**UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**










**FORM
      10-K**





**xANNUAL
      REPORT PURSUANT
      TO SECTION 13 OR 15(d) OF THE**


**SECURITIES
      EXCHANGE ACT OF 1934**





**For
      the fiscal year ended December 31, 2006**





**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 0-21917**









**POINT.360**


(Exact
      name of registrant as specified in its charter)





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





Registrant's
      telephone number, including area code (818) 565-1400





Securities
      registered pursuant to Section 12(b) of the Act:


None





Securities
      registered pursuant to Section 12(g) of the Act:


Common
      Stock, no par value.










Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act.


Yes
o
      No x





Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act.


Yes
o
      No x





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
      during the preceding 12 months (or for such shorter period that the registrant
      was required to file such reports), and (2) has been subject to such filing
      requirements for the past 90 days.


Yes x  No
o




Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K is not contained herein, and will not be contained, to the best
      of registrant’s knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this
      Form 10-K. x









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




Large
      accelerated filer   ̈   Accelerated
      filer   ̈  Non-accelerated
      filer x




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


Yes
 ̈
      No x





The
      aggregate market value of the voting common equity held by non-affiliates of
      the
      registrant as of the last business day of the registrant’s most recently
      completed second fiscal quarter (June 30, 2006) was approximately $11 million.
      As of February 14, 2007, there were 9,977,407 shares of Common Stock
      outstanding.





DOCUMENTS
      INCORPORATED BY REFERENCE





Portions
      of the definitive Proxy Statement relating to the Company’s Annual Meeting of
      Shareholders to be held on May 3, 2006 are incorporated by reference in Part
      III
      of this report.




2


**CAUTIONARY
      STATEMENT**




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




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




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.





3


**PART
      I**





**ITEM
      1. BUSINESS**





**General**




Point.360
      ("Point.360" or the "Company") is a leading integrated media management services
      company providing film, video and audio post production, archival, duplication
      and distribution services to motion picture studios, television networks,
      advertising agencies, independent production companies and multinational
      companies. The Company provides the services necessary to edit, master,
      reformat, archive and ultimately distribute its clients’ audio and video
      content, including television programming, feature films, spot advertising
      and
      movie trailers.




The
      Company provides worldwide electronic and physical distribution using fiber
      optics, satellite, Internet and air and ground transportation. The Company
      delivers commercials, movie trailers, electronic press kits, infomercials and
      syndicated programming, by both physical and electronic means, to thousands
      of
      broadcast outlets worldwide.




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




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




The
      Company was incorporated in California in 1990.
      The Company's executive offices are located at 2777 N. Ontario Street, Burbank,
      California 91504, and its telephone number is (818) 565-1400. The Company’s
      website address is *www.point360.com* *.*





**Markets**




The
      Company derives revenues primarily from (i) the entertainment industry,
      consisting of major and independent motion picture and television studios,
      cable
      television program suppliers and television program syndicators, and (ii) the
      advertising industry, consisting of advertising agencies and corporate
      advertisers. On a more limited basis, the Company also services national
      television networks, local television stations, corporate or instructional
      video
      providers, infomercial advertisers and educational institutions.





*Entertainment
      Industry* .
      The
      entertainment industry creates motion pictures, television programming, and
      interactive multimedia content for distribution through theatrical exhibition,
      home video, pay and basic cable television, direct-to-home, private cable,
      broadcast television, on-line services and video games. Content is released
      into
      a "first-run" distribution channel, and later into one or more additional
      channels or media. In addition to newly produced content, film and television
      libraries may be released repeatedly into distribution. Entertainment content
      produced in the United States is exported and is in increasingly high demand
      internationally. The Company believes that several trends in the entertainment
      industry have and will continue to have a positive impact on the Company's
      business. These trends include growth in worldwide demand for original
      entertainment content, the development of new markets for existing content
      libraries, increased demand for innovation and creative quality in domestic
      and
      foreign markets, and wider application of digital technologies for content
      manipulation and distribution, including the emergence of new distribution
      channels.





*Advertising
      Industry* .
      The
      advertising industry distributes video and audio commercials, or spots, to
      radio
      and television broadcast outlets worldwide. Advertising content is developed
      either by the originating company or in conjunction with an advertising agency.
      The Company receives orders with specific routing and timing instructions
      provided by the customer. These orders are then entered into the Company's
      computer system and scheduled for electronic or physical delivery. When a video
      spot is received, the Company's quality control personnel inspect the video
      to
      ensure that it meets customer specifications and then initiate the sequence
      to
      distribute the video to the designated television stations either
      electronically, over fiber optic lines and/or satellite, or via the most
      suitable package carrier. The Company believes that the growth in the number
      of
      video advertising outlets, driven by expansion in the number of broadcast,
      cable, Internet and satellite channels worldwide, will have a positive impact
      on
      the Company’s businesses.





**Value-Added
      Services**




The
      Company maintains video and audio post-production and editing facilities as
      components of its full service, value-added approach to its customers. The
      following summarizes the value- added post-production services that the Company provides to its customers:




*Film-To-Digital
      Transfer.* Substantially all film content ultimately is distributed to the home video,
      broadcast, cable or pay-per-view television markets, requiring that film images
      be transferred electronically to a digital video format. Each frame must be
      color corrected and adapted to the size and aspect ratio of a television screen
      in order to ensure the highest level of conformity to the original film version.
      The Company transfers film to digital formats using Spirit, URSA and Cintel
      MK-3
      telecine equipment and DaVinci® digital color correction systems. The
      remastering of studio film and television libraries to the HDTV broadcast
      standard has become a growing portion of the Company's film transfer business,
      as well as affiliated services such as foreign language mastering, duplication
      and distribution.




4




*Video
      Editing.* The
      Company provides digital editing services in Hollywood, Burbank and West Los
      Angeles. The editing suites are equipped with (i) state-of-the-art digital
      editing equipment, including the Avid® 9000, that provides precise and
      repeatable electronic transfer of video and/or audio information from one or
      more sources to a new master video and (ii) large production switchers to
      effect complex transitions from source to source while simultaneously inserting
      titles and/or digital effects over background video. Video is edited into
      completed programs such as television shows, infomercials, commercials, movie
      trailers, electronic press kits, specials, and corporate and educational
      presentations.




*Standards
      Conversion.* Throughout the world there are several different broadcasting "standards" in
      use. To permit a program recorded in one standard to be broadcast in another,
      it
      is necessary for the recorded program to be converted to the applicable
      standard. This process involves changing the number of video lines per frame,
      the number of frames per second, and the color system. The Company is able
      to
      convert video between all international formats, including NTSC, PAL and SECAM.
      The Company's competitive advantages in this service line include its
      state-of-the-art systems and its detailed knowledge of the international markets
      with respect to quality-control requirements and technical
      specifications.




*Broadcast
      Encoding.* The
      Company provides encoding services for tracking broadcast airplay of spots
      or
      television programming. Using a process called VEIL encoding; a code is placed
      within the video portion of an advertisement or an electronic press kit. Such
      codes can be monitored from standard television broadcasts to determine which
      advertisements or portions of electronic press kits are shown on or during
      specific television programs, providing customers direct feedback on allotted
      air time. The Company provides VEIL encoding services for a number of its motion
      picture studio clients to enable them to customize their promotional material.
      The Company also provides ICE encoding services which enable it to place codes
      within the audio portion of a video, thereby enhancing the overall quality
      of
      the encoded video.




*Audio
      Post-Production.* Through
      its facilities in Burbank, Hollywood and West Los Angeles, the Company digitally
      edits and creates sound effects, assists in replacing dialog and re-records
      audio elements for integration with film and video elements. The Company designs
      sound effects to give life to the visual images with a library of sound effects.
      Dialog replacement is sometimes required to improve quality, replace lost dialog
      or eliminate extraneous noise from the original recording. Re-recording combines
      sound effects, dialog, music and laughter or applause to complete the final
      product. In addition, the re-recording process allows the enhancement of the
      listening experience by adding specialized sound treatments, such as stereo,
      Dolby Digital®, SDDS®, THX® and Surround Sound®.




*Audio
      Layback.* Audio
      layback is the process of creating duplicate videotape masters with sound tracks
      that are different from the original recorded master sound track. Content owners
      selling their assets in foreign markets require the replacement of dialog with
      voices speaking local languages. In some cases, all of the audio elements,
      including dialog, sound effects, music and laughs, must be recreated, remixed
      and synchronized with the original videotape. Audio sources are premixed foreign
      language tracks or tracks that contain music and effects only. The latter is
      used to make a final videotape product that will be sent to a foreign country
      to
      permit addition of a foreign dialogue track to the existing music and effects
      track.




*Foreign
      Language Mastering.* Programming designed for distribution in markets other than those for which
      it
      was originally produced is prepared for export through language translation
      and
      either subtitling or voice dubbing. The Company provides dubbed language
      versioning with an audio layback and conform service that supports various
      audio
      and videotape formats to create an international language-specific master
      videotape. One of the Company's Burbank facilities also creates music and
      effects tracks from programming shot before an audience to prepare television
      sitcoms for dialog recording and international distribution.




*Syndication.* The
      Company offers a broad range of technical services to domestic and international
      programmers. The Company services the basic and premium cable, broadcast
      syndication and direct-to-home market segments by providing the facilities
      and
      services necessary to assemble and distribute programming via satellite to
      viewers in the United States, Canada and Europe. The Company provides facilities
      and services for the delivery of syndicated television programming in the United
      States and Canada. The Company's customer base consists of the major studios
      and
      independent distributors offering network programming, world-wide independent
      content owners offering niche market programming, and pay-per-view services
      marketing movies and special events to the cable industry and direct-to-home
      viewers. Broadcast and syndication operations are conducted in Hollywood and
      West Los Angeles.




5




*Archival
      Services.* The
      Company currently stores approximately one million videotape and film elements
      in a protected environment. The storage and handling of videotape and film
      elements require specialized security and environmental control procedures.
      The
      Company performs secure management archival services in all of its operating
      facilities as well as its state-of-the-art Media Center in Los Angeles. The
      Company offers on-line access to archival information for advertising clients,
      and may offer this service to other clients in the future.




**Distribution
      Network**




The
      Company operates
      a full service distribution network providing its customers with reliable,
      timely and high quality distribution services. The Company's historical customer
      base consists of advertising agencies, multinational companies, motion picture
      and television studios and post-production facilities .




Commercials,
      trailers, electronic press kits and related distribution instructions are
      typically collected at one of the Company's regional facilities and are
      processed locally or transmitted to another regional facility for processing.
      Orders are routinely received into the evening hours for delivery the next
      morning. The Company has the ability to process customer orders from receipt
      to
      transmission in less than one hour. Customer orders that require immediate,
      multiple deliveries in remote markets are often delivered electronically to
      and
      serviced by third parties with duplication and delivery services in such
      markets. The Company provides the advantage of being able to service customers
      from both of its primary markets (entertainment and advertising) in all of
      its
      facilities to achieve the most efficient project turnaround. The Company's
      network operates 24 hours a day.




For
      electronic distribution, a video master is digitized and delivered by fiber
      optic, Internet, ISDN or satellite transmission to television stations equipped
      to receive such transmissions. All of the Company’s electronic, fiber optic,
      satellite and internet deliveries are made using third party vendors. The
      Company currently derives approximately one-half of its distribution revenues
      from electronic deliveries and anticipates that this percentage will increase
      as
      such technologies become more widely adopted.




The
      Company intends to add new methods of distribution as technologies become both
      standardized and cost-effective. The Company currently operates facilities
      in
      Los Angeles (seven locations), New York, Chicago, Dallas and San Francisco.
      By
      capitalizing on electronic technologies to link instantaneously all of the
      Company's facilities, the Company is able to optimize delivery, thus extending
      the deadline for same- or next-day delivery of time-sensitive
      material.




The
      Company's network and facilities are designed to serve, cost-effectively, the
      time-sensitive distribution needs of its clients. Management believes that
      the
      Company's success is based on its strong customer relationships that are
      maintained through the reliability, quality and cost-effectiveness of its
      services, and its extended deadline for processing customer orders.




**New
      Markets**




The
      Company believes that the development of its network and its array of
      value-added services will provide the Company with the opportunity to enter
      or
      increase its presence in several new or expanding markets.




*International.* The
      Company currently provides electronic and physical duplication and distribution
      services for rich media content providers. Further, the Company believes that
      electronic distribution methods will facilitate further expansion into the
      international distribution arena as such technologies become standardized and
      cost-effective. In addition, the Company believes that the growth in the
      distribution of domestic content into international markets will create
      increased demand for value-added services currently provided by the Company
      such
      as standards conversion and audio and digital mastering.




*High
      Definition Television (HDTV).* The
      Company is focused on capitalizing on opportunities created by emerging industry
      trends such as the emergence of digital television and its more advanced
      variant, high-definition television. HDTV has quickly become the mastering
      standard for domestic content providers. The Company believes that the
      aggressive timetable associated with such conversion, which has resulted both
      from mandates by the Federal Communications Commission (the "FCC") for digital
      television and high-definition television as well as competitive forces in
      the
      marketplace, is likely to accelerate the rate of increase in the demand for
      these services. The Company maintains a state-of-the-art HDTV
      capability.




*DVD
      Authoring* .
      The
      Company believes that there are significant opportunities in the DVD authoring
      market. With the increasing rate of conversion of existing analog libraries,
      as
      well as new content being mastered to digital formats, we believe that the
      Company has positioned itself well to provide value-added services to new and
      existing clients. The Company has made capital investments to expand and upgrade
      its current DVD and digital compression operations in anticipation of the
      increasing demand for DVD and video encoding services.




6




**Sales
      and Marketing**




The
      Company markets its services through a combination of industry referrals, formal
      advertising, trade show participation, special client events, and its Internet
      website. While the
      Company relies
      primarily on its reputation and business contacts within the industry for the
      marketing of its services, the Company also maintains a direct sales force
      to
      communicate the capabilities and competitive advantages of the Company's
      services to potential new customers. In addition, the Company's sales force
      solicits corporate advertisers who may be in a position to influence
      agencies in directing deliveries through the Company. The Company currently
      has
      sales personnel located in Los Angeles, San Francisco, Chicago, Dallas and
      New
      York. The Company's marketing programs are directed toward communicating its
      unique capabilities and establishing itself as the predominant value-added
      distribution network for the motion picture and advertising industries.




In
      addition to its traditional sales efforts directed at those individuals
      responsible for placing orders with the Company’s facilities, the Company also
      strives to negotiate “preferred vendor” relationships with its major customers.
      Through this process, the Company negotiates discounted rates with large volume
      clients in return for being promoted within the client’s organization as an
      established and accepted vendor. This selection process tends to favor larger
      service providers such as the Company that (i) offer lower prices through scale
      economies; (ii) have the capacity to handle large
      orders without outsourcing to other vendors; and (iii) can offer a strategic
      partnership on technological and other industry-specific issues. The Company
      negotiates such agreements periodically with major entertainment studios and
      national broadcast networks.




**Customers**




Since
      its
      inception in 1990, the Company has added customers through acquisitions and
      by
      delivering a favorable mix of reliability, timeliness, quality and price. The
      integration of the Company's regional facilities has given its customers a
      time
      advantage in the ability to deliver broadcast quality material. The Company
      markets its services to major and independent motion picture and television
      production companies, advertising agencies, television program suppliers and,
      on
      a more limited basis, national television networks, infomercial providers,
      local
      television stations, television program syndicators, corporations and
      educational institutions. The Company's motion picture clients include Disney,
      Sony Pictures Entertainment, Twentieth Century Fox, Universal Studios, Warner
      Bros., Metro-Goldwyn-Mayer and Paramount Pictures. The Company's advertising
      agency customers include TBWA/Chiat Day, Young & Rubicam and Saatchi
& Saatchi.




