**UNITED
        STATES SECURITIES AND EXCHANGE COMMISSION**
 **Washington,
        D.C. 20549**
  
 **FORM
        10-Q**
 
 
 (Mark
        One)
 
 xQuarterly
        report
        pursuant to Section 13 or 15(d) of the Securities Exchange Act of
        1934.
 
 For
        the
        quarterly period ended June 30, 2005 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
                    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
o
 
 Indicate
        by check mark whether the registrant is an accelerated filer (as defined
        in Rule
        12b-2 of the Exchange Act).
 
 Yes
o  No
x
 
 As
        of
        June 30, 2005, there were 9,357,532 shares of the registrant’s common stock
        outstanding.
  
  **PART
        I - FINANCIAL INFORMATION**
 
 **ITEM
        1.**  **FINANCIAL
        STATEMENTS**
 
 **POINT.360**
 
 **CONSOLIDATED
        BALANCE SHEETS**
 
 **ASSETS****December
                  31,**
                **2004**
              
              **June
                  30,**
                **2005**(unaudited)Current
                  assets:Cash
                  and cash equivalents
              
              $
              668,000
              
              $
              -Accounts
                  receivable, net of allowances for doubtful
                accounts
                  of $531,000 and $566,000 (unaudited), respectively
              
              
              12,468,000
              
              
              11,383,000Inventories
              
              
              932,000
              
              
              884,000Prepaid
                  expenses and other current assets
              
              
              1,788,000
              
              
              1,676,000Deferred
                  income taxes
              
              
              1,310,000
              
              
              1,310,000Total
                  current assets
              
              
              17,166,000
              
              
              15,253,000Property
                  and equipment, net
              
              
              31,451,000
              
              
              29,810,000Other
                  assets, net
              
              
              742,000
              
              
              645,000Goodwill
                  and other intangibles, net
              
              
              27,288,000
              
              
              27,473,000Total
                  assets
              
              $
              76,647,000
              
              $
              73,181,000**LIABILITIES
                  AND SHAREHOLDERS’ EQUITY**Current
                  liabilities:Bank
                  overdraft
              
              $
              -
              
              $
              613,000Accounts
                  payable
              
              
              4,898,000
              
              
              3,123,000Accrued
                  wages and benefits
              
              
              1,751,000
              
              
              1,872,000Accrued
                  earn-out payments
              
              
              1,000,000
              
              
              -Other
                  accrued expenses
              
              
              1,249,000
              
              
              913,000Income
                  taxes payable
              
              
              1,148,000
              
              
              1,060,000Borrowings
                  under revolving line of credit
              
              
              4,323,000
              
              
              4,294,000Current
                  portion of borrowings under notes payable
              
              
              2,849,000
              
              
              3,051,000Current
                  portion of capital lease and other obligations
              
              
              67,000
              
              
              63,000Total
                  current liabilities
              
              
              17,285,000
              
              
              14,989,000Deferred
                  income taxes
              
              
              5,788,000
              
              
              5,008,000Bank
                  notes payable, less current portion
              
              
              14,494,000
              
              
              13,899,000Capital
                  lease and other obligations, less current portion
              
              
              136,000
              
              
              106,000Total
                  long-term liabilities
              
              
              20,418,000
              
              
              19,013,000Total
                  liabilities
              
              
              37,703,000
              
              
              34,002,000Contingencies
                  (Note 4 and 6)
              
              
              -
              
              
              -Shareholders’
                  equityPreferred
                  stock - no par value; 5,000,000 authorized; none
                  outstanding
              
              
              -
              
              
              -Common
                  stock - no par value; 50,000,000 authorized; 9,236,132and9,357,532(unaudited)
                  shares issued and outstanding, respectively
              
              
              17,903,000
              
              
              18,337,000Additional
                  paid-in capital
              
              
              675,000
              
              
              675,000Retained
                  earnings
              
              
              20,366,000
              
              
              20,167,000Total
                  shareholders’ equity
              
              
              38,944,000
              
              
              39,179,000Total
                  liabilities and shareholders’ equity
              
              $
              76,647,000
              
              $
              73,181,000
 
 See
        accompanying notes to consolidated financial statements.
  2
  **POINT.360**
 
 **CONSOLIDATED
        STATEMENTS OF INCOME (LOSS)**
 **(Unaudited)**
 
 **Three
                  Months Ended**
                **June
                  30,**
              
              **Six
                  Months Ended**
                **June
                  30,****2004**
              
              **2005**
              
              **2004**
              
              **2005**Revenues
              
              $
              13,913,000
              
              $
              15,890,000
              
              $
              29,382,000
              
              $
              33,073,000Cost
                  of goods sold
              
              
              (9,110,000
              )
              
              (10,628,000
              )
              
              (18,929,000
              )
              
              (22,030,000
              )Gross
                  profit
              
              
              4,803,000
              
              
              5,262,000
              
              
              10,453,000
              
              
              11,043,000Selling,
                  general and administrative expense
              
              
              (4,508,000
              )
              
              (5,395,000
              )
              
              (9,102,000
              )
              
              (10,755,000
              )Write-off
                  of deferred acquisition and
                financing
                  costs
              
              
              (60,000
              )
              
              -
              
              
              (62,000
              )
              
              -Operating
                  income (loss)
              
              
              235,000
              
              
              (133,000
              )
              
              1,289,000
              
              
              288,000Interest
                  expense, net
              
              
              (111,000
              )
              
              (314,000
              )
              
              (329,000
              )
              
              (621,000
              )Income
                  (loss) before income taxes
              
              
              124,000
              
              
              (447,000
              )
              
              960,000
              
              
              (333,000
              )(Provision
                  for) benefit from income taxes
              
              
              (51,000
              )
              
              179,000
              
              
              (393,000
              )
              
              134,000Net
                  income (loss)
              
              $
              73,000
              
              $
              (268,000
              )
              $
              567,000
              
              $
              (199,000
              )Earnings(loss)
                  per share:Basic:Net
                  income (loss)
              
