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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended September 30, 2012

 

¨     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      001-33468     

 

                               Point.360                               

(Exact Name of Registrant as Specified in Its Charter)

 

California
(State or other jurisdiction of
incorporation or organization)
  01-0893376
(I.R.S. Employer Identification No.)
2701 Media Center Drive, Los Angeles, CA
(Address of principal executive offices)
  90065
(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.

 

þ Yes   ¨ No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

þ Yes   ¨ No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨ Accelerated filer   ¨
Non-accelerated filer   ¨ Smaller reporting company   þ

 

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

 

¨   Yes     þ No

 

As of September 30, 2012, there were 10,513,166 shares of the registrant’s common stock outstanding.

 

 
 

 

PART I – FINANCIAL INFORMATION

ITEM 1.     FINANCIAL STATEMENTS

 

Point.360

Consolidated Balance Sheets (Unaudited)

(in thousands)

 

   June 30,   Sept. 30, 
   2012   2012 
Assets          
Current assets:          
Cash and cash equivalents  $1,219   $517 
Accounts receivable, net of allowances for doubtful accounts of $330 and $337, respectively   5,916    6,083 
Inventories, net   272    291 
Prepaid expenses and other current assets   274    285 
Prepaid income taxes   70    70 
Total current assets   7,751    7,246 
           
Property and equipment, net   17,475    17,137 
Other assets, net   745    716 
Total assets  $25,971   $25,099 
           
Liabilities and Shareholders’ Equity          
Current liabilities:          
Current portion of notes payable  $77   $315 
Capital lease obligations   95    57 
Accounts payable   1,276    1,193 
Accrued wages and benefits   1,367    1,520 
Other accrued expenses   279    249 
Current portion of deferred gain on sale of real estate   178    178 
Current portion of deferred lease incentive   209    209 
Other current liabilities   9    10 
           
Total current liabilities   3,490    3,731 
           
Notes payable, less current portion   9,236    8,287 
Deferred gain on sale of real estate, less current portion   1,382    1,337 
Deferred lease incentive, less current portion   1,618    1,566 
Other long term liabilities   14    10 
           
Total long-term liabilities   12,250    11,200 
           
Total liabilities   15,740    14,931 
           
Commitments and contingencies (Note 4)   -    - 
           
Shareholders’ equity:          
Preferred stock – no par value; 5,000,000 shares authorized; none outstanding   -    - 
Common stock – no par value; 50,000,000 shares authorized; 10,513,166 shares issued and outstanding on June 30, 2012 and September 30, 2012   21,695    21,695 
Additional paid-in capital   10,419    10,461 
Accumulated deficit   (21,883)   (21,988)
Total shareholders’ equity   10,231    10,168 
           
Total liabilities and shareholders’ equity  $25,971   $25,099 

 

See accompanying notes to condensed consolidated financial statements.

 

2
 

 

POINT.360

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

  

Three Months Ended

September 30,

 
   2011   2012 
         
Revenues  $8,969,000   $7,661,000 
Cost of services sold   (5,526,000)   (4,953,000)
           
Gross profit   3,443,000    2,708,000 
Selling, general and administrative expense   (3,179,000)   (2,933,000)
           
Operating Income (loss)   264,000    (225,000)
Interest expense   (229,000)   (168,000)
Other income   74,000    288,000 
           
Income (loss) before income taxes   109,000    (105,000)
Provision for income taxes   -    - 
Net income (loss)  $109,000   $(105,000)
           
Income (loss) per share:          
Basic:          
Net income (loss)  $0.01   $(0.01)
Weighted average number of shares   10,513,166    10,513,166 
Diluted:          
Net income (loss)  $0.01   $(0.01)
Weighted average number of shares including the dilutive effect of stock options   10,513,166    10,513,166 

 

See accompanying notes to condensed consolidated financial statements.

 

3
 

 

POINT.360

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

  

Three Months Ended

September 30,

(in thousands)

 
   2011   2012 
         
Cash flows from operating activities:          
Net income (loss)  $109   $(105)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:          
(Gain) loss on sale of fixed assets   2    - 
Depreciation and amortization   741    584 
Amortization of deferred gain on real estate   (45)   (45)
Amortization of deferred lease credit       (56)
Provision for (recovery of) doubtful accounts   (2)   7 
Stock compensation expense   85    42 
Changes in operating assets and liabilities:          
(Increase) in accounts receivable   (305)   (174)
(Increase) decrease in inventories   86    (18)
(Increase) in prepaid expenses and other current assets   (260)   (11)
Decrease in prepaid income taxes   2    - 
Decrease in other assets       28 
Increase (decrease) in accounts payable   170    (83)
Increase in accrued wages and benefits   324    153 
Increase (decrease) in other accrued expenses   49    (29)
Net cash provided by operating activities   956    293 
           
Cash flows from investing activities:          
Capital expenditures   (459)   (246)
Net cash (used in) investing activities   (459)   (246)
           
Cash flows from financing activities:          
Repayment of line of credit,   (513)    
Borrowings of notes payable       8,601 
Repayment of notes payable   (72)   (9,312)
Payment of capital lease obligations   (56)   (38)
Net cash (used in) financing activities   (641)   (749)
Net (decrease) in cash and cash equivalents   (144)   (702)
Cash and cash equivalents at beginning of period   355    1,219 
Cash and cash equivalents at end of period  $211   $517 

 

Selected cash payments and non-cash activities were as follows (in thousands):

 

   Three Months Ended 
   September 30, 
   2011   2012 
Cash payments for income taxes (net of refunds)  $2   $- 
Cash payments for interest  $224   $206 

 

See accompanying notes to condensed consolidated financial statements.

 

4
 

 

Point.360

Notes to Condensed Consolidated Financial Statements (unaudited)

September 30, 2012

 

Note 1 – THE COMPANY

 

The Company provides high definition and standard definition digital mastering, data conversion, video and film asset management and sophisticated computer graphics services to owners, producers and distributors of entertainment and advertising content. The Company provides the services necessary to edit, master, reformat, convert, archive and ultimately distribute its clients’ film and video content, including television programming feature films and movie trailers. The Company’s interconnected facilities provide service coverage to all major U.S. media centers. Clients include major motion picture studios and independent producers. The Company also rents and sells DVDs directly to consumers through its Movie>Q retail stores.

