August 21, 2006
Mr. Michael Fay
Accounting Branch Chief
Securities and Exchange Commission
100 F Street NE
Washington, D.C. 90549-3561
RE: Point.360
Form 10-K: For the Year Ended December 31, 2005
Form 10-Q: For the Period Ended March 31, 2006
File Number: 000-21917
Dear Mr. Fay:
The following is provided in response to your August 8, 2006 letter to Haig S.
Bagerdjian. The paragraph numbers correspond to those in your letter.
FORM 10-K
1. Instructions to Paragraph 303(a) #5 of Regulation S-K provides as follows:
"5. The term "liquidity" as used in this item refers to the
ability of an enterprise to generate adequate amounts of cash to
meet the enterprise's needs for cash. Except where it is otherwise
clear from the discussion, the registrant shall indicate those
balance sheet conditions or income or cash flow items which the
registrant believes may be indicators of its liquidity condition.
Liquidity generally shall be discussed on both a long-term and a
short-term basis. The issue of liquidity shall be discussed in the
context of the registrant's own business or businesses. For example,
a discussion of working capital may be appropriate for certain
manufacturing, industrial or related operations, but might be
inappropriate for a bank or public utility."
In discussions with stockholders and lenders, EBITDA is commonly used as a
liquidity measurement to compare our performance to other companies.
Additionally, our lenders have historically and currently base covenant
calculations on EBITDA as we have defined it in Note 1 to the table on
page 12. Because this is a commonly used measurement of liquidity and
required by our lenders, we believe the disclosure meets the requirements
of S-K. Additionally, the reconciliation in Note 1 makes it easier for the
reader of the financial statements to see the computation rather than
having to pull the data from different parts of the Form 10-K. A
reconciliation of EBITDA to cash flows from operating activities would not
conform to the needs of our financial statement readers as indicated
above. We hereby request your concurrence to retain the current
disclosure.
2. In future 10-K filings, we propose to add to the table deductions from
EBITDA for taxes, interest, capital expenditures, and debt principal
payments to arrive at a cash flow figure net of these payments. This will
enable the financial statement reader to easily see the amount of cash
used for those purposes as compared to EBITDA.
3. The pro forma presentation as if IVC was acquired at the beginning of
2003, as required by Article 11 of Regulation S-X, is shown in Note 3 to
the audited financial statements (page 34 of the 10-K). The tables in
Management's Discussion and Analysis will be revised as requested in
future 10-K filings.
4. Rule 5.03.(b) of Regulation S-X requires separate disclosure of each
revenue class comprising 10% or more of total revenue. Delivery costs
(including mark-up) amounted to the following in 2005 and 2004:
- --------------------------------------------------------------------------------
TOTAL SALES DELIVERY REVENUES %
- --------------------------------------------------------------------------------
2005 $ 66,198,000 $ 3,311,000 5.0%
- --------------------------------------------------------------------------------
2004 $ 63,344,000 $ 3,525,000 5.6%
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
While delivery revenues (freight) are less than 10%, we will supplement
future MD&A explanations with amounts if freight variances are cited, and
we will disclose in footnotes the related amounts if above 10% of
revenues.
5. We will change the heading "Cost of goods sold" to "Cost of services sold"
in future 10-K filings.
6. Twentieth Century Fox is the only customer accounting for 10% or more of
total revenues. This includes all entities under common control of Fox.
The actual amount of revenues for any customer providing in excess of 10%
of total sales will be disclosed in future 10-K filings.
7. The reference to other intangible assets on page 29 will be omitted from
future 10-K filings since all such assets were fully amortized by the end
of 2003. If intangible assets other than goodwill are acquired in the
future, appropriate disclosures will be made.
Please refer to the comments under item 18 below and the attached Schedule
18 for a full explanation of how we have evaluated goodwill. We will
clarify future disclosures as requested.
8. The IVC acquisition price was negotiated at approximately three times
EBITDA. IVC's owners, who were also employees, believed fair value to be
$12 million. However, three times then-current EBITDA indicated a $7
million purchase price. We ultimately agreed to pay the $5 million
difference over 30 months if achieved EBITDA reached agreed levels that
would equate to a "three times" total price. There is no linkage of
continuing employment or length of employment to contingent consideration.
Compensation for continuing employment of IVC stockholders who remained
employees was at fair market levels. In accordance with ETIF 95-8 and
paragraph 34 of SFAS 141, resulting additional payments have been treated
as an increase in the purchase price.
9. We will specifically identify the useful life of each major class of
depreciable asset in our next 10-K.
FORM 10-Q
10. This was implemented in the 10-Q for the quarter ended June 30, 2006.
11. The description was changed to "Proceeds from the sale of Media Center
real estate" in the June 30, 2006 10-Q.
12. This was implemented in the 10-Q for the quarter ended June 30, 2006.
13. The amount of stock based compensation recognized in the first quarter of
2006 is materially lower than the comparable 2005 amount because 2006
compensation related to only 20,000 unvested options. In the 2005 first
quarter, there were approximately 1.2 million unvested options. All
outstanding options as of December 31, 2005 became fully vested on that
date; therefore, there was no further compensation expense to be
recognized after that date for such options. The total number of new
options granted in the first quarter of 2006 (on February 16, 2006) was
20,000, which resulted in compensation expense of less than $1,000 for the
quarter ended March 31, 2006.
14. We will include the appropriate disclosures in future filings.
15. Future filings will be revised to include your suggested changes as
appropriate.
16. Future filings will be revised to include your suggestions as appropriate.
17. Future filings will be revised to address your suggestions.
18. We conduct a detailed test for impairment once yearly in October, and more
frequently if circumstances change. For example, we updated the October
2005 test to reflect the changes resulting from the sale of Media Center
real estate which significantly changed Point.360's capital structure.
Attached for your information is Schedule 18, our December 31, 2005 test
which includes assumptions and analysis. We will be updating this test in
October 2006.
We appreciate your questions and comments with respect to our financial
disclosure. We acknowledge that Point.360 is responsible for the adequacy and
accuracy of disclosures in our filings, that our comments do not foreclose the
commission from taking any action with respect to the filings, and that
Point.360 may not assert staff comments as a defense in any proceeding initiated
by the Commission or any person under the federal securities laws of the United
States.
If you have any questions regarding this communication, please call the
undersigned at 818-565-1444.
Very Truly Yours,
/s/ Alan R. Steel
Alan R. Steel
Executive VP, Finance and Administration
Chief Financial Officer
ARS/rdw
SCHEDULE 18
-----------
VALUATION ANALYSIS IN SUPPORT OF THE
SFAS NO. 142 GOODWILL IMPAIRMENT TEST OF
POINT.360
AS OF
DECEMBER 31, 2005
TABLE OF CONTENTS
Page Number
-----------
1.0 INTRODUCTION..........................................................1
1.1 Purpose......................................................1
1.2 Key Provisions of FAS 142....................................1
1.3 Sources of Information.......................................2
1.4 Procedures...................................................2
2.0 HISTORY AND NATURE OF BUSINESS........................................2
3.0 INDUSTRY OUTLOOK......................................................3
4.0 VALUATION APPROACHES..................................................4
5.0 APPLICATION OF INCOME APPROACH........................................5
5.1 Projected Financial Results..................................6
5.2 Discount Rate................................................8
5.3 Present Value of Estimated Future Cash Flows in Projection
Period.......................................................8
5.4 Income Approach Conclusion...................................8
6.0 CONCLUSION OF BUSINESS ENTERPRISE VALUE...............................9
INDEX TO EXHIBITS
EXHIBIT I FAS 142 Step One Test
EXHIBIT II Summary of Business Enterprise Values
Income Approach - Low Case
Income Approach - Moderate Case
Income Approach - High Case
EXHIBIT III Undiscounted Cash Flow Summary
1.0 INTRODUCTION
1.1 PURPOSE
This impairment test of the goodwill of Point.360 has been performed to assess
the possible impairment of Point.360's intangible assets in accordance with the
provisions of SFAS No. 142 "Goodwill and Other Intangible Assets." This test
follows the initial impairment test (as of January 1, 2002) performed
independently by Standard & Poor's as set forth in its report dated June 7,
2002. A similar test will be performed each September 30, or more often as
circumstances dictate. The same methodology is used in this test (as of December
31, 2005) as is intended to be an update of the S&P valuation.
