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, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number: 0-25594
PROTOSOURCE CORPORATION
-----------------------
(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
---------------------------------------------------
(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 8,114,829 shares of the registrant's common stock, no par value
outstanding as of September 30, 2004.
PROTOSOURCE CORPORATION
-----------------------
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
SEPTEMBER 30, 2004
- -------------------------------------------------------------------------------------------------
INDEX
-----
Part I - Financial Information (unaudited):
Item 1. Condensed consolidated balance sheet -
September 30, 2004 3
Condensed consolidated statement of operations for the
nine-month and three-month periods ended
September 30, 2004 and 2003 4
Condensed consolidated statement of stockholders' equity
(deficiency) for the nine-month period ended September 30, 2004 5
Condensed consolidated statement of cash flows for the
nine-month periods ended September 30, 2004 and 2003 6 & 7
Notes to condensed consolidated financial statements -
September 30, 2004 8 to 13
Item 2. Management's discussion and analysis of
financial condition and results of operations 14 to 18
Part II - Other Information
Other Information 19
Signature 20
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, 2004
(unaudited)
- ----------------------------------------------------------------------------------
ASSETS
Current assets:
Cash $ 48,409
Accounts receivable - trade, net of allowance 216,003
Employee advances 2,391
Amounts due from related party - P2i, Inc. 74,738
Notes receivable, current portion 64,256
Prepaid expenses and other 186,254
------------
Total current assets 592,051
------------
Property and equipment, at cost, net of
accumulated amortization of $399,268 135,956
------------
Other assets:
Note receivable, non-current portion - Brand X Networks, Inc. 167,271
Goodwill - Acquisition of P2i Newspaper 375,067
Debt issuance costs, net of accumulated amortization of $110,666 129,835
Investment in corporation, net of impairment 24,000
Deposits 8,263
------------
Total other assets 704,436
------------
Total assets $ 1,432,443
============
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Notes payable $ 2,425,000
Current portion of obligations under capital leases 41,855
Accounts payable 199,692
Accrued expenses 807,664
Due to related company 82,994
------------
Total current liabilities 3,557,205
------------
Obligations under capital leases, non-current portion 11,226
------------
Commitments and contingencies
Stockholders' deficiency:
Preferred stock, Series B, no par value; 5,000,000 shares
authorized, none issued and outstanding --
Preferred stock to be issued, no par value, 193,836 shares 416,179
Common stock, no par value; 10,000,000 shares
authorized, 8,114,829 shares issued and outstanding 25,835,960
Common stock to be issued, no par value; 5,551,188 shares 969,345
Additional paid-in capital 2,864,107
Accumulated deficit (32,221,579)
------------
Net stockholders' deficiency (2,135,988)
------------
Total liabilities and net stockholders' deficiency $ 1,432,443
============
See accompanying notes.
- - 3 -
PROTOSOURCE CORPORATION
-----------------------
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
- --------------------------------------------------------------------------------------------------------------------
NINE-MONTH THREE-MONTH
PERIOD ENDED PERIOD ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net revenues $ 1,195,746 $ -- $ 437,369 $ --
------------ ------------ ------------ ------------
Operating expenses:
Cost of revenues 674,978 -- 237,714 --
Sales & marketing 46,690 -- 6,751 --
General and administrative 646,887 254,061 194,166 94,563
Depreciation and amortization 83,377 6,545 27,798 2,182
------------ ------------ ------------ ------------
Total operating expenses 1,451,932 260,606 466,429 96,745
------------ ------------ ------------ ------------
Operating loss (256,186) (260,606) (29,060) (96,745)
------------ ------------ ------------ ------------
Other income (charges)
Interest income 4,352 75,658 2,080 28,309
Other income 13,495 16,201 4,465 4,465
Interest expense (945,769) (1,461,267) 112,764 (448,587)
Investment banking fees (406,844) -- -- --
Loss on sale of marketable securities -- (65,942) -- --
Other expense (2,628) -- (488) --
------------ ------------ ------------ ------------
Net other income (charges) (1,337,394) (1,435,350) 118,821 (415,813)
------------ ------------ ------------ ------------
Income (loss) from continuing operations (1,593,580) (1,695,956) 89,761 (512,558)
Discontinued operations:
Gain on disposal - ISP 475,454 -- -- --
------------ ------------ ------------ ------------
Net Income (loss) ($ 1,118,126) ($ 1,695,956) $ 89,761 ($ 512,558)
============ ============ ============ ============
Net loss per basic and diluted share of common stock:
Continuing operations ($ .05) ($ .21) $ -- ($ .06)
Discontinued operations .01 -- -- --
------------ ------------ ------------ ------------
Net loss ($ .04) ($ .21) $ -- ($ .06)
------------ ------------ ------------ ------------
Weighted average number of basic and diluted
common shares outstanding 31,940,173 7,943,410 32,049,548 9,097,121
============ ============ ============ ============
See accompanying notes.
