XNAS:PTSX Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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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 March 31, 2012

 

o 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 o Accelerated filer o
Non-accelerated filer o 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).

 

o Yes þ No

 

 

As of March 31, 2012, there were 10,513,166 shares of the registrant’s common stock outstanding.

 

 
 

  

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

POINT.360

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(in thousands)

 

Assets  March 31,
2012
   June 30,
2011*
 
Current assets:          
Cash and cash equivalents  $42   $355 
Accounts receivable, net of allowances for doubtful accounts of $320 and $351, respectively   7,186    6,347 
Inventories, net   346    517 
Prepaid expenses and other current assets   743    216 
Prepaid income taxes   70    68 
Total current assets   8,387    7,503 
           
Property and equipment, net   18,055    17,153 
Other assets, net   732    739 
           
Total assets  $27,174   $25,395 
           
Liabilities and Shareholders’ Equity          
Current liabilities:          
Current portion of notes payable  $1,343   $1,473 
Current portion of capital lease obligations   195    236 
Accounts payable   1,444    1,274 
Accrued wages and benefits   1,520    1,058 
Other accrued expenses   314    399 
Current portion of deferred gain on sale of real estate   178    178 
Current portion of deferred lease incentive   207    - 
Total current liabilities   5,201    4,618 
           
Notes payable, less current portion   9,255    9,541 
Capital lease obligations, less current portion   47    170 
Deferred gain on sale of real estate, less current portion   1,420    1,554 
Deferred lease incentive, less current portion   1,654    - 
Other long-term liabilities   23    23 
Total long-term liabilities   12,399    11,288 
           
Total liabilities   17,600    15,906 
           
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 March 31, 2012 and June 30, 2011   21,695    21,695 
Additional paid-in capital   10,377    10,125 
Accumulated deficit   (22,498)   (22,331)
Total shareholders’ equity   9,574    9,489 
           
Total liabilities and shareholders’ equity  $27,174   $25,395 

 

See accompanying notes to condensed consolidated financial statements.

 

*Amounts derived from audited financial statements

 

1
 

 

POINT.360

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

  

Three Months Ended

March 31,

  

Nine Months Ended

March 31,

 
   2012  

 

2011

  

 

2012

  

 

2011

 
                 
Revenues   $8,497,000   $9,258,000   $26,008,000   $26,600,000 
Cost of services sold   (5,657,000)   (5,990,000)   (16,696,000)   (18,485,000)
                     
Gross profit   2,840,000    3,268,000    9,312,000    8,115,000 
Selling, general and administrative expense   (3,045,000)   (3,221,000)   (9,209,000)   (10,182,000)
Research and development expense   -    (18,000)   -    (352,000)
Impairment of long lived assets   -    (684,000)   -    (684,000)
                     
Operating Income (loss)   (205,000)   (655,000)   103,000    (3,103,000)
Interest expense   (199,000)   (216,000)   (637,000)   (611,000)
Interest income   -    -    20,000    62,000 
Other income   77,000    1,083,000    347,000    1,261,000 
                     
Income (loss) before income taxes   (327,000)   212,000    (167,000)   (2,391,000)
Provision for income taxes
   -    -    -    - 
Net income (loss)  $(327,000)  $212,000   $(167,000)  $(2,391,000)
                     
Income (loss) per share:                    
Basic:                    
Net income (loss)  $(0.03)  $0.02   $(0.02)  $(0.22)
Weighted average number of shares   10,513,166    10,763,166    10,513,166    10,685,611 
Diluted:                    
Net income (loss)  $(0.03)  $0.02   $(0.02)  $(0.22)
Weighted average number of shares
including the dilutive effect of stock
options
   10,513,166    10,763,166    10,513,166    10,685,611 

 

See accompanying notes to condensed consolidated financial statements.

 

2
 

 

POINT.360

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

   Nine Months Ended
March 31,
 
    (in thousands) 
   2012   2011 
         
Cash flows from operating activities:          
Net income (loss)  $(167)  $(2,391)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
          
(Gain) loss on sale of fixed assets   7    (181)
Depreciation and amortization   2,260    2,752 
Amortization of deferred gain on real estate   (134)   (134)
Amortization of deferred lease credit   (103)   -- 
Provision for (recovery of) doubtful accounts   (31)   (50)
        Stock compensation expense   252    232 
Impairment of long lived assets   --    684 
        Amortization of non-compete agreement   4    5 
Changes in operating assets and liabilities:          
(Increase) decrease in accounts receivable   (808)   93 
Decrease in inventories   172    72 
(Increase) in prepaid expenses
and other current assets
   (527)   (925)
Decrease in prepaid income taxes   2    1,497 
(Increase) Decrease in other assets   3    (400)
Increase in deferred lease incentive   1,964    -- 
Increase (decrease) in accounts payable   171    (955)
Increase (decrease) in accrued wages and benefits   462    (53)
(Decrease) in other accrued expenses   (84)   (822)
Net cash provided by (used in) operating
activities
   3,443    (576)
           
