UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





(Mark
One)





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





For the
quarterly period ended December 31, 2008 or





o   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 001-33468





Point.360





(Exact
Name of Registrant as Specified in Its Charter)





California
                  (State
      or other jurisdiction of
                  incorporation
      or organization)
                01-0893376
                  (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.





þ  Yes                 ̈  No





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.  (Check one):





Large
      accelerated filer    o
                Accelerated
      filer   oNon-accelerated
      filer   o
                Smaller
      reporting company    þ





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





o  Yes                þ  No





As of
December 31, 2008, there were 10,391,500 shares of the registrant’s common stock
outstanding.








PART
I – FINANCIAL INFORMATION




ITEM
1.  FINANCIAL STATEMENTS


POINT.360


CONSOLIDATED
BALANCE SHEETS





June 30,
                          
                          
                          December 31,2008
                          
                          
                          2008(unaudited)AssetsCurrent
      assets:Cash
      and cash equivalents
                          
                          $
                          13,056,000
                          
                          
                          $
                          8,252,000Accounts
      receivable, net of allowances for doubtful accounts of $541,000 and
      $555,000, respectively
                          
                          
                          6,971,000
                          
                          
                          
                          9,269,000Inventories,
      net
                          
                          
                          502,000
                          
                          
                          
                          402,000Prepaid
      expenses and other current assets
                          
                          
                          667,000
                          
                          
                          
                          713,000Prepaid
      income taxes
                          
                          
                          1,441,000
                          
                          
                          
                          1,778,000Deferred
      income taxes
                          
                          
                          490,000
                          
                          
                          
                          490,000Total
      current assets
                          
                          
                          23,127,000
                          
                          
                          
                          20,903,000Property
      and equipment, net
                          
                          
                          8,667,000
                          
                          
                          
                          15,319,000Deferred
      income taxes
                          
                          
                          210,000
                          
                          
                          
                          428,000Other
      assets, net
                          
                          
                          533,000
                          
                          
                          
                          352,000Goodwill
                          
                          
                          9,820,000
                          
                          
                          
                          9,961,000Total
      assets
                          
                          $
                          42,358,000
                          
                          
                          $
                          46,964,000Liabilities and Shareholders’
      EquityCurrent
      liabilities:Accounts
      payable
                          
                          $
                          1,716,000
                          
                          
                          $
                          1,626,000Accrued
      wages and benefits
                          
                          
                          2,109,000
                          
                          
                          
                          1,431,000Other
      accrued expenses
                          
                          
                          816,000
                          
                          
                          
                          1,108,000Current
      portion of borrowings under notes payable
                          
                          
                          1,810,000
                          
                          
                          
                          1,920,000Current
      portion of deferred gain on sale of real estate
                          
                          
                          178,000
                          
                          
                          
                          178,000Total
      current liabilities
                          
                          
                          6,631,000
                          
                          
                          
                          6,263,000Notes
      payable, less current portion
                          
                          
                          2,839,000
                          
                          
                          
                          7,908,000Deferred
      gain on sale of real estate, less current portion
                          
                          
                          2,089,000
                          
                          
                          
                          2,000,000Total
      long-term liabilities
                          
                          
                          4,928,000
                          
                          
                          
                          9,908,000Total
      liabilities
                          
                          
                          11,558,000
                          
                          
                          
                          16,171,000Commitments
      and contingencies
                          
                          
                          -
                          
                          
                          
                          -Shareholders’
      equityPreferred
      stock – no par value; 5,000,000 shares authorized; none
      outstanding
                          
                          
                          -
                          
                          
                          
                          -Common
      stock – no par value; 50,000,000 shares authorized; 10,553,410 and
      10,391,500 shares issued and outstanding, respectively
                          
                          
                          21,583,000
                          
                          
                          
                          21,337,000Additional
      paid-in capital
                          
                          
                          9,320,000
                          
                          
                          
                          9,437,000Retained
      earnings (deficit)
                          
                          
                          (103,000
                          )
                          
                          
                          19,000Total
      shareholders’ equity
                          
                          
                          30,800,000
                          
                          
                          
                          30,793,000Total
      liabilities and shareholders’ equity
                          
                          $
                          42,358,000
                          
                          
                          $
                          46,964,000





See
accompanying notes to consolidated financial statements.


2





POINT.360





CONSOLIDATED
STATEMENTS OF INCOME (LOSS)


(Unaudited)




Three Months Ended
                              December 31,
                            
                            
                            Six Months Ended
                              December 312007
                            
                            
                            2008
                            
                            
                            2007
                            
                            
                            2008Revenues
                            
                            $
                            12,141,000
                            
                            
                            $
                            12,079,000
                            
                            
                            $
                            22,501,000
                            
                            
                            $
                            23,445,000Cost
      of services
                            
                            
                            (8,248,000
                            )
                            
                            
                            (7,753,000
                            )
                            
                            
                            (16,238,000
                            )
                            
                            
                            (15,389,000
                            )Gross
      profit
                            
                            
                            3,893,000
                            
                            
                            
                            4,326,000
                            
                            
                            
                            6,263,000
                            
                            
                            
                            8,056,000Selling,
      general and administrative expense
                            
                            
                            (3,820,000
                            )
                            
                            
                            (3,993,000
                            )
                            
                            
                            (7,145,000
                            )
                            
                            
                            (7,701,000
                            )Restructuring
      costs
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (513,000
                            )
                            
                            
                            -Operating
      income (loss)
                            
                            
                            73,000
                            
                            
                            
                            333,000
                            
                            
                            
                            (1,395,000
                            )
                            
                            
                            355,000Interest
      expense
                            
                            
                            (145,000
                            )
                            
                            
                            (195,000
                            )
                            
                            
                            (315,000
                            )
                            
                            
                            (325,000
                            )Interest
      income
                            
                            
                            119,000
                            
                            
                            
                            20,000
                            
                            
                            
                            224,000
                            
                            
                            
                            44,000Other
      income (expense)
                            
                            
                            26,000
                            
                            
                            
                            138,000
                            
                            
                            
                            26,000
                            
                            
                            
                            138,000Income
      (loss) before income taxes
                            
                            
                            73,000
                            
                            
                            
                            297,000
                            
                            
                            
                            (1,460,000
                            )
                            
                            
                            212,000(Provision
      for) benefit from  income taxes
                            
                            
                            55,000
                            
                            
                            
                            (130,000
                            )
                            
                            
                            278,000
                            
                            
                            
                            (91,000
                            )Net
      income (loss)
                            