 

The Company operates in two business segments from three post production and three Movie>Q locations. Each post production location is electronically tied to the others and serves the same customer base. Depending on the location size, the production equipment consists of tape duplication, feature movie and commercial ad editing, encoding, standards conversion, and other machinery. Each location employs personnel with the skills required to efficiently run the equipment and handle customer requirements. While all locations are not exactly the same, an order received at one location may be fulfilled at one or more “sister” facilities to use resources in the most efficient manner.

 

Typically, a feature film or television show or related material will be submitted to a facility by a motion picture studio, independent producer, advertising agency, or corporation for processing and distribution. A common sales force markets the Company’s capability for all facilities. Once an order is received, the local customer service representative determines the most cost-effective way to perform the services considering geographical logistics and facility capabilities.

 

In fiscal 2010, the Company purchased assets and intellectual property for a research and development project to address the viability of the DVD rental business being abandoned by the closure of Movie Gallery/Hollywood Video and Blockbuster stores. The DVD rental market consists principally of online services (Netflix), vending machines (Redbox) and other video stores.

 

As of September 30, 2012, the Company had opened three Movie>Q stores in Southern California. The stores employ an automated inventory management (“AIM”) system in a 1,200-1,600 square foot facility. By saving space and personnel costs which caused the big box stores to be uncompetitive with lower priced online and vending machine rental alternatives, Movie>Q can offer up to 10,000 unit selections to a customer at competitive rental rates. Movie>Q provides online reservations, an in-store destination experience, first run movie titles and a large unit selection (as opposed to 400-700 for a Redbox vending machine).

 

Based on the success of the three stores, the Company may seek to expand the number of Movie>Q stores while further streamlining the design and production of the AIM system. Movie>Q provides the Company with a content distribution capability complimentary to the Company’s post production business.

 

The accompanying unaudited Condensed Consolidated Financial Statements include the accounts and transactions of the Company, including those of the Company’s subsidiaries. The statements have been prepared in accordance with accounting principles generally accepted in the United States of America and by 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. All intercompany balances and transactions have been eliminated in the Condensed Consolidated Financial Statements. Operating results for the three month period ended September 30, 2012 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2013. 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 period ended June 30, 2012.

 

5
 

 

Pro Forma Earnings (Loss) Per Share

 

A reconciliation of the denominator of the basic earnings per share (“EPS”) computation to the denominator of the diluted EPS computation is as follows (in thousands):

 

   Three Months
Ended
September 30,
   Three Months
Ended
September 30,
 
   2011   2012 
         
Pro forma weighted average of number of shares          
Weighted average number of common shares outstanding used in computation of basic EPS   10,513    10,513 
Dilutive effect of outstanding stock options   -    - 
Weighted average number of common and potential Common shares outstanding used in computation of Diluted EPS   10,513    10,513 
Effect of dilutive options excluded in the computation of diluted EPS due to net loss   -    - 

 

The weighted average number of common shares outstanding were the same amount for both basic and diluted income per share in the three month periods ended September 30, 2011 and 2012. The effect of potentially dilutive securities for the three month periods ended September 30, 2011 and 2012 were excluded from the computation of diluted earnings per share because their effect would be anti-dilutive (i.e., including such securities would result in a higher earnings per share, or lower loss per share, respectively). The number of potentially dilutive shares at September 30, 2011 and 2012, was 2,222,475 and 2,491,525, respectively.

 

Fair Value Measurements

 

The Company follows a framework for consistently measuring fair value under generally accepted accounting principles, and the disclosures of fair value measurements. The framework provides a fair value hierarchy to classify the source of the information.  

 

The fair value hierarchy is based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value and include the following:

 

Level 1 – Quoted prices in active markets for identical assets or liabilities.

 

Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

  

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

Cash, the only Level 1 input applicable to the Company (there are no Level 2 or 3 inputs), is stated on the Condensed Consolidated Balance Sheets at fair value.

 

As of September 30, 2012 the carrying value of cash and cash equivalents, accounts receivable, accounts payable, accrued expenses and interest payable approximates fair value due to the short-term nature of such instruments. The carrying value of other long-term liabilities approximates fair value as the related interest rates approximate rates currently available to the Company.

 

Recent Accounting Pronouncements

 

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” This guidance amends the disclosure requirements related to recurring and nonrecurring fair value measurements and requires new disclosures on the transfers of assets and liabilities between Level 1 (quoted prices in active market for identical assets or liabilities) and Level 2 (significant other observable inputs) of the fair value measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the guidance requires a roll forward of activities on purchases, sales, issuance and settlements of the assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements). The guidance became effective for the reporting period beginning July 1, 2010, except for the disclosure on the roll forward activities for Level 3 fair value measurements, which became effective for the reporting period beginning July 1, 2011. Other than requiring additional disclosures, adoption of this new guidance does not have a material impact on our financial statements.

 

6
 

 

In May 2011, the FASB issued updated accounting guidance related to fair value measurements and disclosures that result in common fair value measurements and disclosures between U.S. GAAP and International Financial Reporting Standards. This guidance includes amendments that clarify the application of existing fair value measurement requirements, in addition to other amendments that change principles or requirements for measuring fair value and for disclosing information about fair value measurements. The adoption of this guidance has not had any impact on the Company’s consolidated financial statements.

 

In June 2011, the FASB issued new accounting guidance related to the presentation of comprehensive income that eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity. The amendments require that all non-owner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendments do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The adoption of this guidance has not impacted the Company’s financial position, results of operations or cash flows and will only impact the presentation of other comprehensive income in the financial statements if necessary in the future.

 

NOTE 2 - LONG TERM DEBT AND NOTES PAYABLE

 

In July 2008, the Company entered into a Promissory Note with a bank (the “note”) in order to purchase land and a building that had 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. The mortgage debt was secured by the land and building. The mortgage was paid off in September 2012 and replaced by a new mortgage (see below). The Company received a $332,000 discount in connection with the payoff and wrote off approximately $90,000 of deferred financing costs related to the note, both of which were recorded as other income (expense) in the quarter ended September 30, 2012.

