SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 [Fee Required]
For the fiscal year ended December 31, 1996 or [ ]
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 [No Fee Required]
For the transition period from _______________ to ________________
Commission File No. 33-86242
PROTOSOURCE CORPORATION
--------------------------------------------
(Name of Small Business Issuer in its Charter)
California 77-0190772
- --------------------------------------------- --------------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification Number)
2300 Tulare Street, Suite 210
Fresno, California 93721
- --------------------------------------------- -------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (209) 490-8600
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
No Par Value Common Stock
Redeemable Common Stock Purchase Warrants
(Title of Class)
<PAGE>
Check whether the Registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the Registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days.
Yes X No
----- -----
As of February 28, 1997, 7,730,001 shares of the Registrant's no par value
Common Stock were outstanding. As of February 28, 1997, the market value of the
Registrant's no par value Common Stock, excluding shares held by affiliates, was
$1,692,870 based upon a closing bid price of $.21 per share of Common Stock on
the Electronic Bulletin Board of the National Association of Securities Dealers,
Inc.
Check if there is no disclosure contained herein of delinquent filers in
response to Item 405 of Regulation S-B, and will not be contained, to the best
of the Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [ X ]
The Registrant's revenues for its most recent fiscal year were $697,581.
The following documents are incorporated by reference into Part III, Items
9 through 12 hereof: None.
2
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS
- ------- -----------------------
The following is a summary of certain information contained in this Report
and is qualified in its entirety by the detailed information and financial
statements that appear elsewhere herein. The share information included herein
does not reflect a one share for ten shares reverse stock split approved by the
Company's stockholders on February 28, 1997. Except for the historical
information contained herein, the matters set forth in this Report include
forward- looking statements within the meaning of the "safe harbor" provisions
of the Private Securities Litigation Reform Act of 1995. These forward-looking
statements are subject to risks and uncertainties that may cause actual results
to differ materially. These risks and uncertainties are detailed throughout the
Report and will be further discussed from time to time in the Company's periodic
reports filed with the Commission. The forward-looking statements included in
the Report speak only as of the date hereof.
The Company
Operating through its ProtoSource Network ("PSNW") division, the Company
provides Internet access and related services to individuals, public agencies
and businesses in five small Central California cities. As of December 31, 1996,
the Company had 2,500 subscribers for whom it provided Internet access. The
Company intends to acquire other small Internet providers in markets with
populations of less than 500,000 that are located initially in various Central
California cities between Sacramento and Bakersfield. The Company believes that
certain of these local Internet providers currently doing business in the
Company's target markets will not be able to effectively manage the financial
and administrative burdens imposed by the continuing consumer demand for local
Internet services, unless these providers are integrated into larger, more
diversified Internet products and services companies. The Company's long-term
plan is to target a select number of such target markets and increase revenues
through acquisition in such markets. The Company is not negotiating to acquire
nor has it entered into any agreement to acquire any such Internet related
companies.
History
From July 1988 until August 1996, the Company's primary business was to
design, develop and market software programs (and related hardware) for the
agri-business industry including produce broker accounting programs, product
tracking programs, crop chemical usage reports, crop cost and billing systems
and fruit accounting programs. The programs were packaged under the Company's
"Classic" line of products and were divided by function, sophistication and the
size of the customer into "Classic" (appropriate for customers whose annual
sales are less than $10 million), "Classic Advantage" (appropriate for customers
whose annual sales are between $10 million and $100 million) and "Classic
Custom" (appropriate for customers whose annual sales exceed $100 million).
Prices ranged from $20,000 for a "Classic" program to $200,000 for a "Classic
Custom" program. The Company also sold customized
3
<PAGE>
computer system configurations designed by it which integrated hardware and
software. The Classic product line together with the Company's design services
and hardware and software sales is collectively referred to as the "Classic
Line."
In February 1995, the Company completed an initial public offering ("IPO")
of its securities, consisting of the sale of 690,000 Units to the public at
$5.50 per Unit. Each Unit consisted of one share of Common Stock and one common
stock purchase warrant (the "Public Warrants") to purchase an additional share
of Common Stock at $6.50 per share until February 1998. McClurg Capital
Corporation, the Representative of the Underwriters of the IPO (the "Prior
Representative") received warrants (the "Prior Representative's Unit Warrants")
to purchase 60,000 Units at $6.60 per Unit at any time until February 2000.
In October 1996, the Company sold 6,000,000 shares of its Common Stock to a
group of investors for $.25 per share or a total of $1,500,000. Included in the
$1,500,000 was the conversion of $200,000 of debt to equity which was originally
represented by a bridge loan for which the Company issued 400,000 shares of its
Common Stock to the bridge lenders as additional consideration for the $200,000
loan. The Company also issued a total of 4,400,000 Warrants exercisable at $.25
per share in connection with the bridge loan and the private placement. The
6,400,000 shares, 4,400,000 Warrants and 4,400,000 shares underlying the
Warrants are being registered pursuant to a Registration Statement on Form SB-2
filed with the Commission on January 26, 1997 (the "SB-2 Filing").
In December 1996, the Company sold the Classic Line to a Canadian company
for $300,000 in cash and an unsecured promissory note which the Company has not
valued on its financial statements. As a part of the transaction, the Company
received an exclusive worldwide license through December 2006 to market the
Classic Line based upon a royalty of 16% of gross sales. In January 1997, the
Company sold the remaining assets of the Classic Line (including the worldwide
license to market the Classic Line) to SSC Technologies, Inc. ("SSC"), a
privately-held company owned 25% by the Company and 75% by other stockholders
including four individuals who were previously officers and directors of the
Company (the "SCC Principals"). See "Item 12."
4
<PAGE>
The Internet and the World Wide Web
The Internet is a worldwide network that links thousands of public and
private computer networks. The Internet began in 1969 as a project of the
Advanced Research Projects Agency ("ARPA") of the U.S. Department of Defense to
connect different types of computers across geographically disparate areas. The
ARPA network was designed to allow any computer on the network to communicate
with any other computer on the network through an open communications protocol
known as TCP/IP.
Initially, use of the Internet was limited to governmental, educational and
commercial organizations with a working knowledge of the UNIX operating system
and commands, and the primary use made of the Internet was the communication of
information via electronic mail. However, there has been a rapid growth in the
use and popularity of the Internet in the past several years. According to
industry sources, users in more than 130 countries throughout the world are
connected to the Internet including 24 million users in North America, 17.6
million of whom use the Web.
The dramatic growth in the number of Internet users is attributable to a
number of developments and factors. The first was the introduction in 1992 of
the World Wide Web ("Web"), a client/server system of hyperlinked multimedia
databases which began to unlock the potential of the Internet as a mass medium.
The Web, developed by the European Laboratory for Research Physics ("CERN") in
Switzerland, advanced the potential of the Internet in several significant ways.
