change from year to year.

NOTE 4- STOCK-BASED COMPENSATION

On January 1, 2006, the Company adopted SFAS 123(R) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. SFAS 123(R) requires companies to estimate the fair value of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our Consolidated Statements of Income. Prior to the adoption of SFAS 123(R), the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under SFAS 123.Under the intrinsic value method, no stock-based compensation expense had been recognized in our Consolidated Statements of Income for awards to employees and directors because the exercise price of our stock options equaled the fair market value of the underlying stock at the date of grant.

SFAS 123(R) requires companies to estimate the fair value of share-based payment awards to employees and directors on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s Consolidated Statements of Income (loss). Stock-based compensation expense recognized in the Consolidated Statements of Income (Loss) for the quarters ended March 31, 2006 and 2007 included compensation expense for the share-based payment awards granted subsequent to January 1, 2006 based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). There were no outstanding uninvested share-based payment awards as of January 1, 2006. For stock-based awards issued to employees and directors, stock-based compensation is attributed to expense using the straight-line single option method, which is consistent with how the prior-priced pro formas were provided were provided. As stock-based compensation expense recognized in the Statements of Consolidated Income (Loss) for 2006 and 2007 is based on awards expected to vest, SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

The Company adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of the Company’s fiscal year 2006. The consolidated financial statements as of and for the quarters ended March 31, 2006 and 2007 reflect the impact of SFAS 123(R). Stock-based compensation expense related to employee or director stock options recognized for the quarters ended March 31, 2006 and 2007 was $1,000 ($1,000 net of tax benefit) and $21,000 ($13,000 net of tax benefit) respectively.

The Company’s determination of fair value of share-based payment awards to employees and directors on the date of grant uses the Black-Sholes model, which is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, the expected stock price volatility over the expected volatility over the expected term of the awards, and actual and projected employee stock options exercise behaviors. The Company estimates expected volatility using historical data. The expected term is estimated using the “safe harbor” provisions under SAB 107.

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During the quarter ended March 31, 2007, the Company granted no awards of stock options. At March 31, 2007, there were options outstanding to acquire 2,182,420 shares at an average exercise price of $2.93 per share. The fair value of each option was estimated on the date of grant using the Black-Sholes option-pricing model with the following weighted average assumptions:

	Quarter Ended March 31,
	2006			2007
Risk-free interest rate		2.50	%		-
Expected term (years)		5.0			-
Volatility		48	%		-
Expected annual dividends		-			-

The following table summarizes the status of these plans as of March 31, 2007:

	1996 Plan	2000 Plan	2005 Plan
Options originally available	3,800,000	1,500,000	2,000,000
Stock options outstanding	1,057,070	622,500	502,850
Options available for grant	-	-	1,485,150

Transactions involving stock options are summarized as follows:

	Number of Shares		Weighted Average Exercise Price
Balance at December 31, 2006		2,443,004	$	2.89

Granted	-		-
Exercised	235,075		2.76
Cancelled	25,509		3.14
Balance at March 31, 2007	2,182,420	$	2.93

As of March 31, 2007, the total compensation costs related to non-vested awards yet to be expensed was approximately $0.3 million to be amortized over the next four years.

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The weighted average exercise prices for options granted and exercisable and the weighted average remaining contractual life for options outstanding as of March 31, 2006 and 2007 was as follows:

As of December 31, 2006	Number of Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (Years)		Intrinsic Value
Employees - Outstanding		2,078,004	$	2.80		3.09	$	1,802,000
Employees - Expected to Vest		2,041,009	$	2.81		3.04	$	1,752,000
Employees - Exercisable		1,726,854	$	2.91		2.79	$	1,331,000
Non-Employees - Outstanding		365,000	$	3.42		3.26	$	114,000
Non-Employees - Expected to Vest		365,000	$	3.42		3.26	$	114,000
Non-Employees - Exercisable		365,000	$	3.42		3.26	$	114,000
As of March 31, 2007
Employees - Outstanding		1,817,420	$	2.83		2.92	$	1,363,000
Employees - Expected to Vest		1,783,635	$	2.84		2.90	$	1,320,000
Employees - Exercisable		1,479,570	$	2.96		2.63	$	917,000
Non-Employees - Outstanding		365,000	$	3.42		3.01	$	58,000
Non-Employees - Expected to Vest		365,000	$	3.42		3.01	$	58,000
Non-Employees - Exercisable		365,000	$	3.42		3.01	$	58,000