 

In June 2009, the Company entered into a $3,562,500 Purchase Money Promissory Note secured by a Deed of Trust for the purchase of land and a building. The note was repaid in September 2012 and replaced by a new mortgage (see below).

 

In November 2010, the Company converted approximately $1 million of accounts payable into a note secured by a lien of all the Company’s assets, which security interest was subordinated to that of the $3 million credit agreement and other term and mortgage debt. April 2011, the Company received $1 million in settlement of a claim, and prepaid $333,000 of the above $1 million note. The remaining amount due under the note was paid in October 2011, at a 12.5% discount.

 

In January 2011, the Company entered into a credit agreement which provided $1 million of credit. In March 2011, the credit limit was increased to $3 million. In November 2011, the credit limit remained at $3 million. In August 2012, the credit agreement was replaced as discussed below.

 

In August and September of 2012, the Company entered into revolving credit, equipment financing and two mortgage agreements with a bank as follows:

 

Revolving Credit Facility. The revolving credit facility provides up to $5 million of credit based on 80% of eligible accounts receivable, as defined. The agreement provides for interest at the lower of (i) Libor plus 2.75% (2.97% as of September 30, 2012) or (ii) the bank’s alternative base rate plus 1.75% (5.00% as of September 30, 2012), plus 0.25% per annum assessed on the unused portion of the credit commitment. The maturity date is August 15, 2014 and is renewable for an additional year on each anniversary date upon mutual agreement of the parties.

 

Equipment Financing Facility. The equipment financing facility provides up to $1.25 million of financing for the cost of new and already-owned or leased equipment. The agreement provides for interest at the bank’s cost of funds plus 3% (4.01% as of September 30, 2012). The maturity date for each “schedule” of equipment is up to four years from the borrowing date. Amounts may be borrowed under the facility until August 14, 2013.

 

Hollywood Way and Vine Street Mortgages. In September 2012, the Company entered into two real estate term loan agreements with respect to its Hollywood Way and Vine Street locations for $5.5 million and $3.1 million, respectively. The loans provide for interest at Libor plus 3% (3.22% as of September 30, 2012). Repayment is based on monthly payments with a 25-year amortization, with all principal due in 10 years. The real estate loans are secured by trust deeds on the properties.

 

General Terms. All amounts due under the revolving credit, equipment financing and term loan facilities are secured by all personal property and real estate of the Company. While amounts are outstanding under the credit arrangements, the Company will be subject to financial covenants as follows:

 

1.Minimum tangible net worth (TNW) of $8.5 million (the Company’s actual TNW was $10.2 million as of September 30, 2012).

 

7
 

 

2.Minimum quarterly EBITDA (as defined) of $750,000, provided that EBITDA may be a minimum of $500,000 in any one quarter within four consecutive quarters (the Company’s EBITDA was $0.8 million for the quarter ended September 30, 2012).

 

3.Minimum quarterly fixed charge ratio (as defined) of 1.25 (the Company’s fixed charge ratio was 2.95 for the quarter ended September 30, 2012).

 

All obligations to the bank are cross collateralized and there are cross-default provisions among the bank and all other Company debt obligations. The agreements contain certain other terms and conditions common with such arrangements.

 

Amounts Borrowed. As of September 30, 2012, the Company had no outstanding borrowings under the revolving credit facility and equipment financing facilities.

 

In connection with the termination of the prior credit agreement, the Company paid a $30,000 break-up fee, which was reflected in other income/expense in the quarter ended September 30, 2012.

 

NOTE 3- PROPERTY AND EQUIPMENT

 

In March 2006, the Company entered into a sale and leaseback transaction with respect to its Media Center vaulting real estate. The real estate was sold for approximately $14.0 million resulting in a $1.3 million after tax gain. Additionally, the Company received $0.5 million from the purchaser for improvements. In accordance with the Accounting Standards Codification (ASC) 840-40, the gain will be amortized over the initial 15-year lease term as reduced rent. Net proceeds at the closing of the sale and improvement advance (approximately $13.8 million) were used to pay off the mortgage and other outstanding debt. A $250,000 security deposit related to the lease has been recorded as a deposit in “other assets, net” in the Condensed Consolidated Balance Sheets as of June 30, 2012 and September 30, 2012.

 

The lease is treated as an operating lease for financial reporting purposes. After the initial lease term, the Company has four five-year options to extend the lease. Minimum annual rent payments for the initial five years of the lease are $1,111,000, increasing annually thereafter based on the Consumer Price Index change from year to year.

 

In June 2011, the Company entered into a lease amendment with respect to the Company’s Media Center facility. The amendment provides that the landlord would reimburse the Company up to $2 million for the leasehold improvements to be made by the Company to the premises. The leasehold improvements would be recorded as a fixed asset and amortized over the remaining term of the lease (until March 2021). Pursuant to the lease amendment, the Company’s monthly lease costs increased by approximately $14,000 on July 1, 2011, and by an additional $13,000 to approximately $27,000 on April 1, 2012. The Company incurred $2.1 million of costs for construction, of which $2.0 million was reimbursed by the landlord. A deferred lease incentive has been recorded for the total amount reimbursed by the landlord in accordance with ASC 840-20. The lease incentive is being amortized over the remaining lease term as an offset to rent.

 

The Company vacated one of its Burbank facilities on the February 28, 2012 expiration of the related lease and moved to the Media Center space, which reduced monthly operating expenses by approximately $100,000. Total annual savings beginning in April 2012 are approximately $1.2 million.

