**UNITED
        STATES SECURITIES AND EXCHANGE COMMISSION**
 **Washington,
        D.C. 20549**
 **___________**
 
 **FORM
        10-Q**
 
 
 (Mark One)
 
 **X** **** Quarterly
        report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
        1934.
 
 For the quarterly period ended March 31, 2006 or
 
 __
        Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
        Act
        of 1934.
 
 For
        the
        transition period from   to_________
 
 Commission
        file number  0-21917
 
 Point.360
 **(Exact
        Name of Registrant as Specified in Its Charter)**
 
 **California**
                (State
                  of or other jurisdiction of
                incorporation
                  or organization)
              **95-4272619**
                (I.R.S.
                  Employer Identification No.)**2777
                  North Ontario Street, Burbank, CA**
                (Address
                  of principal executive offices)
              **91504**
                (Zip
                  Code)
 
 (818)
        565-1400
 **(Registrant’s
        Telephone Number, Including Area Code)**
  
 **(Former
        Name, Former Address and Former Fiscal Year,**
 **if
        Changed Since Last Report)**
 
 
 Indicate
        by check mark whether the registrant: (1) has filed all reports required
        to be
        filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
        the
        preceding 12 months (or for such shorter period that the registrant was required
        to file such reports), and (2) has been subject to such filing requirements
        for
        the past 90 days.
 
 Yes  **X**   No
        ____
 
 Indicate
        by check mark whether the registrant is a large accelerated filer, or a
        non-accelerated filer. See definition of “accelerated filer and large
        accelerated filer” in Rule 12b-2 of the Exchange Act.
 
 Large
        accelerated filer     Accelerated
        Filer     Non-accelerated
        filer **X**
 
 Indicate
        by check mark whether the registrant is a shell company (as defined in Rule
        12b-2 of the Exchange Act).
 
 Yes    No  **X**
 
 As
        of
        March 31, 2006, there were 9,372,257 shares of the registrant’s common stock
        outstanding.
  
  **PART
        I - FINANCIAL INFORMATION**
  **ITEM
        1.**  **FINANCIAL
        STATEMENTS**
 **POINT.360**
 
 **CONSOLIDATED
        BALANCE SHEETS**
 
 **ASSETS****December
                  31,**
                **2005**
              
              **March
                  31,**
                **2006**(unaudited)Current
                  assets:Cash
                  and cash equivalents
              
              $
              595,000
              
              $
              2,726,000Accounts
                  receivable, net of allowances for doubtfulaccounts
                  of $563,000 and $587,000 (unaudited), respectively
              
              
              12,662,000
              
              
              15,023,000Inventories
              
              
              797,000
              
              
              731,000Prepaid
                  expenses and other current assets
              
              
              2,432,000
              
              
              2,792,000Deferred
                  income taxes
              
              
              828,000
              
              
              828,000Total
                  current assets
              
              
              17,314,000
              
              
              22,100,000Property
                  and equipment, net
              
              
              28,079,000
              
              
              15,792,000Other
                  assets, net
              
              
              593,000
              
              
              626,000Goodwill
                  and other intangibles, net
              
              
              29,473,000
              
              
              29,473,000Deferred
                  income taxes - long term
              
              
              -
              
              
              870,000Total
                  assets
              
              $
              75,459,000
              
              $
              68,861,000**LIABILITIES
                  AND SHAREHOLDERS’ EQUITY**Current
                  liabilities:Accounts
                  payable
              
              $
              3,986,000
              
              $
              5,089,000Accrued
                  wages and benefits
              
              
              1,711,000
              
              
              1,297,000Accrued
                  earn-out payments
              
              
              2,000,000
              
              
              1,621,000Other
                  accrued expenses
              
              
              683,000
              
              
              741,000Income
                  taxes payable
              
              
              1,231,000
              
              
              2,086,000Borrowings
                  under revolving line of credit
              
              
              4,054,000
              
              
              4,223,000Current
                  portion of borrowings under notes payable
              
              
              2,310,000
              
              
              2,000,000Current
                  portion of capital lease and other obligations
              
              
              63,000
              
              
              63,000Current
                  portion of deferred gain on sale of real estate
              
              
              -
              
              
              178,000Total
                  current liabilities
              
              
              16,038,000
              
              
              17,298,000Deferred
                  income taxes
              
              
              6,121,000
              
              
              6,121,000Bank
                  notes payable, less current portion
              
              
              13,744,000
              
              
              3,500,000Capital
                  lease and other obligations, less current portion
              
              
              46,000
              
              
              23,000Deferred
                  gain on sale of real estate, less current portion
              
              
              -
              
              
              2,496,000Total
                  long-term liabilities
              
              
              19,911,000
              
              
              12,140,000Total
                  liabilities
              
              
              35,949,000
              
              
              29,438,000Contingencies
                  (Note 6)
              
