-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VuOGH8fnOlv8xZSull/0ankCtYFXo0hvV8XnAXLTOSdynbjKPoF/TlvmlSqyry75 RwXAzx7AFJ/Pn3qqKDoQDg== 0001014733-03-000010.txt : 20030514 0001014733-03-000010.hdr.sgml : 20030514 20030513190705 ACCESSION NUMBER: 0001014733-03-000010 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20030331 FILED AS OF DATE: 20030514 FILER: COMPANY DATA: COMPANY CONFORMED NAME: POINT 360 CENTRAL INDEX KEY: 0001014733 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-ALLIED TO MOTION PICTURE PRODUCTION [7819] IRS NUMBER: 954272619 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-21917 FILM NUMBER: 03696713 BUSINESS ADDRESS: STREET 1: 7083 HOLLYWOOD BLVD SUITE 200 STREET 2: SUITE 200 CITY: HOLLYWOOD STATE: CA ZIP: 90028 BUSINESS PHONE: 3239577990 MAIL ADDRESS: STREET 1: 7083 HOLLYWOOD BLVD SUITE 200 STREET 2: SUITE 200 CITY: HOLLYWOOD STATE: CA ZIP: 90028 FORMER COMPANY: FORMER CONFORMED NAME: VDI MULTIMEDIA DATE OF NAME CHANGE: 19991115 FORMER COMPANY: FORMER CONFORMED NAME: VDI MEDIA DATE OF NAME CHANGE: 19960516 10-Q 1 ptsx1q2003.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, 2003 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 ----------------------------------------------------- 95-4272619 (State or Other Jurisdiction of (IRS Employer Incorporation or Organization) Identification Number) California 95-4272619 (State of or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 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 ------- ------- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No X ------- ------- As of April 20, 2003, there were 9,035,482 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, 2002 2003 ---- ---- Current assets: Current assets: Cash and cash equivalents $ 5,372,000 $ 6,680,000 Accounts receivable, net of allowances for doubtful accounts of $801,000 and $862,000, respectively 12,218,000 11,549,000 Income tax receivable 398,000 631,000 Inventories 903,000 816,000 Prepaid expenses and other current assets 857,000 1,031,000 Deferred income taxes 1,383,000 1,463,000 -------------- ------------- Total current assets 21,131,000 22,170,000 Property and equipment, net 19,965,000 19,162,000 Other assets, net 843,000 604,000 Goodwill and other intangibles, net 27,212,000 27,200,000 Investment in acquisitions 929,000 1,206,000 -------------- ------------- Total assets $ 70,080,000 $ 70,342,000 ============== ============= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 3,974,000 $ 4,329,000 Accrued expenses 3,885,000 4,055,000 Current portion of notes payable 5,000,000 5,250,000 Current portion of capital lease obligations 87,000 88,000 -------------- ------------- Total current liabilities 12,946,000 13,722,000 -------------- ------------- Deferred income taxes 3,857,000 4,091,000 Notes payable, less current portion 18,000,000 16,499,000 Capital lease obligations, less current portion 65,000 45,000 Derivative valuation liability 701,000 531,000 Shareholders' equity Preferred stock - no par value; 5,000,000 authorized; none outstanding - - Common stock - no par value; 50,000,000 authorized; 9,014,232 and 9,035,482 shares issued and outstanding, respectively 17,359,000 17,385,000 Additional paid-in capital 1,272,000 1,182,000 Accumulated other comprehensive income (90,000) (75,000) Retained earnings 15,970,000 16,962,000 -------------- ------------- Total shareholders' equity 34,511,000 35,454,000 -------------- ------------- Total liabilities and shareholders' equity $ 70,080,000 $ 70,342,000 ============== =============
See accompanying notes to consolidated financial statements. 2
POINT.360 CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Unaudited) Three Months Ended March 31, --------- 2002 2003 ---- ---- Revenues $ 16,846,000 $ 17,293,000 Cost of goods sold (10,594,000) (10,854,000) ------------- -------------- Gross profit 6,252,000 6,439,000 Selling, general and administrative expense (4,607,000) (4,382,000) ------------- -------------- Operating income 1,645,000 2,057,000 Interest expense, net (678,000) (521,000) Derivative fair value change 176,000 145,000 ------------- -------------- Income before income taxes 1,143,000 1,681,000 Provision for income taxes (492,000) (689,000) ------------- -------------- Net income $ 651,000 $ 992,000 ============= ============== Other comprehensive income: Derivative fair value change $ (15,000) $ (15,000) ------------- -------------- Comprehensive income $ 636,000 $ 977,000 ============= =============== Earnings per share: Basic Net income $ 0.07 $ 0.11 Weighted average number of shares 9,011,324 9,023,440 ============= ============== Diluted Net income $ 0.07 $ 0.11 Weighted average number of shares including the dilutive effect of stock options 9,069,172 9,289,476 ============= ==============
See accompanying notes to consolidated financial statements. 3
