UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period ended September 30, 2008
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
Commission file number: 0-25594
PROTOSOURCE CORPORATION
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(Exact name of registrant as specified in its charter)
California 77-0190772
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(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
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(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 large accelerated filer, an
accelerated filer, a non-accelerated filer, or a small reporting company. See
definitions of "large accelerated filer", "accelerated filer," and "smaller"
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [X]
(Do not check if a smaller reporting company)
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 9,927,329 shares of the registrant's common stock, no par value,
outstanding as of September 30, 2008.
PROTOSOURCE CORPORATION
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
SEPTEMBER 30, 2008
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INDEX
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Part I - Financial Information (unaudited):
Item 1. Condensed consolidated balance sheet as of September
30, 2008 (unaudited) and December 31, 2007 3
Condensed consolidated statement of operations for the
nine-month and three-month periods ended September 30,
2008 and 2007 (unaudited) 4
Condensed consolidated statement of stockholders'
deficiency for the nine-month periods ended September 30, 2008 (unaudited) 5
Condensed consolidated statement of cash flows for the
nine-month periods ended September 30, 2008 and 2007
(unaudited) 6 & 7
Notes to condensed consolidated financial statements (unaudited) 8 to 19
Item 2. Management's discussion and analysis of financial condition
and results of operations 20 to 26
Item 3. Quantitative and qualitative disclosures about market risk 26
Item 4T. Controls and procedures 26
Part II - Other Information
Other Information 27
Signature and certifications 28
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
CONDENSED CONSOLIDATED BALANCE SHEET
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September 30, 2008 December 31,
(unaudited) 2007
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ASSETS
Current assets:
Cash $ 27,263 $ 72,381
Accounts receivable, net of allowance of $5,000 and $0, respectively 422,273 356,263
Advances to employees 1,275 --
Advances to officers, net of obligations to officers 107,089 59,341
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Total current assets 557,900 487,985
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Property and equipment, at cost, net of
accumulated depreciation and amortization of
$630,691 and $575,657, respectively 44,523 93,901
------------ ------------
Other assets:
Due from related party - P2i, Inc. 3,125 400
Goodwill - Acquisition of P2i Newspaper 375,067 375,067
Deposits 16,048 8,749
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Total other assets 394,240 384,216
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Total assets $ 996,663 $ 966,102
============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Notes payable $ 2,425,000 $ 2,425,000
Current portion of obligations under capital leases 14,051 28,359
Accounts payable 236,287 126,289
Accrued interest 1,811,555 1,506,658
Due to related party - P2i, Inc. 164,100 238,800
Accrued expenses - other 488,903 452,238
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Total current liabilities 5,139,896 4,777,344
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Obligations under capital leases, non-current portion -- 17,561
Stock subscriptions payable 661,844 661,844
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Total non-current liabilities 661,844 679,405
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Stockholders' deficiency:
Preferred stock, Series B, no par value; 5,000,000 shares
authorized, 193,836 shares issued and outstanding 416,179 416,179
Common stock, no par value; 500,000,000 shares
authorized, 9,927,329 shares issued and outstanding 26,143,461 26,143,461
Additional paid-in capital 2,291,607 2,291,607
Accumulated other comprehensive income 90,452 92,953
Accumulated deficit (33,746,776) (33,434,847)
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Net stockholders' deficiency (4,805,077) (4,490,647)
------------ ------------
Total liabilities and net stockholders' deficiency $ 996,663 $ 966,102
============ ============
See accompanying notes.
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PROTOSOURCE CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(unaudited)
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NINE-MONTH THREE-MONTH
PERIOD ENDED PERIOD ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
2008 2007 2008 2007
------------ ------------ ------------ ------------
Net revenues $ 2,701,708 $ 2,087,027 $ 918,711 $ 732,897
------------ ------------ ------------ ------------
Operating costs and expenses:
Cost of revenues 1,972,274 1,217,407 587,778 439,473
Selling, general and administrative 663,553 756,362 99,833 265,512
Depreciation and amortization 55,034 37,709 18,052 15,664
------------ ------------ ------------ ------------
Total operating costs and expenses 2,690,861 2,011,478 705,663 720,649
------------ ------------ ------------ ------------
Operating income 10,847 75,549 213,048 12,248
------------ ------------ ------------ ------------
Other income (charges):
Other income 154 7,633 -- 7,505
Impairment charges -- (529,179) -- (529,179)
Interest expense (320,674) (286,629) (108,169) (98,009)
Other expense (2,256) (5,047) (2,234) (200)
------------ ------------ ------------ ------------
Net other (charges) (322,776) (813,222) (110,403) (619,883)
------------ ------------ ------------ ------------
Net income (loss) ($ 311,929) ($ 737,673) $ 102,645 ($ 607,635)
============ ============ ============ ============
Net income (loss) per basic and diluted
share of common stock ($ 0.01) ($ 0.02) $ 0.00 ($ 0.02)
============ ============ ============ ============
Weighted average number of basic and diluted
common shares outstanding 32,874,548 32,874,548 32,874,548 32,874,548
============ ============ ============ ============
See accompanying notes.
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PROTOSOURCE CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIENCY
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2008
(unaudited)
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Accumulated
Preferred Stock Common Stock Additional Other
--------------------------- --------------------------- Paid-In Comprehensive
Shares Amount Shares Amount Capital Income
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 2007 193,836 $ 416,179 9,927,329 $ 26,143,461 $ 2,291,607 $ 92,953
Net loss -- -- -- -- -- --
Other comprehensive income, net of tax:
Foreign currency translation
adjustments -- -- -- -- -- (2,501)
------------ ------------ ------------ ------------ ------------ ------------
Total comprehensive (loss) -- -- -- -- -- --
Balance, September 30, 2008 193,836 $ 416,179 9,927,329 $ 26,143,461 $ 2,291,607 $ 90,452
============ ============ ============ ============ ============ ============
Table continues below.