1.2 KEY PROVISIONS OF FAS 142
Goodwill represents the amount paid to acquire an asset/entity in excess of its
fair market value and represents the intangible value placed on such items as:
customer lists; trademarks; intellectual property; acquired management and
related synergies. Goodwill shall not be amortized, although it will still be
recognized as an asset.
Goodwill shall be tested for impairment annually or more frequently if events or
changes indicate that the asset might be impaired as discussed in paragraph 28
of the statement. Impairment is the condition that exists when the carrying
amount of goodwill exceeds its implied fair value.
Goodwill shall be tested for impairment at a level of reporting referred to as a
reporting segment. Paragraph 30 of the statement defines a reporting unit as an
operating segment or one level below an operating segment (referred to as a
component). A component of an operating segment is a reporting unit if the
component constitutes a business for which discrete financial information is
available and segment management regularly reviews the operating results of that
component. However, two or more components of an operating segment shall be
aggregated and deemed a single reporting unit if the components have similar
economic characteristics. Point.360 is considered a single report unit for
purposes of performing the FAS 142 test.
In performing the test for and quantifying a potential impairment, a two-step
process is used:
o (Step One Test) First, the entity must determine whether an impairment of
the subject assets exists. SFAS No. 142 states that an impairment is
determined by estimating the Fair Value of a reporting unit and comparing
that value to the reporting unit's net carrying value (or book value). If
the Fair Value is more than the carrying amount of the reporting unit, an
impairment loss is not recognized.
o (Step Two Test) Second, if it is determined that an impairment exists,
(i.e., the Fair Value is less than the carrying value of a reporting
unit), the Fair Value of the reporting unit is allocated to all of the
assets and liabilities of that unit, with the excess of Fair Value over
allocated net assets representing the Fair Value of its goodwill. An
impairment loss is measured as the amount by which the carrying value of
the reporting unit's goodwill exceeds the estimated Fair Value of that
goodwill.
1
Point.360 operates in one identifiable reporting unit. Thus, the only entity for
which impairment is tested is Point.360 as a whole.
1.3 SOURCES OF INFORMATION
In the course of the valuation analysis, we used the following:
o Projections including revenues, operating margins (e.g.., earnings before
interest and taxes), working capital investments, and capital expenditures
for Point.360 for the years 2006 through 2008;
o Historical income statement and balance sheet data;
o General business descriptions and information related to Point.360's
markets, competitors, etc.; and
o Published industry data, Stock Reports, Bloomberg.
1.4 PROCEDURES
In general, our procedures included, but were not limited to, the following:
o Review of conditions in, and the economic outlook for the movie and
entertainment industry;
o Review of general market data, including economic, governmental, and
environmental forces, that may affect the value of Point.360;
o Analysis of financial and operating projections including revenues,
operating margins (e.g., earnings before interest and taxes), planned cost
savings, working capital investments, and capital expenditures based on
Point.360's historical operating results and expectations. These
projections have formed the basis for a Discounted Cash Flow analysis.
2.0 HISTORY AND NATURE OF BUSINESS
POINT.360
Point.360 is a provider of video and film asset management services to owners,
producers and distributors of entertainment and advertising content. Point.360
provides the services necessary to edit, master, reformat, archive and
ultimately distribute its clients' video and audio content, including television
programming, feature films, spot advertising and movie trailers.
2
Point.360 provides worldwide electronic distribution, using fiber optics,
satellites, and the Internet. 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 derives revenues primarily from the entertainment industry,
consisting of major and independent motion picture and television studios, cable
television program suppliers and television program syndicators; and the
advertising industry, consisting of advertising agencies and corporate
advertisers. On a more limited basis, the Company also services national
television networks, local television stations, corporate or instructional video
providers, infomercial advertisers and educational institutions.
ACQUISITION HISTORY
Since January 1997, the Company has successfully completed ten acquisitions of
companies providing similar services. As a result of these acquisitions, the
Company is one of the most diversified providers of technical and distribution
services in its markets, and therefore is able to offer its customers a single
source for such services at prices that reflect the Companies' scale economies.
3.0 INDUSTRY OUTLOOK
The creation of feature films and television programs is traditionally divided
into distinct but interrelated phases: production, post production, distribution
and exhibition. Production is the actual recording of visual images on film or
videotape which generally takes place on a physical set or location. Post
production has been generally defined as the various activities required to
prepare a product for commercial release which occur subsequent to production.
Distribution is the process whereby the finished product is delivered, either
physically or electronically, to the specific medium which will exhibit the
product to the consumer, such as a movie theater, television network, cable
channel or prerecorded videotape retailer.
PriceWaterhouseCoopers (PwC), in its 2005 Global Entertainment and Media Outlook
report, estimated the size of the 2004 U.S. motion picture and video production
market for all forms of entertainment and industrial television at $35.0
billion. The size of the worldwide market is estimated at $84.2 billion in 2004,
having grown 8.0% from the year prior, buoyed by continued demand for DVD's but
mitigated somewhat by a drop in box office spending and by continued piracy,
which is cutting into legitimate sales. PwC estimates that worldwide global
filmed entertainment will reach $118.9 billion by 2009, with a compounded annual
growth rate of 7.1%. The U.S. market alone will account for $48.1 billion in
2009. PwC also estimates the size of the U.S. television advertising market at
$31.3 billion in 2004, and will reach a level of $40.0 billion in 2009; a
compounded annual growth rate (CAGR) of 5.0%. The sector will see increased
growth from local cable advertising, which is projected to increase at 11.1%
annually from 2004-2009. The charts below show historical and projected size of
the U.S. filmed entertainment and U.S. television advertising markets:
3
FILMED ENTERTAINMENT(1)
-----------------------
(U.S. $ in Millions)
[GRAPH]
2000 2001 2002 2003 2004p 2005p 2006p 2007p 2008p 2009p
- --------------------------------------------------------------------------------
26,274 28,961 31,703 33,297 34,971 37,240 39,654 42,300 45,303 48,071
TELEVISION ADVERTISING(1)
-------------------------
(U.S. $ in Millions)
[GRAPH]
2000 2001 2002 2003 2004p 2005p 2006p 2007p 2008p 2009p
- --------------------------------------------------------------------------------
29,496 25,438 28,260 28,328 31,291 31,700 34,600 35,100 39,150 40,000
- ---------------------------------------------------------------
(1) Per PwC's Global Entertainment and Media Outlook 2005-2009.
- ---------------------------------------------------------------
4
4.0 VALUATION APPROACHES
Generally accepted valuation theory indicates that all assets, including
intangible assets and goodwill, are valued using a range of methodologies, but
that all methodologies essentially represent combinations of elements of the
following approaches, which themselves are inter-related.
INCOME APPROACH
The Income Approach is a valuation technique that provides an estimation of the
Fair Value of a business based on the cash flows that a business can be expected
to generate. This approach begins with an estimation of the annual cash flows a
prudent investor would expect the subject business to generate over a discrete
projection period. The estimated cash flows for each of the years in the
discrete projection period are then converted to their present value equivalent
using a rate of return appropriate for the risk of achieving the business'
projected cash flows. The present value of the estimated cash flows are then
added to the present value equivalent of the residual value of the business at
the end of the discrete projection period to arrive at an estimate of Fair
Value.
