QUARTERLY REPORT FOR SMALL BUSINESS ISSUERS SUBJECT TO
THE 1934 ACT REPORTING REQUIREMENTS
Form 10-QSB
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period ended September 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number: 0-25594
PROTOSOURCE CORPORATION
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(Exact name of registrant as specified in its charter)
California 77-0190772
---------- ----------
(State or other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification Number)
One Bethlehem Plaza, 4th Floor, Bethlehem, PA 18018
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(Address of Principal Executive Offices, Zip code)
610-332-2893
------------
(Issuers' Telephone Number)
Check whether the issuer (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
----- -----
There were 9,539,829 shares of the registrant's common stock, no par value
outstanding as of September 30, 2003.
PROTOSOURCE CORPORATION
=======================
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
SEPTEMBER 30, 2003
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INDEX
-----
Part I - Financial Information (unaudited):
Item 1. Condensed consolidated balance sheet -
September 30, 2003 3
Condensed consolidated statement of operations for the
nine-month and three-month periods ended
September 30, 2003 and 2002 4
Condensed consolidated statement of
stockholders' equity (deficiency) for the
nine-month period ended September 30, 2003 5
Condensed consolidated statement of cash flows for the
nine-month periods ended September 30, 2003 and 2002 6 & 7
Notes to condensed consolidated financial statements -
September 30, 2003 8 to 12
Item 2. Management's discussion and analysis of
financial condition and results of operations 13 to 19
Part II - Other Information
Other Information 20
Signature 21
When used in this report, the words "estimate," "project," "intend," "believe"
and "expect" and similar expressions are intended to identify forward-looking
statements. Such statements are subject to risk and uncertainties that could
cause actual results to differ materially, including competitive pressures and
new product introductions by the Company and its competitors. Readers are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date hereof. The Company undertakes no obligation to
publicly release updates or revisions to these statements.
- - 2 -
PROTOSOURCE CORPORATION
=======================
CONDENSED CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2003
(unaudited)
- --------------------------------------------------------------------------------
ASSETS
Current assets:
Cash $ 40,428
Interest receivable 125,214
Notes receivable 1,393,953
Assets held for sale 178,115
Prepaid expenses and other 2,151
------------
Total current assets 1,739,861
------------
Property and equipment under capital least,
at cost, net of accumulated amortization of $19,634 41,460
------------
Other assets:
Debt issuance costs, net of accumulated
amortization of $1,358,695 402,084
Investment in corporation 105,000
Deposits 1,500
------------
Total other assets 508,584
------------
Total assets $ 2,289,905
============
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Notes payable $ 1,725,000
Current portion of obligations under capital leases 12,611
Accounts payable 75,851
Accrued expenses 449,100
Deferred revenue 29,688
Liabilities to be assumed upon sale 155,332
------------
Total current liabilities 2,447,582
------------
Obligations under capital leases, non-current portion 25,997
------------
Commitments and contingencies
Stockholders' deficiency:
Preferred stock, no par value; 5,000,000 shares
authorized, none issued and outstanding --
Common stock, no par value; 10,000,000 shares
authorized, 9,539,829 shares issued and outstanding 26,235,960
Additional paid-in capital 2,087,891
Accumulated deficit (28,507,525)
------------
Net stockholders' deficiency (183,674)
------------
Total liabilities and net stockholders' deficiency $ 2,289,905
============
See accompanying notes.
- - 3 -
PROTOSOURCE CORPORATION
=======================
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(unaudited)
- -----------------------------------------------------------------------------------------------------------------
NINE-MONTH THREE-MONTH
PERIOD ENDED PERIOD ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
----------- ------------ ----------- -----------
Operating expenses:
General and administrative $ 254,061 $ 638,516 $ 94,563 $ 336,977
Depreciation and amortization 6,545 6,546 2,182 2,182
----------- ----------- ----------- -----------
Total operating expenses 260,606 645,062 96,745 339,159
----------- ----------- ----------- -----------
Operating loss (260,606) (645,062) (96,745) (339,159)
----------- ----------- ----------- -----------
Other income (charges):
Interest income 75,658 -- 28,309 --
Other income 16,201 11,482 4,465 8,590
Interest expense (1,461,267) (964,139) (448,587) (336,362)
Loss on sale of marketable securities (65,942) (222,586) -- (127,690)
----------- ----------- ----------- -----------
Net other charges (1,435,350) (1,175,243) (415,813) (455,462)
----------- ----------- ----------- -----------
Net loss from continuing operations (1,695,956) (1,820,305) (512,558) (794,621)
Discontinued operations:
Gain (loss) from discontinued
operations - ISP -- (26,675) -- 7,154
----------- ----------- ----------- -----------
Net loss ($1,695,956) ($1,846,980) ($ 512,558) ($ 787,467)
=========== =========== =========== ===========
Net loss per basic and diluted
share of common stock:
Continuing operations ($ .21) ($ .30) ($ .06) ($ .12)
Discontinued operations -- -- -- --
----------- ----------- ----------- -----------
Net loss ($ .21) ($ .30) ($ .06) ($ .12)
=========== =========== =========== ===========
Weighted average number of
basic and diluted common
shares outstanding 7,943,410 6,170,834 9,097,121 6,650,604
=========== =========== =========== ===========
See accompanying notes.
