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

Except for the historical information contained herein, certain statements in this quarterly report are "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995, which involve certain risks and uncertainties, which could cause actual results to differ materially from those discussed herein, including but not limited to competition, customer and industry concentration, dependence on technological developments, risks related to expansion, dependence on key personnel, fluctuating results and seasonality and control by management.

See the relevant portions of the Company's documents filed with the Securities and Exchange Commission and Risk Factors in Item 1A of Part II of this Form 10-Q for a further discussion of these and other risks and uncertainties applicable to the Company's business.

Overview

Point.360 is one of the largest providers of video and film asset management services to owners, producers and distributors of entertainment content. We provide the services necessary to edit, master, reformat and archive our clients' film and video content, including television programming, feature films and movie trailers using electronic and physical means. Clients include major motion picture studios and independent producers.

We operate in a highly competitive environment in which customers desire a broad range of services at a reasonable price. There are many competitors offering some or all of the services provided by us. 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.

We have an opportunity to expand our business by establishing closer relationships with our customers through excellent service at a competitive price and adding to our service offering. 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 acquisitions of IVC in July 2004 and Eden FX in March 2007) that can increase revenues by adding new customers, or expanding current services 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 interconnected facilities provide the ability to better service customers than single-location competitors. We will look to expand both our service offering and geographical presence through acquisition of other businesses or opening additional facilities.

Three Months Ended December 31, 2008 Compared To Three Months Ended December 31, 2007

Revenues. Revenues were $12.1 million for the three months ended December 31, 2008, compared to $12.1 million for the quarter ended December 31, 2007. The current period revenues were similar to the previous four calendar quarters. No unusual trends have been noted; however, revenues may come under some downward pressure in the future due to lower prices that might occur if major studios reduce output due to current difficult economic considerations and other competitors reduce pricing to compete for our business.

Gross Profit. In 2008, gross margin was 35.8% of sales, compared to 32.1% for the same period last year. The increase in gross profit percentage is due to lower wage costs as a percentage of sales. In addition, facility costs declined due to the elimination of lease costs associated with previously occupied real estate purchased earlier in fiscal year. From time to time, we will increase staff capabilities to satisfy potential customer demand. If the expected demand does not materialize, we will adjust personnel levels. We expect gross margins to fluctuate in the future as the sales mix changes.

Selling, General and Administrative Expense. SG&A expense was $4.0 million
(33.1% of sales) in the 2008 period as compared to $3.8 million (31.5% of sales)
in 2007. We expect SG&A expenses to remain at similar levels in future quarters.

Operating Income. Operating income was $0.3 million in 2008 compared to a $0.1 million in 2007.

Interest Expense. Net interest expense in the current quarter was $0.2 million, compared to $0.1 million in the prior year period. The increase is due to a mortgage related to real estate purchase in July 2008.

Other Income. During the current period, the Company realized $0.1 million of income from the sale of equipment.

Net Income. Net income for the current quarter was $0.2 million compared to a $0.1 million in the prior year's quarter.

Six Months Ended December 31, 2008 compared to Six Months Ended December 31, 2007

Revenues. Revenues were $23.4 million for the six months ended December 31, 2008, compared to $22.5 million for the period ended December 31, 2007. We expect revenues to come under some downward pressure in the future if major studios reduce output due to current difficult financial conditions and other competitors reduce prices to compete for our business. However, we continue to invest in high definition capabilities where demand is expected to grow. We believe our high definition service platform will attract additional business in the future.

Gross Profit. In 2008, gross margin was 34.4% of sales, compared to 27.8% for the same period last year. The increase in gross profit percentage is due to lower wages and benefits. From time to time, we will increase staff capabilities to satisfy potential customer demand. If the expected demand does not materialize, we will adjust personnel levels. In addition, facility costs declined due to the elimination of lease costs associated with previously occupied real estate purchased during the period. We expect gross margins to fluctuate in the future as the sales mix changes.

Selling, General and Administrative Expense. SG&A expense was $7.7 million
(32.8% of sales) in the 2008 period as compared to $7.1 million (31.8% of sales)
in 2007 excluding the restructuring charge.

Restructuring Costs. In the six months ended December 31, 2007, in conjunction with the completion of the Merger and Spin-off transactions, we decided to close down one of our post production facilities. Future costs associated with the facility lease and certain severance payments were treated as restructuring costs.

Operating Income (Loss). Operating income was $0.4 million in 2008 compared to a loss of $1.4 million in 2007. Restructuring costs contributed $0.5 million to the loss in 2007.

Interest Expense. Net Interest expense for 2008 was $0.3 million, an increase of $0.1 million from 2007. The increase was due to a mortgage related to real estate purchased in July 2008.

Other Income. During the current period, the Company realized $0.1 million of income from the sale of equipment.

Net Income (Loss). Net income for 2008 was $0.1 million compared to a loss of $1.2 million in 2007.

LIQUIDITY AND CAPITAL RESOURCES

This discussion should be read in conjunction with the notes to the financial statements and the corresponding information more fully described elsewhere in this Form 10-Q.

