**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 September 30, 2005 or
 
 __
        Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
        Act
        of 1934.
 
 For
        the transition period from   to_________
 
 Commission
        file number  0-21917
 
 Point.360
 **(Exact
        Name of Registrant as Specified in Its Charter)**
 
 **California**
                (State
                  of or other jurisdiction of
                incorporation
                  or organization)
              **95-4272619**
                (I.R.S.
                  Employer Identification No.)**2777
                  North Ontario Street, Burbank, CA**
                (Address
                  of principal executive offices)
              **91504**
                (Zip
                  Code)
 
 (818)
        565-1400
 **(Registrant’s
        Telephone Number, Including Area Code)**
 
 
 **(Former
        Name, Former Address and Former Fiscal Year,**
 **if
        Changed Since Last Report)**
  Indicate
        by check mark whether the registrant: (1) has filed all reports required
        to be
        filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
        the
        preceding 12 months (or for such shorter period that the registrant was required
        to file such reports), and (2) has been subject to such filing requirements
        for
        the past 90 days.
 
 Yes   **X**   No
 
 Indicate
        by check mark whether the registrant is an accelerated filer (as defined
        in Rule
        12b-2 of the Exchange Act).
 
 Yes   No  **X**
 
 Indicate
        by check mark whether the registrant is a shell company (as defined in Rule
        12b-2 of the Exchange Act).
 
 Yes   No  **X**
  As
        of September 30, 2005, there were 9,368,857 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**
              
              **September
                  30,**
                **2005**(unaudited)Current
                  assets:Cash
                  and cash equivalents
              
              $
              668,000
              
              $
              431,000Accounts
                  receivable, net of allowances for doubtful
                accounts
                  of $531,000 and $588,000 (unaudited), respectively
              
              
              12,468,000
              
              
              13,305,000Inventories
              
              
              932,000
              
              
              812,000Prepaid
                  expenses and other current assets
              
              
              1,788,000
              
              
              2,056,000Deferred
                  income taxes
              
              
              1,310,000
              
              
              1,310,000Total
                  current assets
              
              
              17,166,000
              
              
              17,914,000Property
                  and equipment, net
              
              
              31,451,000
              
              
              28,809,000Other
                  assets, net
              
              
              742,000
              
              
              625,000Goodwill
                  and other intangibles, net
              
              
              27,288,000
              
              
              27,473,000Total
                  assets
              
              $
              76,647,000
              
              $
              74,821,000**LIABILITIES
                  AND SHAREHOLDERS’ EQUITY**Current
                  liabilities:Accounts
                  payable
              
              $
              4,898,000
              
              $
              4,775,000Accrued
                  wages and benefits
              
              
              1,751,000
              
              
              1,099,000Accrued
                  earn-out payments
              
              
              1,000,000
              
              
              -Other
                  accrued expenses
              
              
              1,249,000
              
              
              1,003,000Income
                  taxes payable
              
              
              1,148,000
              
              
              1,202,000Borrowings
                  under revolving line of credit
              
              
              4,323,000
              
              
              5,988,000Current
                  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
              
              
              17,181,000Deferred
                  income taxes
              
              
              5,788,000
              
              
              5,008,000Bank
                  notes payable, less current portion
              
              
              14,494,000
              
              
              13,149,000Capital
                  lease and other obligations, less current portion
              
              
              136,000
              
              
              68,000Total
                  long-term liabilities
              
              
              20,418,000
              
              
              18,225,000Total
                  liabilities
              
              
              37,703,000
              
              
              35,406,000Contingencies
                  (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; 9,236,132and9,368,857(unaudited)
                  shares issued and outstanding, respectively
              
              
              17,903,000
              
              
              18,358,000Additional
                  paid-in capital
              
              
              675,000
              
              
              675,000Retained
                  earnings
              
              
              20,366,000
              
              
              20,382,000Total
                  shareholders’ equity
              
              
              38,944,000
              
              
              39,415,000Total
                  liabilities and shareholders’ equity
              
              $
              76,647,000
              
              $
              74,821,000
 
 See
        accompanying notes to consolidated financial statements.
 2
  **POINT.360**
 
 **CONSOLIDATED
        STATEMENTS OF INCOME (LOSS)**
 **(Unaudited)**
 
 **Three
                  Months Ended**
                **September
                  30,**
              
              **Nine
                  Months Ended**
                **September
                  30,****2004**
              
              **2005**
              
              **2004**
              
              **2005**Revenues
              
              $
              16,465,000
              
              $
              16,748,000
              
              $
              45,846,000
              
              $
              49,821,000Cost
                  of goods sold
              
              
              (10,729,000
              )
              
