**UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**


**___________**





**FORM
      10-Q**








(Mark
      One)




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





For
      the
      quarterly period ended June 30, 2006 or




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





For
      the
      transition period from _________  to_________


Commission
      file number  0-21917


Point.360


**(Exact
      Name of Registrant as Specified in Its Charter)**





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





(818)
      565-1400


**(Registrant’s
        Telephone Number, Including Area Code)**









**(Former
      Name, Former Address and Former Fiscal Year,**


**if
      Changed Since Last Report)**








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





Yes
x  No
      ____





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





Large
      accelerated filer o    Accelerated
      Filer o     Non-accelerated
      filer x





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





Yes
o  No
x







As
      of
      June 30, 2006, there were 9,421,982 shares of the registrant’s common stock
      outstanding.








**PART
      I - FINANCIAL INFORMATION**




**ITEM
      1.**  **FINANCIAL
      STATEMENTS**


**POINT.360**





**CONSOLIDATED
      BALANCE SHEETS**





**ASSETS****December
                31,**
              **2005**
            
            **June
                30,**
              **2006**(unaudited)Current
                assets:Cash
                and cash equivalents
            
            $
            595,000
            
            $
            31,000Accounts
                receivable, net of allowances for doubtful
              accounts
                of $563,000 and $669,000 (unaudited), respectively
            
            
            12,662,000
            
            
            12,957,000Inventories
            
            
            796,000
            
            
            678,000Prepaid
                expenses and other current assets
            
            
            2,432,000
            
            
            2,500,000Deferred
                income taxes
            
            
            828,000
            
            
            828,000Total
                current assets
            
            
            17,313,000
            
            
            16,994,000Property
                and equipment, net
            
            
            28,079,000
            
            
            15,311,000Other
                assets, net
            
            
            593,000
            
            
            1,478,000Goodwill
                and other intangibles, net
            
            
            29,474,000
            
            
            29,473,000Total
                assets
            
            $
            75,459,000
            
            $
            63,256,000**LIABILITIES
                AND SHAREHOLDERS’ EQUITY**Current
                liabilities:Accounts
                payable
            
            $
            3,986,000
            
            $
            3,260,000Accrued
                wages and benefits
            
            
            1,711,000
            
            
            1,984,000Accrued
                earn-out payments
            
            
            2,000,000
            
            
            -Other
                accrued expenses
            
            
            683,000
            
            
            778,000Income
                taxes payable
            
            
            1,231,000
            
            
            2,126,000Borrowings
                under revolving line of credit
            
            
            4,054,000
            
            
            1,432,000Current
                portion of borrowings under notes payable
            
            
            2,310,000
            
            
            1,158,000Current
                portion of capital lease and other obligations
            
            
            63,000
            
            
            48,000Current
                portion of deferred gain on sale of real estate
            
            
            -
            
            
            178,000Total
                current liabilities
            
            
            16,038,000
            
            
            10,964,000Deferred
                income taxes
            
            
            6,121,000
            
            
            6,121,000Bank
                notes payable, less current portion
            
            
            13,744,000
            
            
            4,053,000Capital
                lease and other obligations, less current portion
            
            
            46,000
            
            
            15,000Deferred
                gain on sale of real estate, less current portion
            
            
            -
            
            
            2,452,000Total
                long-term liabilities
            
            
            19,911,000
            
            
            12,641,000Total
                liabilities
            
            
            35,949,000
            
            
            23,605,000Contingencies
                (Note5)
            
            
            -
            
            
            -Shareholders’
                equityPreferred
                stock - no par value; 5,000,000 authorized; none
                outstanding
            
            
            -
            
            
            -Common
                stock - no par value; 50,000,000 authorized; 9,368,857and9,421,982(unaudited)
                shares issued and outstanding, respectively
            
            
            17,971,000
            
            
            18,086,000Additional
                paid-in capital
            
            
            1,159,000
            
            
            1,159,000Retained
                earnings
            
            
            20,380,000
            
            
            20,406,000Total
                shareholders’ equity
            
            
            39,510,000
            
            
            39,651,000Total
                liabilities and shareholders’ equity
            
            $
            75,459,000
            
            $
            63,256,000




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,****2005**
            
            **2006**
            
            **2005**
            
            **2006**Revenues
            
            $
            15,890,000
            
            $
            16,302,000
            
            $
            33,073,000
            
            $
            32,341,000Cost
                of goods sold
            
            
            (10,628,000
            )
            
            (10,938,000
            )
            
            (22,030,000
            )
            
            (21,653,000
            )Gross
                profit
            
            
            5,262,000
            
            
            5,364,000
            
            
            11,043,000
            
            
            10,688,000Selling,
                general and administrative expense
            
            
            (5,395,000
            )
            