- - 4 -
PROTOSOURCE CORPORATION AND SUBSIDIARY
======================================
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIENCY)
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2003
(unaudited)
- -----------------------------------------------------------------------------------------------------------------------------------
Accumulated
Common Stock Additional Other
------------ Paid-In Comprehensive Accumulated Comprehensive
Shares Amount Capital Income (Loss) Deficit Income (Loss) Total
------ ------ ------- ------------- ------- ------------- -----
Balance, December 31, 2002 7,489,829 $ 25,635,960 $ 1,487,891 ($ 62,069) ($26,811,569) $ 250,213
Issuance of common stock in
connection with financing 2,050,000 600,000 600,000
Beneficial conversion feature
of convertible notes 600,000 600,000
Unrealized (loss) on
marketable securities (3,873) ($ 3,873) (3,873)
Reclassification adjustment
for losses included
in net loss 65,942 65,942 65,942
Net loss (1,695,956) (1,695,956) (1,695,956)
------------ ------------ ------------ ------------ ------------ ------------ ------------
Total comprehensive (loss) ($ 1,633,887)
============
Balance, September 30, 2003 9,539,829 $ 26,235,960 $ 2,087,891 $ -- ($28,507,525) ($ 183,674)
============ ============ ============ ============ ============ ============
See accompanying notes.
- - 5 -
PROTOSOURCE CORPORATION
=======================
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(unaudited)
- ----------------------------------------------------------------------------------------------------------
NINE-MONTH PERIOD
ENDED
SEPTEMBER 30,
2003 2002
------------ ------------
INCREASE (DECREASE) IN CASH
Cash flows from operating activities:
Net loss ($1,695,956) ($1,846,980)
Adjustments to reconcile net loss to net cash
(used in) operating activities:
Depreciation and amortization 6,545 20,788
Provision for bad debts -- 2,950
Loss on sale of marketable securities 65,942 222,586
Amortization of debt issuance costs 741,459 352,040
Amortization of beneficial conversion
feature of notes payable 600,000 571,388
Changes in operating assets and liabilities:
Interest receivable (75,658) (5,696)
Prepaid expenses and other assets -- 39,063
Assets and liabilities held for sale -- (2,243)
Accounts payable (4,982) 43,361
Accrued expenses 133,148 253,916
Deferred revenue 20,688 (4,000)
----------- -----------
Net cash (used in) operating activities (208,814) (352,827)
----------- -----------
Cash flows from investing activities:
Increase in notes receivable (348,673) (770,400)
Deposits (1,000) (500)
Deferred costs of sale -- (10,000)
Proceeds from sale of marketable securities 7,051 247,496
----------- -----------
Net cash (used in) investing activities (342,622) (533,404)
----------- -----------
Cash flows from financing activities:
Proceeds from borrowings 600,000 850,000
Payments on obligations under capital leases (10,807) (30,577)
Debt issuance costs incurred -- (32,749)
----------- -----------
Net cash provided by financing activities 589,193 786,674
----------- -----------
Net increase (decrease) in cash 37,757 (99,557)
Cash at beginning of period 2,671 118,265
----------- -----------
Cash at end of period $ 40,428 $ 18,708
=========== ===========
CONTINUED ON NEXT PAGE
See accompanying notes.
- - 6 -
PROTOSOURCE CORPORATION
=======================
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS - CONTINUED
(unaudited)
- ------------------------------------------------------------------------------------------------------------
NINE-MONTH PERIOD
ENDED
SEPTEMBER 30,
2003 2002
--------- ---------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $119,808 $ 41,571
-------- --------
Income taxes $ -- $ --
-------- --------
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Issuance of common stock in connection with financing $600,000 $806,667
Issuance of warrants in connection with financing -- 46,363
See accompanying notes.
- - 7 -
PROTOSOURCE CORPORATION
=======================
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2003
(unaudited)
- --------------------------------------------------------------------------------
1. Basis of Presentation
---------------------
The accompanying unaudited condensed consolidated financial statements of
the Company are prepared in conformity with generally accepted accounting
principles. The disclosures presented are sufficient, in management's
opinion, to make the interim information presented not misleading. All
adjustments, consisting of normal recurring adjustments, which are
necessary so as to make the interim information not misleading, have been
made. Results of operations for the nine months ended September 30, 2003
are not necessarily indicative of the results expected for the full fiscal
year or for any future period. It is recommended that this financial
information be read with the complete financial statements included in the
Company's Annual Report on Form 10-KSB for the year ended December 31, 2002
previously filed with the Securities and Exchange Commission.
The accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The financial
statements do not include any adjustments relating to the recoverability
and classification of recorded asset amounts or the amount and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern. The Company's continuation as a
going concern is dependent upon its ability to generate sufficient cash
flows to meet its obligations on a timely basis, to obtain additional
financing as may be required, and to generate revenues to a level where the
Company becomes profitable. Additionally, the Company has experienced
extreme cash liquidity shortfalls from operations.
The Company's continued existence is dependent upon its ability to achieve
its operating plan. Management's plans include the following:
o In February, 2003, the Company signed an Agreement and Plan of Merger
with P2i, Inc. ("P2i") to acquire P2i's Print-to-Internet business in
exchange for a controlling interest in the Company.
o Obtaining additional working capital through the sale of common stock
or debt securities.
If management cannot achieve the above objectives, the Company may find it
necessary to dispose of assets, or undertake other actions as may be
appropriate.
2. Summary of Significant Accounting Policies
------------------------------------------
Net (loss) per basic and diluted share of common stock:
Basic loss per share is calculated using the weighted average number of
common shares outstanding. Diluted loss per share is computed on the basis
of the weighted average number of common shares outstanding during the
period increased by the dilutive effect of outstanding stock options using
the "treasury stock" method.
- - 8 -
PROTOSOURCE CORPORATION
=======================
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2003
(unaudited)
- --------------------------------------------------------------------------------
2. Summary of Significant Accounting Policies - Continued
------------------------------------------------------
The basic and diluted loss per share are the same since the Company had a
net loss for all periods presented and the inclusion of stock options and
other incremental shares would be anti-dilutive. Options and warrants to
purchase 1,330,000 and 3,523,500 shares of common stock at September 30,
2003 and 2002, respectively, were not included in the computation of
diluted earnings per share.
Stock-based compensation:
The Company adopted SFAS No. 123, "Accounting for Stock-based Compensation"
for its stock-based compensation plans. The Company will continued to
measure compensation expense for its stock-based employee compensation
plans using the intrinsic value method prescribed by APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations.
If the Company had elected to recognize compensation expense based upon the
fair value at the grant date for awards under these plans consistent with
the methodology prescribed by SFAS No. 123, the Company's net loss and loss
per share would be increased to the following pro forma amounts for the
nine-month periods ended September 30, 2003 and 2002.
2003 2002
----------- -----------
Net loss:
As reported ($1,695,956) ($1,846,980)
Deduct:
Total stock-based compensation
determined under Black-Scholes
option valuation model
for all awards,
net of income taxes -- (26,000)
----------- -----------
Pro forma ($1,695,956) ($1,872,980)
=========== ===========
Net loss per share of common stock:
As reported ($ .21) ($ .30)
Pro forma ($ .21) ($ .30)
These pro forma amounts may not be representative of future disclosures
since the estimated fair value of stock options is amortized to expense
over the vesting period and additional options may be granted in future
periods. The fair value for these options was estimated at the date of
grant using the Black-Scholes option pricing model with the following
assumptions for each period:
Risk free interest rate 4.95%
Expected life 5 years
Expected volatility 76.5%
Expected dividend yield None
- - 9 -
PROTOSOURCE CORPORATION
=======================
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2003
(unaudited)
- --------------------------------------------------------------------------------
2. Summary of Significant Accounting Policies - Continued
------------------------------------------------------
Reclassifications:
Certain amounts in the prior period have been reclassified to conform to
the current period presentation.
3. Pending Sale of ISP Division
----------------------------
Effective May 1, 2002, the Company entered into an agreement to sell
substantially all of the assets of the ISP division to Brand X Networks,
Inc., a California Corporation, for $632,000. The assets have been held and
operated by Brand X Networks, Inc. for its purposes since May 1, 2002, at
which time the Company discontinued its ISP operations. On April 14, 2003,
the Company completed a fifth amendment to the purchase agreement with
Brand X pursuant to which the Company has agreed to accept an aggregate
payment of $632,000 for the ISP Division, less credits to Brand X of
$112,686. Of such amount, $200,000 shall be paid through the provision of
services to the Company from Brand X. The balance shall be paid at the rate
of approximately $5,171 per month, until completely paid. The closing of
the asset sale shall take place upon the earlier of (i) approval of such
sale by the shareholders of the Company, or (ii) ten days after the
acquisition of P2i Newspaper.
A summary of operating results of this discontinued operation for the
three-month and nine-month periods ended September 30, 2002 follows:
3 MONTH PERIOD 9 MONTH PERIOD
ENDED 9/30/02 ENDED 9/30/02
------------- -------------
Net revenues $ - $453,177
Operating expenses ( 7,236) 479,034
--------- --------
Operating income (loss) 7,236 ( 25,857)
Other expenses ( 82) ( 818)
--------- ---------
Net gain (loss) $ 7,154 ($ 26,675)
========= ========
4. Proposed Acquisition
--------------------
On February 13, 2003, the Company announced an agreement and Plan of Merger
to acquire all of the outstanding capital stock of P2i Newspaper, Inc., a
Delaware corporation ("P2i Newspaper") and a wholly-owned subsidiary of
P2i, Inc., a Pennsylvania corporation ("P2i"), in exchange for the issuance
of up to 19,383,531 shares of ProtoSource common stock and satisfaction of
the existing P2i debt to the Company (the "Agreement").