MARKET APPROACH
The Market Approach indicates the Fair Market Value of the Common Stock of a
business by comparing it to publicly traded companies in similar lines of
business. The conditions and prospects of companies in similar lines of business
depend on common factors such as overall demand for their products and services.
An analysis of the market multiples of companies engaged in similar businesses
yields insight into investor perceptions and, therefore, the value of the
subject company.
After identifying and selecting the comparable publicly traded companies, we
analyze their business and financial profiles for relative similarity. Once
these differences and similarities are determined and appropriate adjustments
are made, Market Value of Invested Capital ("MVIC") multiples (i.e. MVIC to
Revenue, MVIC to Earnings Before Interest & Taxes, MVIC to Earnings Before
Interest, Taxes, Depreciation and Amortization) of the publicly traded companies
are calculated.
UNDERLYING ASSETS APPROACH
The Underlying Assets Approach indicates the Fair Value of the Common Stock of a
business by adjusting the asset and liability balances on the Subject Company's
balance sheet to their Fair Value equivalents. The Underlying Assets Approach is
based on the summation of the individual piecemeal values of the underlying
assets. The Fair Value of the equity on a marketable, controlling basis is then
indicated by the sum of the Fair Value of the assets less the Fair Value of the
liabilities. This approach is performed in two steps: (1) the value of each of
the component assets and liabilities are estimated; (2) the net asset value of
the firm is calculated by subtracting the value of the liabilities from the
value of the assets.
5
We utilized the Income Approach in the form of the Discounted Cash Flow analysis
to estimate the Fair Value of Point.360 as of December 31, 2005. The Market
Approach was not utilized due to the lack of companies relative to Point.360
that are publicly traded. The Underlying Assets Approach was not utilized since
Point.360 is a going concern and this approach is typically used for holding
company valuations or where liquidation of the assets is a reasonable prospect.
5.0 APPLICATION OF INCOME APPROACH
The following section details our primary assumptions in the development of the
Income Approach.
5.1 PROJECTED FINANCIAL RESULTS
Projections were prepared for 2006 - 2008. Given the uncertainties in the
marketplace, we prepared three sets of projections: low, moderate, and high, as
well as, the related probabilities to be assigned to each of the scenarios.
Moderate case projections were based on the most likely performance of
Point.360. The high case projections are based on upside potential of Point.360
with increased operating margins and revenue growth. The low case projections
are based on slow economic recovery and downside performance of Point.360 with
possibly lower operating margins and no revenue growth other than for an
impending acquisition.
KEY ASSUMPTIONS
Key assumptions in connection with the projected free cash flows are summarized
below for all three scenarios. Exhibit II illustrates the details of the
Discounted Cash Flow Analysis for all three scenarios.
LOW CASE
o NET SALES - Projected net sales are $71.4 million in 2006, and $71.4
million in 2007 and $71.4 million in 2008.
o COST OF SALES ("COS") - Projected COS (including depreciation and
amortization) as a percentage of net sales are 63.6% in 2006, 63.6% in
2007 and 63.6% in 2008. COS, as a percentage of sales, is forecasted to
reduce to 62.7% for the remainder of the projection period (as annual
depreciation expense falls to the equivalent of annual capital
expenditure).
o OPERATING EXPENSES - Projected operating expenses are approximately 31.9%
of net sales in 2006, 31.9% in 2007 and 31.9% in 2008. Operating expenses
are forecasted to remain at 31.9% for the remainder of the projection
period.
o INCOME TAXES - Income taxes were computed using an effective tax rate of
40%, which is the combined state and federal tax rate, adjusted for
federal deductibility.
6
MODERATE CASE
o NET SALES - Projected net sales are $71.4 million in 2006, increasing to
$74.9 million in 2007 and $77.8 million in 2008. Residual period growth is
projected at 4%.
o COST OF SALES ("COS") - Projected COS (including depreciation and
amortization) as a percentage of net sales are 63.6% in 2006, 62.2% in
2007 and 61.1% in 2008. COS, as a percentage of sales, is forecasted to
reduce to 60.0% for the remainder of the projection period (as annual
depreciation expense falls to the equivalent of annual capital
expenditure).
o OPERATING EXPENSES - Projected operating expenses are approximately 31.9%
of sales in 2006, 31.0% of sales in 2007 and 30.4% of sales in 2008.
Operating expenses, as a percentage of net sales, is forecasted to remain
at 30.0% of sales for the remainder of the projection period.
o INCOME TAXES - Income taxes were computed using an effective tax rate of
40%, which is the combined state and federal tax rate, adjusted for
federal deductibility.
HIGH CASE
o NET SALES - Projected net sales are $71.4 million in 2006, increasing to
$75.0 million in 2007 and $78.7 million in 2008. Residual period growth is
projected at 5%.
o COST OF SALES ("COS") - Projected COS (including depreciation and
amortization) as a percentage of net sales are 63.6% in 2006, 62.2% in
2007 and 60.8% in 2008. COS, as a percentage of net sales, is forecasted
to reduce to 59.5% for the remainder of the projection period (as annual
depreciation expense falls to the equivalent of annual capital
expenditure).
o OPERATING EXPENSES - Projected operating expenses are approximately 31.9%
of net sales in 2006, 31.0% in 2007 and 30.1% in 2008. Operating expenses,
as a percentage of net sales, is forecasted to remain at 29.2% of sales
for the remainder of the projection period.
o INCOME TAXES - Income taxes were computed using an effective tax rate of
40%, which is the combined state and federal tax rate, adjusted for
federal deductibility.
CASH FLOW ADJUSTMENTS
o DEPRECIATION - We added depreciation expense to after tax profit, since
this is an expense that does not require cash outflow.
o CAPITAL EXPENDITURES - We then subtracted anticipated capital
expenditures. Projected capital expenditures are between 3.8% and 4.2% of
net sales in the projection period. Capital expenditures, as a percentage
of net sales, are forecasted to remain approximately at those levels
beyond the projection period.
o RESIDUAL PERIOD - The present value of the residual represents the amount
an investor would pay today for the rights to the cash flows of the
business for years subsequent to the projection period. In calculating the
residual value, a normalized available cash flow was estimated based on
the last year of the projected period. Depreciation, capital expenditures,
and operating working capital investment were normalized to match
long-term expectations of increasing revenues. These cash flows, in the
residual year, were capitalized using a rate calculated by subtracting the
long-term expected annual growth rate from the discount rate.
7
The long-term expected annual growth rate was estimated to be 3.0% in the
low case, 4.0% in the moderate case, and 5.0% in the high case. The
discount rate of 11.0% was the calculated WACC (discussed in Section 5.2
below) used for the purposes of this analysis.
We then applied a present value factor to estimate the present value of
the residual cash flow. We summed the present value of the residual value
and the sum of the present value of available cash flows from 2006 through
2008 to arrive at the indicated values of Point.360 for all three
scenarios. We then weighted the values based on probability factors to
arrive at the indicated value for Point.360's invested capital. The
indicated value of invested capital represents Point.360's value of
long-term interest-bearing debt capital plus equity capital before
consideration of any non-operating assets or liabilities.
5.2 DISCOUNT RATE
The discount rate or Weighted Average Cost of Capital ("WACC") required by
typical investors/lenders for an investment in the capital of Point.360 is
calculated to be 11.0%.
5.3 PRESENT VALUE OF ESTIMATED FUTURE CASH FLOWS IN THE PROJECTION PERIOD
The estimated future cash flows for the fiscal years 2006 - 2008 were discounted
at the calculated WACC of 11.0% for Point.360. While Standard & Poor's used a
discount rate of 13% in its impairment test as of January 1, 2002, we feel that
11.0% is a conservative WACC due to lower interest rates compared to the 2002
period.