POINT.360 CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Three Months Ended March 31, --------- 2002 2003 ---- ---- Cash flows from operating activities: Net income (loss) $ 651,000 $ 992,000 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 1,507,000 1,286,000 Provision for doubtful accounts 169,000 92,000 Deferred income taxes 235,000 154,000 Other non cash item (187,000) (41,000) Write-off of note receivable 148,000 - Changes in assets and liabilities: (Increase) decrease in accounts receivable (711,000) 577,000 (Increase) decrease in inventories (13,000) 87,000 (Increase) in prepaid expenses and other current assets (177,000) (174,000) Decrease (increase) in other assets 29,000 (95,000) (Decrease) increase in accounts payable (1,010,000) 355,000 Increase in accrued expenses 775,000 390,000 Increase (decrease) in income taxes 267,000 (233,000) ------------- ------------ Net cash provided by operating activities 1,683,000 3,390,000 ------------- ------------ Cash used in investing activities: Capital expenditures (287,000) (466,000) Proceeds from sale of equipment 27,000 - Net cash paid for acquisitions (5,000) (282,000) ------------- ------------ Net cash used in investing activities (265,000) (748,000) ------------- ------------ Cash flows used in financing activities: Repurchase of common stock - - Exercise of stock options - 26,000 Repayment of notes payable - (1,251,000) Repayment of capital lease obligations (15,000) (19,000) Contract settlement - (90,000) ------------- ------------ Net cash used in financing activities (15,000) (1,334,000) ------------- ------------ Net increase in cash 1,403,000 1,308,000 Cash and cash equivalents at beginning of period 3,758,000 5,372,000 ------------- ------------ Cash and cash equivalents at end of period 5,161,000 6,680,000 ============= ============ Supplemental disclosure of cash flow information - Cash paid for: Interest 663,000 512,000 ============= ============ Income tax $ - $ 917,000 ============= ============
See accompanying notes to consolidated financial statements. 4 POINT.360 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS March 31, 2003 NOTE 1 - THE COMPANY Point.360 ("Point.360" or the "Company") provides 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, archive and distribute its clients' video content, including television programming, spot advertising and movie trailers. The Company provides worldwide electronic distribution, using fiber optics and satellites. The Company delivers commercials, movie trailers, electronic press kits, infomercials and syndicated programming, by both physical and electronic means, to thousands of broadcast outlets worldwide. 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, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. 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, 2002. 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" (SFAS No. 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 issued SFAS Nos. 141 and 142, "BUSINESS COMBINATIONS" and "GOODWILL AND OTHER INTANGIBLE ASSETS," respectively. SFAS 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. SFAS 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 SFAS No. 142, goodwill will be tested annually and whenever events or circumstances occur indicating that goodwill might be impaired. SFAS No. 141 and SFAS No. 142 are effective for all business combinations completed after June 30, 2001. Upon adoption of SFAS No. 142, amortization of goodwill recorded for business combinations consummated prior to July 1, 2001 ceases, and intangible assets acquired prior to July 1, 2001 that do not meet the criteria for recognition under SFAS No. 141 will be reclassified to goodwill. The Company implemented SFAS No. 142 in the first quarter of fiscal 2002 which required no goodwill impairment. The Company also tested goodwill as of September 30, 2002 with no impairment indicated. 5 We ceased amortization of approximately $26.3 million of goodwill beginning in 2002. We had recorded approximately $2.0 million of amortization on these amounts during the year ended December 31, 2001. In August 2001, the FASB issued SFAS 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. SFAS 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 SFAS No. 143. In October 2001, the FASB issued SFAS 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 SFAS 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." SFAS 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. SFAS 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. SFAS No. 144 has had no impact on the Company. In April 2002, the FASB issued SFAS No. 145, "RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB STATEMENT NO. 13, AND TECHNICAL CORRECTIONS." SFAS No. 145 updates, clarifies, and simplifies existing accounting pronouncements. This statement rescinds SFAS No. 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in APB No. 30 will now be used to classify those gains and losses. SFAS No. 64 amended SFAS No. 4 and is no longer necessary as SFAS No. 4 has been rescinded. SFAS No. 44 has been rescinded as it is no longer necessary. SFAS No. 145 amends SFAS No. 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-lease transactions. This statement also makes technical corrections to existing pronouncements. While those corrections are not substantive in nature, in some instances, they may change accounting practice. The Company does not expect adoption of SFAS No. 145 to have a material impact, if any, on its financial position or results of operations. In June 2002, the FASB issued SFAS No. 146, "ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES." This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "LIABILITY RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS AND OTHER COSTS TO EXIT AN ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A RESTRUCTURING)." This statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF Issue 94-3, a liability for an exit cost, as defined, was recognized at the date of an entity's commitment to an exit plan. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002 with earlier application encouraged. The Company does not expect adoption of SFAS No.146 to have a material impact, if any, on its financial position or results of operations. In October 2002, the FASB issued SFAS No. 147, "ACQUISITIONS OF CERTAIN FINANCIAL INSTITUTIONS." SFAS No. 147 removes the requirement in SFAS No. 72 and Interpretation 9 thereto, to recognize and amortize any excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired as an unidentifiable intangible asset. This statement requires that those transactions be accounted for in accordance with SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." In addition, this statement amends SFAS No. 144, "ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS," to include certain financial institution-related intangible assets. This statement is not applicable to the Company. 6 In December 2002, the FASB issued SFAS No. 148, "ACCOUNTING FOR STOCK-BASED COMPENSATION-TRANSITION AND DISCLOSURE," an amendment of SFAS No. 123. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. This statement is effective for financial statements for fiscal years ending after December 15, 2002. SFAS No. 148 will not have any impact on the Company's financial statements as management does not have any intention to change to the fair value method. NOTE 3 - LONG TERM DEBT AND NOTES PAYABLE In November 1998, the Company borrowed $29,000,000 on a term loan with a bank. The term loan was repaid in 2000 with the proceeds of a new borrowing arrangement with a group of banks. 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. Loans made under the Agreement are collateralized by substantially all of the Company's assets. The borrowing base under the Agreement was 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 limited 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. 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. In connection with the restructuring, the Company wrote off $265,000 of deferred financing costs related to the original Agreement in the second quarter of 2002. Certain legal and other costs associated with the new term loan were capitalized and will be amortized over the life of the loan. In October 2002, the company paid the banks $20,000 and made an additional principal payment of $500,000 in connection with a waiver received from the banks to allow the company's former President and Chief Executive Officer to reduce his percentage ownership in the Company to below 14%. 7 NOTE 4 - ISSUANCE OF WARRANT AND POSSIBLE ACQUISITION In July 2002, the Company acquired an option to purchase three subsidiaries (the "Subsidiaries") of Alliance Atlantis Communications Inc. ("Alliance") engaged in businesses directly related to those of the Company. In consideration for the option, the Company issued to Alliance a warrant to acquire 500,000 shares of the Company's common stock at $2.00 per share. The warrant expires five years from the closing date of the transaction, or July 3, 2005 if the Company does not purchase the Subsidiaries. In connection therewith, the Company capitalized the fair value of the warrant ($619,000 determined by using the Black-Scholes valuation model) and the deposit as other assets on the balance sheet. In December 2002, the option was extended to March 10, 2003. In connection with the extension, the Company made a $300,000 deposit toward the purchase price of the Subsidiaries, which deposit is nonrefundable except in very limited circumstances. The deposit was capitalized as an other asset. Additionally, the Company capitalized approximately $411,000 of due diligence and other expenses associated with the proposed acquisition and related financing during the quarter ended March 31, 2003. The Company did not exercise its option to purchase the Subsidiaries by the March 10, 2003 termination date. Alliance has agreed to continue negotiations with the Company to complete the transaction. If the Company does not purchase the Subsidiaries, the capitalized values or costs of the warrant, deposit and financing will be written off. In order to complete the acquisition, the Company must refinance its existing bank debt and raise additional funds to pay the cash portion of the purchase price. A provision in the Company's current term loan agreement prohibits acquisitions unless approved by the banks, which permission has been denied. In connection with the possible acquisition and financing, the Company will incur additional legal, accounting and other costs subsequent to March 31, 2003. If the acquisition and/or financing transactions are not consummated, such costs will be expensed. If the acquisition and financing is completed, these amounts will be capitalized as costs of the acquisition or deferred financing costs, respectively. NOTE 5 - DERIVATIVE AND HEDGING ACTIVITIES In November 2000, the Company entered into an interest rate swap contract to economically hedge its floating debt rate. Under the terms of the contract, the notional amount is $15,000,000, whereby the Company receives LIBOR and pays a fixed 6.5% rate of interest for three years. FAS 133 requires that the swap contract be recorded at fair value upon adoption of FAS 133 and quarterly by recording (i) a cumulative-effect type adjustment at January 1, 2001 equal to the fair value of the swap contract on that date, (ii) amortizing the cumulative-effect type adjustment quarterly over the life of the derivative contract, and (iii) a charge or credit to income in the amount of the difference between the fair value of the swap contract at the beginning and end of such 8 quarter. The following adjustments were recorded to reflect changes during the quarters ended March 31, 2002 and 2003:
Increase (Decrease) Income --------------------------------------------------------------------- Derivative Fair (Provision for) Benefit Net Derivative Value Change from Income Taxes Fair Value Change ------------ ----------------- ----------------- For the quarter ended March 31, 2002: - ------------------------------------ Amortization of cumulative-effect type adjustment $ (26,000) $ 11,000 $ ( 15,000) Difference in the derivative fair value between the beginning and end of the year 202,000 (87,000) 115,000 ------------ ----------- ----------- $ 176,000 $ (76,000) $ 100,000 ============ =========== =========== For the quarter ended March 31, 2003: - ------------------------------------ Amortization of cumulative-effect type adjustment $ (26,000) $ 11,000 $ (15,000) Difference in the derivative fair value between the beginning and end of the period 171,000 (70,000) 101,000 ----------- ----------- ----------- $ 145,000 $ (59,000) $ 86,000 =========== =========== ===========
NOTE 6 - SETTLEMENT AGREEMENT In the quarter ended March 31, 2003, the Company entered into a Final Settlement agreement with its former Chief Executive Officer. The agreement resulted in a $90,000 reduction of the amount previously credited to Additional Paid-in Capital in connection with the October 2002 resignation of the Chief Executive Officer. 9 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, 2003 Compared To Three Months Ended March 31, 2002. REVENUES. Revenues increased by $0.5 million to $17.3 million for the three-month period ended March 31, 2003, compared to $16.8 million for the three-month period ended March 31, 2002. GROSS PROFIT. Gross profit increased $0.2 million or 3% to $6.4 million for the three-month period ended March 31, 2003, compared to $6.2 million for the three-month period ended March 31, 2002. As a percent of revenues, gross profit was 37%. SELLING, GENERAL AND ADMINISTRATIVE EXPENSE. Selling, general and administrative ("SG&A") expense decreased $0.2 million, or 5% to $4.4 million for the three-month period ended March 31, 2003, compared to $4.6 million for the three-month period ended March 31, 2002. As a percentage of revenues, SG&A decreased to 25% for the three-month period ended March 31, 2003, compared to 27% for the three-month period ended March 31, 2002. OPERATING INCOME. Operating income increased $0.5 million to $2.1 million for the three-month period ended March 31, 2003, compared to a $1.6 million for the three-month period ended March 31, 2002. INTEREST EXPENSE. Interest expense for the three-month period ended March 31, 2003 was $0.5 million, a decrease of $0.1 million from the three-month period ended March 31, 2002 because of lower debt levels due to principal payments made during the last twelve months. DERIVATIVE FAIR VALUE CHANGE. The Company adopted SFAS 133 on January 1, 2001. During the quarters ended March 31, 2003 and 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 periods, or $171,000 ($101,000 net of tax provision) and $202,000 ($115,000 net of tax provision) in 2003 and 2002, respectively, and amortization of the cumulative-effect adjustment. INCOME TAXES. The Company's effective tax rate was 41% for the first quarter of 2003 and 43% for the first quarter of 2002. 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. The net income for the three-month period ended March 31, 2003 was $1.0 million, an increase of $0.4 million compared to net income of $0.6 million for the three-month period ended March 31, 2002. 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, 2002. On March 31, 2003, the Company's cash and cash equivalents aggregated $6.7 million. The Company's operating activities provided cash of $3.4 million for the three months ended March 31, 2003. The Company's investing activities used cash of $0.7 million in the three months ended March 31, 2003. The Company spent approximately $0.5 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 $0.3 million. 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. We estimate that capital expenditures will be $3.5 to $4.5 million in 2003. 10 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 $5.5 million in scheduled principal payments in 2002 and will make additional principal payments of $5.0 million and $18.0 million in 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. In July 2002, we entered into an arrangement regarding earn-out payments related to the July 1997 acquisition of MultiMedia Services, Inc. The original acquisition agreement would have required payments of approximately $1.5 million during the next two years assuming minimum earnings levels are met, which levels have been achieved in the past. In exchange for a one-time $1.1 million payment made in July 2002, we were relieved of all future earn-out obligations under the purchase agreement. In October 2002, the company paid the banks $20,000 and made an additional principal payment of $500,000 in connection with a waiver received from the banks to allow the company's former President and Chief Executive Officer to reduce his percentage ownership in the Company to below the 14% required in the restructured loan agreement. During the past year, the Company has generated sufficient cash to meet operating, capital expenditure and debt service needs and obligations, as well as to provide sufficient cash reserves to address contingencies. When preparing estimates of future cash flows, we consider historical performance, technological changes, market factors, industry trends and other criteria. In our opinion, the Company will continue to be able to fund its needs for the foreseeable future. 