The 19,383,531 shares will be reduced by the number of shares equal to the
total fees incurred to audit the financial statements of P2i or P2i
Newspaper, divided by $0.50 (the "Adjusted Shares"). The P2i Newspaper
shareholders shall receive 10 shares of ProtoSource common stock for each
$1.00 of gross income (as defined in the
- -10 -
PROTOSOURCE CORPORATION
=======================
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2003
(unaudited)
- --------------------------------------------------------------------------------
4. Proposed Acquisition - Continued
--------------------------------
Agreement) earned by P2i Newspaper during calendar years 2003 through 2005,
calculated quarterly, up to the total number of Adjusted Shares. The
Adjusted Shares shall be subject to a three-year lock-up, which may be
released upon the stock price and volume reaching established thresholds.
The Company loaned P2i $50,000 in 2001, $995,280 in 2002, and $348,673
between January 1, 2003 and September 30, 2003. The loans to P2i are in the
form of demand notes which, in the event that the merger does not get
completed, will be due on demand. The notes accrue interest at the rate of
8% per annum. Subject to the conditions of the Agreement and Plan of
Merger, the closing date for the transaction must occur by January 31,
2004. The ultimate repayment of this receivable is highly dependent upon
the completion of the merger.
Upon closing of the transaction, ProtoSource will appoint Thomas Butera,
President of P2i, as a director of ProtoSource, and Mr. Butera, together
with Peter Wardle, President of ProtoSource, shall have the right to
appoint three members to the Board of Directors of ProtoSource. The closing
of this Agreement is subject to approval by the shareholders of ProtoSource
and P2i Newspaper, and other customary terms and conditions. After the
acquisition, P2i Newspaper will become a wholly-owned subsidiary of the
Company. P2i Newspaper is a leader in the conversion of print content into
Web content, and its clients include newspapers from the Tribune, McClatchy
Copley and Gannett newspaper groups in the United States, Northcliffe and
Tindle newspaper groups in the United Kingdom, as well as many others. In
addition to its headquarters in Pennsylvania, P2i Newspaper has a West
Coast sales office and its data conversion center is located in the
Multimedia Super Corridor in Kuala Lumpur, Malaysia.
5. Notes Payable
-------------
During the nine months ended September 30, 2003, the Company issued
$600,000 of promissory notes in exchange for amounts borrowed from
individuals. The notes mature in one year from date of issuance with
interest payable at 10% per annum and each with a conversion feature which
permits the Holder to convert the principal and accrued interest into the
Company's common stock at any time prior to the due date of the repayment
of the note by the Company. The conversion rate is generally the amount to
be converted divided by 50% of the average closing bid price of the common
stock for the five trading days prior to the date of the note. An amount of
approximately $600,000 has been recognized in 2003 as interest expense and
additional paid-in capital as the result of the beneficial conversion
feature of these notes.
Also in connection with the issuance of these notes, the Company issued
2,050,000 shares of common stock valued at $600,000. In addition, the
Company issued 40,000 warrants, which have a deminimis value, to the
underwriter. These amounts are being amortized to interest expense on a
monthly basis over the one-year term of the notes.
- - 11 -
PROTOSOURCE CORPORATION
=======================
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2003
(unaudited)
- --------------------------------------------------------------------------------
6. Recently Issued Accounting Standards
------------------------------------
In December, 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure", which provides
alternative methods of transition for a voluntary change to a fair value
based method of accounting for stock-based employee compensation as
prescribed in SFAS No. 123. Additionally, SFAS No. 148 requires more
prominent and more frequent disclosures in financial statements about the
effects of stock-based compensation. The provisions of this Statement are
effective for fiscal years ending after December 15, 2002. Management does
not expect the adoption of this Statement to have a material impact on the
Company's financial condition or results of operations.
- - 12 -
PROTOSOURCE CORPORATION
=======================
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(unaudited)
- --------------------------------------------------------------------------------
Certain statements in this section and elsewhere in this quarterly report on
Form 10-QSB are forward-looking in nature and relate to the Company's plans,
objectives, estimates and goals. Words such as "expects," "anticipates,"
"intends," "plans," "projects," "forecasts," "believes," and "estimates," and
variations of such words and similar expressions, identify such forward-looking
statements. Such statements are made pursuant to the safe harbor provisions of
the private securities litigation reform act of 1995 and speak only as of the
date of this report. The statements are based on current expectations, are
inherently uncertain, are subject to risks and uncertainties and should be
viewed with caution. Actual results and experience may differ materially from
those expressed or implied by the forward-looking statements as a result of many
factors, including, without limitation, those set forth under "Description of
Business" in the Company's most recent Annual Report on Form 10-KSB. The Company
makes no commitment to update any forward-looking statement or to disclose any
facts, events, or circumstances after the date hereof that may affect the
accuracy of any forward-looking statement.