The
      Company solicits the motion picture and television industries, advertisers
      and
      their agencies to generate revenues. In the year ended December 31, 2006,
      ten major motion picture studios and advertising agencies accounted for
      approximately 51% of the Company's revenues, while sales to Twentieth Century
      Fox and affiliates comprised 24% of 2006 revenues. Sales to Twentieth Century
      Fox and affiliates were made to approximately 50 individual customers within
      the
      group.




The
      Company generally does not have exclusive service agreements with its clients.
      Because clients generally do not make arrangements with the Company until
      shortly before its facilities and services are required, the Company usually
      does not have any significant backlog of service orders. The Company's services
      are generally offered on an hourly or per unit basis based on volume.




**Customer
      Service**




The
      Company believes
      it has built its strong reputation in the market with a commitment to customer
      service. The
      Company receives
      customer orders via courier services, telephone, telecopier and the
      Internet. The sales and customer service staff develops strong relationships
      with clients within the studios and advertising agencies and is trained to
      emphasize the Company's ability to confirm delivery, meet difficult delivery
      time frames and provide reliable and cost-effective service. Several studios
      are
      customers because of the Company's ability to meet often changing or rush
      delivery schedules.




The
      Company has a sales and customer service staff of
      approximately 75 people, at least one member of which is available 24 hours
      a day. This staff serves as a single point of problem resolution and supports
      not only the Company's customers, but also the television stations and cable
      systems to which the Company delivers.




**Competition**




The
      manipulation, duplication and distribution of rich media assets is a highly
      competitive service-oriented business. Certain competitors (both independent
      companies and divisions of large companies) provide all or most of the services
      provided by the Company, while others specialize in one or several of these
      services. Substantially all of the Company's competitors have a presence in
      the
      Los Angeles area, which is currently the largest market for the Company's
      services. Due to the current and anticipated future demand for video duplication
      and distribution services in the Los Angeles area, the Company believes that
      both existing and new competitors may expand or establish video service
      facilities in this area.




7




The
      Company believes that it maintains a competitive position in its market by
      virtue of the quality and scope of the services it provides, and its ability
      to
      provide timely and accurate delivery of these services. The Company believes
      that prices for its services are competitive within its industry, although
      some
      competitors may offer certain of their services at lower rates than the Company.




The
      principal competitive factors affecting this market are reliability, timeliness,
      quality and price. The Company competes with a variety of duplication and
      distribution firms, certain post-production companies and, to a lesser extent,
      the in-house operations of major motion picture studios and ad
      agencies. Some of these competitors have long-standing ties to clients that
      will
      be difficult for the Company to change. Several companies have systems for
      delivering video content electronically. Moreover, some of these firms, such
      as
      Vyvx (a unit of Level 3 Communications, Inc.), DG FastChannel, Inc.,
      Liberty Media Inc. (formerly Ascent Media Group, Inc.) and other post-production
      companies may have greater financial, operational and marketing resources,
      and
      may have achieved a higher level of brand recognition than the Company. As
      a
      result, there is no assurance that the Company will be able to compete
      effectively against these competitors merely on the basis of reliability,
      timeliness, quality, price or otherwise.




**Employees**




The
      Company had 440 full-time employees as of December 31, 2006. The Company's
      employees are not represented by any collective bargaining organization, and
      the
      Company has never experienced a work stoppage. The Company believes that its
      relations with its employees are good.




**ITEM
      1A. RISK FACTORS**




**We
      have a recent history of losses, and we may incur losses in the
      future** .
      The
      Company reported losses in each of the five fiscal quarters ended December
      31,
      2001 and in some quarters thereafter due, in part, to lower gross margins and
      lower sales levels and a number of unusual charges. Although we achieved
      profitability in Fiscal 2000 and prior years, as well as in most fiscal quarters
      between March 31, 2002 and December 31, 2006, there can be no assurance as
      to
      future profitability on a quarterly or annual basis.




**We
      have previously breached our credit agreements and may do so in the
      future** **.** Due to
      lower operating cash amounts resulting from reduced sales levels in 2001 and
      the
      consequential net losses, the Company breached certain covenants of its credit
      facility. The breaches were temporarily cured based on amendments and
      forbearance agreements among the Company and the banks which called for, among
      other provisions, scheduled payments to reduce amounts owed to the banks to
      the
      permitted borrowing base. In August 2001, the Company failed to meet the
      principal repayment schedule and was once again in breach of the credit
      facility. The banks ended their formal commitment to the Company in December
      2001.





In
      May
      2002, we entered into an agreement with the banks to restructure the credit
      facility to a term loan maturing on December 31, 2004. As part of this
      restructuring, the banks waived all existing defaults and the Company was
      required to make principal payments of $5.5 million, $5.0 million and $18.5
      million in 2002, 2003, and 2004, respectively.





In
      March
      2004, we entered into a revised agreement with the banks providing revolving
      and
      term loan facilities. Annual principal payments for the term loan were to be
      $1.6 million each for five years. Any principal outstanding under the revolver
      was to be due in March 2006.





In
      July
      and August 2004, the credit agreement was amended in connection with the
      acquisition of International Video Conversion, Inc. (“IVC”) to increase the
      amounts that can be borrowed under the revolving and term loan portions of
      the
      arrangement. Approximately $4.7 million was borrowed to consummate the
      transaction. Also, in August 2004, we borrowed $6,435,000 to purchase land
      and a
      building to house our Los Angeles area media storage capability.





During
      the second quarter of 2005, we entered into discussions with the banks to amend
      certain financial covenants contained in our credit agreement to more closely
      track our changing business environment which has contributed to lower sales
      and
      profits in previous quarters. As of June 30, 2005, our credit agreement was
      changed to shorten the due date of the outstanding revolving loan from March
      12,
      2006 to January 31, 2006 (subsequently extended to March 31, 2006), eliminate
      a
      re-borrowing provision of the term loan, increase interest rates on the revolver
      and term loans by 0.5% and revise certain financial covenants.





As
      of
      December 30, 2005, the Company did not meet certain financial covenants
      contained in the credit facility and received a compliance waiver from the
      bank.
      The credit facility was paid in full in March 2006.





In
      December 2005, we entered a new five-year term loan, paying off the previously
      existing term loan with the proceeds there from.





In
      March
      2006, we entered a new revolving credit agreement providing for borrowing up
      to
      $10 million (based on qualified accounts receivable) for a two-year period.
      Additionally, we sold and leased back our Media Center facility which reduced
      mortgage debt by $6.0 million and generated approximately $8.0 million for
      other
      debt reduction and general corporate purposes. The resulting annual lease
      payments are approximately $1,100,000 as compared to $687,000 of previously
      scheduled mortgage debt service (principal and interest) and approximately
      $600,000 of annual interest cost on other debt repaid with the sale
      proceeds.




8





If
      the
      Company incurs losses in the future, there is a risk that we will default under
      certain financial covenants contained in the new agreements and/or will not
      be
      able to pay off the revolving and term loans when due. If a default condition
      exists in the future, all amounts outstanding under the new agreements will
      be
      due and payable which could materially and adversely affect our
      business.




**We
      may be unable to compete effectively in a highly competitive
      marketplace** .
      Our
      post production, duplication and distribution industry is a highly competitive,
      service-oriented business. In general, we do not have long-term or exclusive
      service agreements with our customers. Business is acquired on a purchase order
      basis and is based primarily on customer satisfaction with reliability,
      timeliness, quality and price.




We
      compete with a variety of post production, duplication and distribution firms,
      some of which have a national presence, and to a lesser extent, the in-house
      post production and distribution operations of our major motion picture studio
      and advertising agency customers. Some of these firms, and all of the studios,
      have greater financial, distribution and marketing resources and have achieved
      a
      higher level of brand recognition than the Company. In the future, we may not
      be
      able to compete effectively against these competitors merely on the basis of
      reliability, timeliness, quality and price or otherwise.




We
      may
      also face competition from companies in related markets which could offer
      similar or superior services to those offered by the Company. We believe that
      an
      increasingly competitive environment as evidenced by recent price pressure
      and
      some related loss of work and the possibility that customers may utilize
      in-house capabilities to a greater extent could lead to a loss of market share
      or additional price reductions, which could have a material adverse effect
      on
      our financial condition, results of operations and prospects.




There
      is
      also the risk that third party vendors who directly compete with us will succeed
      in taking away business or curtailing services to us. We rely on such companies
      principally to electronically deliver commercial spots on behalf of our
      advertising clients. In June 2005, one such vendor notified us that its
      electronic distribution channel was no longer available to us except under
      certain circumstances. While curtailment of these services in this instance
      has
      not materially affected our ability to deliver commercial spots, any future
      interruption in the supply of such services could materially and adversely
      affect the Company’s financial condition, results of operations and
      prospects.




**We
      would be adversely affected by the loss of key
      customers** .
      Although we have an active client list of over 2,500 customers, ten motion
      picture studios and advertising agencies and/or their affiliates accounted
      for
      approximately 51%, 47% and 38% of the Company’s revenues in 2006, 2005 and 2004,
      respectively. If one or more of these companies were to stop using our services,
      our business could be adversely affected. Because we derive substantially all
      of
      our revenue from clients in the entertainment and advertising industries, the
      financial condition, results of operations and prospects of the Company could
      also be adversely affected by an adverse change in conditions which impact
      those
      industries.




**Our
      expansion strategy may fail** .
      Our
      growth strategy involves both internal development and expansion through
      acquisitions. We currently have no agreements or commitments to acquire any
      company or business. Even though we have completed a number of acquisitions
      in
      the past, the most recent of which was in November 2005, we cannot be sure
      additional acceptable acquisitions will be available or that we will be able
      to
      reach mutually agreeable terms to purchase acquisition targets, or that we
      will
      be able to profitably manage additional businesses or successfully integrate
      such additional businesses into the Company without substantial costs, delays
      or
      other problems.





Acquisitions
      may involve a number of special risks including: adverse effects on our reported
      operating results (including the amortization of acquired intangible assets),
      diversion of management’s attention and unanticipated problems or legal
      liabilities. In addition, we may require additional funding to finance future
      acquisitions. We cannot be sure that we will be able to secure acquisition
      financing on acceptable terms or at all. We may also use working capital or
      equity, or raise financing through equity offerings or the incurrence of debt,
      in connection with the funding of any acquisition. Some or all of these risks
      could negatively affect our financial condition, results of operations and
      prospects or could result in dilution to the Company’s shareholders. In
      addition, to the extent that consolidation becomes more prevalent in the
      industry, the prices for attractive acquisition candidates could increase
      substantially. We may not be able to effect any such transactions. Additionally,
      if we are able to complete such transactions they may prove to be
      unprofitable.





The
      geographic expansion of the Company’s customers may result in increased demand
      for services in certain regions where it currently does not have post
      production, duplication and distribution facilities. To meet this demand, we
      may
      subcontract. However, we have not entered into any formal negotiations or
      definitive agreements for this purpose. Furthermore, we cannot assure you that
      we will be able to effect such transactions or that any such transactions will
      prove to be profitable.




9





If
      we
      acquire any entities, we may have to finance a large portion of the anticipated
      purchase price and/or refinance our existing credit agreements. The cost of
      any
      new financing may be higher than our existing credit facilities. Future earnings
      and cash flow may be negatively impacted if any acquired entity does not
      generate sufficient earnings and cash flow to offset the increased costs.





**We
      are operating in a changing environment that may adversely affect our
      business** .
      In
      prior years, we experienced rapid growth, industry consolidation, changing
      technologies and increased regulation, all of which resulted in new and
      increased responsibilities for management personnel and placed, and continues
      to
      place, increased demands on our management, operational and financial systems
      and resources. To accommodate these circumstances, compete effectively and
      manage future growth, we will be required to continue to implement and improve
      our operational, financial and management information systems, and to expand,
      train, motivate and manage our work force. We cannot be sure that the Company’s
      personnel, systems, procedures and controls will be adequate to support our
      future operations. Any failure to do so could have a material adverse effect
      on
      our financial condition, results of operations and prospects.





**We
      may be unable to adapt our business to changing technological
      requirements** .
      Although we intend to utilize the most efficient and cost-effective technologies
      available for telecine, high definition formatting, editing, coloration and
      delivery of audio and video content, including digital satellite transmission,
      as they develop, we cannot be sure that we will be able to adapt to such
      standards in a timely fashion or at all. We believe our future growth will
      depend in part, on our ability to add to these services and to add customers
      in
      a timely and cost-effective manner. We cannot be sure we will be successful
      in
      offering such services to existing customers or in obtaining new customers
      for
      these services. We intend to rely on third party vendors for the development
      of
      these technologies and there is no assurance that such vendors will be able
      to
      develop such technologies in a manner that meets the needs of the Company and
      its customers. Additionally, in recent years, electronic delivery services
      have
      grown while physical duplication and delivery have been declining. We expect
      this trend to continue over a long term (i.e. the next 5 to 10 years). All
      of
      our electronic, fiber optics, satellite and Internet deliveries are made using
      third party vendors, which eliminates our need to invest in such capability.
      However, the use of others to deliver our services poses the risk that costs
      may
      rise in certain situations that cannot be passed on to customers, thereby
      lowering gross margins.





**The
      loss of key personnel would adversely affect our
      business** .
      The
      Company is dependent on the efforts and abilities of certain of its senior
      management, particularly those of Haig S. Bagerdjian, Chairman, President and
      Chief Executive Officer. The loss or interruption of the services of key members
      of management could have a material adverse effect on our financial condition,
      results of operations and prospects if a suitable replacement is not promptly
      obtained. Mr. Bagerdjian beneficially owns approximately 29% of the Company’s
      outstanding stock. Although we have severance agreements with Mr. Bagerdjian
      and
      certain key executives, we cannot be sure that either Mr. Bagerdjian or other
      executives will remain with the Company. In addition, our success depends to
      a
      significant degree upon the continuing contributions of, and on our ability
      to
      attract and retain, qualified management, sales, operations, marketing and
      technical personnel. The competition for qualified personnel is intense and
      the
      loss of any such persons, as well as the failure to recruit additional key
      personnel in a timely manner, could have a material adverse effect on our
      financial condition, results of operations and prospects. There is no assurance
      that we will be able to continue to attract and retain qualified management
      and
      other personnel for the development of our business.





**We
      may be unable to meet the demands of our customers** .
      Our
      business is dependent on our ability to meet the current and future demands
      of
      our customers, which demands include reliability, timeliness, quality and price.
      Any failure to do so, whether or not caused by factors within our control could
      result in losses to such clients. Although we disclaim any liability for such
      losses, there is no assurance that claims would not be asserted or that
      dissatisfied customers would refuse to make further deliveries through the
      Company in the event of a significant occurrence of lost deliveries, either
      of
      which could have a material adverse effect on our financial condition, results
      of operations and prospects. Although we maintain insurance against business
      interruption, such insurance may not be adequate to protect the Company from
      significant loss in these circumstances and there is no assurance that a major
      catastrophe (such as an earthquake or other natural disaster) would not result
      in a prolonged interruption of our business. In addition, our ability to make
      deliveries within the time periods requested by customers depends on a number
      of
      factors, some of which are outside of our control, including equipment failure,
      work stoppages by package delivery vendors or interruption in services by
      telephone or satellite service providers.





**Our
      quarterly operating results have fluctuated significantly in the past and may
      fluctuate in the future** .
      Our
      operating results have varied in the past, and may vary in the future, depending
      on factors such as the volume of advertising in response to seasonal buying
      patterns, the timing of new product and service introductions, the timing of
      revenue recognition upon the completion of longer term projects, increased
      competition, timing of acquisitions, general economic factors and other factors.
      As a result, we believe that period-to-period comparisons of our results of
      operations are not necessarily meaningful and should not be relied upon as
      an
      indication of future performance. For example, our operating results have
      historically been significantly influenced by the volume of business from the
      motion picture industry, which is an industry that is subject to seasonal and
      cyclical downturns, and, occasionally, work stoppages by actors, writers and
      others. In addition, as our business from advertising agencies tends to be
      seasonal, our operating results may be subject to increased seasonality if
      the
      percentage of business from advertising agencies increases. In any period our
      revenues are subject to variation based on changes in the volume and mix of
      services performed during the period. It is possible that in some future quarter
      the Company’s operating results will be below the expectations of equity
      research analysts and investors. In such event, the price of the Company’s
      Common Stock would likely be materially adversely affected.