5.4 INCOME APPROACH CONCLUSION
Based on the Income Approach summarized above, we have estimated the indicated
Fair Value of the business enterprise of Point.360, as of December 31, 2005. We
have included below a summary of the Business Enterprise Values (`000s):
8
DISCOUNTED CASH FLOW
APPROACH BUSINESS ENTERPRISE
VALUE PROBABILITY FAIR VALUE
------------------- ----------- ----------
LOW CASE $26,000 10.0% $ 2,000
MODERATE CASE $58,000 85.0% $49,300
HIGH CASE $80,000 5.0% $ 4,000
-------
EXPECTED CASE
(ROUNDED) $56,000
=======
The probabilities shown above correspond to our perception regarding the
likelihood of achieving cash flow expectations assumed under each scenario. The
Fair Value of Point.360 above is determined by weighting the probabilities of
value between the low, moderate, and high case scenarios (see Exhibit II for
detail).
6.0 CONCLUSION OF BUSINESS ENTERPRISE VALUE
The enterprise value based on publicly traded data on December 31, 2005 was
approximately $23.4 million ($16.8 million in equity market capitalization (at
$1.79 per share) and $6.6 million in interest bearing debt(after adjusting for
the sale/leaseback of the Media Center). We recognize that shares of Point.360
are extremely thinly traded and there is no significant institutional ownership.
Due to these circumstances, we do not expect the public stock price to be truly
indicative of the Fair Value for Point.360 as of December 31, 2005. Accordingly,
based on these assumptions and the analysis presented in this report and
exhibits, we estimate the Fair Value of Point.360, as defined above to be:
FIFTY SIX MILLION DOLLARS
$56,000,000
9
SFAS NO. 142 - STEP ONE ANALYSIS
SFAS No. 142 states that an impairment is determined by estimating the fair
value of a reporting unit and comparing that value to the reporting unit's
carrying value (or book value). If the fair value is more than the carrying
amount of the reporting unit, an impairment loss is not recognized. Based on the
Step One Test, the book value of equity for Point.360 as of December 31, 2005 is
lower than the respective Fair Value of equity. According to our calculation,
the fair value of equity is $49.4 million (business enterprise value of $56.0
million less $6.6 million of interest bearing liabilities), which is $9.8
million higher than the implied book value of equity of $39.5 million. Since
Point.360 passes the Step One test, it is not required to perform the Step Two
test. See Exhibit I for a summary of the analysis.
For purposes of the cash flow analysis, the current sale/leaseback transaction
of the Media Center, but did not considered potential further enhancements to
improve cash flow, which include the following:
o Sublease the Woodholly facility beginning 4/1/2006 at approximately
$20,000 per month,
o Lease/sublease of 20,000 available square feet at Media Center at
approximately $15,000 per month,
o And sell approximately $80-$100k of fully depreciated Woodholly equipment.
These actions taken by the company would only improve forward-looking cash flow,
and would provide additional cushion to the Step One Analysis of the Goodwill
Impairment Test.
SFAS NO. 121 - ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS
SFAS No. 121 states that the impairment of long-lived assets is determined by
estimating the future cash flows expected to result from the use of the
long-lived assets and their eventual disposition. If the sum of the expected
future cash flows (undiscounted and without interest charges) is more than the
carrying amounts of the assets, an impairment loss is not recognized. We
estimated the undiscounted cash flows for the moderate case scenario to
determine if the long-lived assets of Point.360 would be subject to impairment.
The book value of long-lived assets is less than the sum of undiscounted cash
flows. According to our calculation, the undiscounted cash flow attributable to
total assets is $91.2 million, which is $27.5 million higher than the book value
of total assets of $63.7 million. Therefore, it was determined that the
long-lived assets of Point.360 are not impaired as of December 31, 2005 pursuant
to SFAS 121. See Exhibit III for a summary of the analysis.
10
POINT.360
PROJECTED INCOME STATEMENT ACTUAL % CHANGE
---------------------------
(HIGH ESTIMATE) FY2005 FY2006 FY2007 FY2008 FY2006 FY2007 FY2008
TOTAL TOTAL TOTAL TOTAL
----------- ----------- ----------- -----------
Revenue $66,210,598 $71,426,631 $74,997,963 $78,747,861 7.9% 5.0% 5.0%
Cost of Goods Sold 43,166,735 45,411,444 46,633,012 47,887,440 5.2% 2.7% 2.7%
----------------------------------------------------------- ---------------------------
Gross Margin 23,043,863 26,015,187 28,364,951 30,860,421 12.9% 9.0% 8.8%
% Margin 34.8% 36.4% 37.8% 39.2%
Selling, General & Admin Exp 21,423,626 22,777,609 23,233,161 23,697,824 6.3% 2.0% 2.0%
----------------------------------------------------------- ---------------------------
Operating Income 1,620,237 3,237,578 5,131,790 7,162,596 99.8% 58.5% 39.6%
SG&A% 32.4% 31.9% 31.0% 30.1%
Other Income:
Interest Expense 1,523,776 1,091,026 989,205 889,421 -28.4% -9.3% -10.1%
Theoretical Derivative FV Change -- 0 -- --
Income Taxes 38,582 858,621 1,657,034 2,509,270 2125.4% 93.0% 51.4%
----------------------------------------------------------- ---------------------------
Total Other (Income)/Expense 1,562,358 1,949,647 2,646,239 3,398,691 24.8% 35.7% 28.4%
Net Income 57,879 1,287,931 2,485,550 3,763,905 2125.2% 93.0% 51.4%
Depreciation and Amortization 6,050,362 5,582,065 5,542,339 5,931,185 -7.7% -0.7% 7.0%
EBITDA(1) 7,670,599 8,819,643 10,674,129 13,093,782 15.0% 21.0% 22.7%
% Margin 11.6% 12.3% 14.2% 16.6%
Capital Expenditures 2,466,234 3,000,000 3,000,000 3,000,000 21.6% 0.0% 0.0%
----------------------------------------------------------- ---------------------------
Free Cash Flow(2) 3,642,007 3,869,996 5,027,890 6,695,090 6.3% 29.9% 33.2%
- ------------------------------------
(1) Defined as Operating Income plus Depreciation and Amortization.
(2) Defined as EBITDA less capital expenditures, interest expense, and taxes
11
POINT.360
PROJECTED INCOME STATEMENT ACTUAL % CHANGE
---------------------------
(MODERATE ESTIMATE) FY2005 FY2006 FY2007 FY2008 FY2006 FY2007 FY2008
TOTAL TOTAL TOTAL TOTAL
----------- ----------- ----------- ----------
Revenue $66,210,598 $71,426,631 $74,855,109 $77,849,314 7.9% 4.8% 4.0%
Cost of Goods Sold 43,166,735 45,411,444 46,584,149 47,586,640 5.2% 2.6% 2.2%
----------------------------------------------------------- ---------------------------
Gross Margin 23,043,863 26,015,187 28,270,960 30,262,674 12.9% 8.7% 7.0%
% Margin 34.8% 36.4% 37.8% 38.9%
Selling, General & Admin Exp 21,423,626 22,777,609 23,233,161 23,697,824 6.3% 2.0% 2.0%
----------------------------------------------------------- ---------------------------
Operating Income 1,620,237 3,237,578 5,037,799 6,564,849 99.8% 55.6% 30.3%
SG&A% 32.4% 31.9% 31.0% 30.4%
Other Income:
Interest Expense 1,523,776 1,091,026 989,205 889,421 -28.4% -9.3% -10.1%
Theoretical Derivative FV Change -- -- --
Income Taxes 38,582 858,621 1,619,437 2,270,171 2125.4% 88.6% 40.2%
----------------------------------------------------------- ---------------------------
Total Other (Income)/Expense 1,562,358 1,949,647 2,608,643 3,159,593 24.8% 33.8% 21.1%
Net Income 57,879 1,287,931 2,429,156 3,405,257 2125.2% 88.6% 40.2%
Depreciation and Amortization 6,050,362 5,582,065 5,542,339 5,931,185 -7.7% -0.7% 7.0%
EBITDA(1) 7,670,599 8,819,643 10,580,138 12,496,035 15.0% 20.0% 18.1%
% Margin 11.6% 12.3% 14.1% 16.1%
Capital Expenditures 2,466,234 3,000,000 3,000,000 3,000,000 21.6% 0.0% 0.0%
----------------------------------------------------------- ---------------------------
Free Cash Flow(2) 3,642,007 3,869,996 4,971,496 6,336,442 6.3% 28.5% 27.5%
- ------------------------------------
(1) Defined as Operating Income plus Depreciation and Amortization.
