10-Q 1 f10q1st2002.txt SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------- FORM 10-Q (Mark One) X Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the quarterly period ended March 31, 2002 or __ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the transition period from to_________ Commission file number 0-21917 ------------- Point.360 (Exact Name of Registrant as Specified in Its Charter) California ------------------------------- (State or Other Jurisdiction of Incorporation or Organization) 95-4272619 ---------------- (IRS Employer Identification Number) 7083 Hollywood Boulevard, Suite 200, Hollywood, CA 90028 -------------------------------------------------------- (Address of principal executive offices) (Zip Code) (323) 957-7990 ---------------------------- (Registrant's Telephone Number, Including Area Code) ---------------------------------- (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ____ ------ As of April 20, 2002, there were 9,014,232 shares of the registrant's common stock outstanding. PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS
POINT.360 CONSOLIDATED BALANCE SHEETS ASSETS DECEMBER 31, MARCH 31, 2001 2002 (unaudited) Current assets: Cash and cash equivalents $ 3,758,000 $ 5,161,000 Accounts receivable, net of allowances for doubtful accounts of $681,000 and $779,000, respectively 12,119,000 12,661,000 Notes receivable from officers 928,000 773,000 Income tax receivable 1,399,000 1,132,000 Inventories 820,000 833,000 Prepaid expenses and other current assets 554,000 722,000 Deferred income taxes 884,000 924,000 --------------- --------------- Total current assets 20,462,000 22,206,000 Property and equipment, net 23,232,000 22,007,000 Other assets, net 833,000 804,000 Goodwill and other intangibles, net 26,320,000 26,445,000 --------------- --------------- Total assets $ 70,847,000 $ 71,462,000 =============== =============== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 4,675,000 $ 3,645,000 Accrued expenses 2,715,000 3,632,000 Current portion of notes payable 28,999,000 6,750,000 Current portion of capital lease obligations 79,000 71,000 --------------- --------------- Total current liabilities 36,468,000 14,098,000 --------------- --------------- Deferred income taxes 2,650,000 2,931,000 Notes payable, less current portion - 22,249,000 Capital lease obligations, less current portion 78,000 71,000 Derivative valuation liability 579,000 377,000 Shareholders' equity Preferred stock - no par value; 5,000,000 authorized; none outstanding - - Common stock - no par value; 50,000,000 authorized; 8,992,806 and 9,011,324 shares issued and outstanding, respectively 17,336,000 17,340,000 Additional paid-in capital 439,000 439,000 Comprehensive income - FAS 133 238,000 223,000 Retained earnings 13,059,000 13,734,000 --------------- --------------- Total shareholders' equity 31,072,000 31,736,000 --------------- --------------- Total liabilities and shareholders' equity $ 70,847,000 $ 71,462,000 =============== ===============
See accompanying notes to consolidated financial statements. 2 POINT.360 CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Unaudited)
THREE MONTHS ENDED MARCH 31, 2001 2002 ---- ---- Revenues $ 19,108,000 $ 16,846,000 Cost of goods sold (12,643,000) (10,594,000) ------------ ------------ Gross profit 6,465,000 6,252,000 Selling, general and administrative expense (5,499,000) (4,607,000) ------------ ------------ Operating income 966,000 1,645,000 Interest expense, net (785,000) (678,000) Derivative fair value change (253,000) 217,000 ------------ ------------ Income (loss) before income taxes (72,000) 1,184,000 (Provision for) benefit from income taxes 40,000 (509,000) ------------ ------------ Income (loss) before adoption of FAS 133 (2001) (32,000) 675,000 Cumulative effect of adopting FAS 133 (2001) (139,000) - ------------ ------------ Net income (loss) $ (171,000) $ 675,000 ============ ============ Other comprehensive income: Derivative fair value change $ (26,000) $ (15,000) ------------ ------------ Comprehensive income (loss) $ (197,000) $ 660,000 ============ ============ Earnings per share: Basic: Income (loss) per share before adoption of FAS 133 (2001) $ - $ 0.07 Cumulative effect of adopting FAS 133 (2001) (0.02) - ------------ ------------ Net income (loss) $ (0.02) $ 0.07 ============ ============ Weighted average number of shares 9,136,559 9,011,324 Diluted: Income (loss) per share before adoption of FAS 133 (2001) $ - $ 0.07 Cumulative effect of adopting FAS 133 (2001) (0.02) - ------------ ------------ Net income (loss) $ (0.02) $ 0.07 ============ ============ Weighted average number of shares including the dilutive effect of stock options 9,136,559 9,069,172
See accompanying notes to consolidated financial statements. 3 POINT.360 CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