Additional information with respect to outstanding options as of March 31, 2007 is as follows (shares in thousands):

	Options Outstanding			Options Exercisable
Options Exercise Price Range	Number of Shares	Weighted Average Remaining Contractual Life	Weighted Average Exercise Price	Number of Shares	Weighted Average Exercise Price
$1.75 - 4.79	2,182	3.0 Years	$2.93	1,845	$3.05

We have elected to adopt the detailed method provided in SFAS 123(R) for calculating the beginning balance of the additional paid-in capital pool (APIC pool) related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC pool and Consolidated Statements of Cash Flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of SFAS 123(R).

NOTE 5- CONTINGENCIES

On July 10, 2006, Digital Generation Systems, Inc. (“DG”) filed a claim in the District Court of Dallas County, Texas, alleging that the Company interfered with a contract between DG and Pathfire, Inc. (Pathfire), which contract provided that DG was granted exclusive use of Pathfire’s network for the distribution of advertising content. The DG/Pathfire exclusivity excluded the distribution of certain other types of content (other than advertising content) to be distributed by Pathfire for CBS/Viacom. The claim alleges that the Company was aware of the exclusivity provision during its negotiations with CBS Worldwide Distribution, CBS Broadcasting, Inc. (“CBS”), which resulted in a January 2006 contract between the Company and CBS (“CBS Contract”). Under the CBS Contract, the Company licensed advertising content distribution services from CBS, which services were to be performed utilizing Pathfire’s IP-Multicast Format Store & Forward technology. DG alleges that the Company’s knowledge of the exclusivity provision during the Company’s negotiations with CBS and the resulting use of Pathfire’s technology for distribution of ads caused damage to DG. The claim seeks unspecified actual and punitive damages and other costs of prosecution.

If DG is successful in its claim, the possibility exists that the Pathfire distribution technology will become unavailable to the Company, through which the Company currently distributes a portion of its commercial spots. If that occurs, the Company believes it has alternative means to fulfill customer needs.

8

The Company believes the complaint is without merit and will not have a material effect on the Company’s financial position. Regardless, CBS has agreed to indemnify the Company pursuant to the CBS Contract to the extent permitted by law or otherwise.

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

NOTE 6- SHAREHOLDERS’ EQUITY

During the three-month period ended March 31, 2007, the number of outstanding shares of the Company’s common stock increased by 235,164 shares due to the exercise of employee stock options for $581,000 in cash.

NOTE 7- ACQUISITION

On March 7, 2007, Point.360 acquired substantially all of the assets and business of Eden FX, Inc. (“Eden”) for $1.9 million in cash. The purchase agreement requires possible additional payments of $0.7 million, $0.9 million and $1.2 million in 2008, 2009 and 2010, respectively, if earnings before interest, taxes, depreciation and amortization during the three years after the acquisition reach certain predetermined levels. As part of the transaction, the Point.360 entered into employment and non competition agreements with three senior officers of Eden which fix responsibilities, salaries and other benefits and set forth limitations on the individual’s ability to compete with the Company for the term of the earn-out period (three years). Eden is a producer computer generated visual effects for feature films, television program and commercial advertising content.

The total purchase consideration has been allocated to the assets and liabilities acquired based on their respective estimated fair values as summarized below.

Goodwill	$	2,071,000
Property, plant and equipment		127,000
Total assets acquired		2,198,000
Liabilities assumed		(39,000	)
Net assets acquired over liabilities,
and purchase price	$	2,159,000

The operating results of Eden FX for the quarter ended March 31, 2007 were not material.