              
              -
              
              
              -Shareholders’
                  equityPreferred
                  stock - no par value; 5,000,000 authorized; none
                  outstanding
              
              
              -
              
              
              -Common
                  stock - no par value; 50,000,000 authorized; 9,368,857 and9,372,257(unaudited)
                  shares issued and outstanding, respectively
              
              
              17,971,000
              
              
              17,976,000Additional
                  paid-in capital
              
              
              1,159,000
              
              
              1,159,000Retained
                  earnings
              
              
              20,380,000
              
              
              20,288,000Total
                  shareholders’ equity
              
              
              39,510,000
              
              
              39,423,000Total
                  liabilities and shareholders’ equity
              
              $
              75,459,000
              
              $
              68,861,000
 See
        accompanying notes to consolidated financial statements.
  2
  **POINT.360**
 
 **CONSOLIDATED
        STATEMENTS OF INCOME (LOSS)**
 **(Unaudited)**
 
 **Three
                  Months Ended**
                **March
                  31,****2005**
              
              **2006**Revenues
              
              $
              17,183,000
              
              $
              16,039,000Cost
                  of goods sold
              
              
              (11,402,000
              )
              
              (10,715,000
              )Gross
                  profit
              
              
              5,781,000
              
              
              5,324,000Selling,
                  general and administrative expense
              
              
              (5,360,000
              )
              
              (5,127,000
              )Operating
                  income
              
              
              421,000
              
              
              197,000Interest
                  expense, net
              
              
              (307,000
              )
              
              (350,000
              )Income
                  (loss) before income taxes
              
              
              114,000
              
              
              (153,000
              )(Provision
                  for) benefit from income taxes
              
              
              (45,000
              )
              
              61,000Net
                  income (loss)
              
              $
              69,000
              
              $
              (92,000
              )Earnings(loss)
                  per share:Basic:Net
                  income (loss)
              
              $
              0.01
              
              $
              (0.01
              )Weighted
                  average number of shares
              
              
              9,302,596
              
              
              9,370,724Diluted:Net
                  income (loss)
              
              $
              0.01
              
              $
              (0.01
              )Weighted
                  average number of sharesincluding the dilutive effect of stockoptions
              
              
              9,867,343
              
              
              9,537,361
  See
        accompanying notes to consolidated financial statements.
  3
  **POINT.360**
 
 **CONSOLIDATED
        STATEMENTS OF CASH FLOWS**
 **(Unaudited)**
 
 **Three
                  Months Ended**
                **March
                  31,****2005**
              
              **2006**Cash
                  flows from operating activities:Net
                  income (loss)
              
              $
              69,000
              
              $
              (92,000
              )Adjustments
                  to reconcile net incometo
                  net cash provided by operating activities:Depreciation
                  and amortization
              
              
              1,564,000
              
              
              1,405,000Provision
                  for doubtful accounts
              
              
              24,000
              
              
              24,000Changes
                  in assets and liabilities:(Increase)
                  decrease in accounts receivable
              
              
              892,000
              
              
              (2,384,000
              )Decrease
                  in inventories
              
              
              45,000
              
              
              65,000(Increase)
                  decrease in prepaid expenses andother
                  current assets
              
              
              198,000
              
              
              (360,000
              )(Increase)
                  in goodwill and other tangibles
              
              
              -
              
              
              -(Increase)
                  decrease in other assets
              
              
              65,000
              
              
              (33,000
              )(Increase)
                  decrease in deferred tax asset
              
              
              -
              
              
              (870,000
              )Increase
                  (decrease) in accounts payable
              
              
              (748,000
              )
              
              1,103,000(Decrease)
                  in accrued expenses
              
              
              (466,000
              )
              
              (735,000
              )Increase
                  in income taxes
              
              
              131,000
              
              
              855,000Increase
                  in other current liabilities
              
              
              -
              
              
              178,000Net
                  cash provided by (used in) operating activities
              
              
              1,774,000
              
              
              (844,000
              )Cash
                  used in investing activities:Capital
                  expenditures
              
              
              (804,000
              )
              
              (359,000
              )Amount
                  paid for acquisitions
              
              
              (25,000
              )
              
              -Net
                  cash used in investing activities
              
              
              (829,000
              )
              
              (359,000
              )Cash
                  flows provided by (used in) financing activities:Proceeds
                  from sale of equipment
              
              
              -
              
              
              13,883,000Exercise
                  of stock options
              
              
              11,000
              
              
              4,000Change
                  in revolving credit agreement
              
              
              (498,000
              )
              
              169,000Proceeds
                  from bank note
              
              
              -
              
              
              (310,000
              )Shares
                  issued for an acquisition
              
              
              (400,000
              )
              
              -Repayment
                  of notes payable
              
              
              (700,000
              )
              
              (10,244,000
              )Repayment
                  of capital lease and other obligations
              