10





**Our
      controlling shareholders may cause our company to be operated in a manner that
      is not in the best interests of other shareholders** .
      The
      Company’s Chairman, President and Chief Executive Officer, Haig S. Bagerdjian,
      beneficially owned approximately 29% of the Company’s common stock as of
      December 31, 2006. The ex-spouse of R. Luke Stefanko, the Company’s former
      President and Chief Executive Officer, owned approximately 13% of the common
      stock on that date. In January 2007, Mr. Bagerdjian and Mr. Stefanko entered
      into an 18-month agreement giving Mr. Bagerdjian Ms. Stefanko’s proxy regarding
      proposals for change in control (as defined) of the Company. DG FastChannel,
      Inc., a competitor, owned approximately 15% of the common stock on December
      31,
      2006. By virtue of their stock ownership, Ms. Stefanko, DG and Mr. Bagerdjian
      individually or together may be able to significantly influence the outcome
      of
      matters required to be submitted to a vote of shareholders, including (i) the
      election of the board of directors, (ii) amendments to the Company’s Restated
      Articles of Incorporation and (iii) approval of mergers and other significant
      corporate transactions. The foregoing may have the effect of discouraging,
      delaying or preventing certain types of transactions involving an actual or
      potential change of control of the Company, including transactions in which
      the
      holders of common stock might otherwise receive a premium for their shares
      over
      current market prices.





**Our
      shareholder rights plan and ability to issue preferred stock may discourage,
      delay or prevent a change in control of our company that would benefit our
      shareholders** .
      Our
      Board of Directors has the authority to issue up to 5,000,000 shares of
      preferred stock without par value (the “Preferred Stock”) and to determine the
      price, rights, preferences, privileges and restrictions thereof, including
      voting rights, without any further vote or action by the Company’s shareholders.
      On November 17, 2004, the Company declared a dividend distribution of one
      Preferred Share Purchase Right on each outstanding share of its common stock.
      The Rights will be attached to the Company’s Common Stock and will trade
      separately and be exercisable only in the event that a person or group acquires
      or announces the intent to acquire 20% or more of Point.360’s Common Stock. Each
      Right will entitle shareholders to buy one one-hundredth of a share of a new
      series of junior participating preferred stock at an exercise price of $10.
      If
      the Company is acquired in a merger or other business combination transaction
      after a person has acquired 20% or more of the Company’s outstanding Common
      Stock, each Right will entitle its holder to purchase, at the Right’s
      then-current exercise price, a number of the acquiring company’s common shares
      having a market value of twice such price. In addition, if a person or group
      acquires 20% or more of Point.360’s outstanding Common Stock, each Right will
      entitle its holder (other than such person or members of such group) to
      purchase, at the Right’s then-current exercise price, a number of the Company’s
      common shares having a market value of twice such price. Following an
      acquisition by a person or group of beneficial ownership of 20% of more of
      the
      Company’s Common Stock and before an acquisition of 50% or more of the Common
      Stock, Point.360’s Board of Directors may exchange the Rights (other than Rights
      owned by such person or group), in whole or in part, at an exchange ratio of
      one
      one-hundredth of a share of the new series of junior participating preferred
      stock per Right. Before a person or group acquires beneficial ownership of
      20%
      or more of the Company’s Common Stock, the Rights are redeemable for $.0001 per
      Right at the option of the Board of Directors. The Rights are intended to enable
      Point.360’s shareholders to realize the long-term value of their investment in
      the Company. They will not prevent a takeover, but should encourage anyone
      seeking to acquire the Company to negotiate with the Board prior to attempting
      a
      takeover.




Although
      we have no current plans to issue any other shares of Preferred Stock, the
      rights of the holders of common stock would be subject to, and may be adversely
      affected by, the rights of the holders of any Preferred Stock that may be issued
      in the future. Issuance of Preferred Stock could have the effect of
      discouraging, delaying, or preventing a change in control of the Company.
      Furthermore, certain provisions of the Company’s Restated Articles of
      Incorporation and By-Laws and of California law also could have the effect
      of
      discouraging, delaying or preventing a change in control of the
      Company.




**ITEM
      1B. UNRESOLVED STAFF COMMENTS**





Not
      applicable




11




**ITEM
      2. PROPERTIES**




The
      Company currently leases 11 facilities which all have production capabilities
      and/or sales activities. The terms of leases for leased facilities expire at
      various dates from 2008 to 2021. The following table sets forth the location
      and
      approximate square footage of the Company's properties as of December 31,
      2006:





**Square****Footage**Hollywood,
                CA.
            31,000Hollywood,
                CA.
            13,400Hollywood,
                CA.
            13,000Burbank,
                CA.
            32,000Burbank,
                CA.
            45,500Los
                Angeles, CA.
            64,600Los
                Angeles, CA.
            13,400San
                Francisco, CA.
            9,500Chicago,
                IL.
            13,200New
                York, NY.
            9,000Dallas,
                TX.
            11,300




**ITEM
      3. LEGAL PROCEEDINGS**




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




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




No
      matters were submitted to the Company’s shareholders for a vote during the
      fourth quarter of the fiscal year covered by this report.




12




**PART
      II**





**ITEM
              5.**
            **MARKET
                FOR THE COMPANY'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
                ISSUER
                PURCHASES OF EQUITY
                SECURITIES**




**Market
      Information**




The
      Company's Common Stock is traded on the Nasdaq National Market ("NNM") under
      the
      symbol PTSX. The following table sets forth, for the periods indicated, the
      high
      and low closing price per share for the Common Stock.





**Common
                Stock****Low**
            
            **High****Year
                Ended December 31, 2005**First
                Quarter
            
            $
            3.21
            
            $
            3.95Second
                Quarter
            
            
            2.76
            
            
            3.50Third
                Quarter
            
            
            2.21
            
            
            3.21Fourth
                Quarter
            
            
            1.65
            
            
            2.25**Year
                Ended December 31, 2006**First
                Quarter
            
            $
            1.85
            
            $
            2.70Second
                Quarter
            
            
            1.98
            
            
            2.70Third
                Quarter
            
            
            1.74
            
            
            2.40Fourth
                Quarter
            
            
            1.64
            
            
            3.59





On
      February 14, 2007, the closing sale price of the Common Stock as reported on
      the
      NNM was $3.36 per share. On that date, there were approximately 1,000 holders
      of
      record of the Common Stock.





**Dividends**




The
      Company did not pay dividends on its Common Stock during the years ended
      December 31, 2005 or 2006. The Company’s ability to pay dividends depends
      upon limitations under applicable law and covenants under its bank agreements.
      The Company currently does not intend to pay any dividends on its Common Stock
      in the foreseeable future. See "Management's Discussion and Analysis of
      Financial Condition and Results of Operations -- Liquidity and Capital
      Resources."





**Stock
      Repurchases**





The
      Company did not repurchase any shares of its Common Stock during the year ended
      December 31, 2006.




13




**ITEM
      6. SELECTED FINANCIAL DATA**




The
      following data, insofar as they relate to each of the years 2002 to 2006, have
      been derived from the Company’s annual financial statements. This information
      should be read in conjunction with the Financial Statements and Notes thereto
      and "Management's Discussion and Analysis of Financial Condition and Results
      of
      Operations" included elsewhere herein. All amounts are shown in thousands,
      except per share data.




**Year
                Ended December 31,****2002**
            
            **2003**
            
            **2004**
            
            **2005**
            
            **2006****Statement
                of Income Data**Revenues
            
            $
            68,419
            
            $
            64,900
            
            $
            63,344
            
            $
            66,199
            
            $
            64,218Cost
                of services sold
            
            
            (42,172
            )
            
            (39,670
            )
            
            (40,519
            )
            
            (43,167
            )
            
            (43,071
            )Gross
                profit
            
            
            26,247
            
            
            25,230
            
            
            22,825
            
            
            23,032
            
            
            21,147Selling,
                general and administrative expense
            
            
            (18,977
            )
            
            (17,479
            )
            
            (18,936
            )
            
            (21,424
            )
            
            (20,037
            )Write-off
                of deferred acquisition and financing costs
            
            
            -
            
            
            (1,043
            )
            
            (1,050
            )
            
            -
            
            
            -Operating
                income
            
            
            7,270
            
            
            6,708
            
            
            2,839
            
            
            1,608
            
            
            1,110Interest
                expense, net
            
            
            (2,528
            )
            
            (2,056
            )
            
            (811
            )
            
            (1,524
            )
            
            (846
            )Derivative
                fair value change (2)
            
            
            82
            
            
            611
            
            
            -
            
            
            -
            
            
            -Provision
                for income tax
            
            
            (2,007
            )
            
            (2,114
            )
            
            (781
            )
            
            (70
            )
            
            (188
            )Net
                income
            
            $
            2,817
            
            $
            3,149
            
            $
            1,247
            
            $
            14
            
            $
            76Earnings
                per share:Basic
            
            $
            0.31
            
            $
            0.35
            
            $
            0.14
            
            $
            0.00
            
            $
            0.01Diluted
            
            $
            0.30
            
            $
            0.33
            
            $
            0.13
            
            $
            0.00
            
            $
            0.01Weighted
                average common shares outstanding:Basic
            
            
            9,013
            
            
            9,067
            
            
            9,197
            
            
            9,347
            
            
            9,511Diluted
            
            
            9,377
            
            
            9,555
            
            
            9,671
            
            
            9,714
            
            
            9,615





**Year
                Ended December 31,****2002**
            
            **2003**
            
            **2004**
            
            **2005**
            
            **2006****Other
                Data**
            
            
            
            
            
            (3)
            
            
            
            (4)EBITDA(1)
            
            $
            12,690
            
            $
            12,818
            
            $
            8,715
            
            $
            7,659
            
            $
            6,650Cash
                flows provided by operating activities
            
            
            10,381
            
            
            10,480
            
            
            6,814
            
            
            6,407
            
            
            2,362Cash
                flows used in investing activities
            
            
            (3,485
            )
            
            (1,599
            )
            
            (8,426
            )
            
            (4,412
            )
            
            10,908Cash
                flows provided by (used in) financing activities
            
            
            (5,282
            )
            
            (7,047
            )
            
            (4,926
            )
            
            (2,068
            )
            
            (14,127
            )Capital
                expenditures
            
            
            1,949
            
            
            1,237
            
            
            5,307
            
            
            2,202
            
            
            2,635**Selected
                Balance Sheet Data**Cash
                and cash equivalents
            
            $
            5,372
            
            $
            7,206
            
            $
            668
            
            $
            595
            
            $
            -Working
                capital
            
            
            8,185
            
            
            3,663
            
            
            (119
            )
            
            1,275
            
            
            3,721Property
                and equipment, net
            
            
            19,965
            
            
            15,751
            
            
            31,451
            
            
            28,079
            
            
            14,138Total
                assets
            
            
            70,080
            
            
            64,744
            
            
            76,647
            
            
            75,459
            
            
            62,956Borrowings
                under revolving credit agreements
            
            
            -
            
            
            -
            
            
            4,323
            
            
            4,054
            
            
            3,007Current
                portion of notes payable
            
            
            -
            
            
            -
            
            
            2,849
            
            
            2,310
            
            
            1,174Long-term
                debt, net of current portion
            
            
            18,065
            
            
            6,762
            
            
            14,494
            
            
            13,744
            
            
            3,474Shareholders'
                equity
            
            
            34,512
            
            
            37,368
            
            
            38,944
            
            
            39,510
            
            
            40,021








(1)
            EBITDA
                is defined herein as earnings before interest, taxes, depreciation
                and
                amortization. Interest, taxes, depreciation and amortization are
                annual
                recurring costs for the Company. EBITDA represents a performance
                measure
                before deducting interest which can vary depending upon debt levels,
                taxes
                which can affect net income depending upon effective tax rates from
                year
                to year, and depreciation and amortization expenses which do not
                require a
                cash outlay. Management uses EBITDA (i) to measure the Company’s
                performance as compared to its competitors which also disclose EBITDA,
                (ii) as the principle performance criteria for banks and financial
                institutions as the basis for covenant compliance calculations, and
                (iii)
                to compare performance among the Company’s facilities. EBITDA is also a
                common performance measurement used to determine the possible
                contributions to earnings of acquisition candidates. EBITDA is not
                a
                performance measure in accordance with Generally Accepted Accounting
                Principles (“GAAP”) and is not to be considered as an alternative to net
                income or any other GAAP measurements as a measure of operating
                performance. The Company’s determination of EBITDA may not be comparable
                to other similarly titled measures of other companies. Using EBITDA
                as a
                performance measure may lead to erroneous conclusions as to the Company’s
                net income, the most directly comparable GAAP measure. A reader of
                the
                financial statements should concentrate on computation net income
                shown in
                accordance with GAAP, while using the EBITDA reconciliation to net
                income
                shown below as supplemental disclosure.





14





Computation
      of EBITDA (in thousands):





2002
            
            2003
            
            2004
            
            2005
            
            2006Net
                income (loss)
            
            $
            2,817
            
            $
            3,149
            
            $
            1,247
            
            $
            14
            
            $
            76Add
                back:Interest
            
            
            2,528
            
            
            2,056
            
            
            811
            
            
            1,524
            
            
            846Income
                taxes
            
            
            2,007
            
            
            2,114
            
            
            781
            
            
            70
            
            
            188Depreciation
                & Amortization
            
            
            5,338
            
            
            5,499
            
            
            5,876
            
            
            6,051
            
            
            5,540EBITDA
            
            $
            12,690
            
            $
            12,818
            
            $
            8,715
            
            $
            7,659
            
            $
            6,650





(2)
            In
                November 2000, the Company entered into an interest rate swap contract
                to
                economically hedge its floating debt rate. Under the terms of the
                contract, the notional amount is $15,000,000, whereby the Company
                received
                LIBOR and paid a fixed 6.50% rate of interest for three years. Statement
                of Financial Accounting Standards No. 133,*Accounting
                for Derivative Instruments and Hedging Activities*(“FAS 133”), required that the interest rate swap contract be recorded at
                fair value upon adoption of FAS 133 by recording (i) a cumulative-effect
                type adjustment at January 1, 2001 equal to the fair value of the
                interest
                rate swap contract on that date, (ii) amortizing the cumulative-effect
                type adjustment over the life of the derivative contract, and (iii)
                a
                charge or credit to income in the amount of the difference between
                the
                fair value of the interest rate swap contract at the beginning and
                end of
                such year. The effect of adopting FAS 133 was to record a cumulative
                effect type adjustment by charging Accumulated Other Comprehensive
                Income
                (a component of shareholders’ equity $247,000 (net of $62,000 tax
                benefit), crediting Derivative Valuation Liability by $309,000 gross
                cumulative effect adjustment and charging Deferred Income Taxes $62,000.
                The change in the derivative fair value during the year ($186,000
                and
                $701,000 in 2002 and 2003, respectively) and the amortization of
                the
                cumulative effect adjustment (($104,000) and ($90,000) in 2002 and
                2003
                respectively) were recorded as a charge to Derivative Fair Value
                Change.





(3)
            On
                July 1, 2004, the Company acquired International Video Conversions,
                Inc.
                See Note 3 of the Notes to Consolidated Financial Statements in this
                Form
                10-K.





(4)
            On
                March 29, 2006, the Company sold and leased back its Media Center
                facility. Proceeds were used to repay debt. See Notes 4 and 5 of
                Notes to
                Consolidated Financial Statements.