On August 14, 2007 and thereafter, the Company received $7 million from DG FastChannel upon completion of the Merger. The Company also received approximately $2.2 million for reimbursement of merger expenses and prepayment for ADS Business working capital. The Company expects to receive an additional $0.3 million from DG FastChannel for ADS Business working capital, which amount is included in other assets and is considered fully collectible.

On December 30, 2005, Old Point.360 entered a $10 million term loan agreement. The term loan provides for interest at LIBOR (2.59% at December 31, 2008) plus 3.15% or 5.74% on that date, and is secured by the Company's equipment. The term loan will be repaid in 60 equal principal payments plus interest.

On March 30, 2007, Old Point.360 entered into an additional $2.5 million term loan agreement. The loan provides for interest at 8.35% per annum and is secured by the Company's equipment. The loan will be repaid in 45 equal monthly installments of principal and interest. Both the December 2005 and March 2007 term loans were assumed by the Company in the Spin-off.

In August 2007, the Company entered into a new credit agreement which provides up to $8 million of revolving credit based on 80% of acceptable accounts receivables, as defined. The two-year agreement provides for interest of either
(i) prime (3.25% at December 31, 2008) minus 0% - 1.00% or (ii) LIBOR plus 1.50%
- 2.50% depending on the level of the Company's ratio of outstanding debt to fixed charges (as defined), or 2.50% or 3.93%, respectively, at December 31, 2008. The facility is secured by all of the Company's assets, except for equipment securing term loans as described above.

In March 2006, Old Point.360 entered into a sale and leaseback transaction with respect to its Media Center vaulting real estate. The real estate was sold for $13,946,000 resulting in a $1.3 million after tax gain. Additionally, Old Point.360 received $500,000 from the purchaser for improvements. In accordance with SFAS No.28, "Accounting for Sales with Leasebacks" ("SFAS28"), the gain and the improvement allowance will be amortized over the initial 15-year lease term as reduced rent.

In July 2008, the Company entered into a Promissory Note with a bank (the "Note") in order to purchase land and a building that has been occupied by the Company since 1998 (the total purchase price was approximately $8.1 million). Pursuant to the Note, the company borrowed $6,000,000 payable in monthly installments of principal and interest on a fully amortized bases over 30 years at an initial five-year interest rate of 7.1% and thereafter at a variable rate equal to LIBOR plus 3.6% (6.19% as of December 31, 2008).

The following table summarizes the December 31, 2008 amounts outstanding under our revolving line of credit and term and mortgage loans:

Revolving credit                              $         -
Current portion of term loan and mortgage       1,899,000
Long-term portion of term loan and mortgage     7,830,000
Total                                         $ 9,729,000

Monthly and annual principal and interest payments due under the term debt and mortgage are approximately $213,000 and $2.6 million, respectively, assuming no change in interest rates.

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

The bank revolving credit agreement requires us to maintain a minimum "fixed charge coverage ratio." Our fixed charge coverage ratio compares, on a rolling twelve-month basis, (i) EBITDA plus rent expense and non-cash charges less income tax payments, to (ii) interest expense plus rent expense, the current portion of long term debt and maintenance capital expenditures. As of December 31, 2008, the fixed charge coverage ratio was 1.45 as compared to a minimum requirement of 1.10.

We expect that amounts available under the revolving credit arrangement (approximately $4.4 million at December 31, 2008), 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 $2.0 - $3.0 million of capital expenditures for the next twelve months.

In March 2007, we acquired substantially all the assets of Eden FX for approximately $2.2 million in cash. The purchase agreement requires additional payments of $0.7 million, $0.9 million and $1.2 million in March of 2008, 2009 and 2010, respectively, if earnings during the three years after acquisition meet certain predetermined levels. The earnings level for calendar 2007 was not met; therefore, the 2008 payment was not made.

The following table summarizes contractual obligations as of December 31, 2008 due in the future:

                                                               Payment due by Period
                                                                           Years           Years
Contractual Obligations            Total          Less than 1 Year        2 and 3         4 and 5        Thereafter
Long Term Debt Principal
Obligations                     $  9,729,000     $        1,899,000     $ 2,044,000     $   156,000     $  5,630,000
Long Term Debt Interest
Obligations (1)                    8,085,000                698,000         908,000         814,000        5,665,000
Capital Lease Obligations             97,000                 22,000          52,000          23,000                -
Operating Lease Obligations       18,504,000              2,628,000       5,050,000       3,154,000        7,672,000
Total                           $ 36,416,000     $        5,247,000     $ 8,054,000     $ 4,147,000     $ 18,968,000

(1) Interest on variable rate debt has been computed using the rate on the latest balance sheet date.