 

Property and equipment consist of the following as of September 30, 2012:

 

Land  $3,985,000 
Buildings   9,280,000 
Machinery and equipment   37,690,000 
Leasehold improvements   9,052,000 
Computer equipment   7,800,000 
Equipment under capital lease   856,000 
Office equipment, CIP   604,000 
Subtotal   69,267,000 
Less accumulated depreciation and amortization   (52,130,000)
Property and equipment, net  $17,137,000 

 

8
 

 

NOTE 4- COMMITMENTS AND CONTINGENCIES

 

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

 

NOTE 5- INCOME TAXES

 

The Company reviewed its Accounting Standards Codification (“ASC”) 740-10 documentation for the periods through September 30, 2012 to ascertain if any changes should be made with respect to tax positions previously taken. In addition, the Company reviewed its income tax reporting through September 30, 2012. Based on Company’s review of its tax positions as of September 30, 2012, no new uncertain tax positions have resulted; nor has new information become available that would change management’s judgment with respect to tax positions previously taken.

 

As of September 30, 2012, the Company's net deferred tax assets were nil.  No tax benefit was recorded during the three month period ended September 30, 2012 because future realizability of such benefit was not considered to be more likely than not. 

 

The ASC prescribes a recognition and measurement of a tax position taken or expected to be taken in a tax return and provides guidance on derecognition of tax benefits, classification on the balance sheet, interest and penalties, accounting in interim periods, disclosure, and transition.

 

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 2008. 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.

 

NOTE 6- STOCK OPTION PLAN, STOCK-BASED COMPENSATION

 

In May 2007, the Board of Directors approved the 2007 Equity Incentive Plan (the “2007 Plan”). The 2007 Plan provides for the award of options to purchase up to 2,000,000 shares of common stock, appreciation rights and restricted stock awards.

 

Under the 2007 Plan, the stock option price per share for options granted is determined by the Board of Directors and is based on the market price of the Company’s common stock on the date of grant, and each option is exercisable within the period and in the increments as determined by the Board, except that no option can be exercised later than ten years from the grant date. The stock options generally vest in one to five years.

 

In November 2010, the shareholders approved the 2010 Incentive Plan (the “2010 Plan”). The 2010 Plan provides for the award of options to purchase up to 4,000,000 shares of common stock, appreciation rights and restricted stock and performance awards.

 

Under the 2010 Plan, the stock option price per share for options granted is determined by the Board of Directors and is based on the market price of the Company’s common stock on the date of grant, and each option is exercisable within the period and in the increments as determined by the Board, except that no option can be exercised later than ten years from the grant date. The stock options generally vest in one to five years.

 

The Company measures and recognizes compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. We also estimate the fair value of the award that is ultimately expected to vest to be recognized as expense over the requisite service periods in our Condensed Consolidated Statements of Operations.

 

We estimate the fair value of share-based payment awards to employees and directors on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s Condensed Consolidated Statements of Operations. Stock-based compensation expense recognized in the Condensed Consolidated Statements of Operations for the three month period ended September 30, 2012 included compensation expense for the share-based payment awards based on the grant date fair value. For stock-based awards issued to employees and directors, stock-based compensation is attributed to expense using the straight-line single option method. As stock-based compensation expense recognized in the Condensed Consolidated Statements of Operations for the periods reported in this Form 10-Q is based on awards expected to vest, forfeitures are also estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. For the period being reported in this Form 10-Q, expected forfeitures are immaterial. The Company will re-assess the impact of forfeitures if actual forfeitures increase in future quarters. Stock-based compensation expense related to employee or director stock options recognized for the three month periods ended September 30, 2011 and 2012 was as follows:

 

9
 

 

Three months ended September 30, 2012  $42,000 
Three months ended September 30, 2011   85,000 

 

The Company’s determination of fair value of share-based payment awards to employees and directors on the date of grant uses the Black-Scholes model, which is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, the expected stock price volatility over the expected term of the awards, and actual and projected employee stock options exercise behaviors. The Company estimates expected volatility using historical data. The expected term is estimated using the “safe harbor” provisions provided by the SEC.

 

During each of the three month periods ended September 30, 2011 and 2012, the Company granted no awards of stock options.

 

The following table summarizes the status of the 2007 and 2010 Plans as of September 30, 2012:

 

   2007 Plan   2010 Plan   Total 
Options originally available   2,000,000    4,000,000    6,000,000 
Stock options outstanding   1,952,625    538,900    2,491,525 
Options available for grant   35,375    3,461,100    3,496,475 

 

Transactions involving stock options are summarized as follows:

 

   Number
of Shares
   Weighted Average
Exercise Price
   Weighted Average
Grant Date
Fair Value
 
             
Balance at June 30, 2012   2,493,125   $1.32   $0.64 
Granted   -   $-   $- 
Exercised   -   $-   $- 
Cancelled   (1,600)  $1.10   $0.49 
                
Balance at September 30, 2012   2,491,525   $1.32   $0.64 

 

As of September 30, 2012, the total compensation costs related to non-vested awards yet to be expensed was approximately $0.3 million to be amortized over the next four years.

 

The weighted average exercise prices for options granted and exercisable and the weighted average remaining contractual life for options outstanding as of September 30, 2012 were as follows:

 

As of September 30, 2012 

Number of

Shares

  

Weighted Average

Exercise Price ($)

   Weighted Average
Remaining
Contractual Life
(Years)
  

Intrinsic

Value ($)

 
                 
Employees – Outstanding   2,256,525    1.32    2.03    107,000 
Employees – Expected to Vest   2,030,873    1.32    2.03    107,000 
Employees – Exercisable   1,331,994    1.54    1.09    95,000 
                     
Non-Employees-Outstanding   235,000    1.30    1.70     
Non-Employees- Expected to Vest   235,000    1.30    1.70     
Non-Employees-Exercisable   227,500    1.44    1.65     

 

The aggregate intrinsic value in the table above is the sum of the amounts by which the quoted market price of our common stock exceeded the exercise price of the options at September 30, 2012, for those options for which the quoted market price was in excess of the exercise price.