- - 4 -
PROTOSOURCE CORPORATION
-----------------------
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIENCY
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2004
(unaudited)
- --------------------------------------------------------------------------------------------------------------------------
Preferred Stock Common Stock
To be issued Common Stock to be Issued
--------------------------- --------------------------- ---------------------------
Shares Amount Shares Amount Shares Amount
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 2003 -- -- 8,114,829 $ 25,835,960 2,737,500 $ 700,000
Issuance of preferred stock in
connection with acquisition 193,836 $ 416,179 -- -- -- --
Common stock to be issued in
connection with investment
banking fees for acquisition -- -- -- -- 813,688 406,844
Common stock to be issued in
connection with financing -- -- -- -- 2,000,000 (137,499)
Beneficial conversion feature of
convertible notes -- -- -- -- -- --
Net loss -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Balance, September 30, 2004 193,836 $ 416,179 8,114,829 $ 25,835,960 5,551,188 $ 969,345
============ ============ ============ ============ ============ ============
Table continues below.
Additional
Paid-In Accumulated
Capital Deficit Total
------------ ------------ ------------
Balance, December 31, 2003 $ 2,464,107 ($31,103,453) ($ 2,103,386)
Issuance of preferred stock in
connection with acquisition -- -- 416,179
Common stock to be issued in
connection with investment
banking fees for acquisition -- -- 406,844
Common stock to be issued in
connection with financing -- -- (137,499)
Beneficial conversion feature of
convertible notes 400,000 -- 400,000
Net loss -- (1,118,126) (1,118,126)
------------ ------------ ------------
Balance, September 30, 2004 $ 2,864,107 ($32,221,579) ($ 2,135,988)
============ ============ ============
See accompanying notes.
- - 5 -
PROTOSOURCE CORPORATION
-----------------------
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(unaudited)
- ----------------------------------------------------------------------------------------------
NINE-MONTH PERIOD
ENDED
SEPTEMBER 30,
2004 2003
----------- -----------
INCREASE (DECREASE) IN CASH
Cash flows from operating activities:
Net loss ($1,118,126) ($1,695,956)
Adjustments to reconcile net loss to net cash
(used in) operating activities:
Gain on disposal - ISP (475,454) --
Depreciation and amortization 83,377 6,545
Loss on sale of marketable securities -- 65,942
Amortization of debt issuance costs 332,294 741,459
Amortization of beneficial conversion
feature of notes payable 400,000 600,000
Investment banking fees to be paid by
issuance of common stock 406,844 --
Changes in operating assets and liabilities:
Accounts receivable (52,845) --
Interest receivable -- (75,658)
Prepaid expenses and other assets 7,425 --
Accounts payable (73,826) (4,982)
Deferred revenue -- 20,688
Accrued expenses 114,073 133,148
----------- -----------
Net cash (used in) operating activities (376,238) (208,814)
----------- -----------
Cash flows from investing activities:
Cash obtained from acquisition of P2i Newspaper 56,775 --
Purchase of property and equipment (3,986) --
Deposits -- (1,000)
(Increase) decrease in notes receivable 31,851 (348,673)
Employee receivable (2,265) --
Proceeds from sale of marketable securities -- 7,051
----------- -----------
Net cash provided by (used in) investing activities 82,375 (342,622)
----------- -----------
Cash flows from financing activities:
Proceeds from borrowings 400,000 600,000
Payments on obligations under capital leases (30,029) (10,807)
Net change in amount due related company (23,157) --
Debt issuance costs incurred (52,000) --
----------- -----------
Net cash provided by financing activities 294,814 589,193
----------- -----------
Net increase in cash 951 37,757
Cash at beginning of period 47,458 2,671
----------- -----------
Cash at end of period $ 48,409 $ 40,428
=========== ===========
CONTINUED ON NEXT PAGE
See accompanying notes.