              $
              0.01
              
              $
              (0.03
              )
              $
              0.06
              
              $
              (0.02
              )Weighted
                  average number of shares
              
              
              9,200,211
              
              
              9,349,105
              
              
              9,176,354
              
              
              9,326,020Diluted:Net
                  income (loss)
              
              $
              0.01
              
              $
              (0.03
              )
              $
              0.06
              
              $
              (0.02
              )Weighted
                  average number of shares
                including
                  the dilutive effect of stock
                options
              
              
              9,669,099
              
              
              9,809,551
              
              
              9,778,654
              
              
              9,850,467
 
 
 See
        accompanying notes to consolidated financial statements.
  3
  **POINT.360**
 
 **CONSOLIDATED
        STATEMENTS OF CASH FLOWS**
 **(Unaudited)**
 
 **Six
                  Months Ended**
                **June
                  30,****2004**
              
              **2005**Cash
                  flows from operating activities:Net
                  income (loss)
              
              $
              567,000
              
              $
              (199,000
              )Adjustments
                  to reconcile net income
                to
                  net cash provided by operating activities:Depreciation
                  and amortization
              
              
              2,744,000
              
              
              3,144,000Provision
                  for doubtful accounts
              
              
              48,000
              
              
              45,000Other
                  non cash items
              
              
              (9,000
              )
              
              183,000Changes
                  in assets and liabilities:(Increase)
                  decrease in accounts receivable
              
              
              (120,000
              )
              
              1,130,000(Increase)
                  decrease in inventories
              
              
              (35,000
              )
              
              48,000Decrease
                  in prepaid expenses and
                other
                  current assets
              
              
              299,000
              
              
              189,000Decrease
                  in other assets
              
              
              12,000
              
              
              97,000Increase
                  (decrease) in accounts payable
              
              
              1,642,000
              
              
              (1,775,000
              )(Decrease)
                  in accrued expenses
              
              
              (389,000
              )
              
              (1,215,000
              )Increase
                  (decrease) in income taxes
              
              
              99,000
              
              
              (11,000
              )(Decrease)
                  in deferred taxes
              
              
              -
              
              
              (780,000
              )Net
                  cash provided by operating activities
              
              
              4,858,000
              
              
              856,000Cash
                  used in investing activities:Capital
                  expenditures
              
              
              (1,962,000
              )
              
              (1,290,000
              )Proceeds
                  from sale of equipment
              
              
              40,000
              
              
              (25,000
              )Net
                  cash paid for acquisitions
              
              
              -
              
              
              -Net
                  cash used in investing activities
              
              
              (1,922,000
              )
              
              (1,315,000
              )Cash
                  flows used in financing activities:Exercise
                  of stock options
              
              
              220,000
              
              
              34,000Change
                  in revolving credit agreement
              
              
              -
              
              
              585,000Proceeds
                  from bank note
              
              
              8,000,000
              
              
              1,006,000Change
                  in note payable
              
              
              183,000
              
              
              -Shares
                  issued for an acquisition
              
              
              -
              
              
              (400,000
              )Repayment
                  of notes payable
              
              
              (16,266,000
              )
              
              (1,400,000
              )Repayment
                  of capital lease obligations
              
              
              (52,000
              )
              
              (34,000
              )Net
                  cash used in financing activities
              
              
              (7,915,000
              )
              
              (209,000
              )Net
                  decrease in cash
              
              
              (4,979,000
              )
              
              (668,000
              )Cash
                  and cash equivalents at beginning of period
              
              
              7,206,000
              
              
              668,000Cash
                  and cash equivalents at end of period
              
              $
              2,227,000
              
              $
              -Supplemental
                  disclosure of cash flow information -
                Cash
                  paid for:Interest
              
              $
              327,000
              
              $
              594,000Income
                  tax
              
              $
              295,000
              
              $
              866,000
 
 
 See
        accompanying notes to consolidated financial statements.
  4
  **POINT.360**
 
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**
 
 **June
        30, 2005**
 
 **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 nine 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- and six-month periods ended
        June
        30, 2005 are not necessarily indicative of the results that may be expected
        for
        the year ending December 31, 2005. 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, 2004.
 
 **NOTE
        2**  **-**  **ACCOUNTING
        PRONOUNCEMENTS**
  In
        May
        2003, the Financial Accounting Standards Board issued Statement of Financial
        Accounting Standards (“SFAS”) No. 150, “ *Accounting
        for Certain Financial Instruments with Characteristics of both Liabilities
        and
        Equity* .”
        SFAS
        No. 150 establishes standards for how an issuer classifies and measures in
        its
        statement of financial position certain financial instruments with
        characteristics of both liabilities and equity. In accordance with the standard,
        financial instruments that embody obligations for the issuer are required
        to be
        classified as liabilities. SFAS No. 150 will be effective for financial
        instruments entered into or modified after May 31, 2003 and otherwise will
        be
        effective at the beginning of the first interim period beginning after June
        15,
        2003. This statement does not affect the Company at this time.
 
 In
        November 2004, the FASB issued SFAS No. 151, *“Inventory
        Costs* ”.
        SFAS
        No. 151 amends the accounting for abnormal amounts of idle facility expense,
        freight, handling costs, and wasted material (spoilage) under the guidance
        in
        ARB No. 43, Chapter 4, *"Inventory
        Pricing* ”.
        Paragraph 5 of ARB No. 43, Chapter 4, previously stated that “. . . under some
        circumstances, items such as idle facility expense, excessive spoilage, double
        freight, and rehandling costs may be so abnormal as to require treatment
        as
        current period charges. . . . *”* This
        Statement requires that those items be recognized as current-period charges
        regardless of whether they meet the criterion of "so abnormal." In addition,
        this Statement requires that allocation of fixed production overheads to
        the
        costs of conversion be based on the normal capacity of the production
        facilities. This statement is effective for inventory costs incurred during
        fiscal years beginning after June 15, 2005. Management does not expect adoption
        of SFAS No. 151 to affect the Company’s financial statements.
 