                            $
                            128,000
                            
                            
                            $
                            167,000
                            
                            
                            $
                            (1,182,000
                            )
                            
                            $
                            121,000Earnings
      (loss) per share:Basic:Net
      income (loss)
                            
                            $
                            0.01
                            
                            
                            $
                            0.02
                            
                            
                            $
                            (0.11
                            )
                            
                            $
                            0.01Weighted
      average number of shares
                            
                            
                            10,553,410
                            
                            
                            
                            10,437,323
                            
                            
                            
                            10,553,410
                            
                            
                            
                            10,470,947Diluted:Net
      income (loss)
                            
                            $
                            0.01
                            
                            
                            $
                            0.02
                            
                            
                            $
                            (0.11
                            )
                            
                            $
                            0.01Weighted
      average number of shares including the dilutive effect of stock
      options
                            
                            
                            10,553,410
                            
                            
                            
                            10,437,787
                            
                            
                            
                            10,553,140
                            
                            
                            
                            10,471,473





See
accompanying notes to consolidated financial statements.


3


POINT.360





CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Unaudited)




Six Months Ended
                  December 31,2007
                
                
                2008Cash
      flows from operating activities:Net
      income (loss)
                
                $
                (1,182,000
                )
                
                $
                121,000Stock
      based compensation expense
                
                
                -
                
                
                
                117,000Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
      and amortization
                
                
                2,318,000
                
                
                
                2,457,000Provision
      for doubtful accounts
                
                
                19,000
                
                
                
                14,000Changes
      in assets and liabilities:(Increase)
      in accounts receivable
                
                
                (1,354,000
                )
                
                
                (2,312,000
                )Decrease
      in inventories
                
                
                35,000
                
                
                
                100,000(Increase)
      in prepaid expenses and other current assets
                
                
                (258,000
                )
                
                
                (382,000
                )(Increase)
      decrease in other assets
                
                
                (36,000
                )
                
                
                205,000(Increase)
      in deferred tax asset
                
                
                54,000
                
                
                
                (218,000
                )Increase
      (decrease) in accounts payable
                
                
                92,000
                
                
                
                (90,000
                )(Decrease)
      in accrued expenses
                
                
                (128,000
                )
                
                
                (657,000
                )Increase
      (decrease) in income taxes payable
                
                
                (109,000
                )
                
                
                270,000Net
      cash (used in) operating activities
                
                
                (549,000
                )
                
                
                (375,000
                )Cash
      used in investing activities:Capital
      expenditures
                
                
                (696,000
                )
                
                
                (8,834,000
                )Investment
      in Acquisitions
                
                
                -
                
                
                
                (440,000
                )Net
      cash used in investing activities
                
                
                (696,000
                )
                
                
                (9,274,000
                )Cash
      flows provided by  (used in) financing
    activities:Amortization
      of deferred gain on sale of real estate.
                
                
                (96,000
                )
                
                
                (89,000
                )Stock
      compensation and stock buyback
                
                
                -
                
                
                
                (245,000
                )Decrease
      in invested equity
                
                
                7,128,000
                
                
                
                -Increase
      (decrease) in notes payable
                
                
                (332,000
                )
                
                
                5,082,000Repayment
      of capital lease
                
                
                (3,000
                )
                
                
                (1,000
                )Acquisition
      of capital lease
                
                
                -
                
                
                
                98,000Net
      cash provided by (used in) financing activities
                
                
                6,697,000
                
                
                
                4,845,000Net
      increase (decrease) in cash
                
                
                5,452,000
                
                
                
                (4,804,000
                )Cash
      and cash equivalents at beginning of period
                
                
                7,302,000
                
                
                
                13,056,000Cash
      and cash equivalents at end of period
                
                $
                12,754,000
                
                
                $
                8,252,000Supplemental
      disclosure of cash flow information  -
                  Cash
      paid for:Interest
                
                $
                248,000
                
                
                $
                260,000Income
      tax
                
                $
                6,000
                
                
                $
                375,000





See
accompanying notes to consolidated financial statements.


4





POINT.360





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)





December
31, 2008





NOTE
1 - THE COMPANY




The
Company provides high definition and standard definition digital mastering, data
conversion, video and film asset management and sophisticated computer graphics
services to owners, producers and distributors of entertainment and advertising
content.  The Company provides the services necessary to edit, master,
reformat, convert, archive and ultimately distribute its clients’ film and video
content, including television programming feature films and movie
trailers.  The Company’s interconnected facilities provide service
coverage to all major U.S. media centers.




The
Company seeks to capitalize on growth in demand for the services related to the
distribution of 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.




On August 14, 2007, pursuant to the
terms of an Agreement and Plan of Merger and Reorganization among DG
FastChannel, Inc. (“DG FastChannel”), Point.360 (“Old Point.360”) and New 360
(“the Company”), a wholly owned subsidiary of  Old Point.360, (the
“Merger Agreement”),  Old Point.360 was merged into DG FastChannel,
with DG FastChannel continuing as the surviving corporation (the
“Merger”).  Subsequent to the Merger, the Company changed its name
back to Point.360.




On August 13, 2007,  prior to
the completion of the Merger,  (1) Old Point.360 contributed to the
Company (the “Contribution”) all of the assets used by Old Point.360 in its
post-production business and all other assets owned, licensed, or leased by Old
Point.360 that were not used exclusively in connection with the business of Old
Point.360 representing advertising agencies, advertisers, brands, and other
media companies which require services for short-form media content (the “ADS
Business”), with the Company assuming certain liabilities of Old Point.360 and
(2) Old Point.360 distributed to its shareholders on a pro rata basis all of the
outstanding common stock of  the Company (the
“Spin-Off”).




In the Spin-off, each Old Point.360
shareholder received one share of Company common stock (and a related preferred
share purchase right)  for each share of Old Point.360 common stock
held by the shareholder as of the record date of August 7, 2007.  As a
result of the Contribution and the Spin-off, the assets and liabilities of Old
Point.360 acquired by DG FastChannel in the Merger consisted only of those
assets and liabilities exclusively related to the ADS
Business.  Immediately after the completion of the Spin-off, DG
FastChannel contributed to the Company shares of the Company common stock that
it received in the Spin-off as a shareholder of Old Point.360.  As a
result of the Spin-off, the Company became a publicly held company whose common
stock is traded on the NASDAQ Global Market and is registered under Section 12
of the Securities Exchange Act of 1934.