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. For example, the Company is currently negotiating to acquire three subsidiaries of Alliance Atlantis Communications Inc. ("Alliance"). If we acquire the entities, we will have to finance a large portion of the purchase price and refinance our existing $22 million term loan. The cost of new financing is expected to be higher than our existing term loan. Future earnings and cash flow may be negatively impacted to the extent the acquired entities do not generate sufficient earnings and cash flow to offset the increased 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. 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 11 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 or 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 judgements. 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: ALLOWANCE FOR DOUBTFUL ACCOUNTS. We are required to make judgments, based on historical experience and future expectations, as to the collectibility of accounts receivable. The allowances for doubtful accounts and sales returns represent allowances for customer trade accounts receivable that are estimated to be partially or entirely uncollectible. These allowances are used to reduce gross trade receivables to their net realizable value. The Company records these allowances based on estimates related to the following factors: i) customer specific allowances; ii) amounts based upon an aging schedule and iii) an estimated amount, based on the Company's historical experience, for issues not yet identified. VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS. Long-lived assets, consisting primarily of property, plant and equipment and intangibles comprise a significant portion of the Company's total assets. Long-lived assets, including goodwill and intangibles 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 a comparison of the carrying amount of an asset to future net cash flows expected to be generated by that asset. The cash flow projections are based on historical experience, management's view of growth rates within the industry and the anticipated future economic environment. Factors we consider important which could trigger an impairment review include the following: o significant underperformance relative to expected historical or projected future operating results; o significant changes in the manner of our use of the acquired assets or the strategy for our overall business; o significant negative industry or economic trends; o significant decline in our stock price for a sustained period; and o our market capitalization relative to net book value. When we determine that the carrying value of intangibles, long-lived assets and related goodwill and enterprise level goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, we measure any impairment based on 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. Net intangible assets, long-lived assets, and goodwill amounted to $47.6 million as of March 31, 2003. We ceased amortization of approximately $26.3 million of goodwill beginning in 2002. We had recorded approximately $2.0 million of amortization on these amounts during the year ended December 31, 2001. 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. 12 Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. The net deferred tax liability as of March 31, 2003 was $2.6 million. The Company did not record a valuation allowance against its deferred tax assets as of March 31, 2003. RECENT ACCOUNTING PRONOUNCEMENTS Effective January 1, 2001, the Company adopted SFAS No. 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 issued SFAS Nos. 141 and 142, "BUSINESS COMBINATIONS" and "GOODWILL AND OTHER INTANGIBLE ASSETS," respectively. SFAS 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. SFAS 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 SFAS No. 142, goodwill will be tested annually and whenever events or circumstances occur indicating that goodwill might be impaired. SFAS No. 141 and SFAS No. 142 are effective for all business combinations completed after June 30, 2001. Upon adoption of SFAS No. 142, amortization of goodwill recorded for business combinations consummated prior to July 1, 2001 ceases, and intangible assets acquired prior to July 1, 2001 that do not meet the criteria for recognition under SFAS No. 141 will be reclassified to goodwill. The Company implemented SFAS No. 142 in the first quarter of fiscal 2002 which required no goodwill impairment. The Company also tested goodwill as of September 30, 2002 with no impairment indicated. We ceased amortization of approximately $26.3 million of goodwill beginning in 2002. We had recorded approximately $2.0 million of amortization on these amounts during the year ended December 31, 2001. In August 2001, the FASB issued SFAS 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. SFAS 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 SFAS No. 143. In October 2001, the FASB issued SFAS 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 SFAS 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." SFAS 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. SFAS 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. SFAS No. 144 has had no impact on the Company. In April 2002, the FASB issued SFAS No. 145, "RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB STATEMENT NO. 13, AND TECHNICAL CORRECTIONS." SFAS No. 145 updates, clarifies, and simplifies existing accounting pronouncements. This statement rescinds SFAS No. 