 In
        December 2004, the FASB issued SFAS No. 152, *“Accounting
        for Real Estate Time-Sharing Transactions* ”. The
        FASB
        issued this Statement as a result of the guidance provided in AICPA Statement
        of
        Position (SOP) 04-2, “ *Accounting
        for Real Estate Time-Sharing Transactions* ”.
        SOP
        04-2 applies to all real estate time-sharing transactions. Among other items,
        the SOP provides guidance on the recording of credit losses and the treatment
        of
        selling costs, but does not change the revenue recognition guidance in SFAS
        No.
        66,” *Accounting
        for Sales of Real Estate* ”,
        for
        real estate time-sharing transactions. SFAS No. 152 amends Statement No.
        66 to
        reference the guidance provided in SOP 04-2. SFAS No. 152 also amends SFAS
        No.
        67, “ *Accounting
        for Costs and Initial Rental Operations of Real Estate Projects* ”,
        to
        state that SOP 04-2 provides the relevant guidance on accounting for incidental
        operations and costs related to the sale of real estate time-sharing
        transactions. SFAS No. 152 is effective for years beginning after June 15,
        2005,
        with restatements of previously issued financial statements prohibited. This
        statement is not applicable to the Company.
 
 5
 In
        December 2004, the FASB issued SFAS No. 153, “ *Exchanges
        of Nonmonetary Assets* ,”
        an
        amendment to Opinion
        No. 29, *“Accounting
        for Nonmonetary Transactions* ” . Statement
        No. 153 eliminates certain differences in the guidance in Opinion No. 29
        as
        compared to the guidance contained in standards issued by the International
        Accounting Standards Board. The amendment to Opinion No. 29 eliminates the
        fair
        value exception for nonmonetary exchanges of similar productive assets and
        replaces it with a general exception for exchanges of nonmonetary assets
        that do
        not have commercial substance. Such an exchange has commercial substance
        if the
        future cash flows of the entity are expected to change significantly as a
        result
        of the exchange. SFAS No. 153 is effective for nonmonetary asset exchanges
        occurring in periods beginning after June 15, 2005. Earlier application is
        permitted for nonmonetary asset exchanges occuring in periods beginning after
        December 16, 2004. Management
        does not expect adoption of SFAS No. 153 to have a material impact on the
        Company’s financial statements.
 
 In
        December 2004, the FASB issued SFAS No. 123(R), “ *Share-Based
        Payment.* ”
        SFAS
        123(R) amends SFAS No. 123, “ *Accounting
        for Stock-Based Compensation* ”,
        and
        APB Opinion 25, “ *Accounting
        for Stock Issued to Employees* .”
        SFAS
        No.123(R) requires that the cost of share-based payment transactions (including
        those with employees and non-employees) be recognized in the financial
        statements. SFAS No. 123(R) applies to all share-based payment transactions
        in
        which an entity acquires goods or services by issuing (or offering to issue)
        its
        shares, share options, or other equity instruments (except for those held
        by an
        ESOP) or by incurring liabilities (1) in amounts based (even in part) on
        the
        price of the entity’s shares or other equity instruments, or (2) that require
        (or may require) settlement by the issuance of an entity’s shares or other
        equity instruments. This statement is effective (1) for public companies
        qualifying as SEC small business issuers, as of the first interim period
        or
        fiscal year beginning after December 15, 2005, or (2) for all other public
        companies, as of the first fiscal year beginning after June 15, 2005, or
        (3) for
        all nonpublic entities, as of the first fiscal year beginning after December
        15,
        2005. Management is currently assessing the effect of SFAS No. 123(R) on
        the
        Company’s financial statements.
 
 In
        May
        2005, the FASB issued SFAS No. 154, “ *Accounting
        Changes and Error Corrections* ”,
        an
        amendment to Accounting Principles Bulletin (APB) Opinion No. 20, “ *Accounting
        Changes* ”,
        and
        SFAS No. 3, “ *Reporting
        Accounting Changes in Interim Financial Statements* .”
        Although SFAS No. 154 carries forward the guidance in APB No. 20 and SFAS
        No. 3
        with respect to accounting for changes in estimates, changes in reporting
        entity, and the correction of errors, SFAS No. 154 establishes new standards
        on
        accounting for changes in accounting principles, whereby all such changes
        must
        be accounted for by retrospective application to the financial statements
        of
        prior periods unless it is impracticable to do so. SFAS No. 154 is effective
        for
        accounting changes and error corrections made in fiscal years beginning after
        December 15, 2005, with early adoption permitted for changes and corrections
        made in years beginning after May 2005.
 
 **NOTE
        3**  **-**  **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. For the first two years of the term loan, the Company
        could
        re-borrow all principal payments to finance up to 80% of capital equipment
        purchases. 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. The Company intends to replace the existing credit agreement before
        January 31, 2006.
 
 6
 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 (see
        below). 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 is secured by the land and building.
 
 In
        connection with the Mortgage, the Company entered into a one-year interest
        rate
        swap contract to economically hedge the 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, by 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 banks
        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 a new hedge
        agreement.
 
 **NOTE
        4**  **-**  **ISSUANCE
        OF WARRANT, POSSIBLE ACQUISITION AND WRITE-OFF OF DEFERRED COSTS, RELATED
        LEGAL
        ACTIONS AND SETTLEMENT**
 
 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. All amounts deferred
        prior to the settlement related to possible acquisition of the Subsidiaries
        have
        been expensed. Such amounts have been shown separately in the Consolidated
        Statements of Income for clarity of presentation.
 