Cash flows from investing activities:          
Capital expenditures   (3,175)   (957)
Proceeds from sale of property and
equipment
   --    329 
                  Net cash (used in) investing activities   (3,175)   (628)
           
Cash flows from financing activities:          
Proceeds from line of credit, net   94    1,200 
Issuance of common stock   --    315 
Repayment of notes payable   (510)   (157)
Repayment of capital lease obligations   (165)   (147)
              Net cash provided by (used in) financing activities   (581)   1,211 
Net increase (decrease) in cash and cash
equivalents
   (313)   7 
Cash and cash equivalents at beginning of period   355    249 
Cash and cash equivalents at end of period  $42   $256 

 

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

 

   Nine Months Ended 
   March 31, 
   2012   2011 
 Cash payments for income taxes (net of refunds)  $2   $(1,497)
 Cash payments for interest  $594   $542 
 Settlement of a lawsuit for common stock  $--   $315 
 Assets acquired through capital lease obligations  $--   $148 

 

See accompanying notes to condensed consolidated financial statements.

 

3
 

 

Point.360

Notes to Condensed Consolidated Financial Statements (unaudited)

March 31, 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 and video games directly to consumers through its Movie>Q retail stores.

 

The Company operates in two business segments from four 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 and video game 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 March 31, 2012, the Company had opened three Movie>Q “proof-of-concept” 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 and game titles and a large unit selection (as opposed to 400-700 for a Redbox vending machine).

 

Based on the success of the proof-of-concept, the Company may seek to rapidly 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 and nine month periods ended March 31, 2012 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2012. 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, 2011.

 

4
 

 

Pro Forma Earnings (Loss) Per Share

 

A reconciliation of the denominator of the basic EPS computation to the denominator of the diluted EPS computation is as follows (in thousands):

 

   Three Months
Ended
March 31,
   Three Months
Ended
March 31,
   Nine Months
Ended
March 31,
   Nine Months
Ended
March 31,
 
   2012   2011   2012   2011 
Pro forma weighted average of number of shares   

 

 

              

 

 

 
Weighted average number of common shares outstanding
used in computation of basic EPS
   10,513    10,763    10,513    10,686 
Dilutive effect of outstanding stock options   -    -    -    - 
Weighted average number of common and potential
Common shares outstanding used in computation of
Diluted EPS
   10,513    10,763    10,513    10,686 
Effect of dilutive options excluded in the computation
of diluted EPS due to net loss
   113    -    63    32 

 

The weighted average number of common shares outstanding was the same amount for both basic and diluted income or loss per share in the three and nine month periods ended March 31, 2011. The effect of potentially dilutive securities for the nine month period ended March 31, 2011 were excluded from the computation of diluted earnings per share because the Company reported a net loss, and the effect of inclusion would be anti-dilutive (i.e., including such securities would result in a lower loss per share). Options to purchase 2,496,225 shares were outstanding at March 31, 2012. Diluted weighted average shares outstanding exclude outstanding stock options whose exercise price is in excess of the average price of the Company’s stock price. These options are excluded from the respective computations of diluted net income or loss per share because their effect would be anti-dilutive. The number of potentially dilutive shares at March 31, 2012 and 2011, was 1,540,094 and 651,675, 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 March 31, 2012 and June 30, 2011, 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 September 2011, the FASB issued Accounting Standards Update No. 2011-08, “Testing Goodwill for Impairment” (ASU No. 2011-08), which is intended to simplify goodwill impairment testing. Entities will be allowed to perform a qualitative assessment on goodwill impairment to determine whether a quantitative assessment is necessary. The revised standard is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption of ASC No. 2011-08 will not impact our financial position, results of operations, cash flows, or presentation thereof.

 

5
 

 

In May 2011, the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” ("ASU No. 2011-04"), which amends ASC Topic 820, “Fair Value Measurement”. ASU No. 2011-04 does not extend the use of fair value accounting, but provides guidance on how it should be applied where its use is already required or permitted by other standards within U.S. GAAP or International Financial Reporting Standards (“IFRSs”). ASU No. 2011-14 changes the wording used to describe many requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. Additionally, ASU No. 2011-14 clarifies the FASB's intent about the application of existing fair value measurements. ASU No. 2011-04 is effective for interim and annual periods beginning after December 15, 2011, and is applied prospectively. We adopted this guidance at the beginning of our third quarter of fiscal year 2012. The adoption of ASU No. 2011-04 did not have a material impact on our financial position, results of operations or cash flows.