Results of Operations
- ---------------------
Nine Months ended September 30, 2003 vs. Nine Months ended September 30, 2002
Net revenues - For the nine months ended September 30, 2003, net revenues were
$0. For the nine months ended September 30, 2002, revenues were $453,177, all of
which are included in discontinued operations. Under the terms of a conditional
agreement entered on May 1, 2002, the ISP and Web development assets of the
Company have been operated by Brand X Networks since that date and have been
classified as discontinued operations.
Operating expenses - For the nine months ended September 30, 2003, operating
expenses totaled $260,606 versus $645,062 in 2002. The Company's general and
administrative expenses decreased by $384,456, principally the result of payroll
and related costs associated with employees who are no longer with the Company.
The operations of the ISP for the nine-month period ended September 30, 2002
have been classified as discontinued operations and the related operating
expenses of the ISP have not been included in the aforementioned discussion.
Interest expense - Interest expense totaled $1,461,267 for the nine-month period
ended September 30, 2003 versus $964,139 in the same period in 2002. The
increase in interest expense is a result of the convertible notes obtained
during 2002 and 2003 to fund the operations of the Company and P2i, pending the
merger. A significant component of interest expense includes amortization of
debt issuance costs in each year.
Other (charges) - Other charges included losses on the sale of marketable
securities (Dauphin Technology, Inc. common stock) of $65,942 and $222,586 in
2003 and 2002, respectively.
Discontinued operations - Operations of the ISP division were discontinued under
the terms of the Brand X agreement. On April 14, 2003, the Company completed a
fifth amendment to the purchase agreement with Brand X pursuant to which the
Company has agreed to accept an aggregate payment of $632,000 for the ISP
Division, less credits to Brand X of $112,686. Of such amount, $200,000 shall be
paid through the provision of services to the Company from Brand X. The balance
shall be paid at the rate of approximately $5,171 per month, until completely
paid. The closing of the asset sale shall take place upon the earlier of (i)
approval of such sale by the shareholders of the Company, or (ii) ten days after
the acquisition of P2i Newspaper.
- 13 -
PROTOSOURCE CORPORATION
=======================
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
Three Months ended September 30, 2003 vs. Three Months ended September 30, 2002
Net revenues - For the three-month periods ended September 30, 2003 and 2002,
net revenues were $0. Under the terms of a conditional agreement entered on May
1, 2002, the ISP and Web development assets of the Company have been operated by
Brand X Networks since that date and have been classified as discontinued
operations.
Operating expenses - For the three months ended September 30, 2003, operating
expenses totaled $96,745 versus $339,159 in 2002. The Company's general and
administrative expenses decreased by $242,414, principally the result of payroll
and related costs associated with employees who are no longer with the Company.
The operations of the ISP for the three-month period ended September 30, 2002
have been classified as discontinued operations and the related operating
expenses of the ISP have not been included in the aforementioned discussion.
Interest expense - Interest expense totaled $448,587 for the three-month period
ended September 30, 2003 versus $336,362 in the same period in 2002. The
increase in interest expense is a result of the convertible notes obtained
during 2002 and 2003 to fund the operations of the Company and P2i, pending the
merger. A significant component of interest expense includes amortization of
debt issuance costs in each year.
Other (charges) - Other charges included losses on the sale of marketable
securities (Dauphin Technology, Inc. common stock) of $127,690 during the
three-months ended September 30, 2002.
Discontinued operations - Operations of the ISP division were discontinued under
the terms of the Brand X agreement. On April 14, 2003, the Company completed a
fifth amendment to the purchase agreement with Brand X pursuant to which the
Company has agreed to accept an aggregate payment of $632,000 for the ISP
Division, less credits to Brand X of $112,686. Of such amount, $200,000 shall be
paid through the provision of services to the Company from Brand X. The balance
shall be paid at the rate of approximately $5,171 per month, until completely
paid. The closing of the asset sale shall take place upon the earlier of (i)
approval of such sale by the shareholders of the Company, or (ii) ten days after
the acquisition of P2i Newspaper.
- - 14 -
PROTOSOURCE CORPORATION
=======================
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
Liquidity and Capital Resources
- -------------------------------
For the nine months ended September 30, 2003, we used cash of $208,814 for
operating activities, used net cash of $342,622 in investing activities and were
provided net cash of $589,193 from financing activities. We had negative working
capital of $707,721 at September 30, 2003. As of September 30, 2003, we had
$40,428 in cash and $2,473,579 of total liabilities.