NOTE 8- INCOME TAXES

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No.48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“FAS 109”). This interpretation prescribes a recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition of tax benefits, classification on the balance sheet, interest and penalties, accounting in interim periods, disclosure, and transition. The Company adopted FIN 48 effective January 1, 2007. The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and various state jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal state or local income tax examinations by tax authorities for years before 2002. The Company has analyzed its filing positions in all of the federal and state jurisdictions where it is required to file income tax returns. The Company was last audited by New York taxing authorities for the years 2002 through 2004 resulting in no change. The Company is currently not under audit by income taxing authorities. If audited, the Company believes that its income tax filing positions and deductions will be sustained and does not anticipate any adjustments that will result in a material change to its financial position. As a result, upon the implementation of FIN 48, the Company did not recognize any increase in the liability for unrecognized tax benefits. In addition, the Company did not record a cumulative effect adjustment related to the adoption of FIN 48.

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NOTE 9- SUBSEQUENT EVENT

On April 16, 2007, Point.360, New 360, a newly formed California corporation and wholly owned subsidiary of Point.360 (“New 360”), and DG FastChannel, Inc. (“DG FastChannel”), entered into an Agreement and Plan of Merger and Reorganization (the “Merger Agreement”).

Under the terms of the Merger Agreement, DG FastChannel has agreed to make an exchange offer (the “Exchange Offer”) for all outstanding shares of Point.360 common stock, no par value per share, including the associated preferred stock purchase rights (collectively, the “Point.360 Shares”), in which Exchange Offer each Point.360 Share tendered and accepted by DG FastChannel will be exchanged for a number of shares of common stock, par value $0.001 per share, of DG FastChannel (the “DG Common Stock”) equal to the quotient obtained by dividing (x) 2,000,000 by (y) the number of Point.360 Shares (excluding Point.360 Shares owned by DG or Point.360) issued and outstanding immediately prior to the completion of the Exchange Offer (such amount of shares of DG Common Stock paid per Point.360 Share pursuant to the Exchange Offer is referred to herein as the “Exchange Offer Consideration”). The completion of the Exchange Offer is subject to customary conditions, including a minimum condition that not less than a majority of the outstanding Point.360 Shares on a fully diluted basis are validly tendered and not withdrawn prior to the expiration of the Exchange Offer.

In addition, on April 16, 2007, Point.360, DG FastChannel, and New 360 entered into a Contribution Agreement (the “Contribution Agreement”). Pursuant to the Contribution Agreement, prior to the completion of the Exchange Offer, Point.360 will contribute (the “Contribution”) to New 360 all of the assets owned, licensed, or leased by Point.360 that are not used exclusively in connection with the business of Point.360 representing advertising agencies, advertisers, brands, and other media companies which require services for short-form media content (the “ADS Business”), and New 360 will assume certain liabilities of Point.360. Immediately following the Contribution but prior to the completion of the Exchange Offer, Point.360 will distribute (the “Spin-Off”) to its shareholders (other than DG FastChannel) on a pro rata basis all of the capital stock then outstanding of New 360.

On May 14, 2007, New 360 filed a Registration Statement on Form 10 (the “Form 10”) with the Securities and Exchange Commission for the purpose of registering New 360’s common stock under Section 12(b) of the Securities Exchange Act of 1934, as amended. Among other things, the Form 10 contains: (1) a detailed description of the Contribution and the Spin-Off; (2) a description of Point.360’s post-production business that will be transferred to New 360 pursuant to the Contribution; (3) risk factors relating to New 360’s business, the Contribution and Spin-Off and New 360’s common stock; (4) a valuation of New 360 by Point.360’s financial advisor; (5) management’s discussion and analysis of New 360’s financial condition and results of operations for each of the three years in the period ended December 31, 2006; (6) unaudited pro forma financial statements of New 360 as of December 31, 2006, and for the year then ended, giving effect to the Contribution and Spin-Off; (7) audited financial statements for New 360 as of December 31, 2006 and 2005 and for each of the three years in the period ended December 31, 2006; and (8) a description of New 360’s proposed management and executive compensation policies.

