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 March 31, 2006
[ ] 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
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(Address of Principal Executive Offices, Zip code)
610-332-2893
------------
(Issuers' Telephone Number)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 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 March 31, 2006.
PROTOSOURCE CORPORATION
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QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
MARCH 31, 2006
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INDEX
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Part I - Financial Information (unaudited):
Item 1. Condensed consolidated balance sheet -
March 31, 2006 3
Condensed consolidated statement of operations for the
three-month period ended
March 31, 2006 and 2005 4
Condensed consolidated statement of stockholders'
deficiency for the three-month period ended March 31, 2006 5
Condensed consolidated statement of cash flows for the
three-month periods ended March 31, 2006 and 2005 6 & 7
Notes to condensed consolidated financial statements
for the three-month period ended March 31, 2006 8 to 13
Item 2. Management's discussion and analysis or
plan of operations 14 to 18
Item 3. Controls and procedures 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 or service 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.
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PROTOSOURCE CORPORATION
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CONDENSED CONSOLIDATED BALANCE SHEET
MARCH 31, 2006
(unaudited)
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ASSETS
Current assets:
Cash $ 40,370
Accounts receivable - trade, net of allowance of $7,782 302,573
Advances to officers, net of obligations to officers 90,128
Amounts due from related party - P2i, Inc. 122,608
Prepaid expenses and other 684
------------
Total current assets 556,363
------------
Property and equipment, at cost, net of
accumulated depreciation and amortization of $464,236 52,289
------------
Other assets:
Goodwill - Acquisition of P2i Newspaper 375,067
Deposits 2,359
------------
Total other assets 377,426
------------
Total assets $ 986,078
============
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Notes payable $ 2,425,000
Current portion of obligations under capital leases 12,841
Accounts payable 44,269
Accrued expenses 1,265,124
------------
Total current liabilities 3,747,234
------------
Obligations under capital leases, non-current portion 8,209
------------
Stockholders' deficiency:
Preferred stock, Series B, no par value; 5,000,000 shares
authorized, 193,836 shares issued and outstanding 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 (32,854,956)
------------
Net stockholders' deficiency (2,769,365)
------------
Total liabilities and net stockholders' deficiency $ 986,078
============
See accompanying notes.
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PROTOSOURCE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
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THREE-MONTH
PERIOD ENDED
MARCH 31,
2006 2005
------------ ------------
Net revenues $ 590,390 $ 434,322
------------ ------------
Operating costs and expenses:
Cost of revenues 320,211 259,860
Sales and marketing 695 2,520
General and administrative 187,946 167,723
Depreciation and amortization 5,924 18,407
------------ ------------
Total operating costs and expenses 514,776 448,510
------------ ------------
Operating income (loss) 75,614 (14,188)
------------ ------------
Other income (charges):
Interest income -- 1846
Other income 7,441 4,465
Loss on disposal of property and equipment (21,826) --
Interest expense (86,355) (120,226)
Other expense (280) (258)
------------ ------------
Net other (charges) (101,020) (114,173)
------------ ------------
Net loss ($ 25,406) ($ 128,361)
============ ============
Net loss per basic and diluted share of common stock ($ .00) ($ .00)
============ ============
Weighted average number of basic and diluted
common shares outstanding 32,874,548 32,874,548
============ ============
See accompanying notes.
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PROTOSOURCE CORPORATION
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CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIENCY
FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2006
(unaudited)
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Common Stock
Preferred Stock Common Stock to be Issued
--------------------------- --------------------------- ---------------------------
Shares Amount Shares Amount Shares Amount
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 2005 193,836 $ 416,179 8,114,829 $ 25,835,960 5,376,188 $ 969,345
Net loss
------------ ------------ ------------ ------------ ------------ ------------
Balance, March 31, 2006 193,836 $ 416,179 8,114,829 $ 25,835,960 5,376,188 $ ,969,345
============ ============ ============ ============ ============ ============
Table continues below.