              (10,783,000
              )
              
              (29,657,000
              )
              
              (32,813,000
              )Gross
                  profit
              
              
              5,736,000
              
              
              5,965,000
              
              
              16,189,000
              
              
              17,008,000Selling,
                  general and administrative expense
              
              
              (4,689,000
              )
              
              (5,229,000
              )
              
              (13,785,000
              )
              
              (15,984,000
              )Write-off
                  of deferred acquisition andfinancing
                  costs
              
              
              (988,000
              )
              
              -
              
              
              (1,050,000
              )
              
              -Operating
                  income
              
              
              59,000
              
              
              736,000
              
              
              1,354,000
              
              
              1,024,000Interest
                  expense, net
              
              
              (196,000
              )
              
              (379,000
              )
              
              (530,000
              )
              
              (999,000
              )Income
                  (loss) before income taxes
              
              
              (137,000
              )
              
              357,000
              
              
              824,000
              
              
              25,000(Provision
                  for) benefit from income taxes
              
              
              56,000
              
              
              (143,000
              )
              
              (338,000
              )
              
              (10,000
              )Net
                  income (loss)
              
              $
              (81,000
              )
              $
              214,000
              
              $
              486,000
              
              $
              15,000Earnings(loss)
                  per share:Basic:Net
                  income (loss)
              
              $
              (0.01
              )
              $
              0.02
              
              $
              0.05
              
              $
              -Weighted
                  average number of shares
              
              
              9,211,321
              
              
              9,364,345
              
              
              9,188,095
              
              
              9,338,960Diluted:Net
                  income (loss)
              
              $
              (0.01
              )
              $
              0.02
              
              $
              0.05
              
              $
              -Weighted
                  average number of sharesincluding
                  the dilutive effect of stockoptions
              
              
              9,501,338
              
              
              9,709,515
              
              
              9,655,834
              
              
              9,813,250
 
 
 See
        accompanying notes to consolidated financial statements.
 3
  **POINT.360**
 
 **CONSOLIDATED
        STATEMENTS OF CASH FLOWS**
 **(Unaudited)**
 
 **Nine
                  Months Ended**
                **September
                  30,****2004**
              
              **2005**Cash
                  flows from operating activities:Net
                  income
              
              $
              486,000
              
              $
              15,000Adjustments
                  to reconcile net incometo
                  net cash provided by operating activities:Depreciation
                  and amortization
              
              
              4,138,000
              
              
              4,652,000Provision
                  for doubtful accounts
              
              
              (48,000
              )
              
              71,000Other
                  non cash items
              
              
              181,000
              
              
              183,000Changes
                  in assets and liabilities:(Increase)
                  decrease in accounts receivable
              
              
              417,000
              
              
              (766,000
              )(Increase)
                  decrease in inventories
              
              
              9,000
              
              
              120,000(Increase)
                  decrease in prepaid expenses andother
                  current assets
              
              
              208,000
              
              
              (179,000
              )(Increase)
                  in goodwill and other tangibles
              
              
              -
              
              
              (185,000
              )Decrease
                  in other assets
              
              
              619,000
              
              
              117,000Increase
                  (decrease) in accounts payable
              
              
              315,000
              
              
              (123,000
              )Increase
                  in accrued settlement
              
              
              575,000
              
              
              -(Decrease)
                  in accrued expenses
              
              
              (1,131,000
              )
              
              (1,898,000
              )Increase
                  (decrease) in income taxes
              
              
              (24,000
              )
              
              143,000(Decrease)
                  in deferred taxes
              
              
              -
              
              
              (780,000
              )Net
                  cash provided by operating activities
              
              
              5,745,000
              
              
              1,370,000Cash
                  used in investing activities:Capital
                  expenditures
              
              
              (4,083,000
              )
              
              (1,688,000
              )Proceeds
                  from sale of equipment
              
              
              40,000
              
              
              -Amount
                  paid for acquisitions
              
              
              (3,159,000
              )
              
              (25,000
              )Net
                  cash used in investing activities
              
              
              (7,202,000
              )
              
              (1,713,000
              )Cash
                  flows used in financing activities:Exercise
                  of stock options
              
              
              244,000
              
              
              55,000Change
                  in revolving credit agreement
              
              
              2,876,000
              
              
              1,666,000Proceeds
                  from bank note
              
              
              8,000,000
              
              
              1,007,000Change
                  in note payable
              
              
              163,000
              
              
              -Shares
                  issued for an acquisition
              
              
              -
              
              
              (400,000
              )Repayment
                  of notes payable
              
              
              (16,951,000
              )
              