It is anticipated that New 360’s common stock will be approved for listing on the Nasdaq Global Market. As a result of the Contribution and the Spin-Off, at the completion of the Exchange Offer, the assets and liabilities of Point.360 will consist only of those assets and liabilities exclusively related to the ADS Business.

As soon as practicable following the completion of the Exchange Offer, DG FastChannel has agreed to effect the merger of Point.360 with and into DG FastChannel (the “Merger”), with DG FastChannel continuing as the surviving corporation. Upon the completion of the Merger, each Point.360 Share not purchased in the Exchange Offer will be converted into the right to receive the Exchange Offer Consideration, without interest. The Merger Agreement contains customary representations and warranties, covenants, and conditions. Completion of the Contribution, the Spin-Off, and the Exchange Offer is a condition of DG FastChannel’s obligation to effect the Merger.

Copies of the Merger Agreement and the Contribution Agreement have been filed as Exhibits 2.1 and 2.2, respectively, to the Company’s Current Report on Form 8-K dated April 17, 2007 and are incorporated herein by reference.  The preceding description of the Merger Agreement and the Contribution Agreement does not purport to be complete and is qualified in its entirety by reference to such exhibits.

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This description and that provided in the Form 8-K does not constitute an offer to sell or the solicitation of an offer to buy any securities of Point.360, New 360 or DG FastChannel, nor shall there be any sale of securities in any jurisdiction in which such offer, solicitation, or sale would be unlawful prior to registration or qualification under the securities laws of any such jurisdiction. The exchange offer described above has not commenced, and any offer will be made only through a prospectus that is part of a registration statement on Form S-4 to be filed with the U.S. Securities and Exchange Commission (the “SEC”) by DG FastChannel. DG FastChannel will also file with the SEC a Schedule TO, and Point.360 will file a solicitation/recommendation statement on Schedule 14D-9, in each case with respect to the Exchange Offer. DG FastChannel and Point.360 expect to mail a prospectus of DG FastChannel and related exchange offer materials, as well as the Schedule 14D-9, to Point.360 shareholders. In addition, in connection with the Spin-Off, New 360 expects to file a registration statement on Form 10 with the SEC and to mail an information statement regarding New 360 to Point.360 shareholders. Investors and security holders are urged to carefully read these documents and the other documents relating to the transactions contemplated by the Merger Agreement and the Contribution Agreement when they become available because these documents will contain important information relating to such transactions. Investors and security holders may obtain a free copy of these documents after they have been filed with the SEC, and other annual, quarterly, and special reports and other information filed with the SEC by Point.360 or DG FastChannel, at the SEC’s website at www.sec.gov.

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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

Except for the historical information contained herein, certain statements in this quarterly report are "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995, which involve certain risks and uncertainties, which could cause actual results to differ materially from those discussed herein, including but not limited to competition, customer and industry concentration, dependence on technological developments, risks related to expansion, dependence on key personnel, fluctuating results and seasonality and control by management.

Statements in this Form 10-Q may contain certain forward-looking statements relating to Point.360, New 360, and/or DG FastChannel. All statements included in this Current Report on Form 8-K concerning activities, events, or developments that Point.360 expects, believes, or anticipates will or may occur in the future are forward-looking statements. Actual results could differ materially from the results discussed in the forward-looking statements. Forward-looking statements are based on current expectations and projections about future events and involve known and unknown risks, uncertainties, and other factors that may cause actual results and performance to be materially different from any future results or performance expressed or implied by forward-looking statements, including the following: the risk that the Exchange Offer and the Merger will not close because of a failure to satisfy one or more of the closing conditions; the risk that Point.360’s or DG FastChannel’s business will have been adversely impacted during the pendency of the Exchange Offer and the Merger; the risk that the operations of the ADS Business and DG FastChannel will not be integrated successfully; and the risk that the expected cost savings and other synergies from the transactions contemplated by the Merger Agreement and the Contribution Agreement may not be fully realized, realized at all, or take longer to realize than anticipated. Additional information on these and other risks, uncertainties, and factors is included in Point.360’s and DG FastChannel’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and other documents filed with the SEC.