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

We will continue to consider the acquisition of businesses which compliment our current operations and possible real estate transactions. Consummation of any acquisition, real estate or other expansion transaction by the Company may be subject to the Company securing additional financing, perhaps at a cost higher than our existing term loans. In the current economic climate, additional financing may not be available. Additionally, our current bank line of credit might not be renewed upon its August 2009 expiration due to recent changes in the bank lending environment. Future earnings and cash flow may be negatively impacted to the extent that any acquired entities do not generate sufficient earnings and cash flow to offset the increased financing costs.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

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

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

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

Valuation of long-lived and intangible assets. Long-lived assets, consisting primarily of property, plant and equipment and intangibles (consisting only of goodwill), comprise a significant portion of the Company's total assets. Long-lived assets, including goodwill are reviewed for impairment whenever events or changes in circumstances have indicated that their carrying amounts may not be recoverable. Recoverability of assets is measured by comparing the carrying amount of an asset to its fair value in a current transaction between willing parties, other than in a forced liquidation sale.

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

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

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

· Significant negative industry or economic trends;

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

· Our market capitalization relative to net book value.

When we determine that the carrying value of intangibles, long-lived assets and related goodwill and enterprise level goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, we measure any impairment based on comparing the carrying amount of the asset to its fair value in a current transaction between willing parties or, in the absence of such measurement, on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model. Any amount of impairment so determined would be written off as a charge to the income statement, together with an equal reduction of the related asset. Net intangible assets, long-lived assets and goodwill amounted to approximately $25.3 million as of December 31, 2008.

In 2002, Statement of Financial Accounting Standards ("SFAS") No.142, "Goodwill and Other Intangible Assets" ("SFAS 142") became effective. As a result, Old Point.360 ceased to amortize approximately $26.3 million of goodwill in 2002 and performed an annual impairment review thereafter. The initial test on January 1, 2002, and the Fiscal 2002 to 2007 tests performed as of September 30 of each year required no goodwill impairment. On August 14, 2007, the Company was formed by a spin-off transaction, and a certain portion of Old Point.360's goodwill was assigned to the Company. In the 2008 test performed as of June 30, 2008, the discounted cash flow method was used to evaluate goodwill impairment and included cash flow estimates for 2009 and subsequent years. If actual 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 assets as of December 31, 2008 was $0.9 million. The Company did not record a valuation allowance against its deferred tax assets as of December 31, 2008.

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with Statement FAS 109. This interpretation prescribes a recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition of tax benefits, classification on the balance sheet, interest and penalties, accounting in interim periods, disclosure, and transition. The Company assumed all liability for income taxes of Old Point.360 related to operations prior to the Spin-off and Merger. Effectively, the Company therefore adopted FIN 48, effective January 1, 2007. The Company files income tax returns in the U.S. federal jurisdiction, and various state jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal state or local income tax examinations by tax authorities for years before 2002. The Company has analyzed its filing positions in all of the federal and state jurisdictions where it is required to file income tax returns. Old Point.360, and consequently, the Company, was last audited by New York taxing authorities for the years 2002 through 2004 resulting in no change. Old Point.360, and consequently, the Company, was previously notified by the U.S. Internal Revenue Service of its intent to audit the calendar 2005 tax return. The audit has since been cancelled by the IRS without change; however, the audit could be reopened at the IRS' discretion. Upon the implementation of FIN 48, the Company did not recognize any increase in the liability for unrecognized tax benefits. In addition, the Company did not record a cumulative effect adjustment related to the adoption of FIN 48.

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2007, the FASB issued SFAS No. 141R, "Business Combinations" ("SFAS 141R"), which requires most identifiable assets, liabilities, non-controlling interests, and goodwill acquired in a business combination to be recorded at "full fair value." SFAS 141R applies to all business combinations, including combinations among mutual entities and combinations by contract alone. Under Statement 141R, all business combinations will be accounted for by applying the acquisition method. Statement 141R is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. SFAS 141R will affect acquisitions by the Company after June 30, 2009.

In December 2007, the FASB issued SFAS No. 160, "Non-controlling Interests in Consolidated Financial Statements" ("SFAS 160"). SFAS 160 requires the ownership interests in subsidiaries held by parties other than the parent to be treated as a separate component of equity and be clearly identified, labeled, and presented in the consolidated financial statements. SFAS 160 is effective for periods beginning on or after December 15, 2008. Earlier adoption is prohibited. SFAS 160 has not yet affected the Company's financial statements.

In January 2008, the SEC issued Staff Accounting Bulletin No. 110, "Certain Assumptions Used in Valuation Methods" ("SAB 110") which amends Staff Accounting Bulletin No. 107, "Share-Based Payment" ("SAB 107"). SAB 110 allows for the continued use, under certain circumstances, of the "simplified" method in developing an estimate of expected term of so-called "plain vanilla" stock options accounted for under FAS 123R. SAB 110 amends SAB 107 to permit the use of the "simplified" method beyond December 31, 2007. The adoption of SAB 110 did not have a significant effect on the Company's consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161. "Disclosures about Derivative Instruments and Hedging Activities - an amendment of FASB Statement No, 133" ("FAS 161"). The standard requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments, and disclosures about credit-risk related contingent features in derivative agreements. FAS 161 is effective for financial statements issued after November 15, 2008. The adoption of FAS 161 will not have a significant effect on the Company's consolidated financial statements.