Additional
Paid-In Accumulated
Capital Deficit Total
------------ ------------ ------------
Balance, December 31, 2005 $ 2,864,107 ($32,829,550) ($ 2,743,959)
Net loss (25,406) (25,406)
------------ ------------ ------------
Balance, March 31, 2006 $ 2,864,107 ($32,854,956) ($ 2,769,365)
============ ============ ============
See accompanying notes.
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PROTOSOURCE CORPORATION
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CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(unaudited)
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THREE-MONTH PERIOD
ENDED
MARCH 31,
2006 2005
--------- ---------
INCREASE (DECREASE) IN CASH
Cash flows from operating activities:
Net loss ($ 25,406) ($128,361)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization 5,924 18,407
Loss on disposal of property and equipment 21,826 --
Amortization of debt issuance costs -- 42,643
Changes in operating assets and liabilities:
Accounts receivable (45,988) (17,410)
Prepaid expenses and other assets (717) 2,855
Accounts payable (1,835) (23,181)
Accrued expenses 121,681 142,669
--------- ---------
Net cash provided by operating activities 75,485 37,622
--------- ---------
Cash flows from investing activities:
Acquisitions of property and equipment (18,550) (210)
Collection on notes receivable - Brand X -- 13,670
Increase in directors and employees advances (26,826) (24,032)
--------- ---------
Net cash (used in) investing activities (45,376) (10,572)
--------- ---------
Cash flows from financing activities:
Payments on obligations under capital leases (9,751) (11,656)
Net change in amount due related company (20,800) 17,935
--------- ---------
Net cash provided by (used in) financing activities (30,551) 6,279
--------- ---------
Net increase (decrease) in cash (442) 33,329
Cash at beginning of period 40,812 39,726
--------- ---------
Cash at end of period $ 40,370 $ 73,055
========= =========
CONTINUED ON NEXT PAGE
See accompanying notes.
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PROTOSOURCE CORPORATION
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CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS - CONTINUED
(unaudited)
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THREE-MONTH PERIOD
ENDED
MARCH 31,
2006 2005
------ ------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $5,141 $4,067
------ ------
Income taxes $ -- $ --
------ ------
See accompanying notes.
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PROTOSOURCE CORPORATION
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2006
(unaudited)
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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 three months
ended March 31, 2006 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, 2005 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.
P2i Newspaper is focused on increasing market share in the newspaper
vertical and targeting government, retail, manufacturing and
publishing verticals.
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PROTOSOURCE CORPORATION
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2006
(unaudited)
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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 content 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.
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. The Company continues to pursue business in this
market sector.
Retail
o P2i 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 establish partnerships with media
companies with a retail focus.
Manufacturing
o P2i Newspaper solutions are applicable for any business with
large volumes of frequently updated print content that is
appropriate for Internet distribution.
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.
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PROTOSOURCE CORPORATION
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2006
(unaudited)
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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 LLC, its wholly-owned
subsidiary. All significant intercompany accounts and transactions have
been eliminated.
Revenue recognition - In accordance with the SEC's Staff Accounting
Bulletin No. 104, the Company recognizes service revenue when persuasive
evidence of an arrangement exists, services are performed and delivered
without defect, the price of the transaction is fixed and determinable, and
collectibility is reasonably assured.
In general, no matter the nature of a customer's business, the Company,
through its software technology at its production facilities, converts any
manner of print text and print graphics to interactive web content
accessible via the Internet. This most often is in the form of online
advertising. (i.e., A visitor to a customer's website can, if he so
chooses, interact with the ad because the Company's technology has made
that possible. The interactivity often involves various links to additional
information and possible other pertinent or interested parties or sources
behind the genesis and purpose of the ad.) This electronically processed
service is objective and readily verifiable by both parties immediately
upon delivery to a customer's website.