 **NOTE
        5**  **-**  **STOCK-BASED
        COMPENSATION**
 
 The
        Company applies Accounting Principles Board (“APB”) Opinion No. 25,
“ *Accounting
        for Stock Issued to Employees* ,”
        and
        related interpretations, in accounting for its stock option plans. As such,
        compensation expense would be recorded on the date of grant only if the current
        market price of the underlying stock exceeded the exercise price. SFAS No.
        123
        established accounting and disclosure requirements using a fair value-based
        method of accounting for stock-based employee compensation plans. As allowed
        by
        SFAS No. 123, the Company has elected to continue to apply the intrinsic
        value-based method of accounting described above, and has adopted the disclosure
        requirements of SFAS No. 123. Pro forma net income and earnings per share
        disclosures, as if the Company recorded compensation expense based on the
        fair
        value for stock-based awards, have been presented in accordance with the
        provisions of SFAS No. 148 and are as follows for the three- and six-month
        periods ended June 30, 2004 and 2005.
 
 7
 **Three
                  months ended**
                **June
                  30**
              
              **Six
                  months ended**
                **June
                  30****2004**
              
              **2005**
              
              **2004**
              
              **2005**Net
                  income (loss):As
                  reported
              
              $
              73,000
              
              $
              (268,000
              )
              $
              567,000
              
              $
              (199,000
              )Deduct:
                  Total stock-based employee
                compensation
                  expense determined
                under
                  fair value based method for
                all
                  awards, net of related tax effects
              
              
              (93,000
              )
              
              (81,000
              )
              
              (167,000
              )
              
              (126,000
              )Pro
                  forma
              
              
              (20,000
              )
              
              (349,000
              )
              
              400,000
              
              
              (325,000
              )Basic
                  earnings (loss) per share of
                common
                  stock:As
                  reported
              
              $
              0.01
              
              $
              (0.03
              )
              $
              0.06
              
              $
              (0.02
              )Pro
                  forma
              
              $
              (0.00
              )
              $
              (0.04
              )
              $
              0.04
              
              $
              (0.03
              )Diluted
                  earnings (loss) per share of
                common
                  stock:As
                  reported
              
              $
              0.01
              
              $
              (0.03
              )
              $
              0.06
              
              $
              (0.02
              )Pro
                  forma
              
              $
              (0.00
              )
              $
              (0.04
              )
              $
              0.04
              
              $
              (0.03
              )
 
 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:
 
 **Three
                  months ended**
                **June
                  30**
              
              **Six
                  months ended**
                **June
                  30****2004**
              
              **2005**
              
              **2004**
              
              **2005**Risk-free
                  interest rate
              
              
              1.02
              %
              
              2.76
              %
              
              1.0
              %
              
              2.76
              %Expected
                  term (years)
              
              
              5.00
              
              
              5.00
              
              
              5.00
              
              
              5.00Volatility
              
              
              54
              %
              
              45
              %
              
              54
              %
              
              45
              %Expected
                  annual dividends
              
              
              0.0
              %
              
              0.0
              %
              
              0.0
              %
              
              0.0
              %
 
 **NOTE
        6**  **-**  **CONTINGENCIES**
 
 In
        addition to the legal proceedings the Company had with Alliance (see Note
        4)
        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
        7**  **-**  **SHAREHOLDERS’
        EQUITY**
 
 During
        the six months ended June 30, 2005, the number of outstanding shares of the
        Company’s common stock increased by 121,400 shares due to the exercise of 16,400
        employee stock options for $34,000 in cash, and 105,000 shares issued for
        the
        purchase of the assets of another business (valued at approximately $400,000).
 
 **NOTE
        8**  **-**  **ACQUISITION**
 
 On
        July
        1, 2004, the Company acquired all of the outstanding stock of International
        Video Conversions, Inc. (“IVC”) for $7 million in cash. The purchase agreement
        requires 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
        reach
        certain predetermined levels. As part of the transaction, the Company entered
        into employment and/or non competition agreements with four senior officers
        of
        IVC which fix 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. In connection with the acquisition,
        the
        term loan portion of the Company’s bank facility (see Note 3) was increased by
        $4.7 million. 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 facility.
        As of December 31, 2004, the first additional payment of $1 million was accrued
        on the balance sheet, which amount was paid on April 1, 2005. The total purchase
        consideration has been allocated to the assets and liabilities acquired based
        on
        their respective estimated fair values as summarized below.
 
 8


Cash
                  and cash equivalents
              
              $
              1,205,000Inventories
              
              
              120,000Other
                  current assets
              
              
              1,000Accounts
                  Receivable
              
              
              2,036,000Goodwill
              
              
              242,000Property,
                  plant and equipment
              
              
              6,009,000Total
                  assets acquired
              
              
              9,613,000Accounts
                  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
              
              $
              7,000,000




The
      following table presents unaudited pro forma results of the combined operations
      for the three and six-month periods ended June 30, 2004 as if the acquisition
      had occurred as of the beginning of such periods 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:





**Three
                months ended**
              **June
                30, 2004**
            
            **Six
                months ended**
              **June
                30, 2004**Revenue
            
            $
            16,776,000
            
            $
            35,069,000Operating
                Income
            
            
            543,000
            
            
            1,758,000Net
                income
            
            
            213,000
            
            
            776,000Basic
                earnings per share
            
            
            0.02
            
            
            0.08Diluted
                earnings per share
            
            
            0.02
            
            
            0.08





9





**POINT.360**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS**





**ITEM
      2.** **MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS**





**Overview**





The
      following Management’s Discussion and Analysis of Financial Condition and
      Results of Operations should be read in conjunction with the Consolidated
      Financial Statements and Notes and contains forward-looking statements that
      involve risks and uncertainties. Actual results could differ materially from
      those indicated in the forward-looking statements as a result of various
      factors.





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.





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 International Video Conversions, Inc.
      (“IVC”) and settled all disputes related to a proposed acquisition of three
      subsidiaries of Alliance Atlantis Communications, Inc. (“Alliance”). The
      financial statement comparisons below highlight the effects of these
      transactions.