Accumulated Comprehensive
Deficit Total (Loss)
------------ ------------ ------------
Balance, December 31, 2007 ($33,434,847) ($ 4,490,647) --
Net loss (311,929) (311,929) ($ 311,929)
Other comprehensive income, net of tax:
Foreign currency translation
adjustments -- (2,501) (2,501)
------------ ------------ ------------
Total comprehensive (loss) -- -- ($ 314,430)
============
Balance, September 30, 2008 ($33,746,776) ($ 4,805,077)
============ ============
See accompanying notes.
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PROTOSOURCE CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(unaudited)
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NINE-MONTH PERIOD
ENDED
SEPTEMBER 30,
----------------------
2008 2007
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INCREASE (DECREASE) IN CASH
Cash flows from operating activities:
Net loss ($311,929) ($737,673)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization 55,034 37,709
Provision for bad debts 5,000 52,713
Loss on exchange of currency -- 1,665
Write-off of amounts due from related party - P2i, Inc. -- 257,179
Net assets acquired through foreclosure -- (1,096)
Changes in operating assets and liabilities:
Accounts receivable (71,010) (77,982)
Prepaid expenses and other assets -- 1,261
Accounts payable 109,998 60,383
Due to related party - P2i, Inc. (74,700) --
Accrued interest and expenses - other 341,562 553,423
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Net cash provided by operating activities 53,955 147,582
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Cash flows from investing activities:
Acquisitions of property and equipment (5,656) (5,850)
(Increase) in due from related party- P2i, Inc. (2,725) (66,600)
(Increase) in advances to employees (1,275) --
(Increase) in advances to officers, net (47,748) (14,669)
(Increase) in deposits (7,299) (4,374)
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Net cash (used in) investing activities (64,703) (91,493)
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Cash flows from financing activities:
Payments on obligations under capital leases (31,869) (22,950)
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Net cash (used in) financing activities (31,869) (22,950)
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Net increase (decrease) in cash before effect of
exchange rate changes on cash (42,617) 33,139
Effect of exchange rate changes on cash (2,501) 9,317
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Net increase (decrease) in cash (45,118) 42,456
Cash at beginning of period 72,381 4,842
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Cash at end of period $ 27,263 $ 47,298
========= =========
CONTINUED ON NEXT PAGE
See accompanying notes.
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PROTOSOURCE CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS - CONTINUED
(unaudited)
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NINE-MONTH PERIOD
ENDED
SEPTEMBER 30,
--------------------------
2008 2007
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SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 15,777 $ 10,633
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Income taxes $ -- $ --
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See accompanying notes.
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PROTOSOURCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(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. On May 1, 2002, the Company entered into an agreement
to sell substantially all of the assets pertaining to the ISP to Brand X
Networks, Inc. On August 16, 2007, the Company exercised its security
interests and entered into a foreclosure acquisition agreement with Brand X
Networks, Inc., taking possession of its business assets as collateral due
to its inability to pay its debt to the Company. These assets were
transferred to ProtoSource Acquisition II, Inc., a Nevada corporation
(incorporated August 15, 2007) and a wholly owned subsidiary of the
Company, on September 1, 2007. Effective September 1, 2007, the Company
provides bilingual technical support services, web-hosting, and Internet
connectivity (see Note 3).
Effective January 1, 2004, the Company acquired P2i Newspaper, LLC. (see
Note 4). P2i Newspaper 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.
Interim Financial Statements - The accompanying financial statements for
the three and nine months ended September 30, 2008 and 2007 are unaudited,
and have been prepared pursuant to the rules and regulations of the
Securities and Exchange Commission ("SEC"). Certain information and note
disclosures normally included in annual financial statements prepared in
accordance with generally accepted accounting principles of the United
States of America have been condensed or omitted pursuant to those rules
and regulations. Accordingly, these interim financial statements should be
read in conjunction with the audited financial statements and notes thereto
contained in ProtoSource Corporation (the "Company") Annual Report on Form
10-K for the year ended December 31, 2007, filed with the SEC on March 31,
2008. The results of operations for the interim periods shown in this
report are not necessarily indicative of results to be expected for other
interim periods or for the full fiscal year. In the opinion of management,
the information contained herein reflects all adjustments necessary for a
fair statement of the interim results of operations. All such adjustments
are of a normal, recurring nature. Certain reclassifications have been made
to the prior year amounts to conform to the current year presentation.
The year-end condensed balance sheet data was derived from audited
financial statements in accordance with the rules and regulations of the
SEC, but does not include all disclosures required for financial statements
prepared in accordance with generally accepted accounting principles of the
United States of America.
The accompanying consolidated financial statements include the accounts of
the Company and its subsidiaries. All of the Company's subsidiaries are
wholly owned for the periods presented.
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PROTOSOURCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
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1. Nature of Operations and Summary of Significant Accounting Policies -
Continued
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, 2008 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, 2007 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. These measures are imperative,
as 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:
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PROTOSOURCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
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1. Nature of Operations and Summary of Significant Accounting Policies -
Continued
The Company's long-term business strategy is to focus on delivery of
technologically sophisticated, database-driven, business to business
services and solutions via a coordinated sales and marketing strategy in
the United States and Europe. The product/service offerings fall into two
categories:
- Products and services tailored specifically to create online
versions of print content, primarily for the print and publishing
industries.
The Company's proprietary system allows for the normalization of diverse
forms of data, including text and graphics, which can be integrated by a
seamless, dynamic, and highly customizable front-end interface. This allows
customers to have their data re-purposed for new revenue generation. It
also serves to enhance the customer's own productivity by enabling more
effective information management and exchange between themselves and their
end customers, who both gain greater satisfaction through the enhanced
interactivity.