Only after the Company completes its conversion processing of specific
digital data (printable text and/or graphic image files) provided by the
customer and delivers the results as interactive, online web content
directly to the customer's internet website(s) does the Company identify a
measurable event for purposes of revenue recognition. The measurable,
delivered event or unit is typically identified as a "page" (or "pages") of
service provided to the customer, immediately usable by the customer and
its clients at their website(s). This process service takes place daily, 52
weeks a year, whereupon, digital files are received and processed overnight
for morning delivery. Through contractual agreement, a price is determined
and the customer is billed for each unit of service provided at the agreed
upon price. Although the Company accumulates billable revenue-recognizable
events daily, it typically waits until month end to bill for all units
delivered during the course of that month as a convenience to its
customers.
If there are any identifiable problems or defect with any "page" content,
it is typically fixed by the Company within a matter of hours. With respect
to sales returns or credits, cancellations and warranties, the inherent
nature of the type of services provided and the underlying processes
employed by the Company to create and deliver completed product to its
customers, there is no material exposure to what would be classified as
sales returns or credits. Likewise, cancellations and or warranties are not
significantly measurable in respect to the type of electronic product
(Internet website content) deliverable to the Company's customers.
Historically, there has been little to no applicable sales returns or
credits. For these reasons, the Company has no material need or basis to
make estimates for returns and allowances.
Stock-based compensation - Effective January 1, 2006, the Company adopted
Statement of Financial Accounting Standards ("SFAS") No. 123(R),
"Share-Based Payment", using the modified prospective application
transition method. The modified prospective application transition method
requires compensation cost to be recognized beginning on the effective date
(a) based on the requirements of SFAS 123R for all share-based payments
granted after the effective date and (b) based on the requirements of SFAS
123 for all awards granted to employees prior to the effective date of SFAS
123R that remain unvested on the effective date. As such, prior periods
will not reflect restated amounts. Prior to January 1, 2006, we accounted
for all of our stock option plans in accordance with Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees," and
related Interpretations. No stock-based employee compensation expense
related to stock option plans was reflected in net income or (loss) prior
to January 1, 2006.
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PROTOSOURCE CORPORATION
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2006
(unaudited)
- --------------------------------------------------------------------------------
1. Nature of Operations and Summary of Significant Accounting Policies -
Continued
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 1,185,000 and 2,225,000 shares of common
stock at March 31, 2006 and 2005, 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 2005
financial statement presentation for comparability with the 2006 financial
statements.
2. Recently Issued Accounting Standards
In March 2005, the FASB issued FASB Interpretation ("FIN") No. 47,
"Accounting for Conditional Asset Retirement Obligations". FIN No. 47
requires an entity to recognize a liability for a conditional asset
retirement obligation when incurred if the liability can be reasonably
estimated. The Interpretation also clarifies that the term Conditional
Asset Retirement Obligation refers to a legal obligation to perform an
asset retirement activity in which the timing and/or method of settlement
are conditional on a future event that may or may not be within the control
of the entity. FIN No. 47 also clarifies when an entity would have
sufficient information to reasonably estimate the fair value of an asset
retirement obligation. FIN No. 47 has not had a material impact on our
financial condition or results of operations.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections", which changes the requirements for the accounting and
reporting of a change in accounting principle. The statement requires
retrospective application to prior period financial statements of changes
in accounting principle, unless impracticable to do so. It also requires
that a change in the depreciation, amortization, or depletion method for
long-lived non-financial assets be accounted as a change in accounting
estimate, effected by a change in accounting principle. Accounting for
error corrections and accounting estimate changes will still be handled
according to guidance in APB Opinion 20, "Accounting Changes", as carried
forward in this pronouncement. The statement is effective for fiscal years
beginning after December 15, 2005. We do not expect adoption of SFAS No.
154 to have a material impact on the Company's financial condition or
results of operations.
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 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 was due to
the Company through the provision of services to the Company from Brand X.
The balance was due at the rate of approximately $5,171 per month, until
completely paid.
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PROTOSOURCE CORPORATION
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2006
(unaudited)
- --------------------------------------------------------------------------------
3. Sale of ISP Division - Continued
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 was
collateralized by a pledge of shares in Brand X. In addition, ProtoSource
was entitled to appoint one person to the board of directors of Brand X for
the duration of the agreement.