            (4,976,000
            )
            
            (10,754,000
            )
            
            (10,102,000
            )Operating
                income (loss)
            
            
            (133,000
            )
            
            388,000
            
            
            289,000
            
            
            586,000Interest
                expense, net
            
            
            (314,000
            )
            
            (193,000
            )
            
            (621,000
            )
            
            (544,000
            )Income
                (loss) before income taxes
            
            
            (447,000
            )
            
            195,000
            
            
            (332,000
            )
            
            42,000(Provision
                for) benefit from income taxes
            
            
            179,000
            
            
            (78,000
            )
            
            133,000
            
            
            (17,000
            )Net
                income (loss)
            
            $
            (268,000
            )
            $
            117,000
            
            $
            (199,000
            )
            $
            25,000Earnings(loss)
                per share:Basic:Net
                income (loss)
            
            $
            (0.03
            )
            $
            0.01
            
            $
            (0.02
            )
            $
            0.00Weighted
                average number of shares
            
            
            9,349,105
            
            
            9,390,013
            
            
            9,326,020
            
            
            9,380,441Diluted:Net
                income (loss)
            
            $
            (0.03
            )
            $
            0.01
            
            $
            (0.02
            )
            $
            0.00Weighted
                average number of shares
              including
                the dilutive effect of
              stockoptions
            
            
            9,809,551
            
            
            9,580,012
            
            
            9,850,467
            
            
            9,558,494








See
      accompanying notes to consolidated financial statements.




3





**POINT.360**





**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**(Unaudited)**





**Six
                Months Ended**
              **June
                30,****2005**
            
            **2006**Cash
                flows from operating activities:Net
                income (loss)
            
            $
            (199,000
            )
            $
            25,000Adjustments
                to reconcile net income
              to
                net cash provided by operating activities:Depreciation
                and amortization
            
            
            3,144,000
            
            
            2,746,000Provision
                for doubtful accounts
            
            
            45,000
            
            
            106,000Other
                non cash items
            
            
            183,000
            
            
            -Changes
                in assets and liabilities:(Increase)
                decrease in accounts receivable
            
            
            1,130,000
            
            
            (401,000
            )Decrease
                in inventories
            
            
            48,000
            
            
            118,000(Increase)
                decrease in prepaid expenses and
              other
                current assets
            
            
            189,000
            
            
            (67,000
            )(Increase)
                decrease in other assets
            
            
            97,000
            
            
            (15,000
            )Increase
                (decrease) in accounts payable
            
            
            (1,775,000
            )
            
            (726,000
            )(Decrease)
                in accrued expenses
            
            
            (1,215,000
            )
            
            (1,631,000
            )Increase
                (Decrease) in income taxes
            
            
            (11,000
            )
            
            895,000(Decrease)
                in deferred taxes
            
            
            (780,000
            )
            
            (870,000
            )Increase
                in other current liabilities
            
            
            -
            
            
            33,000Net
                cash provided by (used in) operating activities
            
            
            856,000
            
            
            213,000Cash
                used in investing activities:Capital
                expenditures
            
            
            (1,290,000
            )
            
            (1,307,000
            )Proceeds
                from sale of Media Center real estate
            
            
            
            
            
            13,926,000Amount
                paid for acquisitions
            
            
            (25,000
            )
            
            -Net
                cash used in investing activities
            
            
            (1,315,000
            )
            
            12,619,000Cash
                flows provided by (used in) financing activities:Exercise
                of stock options
            
            
            34,000
            
            
            116,000Change
                in revolving credit agreement
            
            
            585,000
            
            
            (2,622,000
            )Proceeds
                from bank note
            
            
            1,006,000
            
            
            (1,153,000
            )Shares
                issued for an acquisition
            
            
            (400,000
            )
            
            -Repayment
                of notes payable
            
            
            (1,400,000
            )
            
            (9,691,000
            )Repayment
                of capital lease and other obligations
            
            
            (34,000
            )
            
            (46,000
            )Net
                cash provided by (used in) financing activities
            
            
            (209,000
            )
            
            (13,396,000
            )Net
                increase (decrease) in cash
            
            
            (668,000
            )
            
            (564,000
            )Cash
                and cash equivalents at beginning of period
            
            
            668,000
            
            
            595,000Cash
                and cash equivalents at end of period
            
            $
            -
            
            $
            31,000Supplemental
                disclosure of cash flow information -
              Cash
                paid for:Interest
            
            $
            594,000
            
            $
            524,000Income
                tax
            
            $
            866,000
            
            $
            42,000







See
      accompanying notes to consolidated financial statements.