              (2,150,000
              )Repayment
                  of capital lease obligations
              
              
              (81,000
              )
              
              (72,000
              )Net
                  cash provided by (used) in financing activities
              
              
              (5,749,000
              )
              
              106,000Net
                  decrease in cash
              
              
              (7,206,000
              )
              
              (237,000
              )Cash
                  and cash equivalents at beginning of period
              
              
              7,206,000
              
              
              668,000Cash
                  and cash equivalents at end of period
              
              $
              -
              
              $
              431,000Supplemental
                  disclosure of cash flow information -
                Cash
                  paid for:Interest
              
              $
              418,000
              
              $
              999,000Income
                  tax
              
              $
              362,000
              
              $
              866,000
 
 
 See
        accompanying notes to consolidated financial statements.
 4
  **POINT.360**
 
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**
 
 **September
        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 nine-month periods ended
        September 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 is effective for financial instruments
        entered into or modified after May 31, 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.
  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.
  6
 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 nine-month
        periods ended September 30, 2004 and 2005.
  7
 
 **Three
                  months ended**
                **September
                  30**
              
              **Nine
                  months ended**
                **September
                  30****2004**
              
              **2005**
              
              **2004**
              
              **2005**Net
                  income (loss):As
                  reported
              
              $
              (81,000
              )
              $
              214,000
              
              $
              486,000
              
              $
              15,000Deduct:
                  Total stock-based employee compensation expense determined under
                  fair
                  value based method for all awards, net of related tax
                  effects
              
              
              (75,000
              )
              
              (61,000
              )
              
              (204,000
              )
              
              (158,000
              )Pro
                  forma
              
              
              (156,000
              )
              
              153,000
              
              
              282,000
              
              
              (143,000
              )Basic
                  earnings (loss) per share of common stock:As
                  reported
              
              $
              (0.01
              )
              $
              0.02
              
              $
              0.05
              
              $
              0.00Pro
                  forma
              
              $
              (0.02
              )
              $
              0.02
              
              $
              0.03
              
              $
              (0.02
              )Diluted
                  earnings (loss) per share of common stock:As
                  reported
              
              $
              (0.01
              )
              $
              0.02
              
              $
              0.05
              
              $
              0.00Pro
                  forma
              
              $
              (0.02
              )
              $
              0.02
              
              $
              0.03
              
              $
              (0.01
              )
  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**
                **September
                  30**
              
              **Nine
                  months ended**
                **September
                  30****2004**
              
              **2005**
              
              **2004**
              
              **2005**Risk-free
                  interest rate
              
              
              1.51
              %
              
              3.54
              %
              
              1.18
              %
              
              3.02
              %Expected
                  term (years)
              
              
              5.00
              
              
              5.00
              
              
              5.00
              
              
              5.00Volatility
              
              
              44
              %
              
              43
              %
              
              44
              %
              
              43
              %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 nine months ended September 30, 2005, the number of outstanding shares
        of
        the Company’s common stock increased by 132,725 shares due to the exercise of
        27,725 employee stock options for $55,000 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 nine-month period ended September 30, 2004 as if the acquisition had
        occurred as of the beginning of such period 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:
 
 **Nine
                  months ended**
                **September
                  30, 2004**Revenue
              
              $
              51,534,000Operating
                  Income
              
              
              1,816,000Net
                  income
              
              
              695,000Basic
                  earnings per share
              
              
              0.08Diluted
                  earnings per share
              
              
              0.07
  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. 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 in the third quarter. While we are exploring
        other lower cost alternatives, gross margins related to spot delivery revenues
        will be lower until such alternatives become available.
  The
        Company has an opportunity to expand its business by establishing closer
        relationships with our customers through excellent service at a competitive
        price and maintaining adequate third party distribution channels. Our success
        is
        also dependent on attracting and maintaining employees capable of maintaining
        such relationships. Also, growth can be achieved by acquiring similar businesses
        (for example, the acquisition of International Video Conversions, Inc. (“IVC”)
        in July 2004) which can increase revenues by adding new customers, or expanding
        services provided to existing customers.
  Our
        business generally involves the immediate servicing needs of our customers.
        Most
        orders are fulfilled within several days, with occasional larger orders spanning
        weeks or months. At any particular time, we have little firm
        backlog.
  We
        believe that our nationwide interconnected facilities provide the ability
        to
        better service national customers than single-location competitors. We will
        look
        to expand both our service offering and geographical presence through
        acquisition of other businesses or opening additional facilities.
  During
        2004, we completed the acquisition of IVC and settled all disputes related
        to a
        proposed acquisition of three subsidiaries of Alliance Atlantis Communications,
        Inc. (“Alliance”). The financial statement comparisons below highlight the
        effects of these transactions.
  **Statistical
        Analysis**
  The
        table below summarizes pro forma results for the three- and nine-month periods
        ended September 30, 2004 and 2005, without the effects of (1) IVC’s results of
        operations for the first six months of 2005 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****September
                    30, 2004**
                