              
              (26,000
              )
              
              (230,000
              )Net
                  cash provided by (used in) financing activities
              
              
              (1,613,000
              )
              
              (3,479,000
              )Net
                  increase (decrease) in cash
              
              
              (668,000
              )
              
              2,131,000Cash
                  and cash equivalents at beginning of period
              
              
              668,000
              
              
              595,000Cash
                  and cash equivalents at end of period
              
              $
              -
              
              $
              2,726,000Supplemental
                  disclosure of cash flow information -
                Cash
                  paid for:Interest
              
              $
              289,000
              
              $
              330,000Income
                  tax
              
              $
              86,000
              
              $
              -
 
 See
        accompanying notes to consolidated financial statements.
  4
  **POINT.360**
 
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**
 
 **March
        31, 2006**
 
 **NOTE
        1**  **-**  **THE
        COMPANY**
  Point.360
        (“Point.360” or the “Company”) provides video and film asset management services
        to owners, producers and distributors of entertainment and advertising content.
        The Company provides the services necessary to edit, master, reformat, archive
        and distribute its clients’ video content, including television programming,
        spot advertising and movie trailers. The Company provides worldwide electronic
        distribution, using fiber optics and satellites. The Company delivers
        commercials, movie trailers, electronic press kits, infomercials and syndicated
        programming, by both physical and electronic means, to thousands of broadcast
        outlets worldwide. The Company operates in one reportable segment.
  The
        Company seeks to capitalize on growth in demand for the services related
        to the
        distribution of advertising and entertainment content, without assuming the
        production or ownership risk of any specific television program, feature
        film or
        other form of content. The primary users of the Company’s services are
        entertainment studios and advertising agencies that choose to outsource such
        services due to the sporadic demand of any single customer for such services
        and
        the fixed costs of maintaining a high-volume physical plant.
  Since
        January 1, 1997, the Company has successfully completed ten acquisitions
        of
        companies providing similar services. The Company will continue to evaluate
        acquisition opportunities to enhance its operations and profitability. As
        a
        result of these acquisitions, the Company believes it is one of the largest
        and
        most diversified providers of technical and distribution services to the
        entertainment and advertising industries, and is therefore able to offer
        its
        customers a single source for such services at prices that reflect the Company’s
        scale economies.
  The
        accompanying unaudited financial statements have been prepared in accordance
        with generally accepted accounting principles and the Securities and Exchange
        Commission’s rules and regulations for reporting interim financial statements
        and footnotes. In the opinion of management, all adjustments (consisting
        of
        normal recurring adjustments) considered necessary for a fair presentation
        have
        been included. Operating results for the three-month period ended March 31,
        2006
        are not necessarily indicative of the results that may be expected for the
        year
        ending December 31, 2006. These financial statements should be read in
        conjunction with the financial statements and related notes contained in
        the
        Company’s Form 10-K for the year ended December 31, 2005.
  **NOTE
        2**  **-**  **LONG
        TERM DEBT AND NOTES PAYABLE**
  In
        May
        2002, the Company and its banks entered into a term loan agreement amending
        a
        previous credit arrangement and having a maturity date of December 31, 2004.
        Pursuant to the agreement, the Company made a $2 million principal payment
        and
        made additional principal payments of $3.5 million and $7.0 million in 2002
        and
        2003, respectively. The agreement provided for interest at the banks’ reference
        rate plus 1.25% and required the Company to maintain certain financial covenant
        ratios. The term loan was secured by substantially all of the Company’s assets.
        Certain legal and other costs associated with the new term loan, including
        fees
        of $50,000 and $250,000 paid in May 2002 and June 2003, respectively, were
        capitalized to be amortized over the remaining life of the loan.
  On
        March
        12, 2004, the Company entered into a new credit agreement which provided
        up to
        $10 million of revolving credit availability for two years and a five-year
        $8
        million term loan. The agreement provided for interest at the banks’ prime rate
        or LIBOR plus 2.25% for the revolver, prime rate plus 0.25% or LIBOR plus
        2.50%
        for the term loan, and required the Company to maintain certain financial
        covenant ratios. The facilities are secured by all of the Company’s assets. The
        term loan required principal payments of $1.6 million annually. The $15,866,000
        outstanding term loan as of December 31, 2003 was repaid by $1,000,000 of
        scheduled principal payments made in January and February 2004 and, on March
        12,
        2004, by new term loan borrowings of $8,000,000 and cash payment of $6,866,000.
  In
        July
        and August 2004, the term loan and revolving portions of the Company’s bank
        facility were increased by $4.7 million and $1.9 million,
        respectively.
  As
        of
        June 30, 2005, the credit agreement was changed with respect to the following:
        (i) the due date of the revolving portion of loans outstanding was changed
        from
        March 12, 2006 to January 31, 2006; (ii) the re-borrowing commitment under
        the
        term loan was eliminated; (iii) the interest rate for both the LIBOR and
        prime
        rate options was increased by 0.5%; and (iv) certain financial covenants
        were
        changed.
  5
  On
        December 30, 2005, the Company entered into a new $10 million term loan
        agreement. The term loan provides for interest at LIBOR plus 3.15% and is
        secured by the Company’s equipment. The new term loan will be repaid in 60 equal
        monthly principal payments plus interest. Proceeds of the new term loan were
        used to repay the previously existing term loan.
  In
        January 2006, the due date of the existing revolving credit facility was
        extended to March 31, 2006. As of December 30, 2005, the Company did not
        meet
        certain financial covenants contained in the credit facility and received
        a
        compliance waiver from the bank.
  In
        August
        2004, the Company entered into a Standing Loan Agreement and Swap Commitment
        with a bank (the “Mortgage”) in order to purchase land and a building. Pursuant
        to the Mortgage, the Company borrowed $6,435,000 payable in monthly installments
        of principal and interest on a fully amortized basis over 15 years. The mortgage
        debt was secured by the land and building.
  In
        August
        2004, the Company entered into a one-year interest rate swap contract to
        economically hedge Mortgage debt. Under the terms of the swap agreement,
        the
        amount hedged was $6,435,000 at a fixed 4.35% interest rate for the first
        year.
        Prior to the end of the first year, in August 2005, the Company was obligated
        to
“fix” the interest rate with respect to the remaining 14 years of the Mortgage
        debt term based on a fixed rate quoted by the bank or LIBOR plus 1.85% for
        that
        period. In December 2004, the rate was fixed at 6.83% for the remaining term
        of
        the mortgage through new hedge agreement. The hedge was terminated in March
        2006
        in connection with a sale and leaseback transaction with respect to the real
        estate and pay-off of the Mortgage.
  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 (5.1% as of March 31, 2006) plus 1.85% for the first six
        months of the agreement, and thereafter at either (i) prime (7.75% as of
        March
        31, 2006) minus 0% - 1.00% or (ii) LIBOR plus 1.50% - 2.5%, depending on
        the
        level of the Company’s ratio of outstanding debt to fixed charges (as defined).
        The facility is secured by all of the Company’s assets, except for equipment
        securing the term loan. The revolving credit agreement requires the Company
        to
        comply with various financial and business covenants. There are cross default
        provisions contained in both the revolving and term loan
        agreements.
 