First, it enabled full multimedia presentation (including text, graphics, video
and audio) over the Internet. Second, through the Web's system of standardized
information protocols and a communications format called HyperText Transfer
Protocol ("HTTP"), users were allowed access to information ("navigate") on the
Web without entering complex alphanumeric commands. Third, using HyperText
Markup Language ("HTML"), document authors were able to link text or images in
one document to other documents anywhere else on the Web. When the user selected
or, if using a mouse, clicked on the hypertext in one document (often displayed
on the screen as highlighted words or images), the linked document was
automatically accessed and displayed.
The Web is based on a client/server system in which certain computers
("servers"), store information in files and respond to requests issued by remote
user computers to view or download files, thus allowing multiple, geographically
dispersed users to view and use the information stored on a single server. The
user must use software, known as a browser, that can read HTML documents and
follow their hypertext links to retrieve and display linked documents from
servers such as the Company.
An early limitation to growth of the Web was that the browser software
initially provided by CERN was text-based and contained limited retrieval and
display capabilities. In January 1993, the National Center for Supercomputing
Applications ("NCSA") at the University of Illinois at Urbana-Champaign
significantly advanced the use of Web technology with the introduction of NCSA
Mosaic for X Window on the UNIX platform, the first graphical user interface
5
<PAGE>
browser for the Web. The NCSA Mosaic graphical user interface allows users to
access the diverse information archives, data protocols and data formats of the
Internet using point-and-click, mouse-driven commands. NCSA Mosaic, which is
offered to users on a free- with-copyright basis (making it available for use
without charge and without the right to distribute), served as a catalyst for
increased use of the Web. When NCSA released a version of NCSA Mosaic for
Windows in September 1993, the Web became accessible to personal computer users
for the first time.
The increased popularity of the Internet is also attributable to the
proliferation of information and services available on the Internet, as well as
the expanded use of home personal computers, which increasingly contain modems
as a standard feature. Among the types of publications and information available
to Internet users are newspapers, magazines, weather updates, government
documents and industry newsletters, as well as a variety of commercial products
and services such as the Internet Waterway.
In order to support the continued growth and popularity of the Internet,
certain infrastructure elements must expand to handle the resulting increases in
Internet demand and traffic. These elements include widespread, inexpensive
Internet access, either through Internet access providers such as the Company or
on-line services, and widely available high-speed communications channels to
accommodate the increasing number and size of files available for downloading.
As business organizations have begun to realize the potential of the
Internet as an inexpensive and effective means of offering products and services
directly to customers and potential customers, businesses are increasingly
advertising and selling such products and services on the Web. For example,
business organizations are now using the Web to provide product information and
support to existing customers, to advertise products and services and to offer
products and services for sale by means of on-line catalogs. It is this market,
as well as Internet access, that the Company seeks to address. Industry sources
have estimated, based on registered Internet addresses, that the number of
commercial organizations as a percentage of total Internet users has increased
from approximately 30% at the beginning of 1993 to approximately 60% at the end
of 1994.
Computer users wishing to access the vast array of information and services
available on the Web use a browser that can read HTML documents, follow
hypertext links and interface with the diverse information archives and data
formats of the Web. The basic needs of most individual computer users casually
browsing the Web can be fulfilled by a number of different browsers available
today, including certain browsers that are available for no charge.
Strategy
The Company's strategy is to provide low cost direct Internet access to
subscribers by acquiring small Internet providers in target markets or by
establishing its own marketing operations in such markets. Thereafter, the
Company will seek to generate additional revenues by (i) increasing monthly
6
<PAGE>
Internet access fees, (ii) offering monthly community access services, (iii)
providing Internet consulting services, and (iv) generating marketing service
fees charged to businesses seeking a Web site on the Internet.
Increasing Monthly Internet Access Fees. The Web is the driving force
behind the growth in Internet subscribers who use the Web to access information
as well as commerce and communication. The Company intends to continue to
provide low-priced direct Internet access through the Company's
telecommunication network infrastructure which is comprised of two high speed
dedicated data lines that connect directly to the backbone of the Internet. The
Company plans to add additional high-speed dedicated data lines, enhance
system-wide access software, and expand the number of points of presence (POPs)
in local markets in order to attract and support additional subscribers. By
increasing the number of POPs, the Company will offer Internet access through
local phone calls and to more geographic areas which in turn may promote growth
in its subscriber base.
The Company also provides Integrated Services Digital Network (ISDN) and
high-speed Internet access using dedicated data lines to business customers. The
Company believes that the demand for high-speed Internet access and the ability
to integrate Internet access into a corporate-wide computer network is becoming
increasingly more important.
Offering Monthly Community Access Services. Local public agencies, (such as
city agencies, police departments and libraries), are seeking to provide
information resources directly to their citizens through Community Web sites.
Believing that its subscribers will be willing to pay a recurring fee for such
community information access, the Company intends to offer such access in 1998.
Providing Internet Consulting Services. The Company provides Internet
solutions to assist businesses and their employees, including consulting
services for network setup, Internet application implementation, Intranet design
and Web site implementation.
Generating Marketing Service Fees. The Company will continue to design and
develop Web sites for its clients with sophisticated graphics to attract user
attention. The Company also provides all necessary hardware and software and
stores its clients' Web pages on its dedicated servers, which are monitored and
maintained 24 hours a day, 365 days a year.
Acquisition Strategies
The Company will seek to acquire local Internet access providers in its
Central California target markets. The criteria for such acquisition candidates
calls for attracting companies that (i) are located in markets under 500,000
population; (ii) have been in business a minimum of one year; (iii) have at
least 300 subscribers; (iv) have current owners and staff with strong technical
backgrounds, (v) enjoy strong community contacts, and (vi) offer projected
annual growth rates in excess of 200%. The Company may also seek to acquire
other small companies that provide consulting and related Internet services. The
Company is not negotiating to acquire nor has it entered into any agreement to
acquire any such Internet related companies.
7
<PAGE>
Marketing
The Company primarily markets to customers who are new to the Internet, and
who seek to access information using point-and-click graphical interface.
Marketing is conducted through a small sales force which contacts prospective
customers responding to advertisements in computer, professional and business
publications. The Company also seeks customers by participating in industry
trade shows and educational seminars and through referrals from existing
customers. In addition, the Company seeks strategic alliances with local
computer retailers who offer Internet access fee discounts to their customers
and through joint advertising efforts with television and radio stations. The
Company may also distribute Internet services through retail channels.
Direct mailings, telemarketing programs, co-marketing agreements and joint
promotional efforts among organizations and individual users are strategies that
the Company may employ in the future. Finally, the Company seeks to retain
business customers and individual users through what it perceives to be
responsive customer support and services programs.