THREE MONTHS ENDED MARCH 31, --------- 2001 2002 ---- ---- Cash flows from operating activities: Net income (loss) $ (171,000) $ 675,000 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 1,649,000 1,507,000 Provision for doubtful accounts 143,000 169,000 Deferred income taxes (327,000) 241,000 Other non cash item 602,000 (217,000) Cumulative effect of adopting FAS 133 139,000 - Write-off of note receivable - 148,000 Changes in assets and liabilities: Decrease (increase) in accounts receivable 736,000 (711,000) (Increase) in inventories (85,000) (13,000) (Increase) in prepaid expenses and other current assets (29,000) (177,000) Decrease in other assets 8,000 29,000 Decrease in accounts payable (1,174,000) (1,010,000) Increase in accrued expenses 967,000 775.000 (Decrease) increase in income taxes (60,000) 267,000 ------------- --------------- Net cash provided by operating activities 2,398,000 1,683,000 ------------- --------------- Cash used in investing activities: Capital expenditures (1,325,000) (287,000) Proceeds from sale of equipment - 27,000 Net cash paid for acquisitions (333,000) (5,000) ------------- --------------- Net cash used in investing activities (1,658,000) (265,000) Cash flows used in financing activities: Repurchase of common stock (300,000) - Repayment of capital lease obligations (29,000) (15,000) ------------- --------------- Net cash used in financing activities (329,000) (15,000) Net increase in cash 411,000 1,403,000 Cash and cash equivalents at beginning of period 769,000 3,758,000 ------------- --------------- Cash and cash equivalents at end of period $ 1,180,000 $ 5,161,000 ============= =============== Supplemental disclosure of cash flow information - Cash paid for: Interest $ 565,000 $ 663,000 ============= ============== Income tax $ 37,000 $ - ============= ==============
See accompanying notes to consolidated financial statements. 4 POINT.360 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS March 31, 2002 NOTE 1 - THE COMPANY Point.360 (the "Company") is a leading provider of video and film asset management services to owners, producers and distributors of entertainment and advertising content. The Company provides the services necessary to edit, master, reformat, digitize, archive and ultimately distribute its clients' video content. The Company provides physical and electronic delivery of commercials, movie trailers, electronic press kits, infomercials and syndicated programming to thousands of broadcast outlets worldwide. The Company provides worldwide electronic distribution, using fiber optics and satellites. Additionally, the Company provides a broad range of video services, including the duplication of video in all formats, element storage, standards conversions, closed captioning and transcription services and video encoding for air play verification purposes. The Company also provides its customers value-added post production, editing and digital media services. The Company operates in one reportable segment. The Company seeks to capitalize on growth in demand for the services related to the distribution of entertainment content, without assuming the production or ownership risk of any specific television program, feature film or other form of content. The primary users of the Company's services are entertainment studios and advertising agencies that generally choose to outsource such services due to the sporadic demand of any single customer for such services and the fixed costs of maintaining a high-volume physical plant. Since January 1, 1997, the Company has successfully completed eight acquisitions of companies providing similar services. The Company will continue to evaluate acquisition opportunities to enhance its operations and profitability. As a result of these acquisitions, the Company believes it is one of the largest and most diversified providers of technical and distribution services to the entertainment and advertising industries, and is therefore able to offer its customers a single source for such services at prices that reflect the Company's scale economies. The accompanying unaudited financial statements have been prepared in accordance with generally accepted accounting principles and the Securities and Exchange Commission's rules and regulations for reporting interim financial statements and footnotes. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. These financial statements should be read in conjunction with the financial statements and related notes contained in the Company's Form 10-K for the year ended December 31, 2001. NOTE 2 - ACCOUNTING PRONOUNCEMENTS Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities ("FAS 133"). The standard, as amended, requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in other income. In June 2001, the Financial Accounting Standards Board ("FASB") issued FAS Nos. 141 and 142, "Business Combinations" and "Goodwill and Other Intangible Assets," respectively. FAS No. 141 replaces Accounting Principles Board ("APB") Opinion No. 16. It also provides guidance on purchase accounting related to the recognition of intangible assets and accounting for negative goodwill. FAS No. 142 changes the accounting for goodwill and other intangible assets with indefinite useful lives ("goodwill") from an amortization method to an impairment-only approach. Under FAS No. 142, goodwill will be tested annually and whenever events or circumstances occur indicating that goodwill might be impaired. FAS No. 141 and FAS No. 142 are effective for all business combinations completed after June 30, 2001. Upon adoption of FAS No. 142, 5 amortization of goodwill recorded for business combinations consummated prior to July 1, 2001 will cease, and intangible