                **September
                    30, 2005****Pro
                    forma**
                
                **(2)**
                
                **GAAP**
                
                
                
                
                
                **GAAP**Revenues
                
                $
                16,465
                
                $
                -
                
                $
                16,465
                
                
                
                
                
                
                
                $
                16,748Cost
                    of goods sold
                
                
                (10,729
                )
                
                -
                
                
                (10,729
                )
                
                
                
                
                
                
                
                (10,783
                )Gross
                    profit
                
                
                5,736
                
                
                -
                
                
                5,736
                
                
                
                
                
                
                
                
                5,965Selling,
                    general andadministrative
                    expense(3)
                
                
                (4,689
                )
                
                -
                
                
                (4,689
                )
                
                
                
                
                
                
                
                (5,229
                )Write-off
                    of deferredacquisition,
                    financingand
                    settlement costs(3)
                
                
                -
                
                
                (988
                )
                
                (988
                )
                
                
                
                
                
                
                
                -Operating
                    income (loss)
                
                
                1,047
                
                
                (988
                )
                
                59
                
                
                
                
                
                
                
                
                736Interest
                    expense, net
                
                
                (196
                )
                
                -
                
                
                (196
                )
                
                
                
                
                
                
                
                (379
                )Income
                    (loss) before income taxes
                
                
                851
                
                
                (988
                )
                
                (137
                )
                
                
                
                
                
                
                
                357(Provision
                    for) benefit from income taxes
                
                
                (349
                )
                
                405
                
                
                56
                
                
                
                
                
                
                
                
                (143
                )Net
                    income (loss)
                
                $
                502
                
                $
                (583
                )
                $
                (81
                )
                
                
                
                
                
                
                $
                214Earnings
                    (loss) per share:Basic:
                
                $
                0.05
                
                $
                (0.06
                )
                $
                (0.01
                )
                
                
                
                
                
                
                $
                0.02Diluted:
                
                $
                0.05
                
                $
                (0.06
                )
                $
                (0.01
                )
                
                
                
                
                
                
                $
                0.02**Nine
                    Months Ended****September
                    30, 2004**
                
                **September
                    30, 2005****Pro
                    forma**
                
                **(2)**
                
                **GAAP**
                
                **Pro
                    forma**
                
                **(1)**
                
                **GAAP**Revenues
                
                $
                45,846
                
                $
                -
                
                $
                45,846
                
                $
                44,031
                
                $
                5,790
                
                $
                49,821Cost
                    of goods sold
                
                
                (29,657
                )
                
                -
                
                
                (29,657
                )
                
                (28,906
                )
                
                (3,907
                )
                
                (32,813
                )Gross
                    profit
                
                
                16,189
                
                
                -
                
                
                16,189
                
                
                15,125
                
                
                1,883
                
                
                17,008Selling,
                    general and administrative expense(3)
                
                
                (13,785
                )
                
                -
                
                
                (13,785
                )
                
                (14,678
                )
                
                (1,306
                )
                
                (15,984
                )Write-off
                    of deferred acquisition, financing and settlement costs(3)
                
                
                -
                
                
                (1,050
                )
                
                (1,050
                )
                
                -
                
                
                -
                
                
                -Operating
                    income (loss)
                
                
                2,404
                
                
                (1,050
                )
                
                1,354
                
                
                447
                
                
                577
                
                
                1,024Interest
                    expense, net
                
                
                (530
                )
                
                -
                
                
                (530
                )
                
                (882
                )
                
                (117
                )
                
                (999
                )Income
                    (loss) before income taxes
                
                
                1,874
                
                
                (1,050
                )
                
                824
                
                
                (435
                )
                
                460
                
                
                25(Provision
                    for) benefit from income taxes
                
                
                (769
                )
                
                431
                
                
                (338
                )
                
                179
                
                
                (189
                )
                
                (10
                )Net
                    income (loss)
                
                $
                1,105
                
                $
                (619
                )
                $
                486
                
                $
                (256
                )
                $
                271
                
                $
                15Earnings
                    (loss) per share:Basic:
                
                $
                0.11
                
                $
                (0.06
                )
                $
                0.05
                
                $
                (0.03
                )
                $
                0.03
                
                $
                -Diluted:
                
