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.

The market for our services is primarily dependent on our customers' desire and ability to monetize their entertainment content. The major studios derive revenues from re-releases and/or syndication of motion pictures and television content. While the size of this market is not quantifiable, we believe studios will continue to repurpose library content to augment uncertain revenues from new releases. The current uncertain economic environment and entertainment industry labor unrest have negatively impacted the ability and willingness of independent producers to create new content.

The demand for entertainment content should continue to expand through web-based applications. We believe long and short form content will be sought by users of personal computers, hand held devices and home entertainment technology. Additionally, changing formats from standard definition, to high definition, to Blu Ray and perhaps to 3D will continue to give us the opportunity to provide new services with respect to library content.

To meet these needs, we must be prepared to invest in technology and equipment, and attract the talent needed to serve our client needs. Labor, facility and depreciation expenses constitute approximately 75% of our cost of sales. Our goals include maximizing facility and labor usage, and maintaining sufficient cash flow for capital expenditures and acquisitions of complementary businesses to enhance our service offerings.

We continue to look for opportunities to solidify our businesses. During the fiscal year ending June 30, 2009, we have completed the following:

· We purchased the 32,000 square foot Burbank facility to enhance future cash flow and secure that operational capability for the future.

· We purchased the assets of Video Box Studios and consolidated its operations into our West Los Angeles location.

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, Eden FX in March 2007 and those described above) 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 March 31, 2009 Compared To Three Months Ended March 31, 2008

Revenues. Revenues were $11.1 million for the three months ended March 31, 2009, compared to $11.3 million for the quarter ended March 31, 2008. 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.

Cost of Services. Costs of services consist principally of wages and benefits, facility costs and depreciation of physical assets. During the quarter ended March 31, 2009, total costs of services were 67.7% of sales compared to 65.2% in the prior year's period. While wages and benefits and depreciation costs were consistent between periods, facility expenses declined by $89,000 due to elimination of rent for one of our Burbank facilities which we purchased in July 2008. Offsetting the reduction in rent was an increase in the cost of outsourced work of $163,000 due to unusually fast turnaround requirements for a particular project (we occasionally farm out certain tasks for which we have insufficient production capacity). While outsourcing generally involves lower margins, it allows us to better meet infrequent unusually fast delivery time requirements of our clients.

Gross Profit. In 2009, gross margin was 32.3% of sales, compared to 34.8% for the same period last year. The decline in gross profit percentage is due to the cost services of factors cited above. 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 $4.3 million
(38.4% of sales) in the 2009 period as compared to $3.7 million (32.9% of sales)
in 2008. During the quarter ended March 31, 2009, the Company incurred approximately $319,000 of costs associated with documentation of its internal control processes in anticipation of performing its first management assessment of internal controls for the fiscal year ended June 30, 2009. Additionally, the Company spent approximately $257,000 in consulting fees to improve its information technology infrastructure. Excluding these costs, SG&A expenses for the quarter ended March 31, 2009 were $3.7 million, or 33.4% of sales.

Operating Income (Loss). Operating loss was $0.7 million in 2009 compared to income of $0.2 million in 2008.

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 prior year's period, the Company realized $0.1 million of income from the sale of equipment.

Net Income (Loss). Net loss for the current quarter was $0.4 million compared to a $0.2 million profit in the prior year's quarter.

Nine Months Ended March 31, 2009 Compared to Nine Months Ended March 31, 2008

Revenues. Revenues were $34.5 million for the nine months ended March 31, 2009, compared to $33.8 million for the period ended March 31, 2008. 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.

Cost of Services. Costs of services consist principally of wages and benefits, facility costs and depreciation of physical assets. During the nine months ended March 31, 2009, total costs of services were 66.3% of sales compared to 69.9% in the prior year's period. While depreciation costs were consistent between periods, wages and benefits declined $406,000 due to personnel reductions following the August 2007 divestiture of the ADS Business. Additionally, facility expenses declined $349,000 due to elimination of rent for one of our Burbank facilities which we purchased in July 2008. Offsetting the reductions was an increase in the cost of outsourced work of $235,000 due to unusually fast turnaround requirements for several projects (we occasionally farm out certain tasks for which we have insufficient production capacity). While outsourcing generally involves lower margins, it allows us to better meet infrequent unusually fast delivery time requirements of our clients.

Gross Profit. In 2009, gross margin was 33.7% of sales, compared to 30.1% for the same period last year. The increase in gross profit percentage is due to the factors cited above. 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 $12.0 million (34.6% of sales) in the 2009 period as compared to $11.3 million (33.3% of sales) in 2008 excluding the restructuring charge. During the nine months ended March 31, 2009, the Company incurred approximately $319,000 of costs associated with documentation of its internal control processes in anticipation of performing its first management assessment of internal controls for the fiscal year ended June 30, 2009. Additionally, the Company spent approximately $257,000 in consulting fees to improve its information technology infrastructure. Excluding these costs, SG&A expenses for the nine months ended March 31, 2009 were $11.4 million, or 33.0% of sales.

Restructuring Costs. In the nine months ended March 31, 2008, 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 loss was $0.3 million in 2009 compared to a loss of $1.2 million in 2008. Restructuring costs contributed $0.5 million to the loss in 2008.