On April 30, 1999, we entered into a strategic alliance with Infosis Corp., a
privately held corporation and purchased 12.7%, on a non-diluted basis, of its
outstanding common stock. We paid an aggregate of $1.8 million for 600,000
shares of Infosis Corp. common stock. At the time of the purchase, the $1.8
million payment represented 51.1% of our available cash. 30,000 of the purchased
shares were paid to Andrew, Alexander, Wise & Co., Inc. ("AAWC"), as a finder's
fee. After payment of the 30,000 shares of Infosis common stock to AAWC, we
owned 570,000 shares of Infosis Corp. common stock. There was no affiliate or
related party relationships with Infosis prior to this investment. The strategic
alliance pertained to joint marketing and development activities whereby
ProtoSource would become the Web design and development arm of Infosis Corp. As
part of the investment, William Conis, then a Director of ProtoSource, was
appointed to the Board of Directors of Infosis Corp. in June 1999. In June 1999,
the Board of Directors of Infosis Corp. replaced its CEO and CFO. The new
management team changed the direction of Infosis Corp. and did not follow
through on the alliance with ProtoSource.
In January, 2000, Infosis Corp. issued ProtoSource 120,000 shares of its common
stock as an adjustment to reflect a lower offering price per share in a
concluded private placement of its common stock, which brought ProtoSource's
holdings of Infosis Corp. to 690,000 shares. The additional shares issued were
the result of the anti-dilution provision, which was part of the original
investment in Infosis Corp. The receipt of the additional shares from the
anti-dilution provision did not result in a change in the cost basis of
ProtoSource's original investment in Infosis Corp.
In July, 2000, we purchased an $84,177 convertible promissory note from Infosis
Corp. in connection with a bridge financing.
In September, 2000, ProtoSource acquired an aggregate of $329,686 principal
amount of Infosis Corp. convertible promissory notes at $0.05 on the dollar for
a total acquisition price of $16,484. These convertible promissory notes were
then converted into 329,686 shares of preferred stock of Infosis Corp.
Concurrent with the acquisition of the Infosis Corp. promissory notes by
ProtoSource, Infosis Corp. merged into P2i, Inc., a privately held corporation.
ProtoSource's investment in Infosis Corp. was increased by the amount that it
paid for the promissory notes, which were then converted into preferred stock of
Infosis Corp. As a result of this merger, ProtoSource owned 506,225 shares of
common stock or approximately 4% of P2i, Inc. As a result of a lack of interest
in the strategic alliance by Infosis and the merger between Infosis and P2i,
Inc., our original investment into Infosis, which merged into P2i, Inc., has
turned into a passive investment. P2i, Inc. is a privately-held company and
there can be no assurances that we will realize the full value of this
investment if we need to dispose of these assets. In addition, after further
review of this investment, although no formal appraisal or valuation report was
prepared, as of December 31, 2000, we recorded an impairment expense of
$1,271,484 to write down this investment to its estimated market value. The
impairment expense was recorded as the difference between $630,000 and the total
amount of our investment in Infosis.
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PROTOSOURCE CORPORATION
=======================
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
Liquidity and Capital Resources - Continued
- -------------------------------------------
On July 17, 2001, P2i acquired all the assets of Twenty Twenty Design &
Marketing, Inc. of New York City. As a result of this acquisition, our holdings
in P2i were diluted to approximately 2.6% of the resulting entity. Additionally,
the post-merger valuation of P2i was set at approximately $8.7 million. Based on
this new information, we recorded an additional impairment charge of $404,000 as
of June 30, 2001, to write down this investment to fair value. The impairment
charge was recorded as the difference between the previous value of this
investment ($630,000) and the newly established value ($226,000). A further
impairment charge of $121,000 was recorded in 2002.
On August 22, 2000, we acquired all the outstanding common stock of Suncoast
Automation, Inc. in exchange for 1,303,072 shares of our common stock. Although
we did not obtain an independent appraisal of the fair market value of Suncoast,
we based our valuation on the cable television industry standard at that time of
$5,000 per subscriber. On May 17, 2001, we entered into a Term Sheet to sell the
assets of Suncoast Automation to Dauphin Technology, Inc. (DNTK.OB), an Illinois
corporation. The sale was concluded effective July 1, 2001. As a result of the
sale, we received 766,058 shares of Dauphin common stock of which 38,303 shares
were paid to our investment banker, AAWC. Dauphin also agreed to assume $140,269
in Suncoast liabilities. In conjunction with the sale, we negotiated
approximately $362,498 of Suncoast-related liabilities for 268,466 shares of our
common stock and approximately $3,300 in cash. The write-down in connection with
this sale was recorded in the second quarter of 2001. The Dauphin Technology
stock we received was registered effective September 22, 2001. The Company began
liquidation of a portion of the securities in October 2001. Proceeds from the
sale of securities will be used to fund the Company's operations. During the
three months ended March 31, 2003, the remaining shares were liquidated.
On December 14, 2001, after exploring numerous alternatives, the Company entered
into a term sheet to acquire P2i for 22,768,412 shares of our common stock.
In March, 2002, the Company entered into an agreement with AAWC to act as
placement agent for the sale of convertible notes aggregating at least $300,000.
The notes are secured by certain assets of the Company and accrue interest at
10% per annum. P2i has agreed to pay all the costs and obligations incurred with
this financing. The funding was completed during March 2002 and AAWC was paid a
10% commission and a 3% non-accountable expense allowance.