Competition
The Internet services business is highly competitive and there are few
significant barriers to entry. Currently, the Company competes with a number of
national and local California Internet service providers. In addition, a number
of multinational corporations, including giant communications carriers such as
AT&T, Cable and Wireless, MCI, Sprint and the regional Bell operating companies,
are offering, or have announced plans to offer, Internet access or on-line
services. The Company also faces significant competition from the on-line
service firms such as America Online (AOL), CompuServe, Delphi, Genie, Microsoft
and Prodigy. The Company believes that new competitors which may include
computer software and services, telephone, media, publishing, cable television
and other companies, are likely to enter the on-line services market.
The ability of some of the Company's competitors to bundle Internet access
software with other popular products and services could give those competitors
an advantage over the Company. For example, NETCOM, MCI and PSI offer retail
software packages and AOL and Prodigy bundle their software with new PCs.
Many of the Company's competitors possess financial resources significantly
greater than those of the Company and, accordingly, could initiate and support
prolonged price competition to gain market share. If significant price
competition were to develop, the Company might be forced to lower its prices,
possibly for a protracted period, which would have a material adverse effect on
its financial condition and results of operations and could threaten its
economic viability. In addition, the Company believes that the Internet service
and on-line services business are likely to consolidate in the future,
8
<PAGE>
which could result in increased price and other competition in the industry and
consequently adversely impact the Company. A number of on-line services have
recently lowered their monthly service fees, which may cause the Company to
lower its monthly fees in order to compete.
The Company believes that the primary competitive factors among Internet
access providers are price, customer support, technical expertise, local
presence in a market, ease of use, variety of value-added services and
reliability. The Company believes it is able to compete favorably in these
areas. The Company's success in its markets will depend heavily upon its ability
to provide high quality Internet connectivity and value-added Internet services
targeted in select target markets. Other factors that will affect the Company's
success in these markets include the Company's continued ability to attract
additional experienced marketing, sales and management talent, and the expansion
of support, training and field service capabilities.
Employees
As of February 28, 1997, the Company employed 15 full-time individuals. The
Company believes it maintains good relations with its employees. None of the
Company's employees are represented by a labor union or covered by a collective
bargaining agreement.
ITEM 2. DESCRIPTION OF PROPERTY
- ------- -----------------------
In September 1994, the Company acquired, under a 20-year non-cancelable
capital lease, an office building, including land and improvements at 2580 West
Shaw, Fresno, California 93711. The lease requires initial annual minimum lease
payments lease payments of $188,000, increasing every five years to a maximum
annual payment of $338,000 in 2009. Under the lease, the Company has an option
at any time to purchase the building and land for $1,800,000 through April 30,
1997. Such amount increases to $1,900,000 through April 30, 1998. After April
30, 1998, the option amount increases annually by the percentage increase in the
Consumers Price Index, as further described in the lease. Upon exercise of the
purchase option, the principal portion of the lease payments made by the Company
will be applied toward the down payment for the purchase price based upon an
amortized 20-year note with interest accrued at 9% per annum. The Company has
leased a portion of the building to the SSC Principals based upon monthly
payments to the Company of $12,000 through February 28, 1998. The Company also
receives lease payments from another tenant in the amount of $78,000 per year.
The Company leases 4,000 square feet of space for its corporate offices and
PSNW facilities at 2300 Tulare Street, Suite 210, Fresno, California 93721. The
lease is for five years, ending May 2002 and requires minimum annual payments of
$40,250 increasing every year to a maximum of $55,375 in 2002.
9
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
- ------- -----------------
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------- ---------------------------------------------------
Not applicable.
10
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- -----------------------------------------------------------------
The Company's Common Stock traded on the NASDAQ Small Cap Market under the
symbol "PSCO" from February 9, 1995 until July 10, 1996 when it was delisted
from NASDAQ and commenced trading on the Electronic Bulletin Board under the
symbol "PSCO."
The following table sets forth for the quarters indicated the range of high
and low closing prices of the Company's Common Stock as reported by NASDAQ and
the Electronic Bulletin Board but does not include retail markup, markdown or
commissions.
Price
--------------
By Quarter Ended: High Low
- ----------------- ---- ---
March 31, 1997 (through February 28, 1997).............. $ .31 $ .21
December 31, 1996....................................... .75 .21
September 30, 1996...................................... 1.00 .56
June 30, 1996........................................... 1.75 .56
March 31, 1996.......................................... 2.13 .94
December 31, 1995....................................... 2.50 1.75
September 30, 1995...................................... 4.00 1.00
June 30, 1995........................................... 4.88 3.34
March 31, 1995.......................................... 5.00 4.25
As of February 28, 1997, the Company had approximately 355 record and
beneficial stockholders.
Dividend Policy
The Company has never paid cash dividends on its Common Stock and intends
to retain earnings, if any, for use in the operation and expansion of its
business. The amount of future dividends, if any, will be determined by the
Board of Directors based upon the Company's earnings, financial condition,
capital requirements and other conditions.
11
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
- ------------------------------------------------------------------
Background
Operating through its ProtoSource Network ("PSNW") division, the Company
provides Internet access and related services to individuals, public agencies
and businesses in five small Central California cities. As of December 31, 1996,
the Company had 2,500 subscribers for whom it provided Internet access. The
Company intends to acquire other small Internet providers in markets with
populations of less than 500,000 that are located initially in various Central
California cities between Sacramento and Bakersfield. The Company believes that
certain of these local Internet providers currently doing business in the
Company's target markets will not be able to effectively manage the financial
and administrative burdens imposed by the continuing consumer demand for local
Internet services, unless these providers are integrated into larger, more
diversified Internet products and services companies. The Company's long-term
plan is to target a select number of such target markets and increase revenues
through acquisition in such markets. The Company is not negotiating to acquire
nor has it entered into any agreement to acquire any such Internet related
companies.
Results of Operations
Year Ended December 31, 1996 vs. Year Ended December 31, 1995
Net Sales. For fiscal 1996, Internet services revenues were $697,581 versus
$100,901 in fiscal 1995, which represents a 591% increase in revenue. The
increases are attributed to increases in the number of Internet users worldwide
and increased market penetration of the Company's ProtoSource Network ("PSNW")
division in the central California area. PSNW only operated from August to
December in 1995 versus a full year in 1996. Management believes that the PSNW
revenues will continue to increase as the Company increases the number of Points
of Presence ("POPS") to provide Internet services to more geographic areas.
Operating Expenses. Operating expenses were $1,121,773 in 1996 versus
$1,079,503 in 1995. The increased operating expense is the result of increased
depreciation expenses, additional personnel expenses and legal and accounting
expenses related to the Company's restructuring and the divestiture of the
Classic Line. Management believes that the operating expenses will remain at the
same level or decrease as a result of reduced personnel and facilities expenses
after the Classic Line sale. The decreases may be somewhat offset by the
increases in operating expenses as the PSNW grows.