 

10
 

 

Additional information with respect to outstanding options as of September 30, 2012 is as follows (shares in thousands):

 

Options Outstanding  Options Exercisable 
Options Exercise
Price Range
   Number of
Shares
   Weighted
Average
Remaining
Contractual Life
  Weighted
Average
Exercise Price
   Number of
Shares
   Weighted
Average Exercise
Price
 
$1.79    938,300   0.4 Years  $1.79    938,300   $1.79 
$1.37    30,000   1.1 Years  $1.37    30,000   $1.37 
$1.29    303,600   2.4 Years  $1.29    152,050   $1.29 
$1.27    15,000   2.9 Years  $1.27    7,500   $1.27 
$1.20    248,425   1.4 Years  $1.20    186,694   $1.20 
$1.15    30,000   3.1 Years  $1.15    30,000   $1.15 
$1.07    30,000   4.2 Years  $1.07    30,000   $1.07 
$1.05    30,000   2.1 Years  $1.05    30,000   $1.05 
$0.95    247,000   4.5 Years  $0.95    -   $0.95 
$0.86    544,200   3.4 Years  $0.86    136,200   $0.86 
$0.75    75,000   3.6 Years  $0.75    18,750   $0.75 

 

In addition to the above 2007 Plan, the Company issued 10,000 shares of restricted stock during fiscal year ended June 30, 2010 with a weighted average fair value of $0.58 per share.

 

We use the detailed method provided in ASC 718 for calculating the beginning balance of the additional paid-in capital pool (APIC pool) related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC pool and Consolidated Statements of Cash Flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of ASC 718.

 

NOTE 7- STOCK RIGHTS PLAN

 

In July 2007, the Company implemented a stock rights program. Pursuant to the program, stockholders of record on August 7, 2007, received a dividend of one right to purchase for $10 one one-hundredth of a share of a newly created Series A Junior Participating Preferred Stock. The rights are attached to the Company’s Common Stock and will also become attached to shares issued subsequent to August 7, 2007. The rights will not be traded separately and will not become exercisable until the occurrence of a triggering event, defined as an accumulation by a single person or group of 20% or more of the Company’s Common Stock. The rights will expire on August 6, 2017 and are redeemable at $0.0001 per right.

 

After a triggering event, the rights will detach from the Common Stock. If the Company is then merged into, or is acquired by, another corporation, the Company has the opportunity to either (i) redeem the rights or (ii) permit the rights holder to receive in the merger stock of the Company or the acquiring company equal to two times the exercise price of the right (i.e., $20). In the latter instance, the rights attached to the acquirer’s stock become null and void. The effect of the rights program is to make a potential acquisition of the Company more expensive for the acquirer if, in the opinion of the Company’s Board of Directors, the offer is inadequate.

 

No triggering events occurred in the three months ended September 30, 2012.

 

NOTE 8- SHAREHOLDER’S EQUITY

 

The following table analyzes the components of shareholders’ equity from June 30, 2012 to September 30, 2012 (in thousands):

 

   Common
Stock
   Paid-in
Capital
   Accumulated
(Deficit)
   Shareholders’
Equity
 
Balance, June 30, 2012  $21,695   $10,419   $(21,883)  $10,231 
Stock-based compensation expense   -    42    -    42 
Net loss   -    -    (105)   (105)
Balance, September 30, 2012  $21,695   $10,461   $(21,988)  $10,168 

 

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NOTE 9- STOCK REPURCHASE PLAN

 

In February 2008, the Company’s Board of Directors authorized a stock repurchase program. Under the stock repurchase program, the Company may purchase outstanding shares of its common stock on the open market at such times and prices determined in the sole discretion of management. No shares were acquired pursuant to the repurchase program during the three month period ended September 30, 2012.

 

NOTE 10- SEGMENT INFORMATION:

 

In its operation of the business, management reviews certain financial information, including segmented internal profit and loss statements prepared on a basis consistent with U.S. generally accepted accounting principles. Our two segments are Point.360 and Movie>Q. The two segments discussed in this analysis are presented in the way we internally managed and monitored performance for the three month periods ended September 30, 2011 and 2012. Allocations for internal resources were made for the three month periods ended September 30, 2011 and 2012. The Movie>Q segment tracks certain assets separately, and all others are recorded in the Point.360 segment for internal reporting presentations. Cash was not segregated between the two segments but retained in the Point.360 segment.

 

The types of services provided by each segment are summarized below:

 

Point.360 – The Point.360 segment provides high definition and standard definition digital mastering, data conversion, video and film asset management and sophisticated computer graphics services to owners, producers and distributors of entertainment and advertising content. Point.360 provides the services necessary to edit, master, reformat, convert, archive and ultimately distribute its clients’ film and video content, including television programming feature films and movie trailers. The segment’s interconnected facilities provide service coverage to all major U.S. media centers. Clients include major motion picture studios and independent producers.

 

Movie>Q – The Movie>Q segment rents and sells DVDs directly to consumers though its retail stores. The stores employ an automated inventory management (“AIM”) system in a 1,200-1,600 square foot facility. By saving space and personnel costs which caused the big box stores to be uncompetitive with lower priced online and vending machine rental alternatives, Movie>Q can offer up to 10,000 unit selections to a customer at competitive rental rates. Movie>Q provides online reservations, an in-store destination experience, first run movie and game titles and a large unit selection.

 

Segment revenues, operating loss and total assets were as follows (in thousands):

 

Revenue  Three Months
Ended
September 30,
 
   2011   2012 
Point.360  $8,833   $7,544 
Movie>Q   136    117 
Consolidated revenue  $8,969   $7,661 

 

Operating income (loss)   Three Months
Ended
September 30,
 
   2011   2012 
Point.360  $466   $(19)
Movie>Q    (202)   (206)
Operating income (loss)  $264   $(225)

 

Total Assets  June 30,   September 30, 
   2012   2012 
Point.360  $24,536   $23,778 
Movie>Q   1,435    1,321 
Consolidated assets  $25,971   $25,099 

 

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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, depending 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, including the Risk Factors section of the Company’s most recent annual report on Form 10-K, 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. The Company also rents and sells DVDs directly to consumers through its Movie>Q retail stores.

 

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 has 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. We also believe that a potentially large consumer market exists for the rental of DVDs, which market is being abandoned by “big box” DVD rental stores.