(2) Defined as EBITDA less capital expenditures, interest expense, and taxes
ASSUMPTIONS:
1. 2006 approved budget is used....included in the budget is the full year
impact of Visual Sound ($2mil), no acquisitions are included. AS A NOTE, THE
PERCENTAGE INCREASE FOR 2006 WOULD HAVE BEEN 4.8% IF VISUAL SOUND WAS EXCLUDED.
2. 2007 incorporated a 4.8% increase to reflect normalized increase from core
growth. No acquistions are factored in.
3. 2008's growth is reduced to be conservative
12
POINT.360
PROJECTED INCOME STATEMENT ACTUAL % CHANGE
---------------------------
(LOW ESTIMATE) FY2005 FY2006 FY2007 FY2008 FY2006 FY2007 FY2008
TOTAL TOTAL TOTAL TOTAL
----------- ----------- ----------- -----------
Revenue $66,210,598 $71,426,631 $71,426,631 $71,426,631 7.9% 0.0% 0.0%
Cost of Goods Sold 43,166,735 45,411,444 45,411,444 45,411,444 5.2% 0.0% 0.0%
----------------------------------------------------------- ---------------------------
Gross Margin 23,043,863 26,015,187 26,015,187 26,015,187 12.9% 0.0% 0.0%
% Margin 34.8% 36.4% 36.4% 36.4%
Selling, General & Admin Exp 21,423,626 22,777,609 22,777,609 22,777,609 6.3% 0.0% 0.0%
----------------------------------------------------------- ---------------------------
Operating Income 1,620,237 3,237,578 3,237,578 3,237,578 99.8% 0.0% 0.0%
SG&A% 32.4% 31.9% 31.9% 31.9%
Other Income:
Interest Expense 1,523,776 1,091,026 989,205 889,421 -28.4% -9.3% -10.1%
Theoretical Derivative FV Change -- -- -- --
Income Taxes 38,582 858,621 899,349 939,263 2125.4% 4.7% 4.4%
----------------------------------------------------------- ---------------------------
Total Other (Income)/Expense 1,562,358 1,949,647 1,888,554 1,828,684 24.8% -3.1% -3.2%
Net Income 57,879 1,287,931 1,349,024 1,408,894 2125.2% 4.7% 4.4%
Depreciation and Amortization 6,050,362 5,582,065 5,542,339 5,931,185 -7.7% -0.7% 7.0%
EBITDA(1) 7,670,599 8,819,643 8,779,917 9,168,763 15.0% -0.5% 4.4%
% Margin 11.6% 12.3% 12.3% 12.8%
Capital Expenditures 2,466,234 3,000,000 3,000,000 3,000,000 21.6% 0.0% 0.0%
----------------------------------------------------------- ---------------------------
Free Cash Flow(2) 3,642,007 3,869,996 3,891,363 4,340,079 6.3% 0.6% 11.5%
- ------------------------------------
(1) Defined as Operating Income plus Depreciation and Amortization.
(2) Defined as EBITDA less capital expenditures, interest expense, and taxes
ASSUMPTIONS:
1. 2006 approved budget is used....included in the budget is the full year
impact of Visual Sound ($2mil), no acquisitions are included. AS A NOTE, THE
PERCENTAGE INCREASE FOR 2006 WOULD HAVE BEEN 4.8% IF VISUAL SOUND WAS EXCLUDED.
2. 2007 and 2008 assumes no growth. No acquistions are factored in.
13
POINT.360 EXHIBIT I
SFAS 142 GOODWILL IMPAIRMENT TEST PAGE 1 OF 3
VALUATION DATE: DECEMBER 31, 2005
SUMMARY OF VALUES - STEP ONE TEST
($000's except for percentages)
================================================================================
EQUITY VALUATION ASSESSMENT POINT.360
---------
Business Enterprise Value $ 56,000
Less: BV of Short Term Interest Bearing Liabilities (2,540)
Borrowings under credit agreement 477
Current portion of capital lease oblig. and notes payable 2,063
Less: BV of Long Term Interest Bearing Liabilities (4,045)
Borrowings under credit agreement 4,000
Capital Lease obligations, less current portion 45
--------
FAIR VALUE OF EQUITY 49,415
PRELIMINARY CALCULATION OF POTENTIAL IMPAIRMENT (PER MANAGEMENT)
Book Value of Total Assets 63,772
Less: Current Liabilities (17,646)
Accounts Payable 3,974
Accrued Expenses & Other 6,564
Current & Deferred Taxes 7,107
Less: BV of Short Term Interest Bearing Liabilities (2,540)
Borrowings under credit agreement 477
Current portion of capital lease oblig. and notes payable 2,063
Less: BV of Long Term Interest Bearing Liabilities (4,045)
Borrowings under credit agreement 4,000
Capital Lease obligations, less current portion 45
--------
IMPLIED EQUITY VALUE 39,541
IMPAIRMENT TEST 9,873
--------
IMPAIRMENT TEST RESULTS (PASS/FAIL) PASS
========
Effective cost of Capital
-------------------------
Amount Rate Interest
------ ---- --------
Total 39,541 11.0% 4,349.71
- Debt 6,585 8.0% 526.84
- Equity 32,956 11.6% 3,822.88
8.0% Average Borrowing Rate
11.6% Expected Return from Investors
14
POINT.360 EXHIBIT I
SFAS 142 GOODWILL IMPAIRMENT TEST PAGE 2 OF 3
VALUATION DATE: DECEMBER 31, 2005
SUMMARY OF VALUES - STEP ONE TEST
($000's except for percentages)
================================================================================
VALUE BASED ON DISCOUNTED CASH FLOW MODEL:
Fair Value of Point.360 $56,000
(Controlling, Marketable)
Plus: Excess Cash --
-------
ADJUSTED FAIR VALUE 56,000
(CONTROLLING, MARKETABLE)
CONCLUDED FAIR VALUE OF INVESTED CAPITAL $56,000
=======
(BASED ON DCF APPROACH)
15
POINT.360 EXHIBIT I
SFAS 142 GOODWILL IMPAIRMENT TEST PAGE 3 OF 3
VALUATION DATE: DECEMBER 31, 2005
SUMMARY OF VALUES - STEP ONE TEST
================================================================================
SALES/ REVISED
BALANCE SHEET 12/31/2005 LEASEBACK 12/31/2005
------------------------------------------------------------------------------------------
Current Assets:
Cash and cash equiv 594,552 594,552
A/R 12,661,650 12,661,650
Other receivables 203,792 203,792
Inventories 795,719 795,719
Prepaid Expenses and other current assets 654,265 654,265
Deferred Income taxes 1,309,968 867,962 2,177,930
----------- -----------
TOTAL CURRENT ASSETS 16,219,946 17,087,908
PPE, net 28,078,871 (11,460,636) 16,618,235
Other assets, net 592,817 592,817
Goodwill and other intang., net 29,473,466 29,473,466
----------- -----------
TOTAL ASSETS 74,365,100 63,772,426
=========== ===========
Current Liabilities:
Accounts Payable 3,974,292 3,974,292
Accrued expenses 4,394,364 4,394,364
Borrowings under revolving credit agreement 4,054,028 (3,577,115) 476,913
Current portion of notes payable 2,309,691 (309,691) 2,000,000
Current portion of capital lease oblig 63,097 63,097
Income Taxes Payable 1,230,801 867,962 2,098,763
----------- -----------
TOTAL CURRENT LIABILITIES 16,026,273 13,007,429
----------- -----------
Deferred Gain on Sales of Media Center 2,169,904 2,169,904
Deferred income taxes 5,008,338 5,008,338
Notes payable 13,743,734 (9,743,734) 4,000,000
Capital lease obligations, less current portion 45,451 45,451
Shareholders equity
Preferred stock -- 0
Capital Stock 19,116,838 19,116,838
Distributions (5,609,643) (5,609,643)
Current Earnings 57,879 57,879
Retained Earnings 25,976,230 25,976,230
----------- -----------
TOTAL SHAREHOLDERS' EQUITY 39,541,304 39,541,304
TOTAL LIABILITIES AND SE 74,365,100 63,772,426
=========== ===========
16
POINT.360 Exhibit II
SFAS 142 GOODWILL IMPAIRMENT TEST
VALUATION DATE: DECEMBER 31, 2005
BUSINESS ENTERPRISE VALUE SUMMARY