4


**POINT.360**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**





**June
      30, 2006**





**NOTE
      1**  **-**  **THE
      COMPANY**




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




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




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




The
      accompanying unaudited financial statements have been prepared in accordance
      with generally accepted accounting principles and the Securities and Exchange
      Commission’s rules and regulations for reporting interim financial statements
      and footnotes. In the opinion of management, all adjustments (consisting of
      normal recurring adjustments) considered necessary for a fair presentation
      have
      been included. Operating results for the three and six-month periods ended
      June
      30, 2006 are not necessarily indicative of the results that may be expected
      for
      the year ending December 31, 2006. These financial statements should be read
      in
      conjunction with the financial statements and related notes contained in the
      Company’s Form 10-K for the year ended December 31, 2005.




**NOTE
      2**  **-**  **LONG
      TERM DEBT AND NOTES PAYABLE**




On
      December 30, 2005, the Company entered into a new $10 million term loan
      agreement. The term loan provides for interest at LIBOR (5.6% as of June 30,
      2006) plus 3.15% and is secured by the Company’s equipment. The term loan will
      be repaid in 60 equal monthly principal payments plus interest. Proceeds of
      the
      term loan were used to repay a previously existing term loan. In March 2006,
      the
      Company prepaid $4 million of the term loan with proceeds from the sale of
      real
      estate (see Note 3). Monthly principal payments were subsequently reduced pro
      rata.




In
      January 2006, the due date of the then existing credit facility was extended
      to
      March 31, 2006. As of December 30, 2005, the Company did not meet certain
      financial covenants contained in the credit facility and received a compliance
      waiver from the bank.




In
      March
      2006, the Company entered into a new credit agreement which provides up to
      $10
      million of revolving credit. The two-year agreement provides for interest of
      LIBOR plus 1.85% for the first six months of the agreement, and thereafter
      at
      either (i) prime (7.75% as of June 30, 2006) minus 0% - 1.00% or (ii) LIBOR
      plus
      1.50% - 2.5%, depending on the level of the Company’s ratio of outstanding debt
      to fixed charges (as defined). The facility is secured by all of the Company’s
      assets, except for equipment securing the term loan. The revolving credit
      agreement requires the Company to comply with various financial and business
      covenants. There are cross default provisions contained in both the revolving
      and term loan agreements.





**NOTE
      3**  **-**  **SALE
      OF REAL ESTATE**




On
      March
      29, 2006, the Company entered into a sale and leaseback transaction with respect
      to its Media Center vaulting real estate. The real estate was sold for
      approximately $14.0 million resulting in a $1.2 million after tax gain.
      Additionally, the Company received $0.5 million from the purchaser for
      improvements. In accordance with SFAS No. 28, *Accounting
      for Sales with Leasebacks* ,
      the
      gain, related deferred taxes of $870,000 and improvement allowance will be
      amortized over the initial 15-year lease term as reduced rent. Such amounts
      are
      included in deferred gain on sale of real estate on the balance sheet. Net
      proceeds at the closing of the sale and the improvement advance (approximately
      $13.9 million) were used to pay off the mortgage and other outstanding
      debt.




5





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





**As
                Reported**
            
            **Adjustments**
            
            
            
            **Pro
                Forma**Current
                assets
            
            $
            17,313
            
            
            152
            
            
            (1
            )
            $
            17,465Property
                and equipment, net
            
            
            28,079
            
            
            (11,249
            )
            
            (2
            )
            
            16,830Goodwill
                and other assets
            
            
            30,067
            
            
            870
            
            
            (3
            )
            
            30,937Total
                assets
            
            $
            75,459
            
            
            
            
            
            
            
            $
            65,232Accounts
                payable and accrued expenses
            
            $
            8,380
            
            
            870
            
            
            (4
            )
            $
            9,250Deferred
                income taxes
            
            
            1,231
            
            
            
            
            
            
            
            
            1,231Short-term
                debt
            
            
            2,373
            
            
            (310
            )
            
            (5
            )
            
            2,063Borrowings
                under revolving credit
            
            
            4,054
            
            
            (3,735
            )
            
            (5
            )
            
            319Current
                liabilities
            
            
            16,038
            
            
            
            
            
            
            
            
            12,863Deferred
                gain on sale
            
            
            -
            
            
            2,175
            
            
            (6
            )
            
            2,175Deferred
                income taxes and other
            
            
            6,121
            
            
            500
            
            
            (7
            )
            
            6,621Long-term
                notes payable
            
            
            13,790
            
            
            (9,727
            )
            
            (5
            )
            
            4,063Shareholders’
                equity
            
            
            39,510
            
            
            
            
            
            
            
            
            39,510Total
                liabilities and shareholders’ equity
            
            $
            75,459
            
            
            
            
            