15




**ITEM
              7.**
            **MANAGEMENT'S
                DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
                OPERATIONS**




*Except
      for the historical information contained herein, certain statements in this
      annual 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, depending 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
      this Form 10-K, for a further discussion of these and other risks and
      uncertainties applicable to the Company's business.*




**Overview**




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




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




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




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




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




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




During
      2004, we completed the acquisition of IVC and settled all disputes related
      to a
      proposed acquisition of three subsidiaries of Alliance Atlantis Communications,
      Inc. (“Alliance”). In 2006, we completed a sale/leaseback transaction of our
      Media Center facility.





The
      following table sets forth the amount and percentage relationship to revenues
      of
      certain items included within the Company's Consolidated Statement of Income
      for
      the years ended December 31, 2004, 2005 and 2006. The commentary below is
      based on these financial statements (in thousands).




16





**Year
                Ended December 31****2004**
            
            **2005**
            
            **2006****Amount**
            
            **Percent
                of**
              **Revenues**
            
            **Amount**
            
            **Percent
                of**
              **Revenues**
            
            **Amount**
            
            **Percent
                of**
              **Revenues**Revenues
            
            $
            63,344
            
            
            100.0
            %
            $
            66,199
            
            
            100.0
            %
            $
            64,218
            
            
            100.0
            %Costs
                of services sold
            
            
            (40,519
            )
            
            (64.0
            )
            
            (43,167
            )
            
            (65.2
            )
            
            (43,071
            )
            
            (67.1
            )Gross
                profit
            
            
            22,825
            
            
            36.0
            
            
            23,032
            
            
            34.8
            
            
            21,147
            
            
            32.9Selling,
                general and administrative expense
            
            
            (18,936
            )
            
            (29.9
            )
            
            (21,424
            )
            
            (32.4
            )
            
            (20,038
            )
            
            (31.2
            )Write-off
                of deferred acquisition and financing costs
            
            
            (1,050
            )
            
            (1.6
            )
            
            -
            
            
            -
            
            
            -
            
            
            -Operating
                income
            
            
            2,839
            
            
            4.5
            
            
            1,608
            
            
            2.4
            
            
            1,110
            
            
            1.7Interest
                expense, net
            
            
            (811
            )
            
            (1.3
            )
            
            (1,524
            )
            
            (2.3
            )
            
            (846
            )
            
            (1.3
            )(Provision
                for) benefit from income taxes
            
            
            (781
            )
            
            (1.2
            )
            
            (70
            )
            
            (0.1
            )
            
            (188
            )
            
            (0.3
            )Net
                income (loss)
            
            $
            1,247
            
            
            2.0
            %
            $
            14
            
            
            0.0
            %
            $
            76
            
            
            0.1
            %




**Year
      Ended December 31, 2006 Compared To Year Ended December 31,
      2005.**




*Revenues.* Revenues
      were $64.2 million for the year ended December 31, 2006, compared to $66.2
      million for the year ended December 31, 2005. Revenues declined in 2006 due
      to a
      number of factors including: (i) price compression due to competition in post
      production and spot advertising distribution, (ii) consolidation among some
      customers that has resulted in less business being available to Point.360,
      and
      (iii) the continuing trend toward electronic distribution of commercial spots
      as
      opposed to physical duplication and distribution which results in lower
      revenues. Revenue from freight, the charge to customers for sending commercial
      spots physically, declined to about 4.5% of sales in 2006 from 5.0% in the
      prior
      year. These factors have been somewhat offset by acquiring new customers and
      adding new service offerings. We expect the negative trends to continue at
      a
      slower pace in the future, and we will continue to invest in high definition
      capabilities where demand is expected to grow. We believe our high definition
      service platform will attract additional business in the future.




*Gross
      Profit* .
      In
      2006, gross margin was 33% of sales, compared to 35% for last year. The
      sale/leaseback penalized gross margin by 1% of sales (i.e., lease costs
      increased $0.6 million in the 2006 period net of depreciation associated with
      the previously-owned facility). The impact of the sale/leaseback will be
      continuing. The remaining decrease in gross profit percentage is due to lower
      sales offset by declining wages and benefits. Gross margins have been
      historically higher as a percentage of sales for advertising related revenue
      as
      compared to post production, the latter requiring a greater investment in
      equipment (greater depreciation) and higher personnel costs when compared to
      duplication and distribution of advertising content. We expect gross margins
      to
      fluctuate in the future as the sales mix changes.




*Selling,
      General and Administrative Expense.* SG&A
      expense was $20.0 million (31% of sales) in 2006 as compared to $21.4 million
      (32% of sales) in 2005.




*Operating
      Income.* Operating income decreased $0.5 million to $1.1 million in 2006, compared to
      $1.6 million in 2005.




*Interest
      Expense.* Interest
      expense for 2006 was $0.9 million, a decrease of $0.7 million from 2005. The
      decrease was due to lower debt levels resulting from the sale/leaseback
      transaction offset partially by higher rates on remaining variable interest
      debt.




*Net
      Income.* Net
      income for 2006 was $0.1 million compared to $0.0 million in 2006.




**Year
      Ended December 31, 2005 Compared To Year Ended December 31,
      2004.**




*Revenues* . **** Revenues
      increased $2.9 million to $66.2 million for the year ended December 31, 2005,
      compared to $63.3 million in 2004. A $5.8 million increase is due to the
      inclusion of IVC for the entire fiscal year as opposed to six months in 2004
      (IVC was acquired on July 1, 2004). Without IVC sales for the first six months
      of 2005, twelve month 2005 sales declined $2.9 million to $60.4 million as
      compared to 2004. The decline is due to lower spot advertising revenues as
      customer’s switched to electronic from physical distribution. Revenues for
      physical distribution of tapes containing commercial spot advertising include
      tape stock and freight. Revenue from freight, the charge to customers for
      sending commercial spots physically, declined to about 5.0% of sales in 2005
      from 5.6% in the prior year. In electronic distribution, sales consist of only
      the electronic fee for distributing the advertisement.




*Gross
      Profit* .
      In
      2005, gross profit decreased by 1.2% of sales. Gross profit on sales was 35%
      in
      2005 compared to 36% in 2004, the decline being due principally to higher wages
      and benefits and delivery costs.




*Selling,
      General And Administrative Expense* .  SG&A
      expense increased $1.4 million, or 7%, to $21.4 million in 2005, compared to
      $20.0 million in 2004 due principally to higher selling costs. As a percentage
      of revenues, SG&A was 32% for 2005 and 2004.




17




In
      2004,
      the Company wrote off approximately $1.1 million of deferred acquisition and
      financing and settlement costs related to the termination of the potential
      acquisition of three subsidiaries of Alliance. This expense has been set forth
      separately.




*Operating
      Income* .
      Operating income decreased $1.2 million to $1.6 million, compared to $2.8
      million in 2004.




*Interest
      Expense* .  **** Interest
      expense for 2005 was $1.5 million compared to $0.8 million in 2004. The 2005
      amount included a $0.2 million write-off of deferred financing costs associated
      with a terminated term loan. The remainder of the increase in 2005 resulted
      in
      generally increasing interest rates on the Company’s variable rate debt and
      increased outstanding borrowings and a mortgage for all of 2005 due to the
      purchase of IVC in July 2004 and our Media Center land and building in August
      2004, respectively.




*Income
      Taxes* .
      The
      Company’s effective tax rate was 83% for 2005 and 39% for 2004. The increase in
      effective tax rate is the result of the Company’s periodic assessment of the
      relationship of book/tax timing differences to total expected annual pre-tax
      results and the elimination of goodwill expense for financial statement
      purposes. The effective tax rate percentage may change from period to period
      depending on the difference in the timing of the recognition of revenues and
      expenses for book and tax purposes. The high effective rate for 2005 resulted
      from the relatively low amount of pre-tax income when compared to such
      differences.




*Net
      Income* . **** The
      net
      income for 2005 was $0.0 million, a decrease of $1.2 million compared to
      net income of $1.2 million for 2004.




**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-K.




On
      December 30, 2006, the Company entered a new $10 million term loan agreement.
      The term loan provides for interest at LIBOR (5.37% at December 31, 2006) plus
      3.15%, or 8.52% at December 31, 2006, and is secured by the Company’s equipment.
      The term loan was to be repaid in 60 equal principal payments plus interest.
      Proceeds of the loans were used to pay off our previously existing term
      loan.




In
      March
      2006, the Company entered into a new credit agreement which provides up to
      $10
      million of revolving credit based on 80% of acceptable accounts receivables,
      as
      defined. The two-year agreement provides for interest of LIBOR plus 1.85% for
      the first six months of the agreement, and thereafter either (i) prime (8.25%
      at
      December 31, 2006) minus 0% - 1.00% or (ii) LIBOR plus 1.50% - 2.50% depending
      on the level of the Company’s ratio of outstanding debt to fixed charges (as
      defined), or 7.25% or 7.07%, respectively, at December 31, 2006. The facility
      is
      secured by all of the Company’s assets, except for equipment securing a new term
      loan as described above.




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




The
      following table summarizes the December 31, 2006 status of our revolving line
      of
      credit and term loans:


Revolving
                  credit
              
              $
              3,006,000Current
                  portion of term loan
              
              
              1,174,000Long-term
                  portion of term loan
              
              
              3,474,000Total
              
              $
              7,654,000




Monthly
      and annual principal and interest payments due under the term debt are
      approximately $94,000 and $1.1 million, respectively, assuming no change in
      interest rates, down from $260,000 and $3,100,000, respectively, from the term
      loan in existence in 2005. Simultaneously, monthly and annual cash lease costs
      have increased by $93,000 and $1,111,000, respectively.





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




18





The
      bank
      revolving credit agreement requires us to maintain a minimum “quick ratio” and a
      minimum “fixed charge coverage ratio.” Our quick ratio (current assets less
      current liabilities) was 1.13 as of December 31, 2006 as compared to a minimum
      requirement of 0.70 (increasing to .80 on March 31, 2007). Our fixed charge
      coverage ratio compares, on a rolling twelve-month basis, EBITDA plus rent
      expense and non-cash charges less income tax payments, to (ii) interest expense
      plus rent expense, the current portion of long term debt and maintenance capital
      expenditures. As of December 31, 2006, the fixed charge coverage ratio was
      1.55
      as compared to a minimum requirement of 1.10. If we fail to meet minimum
      covenant levels, amounts outstanding under the credit agreement and, by cross
      default provisions, the term loan will become due and payable.





We
      expect
      that remaining amounts available under the revolving credit arrangement
      (approximately $9,100,000 at December 31, 2006), the availability of bank or
      institutional credit from new sources and cash generated from operations will
      be
      sufficient to fund debt service, operating needs and about $2.5 - 3.5 million
      of
      capital expenditures for the next twelve months.





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





The
      following table summarizes contractual obligations as of December 31, 2006
      due
      in the future:





**Payment
                due by Period****Contractual
                Obligations**
            
            **Total**
            
            **Less
                than 1 Year**
            
            **Years**
              **2
                and 3**
            
            **Years**
              **4
                and 5**
            
            **Thereafter**Long
                Term Debt Obligations
            
            $
            4,632,000
            
            $
            1,158,000
            
            $
            2,316,000
            
            $
            1,158,000
            
            $
            -Capital
                Lease Obligations
            
            
            16,000
            
            
            16,000
            
            
            -
            
            
            -
            
            
            -Operating
                Lease Obligations
            
            
            31,870,000
            
            
            5,054,000
            
            
            8,177,000
            
            
            5,298,000
            
            
            13,341,000Total
            
            $
            36,518,000
            
            $
            6,228,000
            
            $
            10,493,000
            
            $
            6,456,000
            
            $
            13,341,000




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




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




**CRITICAL
      ACCOUNTING POLICIES AND ESTIMATES**




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




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




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




19




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




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




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




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




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




·
            Significant
                negative industry or economic
                trends




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




·
            Our
                market capitalization relative to net book
                value.




When
      we
      determine that the carrying value of intangibles, long-lived assets and related
      goodwill and enterprise level goodwill may not be recoverable based upon the
      existence of one or more of the above indicators of impairment, we measure
      any
      impairment based on comparing the carrying amount of the asset to its fair
      value
      in a current transaction between willing parties or, in the absence of such
      measurement, on a projected discounted cash flow method using a discount rate
      determined by our management to be commensurate with the risk inherent in our
      current business model. Any amount of impairment so determined would be written
      off as a charge to the income statement, together with an equal reduction of
      the
      related asset. Net intangible assets, long-lived assets and goodwill amounted
      to
      approximately $45.6 million as of December 31, 2006.




In
      2002,
      Statement of Financial Accounting Standards (“SFAS”) No.142, “Goodwill and Other
      Intangible Assets” (“SFAS 142”) became effective and as a result, we ceased to
      amortize approximately $26.3 million of goodwill in 2002 and an annual
      impairment review thereafter. The initial test on January 1, 2002 and the Fiscal
      2002 to 2006 tests performed as of September 30 of each year required no
      goodwill impairment. In the 2006 test performed as of September 30, 2006, we
      determined the fair value of the enterprise using independent appraisals and
      other valuation techniques. If future appraisals or future performances are
      affected by the factors cited above, resulting potential impairment could
      adversely affect the reported goodwill asset value and earnings.




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




Significant
      management judgment is required in determining our provision for income taxes,
      our deferred tax assets and liabilities and any valuation allowance recorded
      against our net deferred tax assets. The net deferred tax liability as of
      December 31, 2006 was $5.2 million. The Company did not record a valuation
      allowance against its deferred tax assets as of December 31, 2006.




20




**RECENT
      ACCOUNTING PRONOUNCEMENTS**




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




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




In
      July
      2006, the FASB released FASB Interpretation No. 48, “Accounting for Uncertainty
      in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48
      clarifies the accounting and reporting for uncertainties in income tax law.
      This
      interpretation prescribes a comprehensive model for the financial statement
      recognition, measurement, presentation and disclosure of uncertain tax positions
      taken or expected to be taken in income tax returns. This statement is effective
      for fiscal years beginning after December 15, 2006. If there are changes in
      net
      assets as a result of application of FIN 48, these will be accounted for as
      an
      adjustment to retained earnings. The Company expects to adopt FIN 48 in the
      first quarter of 2007 and is currently assessing the impact of FIN 48 on its
      consolidated financial position and results of operations.




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




**ITEM
      7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK**




*Market
      Risk.* The
      Company had borrowings of $7.6 million at December 31, 2006 under term loan
      and
      revolving credit agreements. All debt was subject to a variable interest rate.
      The weighted average interest rate paid during 2006 was 7.8%. For variable
      rate
      debt outstanding at December 31, 2006, a .25% increase in interest rates will
      increase annual interest expense by approximately $19,000. Amounts outstanding
      under the revolving credit facility provide for interest at the banks’ prime
      rate minus 0%-1.00% assuming the same amount of outstanding debt or LIBOR plus
      1.5% to 2.5% and LIBOR plus 3.15% for the term loan. The Company’s market risk
      exposure with respect to financial instruments is to changes in prime or LIBOR
      rates.




21




**ITEM
      8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**


**Page**Report
                  of Independent Registered Public Accounting Firm
              21Financial
                  Statements:Consolidated
                  Balance Sheets -December
                  31, 2005 and 2006
              22Consolidated
                  Statements of Income -Fiscal
                  Years Ended December 31, 2004, 2005 and 2006
              23Consolidated
                  Statements of Shareholders’ Equity -Fiscal
                  Years Ended December 31, 2004, 2005 and 2006
              24Consolidated
                  Statements of Cash Flows -Fiscal
                  Years Ended December 31, 2004, 2005 and 2006
              25Notes
                  to Consolidated Financial Statements
              26Financial
                  Statement Schedule:Schedule
                  II - Valuation and Qualifying Accounts
              41Consent
                  of Independent Registered Public Accounting Firm
              47





Schedules
      other than those listed above have been omitted since they are either not
      required, are not applicable or
      the
      required information is shown in the financial statements or the related
      notes.