In February 2006, still within terms of the purchase agreement, Brand X
notified ProtoSource that it would be unable to make its next payment on
its note payable obligation and could not then specify when the next
payment(s) would be forthcoming. Subsequently, ProtoSource discovered that
Brand X had become insolvent and is unable to meet its obligations to
ProtoSource and, as a consequence, is unable to cure its now default status
on its note payable obligation and, therefore, of the purchase agreement
itself. ProtoSource has assessed the collectibility of the remaining note
receivable balance of $162,582 and its unused services credit balance of
$151,308 and has determined that collection or realization of any portion
of these amounts is highly doubtful and their values should be written down
to $0. As a consequence, the Company recorded a provision for Brand X's
uncollectible note and services credit in the amount of $313,890 in 2005.
Furthermore, in March 2006, ProtoSource agreed to the sale of the Brand X
note to P2i, Inc. ("P2i"), a related party. Under the terms of the sale,
P2i executed a note in favor of ProtoSource which was on the same terms and
conditions as the original note between Brand X and ProtoSource. Brand X
also executed a security agreement in favor of ProtoSource pursuant to
which all of Brand X's assets are pledged to secure the obligations under
the P2i note.
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%.
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PROTOSOURCE CORPORATION
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2006
(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.
- - 13 -
PROTOSOURCE CORPORATION
-----------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
(unaudited)
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS.
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
- ---------------------
Three Months ended March 31, 2006 vs. Three Months ended March 31, 2005
Net Revenues - For the three months ended March 31, 2006 and 2005, net revenues
were $590,390 and $434,322 respectively. All revenues of the Company are
attributed to the operations of P2i Newspaper, Inc. acquired January 1, 2004.
The $156,068 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 March 31, 2006,
operating expenses totaled $514,776 versus $448,510 in 2005. Higher production
expenditures necessary to meet the approximately 36% increase in sales accounted
for most of the increase in operating costs and expenses, but they fell
substantially as a percentage of sales due to higher efficiencies. Sales and
marketing, and general and administrative expenses increased $18,398, largely
due to higher payroll related costs. Administrative costs principally consist of
the Company's management office and personnel, professional fees associated with
restructuring and maintenance of the Company, and officers' and directors'
liability insurance costs.
Interest Expense - Interest expense totaled $86,355 for the three-month period
ended March 31, 2006 versus $120,226 in the same period in 2005. The interest
expense is a result of the convertible notes obtained during 2002, 2003, and
2004 to fund the operations of the Company and P2i Newspaper, pending and post
merger. A significant component of 2005's interest expense includes residual
amortization of debt issuance costs incurred during 2004. As there have been no
new debt issues since April 2004, the current period reflects no amortized
effect of historical debt issue costs.
Other Income (Charges) - In 2006, other charges included a $21,826 loss on
disposal of computer equipment.
- - 14 -
PROTOSOURCE CORPORATION
-----------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
Liquidity and Capital Resources
- -------------------------------
We assess liquidity by our ability to generate cash to fund our operations.
Significant factors that affect the management of our liquidity include: current
balances of cash, expected cash flows provided by operations, current levels of
our accounts receivable and accounts payable balances, access to financing
sources and our expected investment in equipment.
The Company generated positive cash flows from operating activities for each of
the three-month periods ending March 31, 2006 and 2005. Even though the
Company's net loss for the quarter ended March 31, 2006 was approximately
$25,000, cash flows provided by operations were approximately $75,000. In part,
this was due to non-cash charges of approximately $28,000 included in the net
loss; this consisted primarily of depreciation and amortization of approximately
$6,000 and approximately $22,000 of recorded loss on disposal of equipment.
Additionally, cash flows from operations during the quarter was impacted
positively by changes in working capital components of approximately $73,000.