 

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 constituted approximately 84% of our revenues in the three months ended September 30, 2012. 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 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 others) that can increase revenues by adding new customers, or expanding current services to existing customers. Additionally, we are looking to capitalize on the Movie>Q retail opportunity.

 

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 September 30, 2012 Compared to Three Months Ended September 30, 2011

 

Revenues. Revenues were $7.7 million for the three months ended September 30, 2012, compared to $9.0 million for the three months ended September 30, 2011. Revenues declined due to the timing of orders received with respect to seasonal television programming. Several programs from the fiscal 2012 quarter were cancelled and were not replaced in the fiscal 2013 quarter. Networks, and consequently, our major television customer, are tending to spread shows and new season debuts throughout the year to draw greater audiences. We expect revenues to return to historic levels in future quarters. We continue to have excellent relations with our major customers.

 

13
 

 

Cost of Services. Costs of services consist principally of wages and benefits, facility costs and depreciation of physical assets. During the three months ended September 30, 2012, total costs of services declined $0.6 million, and were 65% of sales compared to 62% in the prior year. The majority of the decrease was associated with depreciation, facility and material costs. Material costs declined due to the reorganization of functions associated with the shift from physical to file based processes. This also contributed to lower delivery costs. Beginning in the fourth quarter of fiscal 2012, facility costs decreased by approximately $0.3 million per quarter due to the move of one of our Burbank locations to our Media Center facility, which savings is expected to continue.

 

Gross Profit. In the three months ended September 30, 2012, gross margin was 35% of sales, compared to 38% for the same period last year. The decrease in gross profit percentage is due to the factors cited above. From time to time, we will increase or decrease staff capabilities to satisfy potential customer service demand. We expect gross margins to fluctuate in the future as the sales mix changes.

 

Selling, General and Administrative Expense. SG&A expense was $2.9 million (38% of sales) in the three months ended September 30, 2012 as compared to $3.2 million (35% of sales) in the same period last year. The decrease in SG&A costs was due primarily to lower facility costs in the current period when compared to last year’s period.

 

Operating Income (Loss). Operating loss was $0.2 million in the fiscal 2013 period, compared to a $0.3 million income in the same period last year.

 

Interest Expense. Net interest expense was $0.2 million in both periods. We expect interest expense to decline during the remainder of fiscal 2013 due to a refinancing of our revolving debt and term loans during the quarter ended September 30, 2012 at lower interest rates. Interest expense for our two term loan mortgages will decline by approximately $90,000 per quarter (based on September 30, 2012 rates) beginning in the second quarter of fiscal 2013.

 

Other Income. Other income in both periods represents sublease income and gain on sale of fixed assets. In the 2012 three month period, other income also included a $0.3 million discount on debt repayment and the write off of $0.1 million deferred financing and other costs associated with the termination of a line of credit and one mortgage loan.

 

Net Income (Loss). The net loss was $0.1 million in the fiscal 2012 period, compared to net income of $0.1 million in the 2011 period.

 

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.

 

In July 2008, the Company entered into a Promissory Note with a bank (the “note”) in order to purchase land and a building that had 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. The mortgage was paid off in September 2012 and replaced by a new mortgage (see below). The Company received a $332,000 discount in connection with the payoff and wrote off approximately $90,000 of deferred financing costs related to the note, both of which were recorded as other income (expense) in the quarter ended September 30, 2012.

 

In June 2009, the Company entered into a $3,562,500 Purchase Money Promissory Note secured by a Deed of Trust for the purchase of land and a building. The note was repaid in September 2012 and replaced by a new mortgage (see below).

 

In November 2010, the Company converted approximately $1 million of accounts payable into a note secured by a lien of all the Company’s assets, which security interest was subordinated to that of the $3 million credit agreement and other term and mortgage debt. In April 2011, the Company received $1 million in settlement of a claim, and prepaid $333,000 of the above $1 million note. The remaining amount due under the note was paid in October 2011, at a 12.5% discount.

 

In January 2011, the Company entered into a credit agreement which provided $1 million of credit. In March 2011, the credit limit was increased to $3 million. In August 2012, the credit agreement was terminated and replaced as discussed below.

 

In August and September of 2012, the Company entered into revolving credit, equipment financing and two mortgage agreements with a bank as follows:

 

14
 

 

Revolving Credit Facility. The revolving credit facility provides up to $5 million of credit based on 80% of eligible accounts receivable, as defined. The agreement provides for interest at the lower of (i) Libor plus 2.75% (2.97% as of September 30, 2012) or (ii) the bank’s alternative base rate plus 1.75% (5.00% as of September 30, 2012), plus 0.25% per annum assessed on the unused portion of the credit commitment. The maturity date is August 15, 2014 and is renewable for an additional year on each anniversary date upon mutual agreement of the parties.

 

Equipment Financing Facility. The equipment financing facility provides up to $1.25 million of financing for the cost of new and already-owned or leased equipment. The agreement provides for interest at the bank’s cost of funds plus 3% (4.01% as of September 30, 2012). The maturity date for each “schedule” of equipment is up to four years from the borrowing date. Amounts may be borrowed under the facility until August 14, 2013.

 

Hollywood Way and Vine Street Mortgages. In September 2012, the Company entered into two real estate term loan agreements with respect to its Hollywood Way and Vine Street locations for $5.5 million and $3.1 million, respectively. The loans provide for interest at Libor plus 3% (3.22% as of September 30, 2012). Repayment is based on monthly payments with a 25-year amortization, with all principal due in 10 years.

 

In connection with the new financing of the Hollywood Way mortgage, the Company received $126,000 (the difference between the new $5,526,000 loan and the $5,400,000 payoff amount of the old loan). The Company used cash of $491,000 (the difference between $3,566,000 payoff of the old loan and $3,075,000 provided by the new loan) in the Vine refinancing. The cash used for both transactions was $365,000, net of transaction costs. We expect annual interest savings on the two new mortgages to be approximately $360,000 based on the new mortgage interest rate as of September 30, 2012 as compared to the rates for the prior mortgages.