assets acquired prior to July 1, 2001 that do not meet the criteria for recognition under FAS No. 141 will be reclassified to goodwill. The Company implemented FAS No. 142 in the first quarter of fiscal 2002 which required no goodwill impairment. In August 2001, the FASB issued FAS No. 143, "Accounting for Asset Retirement Obligations," which requires entities to record the fair value of a liability for an asset retirement obligation in the period in which the obligation is incurred. When the liability is initially recorded, the entity capitalizes the cost by increasing the carrying amount of the related long-lived asset. FAS No. 143 is effective for fiscal years beginning after June 15, 2002. The Company does not have asset retirement obligations and, therefore, believes there will be no impact upon adoption of FAS No. 143. In October 2001, the FASB issued FAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which is applicable to financial statements issued for fiscal years beginning after December 15, 2001. The FASB's new rules on asset impairment supersede FAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," and portions of APB Opinion No. 30, "Reporting the Results of Operations." FAS No. 144 provides a single accounting model for long-lived assets to be disposed of and significantly changes the criteria that would have to be met to classify an asset as held-for-sale. Classification as held-for-sale is an important distinction since such assets are not depreciated and are stated at the lower of fair value and carrying amount. FAS No. 144 also requires expected future operating losses from discontinued operations to be displayed in the period(s) in which the losses are incurred, rather than as of the measurement date as presently required. The Company is in the process of evaluating the impact of adopting FAS No. 144. NOTE 3 - STOCK REPURCHASE In February 1999, the Company commenced a stock repurchase program. The board of directors authorized the Company to allocate up to $4,000,000 to purchase its common stock at suitable market prices. In September 2000, the board of directors authorized the Company to allocate an additional $5,000,000 to purchase its common stock. As of March 31, 2002, the Company had repurchased 860,766 shares of the Company's common stock in connection with this program. NOTE 4 - LONG TERM DEBT AND NOTES PAYABLE In November 1998, the Company borrowed $29,000,000 on a term loan with a bank, payable in 60 monthly installments of $483,000 plus interest. The term loan was repaid in 2000 with the proceeds of a new borrowing arrangement with a group of banks. Deferred financing costs related to the term loan of approximately $232,000, net of $168,000 tax benefit, were concurrently written off and treated as an extraordinary item during the quarter ended September 30, 2000. In September 2000, the Company entered into a credit agreement ("Agreement") with a group of banks providing a revolving credit facility of up to $45,000,000. The purpose of the facility was to repay previously outstanding amounts under a prior agreement with a bank, fund working capital and capital expenditures and for general corporate purposes including up to $5,000,000 of stock repurchases under the Company's repurchase program. The Agreement provided for interest at the banks' reference rate, the federal funds effective rate plus 0.5%, or a LIBOR adjusted rate. Loans made under the Agreement are collateralized by substantially all of the Company's assets. The borrowing base under the Agreement is limited to 90% of eligible accounts receivable, 50% of inventory and 100% of operating machinery and equipment. The Agreement provided that the aggregate commitment will decline by $5,000,000 on each December 31 beginning in 2002 until expiration of the entire commitment on December 31, 2005. The Agreement also contained covenants requiring certain levels of annual earnings before interest, taxes, depreciation and amortization (EBITDA) and net worth, and limits the amount of capital expenditures. By December 31, 2000, the Company had borrowed $31,024,000 under the Agreement and was not in compliance with certain financial covenants due to adjustments recorded to prior years' and 2000 results. The bank waived compliance with the covenants and amended the Agreement in April 2001. In connection with the amendment, the Company paid the banks a restructuring fee of $225,000 which was expensed in the second quarter of 2001. 6 As of April 30, May 31 and June 30, 2001, outstanding amounts under the line of credit exceeded the borrowing base. On June 11 and July 20, 2001, the Company entered into amendment and forbearance agreements with the banks which required the Company to repay the amount of excess borrowings and amended the Agreement to reduce the aggregate commitment from $45,000,000 to $30,050,000 until the expiration of the commitment on December 31, 2005. In August 2001, the Company did not make required debt payments which created a breach of the amendment and forbearance agreements. As a consequence of the breach, the amount outstanding under the credit facility became immediately due and payable. In May 2002, the Company and the banks entered into a restructured loan agreement changing the revolving credit facility to a term loan, with all existing defaults being waived. The term loan has a maturity date of December 31, 2004. Pursuant to the agreement, the Company made a $2 million principal payment and will make additional principal payments of $3.5 million, $5.0 million and $18.5 million in 2002, 2003 and 2004, respectively. The agreement provides for interest at the banks' reference rate plus 1.25% and requires the Company to maintain certain financial covenant ratios. The term loan is secured by substantially all of the Company's assets. 