- Technical support and hosting.
Currently, Internet and telephone (IT) companies comprise the bulk of the
customer base for technical support. The hosting services are deployed
across IT and publishing customers.
Executing this strategy starts with the P2i-branded services delivered from
a facility owned and operated by the Company's subsidiary, P2i Newspaper,
LLC. This facility is located south of Kuala Lumpur, Malaysia and employs
approximately 100 staff utilizing proprietary applications and processes.
Each day, 52 weeks a year, electronic files can be received from the
Company's clients. Once received, these are to be processed for delivery
the following morning, or up to 72 hours later. Data is deliverable not
only to the Company's web servers for seamless integration into clients'
existing, hosted web sites, but can also be distributed back to clients and
to their business partners in a wide range of formats to fit their ever
evolving needs.
Services of P2i Newspaper comprise the following:
Hosted Solutions -- Publishers large and small may use the Company's array
of customizable, turnkey, hosted products for entire publications, sections
and vertical-specific solutions. Utilizing proprietary technology, the
Company converts print content comprising editorial and media ads into
interactive, online content that is seamlessly incorporated into existing
newspaper/publisher web sites. At the end of every business day, publishing
clients transmit to the Company the same electronic versions of ads and
pages that go to press. These files are received by the Company's
production group, processed, quality checked, and delivered to the hosting
servers by the start of the following business day.
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PROTOSOURCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
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1. Nature of Operations and Summary of Significant Accounting Policies -
Continued
Data Extraction -- Customers utilizing in-house or third party solutions
may rely upon the Company's ability to database incoming content down to
the minutest subset. The Company has solutions that will convert multiple
forms of disparate electronic content and process them into one constant
data flow as one of its specialties. Extracting relevant data points,
merging consistencies and fielding content to produce a data feed, per the
client's or third party's specifications, is at the core of the Company's
technology. The ensuing data enables tight search functions and powers
retail advertising web sites.
Content Review - Because online content needs to reflect the values,
relevance and accuracy that print institutions have embodied for centuries,
the Company's Content Review team functions to examine thousands of items a
day for retailers and newspapers, editing, proofing and determining
relevancy. The staff reviews pricing, language, brand names, and scores of
other specifics, delivering a critical component in the online publishing
of user-generated content.
Technical Support -- The Company has also launched a poly-lingual Technical
Support team. Unlike a traditional call center that scripts its responses,
this functional group separates itself from the competition by providing a
highly trained, technically skilled support person that is trained to
understand the idiosyncrasies of customers' products and services to ensure
each caller gets the best possible service.
Services of ProtoSource Acquisition II, Inc. comprise the following:
Technical Support & Internet Hosting Services - Bilingual technical support
services, Web-hosting and Internet connectivity.
The Company's second facility in Fresno, CA, operated by, and branded as,
BX-Solutions, is wholly-owned subsidiary, ProtoSource Acquisition II, Inc.,
which employs approximately 30 staff providing 24/7 English and Spanish
technical support via incoming telephone calls to the customers of
technology companies. These comprise small and mid-size Internet service
providers and telecos in the United States. This facility also houses and
manages servers for its own customers.
The combination of on-target sales strategies, low labor costs, a
well-educated labor pool fluent in English, and sophisticated technologies
are key to the Company's competitive strategy.
If management cannot sufficiently execute and achieve the above stated
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
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
- --------------------------------------------------------------------------------
1. Nature of Operations and Summary of Significant Accounting Policies -
Continued
Net (loss) per basic and diluted share of common stock - Basic loss per
share is calculated using the weighted average number of common shares
outstanding. Diluted loss per share is computed on the basis of the
weighted average number of common shares outstanding during the period
increased by the dilutive effect of outstanding stock options using the
"treasury stock" method. The weighted average number of basic and diluted
common shares outstanding includes:
Actual shares issued and outstanding at September 30, 2008 9,927,329
Stock subscriptions payable - note holders 2,750,000
Stock subscriptions payable - investment banker 813,688
Series B convertible preferred stock issued to P2i, Inc. (see Note 4) 19,383,531
----------
32,874,548
==========
The basic and diluted loss per share are the same since the Company had a
net loss for 2008 and 2007 and the inclusion of stock options and other
incremental shares would be anti-dilutive. Options and warrants to purchase
1,070,000 shares of common stock at September 30, 2008 and 2007 were not
included in the computation of diluted loss per share.
Reclassifications - Certain reclassifications have been made to the 2007
financial statement presentation for comparability with the 2008 financial
statements.
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PROTOSOURCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
- --------------------------------------------------------------------------------
2. Recently Issued Accounting Standards
In May 2008, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 162, "The
Hierarchy of Generally Accepted Accounting Principles". This Statement
identifies the sources of accounting principles and the framework for
selecting the principles to be used in the preparation of financial
statements of nongovernmental entities that are presented in conformity
with generally accepted accounting principles (GAAP) in the United States
(the GAAP hierarchy). This Statement shall be effective 60 days following
the SEC's approval of the Public Company Accounting Oversight Board (PCAOB)
amendments to AU Section 411, "The Meaning of Present Fairly in Conformity
With Generally Accepted Accounting Principles". The Company believes that
the adoption of SFAS No. 162 will not have an effect on the Company's
financial position, results of operations and cash flows.
In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative
Instruments and Hedging Activities - an amendment of FASB Statement No.