Operating Loss. For fiscal 1996, the operating loss was $424,192 compared
to an operating loss of $978,602 in 1995 which represents a 56% decrease. The
decrease in the operating loss in 1996 is attributed to the significant
increases in Internet services revenues by $596,680. Management believes that
operating results will improve as revenues increase and operating expenses
decrease.
12
<PAGE>
Interest, Net. Net interest expense for 1996 was $268,721 compared to
$109,301 in 1995. The increase in interest expense is primarily attributed to
additional interest expense related to capital leases on computer equipment and
interest expense related to the building which the Company acquired under a
20-year capital lease. The net interest expense is further increased by
decreases in interest income in 1996.
Financing Costs. Financing costs were $126,000 in 1996 which represented
the commission and expenses related to 400,000 shares of the Company's Common
Stock issued to the investors as additional compensation for the Common Stock
Placement. The Common Stock issued was valued at $.25 per share and resulted in
a financing expense of $100,000 to the Company.
Year Ended December 31, 1995 Compared to Year Ended December 31, 1994
Net Sales. For fiscal 1995, net sales were $1,835,000 versus $1,831,000 in
fiscal 1994. Software product sales increased by 95% from $145,000 in 1994 to
$283,000 in 1995. Hardware equipment sales decreased slightly from $984,000 in
1994 to $942,000 in 1995 due primarily to decreases in prices in the PC product
lines. Professional service fees decreased from $681,000 in 1994 to $610,000 in
1995 as a result of shifting programming resources from professional services to
packaged software development. The lower than expected sales were primarily the
results of development difficulties encountered in the Classic product lines.
The significant increases in software product sales can be attributed to the
acceptance of the new PC software products prior to the development obstacles
encountered. Management believes that focusing in PC product development will
increase the long-term profitability of the Company.
Gross Profit. For fiscal 1995, gross profit was $395,000 versus $557,000 in
1994, representing a decrease of $162,000 or 29.1%. As a percentage of sales,
gross profit declined to 21.5% in 1995 from 30.4% in 1994. The decrease in gross
profit is attributed to the increase in investment of software development which
increases cost of product sales and lower gross margin for PC hardware
equipment. Management believes that the gross margin will improve when the
software sales increase and software development costs decrease.
Sales and Marketing. Sales and marketing expenses were $641,000 in fiscal
1995 versus $275,000 in 1994. The increases in sales and marketing expenses were
caused by increases in sales personnel and increases in advertising and
marketing for the introduction of the Classic product lines. The Company
believes that the sales and marketing expenses will decrease to approximately
15% of total revenues when software sales increase.
Research and Development. Research and development increased from $232,000
in 1994, to $495,000 in 1996. The increase in research and development is
attributable to an increase in the number of full-time equivalent programmers
involved in product development activities from seven programmers in 1994 to
fifteen programmers in 1995. Management believes that the investment in research
and development will give the Company significant competitive advantages over
competitors and will increase long-term profitability of the Company. Management
expects that the Classic product will be completed in early 1996.
13
<PAGE>
General and Administrative. General and administrative costs were
$1,080,000 in 1995 versus $257,000 in 1994. The increase in general and
administrative costs is the result of moving into a larger building, increases
in business transactions, increases of personnel and the significant increase in
the bad debts expenses resulted from the development difficulties that have been
resolved by the research and development team in the fall of 1995 which were
encountered in the development of the Classic product line in the second quarter
of 1995.
Operating Loss. For fiscal 1995, the operating loss was $1,820,000 compared
to an operating loss of $208,000 in 1994. The increase in operating loss in 1995
is attributed to the significant increases in research and development by
$263,000 to develop the Classic product lines for PC, increases in marketing
expenses for the introduction of the new PC product lines and increases in
general and administrative expenses resulting from the move to larger facilities
and the significant increase of bad debt expenses due to the development
obstacles encountered in the second quarter of 1995.
Liquidity and Capital Resources
Historically the Company required funds principally to finance increasing
levels of trade receivables which were caused by increasing sales volume and
business expansion. Those requirements have been met through internally
generated funds, bridge loans and short-term borrowings from a revolving bank
credit line. Funding for expansion of property and equipment has been provided
primarily by capital leases, operating leases and term loans.
The Company's IPO generated gross proceeds of $3,795,000 and net proceeds
of $3,415,500 to the Company in 1995. The Company's Common Stock Placement
generated gross proceeds of $1,500,000 and net proceeds of $1,275,199. The
Company also received a capital contribution of $154,792 from officers through
forgiveness of previously accrued salaries.
For the year ended December 31, 1996, the Company purchased $38,421 of
property and equipment and acquired under capital lease $90,349 of property and
equipment. The Company's capitalized software development costs were $442,100.
The equipment acquired was primarily used to provide Internet services to PSWN's
customers.
For the year ended December 31, 1995, the Company acquired $404,000 of
property and equipment and capitalized software development costs of $593,000.
Included in these transactions were the purchase of computer and related
teaching equipment for the expansion of the Company's computer center facility
and acquisition of PSNW. The assets acquired by the Company are primarily for
Internet access, education and computer training purposes.
In September 1994, the Company acquired, under a 20-year capital lease, a
20,000 square foot office building. The Company occupies approximately half of
the space as its corporate offices and subleases the other half to unrelated
14
<PAGE>
third parties. The capitalized costs for the land, building and improvements was
$1,760,000. The capital lease payments for the land, building and improvements
was $1,760,000. The capital lease payments for the building will increase annual
cash outflows by approximately $60,000 through 2014, net of sublease income.
At December 31, 1996, the Company had working capital of $99,982. The
limited working capital may restrict the ability of the Company to acquire
additional financing. The inability to obtain sufficient financing to support
the Company's planned growth would have a negative impact on its results of
operations.
The Company used net proceeds from the Common Stock Placement to repay
short-term debt and used additional proceeds to sell the Classic Line,
MarketStreet and computer training divisions. The Company also used proceeds to
acquire additional equipment for PSNW in order to expand its capacity. The
Company will use the remaining proceeds for marketing and working capital for
the operation of PSNW division.
In December 1996, the Company sold the Classic Line to a Canadian company
for $300,000 in cash and an unsecured promissory note which the Company has not
valued on its financial statements. As a part of the transaction, the Company
received an exclusive worldwide license through December 2006 to market the
Classic Line based upon a royalty of 16% of gross sales. In January 1997, the
Company sold the remaining assets of the Classic Line (including the worldwide
license to market the Classic Line) to SSC Technologies, Inc. ("SSC"), a
privately-held company owned 25% by the Company and 75% by other stockholders
including four individuals who were previously officers and directors of the
Company (the "SCC Principals"). See "Item 12."