22





**Report
      of Independent Registered Public Accounting Firm**




To
      the
      Board of Directors and


Shareholders
      of Point.360


Burbank,
      California




We
      have
      audited the accompanying consolidated balance sheets of Point.360 and subsidiary
      (collectively, the “Company”) as of December 31, 2006 and 2005, and the
      related consolidated statements of income, shareholders' equity, and cash
      flows for each
      of the three years in the period ended December 31, 2006. These financial
      statements are the responsibility of the Company's management. Our
      responsibility is to express an opinion on these financial statements based
      on
      our audit.





We
      conducted our audits in accordance with auditing standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audits to obtain reasonable assurance about whether the
      financial statements are free of material misstatement. An audit includes
      examining, on a test basis, evidence supporting the amounts and disclosures
      in
      the financial statements. An audit also includes assessing the accounting
      principles used and significant estimates made by management, as well as
      evaluating the overall financial statement presentation. We believe that our
      audits provided a reasonable basis for our opinion.





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the financial position of Point.360 and subsidiaries
      as of December 31, 2006 and 2005, and the results of their operations and their
      cash flows for each of the three years in the period ended December 31, 2006
      in
      conformity with accounting principles generally accepted in the United States
      of
      America.




Singer
      Lewak Greenbaum & Goldstein LLP (signed)


Los
      Angeles, California


February
      28, 2007





23




**Point.360**


**Consolidated
      Balance Sheets**





******December
                31,********2005**
            
            ******2006****Assets**Current
                assets:Cash
                and cash equivalents
            
            $
            595,000
            
            $
            -Accounts
                receivable, net of allowances for doubtful accounts of $563,000 and
                $783,000,respectively
            
            
            12,662,000
            
            
            14,786,000Inventories,
                net
            
            
            796,000
            
            
            750,000Prepaid
                expenses and other current assets
            
            
            2,432,000
            
            
            570,000Deferred
                income taxes
            
            
            828,000
            
            
            683,000Total
                current assets
            
            
            17,313,000
            
            
            16,789,000Property
                and equipment, net (Note 4)
            
            
            28,079,000
            
            
            14,138,000Other
                assets, net
            
            
            593,000
            
            
            555,000Goodwill
                (Note 3)
            
            
            29,474,000
            
            
            31,474,000Total
                assets
            
            $
            75,459,000
            
            $
            62,956,000**Liabilities
                and Shareholders’ Equity**Current
                liabilities:Accounts
                payable
            
            $
            3,986,000
            
            $
            4,259,000Accrued
                wages and benefits
            
            
            1,711,000
            
            
            1,861,000Accrued
                earn-out payments
            
            
            2,000,000
            
            
            2,000,000Other
                accrued expenses
            
            
            683,000
            
            
            466,000Income
                tax payable
            
            
            1,231,000
            
            
            123,000Borrowings
                under revolving credit agreement (Notes 6)
            
            
            4,054,000
            
            
            3,007,000Current
                portion of borrowings under notes payable
            
            
            2,310,000
            
            
            1,158,000Current
                portion of capital lease obligations (Note 6)
            
            
            63,000
            
            
            16,000Current
                portion of deferred gain on sale of real estate
            
            
            -
            
            
            178,000Total
                current liabilities
            
            
            16,038,000
            
            
            13,068,000Deferred
                income taxes
            
            
            6,121,000
            
            
            4,030,000Notes
                payable, less current portion (Note 6)
            
            
            13,744,000
            
            
            3,474,000Capital
                lease and other obligations, less current portion (Note 6)
            
            
            46,000
            
            
            -Deferred
                gain on sale of real estate, less current portion
            
            
            -
            
            
            2,363,000Total
                long-term liabilities
            
            
            19,911,000
            
            
            9,867,000Total
                liabilities
            
            
            35,949,000
            
            
            22,935,000Commitments
                and contingencies (Note 8)
            
            
            -
            
            
            -Shareholders’
                equityPreferred
                stock - no par value; 5,000,000 shares authorized; none
                outstanding
            
            
            -
            
            
            -Common
                stock - no par value; 50,000,000 shares authorized; 9,368,857 and
                9,749,582shares
                issued and outstanding, respectively
            
            
            17,971,000
            
            
            18,488,000Additional
                paid-in capital
            
            
            1,159,000
            
            
            1,077,000Retained
                earnings
            
            
            20,380,000
            
            
            20,456,000Total
                shareholders’ equity
            
            
            39,510,000
            
            
            40,021,000Total
                liabilities and shareholders’ equity
            
            $
            75,459,000
            
            $
            62,956,000





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




24


**Point.360**


**Consolidated
      Statements of Income**





**Year
                Ended December 31,****2004**
            
            **2005**
            
            **2006**Revenues
            
            $
            63,344,000
            
            $
            66,199,000
            
            $
            64,218,000Cost
                of services sold
            
            
            (40,519,000
            )
            
            (43,167,000
            )
            
            (43,071,000
            )Gross
                profit
            
            
            22,825,000
            
            
            23,032,000
            
            
            21,147,000Selling,
                general and administrative expense
            
            
            (18,936,000
            )
            
            (21,424,000
            )
            
            (20,037,000
            )Write-off
                of deferred acquisition and financing costs (Note 3)
            
            
            (1,050,000
            )
            
            -
            
            
            -Operating
                income
            
            
            2,839,000
            
            
            1,608,000
            
            
            1,110,000Interest
                expense (net)
            
            
            (811,000
            )
            
            (1,524,000
            )
            
            (846,000
            )Income
                before income taxes
            
            
            2,028,000
            
            
            84,000
            
            
            264,000Provision
                for income taxes
            
            
            (781,000
            )
            
            (70,000
            )
            
            (188,000
            )Net
                income
            
            $
            1,247,000
            
            $
            14,000
            
            $
            76,000Earnings
                per share:Basic:Net
                income
            
            $
            0.14
            
            $
            0.00
            
            $
            0.01Weighted
                average number of shares
            
            
            9,196,620
            
            
            9,346,533
            
            
            9,511,006Diluted:Net
                income
            
            $
            0.13
            
            $
            0.00
            
            $
            0.01Weighted
                average number of shares including the dilutive effect ofstock
                options
            
            
            9,671,395
            
            
            9,713,811
            
            
            9,615,431




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





25




**Point.360**


**Consolidated
      Statements of Shareholders’ Equity**


**(in
      thousands except for share amounts)**





**Additional**
              **Paid-in**
            
            **Retained**
            
            **Share-holders****Shares**
            
            **Amount**
            
            **Capital**
            
            **Earnings**
            
            ******Equity**Balance
                on December 31, 2003
            
            
            9,134,559
            
            $
            17,625
            
            $
            624
            
            $
            19,119
            
            $
            37,368Net
                income
            
            
            -
            
            
            -
            
            
            -
            
            
            1,247
            
            
            1,247Shares
                issued in connection with
              exercise
                of stock options
            
            
            101,573
            
            
            278
            
            
            -
            
            
            -
            
            
            278Tax
                effect of options exercised
            
            
            -
            
            
            -
            
            
            51
            
            
            -
            
            
            51Balance
                on December 31, 2004
            
            
            9,236,132
            
            
            17,903
            
            
            675
            
            
            20,366
            
            
            38,944Net
                income
            
            
            -
            
            
            -
            
            
            -
            
            
            14
            
            
            14Shares
                issued in connection with
              purchase
                of equipment (Note 3)
            
            
            105,000
            
            
            -
            
            
            484
            
            
            -
            
            
            484Shares
                issued in connection with
              exercise
                of stock options
            
            
            27,725
            
            
            68
            
            
            -
            
            
            -
            
            
            68Balance
                on December 31, 2005
            
            
            9,368,857
            
            
            17,971
            
            
            1,159
            
            
            20,380
            
            
            39,510Net
                income
            
            
            -
            
            
            -
            
            
            -
            
            
            76
            
            
            76Shares
                issued in connection withexercise
                of stock options
            
            
            380,725
            
            
            517
            
            
            -
            
            
            -
            
            
            517Incentive
              - based option expense
            
            
            -
            
            
            -
            
            
            140
            
            
            -
            
            
            140Cash
                paid in conjunction with
              acquisition
            
            
            -
            
            
            -
            
            
            (222
            )
            
            -
            
            
            (222
            )Balance
                on December 31, 2006
            
            $
            9,749,582
            
            $
            18,488
            
            $
            1,077
            
            $
            20,456
            
            $
            40,021




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




26




**Point.360**


**Consolidated
      Statements of Cash Flows**





**Year
                Ended December 31,****2004**
            
            **2005**
            
            **2006**Cash
                flows from operating activities:Net
                income
            
            $
            1,247,000
            
            $
            14,000
            
            $
            76,000Adjustments
                to reconcile net income to net cashprovided
                by operating activities:Depreciation
                and amortization
            
            
            5,876,000
            
            
            6,051,000
            
            
            5,540,000Provision
                for (recovery of) doubtful accounts
            
            
            (48,000
            )
            
            32,000
            
            
            220,000Deferred
                income taxes
            
            
            (324,000
            )
            
            815,000
            
            
            (1,946,000
            )Other
                noncash items
            
            
            (242,000
            )
            
            -
            
            
            -Changes
                in operating assets and liabilities (net of acquisitions):(Increase)
                decrease in accounts receivable
            
            
            (1,146,000
            )
            
            (226,000
            )
            
            (2,344,000
            )(Increase)
                decrease in inventories
            
            
            (18,000
            )
            
            136,000
            
            
            47,000(Increase)
                in prepaid expenses and other current assets
            
            
            (732,000
            )
            
            (645,000
            )
            
            1,863,000(Increase)
                decrease in other assets
            
            
            606,000
            
            
            149,000
            
            
            37,000(Decrease)
                increase in accounts payable
            
            
            996,000
            
            
            (912,000
            )
            
            273,000Increase
                (decrease) in accrued expenses
            
            
            (340,000
            )
            
            394,000
            
            
            (67,000
            )Increase
                in income taxes payable (receivable), net
            
            
            939,000
            
            
            83,000
            
            
            (1,108,000
            )Increase
                in other current liabilities
            
            
            -
            
            
            -
            
            
            33,000Net
                cash and cash equivalents provided by operating activities
            
            
            6,814,000
            
            
            5,891,000
            
            
            2,624,000Cash
                flows from investing activities:Capital
                expenditures
            
            
            (5,307,000
            )
            
            (2,355,000
            )
            
            (2,635,000
            )Proceeds
                from sale of Media Center real estate
            
            
            -
            
            
            -
            
            
            13,543,000Proceeds
                from sale of equipment
            
            
            40,000
            
            
            -
            
            
            -Net
                cash paid for acquisitions
            
            
            (1,094,000
            )
            
            (2,025,000
            )
            
            -Net
                cash paid for acquisition of building
            
            
            (2,065,000
            )
            
            -
            
            
            -Net
                cash and cash equivalents used in investing activities
            
            
            (8,426,000
            )
            
            (4,380,000
            )
            
            10,908,000Cash
                flows from financing activities:Change
                in revolving credit agreement
            
            
            4,323,000
            
            
            (269,000
            )
            
            (1,047,000
            )Proceeds
                from bank note for new loan
            
            
            8,000,000
            
            
            266,000
            
            
            -Change
                in note payable
            
            
            182,000
            
            
            -
            
            
            -Proceeds
                from exercise of stock options
            
            
            329,000
            
            
            68,000
            
            
            657,000Cash
                issued for an acquisition
            
            
            -
            
            
            -
            
            
            (2,222,000
            )Repayment
                of notes payable
            
            
            (17,657,000
            )
            
            (1,555,000
            )
            
            (11,422,000
            )Repayment
                of capital lease obligations
            
            
            (103,000
            )
            
            (94,000
            )
            
            (93,000
            )Net
                cash and cash equivalents used in financing activities
            
            
            (4,926,000
            )
            
            (1,584,000
            )
            
            (14,127,000
            )Net
                increase in cash and cash equivalents
            
            
            (6,538,000
            )
            
            (73,000
            )
            
            (595,000
            )Cash
                and cash equivalents at beginning of year
            
            
            7,206,000
            
            
            668,000
            
            
            595,000Cash
                and cash equivalents at end of year
            
            $
            668,000
            
            $
            595,000
            
            $
            -




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




27


**Point.360**


**Notes
      to Consolidated Financial Statements**





**1.**  **THE
      COMPANY:**




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




**2.**  **SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES:**




*Basis
      of Consolidation*




The
      consolidated financial statements include the accounts of the Company and one
      subsidiary, International Video Conversions, Inc. (“IVC”), a California
      corporation. All significant intercompany accounts and transactions have been
      eliminated in consolidation.





*Use
      of Estimates in the Preparation of Financial Statements*




The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States requires management to make estimates
      and assumptions that affect the reported amounts of assets and liabilities
      and
      disclosure of contingent assets and liabilities at the date of the financial
      statements and the reported amounts of revenues and expenses during the
      reporting period. Actual results could differ from those estimates.




*Cash
      and Cash Equivalents*




Cash
      equivalents represent highly liquid short-term investments with original
      maturities of less than three months.




*Revenues
      and Receivables*




The
      Company records revenues when the services have been completed. Although sales
      and receivables are concentrated in the entertainment and advertising
      industries, credit risk due to financial insolvency is limited because of the
      financial stability of the customer base (i.e., large studios and advertising
      agencies).




*Concentration
      of Credit Risk*




Financial
      instruments which potentially subject the Company to concentrations of credit
      risk consist principally of cash and cash equivalents, and accounts receivable. The
      Company maintains its cash and cash equivalents with high credit quality
      financial institutions; at times, such balances with any one financial
      institution may exceed FDIC insured limits.





Credit
      risk with respect to trade receivables is concentrated due to the large number
      of orders with major entertainment studios and advertising agencies in any
      particular reporting period. Our ten largest studio and advertising agency
      customers represented 52% and 62% of accounts receivable at December 31, 2005
      and December 31, 2006, respectively. The Company reviews credit evaluations
      of
      its customers but does not require collateral or other security to support
      customer receivables.





The ten
      largest studio and advertising agency customers **** accounted
      for 38%, 47% and 51% of net sales for the years ended December 31, 2004, 2005
      and 2006, respectively. Twentieth Century Fox (and affiliates) was the only
      customer, which accounted for more than 10% of net sales in any of the last
      three years, or 17% and 24% in 2005 and 2006, respectively.




*Inventories*




Inventories
      comprise raw materials, principally tape stock, and are stated at the lower
      of
      cost or market. Cost is determined using the average cost method.




28




*Property
      and Equipment*




Property
      and equipment are stated at cost. Expenditures for additions and major
      improvements are capitalized. Depreciation is computed using the straight-line
      method over the estimated useful lives of the related assets. Amortization
      of
      leasehold improvements is computed using the straight-line method over the
      lesser of the estimated useful lives of the improvements or the remaining lease
      term.




*Goodwill*




Prior
      to
      the January 1, 2002 implementation of Statement of Financial Accounting
      Standards (“SFAS”) No. 142, “ *Goodwill
      and Other Intangible Assets* ”
(“SFAS
      142”), goodwill was amortized on a straight-line basis over 5-20 years. Since
      that date, goodwill has been subject to periodic impairment tests in accordance
      with SFAS 142.




The
      Company identifies and records impairment losses on long-lived assets, including
      goodwill that is not identified with an impaired asset, when events and
      circumstances indicate that such assets might be impaired. Events and
      circumstances that may indicate that an asset is impaired include significant
      decreases in the market value of an asset, a change in the operating model
      or
      strategy and competitive forces.




The
      Company evaluates its goodwill on an annual basis and when events and
      circumstances indicate that the carrying amount of an asset may not be
      recoverable. If the independent appraisal or other indicator of value of the
      asset or the expected undiscounted future cash flow attributable to the asset
      is
      less than the carrying amount of the asset, an impairment loss equal to the
      excess of the asset’s carrying value over its fair value is recorded. In 2006,
      fair value was determined using independent appraisals and other valuation
      techniques, depending on the nature of the assets. To date, no such impairment
      has been recorded.




