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, 2005
[ ] 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
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(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 [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
There were 8,114,829 shares of the registrant's common stock, no par value
outstanding as of September 30, 2005.
PROTOSOURCE CORPORATION
-----------------------
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
SEPTEMBER 30, 2005
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INDEX
-----
Part I - Financial Information (unaudited):
Item 1. Condensed consolidated balance sheet -
September 30, 2005 3
Condensed consolidated statement of operations
for the nine-month and three-month periods ended
September 30, 2005 and 2004 4
Condensed consolidated statement of stockholders'
deficiency for the nine-month period ended
September 30, 2005 5
Condensed consolidated statement of cash flows for the
nine-month periods ended September 30, 2005 and 2004 6 & 7
Notes to condensed consolidated financial statements -
for the nine-month period ended September 30, 2005 8 to 12
Item 2. Management's discussion and analysis of
financial condition and results of operations 13 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, 2005
(unaudited)
- --------------------------------------------------------------------------------
ASSETS
Current assets:
Cash $ 50,121
Accounts receivable - trade, net of allowance of $7,782 196,156
Net advances to officers 42,481
Amounts due from related party - P2i, Inc. 73,241
Note receivable, current portion 66,515
Prepaid expenses and other 158,742
------------
Total current assets 587,256
------------
Property and equipment, at cost, net of
accumulated depreciation and amortization of $470,059 56,922
------------
Other assets:
Note receivable, non-current portion - Brand X Networks, Inc. 110,095
Goodwill - Acquisition of P2i Newspaper 375,067
Deposits 4,251
------------
Total other assets 489,413
------------
Total assets $ 1,133,591
============
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Notes payable $ 2,425,000
Current portion of obligations under capital leases 11,226
Accounts payable 124,284
Accrued expenses 1,059,986
------------
Total current liabilities 3,620,496
------------
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; 5,376,188 shares 969,345
Additional paid-in capital 2,864,107
Accumulated deficit (32,572,496)
------------
Net stockholders' deficiency (2,486,905)
------------
Total liabilities and net stockholders' deficiency $ 1,133,591
============
See accompanying notes.
- - 3 -
PROTOSOURCE CORPORATION
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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
- ----------------------------------------------------------------------------------------------------------------------------
NINE-MONTH THREE-MONTH
PERIOD ENDED PERIOD ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
------------ ------------ ------------ ------------
Net revenues $ 1,404,059 $ 1,195,746 $ 475,477 $ 437,369
------------ ------------ ------------ ------------
Operating costs and expenses:
Cost of revenues 762,531 674,978 242,644 237,714
Sales and marketing 3,747 46,690 198 6,751
General and administrative 561,982 646,887 186,259 194,166
Depreciation and amortization 55,388 83,377 18,574 27,798
------------ ------------ ------------ ------------
Total operating costs and expenses 1,383,648 1,451,932 447,675 466,429
------------ ------------ ------------ ------------
Operating income (loss) 20,411 (256,186) 27,802 (29,060)
------------ ------------ ------------ ------------
Other income (charges):
Interest income 5,182 4,352 1,608 2,080
Other income 18,148 13,495 8,707 4,465
Interest expense (282,557) (945,769) (79,027) 112,764
Investment banking fees -- (406,844) -- --
Other expense -- (2,628) -- (488)
------------ ------------ ------------ ------------
Net other income (charges) (259,227) (1,337,394) (68,712) 118,821
============ ============ ============ ============
Income (loss) from continuing operations (238,816) (1,593,580) (40,910) 89,761
Discontinued operations:
Gain on disposal - ISP -- 475,454 -- --
------------ ------------ ------------ ------------
Net income (loss) ($ 238,816) ($ 1,118,126) ($ 40,909) $ 89,761
============ ============ ============ ============
Net income (loss) per basic and diluted share of common stock:
Continuing operations ($ .01) ($ .05) ($ -- ) $ --
Discontinued operations -- .01 -- --
------------ ------------ ------------ ------------
Net income (loss) ($ .01) ($ .04) ($ -- ) $ --
============ ============ ============ ============
Weighted average number of basic and diluted
common shares outstanding 32,874,548 31,940,173 32,874,548 32,049,548
============ ============ ============ ============
See accompanying notes.