            
            
            $
            65,232


(1)
            Prepaid
                rent & property taxes


(2)
            Net
                book value of assets sold


(3)
            Deferred
                taxes associated with gain on sale


(4)
            Current
                tax liability


(5)
            Pay-down
                of debt with net proceeds


(6)
            Deferred
                gain on sale to be amortized over life of
                lease


(7)
            Non-refundable
                advance from purchaser for
                improvements










**NOTE
      4**  **-**  **STOCK-BASED
      COMPENSATION**




On
      January 1, 2006, we adopted Statements of Financial Accounting Standards
      No. 123 (revised 2004), *Share-Based
      Payment* ,
      (SFAS
      123(R)) which requires the measurement and recognition of compensation expense
      for all share-based payment awards made to employees and directors based on
      estimated fair values. SFAS 123(R) supersedes our previous accounting under
      Accounting Principles Board Opinion No. 25, *Accounting
      for Stock Issued to Employees* (APB 25)
      for periods beginning in fiscal 2006. In March 2005, the Securities and Exchange
      Commission issued Staff Accounting Bulletin No. 107 (SAB 107) relating to
      SFAS 123(R).  We have applied the provisions of SAB 107 in its adoption of
      SFAS 123(R).





SFAS
      123(R) requires companies to estimate the fair value of share-based payment
      awards to employees and directors on the date of grant using an option-pricing
      model. The value of the portion of the award that is ultimately expected to
      vest
      is recognized as expense over the requisite service periods in our Consolidated
      Statements of Operations. Prior to the adoption of SFAS 123(R), we accounted
      for
      stock-based awards to employees and directors using the intrinsic value method
      in accordance with APB 25 as allowed under SFAS No. 123, *Accounting
      for Stock-Based Compensation* .
      Under
      the intrinsic value method, no stock-based compensation expense had been
      recognized in our Consolidated Statements of Operations for awards to employees
      and directors because the exercise price of our stock options equaled the fair
      market value of the underlying stock at the date of grant.




We
      adopted SFAS 123(R) using the modified prospective transition method, which
      requires the application of the accounting standard as of January 1, 2006,
      the first day of the Company’s fiscal year 2006. Our consolidated financial
      statements as of and for the three and six-month periods ended June 30, 2006
      reflect the impact of SFAS 123(R). In accordance with the modified prospective
      transition method, our consolidated financial statements for prior periods
      have
      not been restated to reflect, and do not include, the impact of SFAS
      123(R).  Stock-based compensation expense related to employee or director
      stock options recognized for the three and six- month periods ended June 30,
      2006 was $36,000 and $37,000, respectively.





The
      following table illustrates the effect on net loss and loss per share if we
      had
      applied the fair value recognition provisions of SFAS 123 to stock-based awards
      granted under the company’s stock option plans for the three and six-month
      periods ended June 30, 2005.  For purposes of this pro-forma disclosure,
      the fair value of the options is estimated using the Black-Scholes-Merton
      option-pricing formula (Black-Scholes model) and amortized to expense over
      the
      options’ contractual term.




6





**Three
                Months**
              **Ended**
              **June
                30, 2005**
            
            **Six
                Months Ended**
              **June
                30, 2005**Net
                income (loss):As
                reported
            
            $
            (268,000
            )
            $
            (199,000
            )Deduct:
                Total stock-based employee
              compensation
                expense determined
              under
                fair value based method for
              all
                awards, net of related tax effects
            
            
            (81,000
            )
            
            (126,000
            )Pro
                forma
            
            
            (349,000
            )
            
            (325,000
            )Basic
                earnings (loss) per share of
              common
                stock:As
                reported
            
            $
            (0.03
            )
            $
            (0.02
            )Pro
                forma
            
            $
            (0.04
            )
            $
            (0.03
            )Diluted
                earnings (loss) per share of
              common
                stock:As
                reported
            
            $
            (0.03
            )
            $
            (0.02
            )Pro
                forma
            
            $
            (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****2005**
            
            **2006**
            
            **2005**
            
            **2006**Risk-free
                interest rate
            
            
            2.76
            %
            
            4.48
            %
            
            2.76
            %
            
            4.84
            %Expected
                term (years)
            
            
            5.00
            
            
            5.00
            
            
            5.00
            
            
            5.00Volatility
            
            
            45
            %
            
            41
            %
            
            45
            %
            
            43
            %Expected
                annual dividends
            
            
            0.0
            %
            
            0.0
            %
            
            0.0
            %
            
            0.0
            %








At
      June
      30, 2006, the Company had outstanding options under three stock options plans:
      the 1996 Stock Incentive Plan, the 2000 Nonqualified Stock Option Plan, and
      the
      2005 Equity Incentive Plan. The 1996 and 2000 Plans were terminated in May
      2005
      upon shareholder approval of the 2005 Plan, except that outstanding options
      under the 1996 and 2000 Plans were not terminated. The 2005 Plan provides for
      the award of options to purchase up to 2,000,000 shares of common stock, as
      well
      as stock appreciation rights and restricted stock awards.