 

NOTE 2 - LONG TERM DEBT AND NOTES PAYABLE

 

In January 2011, the Company entered into a credit agreement which provides $1 million of credit based on 85% of acceptable accounts receivable, as defined. The loan and security agreement provided for interest at prime rate plus 2% with an interest floor of 5.25%. In addition, the Company paid a monthly “maintenance” fee of 0.6% of the outstanding daily loan balance (an equivalent annual fee of 7.2%), and an annual commitment fee of 1% of the amount of the credit facility. Amounts outstanding under the agreement are secured by all of the Company’s assets other than real estate and are payable on demand. In March 2011, the credit limit was increased to $3 million based on 80% of acceptable accounts receivable, as defined. In November 2011, the credit limit remained at $3 million, however the borrowing base was reduced to 80% of acceptable accounts receivable less $300,000, the interest rate was reduced to prime plus 0.5% (currently 3.75%) with an interest floor of 3.75%, and the monthly maintenance fee was reduced to 0.4% (an equivalent annual fee of 4.8%). As of March 31, 2012, the Company owed $1.3 million under the credit agreement.

 

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 which was payable in monthly installments of principal and interest on a fully amortized base over 30 years at an initial five-year interest rate of 7.1% and thereafter at a variable rate equal to LIBOR plus 3.6% (6.4% as of the purchase date). The mortgage debt is secured by the land and building.

 

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 bears interest at 7% fixed for ten years. The principal amount of the note is payable on June 12, 2019. The note is secured by the property.

 

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. The note was due in 48 monthly installments of $20,000 plus interest at 3% per annum and could be prepaid at any time. The total amount due under the note was subject to a 12.5% or 6% discount if totally paid within 12 months or 18 months, respectively. 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.

 

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 March 31, 2012 and June 30, 2011.

 

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. As of March 31, 2012, the Company had incurred $2.0 million of costs for construction, of which $1.7 million had been reimbursed by the landlord. The balance due from the landlord of $309,000 as of March 31, 2012 has been recorded in prepaid expenses and other current assets on the balance sheet, and 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.

 

6
 

 

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 will reduce monthly operating expenses by approximately $100,000. Total annual savings beginning in March 2012 are expected to be approximately $1.2 million.

 

Property and equipment consist of the following as of March 31, 2012:

     
Land  $3,985,000 
Buildings   9,268,000 
Machinery and equipment   37,467,000 
Leasehold improvements   6,921,000 
Computer equipment   7,742,000 
Equipment under capital lease   856,000 
Office equipment, CIP   2,743,000 
Less accumulated depreciation and amortization    (50,927,000)
      Property and equipment, net  $18,055,000 

 

NOTE 4- COMMITMENTS AND CONTINGENCIES

 

On October 6, 2009, DG FastChannel, Inc. (“DGFC”) filed a claim in the United States District Court Central District of California, alleging that the Company violated certain provisions of agreements governing transactions related to the August 13, 2007 sale of the Company’s advertising distribution business to DGFC. DGFC alleged that (i) the Company did not fulfill its obligation to restrict a former employee from competing against DGFC subsequent to the transaction and, therefore, DGFC did not owe the Company $412,500 related to that portion of the transaction; (ii) the Company violated the noncompetition agreement between DGFC and the Company by distributing advertising content after the transaction; (iii) due to the violation of the noncompetition agreement, the post production services agreement that required DGFC to continue to vault its customers’ physical elements at the Company’s Media Center became null and void; and (iv) the Company must return all of DGFC’s vaulted material to DGFC. DGFC also sought unspecified monetary damages.

 

In September 2010, a settlement between the parties included the following: (1) The Company will be subject to a permanent injunction (until August 13, 2012) from competing in the commercial spot advertising business (as defined), (2) the Company will deliver to DGFC vaulted elements which will result in an annual reduction of vaulting revenues of approximately $0.9 million, (3) the Company will not be entitled to $412,500 (relating to the working capital reconciliation), (4) the Company will issue 250,000 shares of common stock to DGFC and (5) the parties will enter into full mutual releases and will dismiss their respective claims with prejudice. DGFC also received the right to sell the shares to the Company’s Chief Executive Officer for $500,000 on the six-month anniversary date of the agreement.

 

In connection with the settlement, the Company indemnified its Chief Executive Officer against possible losses should DGFC exercise its right to put the stock to the Chief Executive Officer, and there is a negative difference between the stated $500,000 value of the stock ($2.00 per share) and the market value on the date of the put. Alternatively, the Chief Executive Officer had the right to sell the 250,000 shares to the Company for $500,000. In April 2011, the Chief Executive Officer purchased from DGFC the put shares for $500,000, and the Company purchased from the Chief Executive Officer the 250,000 shares for $500,000 and immediately canceled the shares. In the fiscal year ended June 30, 2011, the put option expense was $152,000.