See the relevant portions of the Company's documents filed with the Securities and Exchange Commission and Risk Factors in Item 1A of Part II of this Form 10-Q, for a further discussion of these and other risks and uncertainties applicable to the Company's business.

Overview

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 for the foreseeable future. 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 since June 2005. While we are exploring other lower cost alternatives, gross margins related to spot delivery revenues will be lower until such alternatives become available. Please also refer to Note 8 of Notes to Consolidated Financial Statements.

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 and Eden FX in March 2007) which can increase revenues by adding new customers, or expanding services provided to existing customers.

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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.

Three Months Ended March 31, 2007 Compared To Three Months Ended March 31, 2006.

Revenues. Revenues were $15.5 million for the three-month period ended March 31, 2007, compared to $16.0 million for the three-month period ended March 31,2006. Revenues declined in 2006 due to a number of factors including: (i) price compression due to competition in post production and spot advertising distribution, (ii) consolidation among some customers that has resulted in less business being available to Point.360, and (iii) the continuing trend toward electronic distribution of commercial spots as opposed to physical duplication and distribution which results in lower revenues. Billings to customers for sending commercial spots physically, has declined to about 4.9% of sales in the first quarter of 2007 from 5.3% in the prior year period. These factors have been somewhat offset by acquiring new customers and adding new service offerings. We expect the negative trends to continue at a slower pace in the future, and we will continue to invest in high definition capabilities where demand is expected to grow. We believe our high definition service platform will attract additional business in the future.

Gross Profit. In the first quarter of 2007, gross margin was 33 % of sales, compared to 33% for the quarter ended March 31, 2006. The sale/leaseback penalized first quarter 2007 gross margin by 1% of sales (i.e., lease costs increased $0.2 million in the 2007 quarter net of depreciation associated with the previously-owned facility). The impact of the sale/leaseback will be continuing. Gross margins have been historically higher as a percentage of sales for advertising related revenue as compared to post production, the latter requiring a larger investment in equipment (greater depreciation) and higher personnel costs when compared to duplication and distribution of advertising content. We expect gross margins to fluctuate in the future as the sales mix changes.

Selling, General and Administrative Expense.SG&A expense was $4.8 million (31% of sales) in the first quarter of 2007 as compared to $5.1 million (32% of sales) in the same period of 2006.

Interest Expense.Interest expense for the three-month period ended March 31, 2007 was $0.1 million, a decrease of $0.2 million over the three-month period ended March 31, 2006. The decrease was due to lower debt levels resulting from the sale/leaseback transaction offset partially by higher rates on remaining 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 elsewhere in this Form 10-Q.

On December 30, 2006, the Company entered a new $10 million term loan agreement. The term loan provides for interest at LIBOR (5.32% at March 31, 2007) plus 3.15%, or 8.47% at March 31, 2007, and is secured by the Company’s equipment. The term loan was to be repaid in 60 equal principal payments plus interest. Proceeds of the loans were used to pay off our previously existing term loan.

In March 2006, the Company entered into a new credit agreement which provides up to $10 million of revolving credit based on 80% of acceptable accounts receivables, as defined. The two-year agreement provides for interest of either (i) prime (8.25% at March 31, 2007) minus 0% - 1.00% or (ii) LIBOR plus 1.50% - 2.50% depending on the level of the Company’s ratio of outstanding debt to fixed charges (as defined), or 7.25% or 6.8%, respectively, at March 31, 2007. The facility is secured by all of the Company’s assets, except for equipment securing a new term loan as described above.