The
      following table summarizes the status of these plans as of June 30,
      2006:





**1996
                Plan**
            
            **2000
                Plan**
            
            **2005
                Plan**Options
                originally available
            
            
            3,800,000
            
            
            1,500,000
            
            
            2,000,000Stock
                options outstanding
            
            
            1,635,666
            
            
            719,700
            
            
            539,450Options
                available for grant
            
            
            -
            
            
            -
            
            
            1,460,550





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





A
      summary
      of the status of stock options as of June 30, 2005 and 2006, and changes during
      the three and six-month periods then ended, is as follows.




7





**2005**
            
            **2006****Shares**
            
            **Wtd.
                Avg. Exercise**
              **Price**
            
            **Shares**
            
            **Wtd.
                Avg. Exercise Price**Outstanding
                at beginning of the year
            
            
            2,352,947
            
            $
            2.82
            
            
            2,665,797
            
            $
            2.79Granted
            
            
            5,000
            
            $
            3.81
            
            
            20,000
            
            $
            2.40Exercised
            
            
            (4,400
            )
            $
            2.47
            
            
            (3,400
            )
            $
            1.35Canceled
            
            
            (64,447
            )
            $
            2.50
            
            
            (7,303
            )
            $
            2.73Outstanding
                at March 31
            
            
            2,289,100
            
            $
            2.88
            
            
            2,675,094
            
            $
            2.78Granted
            
            
            501,400
            
            $
            2.95
            
            
            379,950
            
            $
            2.25Exercised
            
            
            (12,000
            )
            $
            1.93
            
            
            (49,725
            )
            $
            1.55Canceled
            
            
            (18,780
            )
            $
            2.42
            
            
            (110,503
            )
            $
            3.22Outstanding
                at June 30
            
            
            2,759,720
            
            $
            2.86
            
            
            2,894,816
            
            $
            2.73





As
      of
      June 30, 2006, the total compensation costs related to non-vested awards yet
      to
      be expensed was approximately $0.3 million to be amortized over the next five
      years.





The
      weighted average exercise prices for options granted and exercisable and the
      weighted average remaining contractual life for options outstanding as of
      December 31, 2005 and June 30, 2006 was as follows:





**As
                of December 31, 2005**
            
            **Number
                of Shares**
            
            **Weighted
                Average Exercise Price**
            
            **Weighted
                Average Remaining Contractual Life (Years)**
            
            **Intrinsic
                Value**Employees
                - Outstanding
            
            
            2,300,797
            
            
            2.69
            
            
            3.33
            
            $
            116,000Employees
                - Expected to Vest
            
            
            2,300,797
            
            
            2.69
            
            
            3.33
            
            $
            116,000Employees
                - Exercisable
            
            
            2,300,797
            
            
            2.69
            
            
            3.33
            
            $
            116,000Non-Employees
                - Outstanding
            
            
            365,000
            
            
            3.44
            
            
            3.87
            
            $
            1,000Non-Employees
                - Expected to Vest
            
            
            365,000
            
            
            3.44
            
            
            3.87
            
            $
            1,000Non-Employees
                - Exercisable
            
            
            365,000
            
            
            3.44
            
            
            3.87
            
            $
            1,000**As
                of June 30, 2006**Employees
                - Outstanding
            
            
            2,529,816
            
            
            2.63
            
            
            3.17
            
            $
            348,000Employees
                - Expected to Vest
            
            
            2,492,821
            
            
            2.63
            
            
            3.14
            
            $
            348,000Employees
                - Exercisable
            
            
            2,160,366
            
            
            2.69
            
            
            2.86
            
            $
            348,000Non-Employees
                - Outstanding
            
            
            365,000
            
            
            3.42
            
            
            3.77
            
            $
            4,000Non-Employees
                - Expected to Vest
            
            
            365,000
            
            
            3.42
            
            
            3.77
            
            $
            4,000Non-Employees
                - Exercisable
            
            
            365,000
            
            
            3.42
            
            
            3.77
            
            $
            4,000





8





Additional
      information with respect to outstanding options as of June 30, 2006 is as
      follows (shares in thousands):







**Options
                Outstanding******
            
            **Options
                Exercisable****Option
                Exercise**
              **Price
                Range**
            
            **Number
                of Shares**
            
            **Weighted
                Average**
              **Remaining****Contractual**
              **Life**
            
            **Weighted
                Average**
              **Exercise
                Price**
            
            **Number
                of**
              **Shares**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**$1.20
                - $5.38
            
            
            2,888,545
            
            
            3.25
                yrs.
            