7 POINT.360 MANAGEMENT'S DISCUSSION AND ANALYSIS ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THREE MONTHS ENDED MARCH 31, 2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001. REVENUES. Revenues decreased by $2.3 million or 12% to $16.8 million for the three-month period ended March 31, 2002, compared to $19.1 million for the three-month period ended March 31, 2001 due to a decline in studio post production sales as some work was brought in-house. Studios have traditionally maintained in-house capacity and several customers utilized that capacity in 2002 to a greater extent thereby affecting our sales. GROSS PROFIT. Gross profit decreased $0.2 million or 3% to $6.3 million for the three-month period ended March 31, 2002, compared to $6.5 million for the three-month period ended March 31, 2001. As a percent of revenues, gross profit increased from 34% to 37%. The increase in gross profit as a percentage of revenues was principally due to lower wages and benefits as headcount was reduced 13% since March 31, 2001. SELLING, GENERAL AND ADMINISTRATIVE EXPENSE. Selling, general and administrative ("SG&A") expense decreased $0.9 million, or 16% to $4.6 million for the three-month period ended March 31, 2002, compared to $5.5 million for the three-month period ended March 31, 2001. As a percentage of revenues, SG&A decreased to 27% for the three-month period ended March 31, 2002, compared to 29% for the three-month period ended March 31, 2001. Excluding amortization of goodwill in 2001, SG&A expenses were $5.1 million, or 27% of sales in the 2001 first quarter. The decrease in 2002 was due principally to lower wage costs. OPERATING INCOME. Operating income increased $0.7 million to $1.6 million for the three-month period ended March 31, 2002, compared to $1.0 million for the three-month period ended March 31, 2001. INTEREST EXPENSE. Interest expense for the three-month period ended March 31, 2002 was $0.7 million, a decrease of $0.1 million from the three-month period ended March 31, 2001 due to a lower average level of debt outstanding partially offset by a 2% default rate of interest premium charged by the Company's banks. ADOPTION OF FAS 133 AND DERIVATIVE FAIR VALUE CHANGE. On January 1, 2001, the Company adopted FAS 133 by recording a cumulative effect adjustment of $0.1 million after tax benefit. During the quarter ended March 31, 2001, the Company recorded the difference between the derivative fair value of the Company's hedge contract at the beginning and end of the first quarter, or $0.3 million. During the quarter ended March 31, 2002, the Company recorded the difference between the derivative fair value of the Company's interest rate hedge contract at the beginning and end of the first quarter, or $0.2 million, and amortization of the cumulative-effect adjustment. INCOME TAXES. The Company's effective tax rate was 43% for the first quarter of 2002 and 55% for the first quarter of 2001. The decrease in effective tax rate is the result of the Company's periodic assessment of the relationship of book/tax timing differences to total expected annual pre-tax results and the elimination of goodwill expense for financial statement purposes. The effective tax rate percentage may change from period to period depending on the difference in the timing of the recognition of revenues and expenses for book and tax purposes. NET INCOME (LOSS). The net income (loss) for the three-month period ended March 31, 2002 was $0.7 million, an increase of $0.9 million compared to a loss of $0.2 million for the three-month period ended March 31, 2001. LIQUIDITY AND CAPITAL RESOURCES This discussion should be read in conjunction with the notes to the financial statements and the corresponding information more fully described in the Company's Form 10-K for the year ended December 31, 2001. On March 31, 2002, the Company's cash and cash equivalents aggregated $5.2 million. The Company's operating activities provided cash of $1.7 million for the three months ended March 31, 2002. 