133". This Statement requires additional disclosures about the objectives
of the derivative instruments and hedging activities, the method of
accounting for such instruments under SFAS No. 133 and its related
interpretations, and a tabular disclosure of the effects of such
instruments and related hedged items on our financial position, results of
operations and cash flows. SFAS No. 161 is effective for the Company
beginning January 1, 2009. The Company is currently assessing the potential
impact that adoption of SFAS No. 161 may have on its financial statements.
In December 2007, the FASB issued SFAS No. 141 (Revised 2007), "Business
Combinations" ("SFAS 141R"). SFAS 141R will significantly change the
accounting for business combinations in a number of areas including the
treatment of contingent consideration, contingencies, acquisition cost,
research and development assets and restructuring costs. In addition, under
SFAS 141R, changes in deferred tax asset valuation allowances and acquired
income tax uncertainties in a business combination after the measurement
period will impact income taxes. SFAS 141R is effective for fiscal years
beginning after December 15, 2008. The adoption of the provisions of SFAS
141R is not expected to have a material effect on the Company's financial
position, results of operation, or cash flows.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests
in Consolidated Financial Statements, An Amendment of ARB No. 51." SFAS 160
amends ARB 51 to establish accounting and reporting standards for the
noncontrolling interests in a subsidiary and for the deconsolidation of a
subsidiary. It also amends certain of ARB 51's consolidation procedures for
consistency with the requirements of SFAS 141R. SFAS 160 is effective for
fiscal years, and interim periods within those fiscal years, beginning on
or after December 15, 2008. The statement shall be applied prospectively as
of the beginning of the fiscal year in which the statement is initially
adopted. The adoption of the provisions of SFAS 160 is not expected to have
a material effect on the Company's financial position, results of
operations, or cash flows.
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PROTOSOURCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
- --------------------------------------------------------------------------------
2. Recently Issued Accounting Standards - Continued
In February 2007, FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities", providing companies with an
option to report selected financial assets and liabilities at fair value.
The Standard's objective is to reduce both complexity in accounting for
financial instruments and the volatility in earnings caused by measuring
related assets and liabilities differently. Generally accepted accounting
principles have required different measurement attributes for different
assets and liabilities that can create artificial volatility in earnings.
SFAS No. 159 helps to mitigate this type of accounting-induced volatility
by enabling companies to report related assets and liabilities at fair
value, which would likely reduce the need for companies to comply with
detailed rules for hedge accounting. SFAS No. 159 also establishes
presentation and disclosure requirements designed to facilitate comparisons
between companies that choose different measurement attributes for similar
types of assets and liabilities. The Standard requires companies to provide
additional information that will help investors and other users of
financial statements to more easily understand the effect of the Company's
choice to use fair value on its earnings. It also requires entities to
display the fair value of those assets and liabilities for which the
Company has chosen to use fair value on the face of the balance sheet. SFAS
No. 159 was effective for the Company on January 1, 2007. The adoption of
the provisions of SFAS No. 159 did not have a material effect on the
Company's financial position, results of operations, or cash flows.
- - 14 -
PROTOSOURCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(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 agreed to accept an aggregate payment
of $632,000 for the ISP Division, less credits to Brand X of $112,686. Of
such amount, $200,000 was to be paid through the provision of services to
the Company from Brand X, and the balance was to be paid at the rate of
approximately $5,172 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
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 was unable to meet its obligations to
ProtoSource and, as a consequence, was unable to cure its default status on
its note payable obligation and, therefore, of the purchase agreement
itself. At December 31, 2005, ProtoSource assessed the collectibility of
the remaining note receivable balance of $162,582 and its unused services
credit balance of $151,308 and determined that collection or realization of
any portion of these amounts was 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.
In an agreement dated March 2006, ProtoSource sold, assigned and
transferred the promissory note it held in respect of the January 2004 sale
of its ISP business to Brand X Networks, Inc. to P2i, Inc., a related
party. As set forth in this transaction, a new promissory note, secured by
all the assets of Brand X Networks, Inc., was issued to P2i, Inc. in the
net amount of $162,582. The principal with interest was to be paid in 33
equal monthly installments of $5,172, until completely paid. Because
regular payments have not been made, this successor note was in default
status and was fully reserved. During 2006, ProtoSource recovered $13,800
from the P2i, Inc. / Brand X Networks, Inc. promissory note arrangement. As
the value of this note was written down to $0 at December 31, 2005, these
payments were classified as "other income" in 2006.
Foreclosure acquisition:
On August 16, 2007 the Company exercised its security interests and entered
into a foreclosure acquisition agreement with Brand X Networks, Inc.,
taking possession of its business assets as collateral due to its inability
to pay its debt to the Company. These assets were transferred to
ProtoSource Acquisition II, Inc., a Nevada corporation (incorporated August
15, 2007) and a wholly owned subsidiary of the Company, on September 1,
2007. Effective September 1, 2007, the Company provides bilingual technical
support services, web-hosting, and Internet connectivity.
In respect to the foreclosure acquisition agreement, ProtoSource
Acquisition II, Inc. acquired computer equipment and software, office
equipment, furniture and fixtures and prepaid expenditures valued at
approximately $57,000. Furthermore, it assumed specific service provider
and miscellaneous third party liabilities, and agreed to honor accrued
vacation pay and unpaid expenses of former Brand X Networks, Inc.
employees, most of whom were hired on September 1, 2007 by ProtoSource
Acquisition II. These liabilities approximated $56,000. As a consequence of
this action, a net recovery of approximately $1,000, classified as "other
income", was recorded during 2007.