 **NOTE
        3**  **-**  **SALE
        OF REAL ESTATE**
  On
        March
        29, 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 $1.2 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, related deferred taxes of $870,000 and improvement allowance will be
        amortized over the initial 15-year lease term as reduced rent. Such amounts
        are
        included in deferred gain on sale of real estate on the balance sheet. 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.
 
 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
              
              
              152
              
              (1)
              $
              17,465Property
                  and equipment, net
              
              
              28,079
              
              
              (11,249
              )
              (2)
              
              16,830Goodwill
                  and other assets
              
              
              30,067
              
              
              870
              
              (3)
              
              30,937Total
                  assets
              
              $
              75,459
              
              
              
              
              
              $
              65,232Accounts
                  payable and accrued expenses
              
              $
              8,380
              
              
              870
              
              (4)
              $
              9,250Deferred
                  income taxes
              
              
              1,231
              
              
              
              
              
              
              1,231Short-term
                  debt
              
              
              2,373
              
              
              (310
              )
              (5)
              
              2,063Borrowings
                  under revolving credit
              
              
              4,054
              
              
              (3,904
              )
              (5)
              
              150Current
                  liabilities
              
              
              16,038
              
              
              
              
              
              
              12,863Deferred
                  gain on sale
              
              
              -
              
              
              2,175
              
              (6)
              
              2,175Deferred
                  income taxes and other
              
              
              6,121
              
              
              500
              
              (7)
              
              6,621Long-term
                  notes payable
              
              
              13,790
              
              
              (9,727
              )
              (5)
              
              4,063Shareholders’
                  equity
              
              
              39,510
              
              
              
              
              
              
              39,510Total
                  liabilities and shareholders’ equity
              
              $
              75,459
              
              
              
              
              
              $
              65,232
 
 (1)
              Prepaid
                  rent & property taxes(2)
              Net
                  book value of assets sold(3)
              Deferred
                  taxes associated with gain on sale(4)
              Current
                  tax liability(5)
              Pay-down
                  of debt with net proceeds(6)
              Deferred
                  gain on sale to be amortized over life of lease(7)
              Non-refundable
                  advance from purchaser for
                  improvements
  6
  **NOTE
        4**  **-**  **STOCK-BASED
        COMPENSATION**
  On
        January 1, 2006, we adopted Statements of Financial Accounting Standards
        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 our previous accounting under
        Accounting Principles Board Opinion No. 25, *Accounting
        for Stock Issued to Employees* (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).  We have applied the provisions of SAB 107 in its adoption of
        SFAS 123(R).
  We
        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. Our consolidated financial
        statements as of and for the three months ended March 31, 2006 reflect the
        impact of SFAS 123(R). In accordance with the modified prospective transition
        method, our 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 three months ended March 31, 2006 was less than
        $1,000.
 