8 The Company's investing activities used cash of $0.3 million in the three months ended March 31, 2002. The Company spent approximately $0.3 million for the addition and replacement of capital equipment and management information systems which we believe is a reasonable capital expenditure level given the current revenue volume. In the prior year, the Company's capital expenditures were greater than a normal recurring amount partially due to the investment of approximately $0.3 million in high definition television equipment. The Company's business is equipment intensive, requiring periodic expenditures of cash or the incurrence of additional debt to acquire additional fixed assets in order to increase capacity or replace existing equipment. In September 2000, the Company signed a $45 million revolving credit facility agented by Union Bank of California. The amount of the commitment was reduced to $30 million in July 2001. The facility provided the Company with funding for capital expenditures, working capital needs and support for its acquisition strategies. Due to lower sales levels in the second and third quarters of Fiscal 2001, the borrowing base (eligible accounts receivable, inventory and machinery and equipment) securing the Company's bank line of credit was less than the amount borrowed under the line. Consequently, the Company was in breach of certain covenants. On June 11 and on July 20, 2001, the Company entered into amendment and forbearance agreements with the banks and agreed to repay the overdraft amount in weekly increments. In August 2001, the Company failed to meet the repayment schedule and again entered discussions with the banks. In May 2002, the Company and the banks entered into a restructured loan agreement changing the revolving credit facility to a term loan, with all existing defaults being waived. The term loan has a maturity date of December 31, 2004. Pursuant to the agreement, the Company made a $2 million principal payment and will make additional principal payments of $3.5 million, $5.0 million and $18.5 million in 2002, 2003 and 2004, respectively. The agreement provides for interest at the banks' reference rate plus 1.25% and requires the Company to maintain certain financial covenant ratios. The term loan is secured by substantially all of the Company's assets. We believe that cash on hand plus that generated from operations will be sufficient to meet debt service and operational requirements for the next twelve months. The Company, from time to time, considers the acquisition of businesses complementary to its current operations. Consummation of any such acquisition or other expansion of the business conducted by the Company may be subject to the Company securing additional financing. CAUTIONARY STATEMENTS AND RISK FACTORS In our capacity as Company management, we may from time to time make written or oral forward-looking statements with respect to our long-term objectives or expectations which may be included in our filings with the Securities and Exchange Commission, reports to stockholders and information provided in our web site. The words or phrases "will likely," "are expected to," "is anticipated," "is predicted," "forecast," "estimate," "project," "plans to continue," "believes," or similar expressions identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. We wish to caution you not to place undue reliance on any such forward-looking statements, which speak only as of the date made. In connection with the "Safe Harbor" provisions of the Private Securities Litigation Reform Act of 1995, we are calling to your attention important factors that could affect our financial performance and could cause actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements. 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: 9 o Recent history of losses o Prior breach of credit agreement covenants and new principal payment requirements. o Our highly competitive marketplace. o The risks associated with dependence upon significant customers. o Our ability to execute our expansion strategy. o The uncertain ability to manage growth. o Our dependence upon and our ability to adapt to technological developments. o Dependence on key personnel. o Our ability to maintain and improve service quality. o Fluctuation in quarterly operating results and seasonality in certain of our markets. o Possible significant influence over corporate affairs by significant shareholders. These risk factors are discussed further below. RECENT HISTORY OF LOSSES. The Company has reported losses for each of the four fiscal quarters ended September 30, 2001 due, in part, to lower gross margins and lower sales levels and a number of unusual charges. Although we achieved profitability in Fiscal 2000 and prior years, as well as in the two fiscal quarters ending March 31, 2002, there can be no assurance as to future profitability on a quarterly or annual basis. PRIOR BREACH OF CREDIT AGREEMENT COVENANTS AND NEW PRINCIPAL PAYMENT REQUIREMENTS. Due to lower operating cash amounts resulting from reduced sales levels in 2001 and the consequential net losses, the Company breached certain covenants of its credit facility. The breaches were temporarily cured based on amendments and forbearance agreements among the Company and the banks which called for, among other provisions, scheduled payments to reduce amounts owed to the banks to the permitted borrowing base. In August 2001, the Company failed to meet the principal repayment schedule and was once again in breach of the credit facility. The banks ended their formal commitment to the Company in December 2001. In May 2002, we entered into an agreement with the banks to restructure the credit facility to a term loan maturing on December 31, 2004. As part of this restructuring, the banks waived all existing defaults and the Company made a principal payment of $2.0 million. The Company also agreed to make additional principal payments of $3.5 million, $5.0 million and $18.5 million in 2002, 