- - 6 -
PROTOSOURCE CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
NINE-MONTH PERIOD
ENDED
SEPTEMBER 30,
2004 2003
-------- --------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 16,953 $119,808
-------- --------
Income taxes $ -- $ --
-------- --------
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Issuance of common stock in connection with financing $400,000 $600,000
Issuance of preferred stock in connection with acquisition 416,179 --
Sale of ISP Division in exchange for note receivable and
credit for future services 475,454 --
See accompanying notes.
- - 7 -
PROTOSOURCE CORPORATION
-----------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2004
(unaudited)
- --------------------------------------------------------------------------------
1. Nature of Operations and Summary of Significant Accounting Policies
-------------------------------------------------------------------
Nature of operations - ProtoSource Corporation, formerly SHR Corporation
doing business as Software Solutions Company (the "Company'), was
incorporated on July 1, 1988, under the laws of the state of California.
Until May 1, 2002, the Company was an Internet service provider (ISP). The
Company provided dial-up Internet access, web hosting services and web
development services. The Company entered into an agreement on May 1, 2002
to sell substantially all of the assets pertaining to the ISP to Brand X
Networks, Inc. (see Note 3). Effective January 1, 2004, the Company
acquired P2i Newspaper, Inc. (see Note 5). P2i Newspaper, Inc. is
principally engaged in the conversion of text and graphics from print to
interactive Web content. Its clients include newspaper groups located in
the United States and the United Kingdom. P2i Newspaper is headquartered in
Bethlehem, Pennsylvania and has a west coast sales office in California and
a data conversion center located in Kuala Lumpur, Malaysia.
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 three months and
nine months ended September 30, 2004 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, 2003 previously filed with the Securities
and Exchange Commission. The accompanying condensed 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 Obtaining additional working capital through the sale of common
stock or debt securities.
o The ability of P2i Newspaper to successfully implement its
strategic plan as follows:
P2i Newspaper's long-term business strategy is to focus on the
processing of print content into web content using
technologically sophisticated, database-driven, services and
solutions across multiple business-to-business verticals. The
combination of on-target sales strategies, low labor costs, a
well-educated labor pool fluent in English, and sophisticated
technologies make P2i Newspaper highly competitive. The Company
intends leveraging these competitive advantages in other markets
over the next five years.
Through 2004 and 2005, P2i Newspaper will focus on the following:
increase market share in the newspaper vertical and target
government, retail and manufacturing verticals.
- - 8 -
PROTOSOURCE CORPORATION
-----------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2004
(unaudited)
- --------------------------------------------------------------------------------
1. Nature of Operations and Summary of Significant Accounting Policies -
Continued
---------------------------------------------------------------------
Newspaper
o In November, 2003, P2i Newspaper made the strategic decision to
withdraw from marketing directly to new newspaper accounts in the
United States, but instead to focus on building partnerships to
build sales. The Company recognized that the conversion of print
content into Internet was viewed by newspapers as an essential
commodity, and as such they were motivated by price as much as
product functionality and features.
o Through its partners and residual direct accounts, P2i Newspaper
is supplying or has access to over 1,600 U.S. newspapers: over
24% of the U.S. market.
Government
o The UK government has mandated that all government publications
must also be available online within the near future. P2i
Newspaper is working closely to maximize this opportunity.
o P2i Newspaper's solution has been evaluated by the city of
Stockport in the UK and has passed the established Bobby AA
standards.
Retail
o P2i Newspaper currently processes inserts for several retailers.
o In addition, the Company is in talks with retailer groups to
provide the ad and special section processing that will be
incorporated into a platform featuring newspaper content and
retail inserts.
o The pricing for converting catalog and retail insert pages has
fallen dramatically over the past 18 months. P2i Newspaper
believes it will continue to fall and that the Company is
perfectly positioned to re-enter this market using a similar
strategy to that used in the newspaper space: partnerships.