- - 4 -
PROTOSOURCE CORPORATION
-----------------------
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIENCY
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2005
(unaudited)
- -----------------------------------------------------------------------------------------------------------------------
Preferred Stock Common Stock
To be issued Common Stock to be Issued
------------ ------------ ------------
Shares Amount Shares Amount Shares Amount
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 2004 193,836 $ 416,179 8,114,829 $ 25,835,960 5,376,188 $ 969,345
Net loss
------------ ------------ ------------ ------------ ------------ ------------
Balance, September 30, 2005 193,836 $ 416,179 8,114,829 $ 25,835,960 5,376,188 $ 969,345
============ ============ ============ ============ ============ ============
Table continues below.
Additional
Paid-In
Capital Deficit Total
------------ ------------ ------------
Balance, December 31, 2004 $ 2,864,107 ($32,333,680) ($ 2,248,089)
Net loss (238,816) (238,816)
------------ ------------ ------------
Balance, September 30, 2005 $ 2,864,107 ($32,572,496) ($ 2,486,905)
============ ============ ============
See accompanying notes.
- - 5 -
PROTOSOURCE CORPORATION
-----------------------
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(unaudited)
- ------------------------------------------------------------------------------------------------
NINE-MONTH PERIOD
ENDED
SEPTEMBER 30,
2005 2004
----------- -----------
INCREASE (DECREASE) IN CASH
Cash flows from operating activities:
Net loss ($ 238,816) ($1,118,126)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Gain on disposal - ISP -- (475,454)
Depreciation and amortization 55,388 83,377
Amortization of debt issuance costs 47,067 332,294
Amortization of beneficial conversion
feature of notes payable -- 400,000
Investment banking fees to be paid by
issuance of common stock -- 406,844
Changes in operating assets and liabilities:
Accounts receivable (15,447) (52,845)
Prepaid expenses and other assets 12,750 7,425
Accounts payable (34,013) (73,826)
Accrued expenses 292,356 114,073
----------- -----------
Net cash provided by (used in) operating activities 119,285 (376,238)
----------- -----------
Cash flows from investing activities:
Cash obtained from acquisition of P2i Newspaper -- 56,775
Purchase of property and equipment (2,302)
Deposits 4,013 --
Decrease in notes receivable - other 41,365 31,851
Employee receivable -- (2,265)
Increase in advances to officers (58,851) --
----------- -----------
Net cash provided by (used in) investing activities (15,775) 82,375
----------- -----------
Cash flows from financing activities:
Proceeds from borrowings -- 400,000
Payments on obligations under capital leases (30,780) (30,029)
Net change in amount due related company (62,335) (23,157)
Debt issuance costs incurred -- (52,000)
----------- -----------
Net cash provided by (used in) financing activities (93,115) 294,814
----------- -----------
Net increase in cash 10,395 951
Cash at beginning of period 39,726 47,458
----------- -----------
Cash at end of period $ 50,121 $ 48,409
=========== ===========
CONTINUED ON NEXT PAGE
See accompanying notes.
- - 6 -
PROTOSOURCE CORPORATION
-----------------------
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
NINE-MONTH PERIOD
ENDED
SEPTEMBER 30,
2005 2004
------- -------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 9,336 $16,953
------- -------
Income taxes $ -- $ --
------- -------
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Issuance of common stock in connection with financing $ -- $400,000
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
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2005
(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 4). 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 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 nine months ended
September 30, 2005 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, 2004 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 previously created content for print into digitized
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 2005 and 2006, P2i Newspaper will focus on the following:
increase market share in the newspaper vertical and target
government, retail, manufacturing and publishing verticals.
- - 8 -
PROTOSOURCE CORPORATION
-----------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2005
(unaudited)
- --------------------------------------------------------------------------------
1. Nature of Operations and Summary of Significant Accounting Policies -
Continued
---------------------------------------------------------------------
Newspaper
o In 2003 the Company shifted its sales efforts to focus on
media companies within the newspaper vertical that have a
demand for the conversion of large volumes, rather than
individual newspapers. That strategic change has yielded
increases in both production volume and revenues. That
strategy will continue unchanged through 2005.
Government
o Through strategic relationships in the UK, the Company
continues to process growing amounts of content for
government and government related entities.