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in APB No. 30 will now be used to classify those gains and losses. SFAS No. 64 amended SFAS No. 4 and is no longer necessary as SFAS No. 4 has been rescinded. SFAS No. 44 has been rescinded as it is no longer necessary. SFAS No. 145 amends SFAS No. 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-lease transactions. This statement also makes technical corrections to existing pronouncements. While those corrections are not substantive in nature, in some instances, they may change accounting practice. The Company does not expect adoption of SFAS No. 145 to have a material impact, if any, on its financial position or results of operations. 13 In June 2002, the FASB issued SFAS No. 146, "ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES." This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "LIABILITY RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS AND OTHER COSTS TO EXIT AN ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A RESTRUCTURING)." This statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF Issue 94-3, a liability for an exit cost, as defined, was recognized at the date of an entity's commitment to an exit plan. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002 with earlier application encouraged. The Company does not expect adoption of SFAS No.146 to have a material impact, if any, on its financial position or results of operations. In October 2002, the FASB issued SFAS No. 147, "ACQUISITIONS OF CERTAIN FINANCIAL INSTITUTIONS." SFAS No. 147 removes the requirement in SFAS No. 72 and Interpretation 9 thereto, to recognize and amortize any excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired as an unidentifiable intangible asset. This statement requires that those transactions be accounted for in accordance with SFAS No. 141, "BUSINESS COMBINATIONS," and SFAS No. 142, "GOODWILL AND OTHER INTANGIBLE ASSETS." In addition, this statement amends SFAS No. 144, "ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS," to include certain financial institution-related intangible assets. This statement is not applicable to the Company. In December 2002, the FASB issued SFAS No. 148, "ACCOUNTING FOR STOCK-BASED COMPENSATION-TRANSITION AND DISCLOSURE," an amendment of SFAS No. 123. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. This statement is effective for financial statements for fiscal years ending after December 15, 2002. SFAS No. 148 will not have any impact on the Company's financial statements as management does not have any intention to change to the fair value method. 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: 14 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 five fiscal quarters ended December 31, 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 five fiscal quarters ended March 31, 2003, 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 principal payments of $5.5 million in 2002, and will make principal payments of $5.0 million and $18.5 million in 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. 15 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, 2002. 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. 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 other than an option to acquire three facilities from Alliance Atlantis Communications Inc. 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. In July 2002, the Company issued a warrant to purchase 500,000 shares of the Company's common stock to Alliance Atlantis Communications, Inc. ("Alliance") in consideration of an option to purchase three post-production facilities (the "Subsidiaries") owned by Alliance. In connection therewith, the Company capitalized the fair value of the warrant ($619,000, determined by using the Black-Scholes valuation model). In December 2002, the option was extended by mutual agreement and we deposited $300,000 toward the ultimate purchase price, which was negotiated downward. Additionally, the Company capitalized $278,000 of due diligence costs associated with the proposed acquisition and $141,000 of costs associated with a new financing arrangement. The Company did not exercise its option to purchase the Subsidiaries by the March 10, 2003 termination date. Alliance has agreed to continue negotiations with the Company to complete the transaction. In the event the Company does not exercise its option to purchase the Alliance subsidiaries, or does not complete the financing, these amounts will be written off. Although such a write-off would represent a non cash charge to income, we cannot predict the effect of such a charge on the market price of our common stock, if any. If we acquire the entities, we will have to finance a large portion of the anticipated purchase price and refinance our existing $22 million term loan. The cost of new financing is expected to be higher than our existing term loan. Future earnings and cash flow may be negatively impacted to the extent the acquired entities do not generate sufficient earnings and cash flow to offset the increased costs. 16 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 Haig S. Bagerdjian, Chairman, 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. Mr. Bagerdjian beneficially owns approximately 25% of the Company's outstanding stock, but does not have an employment contract. Although we have employment agreements with certain of our other key executives, we cannot be sure that either Mr. Bagerdjian or other executives will remain with the Company. 