 

In November 2010, DGFC filed an ex parte application for enforcement of the settlement agreement and related stipulated injunction alleging that the Company violated the terms thereof and seeking an order enforcing the settlement agreement, an order to assess civil contempt charges and other remedies, and an order referring criminal allegations against the Company to the U.S. Attorney’s Office. In September 2011, the Court denied the ex parte application.

 

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

 

NOTE 5- INCOME TAXES

 

The Company reviewed its ASC 740-10 documentation for the periods through March 31, 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 March 31, 2012. Based on Company’s review of its tax positions as of March 31, 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.

 

7
 

 

As of March 31, 2012, the Company's net deferred tax assets were nil.  No tax benefit was recorded during the three and nine month periods ended March 31, 2012 because future realizability of such benefit was not considered to be more likely than not.  At March 31, 2012, the Company had a gross deferred tax asset of $9.3 million, and a corresponding valuation allowance of $9.3 million. At June 30, 2011, the Company had a gross deferred tax asset of $9.1 million, and a corresponding valuation allowance of $9.1 million.

 

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 2002. The Company has analyzed its filing positions in all of the federal and state jurisdictions where it is required to file income tax returns. The Company was last audited by New York taxing authorities for the years 2002 through 2004 resulting in no change. 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.

 

The Company was notified by the IRS in September 2009 of its intent to audit federal tax returns for calendar year 2006 and the period from January 1 to August 13, 2007.

 

During fiscal 2010, the Company received a federal tax refund of approximately $0.4 million related to refunds due for tax year 2005. In July 2010, the Company received a refund of $1.5 million related to tax year 2006.

 

The Company was notified by the Franchise Tax Board in April 2011 of its intent to audit California tax returns for the fiscal years ended June 30, 2008 and 2009. The audit was performed and concluded with no change.

 

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 and nine month periods ended March 31, 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 periods 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 and nine month periods ended March 31, 2012 and 2011 was as follows:

 

8
 

  

Three months ended March 31, 2012  $65,000 
Three months ended March 31, 2011   76,000 
Nine months ended March 31, 2012   252,000 
Nine months ended March 31, 2011   232,000 

 

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 and nine month periods ended March 31, 2012 and 2011, the Company granted awards of stock options as follows:

 

   2007 Plan    2010 Plan
   Options  Exercise    Options  Exercise
   Granted  Price per Share    Granted  Price per Share
Three months ended March 31, 2012  -    -    247,000  $0.95
Three months ended March 31, 2011  329,800    $0.86    222,200  $0.86
Nine months ended March 31, 2012  30,000    $1.07    247,000  $0.95
Nine months ended March 31, 2011  374,800    $0.89    222,200  $0.86

 

As of March 31, 2012, there were options outstanding to acquire 2,496,225 shares at an average exercise price of $1.32 per share.

 

The following table summarizes the status of the 2007 and 2010 Plans as of March 31, 2012:

 

   2007 Plan  2010 Plan  Total
Options originally available  2,000,000    4,000,000    6,000,000
Stock options outstanding  1,956,650    539,575    2,496,225
Options available for grant  31,350    3,460,425    3,491,775

 

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, 2011   2,233,475   $1.36   $0.65 
Granted   -   $-   $- 
Exercised   -   $-   $- 
Cancelled   (11,000)  $1.45   $0.68 
                
Balance at September 30, 2011   2,222,475   $1.36   $0.65 
Granted   30,000   $1.07   $0.57 
Exercised   -   $-   $- 
Cancelled   (2,750)  $1.64   $0.73 
                
Balance at December 31, 2011   2,249,725   $1.36   $0.65 
Granted   247,000   $0.95   $0.57 
Exercised   -   $-   $- 
Cancelled   (500)  $1.07   $0.49 
                
Balance at March 31, 2012   2,496,225   $1.32   $0.64 

 

As of March 31, 2012, the total compensation costs related to non-vested awards yet to be expensed was approximately $0.4 million to be amortized over the next four years.

 

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The weighted average exercise prices for options granted and exercisable and the weighted average remaining contractual life for options outstanding as of March 31, 2012 were as follows:

 

As of March 31, 2012 

  Number of
Shares
 

 

Weighted Average Exercise Price

  Weighted Average Remaining Contractual Life (Years) 

 

 

Intrinsic

Value 

             
Employees – Outstanding   2,261,225  $1.32  2.53  $3,000
Employees – Expected to Vest  2,035,103  $1.32  2.53  $3,000
Employees – Exercisable  1,316,344  $1.55  1.56  --
             
Non-Employees-Outstanding  235,000  $1.30  2.20  --
Non-Employees- Expected to Vest  235,000  $1.30  2.20  --
Non-Employees-Exercisable  223,750  $1.44  2.13  --

 

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 March 31, 2012, for those options for which the quoted market price was in excess of the exercise price.