                $
                0.11
                
                $
                (0.06
                )
                $
                0.05
                
                $
                (0.03
                )
                $
                0.03
                
                $
                -
  (1)
                  Contribution
                      of IVC for the first six months of
                      2005.
 (2)
              Write-off
                  of deferred acquisition, financing and settlement
                  costs.
 (3)
              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.
  In
        total, revenues in the nine-month period were 9%, greater than in the same
        2004
        period. Without the inclusion of IVC for the first six months of 2005 (the
        comparable 2005 period to 2004 when the Company did not own IVC) , revenues
        in
        the 2005 nine-month period would have been $44.0 million, a decrease of 4%
        from
        2004. Pro forma 2004 revenues for the nine-month period if IVC had been
        purchased at the beginning of 2004 would have been $51.5 million.
  11
 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, mortgage debt incurred and 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
        forward-looking statements.
  **Three
        Months Ended September 30, 2005 Compared To Three Months Ended September
        30,
        2004.**
  *Revenues* .  **** Revenues
        were $16.7 million for the three-month period ended September 30, 2005, compared
        to $16.5 million for the three-month period ended September 30, 2004.
  *Gross
        Profit* .  In
        the third quarter of 2005, gross margin was 36% of sales, compared to 35%
        for
        the quarter ended September 30, 2004.
  *Selling,
        General And Administrative Expense* .  SG&A expense was $5.2 million in the third quarter of 2005 as compared to
        $5.7 million in the same period of 2004. Without the special charge in 2004,
        SG&A expense in that period would have been $4.6 million. The increase in
        2005 is due principally to the addition of sales personnel and related
        expenses.
  *Interest
        Expense* .  **** Interest
        expense for the three-month period ended September 30, 2005 was $0.4 million,
        an
        increase of $0.2 million over the three-month period ended September 30,
        2004
        because of higher debt levels due to the acquisition of real property in
        the
        third quarter of 2004 and increasing rates on variable interest
        debt.
  **Nine
        Months Ended September 30, 2005 Compared To Nine Months Ended September 30,
        2004.**
  *Revenues* .  **** Revenues
        were $49.8 million for the nine-month period ended September 30, 2005, compared
        to $45.8 million for the nine-month period ended September 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 4% to $44.0 million
        when
        compared to the 2004 quarter.
  *Gross
        Profit* .  In
        the first nine months of 2005, gross margin was 34% of sales, compared to
        35%
        for the nine-months ended September 30, 2004. The decline is due principally
        to
        lower sales at facilities other than IVC.
  *Selling,
        General And Administrative Expense* .  SG&A expense was $16.0 million in the first nine months of 2005 as compared
        to $14.8 million in the same period of 2004 ($13.8 million before the special
        charge). The increase was due principally to the addition of IVC and sales
        personnel.
  *Interest
        Expense* .  **** Interest
        expense for the nine-month period ended September 30, 2005 was $1.0 million,
        an
        increase of $0.5 million over the nine-month period ended September 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 September 30, 2005 status of our revolving
        line
        of credit and term loans:
 Revolving
                  credit (excluding cash)
              
              $
              5,557,000Current
                  portion of term loans
              
              
              3,051,000Long-term
                  portion of term loans
              
              
              13,149,000Total
              
              $
              21,757,000
  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 $56.3 million as of September
        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, 2004 and 2005
        tests
        performed as of September 30, 2002, 2003, 2004 and 2005, respectively, required
        no goodwill 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
        September 30, 2005 was $5 million. The Company did not record a valuation
        allowance against its deferred tax assets as of September 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 was effective for financial instruments
        entered into or modified after May 31, 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.
 
 Investors
        are encouraged to examine the Company’s 2004 Form 10-K, which more fully
        describes the risks and uncertainties associated with the Company’s business. In
        addition, investors should consider the following:
 
 1.
              During
                  the second quarter of 2005, we entered into discussions with our
                  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.
  2.
              There
                  is a 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, it has lowered gross margins on revenues related
                  to
                  electronic as we have been required to use higher-cost alternatives.
                  Any
                  future interruption in the supply of such services by other vendors
                  could
                  materially and adversely affect the Company’s financial condition, results
                  of operations and prospects.
  **ITEM
        3.**  **QUANTITATIVE
        AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**
  *Market
        Risk* .
        The Company had borrowings of $15.7 million at September 30, 2005 under a
        term
        loan and revolving credit agreement, and $6.1 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.
 16
  **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
        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:
                November 11, 2005
              By:
              /s/ Alan
                R. SteelAlan
                R. SteelExecutive Vice President,Finance and
                Administration(duly
                authorized officer and principal financial officer)
  17