($000's)
================================================================================
DISCOUNTED CASH FLOW APPROACH BUSINESS ENTERPRISE
VALUE PROBABILITY FAIR VALUE
------------------- ----------- ----------
LOW CASE $26,000 10.0% $ 2,600
MODERATE CASE $58,000 85.0% $49,300
HIGH CASE $80,000 5.0% $ 4,000
-------
EXPECTED CASE (ROUNDED) 100.0% $56,000
=======
CONCLUDED BUSINESS ENTERPRISE VALUE $56,000
17
POINT.360 Exhibit II
SFAS 142 GOODWILL IMPAIRMENT TEST
VALUATION DATE: DECEMBER 31, 2005
BUSINESS ENTERPRISE VALUE (LOW)
($000's)
================================================================================
--------------------------------------------------------------
PROJECTIONS FOR FYE DECEMBER 31,
--------------------------------------------------------------
2005(A) 2006 2007 2008 RESIDUAL
--------------------------------------------------------------
TOTAL REVENUE 66,211 71,427 71,427 71,427 73,569
Growth Rate 7.9% 0.0% 0.0% 3.0%
COST OF SALES 43,167 45,411 45,411 45,411 46,138
- ----------------------------------------------------------------------------------------------------------
GROSS PROFIT 23,044 26,015 26,015 26,015 27,431
- ----------------------------------------------------------------------------------------------------------
OPERATING EXPENSES: 31.9% 31.9% 31.9% 31.9%
Total Operating Expenses 21,424 22,778 22,778 22,778 23,461
--------------------------------------------------------------
Total Operating Expenses 21,424 22,778 22,778 22,778 23,461
- ----------------------------------------------------------------------------------------------------------
OPERATING INCOME (EBIT) 1,620 3,238 3,238 3,238 3,970
- ----------------------------------------------------------------------------------------------------------
Operating Income as % of Revenue 2% 5% 5% 5% 5%
Income Taxes, Interest, & Other Expense 1,562 1,950 1,889 1,829 2,030
- ----------------------------------------------------------------------------------------------------------
NET PROFIT AFTER TAXES 58 1,288 1,349 1,409 1,940
- ----------------------------------------------------------------------------------------------------------
Cash Flow
Plus: Depreciation & Amortization 5,582 5,542 5,931 2,750
Less: Capital Expenditures (3,000) (3,000) (3,000) (2,750)
Less: Working Capital Investment (782) -- -- (321)
-----------------------------------------------
Available Cash Flow 3,088 3,891 4,340 1,619
4.3% 5.4% 6.1% 2.2%
Partial Period 1.0000 1.0000 1.0000
MidYear Period 0.5000 1.5000 2.5000
Present Value Factor @ 11.0% 0.9492 0.8551 0.7704
PRESENT VALUE OF AVAILABLE CASH FLOWS 2,931 3,327 3,343
Sum of Present Value of Available Cash Flows 9,601
GORDON
GROWTH
------
Sum of Present Value Cash Flows 9,601
Present Value of Residual Value 15,588
Depreciation Overhang Tax Benefit 739
------
Business Enterprise Value 25,928
------
BUSINESS ENTERPRISE VALUE (ROUNDED) 26,000
------
(A) - Estimated at 9/30/2005
Gordon Growth Approach
- --------------------------------------
Residual Calculation
Available Cash Flow 1,619
Discount Rate 11.0%
Growth Rate 3.0%
-----------
K-G 8.0%
Residual Year Value 20,235
Present Value Factor 0.7704
PV of Residual Value 15,588
- --------------------------------------
18
POINT.360 Exhibit II
SFAS 142 GOODWILL IMPAIRMENT TEST
VALUATION DATE: DECEMBER 31, 2005
BUSINESS ENTERPRISE VALUE (LOW) - COMMON SIZE
(000's)
================================================================================
----------------------------------------------------
PROJECTIONS FOR FYE DECEMBER 31,
----------------------------------------------------
2005(A) 2006 2007 2008 RESIDUAL
----------------------------------------------------
- -----------------------------------------------------------------------------------------------
TOTAL REVENUE 100.0% 100.0% 100.0% 100.0% 100.0%
- -----------------------------------------------------------------------------------------------
COST OF SALES 65.2% 63.6% 63.6% 63.6% 62.7%
- -----------------------------------------------------------------------------------------------
GROSS PROFIT 34.8% 36.4% 36.4% 36.4% 37.3%
- -----------------------------------------------------------------------------------------------
OPERATING EXPENSES:
Total Operating Expenses 32.0% 31.9% 31.9% 31.9% 31.9%
----------------------------------------------------
- -----------------------------------------------------------------------------------------------
OPERATING INCOME (EBIT) 2.8% 4.5% 4.5% 4.5% 5.4%
- -----------------------------------------------------------------------------------------------
Interest & Taxes 2.4% 2.7% 2.6% 2.6% 2.8%
- -----------------------------------------------------------------------------------------------
NET PROFIT AFTER TAXES 0.4% 1.8% 1.9% 2.0% 2.6%
- -----------------------------------------------------------------------------------------------
Cash Flow
Plus: Depreciation & Amortization 7.8% 7.8% 8.3% 3.7%
Less: Capital Expenditures -4.2% -4.2% -4.2% -3.7%
Less: Working Capital Investment -1.1% 0.0% 0.0% -0.4%
------------------------------------------
Available Cash Flow 4.3% 5.4% 6.1% 2.2%
(A) - Estimated at 9/30/2005
19
POINT.360 Exhibit II
SFAS 142 GOODWILL IMPAIRMENT TEST
VALUATION DATE: DECEMBER 31, 2005
ASSUMPTIONS (LOW)
($000's)
================================================================================
Tax Rate 40.0% Valuation Date 9/30/2005
Residual Growth Rate 0.0% Days in Period 0
WARR (Overall) 13.0%
-----------------------------------------------------------------
PROJECTIONS FOR FYE DECEMBER 31,
-----------------------------------------------------------------
2005(A) 2006 2007 2008 RESIDUAL
-----------------------------------------------------------------
REVENUE
TOTAL REVENUE 66,211 71,427 71,427 71,427 73,569
-----------------------------------------------------------------
Revenue Growth 7.9% 0.0% 0.0% 3.0%
-----------------------------------------------------------------
COGS
ACTUAL COGS 43,167 45,411 45,411 45,411 46,138
-----------------------------------------------------------------
COGS % 65.2% 63.6% 63.6% 63.6% 62.7%
-----------------------------------------------------------------
OPERATING EXPENSES:
TOTAL OPERATING EXPENSES 21,424 22,778 22,778 22,778 23,461
-----------------------------------------------------------------
Total Operating Expenses 32.4% 31.9% 31.9% 31.9% 31.9%
-----------------------------------------------------------------
CAPITAL EXPENDITURES 3,000 3,000 3,000 2,750
-----------------------------------------------------------------
Capital Expenditures (%) 4.2% 4.2% 4.2% 3.7%
-----------------------------------------------------------------
WORKING CAPITAL 9,932 10,714 10,714 10,714 11,035
-----------------------------------------------------------------