            $
            2.72
            
            
            2,519,095
            
            $
            2.79$7.00
                - $10.00
            
            
            6,271
            
            
            0.66
                yrs.
            
            $
            7.00
            
            
            6,271
            
            $
            7.00







We
      have
      elected to adopt the detailed method provided in SFAS 123(R) for calculating
      the
      beginning balance of the additional paid-in capital pool (APIC pool) related
      to
      the tax effects of employee stock-based compensation, and to determine the
      subsequent impact on the APIC pool and Consolidated Statements of Cash Flows
      of
      the tax effects of employee stock-based compensation awards that are outstanding
      upon adoption of SFAS 123(R).





**NOTE
      5**  **-**  **CONTINGENCIES**




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




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




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





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











**NOTE
      6**  **-**  **SHAREHOLDERS’
      EQUITY**





During
      the six-month period ended June 30, 2006, the number of outstanding shares
      of
      the Company’s common stock increased by 53,125 shares due to the exercise of
      employee stock options for $81,600 in cash.




9


**POINT.360**




**MANAGEMENT’S
      DISCUSSION AND ANALYSIS**




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




*Except
      for the historical information contained herein, certain statements in this
      quarterly report are "forward-looking statements" as defined in the Private
      Securities Litigation Reform Act of 1995, which involve certain risks and
      uncertainties, which could cause actual results to differ materially from those
      discussed herein, including but not limited to competition, customer and
      industry concentration, dependence on technological developments, risks related
      to expansion, dependence on key personnel, fluctuating results and seasonality
      and control by management. See the relevant portions of the Company's documents
      filed with the Securities and Exchange Commission and Risk Factors in Item
      1A,
      for a further discussion of these and other risks and uncertainties applicable
      to the Company's business.*




**Overview**




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




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




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




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




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




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




**Statistical
      Analysis**




The
      table
      below summarizes pro forma results for the three-month periods ended June 30,
      2005 and 2006, isolating the effects of the March 29, 2006 sale/leaseback
      transaction for the 2006 periods: (in thousands except per share
      amounts)




10






**Quarter
                Ended****June
                30, 2005**
                **GAAP**
            
            
            
            **Proforma**
            
            **June
                30, 2006**
                **(1)**
            
            **GAAP**Revenues
            
            $
            15,890
            
            
            
            $
            16,302
            
            
            
            
            $
            $
                16,302Cost
                of goods sold
            
            
            (10,628
            )
            
            
            
            (10,765
            )
            
            (173
            )
            
            (10,938
            )Gross
                profit
            
            
            5,262
            
            
            
            
            5,537
            
            
            (173
            )
            
            5,364Selling,
                general andadministrative
                expense
            
            
            (5,395
            )
            
            
            
            (4,962
            )
            
            (14
            )
            
            (4,976
            )Operating
                income (loss)
            
            
            (133
            )
            
            
            
            575
            
            
            (187
            )
            
            388Interest
                expense, net
            
            
            (314
            )
            
            
            
            (451
            )
            
            258
            
            
            (193
            )Income
                (loss)before
                income taxes
            
            
            (447
            )
            
            
            
            124
            
            
            71
            
            
            195(Provision
                for) benefitfrom
                income taxes
            
            
            179
            
            
            
            
            (51
            )
            
            (27
            )
            
            (78
            )Net
                income (loss)
            
            $
            (268
            )
            
            
            $
            73
            
            $
            44
            
            $
            117Earnings
                (loss) per share:Basic:
            
            $
            (0.03
            )
            
            
            $
            0.01
            
            
            
            
            $
            0.01Diluted:
            
            $
            (0.03
            )
            
            
            $
            0.01
            
            
            
            
            $
            0.01






**Six
                Months Ended****June
                30, 2005**
              **GAAP**
            
            
            
            **Proforma**
            
            **June
                30, 2006**
                **(1)**
            
            **GAAP**Revenues
            
            $
            33,073
            
            
            
            $
            32,341
            
            
            
            
            $
            $
                32,341Cost
                of goods sold
            
            
            (22,030
            )
            
            
            
            (21,480
            )
            
            (173
            )
            
            (21,653
            )Gross
                profit
            
            
            11,043
            
            
            
            
            10,861
            
            
            (173
            )
            
            10,688Selling,
                general andadministrative
                expense
            
            
            (10,754
            )
            
            
            
            (10,088
            )
            
            (14
            )
            
            (10,102
            )Operating
                income (loss)
            
            
            289
            
            
            