- - 15 -
PROTOSOURCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
- --------------------------------------------------------------------------------
3. Sale of ISP Division - Continued
The following is a summary of the assets recovered and liabilities assumed
upon foreclosure:
Assets recovered:
Prepaid expenses $10,000
Computer equipment and software 35,309
Office furniture and equipment 11,329
-------
Total assets recovered 56,638
-------
Liabilities assumed:
Accrued service providers 34,597
Accrued vacation payable 7,814
Employee expense claims 8,796
Miscellaneous other claims 4,335
-------
Total liabilities assumed 55,542
-------
Net assets recovered $ 1,096
=======
Consideration given in respect to foreclosure acquisition:
As a further component to the reacquisition of the collateralized assets of
Brand X Networks, Inc., the Company gave consideration to P2i, Inc. (a
related party) which became a controlling owner of Brand X Networks, Inc.
through its March 2006 purchase of the original note held by the Company in
respect to the sale of the Company's ISP assets to Brand X. In
consideration for P2i, Inc.'s management and controlling interest in Brand
X Networks, Inc., and such that P2i, Inc. would not act to oppose the
matter of foreclosure on the assets of Brand X Networks, the Company
forgave P2i, Inc.'s existing liabilities to the Company through August 28,
2007 and will continue to support P2i, Inc. in the discharge of liabilities
(arising prior to the January 1, 2004 P2i Newspaper merger with the
Company) out of the Company's cash flow until such obligations are fully
discharged. The value of this consideration is estimated to be $566,186,
which has all been characterized as goodwill. This includes the net amount
of $294,186 outstanding to the Company as at August 28, 2007, plus an
additional $272,000 in future obligations. As a consequence of this action,
during 2007, the Company recorded a $294,186 write-off of amounts due to
the Company and recorded an obligation in accrued expenses of $272,000.
Because of the related party nature of this goodwill, management has deemed
it to be impaired and recorded the charge of $566,186 in other charges in
the consolidated statement of operations in 2007.
A summary of the components of goodwill related to this transaction are as
follows:
Forgiveness of amounts due from related party P2i, Inc. $ 294,186
Obligation to related party P2i, Inc. assumed 272,000
Goodwill arising from foreclosure acquisition 566,186
Less: Impairment of goodwill re: related party P2i, Inc. (566,186)
---------
Net goodwill resulting from this transaction $ 0
=========
- - 16 -
PROTOSOURCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
- --------------------------------------------------------------------------------
4. P2i Newspaper
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").
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").
Upon authorization of sufficient shares of common stock, holders of the
Series B Convertible Preferred Stock ("Series B Stock") are entitled to
convert each share of Series B Stock into 100 shares of common stock.
Series B stockholders are not entitled to receive dividends. In a
liquidation, the holders would be treated as if they were owners of the
number of shares of common stock into which the Series B Stock is
convertible.
The acquisition of P2i Newspaper became effective on January 1, 2004, at
which time P2i Newspaper became a wholly-owned subsidiary of the Company.
The cost was as follows:
Market value of preferred stock to be issued $416,179
Fair market value of net assets of P2i Newspaper 41,112
--------
Goodwill $375,067
========
The acquisition of P2i Newspaper was the central component of the
transaction between the Company and P2i; however, in further accordance to
the agreement, as a consideration for the satisfaction of P2i's existing
debt to the Company (i.e., $1,705,062 in notes receivable plus accrued
interest), the Company acquired an additional interest in P2i's new media
business, bringing the Company's total ownership in P2i to 19.8%. However,
despite the increased ownership of P2i, the ownership in P2i is considered
to be of deminimus value and therefore has no classification within the
Company's financial statements.
- - 17 -
PROTOSOURCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
- --------------------------------------------------------------------------------
5. Business Segment Data
The Company has two reportable business segments. The following is a
description of each operating segment:
Media & Data Conversion Technologies - These operations are principally
engaged in the mining and database management of print, graphic and data
content for the publishing industry, and its distribution via the Internet.
Data is deliverable to the Company's web servers for seamless integration
into the clients' hosted web sites, but also is distributed back to the
client, and their business partners, in a wide range of formats to fit
continually evolving, highly-diversified applications.
Technical Support & Hosting Services - These operations are principally
engaged in providing bilingual technical support services, web-hosting, and
Internet connectivity.
Financial information for the two reporting segments for the three and nine
months ended September 30, 2008 and 2007 is shown below:
NINE-MONTH THREE-MONTH
PERIOD ENDED PERIOD ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
2008 2007 2008 2007
----------- ----------- ----------- -----------
Net revenues
Media & Data Conversion Technologies $ 1,635,461 $ 2,012,891 $ 542,681 $ 658,761
Technical Support & Hosting Services 1,066,247 74,136 376,030 74,136
----------- ----------- ----------- -----------
$ 2,701,708 $ 2,087,027 $ 918,711 $ 732,897
=========== =========== =========== ===========
Cost of revenue
Media & Data Conversion Technologies $ 1,136,210 $ 1,133,028 $ 331,112 $ 355,094
Technical Support & Hosting Services 836,064 84,379 256,666 84,379
----------- ----------- ----------- -----------
$ 1,972,274 $ 1,217,407 $ 587,778 $ 439,473
=========== =========== =========== ===========
Gross margin
Media & Data Conversion Technologies $ 499,251 $ 879,863 $ 211,569 $ 303,667
Technical Support & Hosting Services 230,184 (10,243) 119,364 (10,243)
----------- ----------- ----------- -----------
$ 729,434 $ 869,620 $ 330,933 $ 293,424
=========== =========== =========== ===========
Total operating expenses
Media & Data Conversion Technologies $ 560,081 $ 785,236 $ 65,355 $ 272,341
Technical Support & Hosting Services 158,506 8,835 52,530 8,835
----------- ----------- ----------- -----------
$ 718,587 $ 794,071 $ 117,885 $ 281,176
=========== =========== =========== ===========
Income (loss) from operations
Media & Data Conversion Technologies ($ 60,830) $ 94,627 $ 146,214 $ 31,326
Technical Support & Hosting Services 71,677 (19,078) 66,834 (19,078)
----------- ----------- ----------- -----------
($ 10,847) $ 75,549 $ 213,048 $ 12,248
=========== =========== =========== ===========
Interest and other income/(charges), net
Media & Data Conversion Technologies ($ 320,937) ($ 813,222) ($ 108,614) ($ 619,883)
Technical Support & Hosting Services (1,839) -- (1,789) --
----------- ----------- ----------- -----------
($ 322,776) ($ 813,222) ($ 110,403) ($ 619,883)
=========== =========== =========== ===========
Total income (loss)
Media & Data Conversion Technologies ($ 381,768) ($ 718,595) $ 37,600 ($ 588,557)
Technical Support & Hosting Services 69,839 (19,078) 65,045 (19,078)
----------- ----------- ----------- -----------
($ 311,929) ($ 737,673) $ 102,645 ($ 607,635)
=========== =========== =========== ===========
- - 18 -
PROTOSOURCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
- --------------------------------------------------------------------------------
5. Business Segment Data - continued
SEPTEMBER 30, DECEMBER 31,
2008 2007
-------- --------
Identifiable assets
Media & Data Conversion Technologies $699,389 $905,403
Technical Support & Hosting Services 138,514 60,699
-------- --------
$837,903 $966,102
======== ========
- - 19 -
PROTOSOURCE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS
(unaudited)
- --------------------------------------------------------------------------------
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS.