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PROTOSOURCE CORPORATION
=======================
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
Liquidity and Capital Resources - Continued
- -------------------------------------------
On May 1, 2002, the Company entered into a conditional agreement to sell the
assets of the Fresno-based ISP business to Brand X Networks. Brand X Networks is
a privately-held California-based company whose principal shareholders were
former employees of the Company. The Company agreed to lay off the remaining
employees based in Fresno on April 30, 2002. Most terminated employees were
hired by Brand X. Additionally, Brand X has assumed financial and operational
responsibility for the ISP business. On April 14, 2003, the Company completed a
fifth amendment to the purchase agreement with Brand X pursuant to which the
Company has agreed to accept an aggregate payment of $632,000 for the ISP
Division, less credits to Brand X of $112,686. Of such amount, $200,000 shall be
paid through the provision of services to the Company from Brand X. The balance
shall be paid at the rate of approximately $5,171 per month, until completely
paid. The closing of the asset sale shall take place upon the earlier of (i)
approval of such sale by the shareholders of the Company, or (ii) ten days after
the acquisition of P2i Newspaper.
In July, 2002, the Company executed its merger agreement with P2i. Concurrently,
the Company's CEO, Mr. William Conis, resigned his position as both CEO and
Director. Mr. Peter Wardle, CEO of P2i and a ProtoSource Director, became CEO of
the Company. Mr. Wardle is currently both CEO of ProtoSource and P2i even though
the closing on the P2i acquisition has not yet occurred. This inherent conflict
of interest will remain until the closing of the P2i acquisition takes place.
On September 17, 2002, the Board of Directors approved a revised term sheet
restructuring the P2i acquisition. Under the new terms, ProtoSource will acquire
the Newspaper portion of P2i's business through the acquisition of specific
assets which include the entire newspaper related customer base, technology,
intellectual property and P2i's production company located just south of Kuala
Lumpur, Malaysia. In addition, key P2i employees will transition with the
business. These assets and the key employees have been transferred to P2i
Newspaper, Inc., a wholly-owned subsidiary of P2i formed specifically for this
purpose. The acquisition of P2i by ProtoSource will be accounted for by the
purchase method of accounting as a reverse acquisition. For accounting purposes,
P2i is considered to be the acquirer and ProtoSource is the acquiree.
The number of shares of restricted common stock to be issued to P2i has
subsequently been revised to 19,383,531 shares (subject to earn-out through
2005) which will result in an ownership of approximately 66% by the stockholders
of P2i, on a fully diluted basis assuming conversion of certain bridge loans
into common stock, the balance being held by the current stockholders of
ProtoSource. After the acquisition of P2i is completed, the Board of Directors
of Protosource will consist of seven members. One member shall be appointed by
the investment banker, AAWC (this appointment must be approved by P2i but can't
be unreasonably withheld). One member shall be appointed by Suncoast under the
terms of the Suncoast sale agreement and will expire in accordance with that
agreement to be replaced by a Wardle/Butera appointment. Messrs. Wardle and
Butera will be on the Board and they shall appoint the two independent members
plus one other as long as they hold 25% or more of P2i New Media, Inc. (see
below), collectively, and P2i New Media, Inc. owns 25% or more of ProtoSource.
In the event that P2i's ownership drops below 25% but is not less than 10%, P2i
shall appoint one board member. In the event that P2i's ownership drops below
10%, P2i shall not have the right to appoint any board member. ProtoSource and
P2i both used the same investment banker to represent them in the transaction
and each will pay the investment banker a fee based on the
- - 17 -
PROTOSOURCE CORPORATION
=======================
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
Liquidity and Capital Resource - Continued
- ------------------------------------------
value of the transaction using a pre-set formula. The investment banking fees to
be paid are $406,844 by ProtoSource and $413,422 by P2i. The amounts paid to the
investment banker will be paid through the issuance of common stock, which is
restricted for a three-year period, based on an agreed-upon value of $.50 per
share at the time of signing the term sheet, or 813,688 shares for ProtoSource
and 826,844 shares for P2i. The shares to be issued for P2i's investment banking
fees will be subtracted from the shares to be issued to the P2i stockholders for
the acquisition. P2i's remaining catalog and new media business will stay with
P2i and ProtoSource will change its name to P2i NewMedia, Inc. However,
ProtoSource will increase its ownership in P2i from the current 2.18% (506,225
shares) to 19.8%. The consideration to be paid is $1,100,000 comprising the
forgiveness of P2i debt to ProtoSource ($829,400 at the time the term sheet was
approved) and the balance in the form of a six-month note commencing the day the
merger is approved by shareholders of ProtoSource.