*Income
      Taxes*




The
      Company accounts for income taxes in accordance with SFAS No. 109, “ *Accounting*  *for
      Income Taxes”* (“SFAS
      109”). SFAS 109 requires the recognition of deferred tax assets and liabilities
      for the expected future tax consequences of temporary differences between the
      carrying amounts for financial reporting purposes and the tax basis of assets
      and liabilities. A valuation allowance is recorded for that portion of deferred
      tax assets for which it is more likely than not that the assets will not be
      realized.




*Advertising
      Costs*




Advertising
      costs are not significant to the Company’s operations and are expensed as
      incurred.




*Fair
      Value of Financial Instruments*




To
      meet
      the reporting requirements of SFAS No. 107, “ *Disclosures
      About Fair Value of Financial Instruments* ”
(“SFAS
      107”), the Company calculates the fair value of financial instruments and
      includes this additional information in the notes to financial statements when
      the fair value is different than the book value of those financial instruments.
      When the fair value is equal to the book value, no additional disclosure is
      made. The Company uses quoted market prices whenever available to calculate
      these fair values.





*Accounting
      for Stock-Based Compensation*




Prior
      to
      January 1, 2006, as permitted by SFAS No. 123, “ *Accounting
      for Stock-Based Compensation”* (“SFAS
      123”), the Company measured compensation costs in accordance with Accounting
      Principles Board Opinion No. 25, “ *Accounting
      for Stock Issued to Employees* (“APB
      25”), but provided pro forma disclosures of net income and earnings per share
      using the fair value method defined by FAS 123. Under APB No. 25, compensation
      expense was recognized over the vesting period based on the difference, if
      any,
      on the date of grant between the deemed fair value for accounting purposes
      of
      the Company’s stock and the exercise price on the date of grant. The Company
      accounted for stock issued to non-employees in accordance with the provisions
      of
      SFAS No. 123 and Emerging Issues Task Force (“EITF”) 96-18, “ *Accounting
      for Equity Instruments That Are Issued to Other Than Employees for Acquiring,
      or
      in Conjunction with Selling, Goods and Services* .”




29




Had
      the
      Company determined compensation cost based on the fair value for its stock
      options at grant date, as set forth under SFAS 123, the Company’s net income and
      earnings per share would have been reduced to the pro forma amounts indicated
      below:




**2004**
            
            **2005**Net
                income (loss):As
                reported
            
            $
            1,247,000
            
            $
            14,000Deduct:
                Total stock-based employee compensation
              expense
                determined under fair value based method
              for
                all awards, net of related tax effects
            
            
            (255,000
            )
            
            (738,000
            )Pro
                forma
            
            
            992,000
            
            
            (724,000
            )Earnings
                (loss) per share:As
                reported:Basic
            
            
            0.14
            
            
            0.00Diluted
            
            
            0.13
            
            
            0.00Pro
                forma:Basic
            
            
            0.11
            
            
            (0.07
            )Diluted
            
            
            0.10
            
            
            (0.07
            )




The
      fair
      value for these options was estimated at the grant date using the Black-Scholes
      option-pricing model with the following weighted-average assumptions used for
      grants in 2004 and 2005, respectively: expected volatility of 44% and 38% and
      risk-free interest rates of 1.33% and 3.26%. A dividend yield of 0% and expected
      life of five years was assumed for 2004 and 2005 grants. The weighted average
      fair value of options granted at the fair market price on the grant date in
      2004
      and 2005 were $1.03 and $1.05, respectively. All options granted in 2004 and
      2005 were at fair market price.




On
      January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), *“Share-Based
      Payment,”* (“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) supersedes the Company’s previous accounting
      under APB 25 for periods beginning in fiscal 2006. In March 2005, the Securities
      and Exchange Commission issued Staff Accounting Bulletin No. 107 (“SAB 107”)
      relating to SFAS 123(R). The Company applied the provisions of SAB 107 in its
      adoption of SFAS 123(R). See Note 10.




*Earnings
      Per Share*




The
      Company follows SFAS No. 128, “ *Earnings
      per Share”* (“SFAS
      128”), and related interpretations for reporting Earnings per Share. SFAS 128
      requires dual presentation of Basic Earnings per Share (“Basic EPS”) and Diluted
      Earnings per Share (“Diluted EPS”). Basic EPS excludes dilution and is computed
      by dividing net income (loss) by the weighted average number of common shares
      outstanding during the reported period. Diluted EPS reflects the potential
      dilution that could occur if stock options were exercised using the treasury
      stock method.





In
      accordance with SFAS 128, basic earnings (loss) per share are calculated based
      on the weighted average number of shares of common stock outstanding during
      the
      reporting period. Diluted earnings per share are calculated giving effect to
      all
      potentially dilutive common shares, assuming such shares were outstanding during
      the reporting period.





A
      reconciliation of the denominator of the basic EPS computation to the
      denominator of the diluted EPS computation is as follows:


**2004**
              
              **2005**
              
              **2006**Weighted
                  average number of common shares outstandingused
                  in computation of basic EPS
              
              
              9,196,620
              
              
              9,346,533
              
              
              9,511,006Dilutive
                  effect of outstanding stock options
              
              
              474,775
              
              
              367,278
              
              
              104,425Weighted
                  average number of common and potentialcommon
                  shares outstanding used in computation of diluted EPS
              
              
              9,674,395
              
              
              9,713,811
              
              
              9,615,431Outstanding
                  stock options excluded in thecomputation
                  of diluted EPS
              
              
              1,878,172
              
              
              1,342,357
              
              
              1,921,405




30





*Supplemental
      Cash Flow Information*




Selected
      cash payments and noncash activities were as follows:


**2004**
            
            **2005**
            
            **2006**Cash
                payments for income taxes (net of refunds)
            
            $
            441,000
            
            $
            131,000
            
            $
            1,568,000Cash
                payments for interest
            
            
            708,000
            
            
            1,345,000
            
            
            790,000Noncash
                investing and financing activities:Tax
                benefits related to stock options
            
            
            51,000
            
            
            -Accrual
                for earn-out payments
            
            
            1,000,000
            
            
            2,000,000
            
            
            2,000,000Detail
                of acquisitions:Goodwill
                (1)
            
            
            242,000
            
            
            2,186,000
            
            
            2,000,000





(1)
            Includes
                additional purchase price payments made or accrued to former owners
                in
                periods subsequent to various acquisitions of $1,000,000, $2,000,000
                and
                $2,000,000 in 2004, 2005 and 2006,
                respectively.





*Recent
      Accounting Pronouncements*




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




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




In
      July
      2006, the FASB released FASB Interpretation No. 48, *“Accounting
      for Uncertainty in Income Taxes, an interpretation of FASB Statement No.
      109”* (“FIN
      48”). FIN 48 clarifies the accounting and reporting for uncertainties in income
      tax law. This interpretation prescribes a comprehensive model for the financial
      statement recognition, measurement, presentation and disclosure of uncertain
      tax
      positions taken or expected to be taken in income tax returns. This statement
      is
      effective for fiscal years beginning after December 15, 2006. If there are
      changes in net assets as a result of application of FIN 48, these will be
      accounted for as an adjustment to retained earnings. The Company expects to
      adopt FIN 48 in the first quarter of 2007 and is currently assessing the impact
      of FIN 48 on its consolidated financial position and results of
      operations.




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




**3.**  **ACQUISITIONS**





During
      1997 to 2005, the Company acquired ten businesses. These acquisitions were
      accounted for as purchases, with the excess of the purchase price over the
      fair
      value of the net assets acquired allocated to goodwill. The contingent portion
      of the purchase prices, to the extent earned was recorded as an increase to
      goodwill. As of December 31, 2006, additional earn-out payments are as described
      below. The consolidated financial statements reflect the operations of the
      acquired companies since their respective acquisition dates.




31




Goodwill
      and other intangibles, net as of December 31, 2005 and 2006, consist of the
      following:





**Actual**.**2005**
            
            **2006**Goodwill
            
            $
            35,050,000
            
            $
            37,050,000Covenant
                not to compete
            
            
            1,000,000
            
            
            1,000,00036,050,000
            
            
            38,050,000Less
                accumulated amortization
            
            
            (6,576,000
            )
            
            (6,576,000
            )$
            29,474,000
            
            $
            31,474,000





The
      Company ceased amortizing goodwill on January 1, 2002 with the adoption of
      SFAS
      142. The covenant not to compete was fully amortized in 2003.





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




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





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





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





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





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





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





Pursuant
      to a Settlement and Mutual Release Agreement executed in November 2004, Alliance
      and the Company agreed to settle all claims. Pursuant to the agreement, the
      Company paid Alliance $575,000 in cash in November 2004.





In
      order
      to expand our relationships with our studio customers and gain new customers,
      on
      July 1, 2004, the Company acquired all of the outstanding stock of IVC for
      $7
      million in cash. The purchase agreement required possible additional payments
      of
      $1 million, $2 million and $2 million in 2005, 2006 and 2007, respectively,
      if
      earnings before interest, taxes, depreciation and amortization during the 30
      months after the acquisition reached certain predetermined levels (the second
      two increments of $2 million each were earned and are reflected as accrued
      liabilities on the balance sheets as of December 31, 2005 and 2006,
      respectively). As part of the transaction, the Company entered into employment
      and/or non competition agreements with four senior officers of IVC which fixed
      responsibilities, salaries and other benefits and set forth limitations on
      the
      individuals’ ability to compete with the Company for the term of the earn-out
      period (30 months). IVC is a high definition and standard definition digital
      mastering and data conversion entity serving the motion picture/television
      production industry. To pay for the acquisition, the Company used $2.3 million
      of cash on hand and borrowed $4.7 million under the term loan portion of the
      Company’s bank facility.




32





The
      total
      purchase consideration ($12 million either paid or accrued as of December 31,
      2006) has been allocated to the assets and liabilities acquired based on their
      respective estimated fair values as summarized below.


Cash
                  and cash equivalents
              
              $
              1,205,000Inventories
              
              
              120,000Other
                  current assets
              
              
              1,000Accounts
                  receivable
              
              
              2,036,000Goodwill
              
              
              5,242,000Property,
                  plant and equipment
              
              
              6,009,000Total
                  assets acquired
              
              
              14,613,000Accounts
                  payable
              
              
              (442,000
              )Accrued
              
              
              (417,000
              )Income
                  tax payable
              
              
              (72,000
              )Deferred
                  tax liabilities
              
              
              (1,682,000
              )Current
                  and other liabilities assumed
              
              
              (2,613,000
              )Net
                  assets acquired over liabilities,and
                  purchase price
              
              $
              12,000,000





The
      following table presents unaudited pro forma results of the combined operations
      for the year ended December 31, 2004, as if the acquisition had occurred as
      of
      the beginning of 2004 rather than as of the acquisition date. The pro forma
      information presented below is for illustrative purposes only and is not
      indicative of results that would have been achieved or results which may be
      achieved in the future:





**2004**Revenue
            
            $
            69,032,000Operating
                Income
            
            
            3,303,000Net
                income (loss)
            
            
            1,456,000Basic
                earnings per share
            
            
            0.16Diluted
                earnings per share
            
            
            0.15




In
      2005,
      the Company issued 105,000 shares in connection with a purchase of assets.
      The
      shares were recorded at fair value on the issue date. In connection with the
      transition, $186,000 was recorded as goodwill.




During
      2005, the amount of goodwill, net, increased from $27,288,000 to $29,474,000
      due
      to the $2,000,000 earn-out payment accrued for the IVC acquisition and $186,000
      of excess of fair value of stock issued over the fair value of purchased assets,
      as noted above. During 2006, the amount of goodwill, net, increased from
      $29,474,000 to $31,474,000 due to the $2,000,000 earn-out payment accrued for
      the IVC acquisition. The periodic impairment test of goodwill performed in
      accordance with SFAS 142 as of September 30, 2006 required no goodwill
      impairment.




**4.**  **PROPERTY
      AND EQUIPMENT:**





In
      November 2003, the Company leased a new 64,600 square foot building in Los
      Angeles, California, for the purpose of consolidating four vault locations
      then
      occupying approximately 71,000 square feet. As part of the transaction, the
      Company paid $600,000 for an option to purchase the facility for $8,571,500.
      Additionally, the landlord, General Electric Capital Business Asset Funding
      Corporation (“General Electric”), committed to finance approximately $6,500,000
      of the purchase price at a fixed interest rate of 7.75% over 15 years. The
      Company was not obligated to purchase the building or, if the option was
      exercised, borrow any portion of the purchase price from General Electric.
      The
      cost of the option was included in other assets on the balance sheet as of
      December 31, 2003, to be capitalized as a cost of the building or written off
      when the Company exercised the purchase option or did not exercise the option,
      respectively.





Pursuant
      to the lease, General Electric also advanced the Company $800,000 to pay for
      improvements to the building. As of December 31, 2003, the $800,000 was
      reflected as an obligation to purchase property and equipment with an offsetting
      liability on the balance sheet. In 2004, the Company reduced the right and
      the
      obligation to purchase property and equipment by $800,000 expended for
      improvements to the building. In August 2004, the Company purchased the facility
      for $8.6 million ($2.2 in cash and a $6.4 million mortgage).




33




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




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.




The
      following table presents unaudited pro forma results the year ended December
      31,
      2005, as if the sale and leaseback transaction had occurred as of the beginning
      of the year. The pro forma information presented below is for illustrative
      purposes only and is not indicative of results that would have been achieved
      or
      results which may be achieved in the future (in thousands):




**As
                Reported**
            
            **Adjustments**
            
            **Pro
                Forma**Revenue
            
            $
            66,199
            
            
            
            
            $
            66,199Cost
                of sales
            
            
            (43,167
            )
            
            (837)
                (1
            )
            
            (44,004
            )Gross
                profit
            
            
            23,032
            
            
            
            
            
            22,195Selling,
                general and administrative expense
            
            
            (21,424
            )
            
            
            
            
            (21,424
            )Operating
                income
            
            
            1,608
            
            
            
            
            
            771Interest
                expense
            
            
            (1,524
            )
            
            881
                (2
            )
            
            (643
            )Income
                before income taxes
            
            
            84
            
            
            
            
            
            128Provision
                for income taxes
            
            
            (70
            )
            
            (17)
                (3
            )
            
            (87
            )Net
                income
            
            $
            14
            
            
            
            
            $
            41Diluted
                net income per share
            
            $
            0.00
            
            
            
            
            $
            0.00




(1)
            First
                year rent expense net of amortization of the deferred gain on the
                sale,
                partially offset by the elimination of depreciation
                expense associated with the
                building.




(2)
            Pro
                forma interest saved on the amount of mortgage, term and revolving
                credit
                debt paid off with net sales
                proceeds.




(3)
            Tax
                effect at 40%.




34




The
      following table presents an unaudited pro forma summary balance sheet as of
      December 31, 2005 as if the sale and leaseback had occurred on that date (in
      thousands):





**As
                Reported**
            
            **Adjustments**
            
            **Pro
                Forma**Current
                assets
            
            $
            17,313
            
            
            
            
            $
            17,313Property
                and equipment, net
            
            
            28,079
            
            
            (11,261)
                (1
            )
            
            16,818Goodwill
                and other assets
            
            
            30,067
            
            
            
            
            
            30,067Total
                assets
            
            $
            75,459
            
            
            
            
            $
            64,198Accounts
                payable and accrued expenses
            
            $
            8,380
            
            
            
            
            $
            8,380Deferred
                income taxes
            
            
            1,231
            
            
            879
                (2
            )
            
            2,110Short-term
                debt
            
            
            2,373
            
            
            (310)
                (4
            )
            
            2,063Borrowings
                under revolving credit
            
            
            4,054
            
            
            (3,904)
                (4
            )
            
            150Current
                liabilities
            
            
            16,038
            
            
            
            
            
            12,703Deferred
                gain on sale
            
            
            -
            
            
            1,318
                (3
            )
            
            1,318Deferred
                income taxes and other
            
            
            6,121
            
            
            500
                (5
            )
            
            6,621Long-term
                notes payable
            
            
            13,790
            
            
            (9,744)
                (4
            )
            
            4,046Shareholders’
                equity
            
            
            39,510
            
            
            
            
            
            39,510Total
                liabilities and shareholders’ equity
            
            $
            75,459
            
            
            
            
            $
            64,198





(1)
            Net
                book value of assets sold.