 

Additional information with respect to outstanding options as of March 31, 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  941  0.9 Years  $1.79  941  $1.79
$1.37  30  1.6 Years  $1.37  30  $1.37
$1.29  304  2.9 Years  $1.29  152  $1.29
$1.27  15  3.5 Years  $1.27  4  $1.27
$1.20  249  1.9 Years  $1.20  187  $1.20
$1.15  30  3.6 Years  $1.15  30  $1.15
$1.07  30  4.7 Years  $1.07  30  $1.07
$1.05  30  2.6 Years  $1.05  30  $1.05
$0.95  247  5.0 Years  $0.95  -  $0.95
$0.86  545  3.9 Years  $0.86  136  $0.86
$0.75  75  4.1 Years  $0.75  -  $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 nine months ended March 31, 2012.

 

10
 

 

NOTE 8- SHAREHOLDER’S EQUITY

 

The following table analyzes the components of shareholders’ equity from June 30, 2011 to March 31, 2012 (in thousands):

 

 

  

Common

Stock

  

Paid-in

Capital

  

Accumulated

(Deficit)

  

Shareholders’

Equity 

 
Balance, June 30, 2011  $21,695   $10,125   $(22,331)  $9,489 
Stock-based compensation expense   -    85    -    85 
Net income   -    -    109    109 
Balance, September 30, 2011   21,695    10,210    (22,222)   9,683 
                     
Stock-based compensation expense   -    102    -    102 
Net income   -    -    51    51 
Balance, December 31, 2011  $21,695   $10,312   $(22,171)  $9,836 
                     
Stock-based compensation expense   -    65    -    65 
Net loss   -    -    (327)   (327)
Balance, March 31, 2012  $21,695   $10,377   $(22,498)  $9,574 

 

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 and nine month periods ended March 31, 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 and nine month periods ended March 31, 2012 and 2011. Allocations for internal resources were made for the three and nine month periods ended March 31, 2012 and 2011. 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 and video games 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.

 

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

 

 

 

 

Revenue

  Three Months
Ended
March 31,
   Nine Months
Ended
March 31,
 
   2012   2011   2012   2011 
Point.360  $8,358   $9,110   $25,586   $26,179 
Movie>Q   139    148    422    421 
Consolidated revenue  $8,497   $9,258   $26,008   $26,600 

 

 

 

 

Operating income (loss)

  Three Months
Ended
March 31,
   Nine Months
Ended
March 31,
 
   2012   2011   2012   2011 
Point.360  $(39)  $187   $606   $(1,501)
Movie>Q (1)   (166)   (842)   (503)   (1,602)
Operating income (loss)  $(205)  $(655)  $103   $(3,103)

 

Total Assets    March 31,   June 30,  
   2012   2011 
Point.360  $25,603   $23,608 
Movie>Q   1,571    1,787 
Consolidated assets  $27,174   $25,395 

 

(1) Includes R&D expenses related to the Movie>Q project

 

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 and video games 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.

 

12
 

 

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 and video games, 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 constitute approximately 85% of our revenues. 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 March 31, 2012 Compared to Three Months Ended March 31, 2011

 

Revenues. Revenues were $8.5 million for the three months ended March 31, 2012, compared to $9.3 million for the three months ended March 31, 2011. The decrease was due principally to the timing of orders for our major customers. We are continuing to invest in file-based capabilities where demand is expected to grow. We completed our move of one of our Burbank operations into newly renovated space in our Media Center facility in the third quarter of fiscal 2012, and to date the move has not adversely impacted revenues.

 

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, 2012, total costs of services declined by $0.3 million, and were 67% of sales compared to 65% in the prior year. Wages and benefits declined due to the reorganization of functions associated with the shift from physical to file based processes. This also contributed to a lesser demand for tape stock material. Beginning in the fourth quarter of fiscal 2012, we expect facility costs to decrease by approximately $0.3 million per quarter due to the move of one of our Burbank locations to our Media Center facility.

 

Gross Profit. In the three months ended March 31, 2012, gross margin was 33% of sales, compared to 35% for the same period last year. The decrease in gross profit percentage is due to lower sales. 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 $3.0 million (36% of sales) in the three months ended March 31, 2012 as compared to $3.2 million (35% of sales) in the same period last year. SG&A personnel costs and depreciation expense decreased $0.1 million and $0.1 million, respectively, in the current period when compared to last year’s period.

 

Research and Development Expense. During the fiscal year ended June 30, 2010, the Company undertook a research and development project to evaluate, develop and commercialize “automated” stores to rent and sell digital video discs (DVDs). The Movie>Q stores will contain up to 10,000 DVDs for rent or sale via a software-controlled automated inventory management (AIM) system contained in 1,200 to 1,600 square feet of retail space for each store. As of March 31, 2012, three Movie>Q stores were completed. Expenses associated with R&D activities were $18,000 for the quarter ended March 31, 2011.