            
            773
            
            
            (187
            )
            
            586Interest
                expense, net
            
            
            (621
            )
            
            
            
            (802
            )
            
            258
            
            
            (544
            )Income
                (loss)before
                income taxes
            
            
            (332
            )
            
            
            
            (29
            )
            
            71
            
            
            42(Provision
                for) benefitfrom
                income taxes
            
            
            133
            
            
            
            
            10
            
            
            (27
            )
            
            (17
            )Net
                income (loss)
            
            $
            (199
            )
            
            
            $
            (19
            )
            $
            44
            
            $
            25Earnings
                (loss) per share:Basic:
            
            $
            (0.02
            )
            
            
            $
            (0.00
            )
            
            
            
            $
            0.00Diluted:
            
            $
            (0.02
            )
            
            
            $
            (0.00
            )
            
            
            
            $
            0.00




(1)
            Effect
                of sale/leaseback transaction. The adjustments reflect the decrease
                in
                depreciation and the increase in rent associated with the real estate
                and
                lower interest expense resulting from the pay off of approximately
                $13.9
                million of mortgage and other debt with the sale
                proceeds.




**Three
      Months Ended June 30, 2006 Compared To Three Months Ended June 30,
      2005.**




*Revenues* .  **** Revenues
      were $16.3 million for the three-month period ended June 30, 2006, compared
      to
      $15.9 million for the three-month period ended June 30, 2005.




*Gross
      Profit* .  In
      the
      second quarter of 2006, gross margin was 33% of sales, compared to 33% for
      the
      quarter ended June 30, 2005. The sale/leaseback penalized second quarter gross
      margin by 1%.




11




*Selling,
      General And Administrative Expense* .  SG&A
      expense was $5.0 million in the second quarter of 2006 as compared to $5.4
      million in the same period of 2005.




*Interest
      Expense* .  **** Interest
      expense for the three-month period ended June 30, 2006 was $0.2 million, a
      decrease of $0.1 million over the three-month period ended June 30, 2005. The
      decrease was due to lower debt levels resulting from the sale/leaseback
      transaction offset partially by higher rates on remaining variable interest
      debt.




**Six
      Months Ended June 30, 2006 Compared To Six Months Ended June 30,
      2005.**




*Revenues* .  **** Revenues
      were $32.3 million for the six-month period ended June 30, 2006, compared to
      $33.1 million for the six-month period ended June 30, 2005.




*Gross
      Profit* .  In
      the
      first half of 2006, gross margin was 33% of sales, compared to 33% for the
      six-months ended June 30, 2005. The sale/leaseback penalized first half gross
      margin by 1%




*Selling,
      General And Administrative Expense* s.
      SG&A expense was $10.1 million in the first half of 2006 as compared to
      $10.8 million in the same period of 2005.




*Interest
      Expense* .  **** Interest
      expense for the six-month period ended June 30, 2006 was $0.5 million, a
      decrease of $0.1 million over the six-month period ended June 30, 2005 because
      of lower debt levels due to the March 29, 2006 sale/leaseback, offset somewhat
      by higher rates on variable interest debt prior to the
      sale/leaseback.




**LIQUIDITY
      AND CAPITAL RESOURCES**




On
      December 30, 2005, the Company entered a new $10 million term loan agreement.
      The term loan provides for interest at LIBOR (5.6% at June 30, 2006) plus 3.15%
      and is secured by the Company’s equipment. The term loan will be repaid in 60
      equal principal payments plus interest. Proceeds of the loan were used to pay
      off our previously existing term loan.




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




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




The
      following table summarizes the June 30, 2006 status of our revolving line of
      credit and term loans:





Revolving
                credit
            
            $
            1,432,000Current
                portion of term loan
            
            
            1,158,000Long-term
                portion of term loan
            
            
            4,053,000Total
            
            
            6,643,000Cash
                on hand
            
            
            (31,000
            )Net
                Debt
            
            $
            6,612,000




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




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




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




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




12




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




**CRITICAL
      ACCOUNTING POLICIES AND ESTIMATES**




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




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




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




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




*Valuation
      of long-lived and intangible assets* . Long-lived
      assets, consisting primarily of property, plant and equipment and intangibles,
      comprise a significant portion of the Company's total assets. Long-lived assets,
      including goodwill and intangibles are reviewed for impairment whenever events
      or changes in circumstances have indicated that their carrying amounts may
      not
      be recoverable. Recoverability of assets is measured by a comparison of the
      carrying amount of an asset to future net cash flows expected to be generated
      by
      that asset. The cash flow projections are based on historical experience,
      management’s view of growth rates within the industry and the anticipated future
      economic environment.