**Statistical
      Analysis**





The
      table
      below summarizes pro forma results for the three- and six-month periods ended
      June 30, 2004 and 2005, without the effects of (1) IVC’s results of operations
      and (2) the write-off of deferred Alliance acquisition, financing and settlement
      costs in 2004. IVC was purchased on July 1, 2004. The Alliance write-off
      represents the costs of due diligence, legal, financing and the settlement
      of
      all matters related to the proposed acquisition of three subsidiaries of
      Alliance, which matters were finalized in 2004: (in thousands except per share
      amounts)





10








**Quarter
                  Ended****June
                  30, 2004**
              
              **June
                  30, 2005****Pro
                  forma**
              
              **(2)**
              
              **GAAP**
              
              **Pro
                  forma**
              
              **(1)**
              
              **GAAP**Revenues
              
              $
              13,913
              
              $
              -
              
              $
              13,913
              
              $
              12,769
              
              $
              3,121
              
              $
              15,890Cost
                  of goods sold
              
              
              (9,110
              )
              
              -
              
              
              (9,110
              )
              
              (8,646
              )
              
              (1,982
              )
              
              (10,628
              )Gross
                  profit
              
              
              4,803
              
              
              -
              
              
              4,803
              
              
              4,123
              
              
              1,139
              
              
              5,262Selling,
                  general and
                administrative
                  expense(3)
              
              
              (4,508
              )
              
              -
              
              
              (4,508
              )
              
              (4,733
              )
              
              (662
              )
              
              (5,395
              )Write-off
                  of deferred
                acquisition,
                  financing
                and
                  settlement costs(3)
              
              
              -
              
              
              (60
              )
              
              (60
              )
              
              -
              
              
              -
              
              
              -Operating
                  income (loss)
              
              
              295
              
              
              (60
              )
              
              235
              
              
              (610
              )
              
              477
              
              
              (133
              )Interest
                  expense, net
              
              
              (111
              )
              
              -
              
              
              (111
              )
              
              (254
              )
              
              (60
              )
              
              (314
              )Income
                  (loss) before
                income
                  taxes
              
              
              184
              
              
              (60
              )
              
              124
              
              
              (864
              )
              
              417
              
              
              (447
              )(Provision
                  for) benefit
                from
                  income taxes
              
              
              (76
              )
              
              25
              
              
              (51
              )
              
              350
              
              
              (171
              )
              
              179Net
                  income (loss)
              
              $
              108
              
              $
              (35
              )
              $
              73
              
              $
              (514
              )
              $
              246
              
              $
              (268
              )Earnings
                  (loss) per share:Basic:
              
              $
              0.01
              
              $
              -
              
              $
              0.01
              
              $
              (0.05
              )
              $
              0.02
              
              $
              (0.03
              )Diluted:
              
              $
              0.01
              
              $
              -
              
              $
              0.01
              
              $
              (0.05
              )
              $
              0.02
              
              $
              (0.03
              )
  **Six
                  Months Ended****June
                  30, 2004**
              
              **June
                  30, 2005****Pro
                  forma**
              
              **(2)**
              
              **GAAP**
              
              **Pro
                  forma**
              
              **(1)**
              
              **GAAP**Revenues
              
              $
              29,382
              
              $
              -
              
              $
              29,382
              
              $
              27,283
              
              $
              5,790
              
              $
              33,073Cost
                  of goods sold
              
              
              (18,929
              )
              
              -
              
              
              (18,929
              )
              
              (18,123
              )
              
              (3,907
              )
              
              (22,030
              )Gross
                  profit
              
              
              10,453
              
              
              -
              
              
              10,453
              
              
              9,160
              
              
              1,883
              
              
              11,043Selling,
                  general and
                administrative
                  expense(3)
              
              
              (9,102
              )
              
              -
              
              
              (9,102
              )
              
              (9,449
              )
              
              (1,306
              )
              
              (10,755
              )Write-off
                  of deferred
                acquisition,
                  financing
                and
                  settlement costs(3)
              
              
              -
              
              
              (62
              )
              
              (62
              )
              
              -
              
              
              -
              
              
              -Operating
                  income (loss)
              
              
              1,351
              
              
              (62
              )
              
              1,289
              
              
              (289
              )
              
              577
              
              
              288Interest
                  expense, net
              
              
              (329
              )
              
              -
              
              
              (329
              )
              
              (504
              )
              
              (117
              )
              
              (621
              )Income
                  (loss) before
                income
                  taxes
              
              
              1,022
              
              
              (62
              )
              
              960
              
              
              (793
              )
              
              460
              
              
              (333
              )(Provision
                  for) benefit
                from
                  income taxes
              
              
              (418
              )
              
              25
              
              
              (393
              )
              
              323
              
              
              (189
              )
              
              134Net
                  income (loss)
              
              $
              604
              
              $
              (37
              )
              $
              567
              
              $
              (470
              )
              $
              271
              
              $
              (199
              )Earnings
                  (loss) per share:Basic:
              
              $
              0.06
              
              $
              -
              
              $
              0.06
              
              $
              (0.05
              )
              $
              0.03
              
              $
              (0.02
              )Diluted:
              
              $
              0.06
              
              $
              -
              
              $
              0.06
              
              $
              (0.05
              )
              $
              0.03
              
              $
              (0.02
              )





(1)
              Contribution
                  of IVC.
 (2)
              Write-off of deferred acquisition, financing and
                settlement costs.
 (3)
              Previously reported amounts have been adjusted
                to
                segregate Alliance-related expenses from Selling, General and
                Administrative expense for consistency of presentation among
                periods.





While
      the
      above presentation of pro forma income statements and adjustments do not
      represent the results of operations in accordance with generally accepted
      accounting principles (“GAAP”), we believe that this disclosure provides useful
      information for readers of the financial statements in analyzing the causes
      of
      operating difference from period to period. Additional comparative data is
      set
      forth below.





11


In
      total,
      revenues in the three- and six-month periods of 2005 were 14% and 13%,
      respectively, greater than in the same 2004 periods. Without the inclusion
      of
      IVC, revenues in the 2005 periods would have been $12.8 million and 27.3
      million, respectively, decreases of 8% and 7% from 2004. Pro forma 2004 revenues
      for the three- and six-month periods if IVC had been purchased at the beginning
      of 2004 would have been $16.8 million and $35.1 million,
      respectively.