(2)
            Tax
                on gain on sale at 40%.




(3)
            Deferred
                gain on sale to be amortized over life of
                lease.




(4)
            Pay-down
                of debt with net proceeds.





(5)
            Non-refundable
                advance from purchaser for
                improvements.




Property
      and equipment consist of the following:





**December
                31,****2005**
            
            **2006**Land
            
            $
            4,500,000
            
            $
            -Building
            
            
            6,230,000
            
            
            -Machinery
                and equipment
            
            
            35,537,000
            
            
            36,761,000Leasehold
                improvements
            
            
            8,051,000
            
            
            8,243,000Computer
                equipment
            
            
            4,693,000
            
            
            5,325,000Equipment
                under capital lease
            
            
            297,000
            
            
            297,00059,308,000
            
            
            50,626,000Less
                accumulated depreciation and amortization
            
            
            (31,229,000
            )
            
            (36,487,000
            )$
            28,079,000
            
            $
            14,139,000




Depreciation
      is expensed over the estimated lives of machinery and equipment (7 years),
      computer equipment (5 years) and leasehold improvements (2 to 10 years depending
      on the remaining term of the respective leases or estimated useful life of
      the
      improvement). Depreciation expense totaled $5,876,000, $6,051,000 and $
      5,540,000 for the years ended December 31, 2004, 2005 and 2006, respectively.
      Accumulated amortization on capital leases amounted to $211,000 and $254,000,
      as
      of December 31, 2005 and 2006, respectively.




35




**5.**  **401(K)
      PLAN**





The
      Company has a 401(K) plan, which covers substantially all employees. Each
      participant is permitted to make voluntary contributions not to exceed the
      lesser of: 20% of his or her respective compensation or the applicable statutory
      limitation, and is immediately 100% vested. The Company matches one-fourth
      of
      the first 4% contributed by the employee. Company contributions to the plan
      were
      $92,000, $127,000 and $119,000 in 2004, 2005 and 2006,
      respectively.




**6.**  **LONG
      TERM DEBT AND NOTES PAYABLE:**




On
      December 30, 2005, the Company entered into a $10 million term loan agreement.
      The term loan provides for interest at LIBOR (5.37% as of December 31, 2006)
      plus 3.15% and is secured by the Company’s equipment. In March 2006, the Company
      prepaid $4 million of the principal with proceeds of a sale/leaseback
      transaction. The term loan will be repaid in 60 equal monthly principal payments
      plus interest. Proceeds of the term loan were used to repay the previously
      existing term loan.





In
      March
      2006, the Company entered into a new revolving credit agreement, which provides
      up to $10 million of revolving credit. The two-year agreement provides for
      interest of LIBOR (5.37%
      as
      of December 31, 2006) plus 1.85% for the first six months of the agreement,
      and
      thereafter at either (i) prime minus 0% - 1.00% or (ii) LIBOR plus 1.50% -
      2.5%,
      depending on the level of the Company’s ratio of outstanding debt to fixed
      charges (as defined). The facility is secured by all of the Company’s assets,
      except for equipment securing the new term loan as described in Note 6. The
      revolving credit agreement requires the Company to comply with various financial
      and business covenants. There are cross default provisions contained in the
      two
      in both the new revolving and term loan agreements. As of December 31, 2006,
      the
      company was in compliance with revolving and term loan agreement
      covenants.




The
      Company has financed the purchase of certain equipment through the issuance
      of
      bank notes payable and under capital leasing arrangements. The notes bear
      interest at rates ranging from 3% to LIBOR plus 3.15%. Such obligations are
      payable in monthly installments through May 2019.




Annual
      maturities for debt under bank notes payable and capital lease obligations
      as of
      December 31, 2006, are as follows:


2007
              
              $
              1,174,0002008
              
              
              1,158,0002009
              
              
              1,158,0002010
              
              
              1,158,000$
              4,648,000


**7.****I** **NCOME
      TAXES:**




The
      Company’s provision for (benefit from) income taxes for the three years ended
      December 31, 2006 consists of the following:





**Year
                Ended December 31,********.****2004**
            
            **2005**
            
            **2006**Current
                tax (benefit) expense:Federal
            
            $
            642,000
            
            $
            329,000
            
            $
            1,897,000State
            
            
            142,000
            
            
            6,000
            
            
            331,000Total
                current
            
            
            784,000
            
            
            335,000
            
            
            2,228,000Deferred
                tax expense:Federal
            
            
            (13,000
            )
            
            (253,000
            )
            
            (1,750,000
            )State
            
            
            10,000
            
            
            (12,000
            )
            
            (290,000
            )Total
                deferred
            
            
            (3,000
            )
            
            (265,000
            )
            
            (2,040,000
            )Total
                provision for (benefit from) for income taxes
            
            $
            781,000
            
            $
            70,000
            
            $
            188,000





36




The
      composition of the deferred tax assets (liabilities) at December 31, 2005 and
      December 31, 2006 are listed below:





**2005**
            
            **2006**Accrued
                liabilities
            
            $
            393,000
            
            $
            319,000Allowance
                for doubtful accounts
            
            
            241,000
            
            
            335,000Other
            
            
            194,000
            
            
            29,000Total
                current deferred tax assets
            
            
            828,000
            
            
            688,000Property
                and equipment
            
            
            (3,869,000
            )
            
            (1,970,000
            )Goodwill
                and other intangibles
            
            
            (2,763,000
            )
            
            (3,975,000
            )Other
            
            
            511,000
            
            
            1,915,000Total
                non-current deferred tax liabilities
            
            
            (6,121,000
            )
            
            (4,030,000
            )Net
                deferred tax liability
            
            $
            (5,293,000
            )
            $
            (3,347,000
            )




The
      provision for (benefit from) income taxes differs from the amount of income
      tax
      determined by applying the applicable U.S. Statutory income taxes rates to
      income before taxes as a result of the following differences:





******2004**
            
            ******2005**
            
            ******2006**Federal
                tax computed at statutory rate
            
            
            34
            %
            
            34
            %
            
            34
            %State
                taxes, net of federal benefit and net operating loss
                limitation
            
            
            2
            %
            
            6
            %
            
            6
            %Other
                (meals and entertainment)
            
            
            3
            %
            
            43
            %
            
            32
            %39
            %
            
            83
            %
            
            72
            %





37


**8.**  **COMMITMENTS
      AND CONTINGENCIES:**





*Operating
      Leases*





The
      Company leases office and production facilities in California, Illinois, Texas
      and New York under various operating leases. Approximate minimum rental payments
      under these non-cancelable operating leases as of December 31, 2006 are as
      follows:





2007
            
            $
            4,915,0002008
            
            
            4,624,0002009
            
            
            3,376,0002010
            
            
            2,593,0002011
            
            
            2,600,000Thereafter
            
            
            14,486,000





Total
      rental expense was approximately $4,299,000, $3,838,000 and $4,651,000 for
      the
      three years in the period ended December 31, 2006, respectively.





On
      September 30, 2003 the Company entered into severance agreements with its Chief
      Executive Officer and Chief Financial Officer which continue in effect through
      December 31, 2007, and are renewed automatically on an annual basis after that
      unless notice is received terminating the agreement by September 30 of the
      preceding year. The severance agreements contain a “Golden Parachute”
provision.





*Contingencies*





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





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





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





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.




**9.**  **STOCK
      RIGHTS PLAN:**





In
      November 2004, the Company implemented a stock rights program. Pursuant to
      the
      program, stockholders of record November 17, 2004 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
      November 17, 2004. 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 November 16, 2014 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.




38




**10.**  **STOCK
      OPTION PLANS:**





In
      May
      1996, the Board of Directors approved the 1996 Stock Incentive Plan (the “1996
      Plan”). The 1996 Plan provided for the award of options to purchase up to
      900,000 shares of common stock, as well as stock appreciation rights,
      performance share awards and restricted stock awards. In July 1999, the
      Company’s shareholders approved an amendment to the 1996 Plan increasing the
      number of shares reserved for grant to 2,000,000 and providing for automatic
      increases of 300,000 shares on each August 1 thereafter to a maximum of
      4,000,000 shares. As of December 31, 2006, there were 1,293,904 options
      outstanding under the 1996 Plan and no options were available for
      grant.





In
      December 2000, the Company’s Board of Directors adopted the 2000 Nonqualified
      Stock Option Plan (the “2000 Plan”). As amended, the 2000 Plan provided for the
      award of options to purchase up to 1,500,000 shares of common stock. Options
      may
      be granted under the 2000 Plan solely to attract people who have not previously
      been employed by the Company as a substantial inducement to join the Company.
      As
      of December 31, 2006, there were 627,950 options outstanding under the plan
      and
      no options were available for grant.




In
      February 2005, the Board of Directors approved the 2005 Equity Incentive Plan
      (the “2005 Plan”). The 2005 Plan provides for the award of options to purchase
      up to 2,000,000 shares of common stock, as well as stock appreciation rights
      and
      restricted stock awards. Upon approval of the 2005 Plan by the Company’s
      shareholders in May 2005, the 1996 Plan and the 2000 Plan were terminated,
      except that outstanding options under those plans were not terminated. As of
      December 31, 2006, there were 521,150 options outstanding under the 2005 Plan
      and 1,478,850 options were available for grant.




Under
      all
      plans, 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 date it was granted. The stock options
      generally vest over one to five years.





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





SFAS
      123(R) requires companies to estimate the fair value of share-based payment
      awards to employees and directors on the date of grant using an option-pricing
      model. The value of the portion of the award that is ultimately expected to
      vest
      is recognized as expense over the requisite service periods in the Company’s
      Consolidated Statements of Income (loss). Stock-based compensation expense
      recognized in the Consolidated Statements of Income (Loss) for the year ended
      December 31, 2006 included compensation expense for the share-based payment
      awards granted subsequent to January1, 2006 based on the grant date fair value
      estimated in accordance with the provisions of SFAS 123(R). There were no
      outstanding uninvested share-based payment awards as of January 1, 2006. For
      stock-based awards issued to employees and directors, stock-based compensation
      is attributed to expense using the straight-line single option method, which
      is
      consistent with how the prior-priced pro formas were provided were provided.
      As
      stock-based compensation expense recognized in the Statements of Consolidated
      Income (Loss) for 2006 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
      year ended December 31, 2006, expected forfeitures are immaterial and as such
      the Company is recognizing forfeitures as the occur. In the pro-forma
      information provided under SFAS 123 for the periods prior to fiscal 2006, the
      Company accounted for forfeitures as the occurred.





The
      Company adopted SFAS 123(R) using the modified prospective transition method,
      which requires the application of the accounting standard as of January 1,
      2006,
      the first day of the Company’s fiscal year 2006. The consolidated financial
      statements as of and for the year ended December 31, 2006 reflect the impact
      of
      SFAS 123(R). In accordance with the modified prospective transition method,
      consolidated financial statements for prior periods have not been restated
      to
      reflect, and do not include, the impact of SFAS 123(R). Stock-based compensation
      expense related to employee or director stock options recognized for the year
      ended December 31, 2006 was $81,000 ($23,000 net of tax benefit).





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





39




During
      the year ended December 31, 2006, the Company granted awards of stock options
      for 399,950 shares at an average market price of $2.25 per share. At December
      31, 2006, there were options outstanding to acquire 2,443,004 shares at an
      average exercise price of $2.89 per share. The estimated fair value of all
      awards granted during the year ended December 31, 2006 was $399,000. The total
      fair value of options expensed during 2006 was $81,000. The fair value of each
      option was estimated on the date of grant using the Black-Sholes option -pricing
      model with the following weighted average assumptions:





**Year
                Ended**
              **December
                31,****2005**
            
            **2006**Risk-free
                interest rate
            
            
            3.26
            %
            
            4.95
            %Expected
                term (years)
            
            
            5.0
            
            
            5.0Volatility
            
            
            38
            %
            
            47
            %Expected
                annual dividends
            
            
            -
            
            
            -




The
      following table summarizes the status of these plans as of December 31,
      2006:





**1996
                Plan**
            
            **2000
                Plan**
            
            **2005
                Plan**Options
                originally available
            
            
            3,800,000
            
            
            1,500,000
            
            
            2,000,000Stock
                options outstanding
            
            
            1,314,000
            
            
            632,000
            
            
            540,000Options
                available for grant
            
            
            -
            
            
            -
            
            
            1,479,000







Transactions
      involving stock options are summarized as follows:


**Number**
              **of
                Shares**
            
            **Weighted
                Average**
              **Exercise
                Price**Balance
                at December 31, 2003
            
            
            2,050,678
            
            $
            2.91Granted
                during 2004
            
            
            608,100
            
            
            2.58Exercised
                during 2004
            
            
            (101,573
            )
            
            2.76Cancelled
                during 2004
            
            
            (204,258
            )
            
            3.14Balance
                at December 31, 2004
            
            
            2,352,947
            
            $
            2.82Granted
                during 2005
            
            
            606,400
            
            
            2.63Exercised
                during 2005
            
            
            (27,725
            )
            
            1.97Cancelled
                during 2005
            
            
            (265,825
            )
            
            3.01Balance
                at December 31, 2005
            
            
            2,665,797
            
            $
            2.79Granted
                during 2006
            
            
            399,950
            
            
            2.25Exercised
                during 2006
            
            
            (380,725
            )
            
            1.50Cancelled
                during 2006
            
            
            (242,018
            )
            
            2.95Balance
                at December 31, 2006
            
            
            2,443,004
            
            $
            2.89




As
      of
      December 31, 2006, the total compensation costs related to non-vested awards
      yet
      to be expensed was approximately $0.3 million to be amortized over the next
      four
      years.





The
      weighted average exercise prices for options granted and exercisable and the
      weighted average remaining contractual life for options outstanding as of
      December 31, 2005 and 2006 was as follows:





40




**As
                of December 31, 2005**
            
            **Number
                of**
              **Shares**
            
            **Weighted
                Average****Exercise
                Price**
            
            **Weighted
                Average Remaining Contractual Life****(Years****)**
            
            **Intrinsic**
              **Value**Employees
                - Outstanding
            
            
            2,300,797
            
            $
            2.69
            
            
            3.33
            
            $
            116,000Employees
                - Expected to Vest
            
            
            2,300,797
            
            $
            2.69
            
            
            3.33
            
            $
            116,000Employees
                - Exercisable
            
            
            2,300,797
            
            $
            2.69
            
            
            3.33
            
            $
            116,000Non-Employees
                - Outstanding
            
            
            365,000
            
            $
            3.44
            
            
            3.87
            
            $
            1,000Non-Employees
                - Expected to Vest
            
            
            365,000
            
            $
            3.44
            
            
            3.87
            
            $
            1,000Non-Employees
                - Exercisable
            
            
            365,000
            
            $
            3.44
            
            
            3.87
            
            $
            1,000**As
                of December 31, 2006**Employees
                - Outstanding
            
            
            2,078,004
            
            $
            2.80
            
            
            3.09
            
            $
            1,802,000Employees
                - Expected to Vest
            
            
            2,041,009
            
            $
            2.81
            
            
            3.04
            
            $
            1,752,000Employees
                - Exercisable
            
            
            1,726,854
            
            $
            2.91
            
            
            2.79
            
            $
            1,331,000Non-Employees
                - Outstanding
            
            
            365,000
            
            $
            3.42
            
            
            3.26
            
            $
            114,000Non-Employees
                - Expected to Vest
            
            
            365,000
            
            $
            3.42
            
            
            3.26
            
            $
            114,000Non-Employees
                - Exercisable
            
            
            365,000
            
            $
            3.42
            
            
            3.26
            
            $
            114,000




Additional
      information with respect to outstanding options as of December 31, 2006 is
      a
      follows (shares in thousands):




******Options
                Outstanding******
            
            **Options
                Exercisable****Options
                Exercise**
              **Price
                Range**
            
            **Number
                of**
              **Shares**
            
            **Weighted
                Average**
              **Remaining**
              **Contractual
                Life**
            
            **Weighted
                Average**
              **Exercise
                Price**
            
            **Number
                of**
              **Shares**
            
            **Weighted
                Average**
              **Exercise
                Price**$1.75
                - 4.79
            
            
            2,438
            
            
            3.1
                Years
            
            $
            2.88
            
            
            2,087
            
            $
            2.99$7.00
                - 10.00
            
            
            5
            
            
            0.2
                Years
            
            $
            7.00
            
            
            5
            
            $
            7.00





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).