15
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
- -----------------------------
16
<PAGE>
PROTOSOURCE CORPORATION
INDEX TO FINANCIAL STATEMENTS
Financial Statements Page
- -------------------- ----
Independent Auditors' Report F-2
Balance Sheet as of December 31, 1996 F-3
Statements of Operations for the Years Ended
December 31, 1996 and 1995 F-5
Statements Of Changes in Shareholders' Equity
for the Years Ended December 31, 1996 and 1995 F-6
Statements Of Cash Flows for the Years Ended
December 31, 1996 and 1995 F-7
Notes To Financial Statements F-9
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
ProtoSource Corporation
We have audited the accompanying balance sheet of ProtoSource Corporation as of
December 31, 1996 and the related statements of operations, changes in
shareholders' equity and cash flows for the years ended December 31, 1996 and
1995. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of ProtoSource Corporation as of
December 31, 1996 and the results of its operations and its cash flows for the
years ended December 31, 1996 and 1995 in conformity with generally accepted
accounting principles.
/S/ ANGELL & DEERING
-----------------------------
Angell & Deering
Certified Public Accountants
Denver, Colorado
February 28, 1997
F-2
<PAGE>
PROTOSOURCE CORPORATION
BALANCE SHEET
DECEMBER 31, 1996
ASSETS
------
Current Assets:
Cash and cash equivalents $ 482,357
Accounts receivable:
Trade 29,156
Employees and other 21,397
Inventories 8,980
Prepaid expenses and other 14,587
Current portion of note receivable 47,285
----------
Total Current Assets 603,762
----------
Property and Equipment, at cost:
Land 411,176
Building and improvements 1,381,816
Equipment 680,377
Furniture 104,375
Vehicles 10,090
----------
2,587,834
Less accumulated depreciation and amortization 486,441
----------
Net Property and Equipment 2,101,393
----------
Other Assets:
Goodwill, net of accumulated amortization
of $2,006 19,239
Deferred tax assets 71,550
Note receivable, net of current portion above 723,565
Deposits and other assets 42,346
----------
Total Other Assets 856,700
----------
Total Assets $3,561,855
==========
The accompanying notes are an integral
part of these financial statements.
F-3
<PAGE>
PROTOSOURCE CORPORATION
BALANCE SHEET
DECEMBER 31, 1996
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable $ 195,694
Accrued liabilities 267,228
Customer deposits 1,500
Current portion of long-term debt 39,358
-----------
Total Current Liabilities 503,780
-----------
Long-Term Debt, net of current portion above:
Bank 2,220
Obligations under capital leases 1,852,083
Less current portion above (39,358)
-----------
Total Long-Term Debt 1,814,945
-----------
Commitments and contingencies --
Shareholders' Equity:
Preferred stock, no par value; 5,000,000
shares authorized, none issued and
outstanding --
Common stock, no par value; 10,000,000
shares authorized, 773,000 shares issued
and outstanding 4,839,485
Accumulated deficit (3,596,355)
-----------
Total Shareholders' Equity 1,243,130
-----------
Total Liabilities and Shareholders'
Equity $ 3,561,855
===========
The accompanying notes are an integral
part of these financial statements.
F-4
<PAGE>
<TABLE>
<CAPTION>
PROTOSOURCE CORPORATION
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1996 and 1995
1996 1995
---- ----
<S> <C> <C>
Net Revenues:
Internet service fees $ 697,581 $ 100,901
----------- -----------
Total Revenues 697,581 100,901
----------- -----------
Operating expenses 1,121,773 1,079,503
----------- -----------
Operating Loss (424,192) (978,602)
----------- -----------
Other Income (Expense):
Interest income 3,507 50,891
Interest expense (272,228) (160,192)
Financing costs (126,000) --
Rent income 146,122 124,356
Other, net -- (10,231)
----------- -----------
Total Other Income (Expense) (248,599) 4,824
----------- -----------
Loss From Continuing Operations
Before Provision For Income Taxes (672,791) (973,778)
Provision for income taxes -- 800
----------- -----------
Loss From Continuing Operations (672,791) (974,578)
----------- ------------
Discontinued Operations:
Loss from discontinued
operations (Note 2) (532,663) (841,707)
Loss on disposal (Note 2) (204,346) --
----------- -----------
Loss From Discontinued
Operations (737,009) (841,707)
----------- -----------
Net Loss $(1,409,800) $(1,816,285)
=========== ===========
Net Loss Per Share of Common Stock:
Loss from continuing operations $ (2.46) $ (7.88)
Discontinued operations (2.70) (6.81)
----------- -----------
Net Loss $ (5.16) $ (14.69)
=========== ===========
Weighted Average Number of
Common Shares Outstanding 273,055 123,659
=========== ===========
</TABLE>
The accompanying notes are an integral
part of these financial statements.
F-5
<PAGE>
<TABLE>
<CAPTION>
PROTOSOURCE CORPORATION
STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996 and 1995
Series A
Preferred Stock Common Stock
--------------- ------------ Accumulated
Shares Amount Shares Amount Deficit
------ ------ ------ ------ -------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1994 900,000 $ -- 64,000 $ 303,595 $ (370,270)
Issuance of common stock and warrants
in public offering (net of offering
costs of $808,476) -- -- 69,000 2,986,524 --
Contribution of shares to the Company
by officers and directors for issuance
in connection with an acquisition -- -- -- 19,375 --
Net loss -- -- -- -- (1,816,285)
-------- ---- ------- ---------- -----------
Balance at December 31, 1995 900,000 -- 133,000 3,309,494 (2,186,555)
Contribution of capital by officers
through forgiveness of previously
accrued salaries -- -- -- 154,792 --
Issuance of common stock in
connection with bridge loans -- -- 40,000 100,000 --
Issuance of common stock in private
offering (net of offering costs of
$224,801) -- -- 600,000 1,275,199 --
Cancellation of Preferred Stock in
connection with divestiture of assets (900,000) -- -- -- --
Net loss -- -- -- -- (1,409,800)
-------- ---- ------- ---------- -----------
Balance at December 31, 1996 -- $ -- 773,000 $4,839,485 $(3,596,355)
======== ==== ======= ========== ===========
</TABLE>
The accompanying notes are an integral
part of these financial statements.