The
      addition of IVC will not only increase revenues for all of 2005 (twelve months
      of operations compared to six months in 2004), but will add to the cost
      infrastructure of the Company in both cost of sales and selling, general and
      administrative (“SG&A”) areas. With the inclusion of IVC, we expect 2005
      sales to be higher than experienced in 2004. We expect SG&A in 2005 to be
      higher as a percentage of sales than in 2004 (excluding the special charge
      in
      2004) due to the addition of management and sales personnel and costs associated
      with process documentation required by Sarbanes Oxley. Interest expense is
      expected to be higher in 2005 because of additional debt incurred for the
      acquisition of IVC, capital expenditures made in 2004 for the Media Center
      storage facility and interest rate increases.





Please
      refer to Cautionary Statements and Risk Factors below with respect to these
      forward-looking statements.





**Three
      Months Ended June 30, 2005 Compared To Three Months Ended June 30,
      2004.**




*Revenues* . **** Revenues
      were $15.9 million for the three-month period ended June 30, 2005, compared
      to
      $13.9 million for the three-month period ended June 30, 2004. The addition
      of
      IVC as of July 1, 2004 contributed $3.1 million of revenues in the 2005 period,
      without which sales would have declined 8% to $12.8 million when compared to
      the
      2004 quarter.




*Gross
      Profit* . In
      the
      second quarter of 2005, gross margin was 33% of sales, compared to 35% for
      the
      quarter ended June 30, 2004. The decline is due principally to lower sales
      at
      facilities other than IVC.




*Selling,
      General And Administrative Expense* . SG&A
      expense was $5.4 million in the second quarter of 2005 as compared to $4.6
      million in the same period of 2004. The increase was due to the addition of
      IVC
      and sales personnel.




*Interest
      Expense* . **** Interest
      expense for the three-month period ended June 30, 2005 was $0.3 million, an
      increase of $0.2 million over the three-month period ended June 30, 2004 because
      of higher debt levels due to the acquisition of IVC and real property in the
      third quarter of 2004 and increasing rates on variable interest
      debt.





**Six
      Months Ended June 30, 2005 Compared To Six Months Ended June 30,
      2004.**




*Revenues* . **** Revenues
      were $33.1 million for the six-month period ended June 30, 2005, compared to
      $29.4 million for the six-month period ended June 30, 2004. The addition of
      IVC
      as of July 1, 2004 contributed $5.8 million of revenues in the 2005 period,
      without which sales would have declined 7% to $27.3 million when compared to
      the
      2004 quarter.




*Gross
      Profit* . In
      the
      first half of 2005, gross margin was 33% of sales, compared to 36% for the
      six-months ended June 30, 2004. The decline is due principally to lower sales
      at
      facilities other than IVC.




*Selling,
      General And Administrative Expense* . SG&A
      expense was $10.8 million in the first half of 2005 as compared to $9.1 million
      in the same period of 2004. The increase was due principally to the addition
      of
      IVC.




*Interest
      Expense* . **** Interest
      expense for the six-month period ended June 30, 2005 was $0.6 million, an
      increase of $0.3 million over the six-month period ended June 30, 2004 because
      of higher debt levels due to the acquisition of IVC and real property in the
      third quarter of 2004 and increasing rates on variable interest
      debt.





**LIQUIDITY
      AND CAPITAL RESOURCES**




This
      discussion should be read in conjunction with the notes to the financial
      statements and the corresponding information more fully described in the
      Company’s Form 10-K for the year ended December 31, 2004.




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. For the first two years of the term loan, the Company could
      re-borrow all principal payments on $8 million of the term loan to finance
      up to
      80% of capital equipment purchases. 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 requires the Company to maintain certain
      financial covenant ratios. The term loan requires principal payments of
      approximately $2.5 million annually.




During
      the second quarter of 2005, the Company discussed with its banks the possibility
      that declining margins might cause a breach as of June 30, 2005 of certain
      financial covenants contained in the credit agreement. As of June 2005, the
      credit agreement was changed with respect to the following: (i) the due date
      of
      the revolving portion of loans outstanding was shortened 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. Additionally, the banks
      asked
      the Company to find a new lender.




12


While
      all
      potential breaches of covenants were eliminated, the cost of borrowing increased
      on July 1, 2005 as indicated above. We are currently in discussion with several
      banks and financial institutions to replace the existing revolving and term
      credit agreement, and we expect to finalize a new credit relationship prior
      to
      January 31, 2006.




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 in 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
      $2,137,000 in cash and borrowing the $6,435,000 million balance under a mortgage
      term loan payable over 15 years. We also spent approximately $3.1 million for
      improvements to the building during 2004.




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.





The
      following table summarizes the June 30, 2005 status of our revolving line of
      credit and term loans:





Revolving
                credit (including cash overdraft)
            
            $
            4,907,000Current
                portion of term loans
            
            
            3,051,000Long-term
                portion of term loans
            
            
            13,899,000Total
            
            $
            21,857,000





Monthly
      and annual principal and interest payments due under the term debt are
      approximately $283,000 and $3,400,000, respectively, assuming no change in
      interest rates. Monthly and annual principal and interest payments due under
      the
      mortgage debt are approximately $57,000 and $700,000, respectively. We expect
      that remaining amounts available under the current revolving credit arrangement
      through January 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.




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. Management believes 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.





13


*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; and
 l
              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 $57.3 million as of June
      30,
      2005 .





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 and 2004 tests performed as of September 30, 2002,
      2003 and 2004, respectively, required no goodwill impairment. The discounted
      cash flow method used to evaluate goodwill impairment included cash flow
      estimates for 2005 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 June
      30, 2005 was $5.0 million. The Company did not record a valuation allowance
      against its deferred tax assets as of June 30, 2005.