Significant changes in working capital components included an increase in
working capital of approximately $93,000 related primarily to interest arising
from the Company's convertible debt obligations that was accrued but unpaid, but
this increase was offset by an approximately $46,000 decrease in available cash
resulting from the growth in the Company's accounts receivable due to the higher
level of revenues. Accounts receivable are all current, except for approximately
$7,800 which is considered to be a doubtful account.
During the quarter ended March 31, 2006, we had negative cash flows from
investing activities of approximately $45,000, due to acquisitions of equipment
and advances to directors and officers.
And during the quarter ended March 31, 2006, we used approximately $31,000 of
cash to advance funds of approximately $21,000 to a related company and for
payments on capital lease obligations of approximately $10,000.
As of March 31, 2006, we had $40,370 in cash and $515,993 in accounts receivable
and other current assets. Taken together with $3,747,234 of total current
liabilities, this resulted in a negative working capital position of $3,190,871
at March 31, 2006.
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. 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 was to be paid through the provision
of services to the Company from Brand X. The balance was to be paid at the rate
of approximately $5,171 per month, until completely paid.
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PROTOSOURCE CORPORATION
-----------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
Liquidity and Capital Resources - Continued
- -------------------------------------------
In February 2006, still within terms of the purchase agreement, Brand X notified
ProtoSource that it would be unable to make its next payment on its note payable
obligation and could not then specify when the next payment(s) would be
forthcoming. Subsequently, ProtoSource discovered that Brand X had become
insolvent and is unable to meet its obligations to ProtoSource and, as a
consequence, is unable to cure its now default status on its note payable
obligation and, therefore, of the purchase agreement itself. ProtoSource has
assessed the collectibility of the remaining note receivable balance of $162,582
and its unused services credit balance of $151,308 and has determined that
collection or realization of any portion of these amounts is highly doubtful and
that their values should be written down to $0. As a consequence of these
subsequent events, the Company recorded a provision for Brand X's uncollectible
note and services credit in the amount of $313,890 in 2005. In March 2006,
Protosource agreed to the sale of the Brand X note to P2i, Inc. ("P2i"), a
related party. Under the terms of the sale, P2i executed a note in favor of
Protosource which was on the same terms and conditions as the original note
between Brand X and Protosource. Brand X also executed a security agreement in
favor of Protosource pursuant to which all of Brand X's assets are pledged to
secure the obligations under the P2i note.
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.
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 has increased
its ownership in P2i from the current 2.18% (506,225 shares) to 19.8%. The
consideration paid was the forgiveness of P2i debt to ProtoSource.
- - 16 -
PROTOSOURCE CORPORATION
-----------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
Liquidity and Capital Resources - Continued
- -------------------------------------------
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 were in the form of demand notes accruing interest at
8% per annum. These loans, with their related interest receivable, were written
off in 2003.
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 loans were in the form of a demand notes accruing interest
at 8% per annum. These loans, with their related interest receivable, were
written off in 2003.
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 Newspaper, Inc. The loans were
in the form of demand notes accruing 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.
On October 15, 2005, the Company entered into a 24-month term capital lease
agreement with Bankers Capital for the purchase of computer and computer related
items valued at $27,767 with monthly lease payments of $1,596 each. The lease
term expires September 14, 2007 and the residual maturity date is October 15,
2007 with a $1.00 purchase option. $3,487.38 was paid to Bankers Capital at the
start of the lease to cover the first payment, one payment held for a security
deposit, and for UCC filing and documentation fees. Company officers Peter A.
Wardle and Thomas C. Butera are personal Guarantors of this agreement.
- - 17 -
PROTOSOURCE CORPORATION
-----------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN 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 $5,560,000 as of March 31, 2006 on deferred
tax assets relating to its net operating losses which the Company has not
determined to be more likely than not realizable.
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 certain trade accounts receivable to be of doubtful
collection; accordingly, the Company has a $7,782 allowance for doubtful
accounts. The Company considers the balances of its note receivable of $162,582
and its unused services credit of $151,308 as uncollectible or unrealizable;
accordingly, a $313,890 allowance was recorded in 2005.
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
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.
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: May 10, 2006
- - 20 -