The accompanying Consolidated Financial
Statements include the accounts and transactions of the Company, including those
of the Company’s only subsidiary, International Video Conversions, Inc.
(“IVC”).  The accompanying Consolidated Financial Statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America.  All intercompany balances and transactions
have been eliminated in the consolidated Financial Statements.




The Company’s consolidated results of
operations, financial position and cash flow may not be indicative of its future
performance and do not necessarily reflect what the consolidated results of
operations, financial position and cash flows would have been had the Company
operated as a separate, stand-alone entity during the periods presented,
including changes in its operations and capitalization as a result of the
separation and distribution form Old Point.360.




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 and six month periods
ended December 31, 2008 are not necessarily indicative of the results that may
be expected for the fiscal year ending June 30, 2009.  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 period ended June 30,
2008.




Earnings
Per Share




The weighted number of shares
outstanding reflects the dilutive effect of stock options
outstanding.


5




NOTE
2 - LONG TERM DEBT AND NOTES PAYABLE




On
December 30, 2005, Old Point.360 entered into a new $10 million term loan
agreement.  The term loan provides for interest at LIBOR (2.59% as of
December 31, 2008) plus 3.15%, or 5.74% on that date, and is secured by
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, Old Point.360 prepaid
$4 million of the term loan.  Monthly principal payments were
subsequently reduced pro rata.




On March
30, 2007, Old Point.360 entered into an additional $2.5 million term loan
agreement. The loan provides for interest at 8.35% per annum and is secured by
equipment. The loan will be repaid in 45 equal monthly installments of principal
and interest.




The Company assumed both term loan
agreements upon the Spin-off.




In August 2007, the Company entered
into a new credit agreement which provides up to $8 million of revolving
credit.  The two-year agreement provides for interest at either (i)
prime (3.25% as of December 31, 2008) minus 0% - 1.00% or (ii) LIBOR plus 1.5% -
2.5%, depending on the level of the Company’s ratio of outstanding debt to fixed
charges (as defined), or 2.50% and 3.93%, respectively, on  December
31, 2008.  The facility is secured by all of the Company’s assets,
except for equipment securing the term loans.  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.  No amount was outstanding under
the credit agreement as of December 31, 2008.





In July
2008, the Company entered into a Promissory Note with a bank (the “Note”) in
order to purchase land and a building that has been occupied by the Company
since 1998 (the total purchase price was approximately $8.1 million, of which
$2.4 million was allocated to land).  Pursuant to the Note, the
Company borrowed $6,000,000 payable in monthly installments of principal and
interest on a fully amortized bases over 30 years at an initial five-year
interest rate of 7.1% and thereafter at a variable rate equal to LIBOR plus 3.6%
(6.19% as of December 31, 2008).  The mortgage debt is secured by the
land and building.





NOTE
3- SALE OF REAL ESTATE




In March 2006, Old Point.360 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, Old
Point.360 received $0.5 million from the purchaser for
improvements.  In accordance with SFAS No. 28, “Accounting for Sale and
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
improvement advance (approximately $13.8 million) were used to pay off the
mortgage and other outstanding debt.




All rights and obligations under the
lease were transferred to the Company in the Spin-off.  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- CONTINGENCIES





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
5- 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 assumed all liability for
income taxes of Old Point.360 related to operations prior to the Spin-off and
Merger.  Effectively, the Company therefore 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. Old Point.360, and
consequently, the Company, were last audited by New York taxing authorities for
the years 2002 through 2004 resulting in no change.  Old Point.360
and, consequently, the Company, was previously notified by the U.S Internal
Revenue Service of its intent to audit the calendar 2005 tax
return.  The audit has since been cancelled by the IRS without change;
however, the audit could be reopened at the IRS’ discretion.  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.


6


NOTE
6- STOCK OPTION PLAN, STOCK-BASED COMPENSATION





In May
2007, the Board of Directors approved the 2007 Equity Incentive Plan (the “2007
Plan”).  The 2007 Plan provides for the award of options to purchase
up to 2,000,000 shares of common stock, appreciation rights and restricted stock
awards.




Under the
2007 Plan, the stock option price per share for options granted is determined by
the Board of Directors and is based on the market price of the Company’s common
stock on the date of grant, and each option is exercisable within the period and
in the increments as determined by the Board, except that no option can be
exercised later than ten years from the grant date.  The stock options
generally vest in one to five years.




The
Company has 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 to be recognized as expense over the requisite service periods in our
Consolidated Statements of Income (Loss).




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 quarter and six months ended
December 31, 2008 included compensation expense for the share-based payment
awards based on the grant date fair value estimated in accordance with the
provisions of SFAS 123(R).  For stock-based awards issued to employees
and directors, stock-based compensation is attributed to expense using the
straight-line single option method.  As stock-based compensation
expense recognized in the Statements of Consolidated Income (Loss) for the
periods reported in this Form 10-Q 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. For the periods being reported in this Form 10-Q, expected
forfeitures are immaterial. The Company will re-assess the impact of forfeitures
if actual forfeitures increase in future quarters.  Stock-based
compensation expense related to employee or director stock options recognized
for the three and six month periods ended December 31, 2008 was $66,000 ($37,000
net of tax benefit) and $117,000 ($67,000 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-Scholes 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 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 110.





During the quarter and six months ended
December 31, 2008, the Company granted awards of stock options for 30,000 shares
at a market price of $1.37 per share.  No stock options were granted
in the three and six month periods ended December 31, 2007.  As of
December 31, 2008, there were options outstanding to acquire 1,070,600 shares at
an average exercise price of $1.78 per share.  The estimated fair
value of all awards granted during the three months ended December 31, 2008 was
$16,000.   The fair value of each option was estimated on the
date of grant using the Black-Scholes option–pricing model with the following
weighted average assumptions:





Risk-free
      interest rate
                      
                      
                      0.35
                      %Expected
      term (years)
                      
                      
                      5.0Volatility
                      
                      
                      44
                      %Expected
      annual dividends
                      
                      
                      -


The following table summarizes the
status of the 2007 Plan as of December 31, 2008:





Options
      originally available
                    
                    
                    2,000,000Stock
      options outstanding
                    
                    
                    1,070,600Options
      available for grant
                    
                    
                    929,400


7





Transactions
involving stock options are summarized as follows:




Number
                        of Shares
                      
                      
                      Weighted Average
                        Exercise PriceBalance
      at June 30, 2008
                      
                      
                      1,045,600
                      
                      
                      $
                      1.79Granted
                      
                      
                      -
                      
                      
                      
                      -Exercised
                      
                      
                      -
                      
                      
                      
                      -Cancelled
                      
                      
                      -
                      
                      
                      
                      -Balance
      at September 30, 2008
                      
                      
                      1,045,600
                      
                      
                      $
                      1.79Granted
                      
                      
                      30,000
                      
                      
                      
                      1.37Exercised
                      
                      
                      -
                      
                      
                      
                      -Cancelled
                      
                      
                      (5,000
                      )
                      
                      
                      1.79Balance
      at December 31, 2008
                      
                      
                      1,070,600
                      
                      
                      $
                      1.78





As of December 31, 2008, the total
compensation costs related to non-vested awards yet to be expensed was
approximately $0.7 million to be amortized over the next four
years.