In March 2006, the Company entered into a sale and leaseback transaction with respect to its Media Center vaulting real estate. The real estate was sold for $13,946,000 resulting in a $1.2 million after tax gain. Additionally, we received $500,000 from the purchaser for improvements. In accordance with SFAS No.28. “Accounting for Sales with Leasebacks” (“SFAS28”), the gain and the improvement allowance will be amortized over the initial 15-year lease term as reduced rent. Net proceeds at the closing of the sale and the improvement advance (approximately $13.9 million) were used to pay off the mortgage and other outstanding debt. In accordance with our agreement with the revolving credit lender, we prepaid $4 million of the term loan. As a result of the prepayment, monthly principal payments on the term loan were reduced by approximately $70,000 per month (840,000 per year).

On March 30, 2007, the Company entered into an additional $2.5 million term loan agreement. The loan provides for interest at 8.35% per annum and is secured by the Company’s equipment. The loan will be repaid in 45 equal monthly installments of principal and interest.

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The following table summarizes the March 31, 2007 status of our revolving line of credit and term loans:

Revolving credit	$	1,893,000
Current portion of term loan		1,798,000
Long-term portion of term loan		5,092,000
Total	$	8,783,000

Monthly and annual principal and interest payments due under the term debt are approximately $193,000 and $2.3 million, respectively, assuming no change in interest rates.

Cash generated by operating activities is directly dependent upon sales levels and gross margins achieved. We generally receive payments from customers in 50-90 days after services are performed. The larger payroll and freight components of cost of sales must be paid currently and within 30 days, respectively. Payment terms of other liabilities vary by vendor and type. Income taxes must be paid quarterly. Fluctuations in sales levels will generally affect cash flow negatively or positively in early periods of growth or contraction, respectively, because of operating cash receipt/payment timing. Other investing and financing cash flows also affect cash availability.

The bank revolving credit agreement requires us to maintain a minimum “quick ratio” and a minimum “fixed charge coverage ratio.” Our quick ratio (current assets less current liabilities) was 1.28 as of March 31, 2007 as compared to a minimum requirement of 0.80. Our fixed charge coverage ratio compares, on a rolling twelve-month basis, EBITDA plus rent expense and non-cash charges less income tax payments, to (ii) interest expense plus rent expense, the current portion of long term debt and maintenance capital expenditures. As of March 31, 2007, the fixed charge coverage ratio was 1.41 as compared to a minimum requirement of 1.10. If we fail to meet minimum covenant levels, amounts outstanding under the credit agreement and, by cross default provisions; the term loan will become due and payable.

We expect that remaining amounts available under the revolving credit arrangement (approximately $6,300,000 at March 31, 2007), 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.

The acquisition of IVC was completed in July 2004 for $2.3 million in cash and $4.7 million in borrowings. 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. $2 million was paid in 2006 and in 2007.

In March 2007, we acquired substantially all the assets of Eden FX for approximately $1.9 million in cash. The purchase agreement requires additional payments of $0.7 million, $0.9 million and $ 1.2 million in March of 2008, 2009 and 2010, respectively, if earnings during the three years after acquisition meet certain predetermined levels.

In April 2007, we received a $0.9 million tax refund for excess use taxes paid in prior years.

Due to an increase in the market price of our stock in the first quarter and after the execution of the Merger Agreement, many employees have exercised “in-the-money” stock options generating approximately $5.5 million in cash proceeds to the Company. If all remaining “in-the-money” options are exercised before the Effective Date, we will receive additional cash of approximately $1 million.

The following table summarizes contractual obligations as of March 31, 2007 due in the future:

	Payment due by Period
Contractual Obligations	Total		Less than 1 Year		Years 2 and 3		Years 4 and 5		Thereafter
Long Term Debt Obligations	$	6,903,000	$	1,937,000	$	3,095,000	$	1,872,000	$	-
Capital Lease Obligations		48,000		48,000		-		-		-
Operating Lease Obligations		31,600,000		5,038,000		8,177,000		5,329,000		13,055,000
Total	$	38,551,000	$	7,023,000	$	11,272,000	$	7,201,000	$	13,055,000

During the past year, the Company has generated sufficient cash to meet operating, capital expenditure and debt service needs and obligations, as well as to provide sufficient cash reserves to address contingencies. When preparing estimates of future cash flows, we consider historical performance, technological changes, market factors, industry trends and other criteria. In our opinion, the Company will continue to be able to fund its needs for the foreseeable future.