 

Impairment of Long Lived Assets. During the period ended March 31, 2011, the Movie>Q R&D proof of concept was completed. With the selection of the AIM system as the operative DVD distribution method, we determined that the kiosk assets were impaired for accounting purposes, resulting in an impairment charge of $684,000.

 

13
 

 

Operating Loss. Operating loss was $0.2 million in the fiscal 2012 period, compared to a $0.7 million loss in the same period last year.

 

Interest Expense. Net interest expense was $0.2 million in both quarterly periods.

 

Other Income. Other income in the current year period represents principally sublease income. In last year’s period, other income included a $1.0 million settlement.

 

Net Income (Loss). Net loss was $0.3 million in the fiscal 2012 period, compared to a net income of $0.2 million in the 2011 period. Excluding the impairment charge and settlement income, the Company incurred a $0.1 loss in the quarter ended March 31, 2011.

 

Nine Months Ended March 31, 2012 Compared to Nine Months Ended March 31, 2011

 

Revenues. Revenues were $26.0 million for the nine months ended March 31, 2012, compared to $26.6 million for the nine months ended March 31, 2012. Service revenues remained consistent between the periods. We are continuing to invest in file-based capabilities where demand is expected to grow. We completed the move of one of our Burbank operations into newly renovated space in our Media Center facility in the third quarter of fiscal 2012.

 

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, 2012, total costs of services declined $1.8 million, and were 64% of sales compared to 70% in the prior year. The majority of the decrease was associated with wages and benefits and material costs. Wages and benefits declined due to the reorganization of functions associated with the shift from physical to file based processes. This also contributed to a lesser demand for tape stock material. Beginning in the fourth quarter of fiscal 2012, we expect facility costs to decrease by approximately $0.3 million per quarter due to the move of one of our Burbank locations to our Media Center facility.

 

Gross Profit. In the nine months ended March 31, 2012, gross margin was 36% of sales, compared to 31% 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 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 $9.2 million (35% of sales) in the nine months ended March 31, 2012 as compared to $10.2 million (38% of sales) in the same period last year. SG&A personnel costs, professional fees, and depreciation decreased $0.6 million $0.3 million and $0.3 million, respectively, in the current period when compared to last year’s period.

 

Research and Development Expense. During the fiscal year ended June 30, 2010, the Company undertook a research and development project to evaluate, develop and commercialize “automated” stores to rent and sell digital video discs (DVDs). The Movie>Q stores can contain up to 10,000 DVDs for rent or sale via a software-controlled automated inventory management (AIM) system contained in 1,200 to 1,600 square feet of retail space for each store. As of March 31, 2012, three Movie>Q stores were completed. Expenses associated with R&D activities were $0.4 million for the nine months ended March 31, 2011.

 

Impairment of Long Lived Assets. During the period ended March 31, 2011, the Movie>Q R&D proof of concept was completed. With the selection of the AIM system as the operative DVD distribution method, we determined that the kiosk assets were impaired for accounting purposes, resulting in an impairment charge of $684,000.

 

Operating Income (Loss). Operating income was $0.1 million in the fiscal 2012 period, compared to a $3.1 million loss in the same period last year.

 

Interest Expense. Net interest expense was $0.6 million in both quarterly periods.

 

Other Income. Other income in the current year period represents principally sublease income. In last year’s period, other income included a $1.0 million settlement.

 

Net Loss. Net loss was $0.2 million in the fiscal 2012 period, compared to a net loss of $2.4 million in the 2011 period. Excluding the impairment charge and settlement income, the loss for the nine months ended march 31, 2011 was $2.7 million.

 

14
 

 

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 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% (6.4% as of the purchase date). The mortgage debt is secured by the land and building.

 

In June 2009, the Company entered into a $3,562,500 million Purchase Money Promissory Note secured by a Deed of Trust for the purchase of land and a building (“Vine Property”). The note bears interest at 7% fixed for ten years. The principal amount of the note is payable on June 12, 2019. The note is secured by the property.

 

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. The note was due in 48 monthly installments of $20,000 plus interest at 3% per annum and could be prepaid at any time. The total amount due under the note is subject to a 12.5% or 6% discount if totally paid within 12 months or 18 months, respectively. 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.

 

Monthly and annual principal and interest payments due under the term debt and mortgages are approximately $264,000 and $3.1 million, respectively, assuming no change in interest rates.