The weighted average exercise prices
for options granted and exercisable and the weighted average remaining
contractual life for options outstanding as of December 31, 2008 were as
follows:





As of June 30, 2008
                      
                      Number of
                        Shares
                      
                      
                      Weighted Average
                        Exercise Price
                      
                      
                      Weighted Average
                        Remaining
                        Contractual Life
                        (Years)
                      
                      
                      Intrinsic
                        ValueEmployees
      – Outstanding
                      
                      
                      945,600
                      
                      
                      $
                      1.79
                      
                      
                      
                      4.63
                      
                      
                      $
                      -Employees
      – Expected to Vest
                      
                      
                      851,040
                      
                      
                      $
                      1.79
                      
                      
                      
                      4.63
                      
                      
                      $
                      -Employees
      – Exercisable
                      
                      
                      -
                      
                      
                      $
                      -
                      
                      
                      
                      -
                      
                      
                      $
                      -Non-Employees-Outstanding
                      
                      
                      100,000
                      
                      
                      $
                      1.79
                      
                      
                      
                      4.63
                      
                      
                      $
                      -Non-Employees-Vested
                      
                      
                      -
                      
                      
                      $
                      -
                      
                      
                      
                      4.63
                      
                      
                      $
                      -Non-Employees-Exercisable
                      
                      
                      -
                      
                      
                      $
                      -
                      
                      
                      
                      -
                      
                      
                      $
                      -





As of December 31, 2008
                      
                      Number ofShares
                      
                      
                      Weighted Average
                        Exercise Price
                      
                      
                      Weighted Average
                        Remaining
                        Contractual Life
                        (Years)
                      
                      
                      Intrinsic
                        ValueEmployees
      – Outstanding
                      
                      
                      940,600
                      
                      
                      $
                      1.79
                      
                      
                      
                      4.12
                      
                      
                      $
                      -Employees
      – Expected to Vest
                      
                      
                      851,040
                      
                      
                      $
                      1.79
                      
                      
                      
                      4.12
                      
                      
                      $
                      -Employees
      – Exercisable
                      
                      
                      -
                      
                      
                      $
                      -
                      
                      
                      
                      -
                      
                      
                      $
                      -Non-Employees
      – Outstanding
                      
                      
                      130,000
                      
                      
                      $
                      1.69
                      
                      
                      
                      4.30
                      
                      
                      $
                      -Non-Employees
      – Vested
                      
                      
                      30,000
                      
                      
                      $
                      1.37
                      
                      
                      
                      4.87
                      
                      
                      $
                      -Non-Employees
      – Exercisable
                      
                      
                      30,000
                      
                      
                      $
                      1.37
                      
                      
                      
                      4.87
                      
                      
                      $
                      -


8





Additional information with respect to
outstanding options as of December 31, 2008 is as follows (shares in
thousands):





Options Outstanding
                              
                              
                              
                              
                              Options ExercisableOptions Exercise
                                Price Range
                              
                              
                              Number of
                                Shares
                              
                              Weighted Average
                                Remaining
                                Contractual Life
                              
                              Weighted Average
                                Exercise Price
                              
                              
                              Number of
                                Shares
                              
                              
                              Weighted Average
                                Exercise Price$
                              1.79
                              
                              
                              
                              1,040
                              
                              4.1
      Years
                              
                              $
                              1.79
                              
                              
                              
                              -
                              
                              
                              $
                              1.791.37
                              
                              
                              
                              30
                              
                              4.9
      Years
                              
                              
                              1.37
                              
                              
                              
                              30
                              
                              
                              
                              1.37





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
7- STOCK RIGHTS PLAN





In July 2007, the Company implemented a
stock rights program.  Pursuant to the program, stockholders of record
on August 7, 2007, received a dividend of one right to purchase for $10 one
one-hundredth of a share of a newly created Series A Junior Participating
Preferred Stock.  The rights are attached to the Company’s Common
Stock and will also become attached to shares issued subsequent to August 7,
2007.  The rights will not be traded separately and will not become
exercisable until the occurrence of a triggering event, defined as an
accumulation by a single person or group of 20% or more of the Company’s Common
Stock.  The rights will expire on August 6, 2017 and are redeemable at
$0.0001 per right.





After a triggering event, the rights
will detach from the Common Stock.  If the Company is then merged
into, or is acquired by, another corporation, the Company has the opportunity to
either (i) redeem the rights or (ii) permit the rights holder to receive in the
merger stock of the Company or the acquiring company equal to two times the
exercise price of the right (i.e., $20).  In the latter instance, the
rights attached to the acquirer’s stock become null and void.  The
effect of the rights program is to make a potential acquisition of the Company
more expensive for the acquirer if, in the opinion of the Company’s Board of
Directors, the offer is inadequate.





No triggering events occurred in the
six months ended December 31, 2008.





NOTE
8- SHAREHOLDER’S EQUITY





The following table analyzes the
components of shareholders’ equity from June 30, 2008 to September 30, 2008 (in
thousands):





Common
                    Stock
                  
                  
                  Paid-in
                    Capital
                  
                  
                  Retained
                    Earnings
                  
                  
                  Shareholders’
                    EquityBalance,
      June 30, 2008
                  
                  $
                  21,583
                  
                  
                  $
                  9,320
                  
                  
                  $
                  (103
                  )
                  
                  $
                  30,800FAS
      123R option expense
                  
                  
                  -
                  
                  
                  
                  51
                  
                  
                  
                  -
                  
                  
                  
                  51Net
      income (loss)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (45
                  )
                  
                  
                  (45
                  )Stock
      buyback
                  
                  
                  (94
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (94
                  )Balance,
      September 30, 2008
                  
                  
                  21,488
                  
                  
                  
                  9,371
                  
                  
                  
                  (148
                  )
                  
                  
                  30,711





FAS
      123R option expense
                  
                  
                  -
                  
                  
                  $
                  66
                  
                  
                  $
                  -
                  
                  
                  
                  66Net
      income (loss)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  167
                  
                  
                  
                  167Stock
      buyback
                  
                  
                  (151
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (151
                  )Balance, December
      31, 2008
                  
                  $
                  21,337
                  
                  
                  $
                  9,437
                  
                  
                  $
                  19
                  
                  
                  $
                  30,973





NOTE
9- RESTRUCTURING CHARGE





In the first quarter of fiscal 2008, in
conjunction with the completion of the Merger and Spin-off transactions, we
decided to close down one of our post production facilities.  Future
costs associated with the facility lease and certain severance payments totaling
$513,000 were treated as restructuring costs.