2003, and 2004, respectively. Based upon the Company's financial forecast, the Company will have to refinance the facility by 2004 to satisfy the final payment requirement. COMPETITION. Our broadcast video post production, duplication and distribution industry is a highly competitive, service-oriented business. In general, we do not have long-term or exclusive service agreements with our customers. Business is acquired on a purchase order basis and is based primarily on customer satisfaction with reliability, timeliness, quality and price. We compete with a variety of post production, duplication and distribution firms, some of which have a national presence, and to a lesser extent, the in-house post production and distribution operations of our major motion picture studio and advertising agency customers. Some of these firms, and all of the studios, have greater financial, distribution and marketing resources and have achieved a higher level of brand recognition than the Company. In the future, we may not be able to compete effectively against these competitors merely on the basis of reliability, timeliness, quality and price or otherwise. We may also face competition from companies in related markets which could offer similar or superior services to those offered by the Company. We believe that an increasingly competitive environment and the possibility that customers may utilize in-house capabilities to a greater extent could lead to a loss of market share or price reductions, which could have a material adverse effect on our financial condition, results of operations and prospects. CUSTOMER AND INDUSTRY CONCENTRATION. Although we have an active client list of over 2,500 customers, seven motion picture studios accounted for approximately 34% of the Company's revenues during the year ended December 31, 2001. If one or more of these companies were to stop using our services, our business could be adversely affected. Because we derive substantially all of our revenue from clients in the entertainment and advertising industries, the financial condition, results of operations and prospects of the Company could also be adversely affected by an adverse change in conditions which impact those industries. 10 EXPANSION STRATEGY. Our growth strategy involves both internal development and expansion through acquisitions. We currently have no agreements or commitments to acquire any company or business. Even though we have completed eight acquisitions in the last five fiscal years, we cannot be sure additional acceptable acquisitions will be available or that we will be able to reach mutually agreeable terms to purchase acquisition targets, or that we will be able to profitably manage additional businesses or successfully integrate such additional businesses into the Company without substantial costs, delays or other problems. Certain of the businesses previously acquired by the Company reported net losses for their most recent fiscal years prior to being acquired, and our future financial performance will be in part dependent on our ability to implement operational improvements in, or exploit potential synergies with, these acquired businesses. Acquisitions may involve a number of special risks including: adverse effects on our reported operating results (including the amortization of acquired intangible assets), diversion of management's attention and unanticipated problems or legal liabilities. In addition, we may require additional funding to finance future acquisitions. We cannot be sure that we will be able to secure acquisition financing on acceptable terms or at all. We may also use working capital or equity, or raise financing through equity offerings or the incurrence of debt, in connection with the funding of any acquisition. Some or all of these risks could negatively affect our financial condition, results of operations and prospects or could result in dilution to the Company's shareholders. In addition, to the extent that consolidation becomes more prevalent in the industry, the prices for attractive acquisition candidates could increase substantially. We may not be able to effect any such transactions. Additionally, if we are able to complete such transactions they may prove to be unprofitable. The geographic expansion of the Company's customers may result in increased demand for services in certain regions where it currently does not have post production, duplication and distribution facilities. To meet this demand, we may subcontract. However, we have not entered into any formal negotiations or definitive agreements for this purpose. Furthermore, we cannot assure you that we will be able to effect such transactions or that any such transactions will prove to be profitable. MANAGEMENT OF GROWTH. During the three years ended December 31, 1999, we experienced rapid growth that resulted in new and increased responsibilities for management personnel and placed and continues to place increased demands on our management, operational and financial systems and resources. To accommodate this growth, compete effectively and manage future growth, we will be required to continue to implement and improve our operational, financial and management information systems, and to expand, train, motivate and manage our work