**RECENT
      ACCOUNTING PRONOUNCEMENTS**




In
      May
      2003, the Financial Accounting Standards Board issued Statement of Financial
      Accounting Standards (“SFAS”) No. 150, “ *Accounting
      for Certain Financial Instruments with Characteristics of both Liabilities
      and
      Equity* .”
      SFAS
      No. 150 establishes standards for how an issuer classifies and measures in
      its
      statement of financial position certain financial instruments with
      characteristics of both liabilities and equity. In accordance with the standard,
      financial instruments that embody obligations for the issuer are required to
      be
      classified as liabilities. SFAS No. 150 will be effective for financial
      instruments entered into or modified after May 31, 2003 and otherwise will
      be
      effective at the beginning of the first interim period beginning after June
      15,
      2003. This statement does not affect the Company at this time.





In
      November 2004, the FASB issued SFAS No. 151, *“Inventory
      Costs* ”.
      SFAS
      No. 151 amends the accounting for abnormal amounts of idle facility expense,
      freight, handling costs, and wasted material (spoilage) under the guidance
      in
      ARB No. 43, Chapter 4, *"Inventory
      Pricing* ”.
      Paragraph 5 of ARB No. 43, Chapter 4, previously stated that “. . . under some
      circumstances, items such as idle facility expense, excessive spoilage, double
      freight, and rehandling costs may be so abnormal as to require treatment as
      current period charges. . . . *”* This
      Statement requires that those items be recognized as current-period charges
      regardless of whether they meet the criterion of "so abnormal." In addition,
      this Statement requires that allocation of fixed production overheads to the
      costs of conversion be based on the normal capacity of the production
      facilities. This statement is effective for inventory costs incurred during
      fiscal years beginning after June 15, 2005. Management does not expect adoption
      of SFAS No. 151 to affect the Company’s financial statements.





14


In
      December 2004, the FASB issued SFAS No. 152, *“Accounting
      for Real Estate Time-Sharing Transactions* .” The
      FASB
      issued this Statement as a result of the guidance provided in AICPA Statement
      of
      Position (SOP) 04-2, “ *Accounting
      for Real Estate Time-Sharing Transactions* . ”
      SOP
      04-2 applies to all real estate time-sharing transactions. Among other items,
      the SOP provides guidance on the recording of credit losses and the treatment
      of
      selling costs, but does not change the revenue recognition guidance in SFAS
      No.
      66, “ *Accounting
      for Sales of Real Estate* ”,
      for
      real estate time-sharing transactions. SFAS No. 152 amends Statement No. 66
      to
      reference the guidance provided in SOP 04-2. SFAS No. 152 also amends SFAS
      No.
      67, “ *Accounting
      for Costs and Initial Rental Operations of Real Estate Projects* ”,
      to
      state that SOP 04-2 provides the relevant guidance on accounting for incidental
      operations and costs related to the sale of real estate time-sharing
      transactions. SFAS No. 152 is effective for years beginning after June 15,
      2005,
      with restatements of previously issued financial statements prohibited. This
      statement is not applicable to the Company.





In
      December 2004, the FASB issued SFAS No. 153, “ *Exchanges
      of Nonmonetary Assets* ,”
      an
      amendment to Opinion
      No. 29, *“Accounting
      for Nonmonetary Transactions* . ”  Statement
      No. 153 eliminates certain differences in the guidance in Opinion No. 29 as
      compared to the guidance contained in standards issued by the International
      Accounting Standards Board. The amendment to Opinion No. 29 eliminates the
      fair
      value exception for nonmonetary exchanges of similar productive assets and
      replaces it with a general exception for exchanges of nonmonetary assets that
      do
      not have commercial substance. Such an exchange has commercial substance if
      the
      future cash flows of the entity are expected to change significantly as a result
      of the exchange. SFAS No. 153 is effective for nonmonetary asset exchanges
      occurring in periods beginning after June 15, 2005. Earlier application is
      permitted for nonmonetary asset exchanges occuring in periods beginning after
      December 16, 2004. Management
      does not expect adoption of SFAS No. 153 to have a material impact on the
      Company’s financial statements.





In
      December 2004, the FASB issued SFAS No. 123(R), “ *Share-Based
      Payment* .”
      SFAS
      123(R) amends SFAS No. 123, “ *Accounting
      for Stock-Based Compensation* ”,
      and
      APB Opinion 25, “ *Accounting
      for Stock Issued to Employees* .”
      SFAS
      No.123(R) requires that the cost of share-based payment transactions (including
      those with employees and non-employees) be recognized in the financial
      statements. SFAS No. 123(R) applies to all share-based payment transactions
      in
      which an entity acquires goods or services by issuing (or offering to issue)
      its
      shares, share options, or other equity instruments (except for those held by
      an
      ESOP) or by incurring liabilities (1) in amounts based (even in part) on the
      price of the entity’s shares or other equity instruments, or (2) that require
      (or may require) settlement by the issuance of an entity’s shares or other
      equity instruments. This statement is effective (1) for public companies
      qualifying as SEC small business issuers, as of the first interim period or
      fiscal year beginning after December 15, 2005, or (2) for all other public
      companies, as of the first fiscal year beginning after June 15, 2005, or (3)
      for
      all nonpublic entities, as of the first fiscal year beginning after December
      15,
      2005. Management is currently assessing the effect of SFAS No. 123(R) on the
      Company’s financial statements.





In
      May
      2005, the FASB issued SFAS No. 154, “ *Accounting
      Changes and Error Corrections* ”,
      an
      amendment to Accounting Principles Bulletin (APB) Opinion No. 20, “ *Accounting
      Changes* ”,
      and
      SFAS No. 3, “ *Reporting
      Accounting Changes in Interim Financial Statements* .”
      Though
      SFAS No. 154 carries forward the guidance in APB No. 20 and SFAS No. 3 with
      respect to accounting for changes in estimates, changes in reporting entity,
      and
      the correction of errors, SFAS No. 154 establishes new standards on accounting
      for changes in accounting principles, whereby all such changes must be accounted
      for by retrospective application to the financial statements of prior periods
      unless it is impracticable to do so. SFAS No. 154 is effective for accounting
      changes and error corrections made in fiscal years beginning after December
      15,
      2005, with early adoption permitted for changes and corrections made in years
      beginning after May 2005.