9





NOTE
10- STOCK REPURCHASE PLAN





In February 2008, the Company’s Board
of Directors authorized a stock repurchase program.  Under the stock
repurchase program, the Company may purchase outstanding shares of its common
stock on the open market at such times and prices determined in the sole
discretion of management.  During the three and six month periods
ended December 31, 2008, the Company purchased 101,910 and 161,910 shares for
$151,000 and $246,000, respectively.  In January and February 2009,
the Company purchased an additional 4,600 shares for $6,000.





NOTE
11- ACQUISITION





On November 1, 2008, the Company
acquired the assets and business of Video Box Studios, Inc., for $315,000 and
the assumption of $98,000 of capital lease obligations.  Of the total
purchase price, $275,000 was allocated to machinery and equipment, $24,000 to a
covenant not to compete and the balance to goodwill.





NOTE
12- POTENTIAL ACQUISITION




On
September 29, 2008, the Company and Centerstaging Musical Productions, Inc.
(“CMPI”) entered an Asset Purchase Agreement (the “Agreement”) whereby the
Company intends to acquire certain assets of CMPI for $3 million and the
assumption of up to $1.3 million of equipment financing obligations subject to
bankruptcy court approval and overbid in CMPI’s pending Chapter 11 bankruptcy
case.  The Company was approved as the “stalking horse” bidder
pursuant to a motion to approve sale procedures in the United States Bankruptcy
Court.




CMPI is
primarily engaged in the business of (i) providing production and support
services for live musical performances for major television programs; (ii)
renting its studio and soundstage facilities, and (iii) renting musical
instruments and related equipment for use at its studios and other venues as
debtor and debtor in possession pursuant to Sections 1107(a) and 1108 of the
Bankruptcy Code.  The Agreement provides that CMPI will sell,
transfer, convey, assign and deliver to the Company, in accordance with Section
363 and 365 and the other applicable provisions of the Bankruptcy Code, certain
assets and liabilities of CMPI upon the terms and subject to the conditions set
forth in the Agreement.




The
proposed sale of CMPI’s assets to the Company was subject to overbid pursuant to
sale procedures approved by the Bankruptcy Court and any sale will be pursuant
to a Sale Order of the Bankruptcy Court approving such sale under Section 363 of
the Bankruptcy Code and will include the assumption and assignment of certain
executory contracts, unexpired leases and liabilities thereunder pursuant to
Section 365 of the Bankruptcy Code and the terms and conditions of the
Agreement.  Another party offered to purchase the CMPI assets for an
amount in excess of that proposed by the Company, and the Court approved the
sale.  The sale failed to close by the December 31, 2008 deadline
established by the Court.  The Company is once again considering the
purchase and may submit a new offer to the Court.




Any new
offer will be conditioned upon the approval of the bankruptcy
court.  Additionally, the Company’s obligation to complete a purchase
will be subject to satisfactory negotiation of real estate and personal property
leases and other conditions.   There can be no assurance that the
transaction will ultimately be approved by the Bankruptcy Court and
completed.




NOTE
13- PROPERTY AND EQUIPMENT:




Property
and equipment as of December 31, 2008 consists of the following:




Land
                  
                  
                  2,406,000Building
                  
                  
                  5,716,000Machinery
      and equipment
                  
                  
                  33,686,000Leasehold
      improvements
                  
                  
                  6,864,000Computer
      equipment
                  
                  
                  6,402,000Equipment
      under capital lease
                  
                  
                  285,000Office
      equipment, CIP
                  
                  
                  599,000Less
      accumulated depreciation and amortization
                  
                  
                  (40,639,000
                  )Property
      and equipment, net
                  
                  $
                  15,319,000


10




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.




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


Point.360
is one of the largest providers of video and film asset management services to
owners, producers and distributors of entertainment content.  We provide
the services necessary to edit, master, reformat and archive our clients’ film
and video content, including television programming, feature films and movie
trailers using electronic and physical means. Clients include major motion
picture studios and independent producers.




We
operate in a highly competitive environment in which customers desire a broad
range of services at a reasonable price.  There are many competitors
offering some or all of the services provided by us.  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.




We have
an opportunity to expand our business by establishing closer relationships with
our customers through excellent service at a competitive price and adding to our
service offering.  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
acquisitions of IVC in July 2004 and Eden FX in March 2007) that can increase
revenues by adding new customers, or expanding current services to existing
customers.




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




We
believe that our interconnected facilities provide the ability to better service
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 December 31, 2008 Compared To Three Months Ended December 31,
2007





Revenues.  Revenues
were $12.1 million for the three months ended December 31, 2008, compared to
$12.1 million for the quarter ended December 31, 2007.  The current
period revenues were similar to the previous four calendar
quarters.  No unusual trends have been noted; however, revenues may
come under some downward pressure in the future due to lower prices that might
occur if major studios reduce output due to current difficult economic
considerations and other competitors reduce pricing to compete for our
business.





Gross Profit.  In
2008, gross margin was 35.8% of sales, compared to 32.1% for the same period
last year. The increase in gross profit percentage is due to lower wage costs as
a percentage of sales.  In addition, facility costs declined due to
the elimination of lease costs associated with previously occupied real estate
purchased earlier in fiscal year.  From time to time, we will increase
staff capabilities to satisfy potential customer demand. If the expected demand
does not materialize, we will adjust personnel levels.  We expect
gross margins to fluctuate in the future as the sales mix changes.




Selling, General and Administrative
Expense.SG&A expense was $4.0 million (33.1% of sales) in
the 2008 period as compared to $3.8 million (31.5% of sales) in
2007.  We expect SG&A expenses to remain at similar levels in
future quarters.


11


Operating
Income.Operating income was $0.3 million in 2008
compared to a $0.1 million in 2007.




Interest
Expense.Net interest expense in the current quarter was $0.2
million, compared to $0.1 million in the prior year period.  The
increase is due to a mortgage related to real estate purchase in July
2008.