 The
        following table illustrates the effect on net loss and loss per share if
        we had
        applied the fair value recognition provisions of SFAS 123 to stock-based
        awards
        granted under the company’s stock option plans for the three months ended March
        31, 2005.  For purposes of this pro-forma disclosure, the fair value of the
        options is estimated using the Black-Scholes-Merton option-pricing formula
        (Black-Scholes model) and amortized to expense over the options’ contractual
        term.
  
 Net
                  income (loss):As
                  reported
              
              $
              69,000Deduct:
                  Total stock-based employeecompensation
                  expense determinedunder
                  fair value based method forall
                  awards, net of related tax effects
              
              
              (51,000
              )Pro
                  forma
              
              
              18,000Basic
                  earnings (loss) per share ofcommon
                  stock:As
                  reported
              
              $
              0.01Pro
                  forma
              
              $
              0.00Diluted
                  earnings (loss) per share ofcommon
                  stock:As
                  reported
              
              $
              0.01Pro
                  forma
              
              $
              0.00
  The
        fair
        value of each option was estimated on the date of grant using the Black-Scholes
        option-pricing model with the following weighted average
        assumptions:
 
 Risk-free
                  interest rate
              
              
              2.50
              %Expected
                  term (years)
              
              
              5.00Volatility
              
              
              48
              %Expected
                  annual dividends
              
              
              0.0
              %
 
 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 our Consolidated
        Statements of Operations. Prior to the adoption of SFAS 123(R), we accounted
        for
        stock-based awards to employees and directors using the intrinsic value method
        in accordance with APB 25 as allowed under SFAS No. 123, *Accounting
        for Stock-Based Compensation* .
        Under
        the intrinsic value method, no stock-based compensation expense had been
        recognized in our Consolidated Statements of Operations 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.
 
 We
        have
        elected to adopt the detailed method provided in SFAS 123(R) for calculating
        the
        beginning balance of the additional paid-in capital pool (APIC pool) related
        to
        the tax effects of employee stock-based compensation, and to determine the
        subsequent impact on the APIC pool and Consolidated Statements of Cash Flows
        of
        the tax effects of employee stock-based compensation awards that are outstanding
        upon adoption of SFAS 123(R).
 
 **NOTE
        5**  **-**  **CONTINGENCIES**
 
 From
        time
        to time the Company may become a party to various legal actions and complaints
        arising in the ordinary course of business, although it is not currently
        involved in any such material legal proceedings.
 