Retail
o P2i Newspaper currently processes inserts for several media
companies focusing on retail advertising and content.
Publishing
o Projects from potential customers are currently being
reviewed.
Manufacturing
o The Company is still evaluating the potential and applicable
strategy.
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
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2005
(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, 2005 and 2004,
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 income (loss) per basic and diluted share of common stock - Basic net
income (loss) per share is calculated using the weighted average number of
common shares outstanding. Diluted net income (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.
Options and warrants to purchase 2,225,000 and 2,247,500 shares of common
stock at September 30, 2005 and 2004, respectively, were not included in
the computation of diluted earnings per share, since their inclusion would
be anti-dilutive or would have no effect on net income (loss) per share.
Reclassifications - Certain reclassifications have been made to the 2004
financial statement presentation for comparability with the 2005 financial
statements.
2. Recently Issued Accounting Standards
------------------------------------
In December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment".
This Statement replaces SFAS No. 123 and supersedes APB No. 25. SFAS No.
123 (R) will require the fair value of all stock option awards issued to
employees to be recorded as an expense over the related vesting period. The
Statement also requires the recognition of compensation expense for the
fair value of any unvested stock option awards outstanding at the date of
adoption. As permitted by SFAS No. 123, the Company currently accounts for
share-based payments to employees using the APB No. 25 intrinsic value
method and, as such, generally recognizes no compensation cost for employee
stock options. Accordingly, the adoption of SFAS No. 123(R)'s fair value
method will have an impact on the Company's results of operations. The
Company expects to adopt the provisions of SFAS No. 123(R) beginning in
2006.
- - 10 -
PROTOSOURCE CORPORATION
-----------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2005
(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 and interim payments received of $34,859. 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. 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.
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 (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.
As part of this transaction, the Company also acquired an additional
interest in P2i's new media business which brings its total ownership in
P2i to 19.8%
- - 11 -
PROTOSOURCE CORPORATION
-----------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
FOR THE SIX-MONTH PERIOD ENDED SEPTEMBER 30, 2005
(unaudited)
- --------------------------------------------------------------------------------
4. Acquisition (continued)
-----------------------
The acquisition of P2i Newspaper became effective on January 1, 2004, at
which time P2i Newspaper became a wholly-owned subsidiary of the Company.
P2i Newspaper is a leader in the conversion of previously created print
advertising into interactive Web products for newspaper, magazine and mail
order/retail catalog advertising. Clients include newspapers from the
Gannett, Tribune and McClatchy Newspaper groups. The Company is
headquartered in Bethlehem, PA, and has a data conversion facility in Kuala
Lumpur, Malaysia.
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.
- - 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, 2005 vs. Nine Months ended September 30, 2004
Net revenues - For the nine months ended September 30, 2005 and 2004, net
revenues were $1,404,059 and $1,195,746 respectively. All revenues of the
Company are attributed to the operations of P2i Newspaper acquired January 1,
2004. The $208,313 increase in revenues over the previous year is largely
attributable to a sales effort that has focused on media companies within the
newspaper vertical that have a demand for the conversion of large volumes.
Operating costs and expenses - For the nine months ended September 30, 2005,
operating costs and expenses totaled $1,383,648 versus $1,451,932 in 2004.
Despite the increase in revenues, these expenses decreased by $68,284,
principally because of increased productivity, a reduction in office facilities,
and the elimination of unneeded staffing and related overhead costs.
Interest expense - Interest expense totaled $282,557 for the nine-month period
ended September 30, 2005 versus $945,769 in the same period in 2004. In the
current period, the interest expense is principally the result of the
convertible notes obtained during 2004, 2003, and 2002 to fund the operations of
the Company and P2i Newspaper, pending and post merger. In the preceding year, a
significant component of interest expense included amortization of debt issuance
costs incurred during 2004 and 2003. As there have been no new debt issues since
April 2004, the current period reflects a vast reduction of the effect of
amortization of residual historical debt issue costs.
Other charges - Other charges included investment-banking fees relating to the
acquisition of P2i Newspaper of $406,844 in 2004.
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 and interim
payments received of $34,859. Of such amount, $200,000 shall be paid through the
provision of services to the Company from Brand X.
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.