Certain statements in this section and elsewhere in this quarterly report on
Form 10-Q 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, 2008 vs. Nine Months
Ended September 30, 2007
- ----------------------------------------------------------------------------
Net Revenues - For the nine months ended September 30, 2008 and 2007, net
revenues were $2,701,708 and $2,087,027 respectively. In the current year,
$1,635,461 of these revenues are attributed to the operations of P2i Newspaper
(acquired January 1, 2004) and $1,066,247 are attributed to the operations of
ProtoSource Acquisition II (established August 15, 2007, d.b.a. "BX-Solutions"
with operations commencing September 1, 2007). This represents a combined
increase of $614,681 in revenues over the previous year.
{P2i Newspaper's net revenues are attributable to Media and Data Conversion
Technologies and BX-Solutions' (ProtoSource Acquisition II) net revenues are
attributable to Technical Support and Hosting Services operations.}
As BX-Solutions began operations September 1, 2007, its $1,066,247 of revenues
for the first nine months of 2008 represent nine months of contributions to
combined revenues versus $74,136 for one month of 2007. P2i Newspaper recorded
$2,012,891 during the same period in 2007; its current year revenues of
$1,635,461 represent a decrease over last year of $377,430. This is largely
attributable to competitive pricing in the marketplace that has resulted in
substantially reduced unit prices to 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, 2008,
combined total operating costs and expenses totaled $2,690,861 versus $2,011,478
in 2007, a $679,383 rise over the previous year. $901,356 of such additional
costs is directly attributable to the operations of ProtoSource Acquisition II,
Inc. (d.b.a. BX-Solutions) which commenced operations September 1, 2007.
However, there was a $221,973 reduction of total operating costs and expenses
over the prior year for P2i Newspaper.
Total operating costs and expenses in the amount of $1,696,291 are related to
the operations of P2i Newspaper: For P2i Newspaper, this is a reduction of
approximately $222,000 over the preceding year and breaks down as follows:
Approximately $3,000 in more production expenditures, approximately $35,000 less
in selling expenses, and approximately $190,000 less in general and
administrative costs. In respect to production expenditures, most of the
increase is attributable to a weakening U.S. dollar against the Malaysian
Ringgit. In respect to selling expenses, an approximately $53,000 provision (for
uncollectible billings to Brand X Networks) was made in 2007 compared with no
such provision in the current year; however, that favorable difference was
offset in 2008 by approximately $50,000 more in selling expenses attributable to
the retention of the Company's V.P. of Marketing and Sales.
- - 20 -
PROTOSOURCE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
Total operating costs and expenses in the amount of $994,570 are related to the
operations of ProtoSource Acquisition II, Inc. (d.b.a. BX-Solutions): These
costs break down as follows: Approximately $836,000 in production expenditures,
approximately $136,000 in general and administrative costs, a $5,000 provision
for doubtful accounts, and approximately $17,500 in depreciation expense. The
2008 amount represents nine months of operations versus one month of 2007, as
operations did not commence until September 1, 2007.
For the nine months ended September 30, 2008, combined cost of revenues -- as a
percentage of combined revenues -- were 73.0% versus 58.3% for the same period
in 2007.
P2i Newspaper's cost of revenues as a percentage of revenues were 69.5% and
56.3% in 2008 and 2007, respectively. This substantial difference is due largely
to the effect of a reduction in unit sales prices during a period of rising
production costs driven by adverse changes in the Ringgit exchange rate.
Production cost cutting and operating efficiencies held the overall rise in cost
of revenues over the same period in 2007 to approximately 0.3%.
BX-Solutions cost of revenues as a percentage of revenues for the nine months
ended September 30 were 78.4% for 2008 and 113.8% for 2007. The 2008 figure
represent nine months of contributions to revenues versus one month of 2007, as
operations did not commence until September 1, 2007.
For the nine months ended September 30, 2008, combined selling, general and
administrative expenses posted a decrease of approximately $93,000 over the
previous year due to the following significant components: In respect to
BX-Solutions, which started operations September 1, 2007, approximately $127,000
increase is attributable to general and administrative costs (for the facility
in Fresno, CA) and a provision of $5,000 for uncollectible accounts was recorded
in 2008. In respect to P2i Newspaper, approximately $35,000 less in selling
expenses is attributable to $17,000 increase in expense and an approximately
$52,000 decrease due to a provision (for uncollectible billings to Brand X
Networks) that was made in 2007 compared with no such provision in the current
year. And for P2i Newspaper, approximately $190,000 less in general and
administrative expenses, largely attributable to reductions in the Company's
liability insurance, legal fees, local taxes and period travel expenses, was
realized this year over last for the nine months ended September 30, 2008.