 

General Terms. All amounts due under the revolving credit, equipment financing and term loan facilities are secured by all personal property and real estate of the Company. While amounts are outstanding under the credit arrangements, the Company will be subject to financial covenants as follows:

 

1.Minimum tangible net worth (TNW) of $8.5 million (the Company’s actual TNW was $10.2 million as of September 30, 2012).

 

2.Minimum quarterly EBITDA (as defined) of $750,000, provided that EBITDA may be a minimum of $500,000 in any one quarter within four consecutive quarters (the Company’s EBITDA was $0.8 million for the quarter ended September 30, 2012).

 

3.Minimum quarterly fixed charge ratio (as defined) of 1.25 (the Company’s fixed charge ratio was 2.95 for the quarter ended September 30, 2012).

 

All obligations to the bank are cross collateralized and there are cross-default provisions among the bank and all other Company debt obligations. The agreements contain certain other terms and conditions common with such arrangements.

 

Amounts Borrowed. As of September 30, 2012, the Company had no outstanding borrowings under the revolving credit facility and equipment financing facilities.

 

In connection with the termination of the prior credit agreement, the Company paid a $30,000 break-up fee, which was reflected in other income/expense in the quarter ended September 30, 2012.

 

Monthly and annual principal and interest payments due under the capital leases and mortgages are approximately $53,000 and $0.6 million, respectively, assuming no change in interest rates.

 

The following table summarizes the September 30, 2012 amounts outstanding under our line of credit, capital lease obligations and mortgage loans:

 

Line of credit  $- 
Current portion of, capital leases and mortgages   372,000 
Long-term portion of notes payable, capital leases and mortgages   8,287,000 
Total  $8,659,000 

 

15
 

 

The Company’s cash balance decreased from $1,219,000 on July 1, 2012 to $517,000 on September 30, 2012, due to the following:

 

Balance July 1, 2012  $1,219,000 
Increase in accounts receivable   (174,000)
Increase in accrued expenses   122,000 
Capital expenditures for property and equipment   (246,000)
Decrease in notes payable   (749,000)
Changes in other assets and liabilities   345,000 
Balance September 30, 2012  $517,000 

 

Cash generated by operating activities is directly dependent upon sales levels and gross margins achieved. We generally receive payments from customers in 60-120 days after services are performed. The larger payroll and facilities components of our cost structure must be paid currently. Payment terms of other liabilities vary by vendor and type. 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 fiscal 2012 and 2013, the underlying drivers of operating cash flows (sales, receivable collections, the timing of vendor payments, facility costs and employment levels) have been consistent. Sales outstanding in accounts receivable have increased from approximately 64 days to 77 days within the last 12 months. We do not expect days sales outstanding to materially fluctuate in the future.

 

The Company purchased the Vine Property in June 2009. The building is currently being used for storage. Building renovations will cost about $1.0-$1.5 million depending on the expected use of the space. One alternative will be to move our entire West Los Angeles operation to Vine by the May 2014 expiration of the West Los Angles lease if we decide not to exercise our option to extend the lease.

 

In June 2011, the Company entered into a lease amendment with respect to the Company’s Media Center facility. The amendment provided that the landlord would reimburse the Company for up to $2 million of improvements to be made to the premises. The amendment also provided that the Company’s monthly rent cost would increase approximately $14,000 on July 1, 2011, and an additional $13,000 to approximately $27,000 on April 1, 2012.

 

The Company incurred $2.1 million of costs for the Media Center construction, of which $2.0 million was reimbursed by the landlord. The Company completed the project and vacated one of its Burbank facilities on the February 28, 2012 expiration of the related lease and move to the Media Center space. Total annual savings beginning in April 2012 are approximately $1.2 million.

 

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.

 

The following table summarizes contractual obligations as of September 30, 2012 due in the future:

 

   Payment due by Period 
Contractual Obligations  Total   Less than 1 Year   Years
2 and 3
   Years 
4 and 5
   Thereafter 
Long-Term Debt  Principal Obligations  $8,603,000   $316,000   $688,000   $688,000   $6,911,000 
Long-Term Debt Interest Obligations (1)   2,247,000    260,000    524,000    479,000    984,000 
Capital Lease Obligations   57,000    57,000    -    -    - 
Capital Lease Interest Obligations   1,000    1,000    -    -    - 
Operating Lease Obligations   16,454,000    1,909,000    3,715,000    3,844,000    6,986,000 
Line of Credit Obligations   -    -    -    -    - 
Total  $27,362,000   $2,543,000   $4,927,000   $5,011,000   $14,881,000 

 

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

 

As described elsewhere in this Form 10-Q, the Company began a research and development project in Fiscal 2010 to create “proof of concept” stores to distribute digital video discs (DVDs) to consumers. The Company hopes to capture a portion of the DVD rental market being vacated by the closure of many larger distribution vendors (e.g., Blockbuster and Hollywood Video) locations. The Company initially issued stock (valued at $500,000) and cash for assets and intellectual property, and spent $4.7 million in Fiscal 2010 and 2011 to test the concept. The plan was to open five test stores, three of which were completed at a cost of approximately $200,000 per store for the physical build-out and inventory. The remaining two of the leased facilities remain unimproved. Over the last 12 months, the quarterly negative cash flow (defined as earnings before interest, taxes, depreciation and amortization) for each of the three stores has averaged $13,000 on revenues of $44,000, including rent for the two vacant locations. We estimate that cash flow break even can be achieved on revenues of $60,000 per quarter per store, which level may be lower if administrative costs were spread over a larger number of stores. Further expansion of Movie>Q will depend on the performance of the stores and the availability of additional funding.

 

16
 

 

During the past year, the Company had generated sufficient cash flow to meet operating, capital expenditure and debt service needs and most of its other obligations. 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 line of credit and term loans. In the current economic climate, additional financing may not be available. 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 (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. At the end of an accounting period, revenue is accrued for un-invoiced but shipped work.

 

Certain jobs specify that many discrete tasks must be performed which require up to four months to complete. In such cases, we use the proportional performance method for recognizing revenue. Under the proportional performance method, revenue is recognized based on the value of each stand-alone service completed.

 

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. We do not treat vaulting as a separate deliverable in those instances in which the customer does not pay.