force. We cannot be sure that the Company's personnel, systems, procedures and controls will be adequate to support our future operations. Any failure to do so could have a material adverse effect on our financial condition, results of operations and prospects. DEPENDENCE ON TECHNOLOGICAL DEVELOPMENTS. Although we intend to utilize the most efficient and cost-effective technologies available for telecine, high definition formatting, editing, coloration and delivery of video content, including digital satellite transmission, as they develop, we cannot be sure that we will be able to adapt to such standards in a timely fashion or at all. We believe our future growth will depend in part, on our ability to add to these services and to add customers in a timely and cost-effective manner. We cannot be sure we will be successful in offering such services to existing customers or in obtaining new customers for these services, including the Company's significant investment in high definition technology in 2000 and 2001. We intend to rely on third party vendors for the development of these technologies and there is no assurance that such vendors will be able to develop such technologies in a manner that meets the needs of the Company and its customers. Any material interruption in the supply of such services could materially and adversely affect the Company's financial condition, results of operations and prospects. DEPENDENCE ON KEY PERSONNEL. The Company is dependent on the efforts and abilities of certain of its senior management, particularly those of R. Luke Stefanko, President and Chief Executive Officer. The loss or interruption of the services of key members of management could have a material adverse effect on our financial condition, results of operations and prospects if a suitable replacement is not promptly obtained. Although we have employment agreements with Mr. Stefanko and certain of our other key executives and technical personnel, we cannot be sure that such executives will remain with the Company during or after the term of their employment agreements. In addition, our success depends to a significant degree upon the continuing contributions of, and on our ability to attract and retain, qualified management, sales, operations, marketing and technical personnel. The competition for qualified 11 personnel is intense and the loss of any such persons, as well as the failure to recruit additional key personnel in a timely manner, could have a material adverse effect on our financial condition, results of operations and prospects. There is no assurance that we will be able to continue to attract and retain qualified management and other personnel for the development of our business. ABILITY TO MAINTAIN AND IMPROVE SERVICE QUALITY. Our business is dependent on our ability to meet the current and future demands of our customers, which demands include reliability, timeliness, quality and price. Any failure to do so, whether or not caused by factors within our control could result in losses to such clients. Although we disclaim any liability for such losses, there is no assurance that claims would not be asserted or that dissatisfied customers would refuse to make further deliveries through the Company in the event of a significant occurrence of lost deliveries, either of which could have material adverse effect on our financial condition, results of operations and prospects. Although we maintain insurance against business interruption, such insurance may not be adequate to protect the Company from significant loss in these circumstances or that a major catastrophe (such as an earthquake or other natural disaster) would not result in a prolonged interruption of our business. In addition, our ability to make deliveries within the time periods requested by customers depends on a number of factors, some of which are outside of our control, including equipment failure, work stoppages by package delivery vendors or interruption in services by telephone or satellite service providers. FLUCTUATING RESULTS, SEASONALITY. Our operating results have varied in the past, and may vary in the future, depending on factors such as the volume of advertising in response to seasonal buying patterns, the timing of new product and service introductions, the timing of revenue recognition upon the completion of longer term projects, increased competition, timing of acquisitions, general economic factors and other factors. As a result, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as an indication of future performance. For example, our operating results have historically been significantly influenced by the volume of business from the motion picture industry, which is an industry that is subject to seasonal and cyclical downturns, and, occasionally, work stoppages by actors, writers and others. In addition, as our business from advertising agencies tends to be seasonal, our operating results may be subject to increased seasonality as the percentage of business from advertising agencies increases. In any period our revenues are subject to variation based on changes in the volume and mix of services performed during the period. It is possible that in some future quarter the Company's operating results will be below the expectations