F-6
<PAGE>
<TABLE>
<CAPTION>
PROTOSOURCE CORPORATION
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996 and 1995
1996 1995
---- ----
<S> <C> <C>
Cash Flows From Operating Activities:
Net loss $(1,409,800) $(1,816,285)
Adjustments to reconcile net
loss to net cash used by
operating activities:
Depreciation and amortization 367,049 584,810
Provision for bad debts -- 508,187
Assets and liabilities disposed of
in divestiture and note receivable
received 17,176 --
Gain on disposal of equipment (4,607) --
Issuance of common stock for
costs of financing 100,000 --
Changes in operating assets
and liabilities:
Accounts receivable 163,556 (499,436)
Inventories 7,079 (4,625)
Deposits and other assets 15,441 (18,814)
Accounts payable 32,536 (150,623)
Accrued liabilities 344,284 (10,618)
Customer deposits (4,000) (12,213)
Unearned customer support revenue (34,542) (5,286)
----------- -----------
Net Cash (Used) By Operating
Activities (405,828) (1,424,903)
----------- -----------
Cash Flows From Investing Activities:
Purchases of property and equipment (38,421) (403,591)
Proceeds from disposal of equipment 10,536 --
Software development costs capitalized (442,100) (592,754)
Receivable from shareholders -- (35,000)
----------- ------------
Net Cash (Used) By Investing
Activities (469,985) (1,031,345)
----------- -----------
Cash Flows From Financing Activities:
Payments on notes payable (55,675) (625,998)
Proceeds from borrowing 200,000 20,000
Issuance of common stock 1,300,000 3,795,000
Offering costs incurred (224,801) (619,990)
----------- -----------
Net Cash Provided By Financing
Activities 1,219,524 2,569,012
----------- -----------
</TABLE>
The accompanying notes are an integral
part of these financial statements.
F-7
<PAGE>
<TABLE>
<CAPTION>
PROTOSOURCE CORPORATION
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996 and 1995
1996 1995
---- ----
<S> <C> <C>
Net Increase in Cash and
Cash Equivalents $343,711 $112,764
Cash and Cash Equivalents at
Beginning of Year 138,646 25,882
-------- --------
Cash and Cash Equivalents at
End of Year $482,357 $138,646
======== ========
Supplemental Disclosure of
Cash Flow Information:
Cash paid during the year for:
Interest $272,228 $174,251
Income taxes -- 800
Supplemental Disclosure of Noncash
Investing and Financing Activities:
Acquisition of equipment
under capital leases $ 90,349 $118,701
Common stock contributed by
stockholders for issuance in
acquisition by the Company -- 19,375
Conversion of account payable to a
note payable 32,000 --
Capital contribution by officers
through forgiveness of previously
accrued salaries 154,792 --
Conversion of note payable into
common stock 200,000 --
</TABLE>
The accompanying notes are an integral
part of these financial statements.
F-8
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
- ---------------------------------------------
Description of Business
-----------------------
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. The Company is an Internet
services provider.
Reclassifications
-----------------
The former software development, MarketStreet and computer training center
divisions are presented as discontinued operations in accordance with
Accounting Principles Board (APB) Opinion No. 30 (Note 2). The 1995
operations and per share information have been reclassified to present the
operations of the three divisions as discontinued operations also.
Stock Split
-----------
On February 28, 1997, the Company's shareholders adopted a resolution
approving a one for ten reverse stock split of the issued and outstanding
common shares, effective April 2, 1997. All share information and per share
data have been retroactively restated for all periods presented to reflect
the reverse stock split.
Revenue Recognition
-------------------
Product sales represent sales of application software to end users.
Equipment sales represent sales of computer and peripheral equipment
bundled with the Company's software. Professional service fees represent
revenue from custom programming, post contract customer support (PCS)
agreements and training and installation related services. Fees associated
with insignificant vendor obligations related to installation of systems
are deferred and recognized upon completion of performance. Other income
represents primarily sales of promotional brochures, marketing materials
and sales of miscellaneous equipment and supplies.
Revenue from product sales is recognized upon delivery to the customer,
provided that no significant vendor or PCS obligations remain, and
collection of the related receivable is deemed probable. Revenue from PCS
agreements is recognized on a straight-line basis over the period of the
PCS agreement.
Revenue from the Internet operations are recognized as the customers is
billed for the monthly access fees.
Cash and Cash Equivalents
-------------------------
For purposes of the statements of cash flows, the Company considers all
highly liquid investments with a maturity of three months or less to be
cash equivalents.
Inventories
-----------
Inventories, consisting of computer equipment and supplies held for resale,
are stated at the lower of cost (determined on the first in, first out
method) or market.
F-9
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies (Continued)
- ---------------------------------------------------------
Property and Equipment
----------------------
Depreciation and amortization of equipment, furniture and vehicles are
computed using the straight-line method over estimated useful lives of
three to seven years. Assets held under capital lease obligations,
exclusive of land, are amortized using the straight-line method over the
shorter of the useful lives of the assets or the term of the lease.
Depreciation of property and equipment charged to operations was $233,201
and $171,695 for the years ended December 31, 1996 and 1995, respectively.
Goodwill
--------
Goodwill is being amortized using the straight-line method over an
estimated useful life of 15 years.
Investment
----------
The Company has a 25% ownership interest in SSC Technologies, Inc. ("SSC").
The Company received the equity interest in connection with the divestiture
of three operating divisions of the Company (Note 2). The cost of its
investment is $--, and since the Company does not have the ability to
exercise influence over operating and financial policies of SSC, the
Company is accounting for its investment in SSC utilizing the cost method
of accounting. Under the cost method, net accumulated earnings of an
investee subsequent to the date of investment are recognized by the
investor only to the extent distributed by the investee as dividends.
Dividends received in excess of earnings subsequent to the date of
investment are considered a return of investment and are recorded as
reductions of cost of the investment.
Software Development Costs
--------------------------
Software development costs are capitalized with respect to those products
for which technological feasibility (as defined in Statement of Financial
Accounting Standards No. 86) has been established. Capitalized amounts are
reported at the lower of unamortized cost or net realizable value. These
costs are amortized into cost of goods sold on a product-by-product basis.
The annual amortization expense is the greater of the amount computed using
the ratio of current revenue to the total anticipated revenue for the
product or the straight-line method over the estimated life of the product
starting when the product is available for general release to customers.
Generally, the Company amortizes these costs over three years. Software
development costs capitalized relate primarily to product enhancements.
Amortization expense for capitalized software was $132,254 and $412,258 for
the years ended December 31, 1996 and 1995, respectively.
Deferred Offering Costs
-----------------------
In connection with the Company's public offering (Note 6), costs incurred
to complete the offering have been deferred and were offset against the
proceeds of the offering.
F-10
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies (Continued)
- ---------------------------------------------------------
Stock-Based Compensation
------------------------
During the year ended December 31, 1996, the Company adopted Statement of
Financial Accounting Standard (SFAS) No. 123, "Accounting for Stock-Based
Compensation". The Company will continue to measure compensation expense
for its stock-based employee compensation plans using the intrinsic value
method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to
Employees". See Note 8 for pro forma disclosures of net income and earnings
per share as if the fair value- based method prescribed by SFAS 123 had
been applied in measuring compensation expense.