Manufacturing
o P2i Newspaper solutions are applicable for any business with
large volumes of frequently updated print content that is
appropriate for Internet distributions.
o Manufacturing companies are generally putting all technical
manuals online in crude PDF format.
o The potential revenue opportunity is being quantified, but is
believed to be substantial.
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.
- - 9 -
PROTOSOURCE CORPORATION
-----------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2004
(unaudited)
- --------------------------------------------------------------------------------
1. Nature of Operations and Summary of Significant Accounting Policies -
Continued
---------------------------------------------------------------------
Principles of consolidation - The consolidated financial statements include
the accounts of the Company and P2i Newspaper, Inc., its wholly-owned
subsidiary. All significant intercompany accounts and transactions have
been eliminated.
Revenue recognition - The Company recognizes service revenue when
persuasive evidence of an arrangement exists, services are performed, the
price of the transaction is fixed and determinable, and collectibility is
reasonably assured.
Stock-based compensation - The Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," for its stock-based compensation plans. The Company will
continue 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.
During each of the nine-month periods ended September 30, 2004 and 2003,
there would have been no 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.
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.
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 2,247,500 and 1,435,000 shares of common stock at September 30,
2004 and 2003, respectively, were not included in the computation of
diluted earnings per share.
Reclassifications - Certain reclassifications have been made to the 2003
financial statement presentation for comparability with the 2004 financial
statements.
2. Recently Issued Accounting Standards
------------------------------------
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46 or FIN 46, "Consolidation of Variable Interest
Entities", an interpretation of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements". In October 2003, the FASB issued FASB
Staff Position FIN 46-6, "Effective Date of FASB Interpretation No. 46,
Consolidation of Variable Interest Entities," deferring the effective date
for applying the provisions of FIN 46 for public entities' interests in
variable interest entities or potential variable interest entities created
before February 1, 2003 for financial statements of interim or annual
periods that end after December 15, 2003. FIN 46 establishes accounting
guidance for consolidation of variable interest entities that function to
support the activities of the primary beneficiary. In December 2003, the
FASB issued FIN 46 (revised December 2003), "Consolidation of Variable
Interest Entities." This revised interpretation is effective for all
entities no later than the end of the first reporting period that ends
after March 15, 2004. The Company has no investment in or contractual
relationship or other business relationship with a variable interest entity
and therefore the adoption of this interpretation did not have any impact
on its consolidated financial position or results of operations. However,
if the Company enters into any such arrangement with a variable interest
entity in the future or any entity with which we have a relationship is
reconsidered, based on guidance in FIN 46, to be a variable interest
entity, the Company's consolidated financial position or results of
operations might be materially impacted.
- - 10 -
PROTOSOURCE CORPORATION
-----------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2004
(unaudited)
- --------------------------------------------------------------------------------
3. 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.
On January 1, 2004, the sale of the ISP business to Brand X closed. Under
the terms of that agreement a promissory note of $284,455 was executed by
Brand X to be paid in 55 equal monthly installments. This note is
collateralized by a pledge of shares in Brand X. In addition, ProtoSource
is entitled to appoint one person to the board of directors of Brand X for
the duration of the agreement.
4. Notes Payable
-------------
During the nine months ended September 30, 2004, the Company issued
$400,000 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 a predetermined price established at note issuance.
An amount of $400,000 has been recognized in 2004 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 will issue
2,000,000 shares of common stock valued at $195,000. In addition, the
Company will issue 550,000 warrants to the underwriter which have a
deminimis value. These amounts are being amortized to interest expense on a
monthly basis over the one-year term of the notes.
5. 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 Adjusted Shares
shall be subject to a three-year lock-up, which may be released upon the
stock price and volume reaching established thresholds.