 

In January 2011, the Company entered into a credit agreement which provides $1 million of credit based on 85% of acceptable accounts receivable, as defined. The loan and security agreement provides for interest at prime rate plus 2% with an interest floor of 5.25%. In addition, the Company paid a monthly “maintenance” fee of 0.6% of the outstanding daily loan balance (an equivalent annual fee of 7.2%), and an annual commitment fee of 1% of the amount of the credit facility. Amounts outstanding under the agreement are secured by all of the Company’s assets other than real estate and are payable on demand. In March 2011, the credit limit was increased to $3 million based on 80% of acceptable accounts receivable, as defined. In November 2011, the credit limit was reduced to 80% of acceptable accounts receivable less $300,000, the interest rate was reduced to prime plus 0.5% (currently 3.75%) with an interest floor of 3.75%, and the monthly maintenance fee was reduced to 0.4% (an equivalent annual fee of 4.8%). As of March 31, 2012, the Company owed $1.3 million under the credit agreement.

 

The following table summarizes the March 31, 2012 amounts outstanding under our line of credit, note payable, and term (including capital lease obligations) and mortgage loans:

 

Line of credit  $1,267,000 
 
Current portion of notes payable,
   capital leases and mortgages
   271,000 
Long-term portion of notes payable,
   capital leases and mortgages
   9,302,000 
 
Total
  $10,840,000 

 

 

The Company’s cash balance decreased from $355,000 on July 1, 2011 to $42,000 on March 31, 2012, due to the following:

 

Balance July 1, 2011  $355,000 
Increase in accounts receivable   (808,000)
Increase in accounts payable   171,000 
Increase in accrued expenses   378,000 
Cash provided by other operating activities   2,088,000 
Capital expenditures for property and equipment   (3,175,000)
Decrease in notes payable   (675,000)
Line of credit borrowings   94,000 
Changes in other assets and liabilities (A)   1,614,000 
Balance March 31, 2012  $42,000 

 

  (A) Includes changes in liabilities related to deferred lease incentive.

 

15
 

 

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 2011, 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 71 days to 80 days within the last 12 months. We do not expect days sales outstanding to materially fluctuate in the future.

 

As of March 31, 2012, 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. The mortgage payments are approximately $489,000 per year.

 

In March 2009, the lease on one of our facilities in Hollywood, CA (“Highland”) expired and the Company became a holdover tenant. The landlord issued a Notice to Quit which required us to move out of the facility. The Highland operations have been housed at another Company facility. Our Eden FX facility was moved to our West Los Angeles location in September 2010.

 

The Company purchased the Vine Property in June 2009. The purchase price of the Vine Property was $4.75 million, $1.2 million of which was paid in cash with the balance being financed by the seller over ten years, interest only at 7% for the entire term, with the principal amount being due at the end of the term. Building renovations, which are currently being evaluated, will cost about $1.5 million.

 

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 for up to $2 million of improvements to be made to the premises. The amendment also provides 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.

 

As of March 31, 2012, the Company had incurred $2.0 million of costs for construction, of which $1.7 million had been 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 March 2012 are expected to be 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 March 31, 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  $9,331,000   $76,000   $184,000   $214,000   $8,857,000 

Long-Term Debt Interest Obligations (1)

   8,183,000    662,000    1,246,000    1,201,000    5,074,000 
Capital Lease Obligations   242,000    195,000    47,000    -    - 
Capital Lease Interest Obligations   13,000    12,000    1,000    -    - 
Operating Lease Obligations   16,682,000    1,971,000    3,730,000    3,835,000    7,146,000 
Line of Credit Obligations   1,267,000    1,267,000    -    -    - 
Total  $35,718,000   $4,183,000   $5,208,000   $5,250,000   $21,077,000 

 

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

 

16
 

 

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 has initially issued stock (valued at $500,000) and cash for assets and intellectual property, and spent $3.7 million in Fiscal 2010 and $1.0 million in Fiscal 2011 to test the concept. We finalized the proof-of-concept in March 2011. Since then, the quarterly negative cash flow (defined as earnings before interest, taxes, depreciation and amortization) for each of the three stores has averaged $15,000 on revenues of $47,000. 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. The estimated cost of opening a store (physical build-out and inventory) is approximately $200,000 in the current store configuration. Further expansion of Movie>Q will depend on the availability of additional funding.

 

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. The Company also received in July 2010 a refund of $1.5 million in federal income taxes for the tax year 2006, and a $1 million settlement of a claim in April 2011. 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.

 

17
 

 

Valuation of long-lived and intangible assets. Long-lived assets, consisting primarily of property, plant and equipment and intangibles, comprise a significant portion of the Company’s total assets. Long-lived assets 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 $18.1 million as of March 31, 2012.

 

During the fiscal year ended June 30, 2011, the Company determined that certain unutilized assets related to our Movie>Q business segment were impaired, resulting in a write-off. We concluded that there were no other triggering events under ASC 360-10-35 and, accordingly, further impairment testing was not performed as of that date.

 

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 March 31, 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 March 31, 2012.