Interest Expense. Net Interest expense for 2009 was $0.5 million, an increase of $0.1 million from 2008. The increase was due to a mortgage related to real estate purchased in July 2008.

Other Income. During the current period, the Company realized $0.2 million of income from the sale of equipment.

Net Income (Loss). Net loss for 2009 was $0.3 million compared to a loss of $1.0 million in 2008.

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 (1.80% at March 31, 2009) plus 3.15% (4.95% 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 is being 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 March 31, 2009) 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 2.75% or 3.80%, respectively, at March 31, 2009. 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 basis 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% (5.40% as of March 31, 2009).

The following table summarizes the March 31, 2009 amounts outstanding under our revolving line of credit, and term (including capital lease obligations) and mortgage loans:

 Revolving credit                              $         -
 Current portion of term loan and mortgage       1,962,000
 Long-term portion of term loan and mortgage     7,458,000
 Total                                         $ 9,420,000

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.

Our 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 March 31, 2009, the fixed charge coverage ratio was 1.37 as compared to a minimum requirement of 1.10.

We expect that amounts available under the revolving credit arrangement (approximately $4.1 million at March 31, 2009), 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 levels for calendar 2007 and 2008 were not met; therefore, the 2008 and 2009 payments were not made.

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.

In recent quarters, the underlying drivers of operating cash flows (sales, receivable collections, the timing of vender payments, facility costs and employment levels) have been consistent, except that days sales outstanding in accounts receivable have risen from approximately 54 days to 66 days within the last 12 months. Major studios have generally delayed payments in response to the general economic slowdown. However, we do not expect days sales outstanding to materially increase in the future.

As of March 31, 2009, our facility costs consisted of building rent, maintenance and communication expenses. In July 2008, rents were reduced by the purchase of our Hollywood Way facility in Burbank, CA, eliminating approximately $625,000 of annual rent expense. The real estate purchase involved a down payment of $2.1 million and $6 million of mortgage debt (described above). The mortgage payments are approximately $488,000 per year. We believe our current cash position and a difficult economy may provide us with the opportunity to invest in facility assets that will not only help fix our operating costs, but give us the potential to own appreciating real estate assets. We will continue to evaluate opportunities to reduce facility costs. See below for descriptions of additional facility related transactions occurring subsequent to March 31, 2009 and their impact on future cash flows.

The following table summarizes contractual obligations as of March 31, 2009 due in the future:

                                                                      Payment due by Period
                                                           Less than 1         Years           Years
Contractual Obligations                      Total             Year           2 and 3         4 and 5        Thereafter
Long Term Debt Principal Obligations      $  9,261,000     $  1,629,000     $ 1,858,000     $   162,000     $  5,612,000
Long Term Debt Interest Obligations (1)      7,843,000          589,000         879,000         800,000        5,575,000
Capital Lease Obligations                      159,000           53,000         101,000           5,000                -
Capital Lease Interest Obligations              16,000            8,000           8,000               -                -
Operating Lease Obligations                 17,995,000        2,120,000       5,049,000       3,154,000        7,672,000
Total                                     $ 35,274,000     $  4,399,000     $ 7,895,000     $ 4,121,000     $ 18,859,000

In March 2009, the lease on one of our facilities in Hollywood, CA ("Highland") expired and the Company became a holdover tenant. The landlord has issued a Notice to Quit which will require us to move out of the facility within the next 60 days. The Company is evaluating several alternatives, including moving a portion of our operations to our other facilities and renting a significantly smaller location, to purchasing an alternate facility.

Subsequent to March 31, 2009, the Company assumed the lease of MI (see Note 14), calling for annual rent payments of approximately $550,000 per year. The following table summarizes the pro forma contractual obligations assuming completion of the purchase of the building, termination of the Highland and Eden FX leases and assumption of the MI lease:

                                                                      Payment due by Period
                                                           Less than 1         Years           Years
Contractual Obligations                      Total             Year           2 and 3         4 and 5        Thereafter
Long Term Debt Principal Obligations      $  9,261,000     $  1,629,000     $ 1,858,000     $   162,000     $  5,612,000
Long Term Debt Interest Obligations (1)      7,843,000          589,000         879,000         800,000        5,575,000
Capital Lease Obligations                      632,000          162,000         343,000         127,000                -
Capital Lease Interest Obligations              84,000           38,000          42,000           4,000                -
Operating Lease Obligations                 22,704,000        2,771,000       6,323,000       4,419,000        9,193,000
Total                                     $ 40,526,000     $  5,189,000     $ 9,445,000     $ 5,512,000     $ 20,380,000

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.

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.

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 and delivered on that element.

In some instances, a client will request that we store (or "vault") an element for a period ranging from a day to indefinitely. The Company attempts to bill customers a nominal amount for storage, but some customers, especially major movie studios, will not pay for this service. In the latter instance, storage is an accommodation to foster additional business with respect to the related element. It is impossible to estimate (i) the length of time we may house the element, or (ii) the amount of additional services we may be called upon to perform on an element. Because these variables are not reasonably estimable and revenues from vaulting are not material (billed vaulting revenues are approximately 3% of sales), we do not treat vaulting as a separate deliverable in those instances in which the customer does not pay.

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 . . .