- - 11 -
PROTOSOURCE CORPORATION
-----------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2004
(unaudited)
- --------------------------------------------------------------------------------
5. Acquisition (continued)
-----------------------
On January 1, 2004, the Company, P2i Newspaper and P2i amended the terms of
the Agreement (the "Amendment"). Pursuant to the terms of the Amendment, in
exchange for all of the issued and outstanding shares of P2i Newspaper, the
Company issued 193,836 shares of series B preferred stock to be issued (the
"Preferred Stock"), which shares shall be reduced by the total fees
incurred to audit the financial statements of P2i or P2i Newspaper, divided
by $50. Each share of Preferred Stock is exchangeable for 100 shares of the
Company's common stock at any time after the Company increases its
authorized number of shares of common stock to 100,000,000 shares.
The acquisition was effective on January 1, 2004. The cost was as follows:
Market value of common stock to be issued $416,179
Fair market value of net assets of P2i Newspaper 41,112
--------
Goodwill $375,067
========
Management will test goodwill annually for impairment, beginning December
31, 2004.
As part of this transaction, the Company also acquired an additional
interest in P2i's new media business which will bring its total ownership
in P2i to 19.8%.
The Company loaned P2i $50,000 in 2001, $995,280 in 2002, and $597,023 in
2003. The loans to P2i are in the form of demand notes. The notes accrue
interest at the rate of 8% per annum. The notes receivable, together with
the related accrued interest, were written-off during the fourth quarter of
2003 as collection on these notes was deemed to be doubtful.
6. Pro forma Financial Information
-------------------------------
In connection with the acquisition of P2i Newspaper, proforma financial
statements of ProtoSource Corporation for the nine-months ended September
30, 2003 as if the acquisition occurred on January 1, 2003 follows.
- - 12 -
PROTOSOURCE CORPORATION AND SUBSIDIARY
--------------------------------------
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003
(unaudited)
- ----------------------------------------------------------------------------------------------------------------------------------
Historical Proforma
-------------------------------------------- ------------------------------------
Adjustments
ProtoSource P2i Newspaper, Increase/
Corporation Inc., Total Notes (Decreases) Consolidated
------------ ------------ ------------ ----- ------------ ------------
Net revenues $ -- $ 1,081,077 $ 1,081,077 $ 1,081,077
Cost of revenues -- 677,076 677,076 677,076
------------ ------------ ------------ ------------
Gross profit -- 404,001 404,001 404,001
------------ ------------ ------------ ------------
Operating expenses:
Selling, general and administrative 254,061 491,397 745,458 745,458
Research and development 81,850 81,850 81,850
Depreciation and amortization 6,545 109,627 116,172 116,172
------------ ------------ ------------ ------------
260,606 682,874 943,480 943,480
------------ ------------ ------------ ------------
Operating loss (260,606) (278,873) (539,479) (539,479)
------------ ------------ ------------ ------------
Other Income (charges):
Interest expense (1,461,267) (87,242) (1,548,509) (A) $ 75,658 (1,472,851)
Interest income 75,658 75,658 (A) (75,658) --
Loss on sale of marketable securities (65,942) (65,942) (65,942)
Other income 16,201 16,201 16,201
Other expenses -- (3,173) (3,173) (3,173)
------------ ------------ ------------ ------------ ------------
(1,435,350) (90,415) (1,525,765) -- (1,525,765)
------------ ------------ ------------ ------------ ------------
Net loss from continuing operations $ (1,695,956) $ (369,288) $ (2,065,244) $ -- $ (2,065,244)
============ ============ ============ ============ ============
Net loss per basic and diluted share
of common stock from continuing operations $ (0.21) $ (0.06)
============ ============
Weighted average number of basic and
diluted common shares outstanding 7,943,410 (B) 19,383,531 27,326,941
============ ============ ============
Notes:
(A) Represents elimination of interest income/expense associated with the intercompany note payable/receivable.
(B) Represents estimated number of shares of ProtoSource common shares to be issued and exchanged for P2i Newspaper, Inc.
- - 13 -
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, 2004 vs. Nine Months ended September 30, 2003
Net revenues - For the nine months ended September 30, 2004, net revenues were
$1,195,746. All revenues of the Company are attributed to the operations of P2i
Newspaper, Inc. acquired January 1, 2004. For the nine months ended September
30, 2003, 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. The Company had no operating
assets generating revenue subsequent to this agreement. This condition continued
throughout all of 2003 until the acquisition of P2i Newspaper on January 1,
2004.