 

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Market Risk. The Company had borrowings of $10.8 million on March 31, 2012 under line of credit, note payable and mortgage agreements. The line of credit and one mortgage loan were subject to variable interest rates. The weighted average interest rate paid during the first nine months of fiscal 2012 was 7.3%. For variable rate debt outstanding at March 31, 2012, a .25% increase in interest rates will increase annual interest expense by approximately $3,000. Amounts outstanding or that may become outstanding under the revolving credit facility provide for interest at the banks’ prime rate plus 5.3% (8.55% as of March 31, 2012). The Company’s market risk exposure with respect to financial instruments is to changes in the prime rate.

 

18
 

 

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 March 31, 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 March 31, 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

 

On October 6, 2009, DG FastChannel, Inc. (“DGFC”) filed a claim in the United States District Court Central District of California, alleging that the Company violated certain provisions of agreements governing transactions related to the August 13, 2007 sale of the Company’s advertising distribution business to DGFC. DGFC alleged that (i) the Company did not fulfill its obligation to restrict a former employee from competing against DGFC subsequent to the transaction and, therefore, DGFC did not owe the Company $412,500 related to that portion of the transaction; (ii) the Company violated the noncompetition agreement between DGFC and the Company by distributing advertising content after the transaction; (iii) due to the violation of the noncompetition agreement, the post production services agreement that required DGFC to continue to vault its customers’ physical elements at the Company’s Media Center became null and void; and (iv) the Company must return all of DGFC’s vaulted material to DGFC. DGFC also sought unspecified monetary damages.

 

In September 2010, a settlement between the parties included the following: (1) The Company will be subject to a permanent injunction (until August 13, 2012) from competing in the commercial spot advertising business (as defined), (2) the Company will deliver to DGFC vaulted elements which will result in an annual reduction of vaulting revenues of approximately $0.9 million, (3) the Company will not be entitled to $412,500 (relating to the working capital reconciliation), (4) the Company will issue 250,000 shares of common stock to DGFC and (5) the parties will enter into full mutual releases and will dismiss their respective claims with prejudice. DGFC also received the right to sell the shares to the Company’s Chief Executive Officer for $500,000 on the six-month anniversary date of the agreement.

 

In connection with the settlement, the Company indemnified its Chief Executive Officer against possible losses should DGFC exercise its right to put the stock to the Chief Executive Officer, and there is a negative difference between the stated $500,000 value of the stock ($2.00 per share) and the market value on the date of the put. Alternatively, the Chief Executive Officer had the right to sell the 250,000 shares to the Company for $500,000. In April 2011, the Chief Executive Officer purchased from DGFC the put shares for $500,000, and the Company purchased from the Chief Executive Officer the 250,000 shares for $500,000 and immediately canceled the shares. In the fiscal year ended June 30, 2011, the put option expense was $152,000.

 

19
 

 

In November 2010, DGFC filed an ex parte application for enforcement of the settlement agreement and related stipulated injunction alleging that the Company violated the terms thereof and seeking an order enforcing the settlement agreement, an order to assess civil contempt charges and other remedies, and an order referring criminal allegations against the Company to the U.S. Attorney’s Office. In September 2011, the Court denied the ex parte application.

 

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

 

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:

 

lRecent history of losses.
lPrior breaches and changes in credit agreements and ongoing liquidity.
lOur highly competitive marketplace.
lThe risks associated with dependence upon significant customers.
lOur ability to execute our expansion strategy.
lThe uncertain ability to manage in a changing environment.
lOur dependence upon and our ability to adapt to technological developments.
lDependence on key personnel.
lOur ability to maintain and improve service quality.
lFluctuation in quarterly operating results and seasonality in certain of our markets.
lPossible significant influence over corporate affairs by significant shareholders.
lOur ability to operate effectively as a stand-alone, publicly traded company.
 lThe 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, 2011, 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.

 

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.

 

20
 

 

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 March 31, 2012, formatted in XBRL (eXtensible Business Reporting Language): (1) Consolidated Condensed Balance Sheets as of March 31, 2012 and June 30, 2011; (2) Consolidated Condensed Statements of Operations for the three and nine months ended March 31, 2012 and 2011; (3) Consolidated Condensed Statements of Cash Flows for the nine months ended March 31, 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: May 11, 2012   BY:  /s/ Alan R. Steel
    Alan R. Steel
Executive Vice President,
Finance and Administration
(duly authorized officer and principal financial officer)

 

21

 

XNAS:PTSX Point 360 Quarterly Report 10-Q Filling

Point 360 XNAS:PTSX Stock - Get Quarterly Report SEC Filing of Point 360 XNAS:PTSX stocks, including company profile, shares outstanding, strategy, business segments, operations, officers, consolidated financial statements, financial notes and ownership information.

XNAS:PTSX Point 360 Quarterly Report 10-Q Filing - 3/31/2012
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