Change in working cap (782) -- -- (321)
Change % of annual revenue 0.0% -1.1% 0.0% 0.0% -0.4%
Change % of change in revenue 15.0% #DIV/0! #DIV/0! 15.0%
-----------------------------------------------------------------
WC % Revenue 15.0% 15.0% 15.0% 15.0% 15.0%
-----------------------------------------------------------------
------
Partial Period adjustment -- 1.0000 1.0000 1.0000 1.0000
------
Mid-Period adjustment -- 0.5000 1.5000 2.5000 3.5000
(A) - Estimated at 9/30/2005
20
POINT.360 Exhibit II
SFAS 142 GOODWILL IMPAIRMENT TEST
VALUATION DATE: DECEMBER 31, 2005
BUSINESS ENTERPRISE VALUE (MODERATE)
($000's)
================================================================================
----------------------------------------------------------
PROJECTIONS FOR FYE DECEMBER 31,
----------------------------------------------------------
2005(A) 2006 2007 2008 RESIDUAL
----------------------------------------------------------
TOTAL REVENUE 66,211 71,427 74,855 77,849 80,963
Growth Rate 7.9% 4.8% 4.0% 4.0%
COST OF SALES 43,167 45,411 46,584 47,587 48,538
- ---------------------------------------------------------------------------------------------------------------
GROSS PROFIT 23,044 26,015 28,271 30,263 32,425
- ---------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES: 31.9% 31.0% 30.4% 30.0%
Total Operating Expenses 21,424 22,778 23,233 23,698 24,290
----------------------------------------------------------
Total Operating Expenses 21,424 22,778 23,233 23,698 24,290
- ---------------------------------------------------------------------------------------------------------------
OPERATING INCOME (EBIT) 1,620 3,238 5,038 6,565 8,135
- ---------------------------------------------------------------------------------------------------------------
Operating Income as % of Revenue 2% 5% 7% 8% 10%
Income Taxes, Interest, & Other Expense 1,562 1,950 2,609 3,160 3,704
- ---------------------------------------------------------------------------------------------------------------
NET PROFIT AFTER TAXES 58 1,288 2,429 3,405 4,430
- ---------------------------------------------------------------------------------------------------------------
Cash Flow
Plus: Depreciation & Amortization 5,582 5,542 5,931 3,250
Less: Capital Expenditures (3,000) (3,000) (3,000) (3,000)
Less: Working Capital Investment (782) (514) (449) (467)
----------------------------------------------------------
Available Cash Flow 3,088 4,457 5,887 4,213
4.3% 6.0% 7.6% 5.2%
Partial Period 1.0000 1.0000 1.0000
MidYear Period 0.5000 1.5000 2.5000
Present Value Factor @ 11.0% 0.9492 0.8551 0.7704
PRESENT VALUE OF AVAILABLE CASH FLOWS 2,931 3,811 4,535
Sum of Present Value of Available Cash Flows 11,277
GORDON
GROWTH
------
Sum of Present Value Cash Flows 11,277
Present Value of Residual Value 46,365
Depreciation Overhang Tax Benefit 739
------
Business Enterprise Value 58,381
------
BUSINESS ENTERPRISE VALUE (ROUNDED) 58,000
------
(A) - Estimated at 9/30/2005
Gordon Growth Approach
- ------------------------------------
Residual Calculation
Available Cash Flow 4,213
Discount Rate 11.0%
Growth Rate 4.0%
--------
K-G 7.0%
Residual Year Value 60,187
Present Value Factor 0.7704
PV of Residual Value 46,365
21
POINT.360 Exhibit II
SFAS 142 GOODWILL IMPAIRMENT TEST
VALUATION DATE: DECEMBER 31, 2005
ASSUMPTIONS (MODERATE)
($000's)
================================================================================
Tax Rate 40.0% Valuation Date 9/30/2005
Residual Growth Rate 0.0% Days in Period 0
WARR (Overall) 13.0%
-----------------------------------------------------------------------
PROJECTIONS FOR FYE DECEMBER 31,
-----------------------------------------------------------------------
2005(A) 2006 2007 2008 RESIDUAL
-----------------------------------------------------------------------
REVENUE
TOTAL REVENUE 66,211 71,427 74,855 77,849 80,963
-----------------------------------------------------------------------
Revenue Growth 7.9% 4.8% 4.0% 4.0%
-----------------------------------------------------------------------
COGS
ACTUAL COGS 43,167 45,411 46,584 47,587 48,538
-----------------------------------------------------------------------
COGS % 65.2% 63.6% 62.2% 61.1% 60.0%
-----------------------------------------------------------------------
OPERATING EXPENSES:
TOTAL OPERATING EXPENSES 21,424 22,778 23,233 23,698 24,290
-----------------------------------------------------------------------
Total Operating Expenses 32.4% 31.9% 31.0% 30.4% 30.0%
-----------------------------------------------------------------------
CAPITAL EXPENDITURES 3,000 3,000 3,000 3,000
-----------------------------------------------------------------------
Capital Expenditures (%) 4.2% 4.0% 3.9% 3.7%
-----------------------------------------------------------------------
WORKING CAPITAL 9,932 10,714 11,228 11,677 12,144
-----------------------------------------------------------------------
Change in working cap (782) (514) (449) (467)
Change % of annual revenue 0.0% -1.1% -0.7% -0.6% -0.6%
Change % of change in revenue 15.0% 15.0% 15.0% 15.0%
-----------------------------------------------------------------------
WC % Revenue 15.0% 15.0% 15.0% 15.0% 15.0%
-----------------------------------------------------------------------
------
Partial Period adjustment -- 1.0000 1.0000 1.0000 1.0000
------
Mid-Period adjustment -- 0.5000 1.5000 2.5000 3.5000
(A) - Estimated at 9/30/2005
22
POINT.360 Exhibit II
SFAS 142 GOODWILL IMPAIRMENT TEST
VALUATION DATE: DECEMBER 31, 2005
BUSINESS ENTERPRISE VALUE (HIGH)
($000's)
================================================================================
----------------------------------------------------
PROJECTIONS FOR FYE DECEMBER 31,
----------------------------------------------------
2005(A) 2006 2007 2008 RESIDUAL
----------------------------------------------------
TOTAL REVENUE 66,211 71,427 74,998 78,748 82,685
Growth Rate 7.9% 5.0% 5.0% 5.0%
COST OF SALES 43,167 45,411 46,633 47,887 49,176
- -----------------------------------------------------------------------------------------------
GROSS PROFIT 23,044 26,015 28,365 30,860 33,510
- -----------------------------------------------------------------------------------------------
OPERATING EXPENSES: 31.9% 31.0% 30.1% 29.2%
Total Operating Expenses 21,424 22,778 23,233 23,698 24,172
----------------------------------------------------
Total Operating Expenses 21,424 22,778 23,233 23,698 24,172
- -----------------------------------------------------------------------------------------------
OPERATING INCOME (EBIT) 1,620 3,238 5,132 7,163 9,338
- -----------------------------------------------------------------------------------------------
Operating Income as % of Revenue 2.4% 4.5% 6.8% 9.1% 11.3%