Operating expenses - For the nine months ended September 30, 2004, operating
expenses totaled $1,451,932 versus $260,606 in 2003. The Company's general and
administrative expenses increased by $1,191,326 - principally, the result of the
P2i Newspaper acquisition.
Interest expense - Interest expense totaled $945,769 for the nine-month period
ended September 30, 2004 versus $1,461,267 in the same period in 2003. The
overall reduction in interest expense, as compared to last year, is attributed
to lower residual amortized debt issue costs, including a $414,163 adjustment to
previously over-estimated debt issuance costs. A significant component of
interest expense includes amortization of debt issuance costs in each year.
Apart from debt issuance costs, interest expense is the result of the
convertible notes obtained during 2003 and 2004 to fund the operations of the
Company and P2i Newspaper, pending and post merger.
Other (charges) - Other charges included investment banking fees relating to the
acquisition of P2i Newspaper of $406,844 in 2004 and losses on the sale of
marketable securities (Dauphin Technology, Inc. common stock) of $65,942 in
2003.
Discontinued operations - 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.
On January 1, 2004, the sale of the ISP business to Brand X closed. Under the
terms of that agreement a promissory note of $284,455 was executed by Brand X to
be paid in 55 equal monthly installments. This note is collateralized by a
pledge of shares in Brand X. In addition, ProtoSource is entitled to appoint one
person to the board of directors of Brand X for the duration of the agreement.
The assets sold and liabilities assumed with respect to this sale were removed
from Company's books and a $475,454 gain on disposal of the ISP was recorded
during the quarter ended March 31, 2004.
- - 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, 2004, the Company used cash of $376,238
from operating activities, and generated net cash of $82,375 from investing
activities and $294,814 from financing activities. We had negative working
capital of $2,965,154 at September 30, 2004. As of September 30, 2004, we had
$48,409 in cash and $3,568,431 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.
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). Further
impairment charges of $81,000 and $121,000 were recorded in 2003 and 2002
respectively.
- - 15 -
PROTOSOURCE CORPORATION
-----------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
Liquidity and Capital Resources - Continued
- -------------------------------------------
On December 5, 2001, the Company received notification from Nasdaq that the
Company no longer satisfied the minimum requirements for continued listing on
the Nasdaq Small Cap Market. The Company applied for an exception to the Nasdaq
listing requirements, which was granted on March 12, 2002. A temporary exemption
was given until April 22, 2002. It was conditioned on the Company filing a proxy
statement with the Securities and Exchange Commission by March 15, 2002, which
provides our shareholders the opportunity to approve the acquisition of P2i, as
well as certain other conditions. Due to a delay in the receipt of audited
financials for P2i, the Company was unable to meet the deadline. Subsequently,
the Company's securities were delisted from Nasdaq. The Company's securities now
trade on the OTC Bulletin Board.
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.
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 30th. 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, and the transaction closed on
January 1, 2004. 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.
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.
On September 17, 2002, the Board of Directors approved a revised term sheet
restructuring the P2i acquisition, and on January 1, 2004, this transaction
closed. Under the new terms, ProtoSource acquired the Newspaper portion of P2i,
Inc.'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 transitioned 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
Newspaper, Inc. by ProtoSource has been accounted for by the purchase method of
accounting as a reverse acquisition. For accounting purposes, P2i Newspaper,
Inc. is considered to be the acquirer and ProtoSource is the acquiree.
- - 16 -
PROTOSOURCE CORPORATION
-----------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
Liquidity and Capital Resource - Continued
- ------------------------------------------
The number of shares of restricted common stock to be issued to P2i ("P2i,
Inc.") has subsequently been revised to 19,383,531 shares (after conversion of
the preferred stock issued as merger consideration) which will result in an
ownership of approximately 37% 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 Newspaper, the Board of Directors of ProtoSource consists of seven members.