of equity research analysts and investors. In such event, the price of the Company's Common Stock would likely be materially adversely affected. Fluctuations in sales due to seasonality may become more pronounced if the growth rate of the Company's sales slows. CONTROL BY PRINCIPAL SHAREHOLDER; POTENTIAL ISSUANCE OF PREFERRED STOCK; ANTI-TAKEOVER PROVISIONS. The Company's President and Chief Executive Officer, R. Luke Stefanko, beneficially owned approximately 18.4% of the outstanding common stock as of February 28, 2002. Mr. Stefanko's ex-spouse owned approximately 25.2% of the common stock on that date. Together, they owned approximately 43.6%. In August 2000 and May 2001, Mr. Stefanko was granted one-time proxies to vote his ex-spouse's shares in connection with the election of directors at the Company's annual meetings. The Company's Chairman of the Board, Haig Bagerdjian, beneficially owned approximately 6.7% of the common stock on February 28, 2002. By virtue of their stock ownership, Messrs. Stefanko and Bagerdjian individually or together may be able to significantly influence the outcome of matters required to be submitted to a vote of shareholders, including (i) the election of the board of directors, (ii) amendments to the Company's Restated Articles of Incorporation and (iii) approval of mergers and other significant corporate transactions. The foregoing may have the effect of discouraging, delaying or preventing certain types of transactions involving an actual or potential change of control of the Company, including transactions in which the holders of common stock might otherwise receive a premium for their shares over current market prices. Our Board of Directors also has the authority to issue up to 5,000,000 shares of preferred stock without par value (the "Preferred Stock") and to determine the price, rights, preferences, privileges and restrictions thereof, including voting rights, without any further vote or action by the Company's shareholders. Although we have no current plans to issue any shares of Preferred Stock, the rights of the holders of common stock would be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. Issuance of Preferred Stock could have the effect of discouraging, delaying, or preventing a change in control of the Company. Furthermore, certain provisions of the Company's Restated Articles of Incorporation and By-Laws and of California law also could have the effect of discouraging, delaying or preventing a change in control of the Company. 12 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK. The Company had borrowings of $28,999,000 at March 31, 2002 under a credit agreement. Amounts outstanding under the credit agreement now bear interest at the bank's reference rate plus 1.25%. The Company's market risk exposure with respect to financial instruments is to changes in the London Interbank Offering Rate ("LIBOR"). The Company entered into an interest rate swap transaction with a bank on November 28, 2000. The swap transaction was for a notional amount of $15,000,000 for three years and fixes the interest rate paid by the Company on such amount at 6.50% less the applicable LIBOR rate, plus 1.25% over prime rate. On June 15, 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities. The standard, as amended by Statement of Financial Accounting Standards No. 137, Accounting for Derivative Instruments and Hedging Activities Deferral of the Effective Date of FASB Statement No. 133, an amendment of FASB Statement No. 133, and Statement of Financial Accounting Standards No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, an amendment of FASB Statement No. 133 (referred to hereafter as "FAS 133"), is effective for all fiscal quarters of all fiscal years beginning after June 15, 2000 (January 1, 2001 for the Company). FAS 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or in other comprehensive income, depending on whether a derivative is designated as part of a hedging relationship and, if it is, depending on the type of hedging relationship. During 2001, the Company recorded a cumulative effect type adjustment of $247,000 (net of $62,000 tax benefit), and an expense of $508,000 ($406,000 net of tax benefit) for the derivative fair value change of an interest rate hedging contract. During the quarter ended March 31, 2002, the Company recorded income of $124,000 (net of $93,000 tax expense) for the derivative fair value change and amortization of the cumulative effect type adjustment. PART II - OTHER INFORMATION ITEM 3. DEFAULTS UPON SENIOR SECURITIES For a discussion of the May 2002 agreement in which the Company's defaults under its bank borrowings were waived, see Note 4 to the Financial Statements that are included in Part I, Item 1 of this Report on Form 10-Q. ITEM 4. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.1 Third Amendment and Restated Credit Agreement dated May 2, 2002, among the Company, Union Bank of California, N.A., United California Bank, and U.S. Bank National Association (b) Reports On Form 8-K None. 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 14, 2002 BY: /s/ Alan Steel ----------------------------- Alan Steel Executive Vice President, Finance and Administration (duly authorized officer and principal financial officer) 13