Other
Income.During the current period, the Company realized
$0.1 million of income from the sale of equipment.




Net Income.Net
income for the current quarter was $0.2 million compared to a $0.1 million in
the prior year’s quarter.




Six
Months Ended December 31, 2008 compared to Six Months Ended December 31,
2007





Revenues.  Revenues
were $23.4 million for the six months ended December 31, 2008, compared to $22.5
million for the period ended December 31, 2007.  We expect revenues to
come under some downward pressure in the future if major studios reduce output
due to current difficult financial conditions and other competitors reduce
prices to compete for our business.  However, we 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
2008, gross margin was 34.4% of sales, compared to 27.8% for the same period
last year. The increase in gross profit percentage is due to lower wages and
benefits.  From time to time, we will increase staff capabilities to
satisfy potential customer demand. If the expected demand does not materialize,
we will adjust personnel levels.  In addition, facility costs declined
due to the elimination of lease costs associated with previously occupied real
estate purchased during the period.  We expect gross margins to
fluctuate in the future as the sales mix changes.




Selling, General and Administrative
Expense.SG&A expense was $7.7 million (32.8% of sales) in
the 2008 period as compared to $7.1 million (31.8% of sales) in 2007 excluding
the restructuring charge.




Restructuring
Costs.In the six months ended December 31, 2007, in
conjunction with the completion of the Merger and Spin-off transactions, we
decided to close down one of our post production facilities.  Future
costs associated with the facility lease and certain severance payments were
treated as restructuring costs.




Operating Income (Loss).Operating income was $0.4 million in 2008 compared to a loss of $1.4
million in 2007.  Restructuring costs contributed $0.5 million to the
loss in 2007.




Interest Expense. Net
Interest expense for 2008 was $0.3 million, an increase of $0.1 million from
2007. The increase was due to a mortgage related to real estate purchased in
July 2008.




Other
Income.  During the current period, the Company realized $0.1
million of income from the sale of equipment.




Net Income (Loss).Net income
for 2008 was $0.1 million compared to a loss of $1.2 million in
2007.




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 August
14, 2007 and thereafter, the Company received $7 million from DG FastChannel
upon completion of the Merger.  The Company also received
approximately $2.2 million for reimbursement of merger expenses and prepayment
for ADS Business working capital.  The Company expects to receive an
additional $0.3 million from DG FastChannel for ADS Business working capital,
which amount is included in other assets and is considered fully
collectible.




On
December 30, 2005, Old Point.360 entered a $10 million term loan agreement. The
term loan provides for interest at LIBOR (2.59% at December 31, 2008) plus 3.15%
or 5.74% on that date, and is secured by the Company’s equipment. The term loan
will be repaid in 60 equal principal payments plus interest.




On March
30, 2007, Old Point.360 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.  Both the December 2005 and
March 2007 term loans were assumed by the Company in the Spin-off.




In August
2007, the Company entered into a new credit agreement which provides up to $8
million of revolving credit based on 80% of acceptable accounts receivables, as
defined. The two-year agreement provides for interest of either (i) prime (3.25%
at December 31, 2008) 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 2.50% or 3.93%, respectively, at December 31,
2008.  The facility is secured by all of the Company’s assets, except
for equipment securing  term loans as described
above.


12




In March
2006, Old Point.360 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 $1.3 million after tax gain. Additionally, Old
Point.360 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.




In July
2008, the Company entered into a Promissory Note with a bank (the “Note”) in
order to purchase land and a building that has been occupied by the Company
since 1998 (the total purchase price was approximately $8.1
million).  Pursuant to the Note, the company borrowed $6,000,000
payable in monthly installments of principal and interest on a fully amortized
bases over 30 years at an initial five-year interest rate of 7.1% and thereafter
at a variable rate equal to LIBOR plus 3.6% (6.19% as of December 31,
2008).




The
following table summarizes the December 31, 2008 amounts outstanding under our
revolving line of credit and term and mortgage loans:





Revolving
      credit
                  
                  $
                  -Current
      portion of term loan and mortgage
                  
                  
                  1,899,000Long-term
      portion of term loan and mortgage
                  
                  
                  7,830,000Total
                  
                  $
                  9,729,000





Monthly
and annual principal and interest payments due under the term debt and mortgage
are approximately $213,000 and $2.6 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 component of cost of sales
must be paid currently.  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 “fixed charge
coverage ratio.” Our fixed charge coverage ratio compares, on a rolling
twelve-month basis, (i) 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 December
31, 2008, the fixed charge coverage ratio was 1.45 as compared to a minimum
requirement of 1.10.





We expect
that amounts available under the revolving credit arrangement (approximately
$4.4 million at December 31, 2008), 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 $2.0 – $3.0 million of capital
expenditures for the next twelve months.




In March
2007, we acquired substantially all the assets of Eden FX for approximately $2.2
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.  The earnings level for calendar 2007 was not
met; therefore, the 2008 payment was not made.





The
following table summarizes contractual obligations as of December 31, 2008 due
in the future:





Payment due by PeriodContractual Obligations
                  
                  Total
                  
                  
                  Less than 1 Year
                  
                  
                  Years
                    2 and 3
                  
                  
                  Years
                    4 and 5
                  
                  
                  ThereafterLong
      Term Debt  Principal Obligations
                  
                  $
                  9,729,000
                  
                  
                  $
                  1,899,000
                  
                  
                  $
                  2,044,000
                  
                  
                  $
                  156,000
                  
                  
                  $
                  5,630,000Long
      Term Debt Interest Obligations  (1)
                  
                  
                  8,085,000
                  
                  
                  
                  698,000
                  
                  
                  
                  908,000
                  
                  
                  
                  814,000
                  
                  
                  
                  5,665,000Capital
      Lease Obligations
                  
                  
                  97,000
                  
                  
                  
                  22,000
                  
                  
                  
                  52,000
                  
                  
                  
                  23,000
                  
                  
                  
                  -Operating
      Lease Obligations
                  
                  
                  18,504,000
                  
                  
                  
                  2,628,000
                  
                  
                  
                  5,050,000
                  
                  
                  
                  3,154,000
                  
                  
                  
                  7,672,000Total
                  
                  $
                  36,416,000
                  
                  
                  $
                  5,247,000
                  
                  
                  $
                  8,054,000
                  
                  
                  $
                  4,147,000
                  
                  
                  $
                  18,968,000




(1)
Interest on variable rate debt has been computed using the rate on the latest
balance sheet date.




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.