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




l
            significant
                underperformance relative to expected historical or projected future
                operating results;


l
            significant
                changes in the manner of our use of the acquired assets or the strategy
                for our overall business;


l
            significant
                negative industry or economic
                trends;


l
            significant
                decline in our stock price for a sustained period;
                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 $44.8 million as of June
      30,
      2006 .




13




In
      2002,
      Statement of Financial Accounting Standards (“SFAS”) No. 142, “ *Goodwill
      and Other Intangible Assets* ”
(“SFAS
      142”) became effective and as a result, we ceased to amortize approximately
      $26.3 million of goodwill beginning in 2002. In lieu of amortization, we
      were required to perform an initial impairment review of our goodwill in 2002
      and an annual impairment review thereafter. The initial test on January 1,
      2002,
      and the Fiscal 2002, 2003, 2004 and 2005 tests performed as of September 30,
      2002, 2003, 2004 and 2005, respectively, required no goodwill impairment. An
      additional test was performed as of December 31, 2005 which required no
      impairment. The discounted cash flow method used to evaluate goodwill impairment
      included cash flow estimates for 2006 and subsequent years. If actual cash
      flow
      performance does not meet these expectations due to factors cited above, any
      resulting potential impairment could adversely affect reported goodwill asset
      values and earnings.




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




Significant
      management judgment is required in determining our provision for income taxes,
      our deferred tax assets and liabilities and any valuation allowance recorded
      against our net deferred tax assets. The net deferred tax liability as of June
      30, 2006 was $4.4 million. The Company did not record a valuation allowance
      against its deferred tax assets as of June 30, 2006.




**ITEM
      3.**  **QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**




*Market
      Risk* .
      The
      Company had borrowings of $6.6 million at June 30, 2006 under a term loan and
      revolving credit agreements. All debt was subject to a variable interest rate.
      The weighted average interest rate paid during the first half of 2006 was 7.6%.
      For variable rate debt outstanding at June 30, 2006, a .25% increase in interest
      rates will increase annual interest expense by approximately $17,000. Amounts
      outstanding under the revolving credit facility provide for interest at the
      banks’ prime rate minus 0%- 1.00% assuming the same amount of outstanding debt
      or LIBOR plus 1.5% to 2.5%, and LIBOR plus 3.15% for the term loan. The
      Company’s market risk exposure with respect to financial instruments is to
      changes in prime or LIBOR rates.




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




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





**PART
      II - OTHER INFORMATION**




**ITEM
      1.**  **LEGAL
      PROCEEDINGS**




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




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




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




14




**ITEM
      1A. RISK FACTORS**




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




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




The
      following list of important factors may not be all-inclusive, and we
      specifically decline to undertake an obligation to publicly revise any
      forward-looking statements that have been made to reflect events or
      circumstances after the date of such statements or to reflect the occurrence
      of
      anticipated or unanticipated events. Among the factors that could have an impact
      on our ability to achieve expected operating results and growth plan goals
      and/or affect the market price of our stock are:




l
            Recent
                history of losses.


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


l
            Our
                highly competitive marketplace.


l
            The
                risks associated with dependence upon significant
                customers.


l
            Our
                ability to execute our expansion
                strategy.


l
            The
                uncertain ability to manage in a changing
                environment.


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


l
            Dependence
                on key personnel.


l
            Our
                ability to maintain and improve service
                quality.


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


l
            Possible
                significant influence over corporate affairs by significant
                shareholders.





Investors
      are encouraged to examine the Company’s 2005 Form 10-K, which more fully
      describes the risks and uncertainties associated with the Company’s
      business.




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




The
      Company’s Annual Meeting of Shareholders was held on May 3, 2006 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, and (ii) approval of the appointment
      of Singer Lewak Greenbaum & Goldstein LLP as the Company’s independent
      public accountants for the fiscal year ending December 31, 2006. The results
      of
      shareholder voting was as follows:




1.
            Election
                of Directors




The
      following individuals were elected as directors:


**Name**
              
              **Votes
                  For**
              
              **Votes
                  Withheld**Haig
                  S. Bagerdjian
              
              8,329,050
              
              13,904Robert
                  A. Baker
              
              8,316,628
              
              26,326Greggory
                  J. Hutchins
              
              8,246,012
              
              96,942Sam
                  P. Bell
              
              8,337,350
              
              5,604G.
                  Samuel Oki
              
              8,337,350
              
              5,604




15




2.
            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, 2006 was ratified with 8,083,623
                votes
                for the proposal, 255,611 votes against the proposal and 3,720 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 11, 2006
            By:
            /s/
              Alan
              R. SteelAlan
              R. SteelExecutive
                Vice President,
              Finance
                and Administration
              (duly
                authorized officer and principal financial
                officer)




16