Income Taxes, Interest, & Other Expense 1,562 1,950 2,646 3,399 4,192
- -----------------------------------------------------------------------------------------------
NET PROFIT AFTER TAXES 58 1,288 2,486 3,764 5,146
- -----------------------------------------------------------------------------------------------
Cash Flow
Plus: Depreciation & Amortization 5,582 5,542 5,931 3,750
Less: Capital Expenditures (3,000) (3,000) (3,000) (3,000)
Less: Working Capital Investment (782) (536) (562) (591)
------------------------------------------
Available Cash Flow 3,088 4,492 6,133 5,306
4.3% 6.0% 7.8% 6.4%
Partial Period 1.0000 1.0000 1.0000
MidYear Period 0.5000 1.5000 2.5000
Present Value Factor @ 11.0% 0.9492 0.8551 0.7704
PRESENT VALUE OF AVAILABLE CASH FLOWS 2,931 3,841 4,724
Sum of Present Value of Available Cash Flows 11,496
GORDON
GROWTH
------
Sum of Present Value Cash Flows 11,496
Present Value of Residual Value 68,116
Depreciation Overhang Tax Benefit 739
------
Business Enterprise Value 80,351
------
BUSINESS ENTERPRISE VALUE (ROUNDED) 80,000
------
(A) - Estimated at 9/30/2005
Gordon Growth Approach
- ------------------------------------
Residual Calculation
Available Cash Flow 5,306
Discount Rate 11.0%
Growth Rate 5.0%
---------
K-G 6.0%
Residual Year Value 88,422
Present Value Factor 0.7704
PV of Residual Value 68,116
23
POINT.360 Exhibit II
SFAS 142 GOODWILL IMPAIRMENT TEST
VALUATION DATE: DECEMBER 31, 2005
BUSINESS ENTERPRISE VALUE (MODERATE) - COMMON SIZE
(000's)
================================================================================
----------------------------------------------------
PROJECTIONS FOR FYE DECEMBER 31,
----------------------------------------------------
2005(A) 2006 2007 2008 RESIDUAL
----------------------------------------------------
- -----------------------------------------------------------------------------------------------
TOTAL REVENUE 100.0% 100.0% 100.0% 100.0% 100.0%
- -----------------------------------------------------------------------------------------------
COST OF SALES 65.2% 63.6% 62.2% 61.1% 60.0%
- -----------------------------------------------------------------------------------------------
GROSS PROFIT 34.8% 36.4% 37.8% 38.9% 40.0%
- -----------------------------------------------------------------------------------------------
OPERATING EXPENSES:
Total Operating Expenses 32.4% 31.9% 31.0% 30.4% 30.0%
----------------------------------------------------
- -----------------------------------------------------------------------------------------------
OPERATING INCOME (EBIT) 2.4% 4.5% 6.7% 8.4% 10.0%
- -----------------------------------------------------------------------------------------------
Interest & Taxes 2.4% 2.7% 3.5% 4.1% 4.6%
- -----------------------------------------------------------------------------------------------
NET PROFIT AFTER TAXES 0.1% 1.8% 3.2% 4.4% 5.5%
- -----------------------------------------------------------------------------------------------
Cash Flow
Plus: Depreciation & Amortization 7.8% 7.4% 7.6% 4.0%
Less: Capital Expenditures -4.2% -4.0% -3.9% -3.7%
Less: Working Capital Investment -1.1% -0.7% -0.6% -0.6%
------------------------------------------
Available Cash Flow 4.3% 6.0% 7.6% 5.2%
(A) - Estimated at 9/30/2005
24
POINT.360 Exhibit II
SFAS 142 GOODWILL IMPAIRMENT TEST
VALUATION DATE: DECEMBER 31, 2005
ASSUMPTIONS (HIGH)
($000's)
================================================================================
Tax Rate 40.0% Valuation Date 9/30/2005
Residual Growth Rate 0.0% Days in Period 0
WARR (Overall) 13.0%
----------------------------------------------------
PROJECTIONS FOR FYE DECEMBER 31,
----------------------------------------------------
2005(A) 2006 2007 2008 RESIDUAL
----------------------------------------------------
REVENUE
TOTAL REVENUE 66,211 71,427 74,998 78,748 82,685
----------------------------------------------------
Revenue Growth 7.9% 5.0% 5.0% 5.0%
----------------------------------------------------
COGS
ACTUAL COGS 43,167 45,411 46,633 47,887 49,176
----------------------------------------------------
COGS % 65.2% 63.6% 62.2% 60.8% 59.5%
----------------------------------------------------
OPERATING EXPENSES:
TOTAL OPERATING EXPENSES 21,424 22,778 23,233 23,698 24,172
----------------------------------------------------
Total Operating Expenses 32.4% 31.9% 31.0% 30.1% 29.2%
----------------------------------------------------
CAPITAL EXPENDITURES 3,000 3,000 3,000 3,000
----------------------------------------------------
Capital Expenditures (%) 4.2% 4.0% 3.8% 3.6%
----------------------------------------------------
WORKING CAPITAL 9,932 10,714 11,250 11,812 12,403
----------------------------------------------------
Change in working cap (782) (536) (562) (591)
Change % of annual revenue 0.0% -1.1% -0.7% -0.7% -0.7%
Change % of change in revenue 15.0% 15.0% 15.0% 15.0%
----------------------------------------------------
WC % Revenue 15.0% 15.0% 15.0% 15.0% 15.0%
----------------------------------------------------
----------
Partial Period adjustment -- 1.0000 1.0000 1.0000 1.0000
----------
Mid-Period adjustment -- 0.5000 1.5000 2.5000 3.5000
(A) - Estimated at 9/30/2005
25
POINT.360 Exhibit III
SFAS 142 GOODWILL IMPAIRMENT TEST Page 1 of 1
VALUATION DATE: DECEMBER 31, 2005
FAS 121 TEST - IMPAIRMENT OF LONG-LIVED ASSETS
($000's execept for percentages
================================================================================
Moderate Case
Sum of Undiscounted Cash Flows $73,619
Add: Current Liabilities $17,646
Accounts Payable $ 3,974
Accrued Expenses $ 6,564
Other $ 7,107
CASH FLOW TO TOTAL ASSETS $91,265
BOOK VALUE OF TOTAL ASSETS $63,772
-------
CASH FLOW OF ASSETS LESS BOOK VALUE OF ASSETS $27,492
TEST NO IMPAIRMENT
26
POINT.360
FAS 142
Correlation coifficient (COGS vs Sales Changes)
SALES COGS G.P.
----- ---- ----
Jan-05 5,276,445 3,749,723 71.1% 1,526,722
Feb-05 5,188,408 3,675,249 70.8% 1,513,159
Mar-05 6,718,258 3,976,788 59.2% 2,741,470
Apr-05 5,118,516 3,495,395 68.3% 1,623,121
May-05 5,111,736 3,773,308 73.8% 1,338,428
Jun-05 5,659,828 3,359,460 59.4% 2,300,368
Jul-05 4,696,404 3,412,800 72.7% 1,283,604
Aug-05 6,325,626 3,711,829 58.7% 2,613,797
Sep-05 5,726,089 3,658,594 63.9% 2,067,495
Oct-05 5,312,953 3,409,638 64.2% 1,903,315
Nov-05 5,452,732 3,482,121 63.9% 1,970,611
Dec-05 5,623,605 3,461,832 61.6% 2,161,773 0.5380 Correlation coifficient (COGS vs Sales Changes)
66,210,600 43,166,737 65.2%
POINT.360
Media Center
Sale/Leaseback Deal
DEBIT CREDIT
----- ------
Loan 7,454,991
B of A Mortgage 6,175,549
Accumulated Depreciation 211,364
Deferred Tax Assets 867,962
Fixed Assets 11,672,000
Deferred Gain 2,169,904
Taxes Payable 867,962
14,709,866 14,709,866
27