**CAUTIONARY
      STATEMENTS AND 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.





15


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.


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 growth.


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.





These
      risk factors are discussed further below.





**Recent
      History of Losses** .
      The
      Company reported losses in the fiscal quarter ended June 30, 2005 and for each
      of the five fiscal quarters ended December 31, 2001 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 all fiscal
      quarters ending between March 31, 2002 and March 31, 2005, there can be no
      assurance as to future profitability on a quarterly or annual basis.





**Prior
      Breach and Changes in Credit Agreements** **.** 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 are $1.6
      million each for five years. Any principal outstanding under the revolver will
      be due in March 2006.





In
      July
      and August 2004, the credit agreement was amended in connection with the
      acquisition of 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 vault
      storage facilities. While we believe operating cash flows are sufficient to
      service increased total debt levels, reduced future sales levels, if they occur,
      could possibly result in a breach of the financial covenants contained in the
      credit agreements.





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 recent 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, 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. We have also entered negotiations with several
      other banks and financial institutions to replace both the revolving and term
      credit facilities. If we are not successful in obtaining a replacement credit
      agreement, there is a risk that we will be in default of certain financial
      covenants in future quarters 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 credit agreement will be due and payable which
      could materially and adversely affect our business.





16


**Competition.** 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.





**Customer
      and Industry Concentration.** Although
      we have an active client list of over 2,500 customers, ten motion picture
      studios and advertising agencies accounted for approximately 38% of the
      Company’s revenues during the year ended December 31, 2004. 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.





**Expansion
      Strategy.** 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 nine acquisitions in the
      last
      seven fiscal years, the most recent of which was in July 2004, 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.





If
      we
      acquire any entities, we may have to finance a large portion of the anticipated
      purchase price and/or refinance our existing credit agreement. The cost of
      any
      new financing may be higher than our existing credit facility. 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.





**Management
      of Growth.** In prior
      years, we experienced rapid growth that 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 this growth, 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.





17


**Dependence
      on Technological Developments.** 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 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.





**Dependence
      on Key Personnel.** 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 27% 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.





**Ability
      to Maintain and Improve Service Quality.** 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.





**Fluctuating
      Results, Seasonality.** 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 as
      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. Fluctuations in
      sales due to seasonality may become more pronounced if the growth rate of the
      Company’s sales slows.





**Control
      by Principal Shareholder; Potential Issuance of Preferred Stock; Anti-Takeover
      Provisions.** The
      Company’s Chairman, President and Chief Executive Officer, Haig S. Bagerdjian,
      beneficially owned approximately 27% of the outstanding common stock as of
      June
      30, 2005. The ex-spouse of R. Luke Stefanko, the Company’s former President and
      Chief Executive Officer, owned approximately 19% of the common stock on that
      date. Together, they owned approximately 46%. By virtue of their stock
      ownership, Ms. Stefanko 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.





18


Our
      Board
      of Directors also 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
      3.**  **QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**





*Market
      Risk* .
      The
      Company had borrowings of $15 million at June 30, 2005 under a term loan and
      revolving credit agreement, and $6.2 million outstanding under a mortgage.
      Amounts outstanding under the term loan and revolving credit facility and the
      mortgage debt provide for interest at the banks’ prime rate plus 0.50% or LIBOR
      plus 2.75% for the revolver, prime plus 0.75% or LIBOR plus 2.75% for the term
      loan and 6.83% for the mortgage debt. The Company’s market risk exposure with
      respect to financial instruments is to changes in prime or LIBOR rates.





**ITEM
      4.**  **CONTROLS
      AND PROCEDURES**




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





**PART
      II - OTHER INFORMATION**





**ITEM
      1. LEGAL PROCEEDINGS**





F rom **** 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**





The
      Company’s Annual Meeting of Shareholders was held on May 4, 2005 after a
      solicitation of proxies pursuant to Regulation 14 of the Securities Exchange
      Act
      of 1934 .
      At the
      meeting, shareholders voted on: (i) the election of directors to hold office
      until the next annual meeting of shareholders of the Company or until their
      successors are duly elected and qualified (ii) the adoption of the 2005 Equity
      Incentive Plan of Point.360, and (iii) approval of the appointment of Singer
      Lewak Greenbaum & Goldstein LLP as the Company’s independent public
      accountants for the fiscal year ending December 31, 2005. The results of
      shareholder voting was as follows:





1.
            Election
                of Directors





The
      following individuals were elected as directors:





19




**Name**
              **Votes
                  For**
              **Votes
                  Withheld**Haig
                  S. Bagerdjian
              8,458,160
              189,357Robert
                  A. Baker
              8,471,860
              175,656Greggory
                  J. Hutchins
              8,135,845
              511,672Sam
                  P. Bell
              8,469,192
              178,325G.
                  Samuel Oki
              8,474,092
              173,425





2.
            The
                2005 Equity Incentive Plan of Point.360 (the “Plan”) was approved with
                4,565,809 votes for approval of the Plan, 918,986 votes against the
                Plan
                and 5,195,421 votes abstaining.





3.
            The
                appointment by the Board of Directors of the Company of Singer Lewak
                Greenbaum & Goldstein LLP as the Company’s independent auditors for
                the fiscal year ending December 31, 2005 was ratified with 8,649,467
                votes
                for the proposal, 6,450 votes against the proposal and 600 votes
                abstaining.





**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:
              August 12, 2005
            BY:
            /s/
              Alan R. SteelAlan
              R. SteelExecutive
                Vice President,
              Finance
                and Administration
              (duly
                authorized officer and principal financial
                officer)







20