Income Taxes
------------
The Company adopted Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes," in 1992. Under the statement, deferred
income taxes are provided for temporary differences between the financial
reporting and tax bases of assets and liabilities using enacted tax laws
and rates for the years when the differences are expected to reverse.
NetIncome (Loss) Per Share of Common Stock
------------------------------------------
Net income (loss) per share of common stock is based upon the weighted
average number of shares of common stock and common stock equivalents
outstanding during the year. Common stock equivalents represent the
dilutive effect of the assumed exercise of certain outstanding stock
options and warrants.
Estimates
---------
The preparation of the Company's financial statements in conformity with
generally accepted accounting principles requires the Company's management
to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amount of revenues
and expenses during the reporting period. Actual results could differ from
those estimates.
2. Discontinued Operations
- --------------------------
In 1996, the Company retained the Kriegsman Group ("Kriegsman"), a
financial consulting firm, to assist it with a financial restructuring of
its operations. In connection with the financial restructuring the Company
divested the software development, MarketStreet (advertising division) and
the computer training center divisions. The divisions were to be spun-off
to a new Company owned by the former management of the Company effective
August 31, 1996. The closing for the divestiture occurred on December 31,
1996. All of the assets of the three divisions and the related liabilities
and facilities leases were assumed by the former management and a note
payable was issued by the former management to the Company in the amount of
$770,850 (Note 9). Also included in the assets of the divested divisions
F-11
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
2. Discontinued Operations (Continued)
- --------------------------------------
was $500,000 in cash less approximately $200,000 in liabilities which were
paid by the Company which resulted in approximately $300,000 in cash paid
to the divested divisions. The management of the divested divisions also
assumed all litigation and claims related to the divisions which includes
one law suit in the amount of approximately $70,000. The Kriegsman Group
also nominated new members for the Board of Directors upon completion of
the divestiture of the three divisions which were approved in January 1997.
The Company received a 25% ownership interest in the common stock of the
new company formed to acquire the divested divisions and the divested
divisions will lease the principal office from the Company for a period of
eighteen months at the current market rate.
Kriegsman was to use its best efforts to provide a minimum of $1,500,000 of
financing for the Company through bridge loans or equity financing. In
August 1996, a bridge loan of $200,000 was obtained by the Company for
which the Company issued 400,000 shares of common stock to the bridge
lenders as additional consideration for the $200,000 loan. In October and
November 1996 the Company sold 600,000 shares of its common stock at $2.50
per share through an Underwriter, which included the conversion of the
$200,000 bridge loan into common stock. The Company paid the Underwriter a
10% sales commission and a 3% nonaccountable expense allowance on the
bridge loan and sale of common stock. The Company also entered into a two
year financial consulting agreement with the Underwriter which provides for
a monthly consulting fee of $5,000 for the two year period.
As a part of the financing transaction, the Company granted both the
Underwriter and Kriegsman warrants to purchase common stock. The Company
granted 220,000 warrants to each which are exercisable at $2.50 per share
for a four year period through October 31, 2001. The Company also agreed to
use its best efforts to file a Registration Statement within 90 days of the
closing of the Private Placement to register the shares issued in the
Private Placement and the shares underlying the warrants issued to the
Underwriter and Kriegsman.
Revenues applicable to the Company's discontinued operations were $540,112
and $1,734,605 for the years ended December 31, 1996 and 1995,
respectively.
3. Long-Term Debt
- -----------------
Long-term debt consists of the following:
Bank
----
10.5% installment note due in 1997 with
monthly principal and interest payments of
$328, collateralized by an automobile. $ 2,220
F-12
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
3. Long-Term Debt (Continued)
- -----------------------------
Obligations Under Capital Leases
--------------------------------
5.7% to 25.1% installment notes due in 1997
to 2001, collateralized by equipment. 193,146
13% capital lease for building and land with
a 20 year lease term, with monthly principal
and interest payments of $15,634 for the
first five years, $19,021 for the next five
years, $23,142 for the next five years and
$28,156 for the next five years with an
escalating purchase option (Note 7). 1,658,937
-----------
Total Long-Term Debt 1,854,303
Less current portion of long-term debt (39,358)
-----------
Long-Term Debt $1,814,945
==========
Installments due on debt principal, including the capital leases, at
December 31, 1996 are as follows:
Year Ending
December 31,
------------
1997 $ 39,358
1998 26,058
1999 16,325
2000 42,101
2001 10,591
Later years 1,719,870
----------
Total $1,854,303
==========
4. Income Taxes
- ---------------
The components of the provision for income taxes are as follows:
1996 1995
---- ----
Current:
Federal $ -- $ --
State -- 800
-------- --------
Total -- 800
-------- --------
Deferred:
Federal -- --
State -- --
-------- --------
Total -- --
-------- --------
Total Provision For Income Taxes $ -- $ 800
======== ========
The provision for income taxes reconciles to the amount computed by
applying the federal statutory rate to income before the provision for
income taxes as follows:
F-13
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
4. Income Taxes (Continued)
- ---------------------------
1996 1995
---- ----
Federal statutory rate (25)% (25)%
State franchise taxes,
net of federal benefits (4) (4)
Valuation allowance 29 29
------ ------
Total -- % -- %
====== =======
Significant components of deferred income taxes as of December 31, 1996 are
as follows:
Net operating loss carryforward $1,051,240
Vacation accrual 2,070
----------
Total deferred tax asset 1,053,310
----------
Accelerated depreciation (43,540)
State income taxes (1,520)
----------
Total deferred tax liability (45,060)
Less valuation allowance (936,700)
----------
Net Deferred Tax Asset $ 71,550
==========
The Company has assessed its past earnings history and trends, sales
backlog, budgeted sales, and expiration dates of carryforwards and has
determined that it is more likely than not that $71,550 of deferred tax
assets will be realized. The remaining valuation allowance of $936,700 is
maintained on deferred tax assets which the Company has not determined to
be more likely than not realizable at this time. The net change in the
valuation allowance for deferred tax assets was an increase of $406,760.
The Company will continue to review this valuation on a quarterly basis and
make adjustments as appropriate.
At December 31, 1996, the Company had federal and California net operating
loss carryforwards of approximately $3,900,000 and $1,900,000,
respectively. Such carryforwards expire in the years 2007 through 2011 and
1997 through 2001 for federal and California purposes, respectively.
5. Acquisitions
- ---------------
In July 1995, the Company purchased, from an unrelated individual certain
assets of ValleyNet Communications, an Internet services provider. The
purchase price was $50,000 in cash and 500 shares of the Company's common
stock. The common stock was issued by the Company's shareholders in
accordance with their agreement to use certain of their shares owned
individually in connection with future acquisitions of the Company (Note
9). The assets acquired consists of computer hardware and software, and
goodwill of $21,245 was recorded in connection with the acquisition. The
goodwill is being amortized over a fifteen year useful life.