 **NOTE
        6**  **-**  **SHAREHOLDERS’
        EQUITY**
 
 During
        the three-month period ended March 31, 2006, the number of outstanding shares
        of
        the Company’s common stock increased by 3,400 shares due to the exercise of
        employee stock options for $5,000 in cash.
  7
  **POINT.360**
  **MANAGEMENT’S
        DISCUSSION AND ANALYSIS**
  **ITEM
        2.**  **MANAGEMENT’S
        DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
        OPERATIONS**
  *Except
        for the historical information contained herein, certain statements in this
        quarterly report are "forward-looking statements" as defined in the Private
        Securities Litigation Reform Act of 1995, which involve certain risks and
        uncertainties, which could cause actual results to differ materially from
        those
        discussed herein, including but not limited to competition, customer and
        industry concentration, 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,
        for a further discussion of these and other risks and uncertainties applicable
        to the Company's business.*
  **Overview**
  We
        are
        one of the largest providers of video and film asset management services
        to
        owners, producers and distributors of entertainment and advertising content.
        We
        provide the services necessary to edit, master, reformat, archive and ultimately
        distribute our clients’ film and video content, including television
        programming, spot advertising, feature films and movie trailers using electronic
        and physical means. We deliver commercials, movie trailers, electronic press
        kits, infomercials and syndicated programming to hundreds of broadcast outlets
        worldwide. Our interconnected facilities in Los Angeles, New York, Chicago,
        Dallas and San Francisco provide service coverage in each of the major U.S.
        media centers. Clients include major motion picture studios, advertising
        agencies and corporations.
  We
        operate in a highly competitive environment in which customers desire a broad
        range of service at a reasonable price. There are many competitors offering
        some
        or all of the services provided by the Company. Additionally, some of our
        customers are large studios, which also have in-house capabilities that may
        influence the amount of work outsourced to companies like Point.360. We attract
        and retain customers by maintaining a high service level at reasonable
        prices.
  In
        recent
        years, electronic delivery services have grown while physical duplication
        and
        delivery have been declining. We expect this trend to continue over a long
        term
        (i.e. the next 10 years). All of our electronic, fiber optics, satellite
        and
        Internet deliveries are made using third party vendors, which eliminates
        our
        need to invest in such capability. However, the use of others to deliver
        our
        services poses the risk that costs may rise in certain situations that cannot
        be
        passed on to customers, thereby lowering gross margins. There is also the
        risk
        that third party vendors who directly compete with us will succeed in taking
        away business or refuse to allow us to use their distribution channels. In
        fact,
        in June 2005, one such vendor/competitor notified us that its electronic
        distribution channel would not be available to us except in very limited
        circumstances, or unless we entered certain “preferred vendor” arrangements that
        we believed would not be in the best long-term interests of Point.360. While
        curtailment of these services has not materially affected our ability to
        deliver
        commercial spots, we have not been able to pass on increased alternative
        delivery costs to our customers 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.
  **Three
        Months Ended March 31, 2006 Compared To Three Months Ended March 31,
        2005.**
  *Revenues* .  **** Revenues
        were $16.0 million for the three-month period ended March 31, 2006, compared
        to
        $17.2 million for the three-month period ended March 31, 2005.
  *Gross
        Profit* .  In
        the
        first quarter of 2006, gross margin was 33% of sales, compared to 34% for
        the
        quarter ended March 31, 2005.
  8
  *Selling,
        General And Administrative Expense* .  SG&A
        expense was $5.1 million in the first quarter of 2006 as compared to $5.4
        million in the same period of 2005.
  *Interest
        Expense* .  **** Interest
        expense for the three-month period ended March 31, 2006 was $0.4 million,
        an
        increase of $0.1 million over the three-month period ended March 31, 2005
        because of increasing rates on variable interest debt.
  **LIQUIDITY
        AND CAPITAL RESOURCES**
  In
        May
        2002, the Company and its banks entered into a term loan agreement with a
        maturity date of December 31, 2004. In January and February 2004, the Company
        made $1 million of scheduled principal payments under the term loan. In March
        2004, the Company paid off the remaining $14.9 million prior term loan principal
        balance with $6.9 of cash and proceeds from the new $8 million term loan
        pursuant to a new credit agreement. The new agreement provided up to $10
        million
        of revolving credit availability for two years and a five-year $8 million
        five-year term loan. The agreement was subsequently amended to increase the
        revolving credit and term loan availability by $1.9 million and $4.7 million,
        respectively, concurrent with the acquisition of IVC.
  In
        November 2003, the Company leased a new 64,600 square foot building in Los
        Angeles, California, for the purpose of consolidating four vault locations
        then
        occupying approximately 71,000 square feet. A provision of the lease provided
        that until May 2005, the Company had an option to purchase the building for
        approximately $8,572,000. We purchased the building in August 2004 by paying
        $2,065,000 in cash and borrowing the $6,435,000 million balance under a mortgage
        loan payable over 15 years. We also spent approximately $3.1 million for
        improvements to the building during 2004.
  On
        December 30, 2005, the Company entered a new $10 million term loan agreement.
        The term loan provides for interest at LIBOR plus 3.15% and is secured by
        the
        Company’s equipment. The term loan will be repaid in 60 equal principal payments
        plus interest. Proceeds of the loan were used to pay off our 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 plus 1.85% for the first six months of the agreement, and
        thereafter either (i) prime 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). 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
        real estate discussed above. 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* (“SFAS
        28”), 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 new term
        loan.
  The
        following table summarizes the March 31, 2006 status of our revolving line
        of
        credit and term loans:
 