13




We will continue to consider the
acquisition of businesses which compliment our current operations and possible
real estate transactions.  Consummation of any acquisition, real
estate or other expansion transaction by the Company may be subject to the
Company securing additional financing, perhaps at a cost higher than our
existing term loans.  In the current economic climate, additional
financing may not be available.  Additionally, our current bank line
of credit might not be renewed upon its August 2009 expiration due to recent
changes in the bank lending environment.  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 special
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 not 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.




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 $25.3 million as of December 31,
2008.


14




In 2002, Statement of Financial
Accounting Standards (“SFAS”) No.142, “Goodwill and Other Intangible
Assets” (“SFAS 142”) became effective.  As a result, Old
Point.360 ceased to amortize approximately $26.3 million of goodwill in 2002 and
performed an annual impairment review thereafter.  The initial test on
January 1, 2002, and the Fiscal 2002 to 2007 tests performed as of September 30
of each year required no goodwill impairment. On August 14, 2007, the Company
was formed by a spin-off transaction, and a certain portion of Old Point.360’s
goodwill was assigned to the Company.  In the 2008 test performed as
of June 30, 2008, the discounted cash flow method was used to evaluate goodwill
impairment and included cash flow estimates for 2009 and subsequent
years.  If actual flow performance does not meet these expectations
due to factors cited above, any resulting potential impairment could adversely
affect reported goodwill asset values and earnings.




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




Significant management judgment is
required in determining our provision for income taxes, our deferred tax assets
and liabilities and any valuation allowance recorded against our net deferred
tax assets.  The net deferred tax assets as of December 31, 2008 was
$0.9 million.  The Company did not record a valuation allowance
against its deferred tax assets as of December 31, 2008.





In June 2006, the 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 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 assumed all liability for income taxes of Old Point.360 related to
operations prior to the Spin-off and Merger.  Effectively, the Company
therefore adopted FIN 48, effective January 1, 2007. The Company 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. Old Point.360,
and consequently, the Company, was last audited by New York taxing authorities
for the years 2002 through 2004 resulting in no change. Old Point.360, and
consequently, the Company, was previously notified by the U.S. Internal Revenue
Service of its intent to audit the calendar 2005 tax return. The audit has since
been cancelled by the IRS without change; however, the audit could be reopened
at the IRS’ discretion. 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 December 2007, the FASB issued
SFAS No. 141R, “Business
Combinations”(“SFAS 141R”), which requires most identifiable assets,
liabilities, non-controlling interests, and goodwill acquired in a business
combination to be recorded at “full fair value.” SFAS 141R applies to all
business combinations, including combinations among mutual entities and
combinations by contract alone. Under Statement 141R, all business combinations
will be accounted for by applying the acquisition method. Statement 141R is
effective for business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008.  SFAS 141R will affect acquisitions by the
Company after June 30, 2009.




In December 2007, the FASB issued
SFAS No. 160, “Non-controlling
Interests in Consolidated Financial Statements”(“SFAS
160”).  SFAS 160 requires the ownership interests in subsidiaries held
by parties other than the parent to be treated as a separate component of equity
and be clearly identified, labeled, and presented in the consolidated financial
statements. SFAS 160 is effective for periods beginning on or after
December 15, 2008. Earlier adoption is prohibited.  SFAS 160 has
not yet affected the Company’s financial statements.




In January 2008, the SEC issued Staff
Accounting Bulletin No. 110, “Certain Assumptions Used in
Valuation Methods” (“SAB 110”) which amends Staff Accounting Bulletin No.
107, “Share-Based
Payment” (“SAB 107”).  SAB 110 allows for the continued use,
under certain circumstances, of the “simplified” method in developing an
estimate of expected term of so-called “plain vanilla” stock options accounted
for under FAS 123R.  SAB 110 amends SAB 107 to permit the use of the
“simplified” method beyond December 31, 2007.  The adoption of SAB 110
did not have a significant effect on the Company’s consolidated financial
statements.


15




In March 2008, the FASB issued SFAS No.
161. “Disclosures about
Derivative Instruments and Hedging Activities – an amendment of FASB Statement No,
133” (“FAS 161”).  The standard requires qualitative
disclosures about objectives and strategies for using derivatives, quantitative
disclosures about fair value amounts of gains and losses on derivative
instruments, and disclosures about credit-risk related contingent features in
derivative agreements.  FAS 161 is effective for financial statements
issued after November 15, 2008.  The adoption of FAS 161 will not have
a significant effect on the Company’s consolidated financial
statements.




ITEM
3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK




Market
Risk.The Company had borrowings of $9.7 million on
December 31, 2008 under term loan agreements.  One term loan was
subject to variable interest rates.  The weighted average interest
rate paid during the first six months of fiscal 2009 was 6.4%.  For
variable rate debt outstanding at December 31, 2008, a .25% increase in interest
rates will increase annual interest expense by approximately
$7,000.  Amounts that may become 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.T  CONTROLS AND PROCEDURES




Disclosure
Controls





Pursuant to Rules 13a-15(b) and
15d-15(b) under the Exchange Act, an evaluation was performed under the
supervision and with the participation of the Company’s management, including
the Chief Executive Officer and President and the Chief Financial Officer, of
the effectiveness of the design and operation of the Company’s disclosure
controls and procedures as of the end of the period covered by this
report.  Based on the evaluation, the Chief Executive Officer and
President and the Chief Financial Officer, concluded that the Company’s
disclosure controls and procedures were effective as of the end of the period
covered by the report.





Changes
in Internal Control over Financial Reporting





The Chief Executive Officer and
President and the Chief Financial Officer conducted an evaluation of our
internal control over financial reporting (as defined in Exchange Act Rule
13a-15(f) (“Internal Control”)) to determine whether any changes in Internal
Control occurred during the quarter ended December 31, 2008 that have materially
affected or which are reasonably likely to materially affect Internal
Control.  Based on the evaluation, no such change occurred during such
period.





Internal control over financial
reporting refers to a process designed by, or under the supervision of, our
Chief Executive Officer and Chief Financial Officer and effected by our board of
directors, management and other personnel, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted
accounting principles and includes those policies and procedures
that:





·
            Pertain
      to the maintenance of records that in reasonable detail accurately and
      fairly reflect the transactions and dispositions of our
      assets;





·
              Provide
      reasonable assurance that transactions are recorded as necessary to permit
      the preparation of financial statements in accordance with generally
      accepted accounting principles, and that our receipts and expenditures are
      being made only in accordance with authorizations of our management and
      members of our board of directors;
and





·
            Provide
      reasonable assurance regarding the prevention or timely detection of
      unauthorized acquisition, use, or disposition of our assets that could
      have a material effect on our financial
  statements.