During 2002, the Company entered into an agreement with AAWC to act as a
placement agent for the sale of convertible notes aggregating $1,300,000. The
notes are secured by stock in P2i and accrue interest at 10% per annum. The
Company pays the cost and obligations of the first $200,000 incurred with this
financing and P2i has agreed to pay all remaining costs and obligations. Through
September 30, 2003, $1,225,000 in funding had been completed. AAWC was paid a
10% commission and a 3% non-accountable expense. Substantially all of the
proceeds from these notes have been loaned to P2i. The loans are in the form of
demand notes which accrue interest at 8% per annum.
During the nine-month period ended September 2003, the Company entered into
certain agreements with AAWC to act as a placement agent for the sale of
convertible notes aggregating $400,000. The notes are secured by stock in P2i
and accrue interest at 10% per annum. P2i has agreed to pay the related costs
and obligations. Through September 30, 2003, $300,000 in funding had been
completed; an additional $100,000 was completed during October 2003. AAWC was
paid a 10% commission and a 3% non-accountable expense. Substantially all of the
proceeds from these notes have been loaned to P2i. The loans are in the form of
demand notes which accrue interest at 8% per annum.
During May 2003, the Company entered into an agreement with Carl R. Butera for
the sale of a convertible note aggregating $200,000. The note is secured by
stock in P2i and accrues interest at 10% per annum. Substantially all of the
proceeds from this note have been loaned to P2i. The loan is in the form of a
demand note which accrues interest at 8% per annum.
On July 1, 2001, an agreement was entered into with Dauphin Technology, Inc.
where Dauphin Technoloy, Inc. is to pay the two leases guaranteed by ProtoSource
for leased equipment located at Suncoast Automation's locations.
- - 18 -
PROTOSOURCE CORPORATION
=======================
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
Critical Accounting Policies and Estimates
- ------------------------------------------
Management's discussion and analysis of its financial position and results of
operations are based upon the Company's 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
management to make estimates and assumptions that affect the reported amounts of
assets, liabilities, revenue and expenses and related disclosure of contingent
assets and liabilities. The significant accounting policies which we believe are
the most critical to aid in fully understanding and evaluating our reported
financial results include the following:
In accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of" (and superceded in 2001 by
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets"),
the Company recorded impairment charges through December 31, 2002 to reduce the
carrying value of its investment in P2i to $105,000.
In accordance with SFAS No. 109, "Accounting for Income Taxes", the Company
maintains a valuation allowance of $5,505,000 as of September 30, 2003 on
deferred tax assets relating to its net operating losses which the Company has
not determined to be more likely than not realizable.
Through September 30, 2003, the Company has advanced $1,393,953 to P2i, a
company whose Chief Executive Officer serves in the same capacity at ProtoSource
Corporation. The ultimate repayment of this receivable is highly dependent upon
the completion of a merger between P2i's Newspaper Division and the Company
which the Company believes will occur prior to January 31, 2004.
Item 3. CONTROLS AND PROCEDURES.
(a) The Chief Executive Officer and the Chief Financial Officer of the
Company have evaluated the effectiveness of the design and operation of the
Company's system of disclosure controls and procedures (as defined in Rules
13a-14(c) and 15d-14(c) under the Exchange Act) as of a date within 90 days
prior to the filing of this Form 10-QSB. As a result of that evaluation, they
have concluded that the Company's disclosure controls and procedures are
effective to ensure that information required to be disclosed in the Company's
reports filed or submitted under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in Securities and
Exchange Commission rules and forms.
(b) There have been no significant changes in the Company's system of
internal controls or in other factors that could significantly affect internal
controls subsequent to the date of their evaluation. There were no discoveries
of any significant deficiencies or material weaknesses in such controls that
would require the Company to take corrective actions.
- - 19 -
PROTOSOURCE CORPORATION
=======================
OTHER INFORMATION
(unaudited)
- --------------------------------------------------------------------------------
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.
From time to time the Company is subject to litigation incidental to its
business. The Company is not currently a party to any material legal proceedings
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
During the three-month period ended September 30, 2003, the Company issued
promissory notes totaling $200,000 to various individuals. Each note has a
one-year maturity, carries interest at 10% per annum, and includes a conversion
feature which permits the holder to convert this principal and accrued interest
into the Company's common stock any time prior to the due date of the note. The
conversion rate had been contractually set at $0.16 per share.
Also in connection with the issuance of these notes, the Company issued to
the note holders 625,000 shares of common stock valued at $200,000, and 20,000
warrants to the placement agent which had a deminimis value.
Item 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
Item 5. OTHER INFORMATION.
None.
.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
The following exhibits are filed with this report:
Exhibit 31.1 - Certification of CEO and CFO pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
Exhibit 32.1 - Certification of CEO and CFO pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K.
During the quarterly period ended September 30, 2003, the Company filed no
report on Form 8-K.
- - 20 -
PROTOSOURCE CORPORATION
=======================
SIGNATURE
- --------------------------------------------------------------------------------
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.
PROTOSOURCE CORPORATION
/s/ Peter Wardle
-----------------------------
Peter Wardle,
Chief Executive Officer/
Chief Financial Officer
Date: November 13, 2003
- - 21 -