 Revolving
                  credit
              
              $
              4,223,000Current
                  portion of term loan
              
              
              2,000,000Long-term
                  portion of term loan
              
              
              3,500,000Total
              
              
              9,723,000Cash
                  on hand
              
              
              (2,726,000
              )Net
                  Debt
              
              $
              6,997,000
  Monthly
        and annual principal and interest payments due under the new term debt are
        approximately $167,000 and $2 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.
  We
        expect
        that remaining amounts available under the new revolving credit arrangement,
        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 which we paid $2.3 million
        in
        cash and borrowed the $4.7 million. The IVC purchase agreement also required
        payments of $1 million, $2 million and $2 million in 2005, 2006 and 2007,
        respectively, if certain predetermined earnings levels (as defined) are met.
        In
        April 2005, $1 million was paid. $2 million was paid or accrued on March
        31,
        2006.
  9
  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 or 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 judgements. Critical accounting policies
        cover accounting matters that are inherently uncertain because the future
        resolution of such matters is unknown. We have made critical estimates in
        the
        following areas:
  *Revenues.* We
        perform a multitude of services for our clients, including film-to-tape
        transfer, video and audio editing, standards conversions, adding effects,
        duplication, distribution, etc. A customer orders one or more of these services
        with respect to an element (commercial spot, movie, trailer, electronic press
        kit, etc.). The sum total of services performed on a particular element (a
        “package”) becomes the deliverable (i.e., the customer will pay for the services
        ordered in total when the entire job is completed). Occasionally, a major
        studio
        will request that package services be performed on multiple elements. Each
        element creates a separate revenue stream which is recognized only when all
        requested services have been performed on that element.
  *Allowance
        for doubtful accounts* .
        We are
        required to make judgments, based on historical experience and future
        expectations, as to the collectibility of accounts receivable. The allowances
        for doubtful accounts and sales returns represent allowances for customer
        trade
        accounts receivable that are estimated to be partially or entirely
        uncollectible. These allowances are used to reduce gross trade receivables
        to
        their net realizable value. The Company records these allowances as a charge
        to
        selling, general and administrative expenses based on estimates related to
        the
        following factors: i) customer specific allowances; ii) amounts based upon
        an
        aging schedule and iii) an estimated amount, based on the Company's historical
        experience, for issues not yet identified.
  *Valuation
        of long-lived and intangible assets* . Long-lived
        assets, consisting primarily of property, plant and equipment and intangibles,
        comprise a significant portion of the Company's total assets. Long-lived
        assets,
        including goodwill and intangibles are reviewed for impairment whenever events
        or changes in circumstances have indicated that their carrying amounts may
        not
        be recoverable. Recoverability of assets is measured by a comparison of the
        carrying amount of an asset to future net cash flows expected to be generated
        by
        that asset. The cash flow projections are based on historical experience,
        management’s view of growth rates within the industry and the anticipated future
        economic environment.
  Factors
        we consider important which could trigger an impairment review include the
        following:
  l
              significant
                  underperformance relative to expected historical or projected future
                  operating results;l
              significant
                  changes in the manner of our use of the acquired assets or the
                  strategy
                  for our overall business;l
              significant
                  negative industry or economic trends;l
              significant
                  decline in our stock price for a sustained period; andl
              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 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 $45.3 million as of March
        31,
        2006 .
  10
  In
        2002,
        Statement of Financial Accounting Standards (“SFAS”) No. 142, “ *Goodwill
        and Other Intangible Assets* ”
(“SFAS
        142”) became effective and as a result, we ceased to amortize approximately
        $26.3 million of goodwill beginning in 2002. In lieu of amortization, we
        were required to perform an initial impairment review of our goodwill in
        2002
        and an annual impairment review thereafter. The initial test on January 1,
        2002,
        and the Fiscal 2002, 2003, 2004 and 2005 tests performed as of September
        30,
        2002, 2003, 2004 and 2005, respectively, required no goodwill impairment.
        An
        additional test was performed as of December 31, 2005 which required no
        impairment. The discounted cash flow method used to evaluate goodwill impairment
        included cash flow estimates for 2006 and subsequent years. If actual cash
        flow
        performance does not meet these expectations due to factors cited above,
        any
        resulting potential impairment could adversely affect reported goodwill asset
        values and earnings.
  *Accounting
        for income taxes* .
        As part
        of the process of preparing our consolidated financial statements, we are
        required to estimate our income taxes in each of the jurisdictions in which
        we
        operate. This process involves us estimating our actual current tax exposure
        together with assessing temporary differences resulting from differing treatment
        of items, such as deferred revenue, for tax and accounting purposes. These
        differences result in deferred tax assets and liabilities, which are included
        within our consolidated balance sheet. We must then assess the likelihood
        that
        our deferred tax assets will be recovered from future taxable income and
        to the
        extent we believe that recovery is not likely, we must establish a valuation
        allowance. To the extent we establish a valuation allowance or increase this
        allowance in a period, we must include an expense within the tax provision
        in
        the statement of operations.
  Significant
        management judgment is required in determining our provision for income taxes,
        our deferred tax assets and liabilities and any valuation allowance recorded
        against our net deferred tax assets. The net deferred tax liability as of
        March
        31, 2006 was $4.4 million. The Company did not record a valuation allowance
        against its deferred tax assets as of March 31, 2006.
  **ITEM
        3.**  **QUANTITATIVE
        AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**
  *Market
        Risk* .
        The
        Company had borrowings of $9.7 million at March 31, 2006 under a term loan
        and
        revolving credit agreements. All debt was subject to a variable interest
        rate.
        The weighted average interest rate paid during the first quarter of 2006
        was
        8.0%. For variable rate debt outstanding at March 31, 2006, a .25% increase
        in
        interest rates will increase annual interest expense by approximately $25,000.
        Amounts outstanding under the revolving credit facility provide for interest
        at
        the banks’ prime rate minus 0%- 1.00% assuming the same amount of outstanding
        debt or LIBOR plus 1.5% to 2.5%, and LIBOR plus 3.15% for the term loan.
        The
        Company’s market risk exposure with respect to financial instruments is to
        changes in prime or LIBOR rates.
  **ITEM
        4.**  **CONTROLS
        AND PROCEDURES**
  Pursuant
        to Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange
        Act”), the Company’s management, with the participation of the Chief Executive
        Officer and Chief Financial Officer, evaluated the effectiveness of the
        Company’s disclosure controls and procedures, as of the end of the period
        covered by this report. Based on that evaluation, the Chief Executive Officer
        and Chief Financial Officer concluded that the Company’s disclosure controls and
        procedures are effective in ensuring that information required to be disclosed
        in reports that the Company files or submits under the Exchange Act is recorded,
        processed, summarized and reported within the time periods specified in the
        SEC’s rules and forms. No change in the Company’s internal control over
        financial reporting occurred during the Company’s most recent fiscal quarter
        that materially affected, or is reasonably likely to materially affect, the
        Company’s internal control over financial reporting.
 