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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 and conditions. We believe 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 judgments. 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.

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 allowance; 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 (consisting only of goodwill), comprise a significant portion of the Company’s total assets. Long-lived assets, including goodwill are reviewed for impairment whenever events or changes in circumstances have indicated that their carrying amounts may be recoverable. Recoverability of assets is measured by comparing the carrying amount of an asset to its fair value in a current transaction between willing parties, other than in a forced liquidation sale. Fair value was estimated by independent appraisals and other valuation techniques.

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

·       Significant underperformance relative to expected historical or projected future operating results;

·       Significant changes in the manner of our use of the acquired assets or the strategy of our overall business;

·       Significant negative industry or economic trends

·       Significant decline in our stock price for a sustained period; and

·       Our 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 comparing the carrying amount of the asset to its fair value in a current transaction between willing parties or, in the absence of such measurement, 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 $46.8 million as of March 31, 2007.

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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 in 2002 and an annual impairment review thereafter. The initial test on January 1, 2002 and the Fiscal 2002 to 2006 tests performed as of September 30 of each year required no goodwill impairment. In the 2006 test performed as of September 30, 2006, we determined the fair value of the enterprise using independent appraisals and other valuation techniques. If future appraisals or future performances are affected by the factors cited above, resulting potential impairment could adversely affect the reported goodwill asset value 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 March 31, 2007 was $3.3 million. The Company did not record a valuation allowance against its deferred tax assets as of March 31, 2007.

In June 2006, the FASB issued “FIN 48”. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with Statement FAS 109. This interpretation prescribes a recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition of tax benefits, classification on the balance sheet, interest and penalties, accounting in interim periods, disclosure, and transition. The Company adopted FIN 48 effective January 1, 2007. The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and various state jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal state or local income tax examinations by tax authorities for years before 2002. The Company has analyzed its filing positions in all of the federal and state jurisdictions where it is required to file income tax returns. The Company was last audited by New York taxing authorities for the years 2002 through 2004 resulting in no change. The Company is currently not under audit by income taxing authorities. If audited, the Company believes that its income tax filing positions and deductions will be sustained and does not anticipate any adjustments that will result in a material change to its financial position. As a result, upon the implementation of FIN 48, the Company did not recognize any increase in the liability for unrecognized tax benefits. In addition, the Company did not record a cumulative effect adjustment related to the adoption of FIN 48.

RECENT ACCOUNTING PRONOUNCEMENTS

In February 2006, the FASB issued Statement of Financial Accounting Standards No. 155, “Accounting for Certain Hybrid Financial Instruments” (“SFAS 155”), which amends SFAS No. 133, “Accounting for Derivatives Instruments and Hedging Activities” (SFAS 133”) and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities” (SFAS 140”). SFAS 155 amends SFAS 133 to narrow the scope exception for interest-only and principal-only strips on debt instruments to include only such strips representing rights to receive a specified portion of the contractual interest or principle cash flows. SFAS 155 also amends SFAS 140 to allow qualifying special-purpose entities to hold a passive derivative financial instrument pertaining to beneficial interests that it is derivative instrument. The Company is currently evaluating the impact this new Standard, but believes that it will not have a material impact on the Company’s financial position, results of operations or cash flows.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140”. The provisions of SFAS 156 are effective for fiscal years beginning after September 15, 2006. This statement was issued to simplify the accounting for servicing rights and to reduce the volatility that results from using different measurement attributes. The Company is currently assessing the impact that the adoption of SFAS 156 will have on its results of operations and financial position.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurement.” SFAS 157 establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is required to adopt the provision of SFAS 157, as applicable, beginning in fiscal year 2008. Management does not believe the adoption of SFAS 157 will have a material impact on the Company’s financial position or results of operations.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Options for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115” (“SFAS 159”), which expands the use of fair value. Under SFAS 159 a company may elect to use fair value to measure accounts and loans receivable, available-for-sale and held-to-maturity securities, equity method investments, accounts payable, guarantees, issued debt and other eligible financial instruments. SFAS 159 is effective for years beginning after November 15, 2007. We do not believe that SFAS 159 will have a material impact on our financial position, results of operations or cash flows.