- - 13 -
PROTOSOURCE CORPORATION
-----------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
Three Months ended September 30, 2005 vs. Three Months ended September 30, 2004
Net revenues - For the three-month periods ended September 30, 2005 and 2004,
net revenues were $475,477 and $437,369 respectively. All revenues of the
Company are attributed to the operations of P2i Newspaper acquired January 1,
2004. The $38,108 increase in revenues over the previous year is largely
attributable to a sales effort that has focused on media companies within the
newspaper vertical that have a demand for the conversion of large volumes.
Operating costs and expenses - For the three months ended September 30, 2005,
operating costs and expenses totaled $447,675 versus $466,429 in 2004. Despite
the increase in revenues, these expenses decreased by $18,754, principally
because of increased productivity, a reduction in office facilities, and the
elimination of unneeded staffing and related overhead costs.
Interest expense - Interest expense totaled $79,027 for the three-month period
ended September 30, 2005 versus a net credit of $112,764 in the same period in
2004. This net credit was the result of a $414,163 adjustment to previously
over-estimated debt issuance costs. In this context, third quarter 2004 interest
expense, stated correctly without the effects of over-estimated debt issuance
costs, is $189,167, of which $113,226 is the debt issue amortization component.
The current period interest expense is principally the result of the convertible
notes obtained during 2004, 2003, and 2002 to fund the operations of the Company
and P2i Newspaper, pending and post merger. As just disclosed, the preceding
year's third quarter interest expense contained a significant component of
interest expense arising from amortization of debt issuance costs incurred
during 2004 and 2003. As there have been no new debt issues since April 2004,
the current period reflects a vast reduction of the effect of amortization of
residual historical debt issue costs.
- - 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, 2005, the Company generated a positive
cash flow of $10,395, most of which was the result of positive cash flows from
operating activities. Despite a net loss of $238,816 for the nine months ended
September 30, 2005, the Company generated cash flows from operating activities
of $119,285. This was principally the result of expenses that were accrued but
unpaid during the nine months ended September 30, 2005. These expenses included
approximately $226,000 for interest expense, approximately $24,000 for accrued
payroll liabilities, and approximately $13,000 for accrued consulting fees.
Offsetting cash flows from operating activities was cash flows used in financing
activities. This included approximately $31,000 for capital lease payments and
approximately $62,000 loaned to a related company. As of September 30, 2005, we
had $50,121 in cash, $537,135 in accounts receivable and other current assets
and $3,620,496 of total current liabilities. This resulted in a negative working
capital position of $3,033,240.
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
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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
- -------------------------------------------
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 $121,000 were recorded in 2002, $81,000 in 2003, and a
final $24,000 in 2004 resulting in the full impairment of this investment.
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.
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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 preferred stock to be issued to P2i was subsequently
revised to 193,836 shares which results 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 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 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 increased its
ownership in P2i from 2.18% (506,225 shares) to 19.8%. The consideration paid
was 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 were 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 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 which accrues 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. These loans, with their
related interest receivable, were written off in 2003.
During 2004, the Company entered into certain agreements with AAWC to act as a
placement agent for the sale of convertible notes aggregating $500,000, of which
$300,000 was raised during the first and second quarters of 2004. These notes
accrue interest at 10% per annum. AAWC was paid a 10% commission and a 3%
non-accountable expense. These notes and all other notes are secured by the
assets of ProtoSource and P2i Newspaper.
The Company did not receive any external funding during the third and fourth
quarters of 2004, nor had it received any external funding during the nine
months ended September 30, 2005.
- - 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 of $24,000 in 2004 to reduce the
carrying value of its investment in P2i, Inc. to zero.
In accordance with SFAS No. 109, "Accounting for Income Taxes", the Company
maintains a valuation allowance of $5,900,000 as of September 30, 2005 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 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 4th quarter.
The Company considers certain trade accounts receivable to be of doubtful
collection; accordingly, a $7,782 allowance for doubtful accounts was recorded
in 2004. The Company considers its note receivable to be fully collectible;
accordingly, no allowance for doubtful collection of this note had been
established. If any 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
the end of the period covered by this Report, our principal executive officer
and chief 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 except as disclosed.
- - 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.
None.
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
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
- - 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 9, 2005
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