 **PART
        II - OTHER INFORMATION**
  **ITEM
        1A. RISK FACTORS**
  In
        our
        capacity as Company management, we may from time to time make written or
        oral
        forward-looking statements with respect to our long-term objectives or
        expectations which may be included in our filings with the Securities and
        Exchange Commission (the “SEC”), reports to stockholders and information
        provided in our
        web
        site.
  The
        words
        or phrases “will likely,” “are expected to,” “is anticipated,” “is predicted,”
“forecast,” “estimate,” “project,” “plans to continue,” “believes,” or similar
        expressions identify “forward-looking statements” within the meaning of the
        Private Securities Litigation Reform Act of 1995. Such forward-looking
        statements are subject to certain risks and uncertainties that could cause
        actual results to differ materially from historical earnings and those presently
        anticipated or projected. We wish to caution you not to place undue reliance
        on
        any such forward-looking statements, which speak only as of the date made.
        In
        connection with the “Safe Harbor” provisions of the Private Securities
        Litigation Reform Act of 1995, we are calling to your attention important
        factors that could affect our financial performance and could cause actual
        results for future periods to differ materially from any opinions or statements
        expressed with respect to future periods in any current
        statements.
  11
   The
        following list of important factors may not be all-inclusive, and we
        specifically decline to undertake an obligation to publicly revise any
        forward-looking statements that have been made to reflect events or
        circumstances after the date of such statements or to reflect the occurrence
        of
        anticipated or unanticipated events. Among the factors that could have an
        impact
        on our ability to achieve expected operating results and growth plan goals
        and/or affect the market price of our stock are:
  l
              Recent
                  history of losses.l
              Prior
                  breach and changes in credit agreements and ongoing
                  liquidity.l
              Our
                  highly competitive marketplace.l
              The
                  risks associated with dependence upon significant
                  customers.l
              Our
                  ability to execute our expansion strategy.l
              The
                  uncertain ability to manage in a changing environment.l
              Our
                  dependence upon and our ability to adapt to technological
                  developments.l
              Dependence
                  on key personnel.l
              Our
                  ability to maintain and improve service quality.l
              Fluctuation
                  in quarterly operating results and seasonality in certain of our
                  markets.l
              Possible
                  significant influence over corporate affairs by significant
                  shareholders.
 
 Investors
        are encouraged to examine the Company’s 2005 Form 10-K, which more fully
        describes the risks and uncertainties associated with the Company’s
        business.
  **ITEM
        5. OTHER INFORMATION**
  None.
  **ITEM
                  6.**
              **EXHIBITS**
  (a)
              **Exhibits**
 
 31.1
              Certification
                  of Chief Executive Officer Pursuant to 15 U.S.C. § 7241, as Adopted
                  Pursuant to Section 302 of the Sarbanes-Oxley Act of
                  2002.31.2
              Certification
                  of Chief Financial Officer Pursuant to 15 U.S.C. § 7241, as Adopted
                  Pursuant to Section 302 of the Sarbanes-Oxley Act of
                  2002.32.1
              Certification
                  of Chief Executive Officer Pursuant to 18 U.S.C. § 1350, as Adopted
                  Pursuant to Section 906 of the Sarbanes-Oxley Act of
                  2002.32.2
              Certification
                  of Chief Financial Officer Pursuant to 18 U.S.C. § 1350, as Adopted
                  Pursuant to Section 906 of the Sarbanes-Oxley Act of
                  2002.
 
 
 **SIGNATURES**
  Pursuant
        to the requirements of the Securities Exchange Act of 1934, the registrant
        has
        duly caused this report to be signed on its behalf by the undersigned thereunto
        duly authorized.
  POINT.360DATE:
                May 11, 2006
              By:
              /s/
                  Alan R.
                  SteelAlan
                  R. SteelExecutive
                Vice
                President, Finance
                and Administration
                (duly
                    authorized officer and principal financial
                    officer)
  12