Administrative costs principally consist of the Company's management office and
personnel, professional fees associated with maintenance of the Company, and
officers' and directors' liability insurance costs.
Interest Expense - Interest expense totaled $320,674 for the nine-month period
ended September 30, 2008 versus $286,629 in the same period in 2007. The
interest expense is predominantly due to the convertible notes obtained during
2002, 2003, and 2004 to fund the operations of the Company and P2i Newspaper --
pending and post merger -- with approximately $16,000 and $10,000 attributable
to equipment lease financing in 2008 and 2007, respectively.
- - 21 -
PROTOSOURCE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
Results of Operations - Three Months Ended September 30, 2008 vs. Three Months
Ended September 30, 2007
- ------------------------------------------------------------------------------
Net Revenues - For the three months ended September 30, 2008 and 2007, net
revenues were $918,711 and $732,897, respectively. In the current year, $542,681
of these revenues are attributed to the operations of P2i Newspaper (acquired
January 1, 2004) and $376,030 are attributed to the operations of ProtoSource
Acquisition II (established August 15, 2007, d.b.a. "BX-Solutions" with
operations commencing September 1, 2007). This represents a combined increase of
$186,814 in revenues over the previous year.
P2i Newspaper's net revenues are attributable to Media and Data Conversion
Technologies and BX-Solutions' (ProtoSource Acquisition II) net revenues are
attributable to Technical Support and Hosting Services operations.
As BX-Solutions began operations in the September 1, 2007, its $376,030 of
revenues for the three months of 2008 versus $74,136 for one month of 2007. P2i
Newspaper recorded $658,761 during the same period in 2007, its current year
revenues of $542,681 represent a decrease over last year of $116,080. This is
largely attributable to competitive pricing in the marketplace that has resulted
in substantially reduced unit prices to 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, 2008,
combined total operating costs and expenses totaled $705,663 versus $720,649 in
2007, a $14,986 decrease from the previous year. However, $215,982 of increased
costs is directly attributable to the operations of ProtoSource Acquisition II,
Inc. (d.b.a. BX-Solutions) which commenced operations September 1, 2007. There
was a $230,969 reduction of total operating costs and expenses over the prior
year for P2i Newspaper.
For the three months ended September 30, 2008, $396,467 of total operating costs
and expenses are related to the operations of P2i Newspaper: For P2i Newspaper,
this is a reduction of approximately $230,969 over the same quarter in the
preceding year and breaks down as follows: Approximately $24,000 in less
production expenditures, approximately $32,000 less in selling expenses,
approximately $172,000 less in general and administrative costs, and
approximately $3,000 less in depreciation expense. In respect to production
expenditures, most of the decrease is attributable to efficiencies and cost
cutting measures..
For the three months ended September 30, 2008, $309,196 of total operating costs
and expenses are related to the operations of ProtoSource Acquisition II, Inc.
(d.b.a. BX-Solutions): These costs break down as follows: Approximately $256,000
in production expenditures, approximately $47,000 in general and administrative
costs, and approximately $6,000 in depreciation expense. This is an increase of
$215,982 over the same quarter in the preceding year and breaks down as follows:
Approximately $172,000 in increased production expenditures, approximately
$38,000 more in general and administrative costs, and approximately $6,000 more
in depreciation expense. The 2008 figure represents three months of
contributions to revenues versus one month of 2007, as operations did not
commence until September 1, 2007.
For the three months ended September 30, 2008, combined cost of revenues, as a
percentage of combined revenues, were 64.0% versus 60.0% for the same period in
2007.
For the three months ended September 30, 2008, P2i Newspaper's cost of revenues
as a percentage of revenues were 61.0% and 53.9% in 2008 and 2007, respectively.
This difference is due largely to the effect of a reduction in unit sales prices
resulting in lower total sales revenue, exacerbated by a significant drop in the
value of the US Dollar relative to the Malaysian Ringgit, driving up production
costs at the production facility in Malaysia. However, although the percentage
increased, the actual cost of revenues was down by 6.8% compared to 2007. This
was a function of cutting costs and increasing operating efficiencies at the
production facility in Malaysia.
- - 22 -
PROTOSOURCE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
BX-Solutions cost of revenues for the three months ended September 30, 2008 was
reported to be 68.3%. This amount represents three months of operations versus
one month of 2007, as operations did not commence until September 1, 2007.
For the three months ended September 30, 2008, combined selling, general and
administrative expenses posted a net decrease of approximately $166,000 over the
same quarter in the previous year due to the following significant components:
In respect to BX-Solutions, which commenced operations September 1, 2007,
approximately $38,000 increase is attributable to general and administrative
costs (for the facility in Fresno, CA.) In respect to P2i Newspaper,
approximately $32,000 less in selling expenses. And for P2i Newspaper,
approximately $172,000 less in general and administrative expenses, largely
attributable to reductions in the Company's liability insurance, legal fees,
local taxes and period travel expenses, was realized this year over last for the
three months ended September 30, 2008.
Administrative costs principally consist of the Company's management office and
personnel, professional fees associated with maintenance of the Company, and
officers' and directors' liability insurance costs.
Interest Expense - Interest expense totaled $108,169 for the three-month period
ended September 30, 2008 versus $98,009 in the same period in 2007. Interest
expense is predominantly due to the convertible notes obtained during 2002,
2003, and 2004 to fund the operations of the Company and P2i Newspaper --
pending and post merger -- with approximately $4,000 attributable to equipment
lease financing recorded in each of the three-month periods.