**11.**  **SUPPLEMENTAL
      DATA (unaudited)**





The
      following tables set forth quarterly supplementary data for each of the years
      in
      the two-year period ended December 31, 2006 (in thousands except per share
      data).





**2005****Quarter
                Ended**
            
            **Year
                Ended****March
                31**
            
            **June
                30**
            
            **Sept
                30**
            
            **Dec
                31**
            
            **Dec
                31**Revenues
            
            $
            17,183
            
            $
            15,890
            
            $
            16,748
            
            $
            16,378
            
            $
            66,199Gross
                profit
            
            $
            5,781
            
            $
            5,262
            
            $
            5,965
            
            $
            6,024
            
            $
            23,032Net
                income (loss)
            
            $
            69
            
            $
            (268
            )
            $
            214
            
            $
            (1
            )
            $
            14Income
                (loss) per share:Basic
            
            $
            0.01
            
            $
            (0.03
            )
            $
            0.02
            
            $
            (0.00
            )
            $
            0.00Diluted
            
            $
            0.01
            
            $
            (0.03
            )
            $
            0.02
            
            $
            (0.00
            )
            $
            0.00





41




**2006****Quarter
                Ended**
            
            **Year
                Ended****March
                31**
            
            **June
                30**
            
            **Sept
                30**
            
            **Dec
                31**
            
            **Dec
                31**Revenues
            
            $
            16,039
            
            $
            16,302
            
            $
            15,313
            
            $
            16,564
            
            $
            64,218Gross
                profit
            
            $
            5,324
            
            $
            5,364
            
            $
            4,978
            
            $
            5,481
            
            $
            21,147Net
                income (loss)
            
            $
            (92
            )
            $
            117
            
            $
            65
            
            $
            (14
            )
            $
            76Income
                (loss) per share:Basic
            
            $
            (0.01
            )
            $
            0.01
            
            $
            0.01
            
            $
            -
            
            $
            0.01Diluted
            
            $
            (0.01
            )
            $
            0.01
            
            $
            0.01
            
            $
            -
            
            $
            0.01




42




**Report
      of Independent Registered Public Accounting Firm**





To
      the
      Board of Directors


and
      Shareholders of Point.360


Burbank,
      California





Our
      audit
      of the consolidated financial statements referred to in our report dated
      February 28, 2007, also included the financial statement schedule of Point.360 ,
      listed
      in Item 8 of this Form 10-K. This schedule is the responsibility of Point.360 's
      management. Our responsibility is to express an opinion based on our audit
      of
      the consolidated financial statements.





In
      our
      opinion, the financial statement schedule, when considered in relation to the
      basic consolidated financial statements taken as a whole, presents fairly in
      all
      material respects the information set forth therein.




Singer
      Lewak Greenbaum & Goldstein, LLP (signed)


Los
      Angeles, CA


February
      28, 2007




**Point.360**


**Schedule
      II- Valuation and Qualifying Accounts**




**Allowance
                for Doubtful Accounts**
            
            **Balance
                at**
              **Beginning
                of**
              **Year**
            
            **Charged
                to**
              **Costs
                and**
              **Expenses**
            
            **Other**
            
            **Deductions/**
              **Write-Offs**
            
            **Balance
                at**
              **End
                of**
              **Year**Year
                ended December 31, 2004
            
            $
            735,000
            
            $
            48,000
            
            $
            (153,000
            )
            $
            (99,000
            )
            $
            531,000Year
                ended December 31, 2005
            
            $
            531,000
            
            $
            113,000
            
            $
            --
            
            $
            (81,000
            )
            $
            563,000Year
                ended December 31, 2006
            
            $
            563,000
            
            $
            341,000
            
            $
            --
            
            $
            (121,000
            )
            $
            783,000




43




**ITEM
              9.**
            **CHANGES
                IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
                DISCLOSURE**




None.




**ITEM
      9A.** **CONTROLS
      AND PROCEDURES**




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




**ITEM
      9B.** **OTHER
      INFORMATION**




None.





**PART
      III**





**ITEM
      10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE**





On
      July
      3, 2003, the Company adopted a Code of Ethics (the “Code”) applicable to the
      Company’s Chief Executive Officer, Chief Financial Officer and all other
      employees. Among other provisions, the Code sets forth standards for honest
      and
      ethical conduct, full and fair disclosure in public filings and shareholder
      communications, compliance with laws, rules and regulations, reporting of code
      violations and accountability for adherence to the Code. The text of the Code
      has been posted on the Company’s website ( www.point360.com ).
      A copy
      of the Code can be obtained free-of-charge upon written request to:





Corporate
      Secretary


Point.360


2777
      North Ontario Street


Burbank,
      CA 91504





If
      the
      Company makes any amendment to, or grant any waivers of, a provision of the
      Code
      that applies to our principal executive officer or principal financial officer
      and that requires disclosure under applicable SEC rules, we intend to disclose
      such amendment or waiver and the reasons for the amendment or waiver on our
      website.





Other
      information called for by Item 10 of Form 10-K is set forth under the heading
      “Election of Directors” in the Company’s Proxy Statement for its annual meeting
      of shareholders to be held on May 9, 2007 (the “Proxy Statement”), which is
      incorporated herein by reference.




**ITEM
      11. EXECUTIVE COMPENSATION**





Information
      called for by Item 11 of Form 10-K is set forth under the heading “Executive
      Compensation” in the Proxy Statement, which is incorporated herein by
      reference.




**ITEM
              12.**
            **SECURITY
                OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
                STOCKHOLDER MATTERS**




Information
      called for by Item 12 of Form 10-K is set forth under the headings “Security
      Ownership of Certain Beneficial Owners and Management” and “Equity Compensation
      Plan Information” in the Proxy Statement, which is incorporated herein by
      reference.




**ITEM
      13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE**





Information
      called for by Item 13 of Form 10-K is set forth under the heading “Certain
      Relationships and Related Transactions” in the Proxy Statement, which is
      incorporated herein by reference.




44


**ITEM
      14. PRINCIPAL ACCOUNTANT FEES AND SERVICES**





Information
      called for by Item 14 of Form 10-K is set forth under the heading “Independent
      Public Accountants” in the Proxy Statement, which is incorporated herein by
      reference.




**PART
      IV**





**ITEM
      15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**





(a)  Documents
      Filed as Part of this Report:





(1,2)  Financial
      Statements and Schedules.





The
      following financial documents of Point.360 are filed as part of this report
      under Item 8:





Consolidated
      Balance Sheets - December 31, 2005 and 2006


Consolidated
      Statements of Income - Fiscal Years Ended December 31, 2004, 2005 and
      2006


Consolidated
      Statements of Shareholders’ Equity - Fiscal Years Ended December 31, 2004, 2005
      and 2006


Consolidated
      Statements of Cash Flows - Fiscal Years Ended December 31, 2004, 2005 and
      2006


Notes
      to
      Consolidated Financial Statements


Schedule
      II - Valuation and Qualifying Accounts


(3)
              **Exhibit**
                **Number**
              **Description**


3.1
            Restated
                Articles of Incorporation of the Company.(2)





3.2
            By-laws
                of the Company.(2)





10.1
            Agreement
                and Plan of Merger, dated as of December 24, 1999, among VDI MultiMedia,
                VDI MultiMedia, Inc. and VMM Merger Corp.(1)





10.2
            1996
                Stock Incentive Plan of the Company.(2)





10.3
            2000
                Stock Incentive Plan of the Company.(7)





10.4
            Asset
                Purchase Agreement, dated as of December 28, 1996 by and among VDI
                Media, Woodholly Productions, Yvonne Parker, Rodger Parker, Jim Watt
                and
                Kim Watt.(3)





10.5
            Asset
                Purchase Agreement, dated as of June 12, 1998 by and between VDI
                Media and
                All Post, Inc.(4)





10.6
            Asset
                Purchase Agreement, dated as of November 9, 1998 by and among VDI
                Media,
                DubsIncorporated,
                Vincent Lyons and Barbara Lyons.(5)





10.7
            Asset
                Purchase Agreement dated November 3, 2000 by and among the Company,
                Creative Digital, Inc. and Larry Hester. (7)




10.8
            Third
                Amendment and Restated Credit Agreement dated May 2, 2002, among
                the
                Company, Union Bank of California, N.A., United California Bank,
                and U.S.
                Bank National Association.(8)




10.9
            Option
                Agreement dated July 3, 2002 between the Company and Alliance Atlantis
                Communications Inc.(9)





10.10
            First
                Amendment to Credit Agreement dated October 2, 2002, among the Company,
                Union Bank of California, Bank of the West and U.S. National Bank
                Association.(11)





10.11
            Resignation
                and General Release Agreement dated October 2, 2002 between R. Luke
                Stefanko and the Company.(10)





10.12
            Consulting
                Agreement dated October 2, 2002 between R. Luke Stefanko and the
                Company.(10)





10.13
            Non-competition
                Agreement dated October 2, 2002 between R. Luke Stefanko and the
              Company.(10)




45




10.14
            Amended
                and Restated Option Agreement dated December 30, 2002 between the
                Company
                and Alliance Atlantis Communications Inc.(12)





10.15
            Severance
                Agreement dated September 30, 2003 between the Company and Haig S.
              Bagerdjian.(13)





10.16
            Severance
                Agreement dated September 30, 2003 between the Company and Alan R.
                Steel.(13)





10.17
            Lease
                Agreement dated November 26, 2003 between the Company and General
                Electric
                Capital Business Asset Funding
                Corporation.





10.18
            Credit
                Agreement dated March 12, 2004 among the Company, Union Bank of
                California, N.A. and U.S. National Bank Association.(14)





10.19
            Stock
                Purchase Agreement dated June 23, 2004 among the Company, International
                Video Conversions, Inc. (“IVC”) and the Stockholders of IVC.(15)





10.20
            First
                Amendment to Credit Agreement dated July 1, 2004 among the Company,
                Union
                Bank of California, N.A. and U.S. National Bank Association.(15)





10.21
            Second
                Amendment to Credit Agreement dated August 13, 2004 among the Company,
                Union Bank of California, N.A. and U.S. National Bank Association.(16)





10.22
            Standing
                Loan Agreement and Swap Commitment dated August 18, 2004 between
                the
                Company and Bank of America, N.A.(17)





10.23
            Settlement
                and Mutual Release Agreement executed November 9, 2004 between the
                Company
                and Alliance Atlantis Communications, Inc.(18)





10.24
            Amended
                and Restated Rights Agreement, dated as of November 17, 2004, between
                the
                Company and American Stock Transfer and Trust Company.(19)





10.25
            2005
                Equity Incentive Plan of Point.360.(20)





10.26
            Promissory
                Note between General Electric Capital Corporation and the Company
                dated
                December 30, 2005.(21)





10.27
            Master
                Security Agreement between General Electric Capital Corporation and
                the
                Company dated December 30, 2005.(21)





10.28
            Standard
                Loan Agreement dated March 29, 2006 between the Company and Bank
                of
                America, N.A.(22)





10.29
            Agreement
                of Purchase and Sale dated December 30, 2005 between the Company
                and
                United Trust Fund Limited Partnership.(22)





10.30
            Lease
                Agreement between UTFLA LLC and the Company dated March 28,
                2006.(22)





23.1
            Consent
                of Independent Accountants.





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.





(1)
            Filed
                with the Securities and Exchange Commission (“SEC”) on January 11, 2000 as
                an exhibit to the Company’s Form 8-K and incorporated herein by
                reference.


(2)
            Filed
                with the SEC as an exhibit to the Company’s Registration Statement on Form
                S-1 filed with the SEC on May 17, 1996 or as an exhibit to Amendment
                No. 1
                to the Form S-1 filed with the SEC on December 31, 1996 and incorporated
                herein by reference.


(3)
            Filed
                with the SEC on June 29, 1998 as an exhibit to the Company’s Form 8-K and
                incorporated herein by reference


(4)
            Filed
                with SEC on December 2, 1998 as an exhibit to the Company’s Form 8-K and
                incorporated herein by reference.


(5)
            Filed
                with the SEC on April 11, 2001 as an exhibit to the Company’s Form 10-K
                and incorporated herein by reference.


(6)
            Filed
                with the SEC on August 14, 2001 as an exhibit to the Company’s Form 10-Q
                and incorporated herein by reference.


(7)
            Filed
                with the SEC on September 7, 2001 as an exhibit to the Company’s Form S-8
                and incorporated herein by reference.


(8)
            Filed
                with the Commission on May 14, 2002 as an exhibit to Form 10-Q for
                the
                period ended March 31, 2002.


(9)
            Filed
                as an exhibit to Form 8-K with the Commission on July 15,
                2002.


(10)
            Filed
                as an exhibit to Form 8-K with the Commission on October 7,
                2002.


(11)
            Filed
                with the Commission on November 14, 2002 as an exhibit to Form 10-Q
                for
                the period ended September 30, 2002.


(12)
            Filed
                as exhibit to Form 8-K with the Commission on January 8,
                2003.


(13)
            Filed
                as an exhibit to Form 10-Q with the Commission on November 12,
                2003.


(14)
            Filed
                as an exhibit to Form 8-K with the Commission on March 16,
                2004.


(15)
            Filed
                as an exhibit to Form 8-K with the Commission on July 1,
                2004.


(16)
            Filed
                as an exhibit to Form 8-K with the Commission on August 20,
                2004.


(17)
            Filed
                as an exhibit to Form 8-K with the Commission on August 26,
                2004.


(18)
            Filed
                as an exhibit to Form 10-Q with the Commission on November 12,
                2004.


(19)
            Filed
                as an exhibit to Form 8-K with the Commission on December 29,
                2004.


(20)
            Filed
                as an exhibit to Form S-8 with the Commission on May 25,
                2005.


(21)
            Filed
                as an exhibit to Form 8-K with the Commission on January 3,
                2006.


(22)
            Filed
                as an exhibit to Form 8-K with the Commission on March 30,
                2006.





46




**SIGNATURES**





Pursuant
      to the requirements of Section 13 or 15(d) 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.





Dated:
      February 22, 2007


Point.360By:
            /s/
              Haig
              S. BagerdjianHaig
                S. Bagerdjian
              Chairman
                of the Board of Directors,
              President
                and Chief Executive Officer





Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed by the following persons on behalf of the Registrant and in the
      capacities and on the dates indicated.




/s/
                Haig S. Bagerdjian
              Haig
                S. Bagerdjian
            Chairman
                of the Board of Directors,
              President
                and Chief Executive Officer
            February
                22, 2007/s/
                Alan R. Steel
              Alan
                R. Steel
            Executive
                Vice President,
              Finance
                and Administration, Chief Financial Officer
              (Principal
                Accounting and Financial Officer)
            February
                22, 2007/s/
                Robert A. Baker
              Robert
                A. Baker
            Director
            February
                22, 2007/s/
                Greggory J. Hutchins
              Greggory
                J. Hutchins
            Director
            February
                22, 2007/s/
                Sam P. Bell
              Sam
                P. Bell
            Director
            February
                22, 2007/s/
                G. Samuel Oki
              G.
                Samuel Oki
            Director
            February
                22, 2007





47