 

The Company records all revenues when all of the following criteria are met: (i) there is persuasive evidence that an arrangement exists; (ii) delivery has occurred or the services have been rendered; (iii) the Company’s price to the customer is fixed or determinable; and (iv) collectability is reasonably assured. Additionally, in instances where package services are performed on multiple elements or where the proportional performance method is applied, revenue is recognized based on the value of each stand-alone service completed.

 

Allowance for doubtful accounts. We are required to make judgments, based on historical experience and future expectations, as to the collectability 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.

 

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Valuation of long-lived and intangible assets. Long-lived assets, consisting primarily of property, plant and equipment comprise a significant portion of the Company’s total assets. Long-lived assets 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 and long-lived assets 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 statement of operations, together with an equal reduction of the related asset. Net long-lived assets amounted to approximately $17.1 million as of September 30, 2012.

 

Research and Development. Research and development costs include expenditures for planned search and investigation aimed at discovery of new knowledge to be used to develop new services or processes or significantly enhance existing processes. Research and development costs also include the implementation of the new knowledge through design, testing of service alternatives, or construction of prototypes. The cost of materials and equipment or facilities that are acquired or constructed for research and development activities and that have alternative future uses are capitalized as tangible assets when acquired or constructed. All other research and development costs are expensed as incurred.

 

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.

 

At September 30, 2012, the Company has no uncertain tax positions. 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 deferred tax assets are fully reserved at September 30, 2012.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Market Risk. The Company had borrowings of $8.7 million on September 30, 2012 under note payable and mortgage agreements. Our new line of credit, equipment financing and two mortgage loans are subject to variable interest rates. The weighted average interest rate paid during the first three months of fiscal 2013 was 6.5%. On a pro forma basis had the new credit agreements been in effect at the beginning of the quarter, the weighted average interest rate would have been 3.3%. For variable rate debt outstanding at September 30, 2012, a .25% increase in interest rates will increase annual interest expense by approximately $22,000. Amounts outstanding or that may become outstanding under the new credit facilities provide for interest primarily at the LIBOR plus 2.5-3.0% (2.72% to 3.22% as of September 30, 2012). The Company’s market risk exposure with respect to financial instruments is to changes in LIBOR.

 

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ITEM 4. CONTROLS AND PROCEDURES

 

Disclosure 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 were effective as of September 30, 2012.

 

Changes in Internal Control over Financial Reporting

 

The Chief Executive Officer and President and the Chief Financial Officer conducted an evaluation of our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) to determine whether any changes in internal control over financial reporting occurred during the quarter ended September 30, 2012 that have materially affected or which are reasonably likely to materially affect internal control over financial reporting. Based on the evaluation, no such change occurred during such period.

 

Internal control over financial reporting refers to a process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

 

·Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;

 

·Provide reasonable assurance that transactions are recorded as necessary to permit the preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and members of our board of directors; and

 

·Provide reasonable assurance regarding the prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on our financial statements.

 

PART II – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

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

 

ITEM 1A. RISK FACTORS

 

In our capacity as Company management, we may from time to time make written or oral forward-looking statements with respect to our long-term objectives or expectations which may be included in our filings with the Securities and Exchange Commission (the “SEC”), reports to stockholders and information provided on 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.” 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. We are calling to your attention important factors that could affect our financial performance and could cause actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.

 

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

 

·Recent history of losses.
·Prior breaches and changes in credit agreements and ongoing liquidity.
·Our highly competitive marketplace.
·The risks associated with dependence upon significant customers.
·Our ability to execute our expansion strategy.

 

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·The uncertain ability to manage in a changing environment.
·Our dependence upon and our ability to adapt to technological developments.
·Dependence on key personnel.
·Our ability to maintain and improve service quality.
·Fluctuation in quarterly operating results and seasonality in certain of our markets.
·Possible significant influence over corporate affairs by significant shareholders.
·Our ability to operate effectively as a stand-alone, publicly traded company.
·The consequences of failing to implement effective internal controls over financial reporting as required by Section 404 of the Sarbanes-Oxley Act of 2002.

 

Other factors not identified above, including the risk factors described in the “Risk Factors” section of the Company’s June 30, 2012, Form 10-K filed with the Securities and Exchange Commission, may also cause actual results to differ materially from those projected by our forward-looking statements. Most of these factors are difficult to anticipate and are generally beyond our control. You should consider these areas of risk in connection with considering any forward-looking statements that may be made in this Form 10-Q and elsewhere by us and our business generally. Except to the extent of any obligation to disclose material information under the federal securities laws or the rules of the NASDAQ Global Market, we undertake no obligation to release publicly any revisions to any forward-looking statements, to report events or to report the occurrence of unanticipated events.

 

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ITEM 6. EXHIBITS

 

(a)Exhibits

 

31.1Certification of Chief Executive Officer Pursuant to 15 U.S.C. § 7241, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2Certification of Chief Financial Officer Pursuant to 15 U.S.C. § 7241, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1Certification of Chief Executive Officer Pursuant to 18 U.S.C. § 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2Certification of Chief Financial Officer Pursuant to 18 U.S.C. § 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

101The following unaudited financial information from our Quarterly Report on Form 10-Q for the quarter ended September 30, 2012, formatted in XBRL (eXtensible Business Reporting Language): (1) Consolidated Condensed Balance Sheets as of September 30, 2012 and June 30, 2012; (2) Consolidated Condensed Statements of Operations for the three months ended September 30, 2012 and 2011; (3) Consolidated Condensed Statements of Cash Flows for the three months ended September 30, 2012 and 2011; and (4) Notes to Condensed Consolidated Financial Statements.*

______________________________________

* Pursuant to Rule 406T of Regulation S-T, the information in Exhibit 101 (a) is “furnished” and is not deemed to be “filed” or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, (b) is deemed not to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and (c) is not otherwise subject to liability under those sections.

 

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.360
     
DATE: November 8, 2012 BY: /s/  Alan R. Steel
    Alan R. Steel
    Executive Vice President,
    Finance and Administration
    (duly authorized officer and principal financial officer)

 

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