- - 23 -
PROTOSOURCE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS AND RESULTS 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.
For the nine-month period ended September 30, 2008, the Company generated from
the Company's working capital resources, approximately $45,000 more cash than
was used.
Even though the Company's net loss for the nine-month period ended September 30,
2008 was approximately $312,000, cash flows provided by operations approximated
$54,000. In part, this was due to non-cash charges of approximately $55,000 of
depreciation and amortization and a $5,000 provision for uncollectible accounts
included in the net loss. Additionally, cash flows from operations were enhanced
approximately $307,000 by net positive changes in the Company's working capital
components. Significant components enhancing working capital and available cash
- - because they were accrued but unpaid during the period -- were as follows:
Approximately $305,000 of accrued interest arising from the Company's
convertible debt obligations, approximately $112,000 of accrued supplier and
service provider obligations together with office and facilities maintenance
expenses, approximately $40,000 of accrued payroll expenses, offset by an
approximately $71,000 increase in outstanding accounts receivable levels over
that at the beginning of the year. These positive contributing factors of
working capital and available cash were offset by an approximately $80,000
decrease in related party obligations.
During the nine-month period ended September 30, 2008, the Company had net
negative cash flows from investing activities of approximately $65,000. This was
primarily due to an approximately $48,000 increase in advances to officers,
$5,000 for acquisitions of new equipment, approximately $7,000 deposited with an
equipment finance company, a $3,000 increase in amounts due related parties, and
approximately $2,000 advanced to employees.
And during the nine-month period ended September 30, 2008, the Company used
approximately $32,000 through its financing activities for payments on its
capital lease obligations.
As of September 30, 2008, the Company had $27,263 in cash and $530,637 in
accounts receivable and other current assets. Taken together with $5,139,896 of
total current liabilities, this resulted in a negative working capital position
of $4,581,996 at September 30, 2008. $4,236,555 of this amount pertains to the
Company's obligations to its convertible debt holders.
- - 24 -
PROTOSOURCE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
Liquidity and Capital Resources - Continued
- -------------------------------------------
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 expired September 14, 2007 and the residual maturity date was October 15,
2007 with a $1 purchase option. $3,487 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.
On July 15, 2006, 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 $26,827 with monthly lease payments of $1,521. The lease term
expired June 14, 2008 and the residual maturity date was July 15, 2008 with a $1
purchase option. $3,438 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.
In July 2007, the Company entered into an investment banking agreement with
Colebrooke Capital, Inc. The fees under this arrangement were $7,500 down and
$3,500 for the first 90 days of the agreement. Under this arrangement the
Company will be required to a pay a 7% financing fee on any funds raised by
Colebrooke Capital. Furthermore, in respect to capital transactions introduced
by Colebrooke Capital, there will be a 5% transaction fee requirement, but no
fees on any Company generated deals.
On August 15, 2007, 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 $20,123 with monthly lease payments of $1,163. The lease term
expires July 14, 2009 and the residual maturity date is July 15, 2009 with a $1
purchase option. $2,720 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.
On October 15, 2007, 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 $24,380 with monthly lease payments of $1,408. The lease term
expires September 14, 2009 and the residual maturity date is September 15, 2009
with a $1 purchase option. $3,212 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.
At a meeting held on December 11, 2007, the Company's shareholders approved an
increase in authorized shares of common stock to 500,000,000. At September 30,
2008, 9,927,329 of common shares were issued and outstanding and the Company had
obligations to issue an additional 22,947,219 shares of common with a further
33,945,000 shares committed for issuance.
On May 13, 2008 the Company paid a $5,460 security deposit to Bankers Capital
pertaining to a commitment to purchase computer and computer related items
valued at approximately $61,000 under a pending 24-month term capital lease
agreement(s). Neither the purchases nor the capital lease agreement(s) have been
settled at this date.
- - 25 -
PROTOSOURCE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS - CONTINUED
(unaudited)
- --------------------------------------------------------------------------------
Critical Accounting Policies and Estimates
- ------------------------------------------
Management's discussion and analysis of its financial position and results of
operations are based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires
management to make estimates and assumptions that affect the reported amounts of
assets, liabilities, revenue and expenses and related disclosure of contingent
assets and liabilities. The significant accounting policies which we believe are
the most critical to aid in fully understanding and evaluating our reported
financial results include the following:
In accordance with SFAS No. 109, "Accounting for Income Taxes", the Company
maintains a valuation allowance of $5,600,000 as of December 31, 2007 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. In August 2007 in connection with a
foreclosure acquisition agreement with Brand X Networks, Inc., the Company
recognized $566,186 of goodwill related to the transaction but deemed it fully
impaired, as this matter involved P2i, Inc., a related party.
The Company considers certain trade accounts receivable to be of doubtful
collection; accordingly, the Company has a $5,000 allowance for doubtful
accounts.
In consideration of SEC Proposed Rule Release 33-8098, the Company does not
maintain estimates for sales returns or credits, cancellations and warranties.
Due to the peculiar nature of the type of services provided and the underlying
processes employed by the Company to create and deliver completed product
(without defect) 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; and
historically, there has been no basis or need for such.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
N/A
Item 4T. CONTROLS AND PROCEDURES.
Evaluation of disclosure controls and procedures.
As of September 30, 2008, 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.
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PROTOSOURCE CORPORATION
OTHER INFORMATION
(unaudited)
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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
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PROTOSOURCE CORPORATION
SIGNATURE
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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
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Peter Wardle,
Chief Executive Officer/
Chief Financial Officer
Date: November 18, 2008
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