Limitations
on Internal Control over Financial Reporting





Internal control over financial
reporting cannot provide absolute assurance of achieving financial reporting
objectives because of its inherent limitations.  Internal control over
financial reporting is a process that involves human diligence and compliance
and is subject to lapses in judgment and breakdowns resulting from human
failures.  Internal control over financial reporting also can be
circumvented by collusion or improper override.  Because of such
limitations, there is a risk that material misstatements may not be prevented or
detected on a timely basis by internal control over financial
reporting.  However, these inherent limitations are known features of
the financial reporting process, and it is possible to design into the process
safeguards to reduce, though not eliminate, this risk.


16





PART
II – OTHER INFORMATION




ITEM
1.  LEGAL PROCEEDINGS




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.




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 on 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.”  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.  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.




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:




·
            Recent
      history of losses.


·
            Prior
      breach and changes in credit agreements and ongoing
    liquidity.


·
            Our
      highly competitive marketplace.


·
            The
      risks associated with dependence upon significant
    customers.


·
            Our
      ability to execute our expansion
strategy.


·
            The
      uncertain ability to manage in a changing
  environment.


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


·
            Dependence
      on key personnel.


·
            Our
      ability to maintain and improve service
quality.


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


·
            Possible
      significant influence over corporate affairs by significant
      shareholders.


·
            Our
      ability to operate effectively as a stand-alone, publicly traded
      company.


·
            The
      cost associated with becoming compliant with the Sarbanes-Oxley Act of
      2002, and the consequences
      of failing to implement effective internal controls over financial
      reporting asrequired
      by Section 404 of the Sarbanes-Oxley Act of 2002 by the date that we must
      complywith
      that section of the Sarbanes-Oxley
Act.


Other factors not identified above,
including the risk factors described in the “Risk Factors” section of the
Company’s June 30, 2008 Form 10-K filed with the Securities and Exchange
Commission may also cause actual results to differ materially from those
projected by our forward-looking statements.  Most of these factors
are difficult to anticipate and are generally beyond our control.  You
should consider these areas of risk in connection with considering any
forward-looking statements that may be made in this Form 10-Q and elsewhere by
us and our business generally.  Except to the extent of any obligation
to disclose material information under the federal securities laws or the rules
of the NASDAQ Global Market, we undertake no obligation to release publicly any
revisions to any forward-looking statements, to report events or to report the
occurrence of unanticipated events.


17





ITEM
2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS





During the quarter and six months ended
December 31, 2008, the Company purchased shares of its common stock in open
market transactions pursuant to Rule 10b5-1 purchase plans as
follows:





(a)
                  
                  
                  (b)
                  
                  
                  (c)
                  
                  
                  (d)Period
                  
                  Total Number of
                    Shares (or Units)
                    Purchased
                  
                  
                  Average Price
                    Paid per
                    Share (or
                    Unit)
                  
                  
                  Total Number of
                    Shares (or Units)
                    Purchased as Part
                    Of Publicly
                    Announced Plans
                    or Programs
                  
                  
                  Maximum (or
                    Approximate Dollar
                    Value) of Shares (or
                    Units) that May Yet be
                    Purchased Under the
                    Plans or ProgramsJuly
      1 to July 31, 2008
                  
                  
                  60,000
                  
                  
                  $
                  1.57
                  
                  
                  
                  -
                  
                  
                  
                  -August
      1 to August 31, 2008
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -September
      1 to September 30, 2008
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -October
      1 to October  31, 2008
                  
                  
                  59,500
                  
                  
                  
                  1.54
                  
                  
                  
                  -
                  
                  
                  
                  -November  1
      to November 30, 2008
                  
                  
                  3,600
                  
                  
                  
                  1.40
                  
                  
                  
                  -
                  
                  
                  
                  -December  1
      to December 31, 2008
                  
                  
                  38,810
                  
                  
                  
                  1,41
                  
                  
                  
                  -
                  
                  
                  
                  -Total
                  
                  
                  161,910
                  
                  
                  $
                  1.52
                  
                  
                  
                  -
                  
                  
                  
                  -




ITEM
4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS




The
Company’s Annual Meeting of Shareholders was held on November 12, 2008 after a
solicitation of proxies pursuant to Regulation 14A of the Securities Exchange
Act of 1934.  At the meeting, shareholders voted on: (i) the election
of directors to hold office until the next annual meeting of shareholders of the
Company or until their successors are duly elected and qualified, and (ii)
approval of the appointment of Singer Lewak  LLP as the Company’s
independent public accountants for the fiscal year ending June 30,
2009.  The results of shareholder voting were as follows:




1.
            Election
      of Directors




The
following individuals were elected as directors:




Name
              
              Votes For
              
              
              Votes WithheldHaig
      S. Bagerdjian
              
              
              7,583,788
              
              
              
              46,579Robert
      A. Baker
              
              
              7,584,364
              
              
              
              45,699Greggory
      J. Hutchins
              
              
              7,139,364
              
              
              
              491,003Sam
      P. Bell
              
              
              7,584,364
              
              
              
              45,699G.
      Samuel Oki
              
              
              7,584,364
              
              
              
              45,699




2.
            The
      appointment by the Board of Directors of the Company of Singer Lewak LLP
      as the Company’s independent auditors for the fiscal year ending June 30,
      2009 was ratified with 7,567,172 votes for the proposal, 44,395 votes
      against the proposal and 18,800 votes
  abstaining.





ITEM  6.  EXHIBITS




(a)
              Exhibits





31.1
            Certification
      of Chief Executive Officer Pursuant to 15 U.S.C. § 7241, as Adopted
      Pursuant to Section 302 of the Sarbanes-Oxley Act of
  2002.





31.2
            Certification
      of Chief Financial Officer Pursuant to 15 U.S.C. § 7241, as Adopted
      Pursuant to Section 302 of the Sarbanes-Oxley Act of
  2002.





32.1
            Certification
      of Chief Executive Officer Pursuant to 18 U.S.C. § 1350, as Adopted
      Pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002.





32.2
            Certification
      of Chief Financial Officer Pursuant to 18 U.S.C. § 1350, as Adopted
      Pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002.


18





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.360DATE:  February
      12, 2009
                BY:
                /s/  Alan R.
  SteelAlan
      R. SteelExecutive
      Vice President,
                  Finance
      and Administration
                  (duly
      authorized officer and principal financial
  officer)


19