One member has been appointed by the investment banker, AAWC. (This appointment
must be approved by P2i but can't be unreasonably withheld.) 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 (see below) collectively,
and P2i 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 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. 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 the forgiveness of P2i debt to 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 Newspaper, Inc. 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 Newspaper, Inc. has agreed to pay all remaining
costs and obligations. Through December 31, 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
Newspaper, Inc. The loans are in the form of demand notes which accrue interest
at 8% per annum.
During the twelve-month period ended December 31, 2003, the Company entered into
certain agreements with AAWC to act as a placement agent for the sale of
convertible notes aggregating $700,000. 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 December 31, 2003, $600,000 in funding had been
completed; an additional $100,000 was completed during January 2004. 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 Newspaper, Inc. and accrues interest at 10% per annum.
Substantially all of the proceeds from this note have been loaned to P2i
Newspaper, Inc. The loan is in the form of a demand note accruing interest at 8%
per annum.
During the nine-month period ended September 30, 2004, the Company entered into
certain agreements with AAWC to act as a placement agent for the sale of
convertible notes aggregating $500,000. The notes are secured by stock in P2i
Newspaper and accrue interest at 10% per annum. Through September 30, 2004,
$400,000 in funding had been completed; $0 of additional funding was completed
through November 12, 2004. AAWC was paid a 10% commission and a 3%
non-accountable expense. Substantially all of the proceeds from these notes have
been used to fund the operations of P2i Newspaper. The loans are in the form of
demand notes that accrue interest at 8% per annum.
- - 17 -
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 condensed 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 in 2001 of $328,543 to write-down
goodwill to zero and $81,000 and $121,000 to reduce the carrying value of its
investment in P2i in 2003 and 2002, respectively.
In accordance with SFAS No. 109, "Accounting for Income Taxes", the Company
maintains a valuation allowance of $6,270,000 as of September 30, 2004 on
deferred tax assets relating to its net operating losses which the Company has
not determined to be more likely than not realizable.
Through December 31, 2003, the Company has advanced $1,642,303 to P2i, a company
whose Chief Executive Officer serves in the same capacity at ProtoSource
Corporation. This was used to help fund P2i Newspaper, Inc.'s operations from
the date the first term sheet was executed on December 17, 2001 to the closing
of the transaction on January 1, 2004. Effective December 31, 2003, amounts due
from P2i, Inc. have been written off.
In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets",
goodwill is not amortized, rather, management tests goodwill annually for
impairment in the fourth quarter.
The Company considers notes and accounts receivable to fully collectible;
accordingly, no allowance for doubtful accounts is required. If amounts become
uncollectible, they will be charged to operations when that determination is
made
Item 3. CONTROLS AND PROCEDURES.
Evaluation of disclosure controls and procedures. An evaluation was performed
under the supervision and with the participation of our management, including
the chief executive officer, or CEO, who is also the acting chief financial
officer, or CFO, of the effectiveness of the design and operation of our
disclosure procedures. Based on management's evaluation as of November 12, 2004,
our principal executive officer and acting principal financial officer has
concluded that our disclosure controls and procedures (as defined in Rules
13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), were sufficiently effective to ensure that the information
required to be disclosed by us in the reports that we file under the Exchange
Act is gathered, analyzed and disclosed with adequate timeliness, accuracy and
completeness.
Changes in internal controls. There have been no significant changes in our
internal controls or in other factors that could significantly affect these
controls subsequent to the date of the evaluation referred to above, nor were
there any significant deficiencies or material weaknesses in our internal
controls. Accordingly, no corrective actions were required or undertaken.
- - 18 -
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. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
During the nine-month period ended September 30, 2004, the Company issued
promissory notes totaling $400,000 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 $0.10 per share for the first
$100,000 and $0.06667 for the next $300,000.
Also in connection with the issuance of these notes, the Company will issue to
the note holders 2,000,000 shares of common stock valued at $195,000, and
550,000 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 18 U.S.C. Section 1350
(b) Reports on Form 8-K.
None. {During the quarterly period ended September 30, 2004}
- - 19 -
PROTOSOURCE CORPORATION
SIGNATURE
- --------------------------------------------------------------------------------
In accordance with the requirements of the Exchange Act, the registrant has
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 12, 2004
- - 20 -