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ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk. The Company had borrowings of $8.8 million at March 31, 2007 under term loan and revolving credit agreements. Revolving credit advances and one term loan were subject to variable interest rates. The weighted average interest rate paid during the first quarter of 2007 was 8.1%. For variable rate debt outstanding at March 31, 2007, a .25% increase in interest rates will increase annual interest expense by approximately $19,000. Amounts outstanding under the revolving credit facility provide for interest at the banks’ prime rate minus 0%-1.00% assuming the same amount of outstanding debt or LIBOR plus 1.5% to 2.5% and LIBOR plus 3.15% for the term loan. 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.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On July 10, 2006, Digital Generation Systems, Inc. (“DG”) filed a claim in the District Court of Dallas County, Texas, alleging that the Company interfered with a contract between DG and Pathfire, Inc. (Pathfire), which contract provided that DG was granted exclusive use of Pathfire’s network for the distribution of advertising content. The DG/Pathfire exclusivity excluded the distribution of certain other types of content (other than advertising content) to be distributed by Pathfire for CBS/Viacom. The claim alleges that the Company was aware of the exclusivity provision during its negotiations with CBS Worldwide Distribution, CBS Broadcasting, Inc. (“CBS”), which resulted in a January 2006 contract between the Company and CBS (“CBS Contract”). Under the CBS Contract, the Company licensed advertising content distribution services from CBS, which services were to be performed utilizing Pathfire’s IP-Multicast Format Store & Forward technology. DG alleges that the Company’s knowledge of the exclusivity provision during the Company’s negotiations with CBS and the resulting use of Pathfire’s technology for distribution of ads caused damage to DG. The claim seeks unspecified actual and punitive damages and other costs of prosecution.

If DG is successful in its claim, the possibility exists that the Pathfire distribution technology will become unavailable to the Company, through which the Company currently distributes a portion of its commercial spots. If that occurs, the Company believes it has alternative means to fulfill customer needs.

The Company believes the complaint is without merit and will not have a material effect on the Company’s financial position. Regardless, CBS has agreed to indemnify the Company pursuant to the CBS Contract to the extent permitted by law or otherwise.

In April 2007, the Company entered the Merger Agreement with DG. Upon completion of the transaction contemplated in the Merger Agreement, the DG actions will be dismissed.

ITEM 1A. 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 and ongoing liquidity.

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 in a changing environment.

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.

There is also the risk that the transaction contemplated by the Merger Agreement will not be completed. Between now and the Effective Date, we will begin to utilize DG as an electronic vendor. We will also be sharing with DG confidential information about the ad distribution business. If the merger is not completed, there are risks that our competitive advantage will erode, that key ads employees will depart due to perceived uncertainties and that customers will choose other vendors to handle their spot advertising distribution needs.

Investors are encouraged to examine the Company’s 2006 Form 10-K, which more fully describes the risks and uncertainties associated with the Company’s business.

ITEM 6. EXHIBITS

(a)   Exhibits

10.1 First Amendment to Standard Loan Agreement dated March 15, 2007 between Bank of America and the Company.

10.2 Second Amendment to Standard Loan Agreement dated April 9, 2007 between Bank of America and the Company.

10.3 Promissory Note dated March 30, 2007 between General Electric Capital Corporation and the Company.

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.

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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: May 15, 2007	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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