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 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 a 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 and there is no assurance 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. 17 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 Chairman, President and Chief Executive Officer, Haig S. Bagerdjian, beneficially owned approximately 25% of the outstanding common stock as of March 31, 2003. The ex-spouse of R. Luke Stefanko, the Company's former President and Chief Executive Officer, owned approximately 25% of the common stock on that date. Together, they owned approximately 50%. By virtue of their stock ownership, Ms. Stefanko and Mr. 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. 18 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK. The Company had borrowings of $22,000,000 at March 31, 2003 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"). In November 2000, the Company entered into an interest rate swap contract to economically hedge its floating debt rate. Under the terms of the contract, the notional amount is $15,000,000, whereby the Company receives LIBOR and pays a 6.50% rate of interest for the three years. 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) as a charge to Accumulated Other Comprehensive Income, a component of Shareholders' Equity, and an expense of $700,000 ($560,000 net of tax benefit) for the derivative fair value change of an interest rate swap contract and amortization of the cumulative effect adjustment. During the twelve month period ended December 31, 2002, the Company recorded income of $82,000 ($48,000 net of tax provision), for the derivative fair value change and amortization of the cumulative effect type adjustment. During the quarter ended March 31, 2003, the Company recorded income of $171,000 ($101,000 net of tax provision), for the derivative fair value change and amortization of the cumulative effect-type adjustment. ITEM 4. CONTROLS AND PROCEDURES Within the 90-day period prior to the filing date of this report, an evaluation was conducted under the supervision and with the participation of the Company's management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures, as such term is defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the "Exchange Act"). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in bringing to their attention on a timely basis material information relating to the Company that is required to be disclosed in the Company's reports that are filed under the Exchange Act. Subsequent to the date that the Chief Executive Officer and Chief Financial Officer completed their evaluation, there have not been any significant changes in the Company's internal controls or in other factors that could significantly affect such internal controls. 19 PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.1 Amended and Restated Option Agreement dated December 30, 2002 between the Company and Alliance Atlantis Communications Inc. (1) 99.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C.ss.1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C.ss.1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Notes: (1) Filed as an exhibit to Form 8-K with the Commission on January 8, 2003. (b) Reports On Form 8-K The Company filed a Form 8-K dated January 8, 2003 related to an extension of the period in which the Company could exercise an option to purchase three entities. 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, 2003 BY: /s/ Alan Steel ----------------------------- Alan Steel Executive Vice President, Finance and Administration (duly authorized officer and principal financial officer) 20 CERTIFICATIONS I, Haig S. Bagerdjian, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Point.360; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors: (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 14, 2003 /s/ Haig S. Bagerdjian ----------------------------------- Haig S. Bagerdjian Chairman of the Board of Directors, President and Chief Executive Officer 21 I, Alan R. Steel, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Point.360; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors: (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 14, 2003 /s/ Alan R. Steel ---------------------------------- Alan R. Steel Executive Vice President Finance and Administration and Chief Financial Officer 22 Exhibit 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. ss. 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Point.360 ( the "Company") on Form 10-Q for the period ended March 31, 2003, as filed with the Securities and Exchange Commission (the "Report"), I, Haig S. Bagerdjian, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: (1) The Report fully complies with the requirements of Section 13 (a) or 15 (d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Haig S. Bagerdjian - --------------------------- Haig S. Bagerdjian Chief Executive Officer May 14, 2003 23 Exhibit 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. ss. 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Point.360 ( the "Company") on Form 10-Q for the period ended March 31, 2003, as filed with the Securities and Exchange Commission (the "Report"), I, Alan R. Steel, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: (1) The Report fully complies with the requirements of Section 13 (a) or 15 (d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Alan R. Steel - --------------------------- Alan R. Steel Chief Financial Officer May 14, 2003 24 -----END PRIVACY-ENHANCED MESSAGE-----