F-14
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
6. Shareholders' Equity
- -----------------------
Incentive Stock Option Plan
---------------------------
In November 1994, the Company's Board of Directors authorized and the
shareholders approved, a stock option plan which provides for the grant of
incentive and nonqualified options to eligible officers and key employees
of the Company to purchase up to 150,000 shares of the Company's common
stock. The purchase price of such shares shall be at least equal to the
fair market value at the date of grant. Such options vest at the discretion
of the Board of Directors, generally over a four-year period. The stock
option plan expires in 2004. As of December 31, 1996, no options have been
granted under the Plan.
Preferred Stock
---------------
In December 1994, the Company issued to six individuals, including the
Company's five executive officers, for no consideration, a total of 900,000
shares of Series A Convertible Preferred Stock, no par value. Such shares
are automatically convertible, in varying amounts per year, into an
equivalent number of shares of common stock through 2003 if certain revenue
and net income milestones are met as follows:
(i) an aggregate of 9,375 shares of Series A Preferred Stock will
convert to common stock if the Company reports gross annual revenues
of at least $9,600,000 and annual after tax earnings of at least
$1,550,000 for the calendar year ended December 31, 1996, an
additional 9,375 shares per year will convert to common stock from
1997 to 2002, and 121,875 shares in 2003 if the company reports gross
annual revenues of at least $9,600,000, and annual after tax earnings
of at least $1,550,000 for calendar years 1997 through 2003.
(ii) an aggregate of 9,375 shares of Series A Preferred Stock will
convert to common stock if the Company reports gross annual revenues
of at least $15,500,000 and annual after tax earnings of at least
$3,000,000 for the calendar year ending December 31, 1997, an
additional 9,375 shares per year will convert to common stock from
1998 to 2002, and 131,250 shares in 2003 if the Company reports gross
annual revenues of at least $15,500,000, and annual after tax earnings
of at least $3,000,000 for calendar years 1998 through 2003.
(iii) An aggregate of 15,000 shares of Series A Preferred Stock will
convert to common stock if the Company reports gross annual revenues
of at least $23,800,000 and annual after tax earnings of at least
$5,100,000 for the calendar year ending December 31, 1998, an
additional 5,000 shares per year will convert to common stock from
1999 to 2002, and 225,000 shares in 2003 if the Company reports gross
annual revenues of at least $23,800,000, and annual after tax earnings
of at least $5,100,000 for calendar years 1999 through 2003.
F-15
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
6. Shareholders' Equity (Continued)
- -----------------------------------
Preferred Stock (Continued)
---------------------------
The fair market value of the common stock issued upon conversion will be
charged to operations at that time. Any preferred shares not converted
during such period will be canceled. If, prior to January 1, 1999 (i) the
Company consolidates with or merges into another corporation or entity (and
the Company is not the survivor) or if the Company sells or leases
substantially all of its assets and the Company's common stock has
appreciated an average of 10% per annum for each 12 month period following
the date of the Company's Prospectus (February 9, 1995) or (ii) any person,
entity or affiliated group or entities acquires 40% or more of the
Company's common stock in any 12 month period, then all preferred stock
will be automatically converted into common stock. While outstanding, the
preferred stock does not carry voting rights or dividend rights and has a
liquidation preference of $.01 per share.
In connection with the divestiture of three operating divisions (Note 2)
all of the outstanding shares of Series A Preferred Stock were cancelled on
December 31, 1996.
Common Stock and Warrants
-------------------------
The closing for the Company's IPO occurred on February 17, 1995. The
Company sold 69,000 units at $55.00 per unit and paid the Underwriter a 10%
commission and a 3% nonaccountable expense allowance which resulted in net
proceeds to the Company of $2,986,524. Each unit consists of one share of
the Company's common stock and one warrant to purchase an additional share
of common stock at $65.00 per share until February 9, 1998. The warrants
may be redeemed by the Company at any time, upon 30 days written notice to
the holders at a price of $.01 per warrant if the closing price of the
common stock is $75.00 or more for 30 consecutive days. The Company also
entered into a one year financial consulting contract with the Underwriter
for $36,000 which was paid in full in advance. In connection with the
offering, the Company issued the Underwriter, for $100, a warrant to
purchase 10% of the number of Units sold in the offering. The Warrant is
exercisable for a period of four years beginning February 9, 1996. The
Underwriter's Warrant is exercisable at a price of $66.00 per Unit. The
Units subject to the Underwriter's Warrant are identical to the Units sold
to the public.
7. Commitments and Contingencies
- --------------------------------
In September 1994, the Company acquired, under a 20 year noncancellable
capital lease, an office building, including land and improvements. The
Company occupies approximately half of the space as its corporate office
facility and has sublet the remaining space to unrelated parties. The lease
requires initial annual minimum lease payments of $187,608, increasing
every five years to a maximum annual payment of $337,872 in 2009. Under the
lease, the Company has an
F-16
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
7. Commitments and Contingencies (Continued)
- --------------------------------------------
option at any time through April 30, 1996, to purchase the building and
land for $1,700,000. Such amount increases to $1,800,000 through April 30,
1997 and $1,900,000 through April 30, 1998. After April 30, 1998, the
option amount increases annually by the percentage increase in the Consumer
Price Index, as further described in the lease. Upon exercise of the
purchase option, all lease payments made by the Company will be applied
toward the down payment for the purchase price based upon an amortized 20
year note with interest accrued at 9% per annum.
The Company also leases certain computer equipment and furniture and
fixtures under noncancellable capital leases. The Company leases other
facilities, certain vehicles and computer equipment under noncancellable
operating leases. The Company entered into a sublease for its office
building described above in connection with the divestiture of three
operating divisions. The sublease rentals to be received in the future are
approximately $168,000 and have been deducted from the future minimum lease
payments in the table below.
The following is a schedule of future minimum lease payments at December
31, 1996 under the Company's capital leases (together with the present
value of minimum lease payments) and operating leases that have initial or
remaining noncancellable lease terms in excess of one year:
<TABLE>
<CAPTION>
Year Ending Capital Operating
December 31, Leases Leases Total
------------ ------ ------ -----
<S> <C> <C> <C>
1997 $ 132,142 $ 57,074 $ 189,216
1998 235,146 53,242 288,388
1999 245,162 53,841 299,003
2000 266,169 54,918 321,087
2001 230,523 56,016 286,539
Later years 3,705,573 23,340 3,728,913
----------- -------- ----------
Total Minimum Lease
Payments 4,814,715 $298,431 $5,113,146
======== ==========
Less amount representing
interest (2,962,632)
-----------
Present Value of Net
Minimum Lease Payments $ 1,852,083
===========
</TABLE>
Rent expense amounted to approximately $120,100 and $133,600 for the years
ended December 31, 1996 and 1995, respectively.
Leased equipment under capital leases as of December 31, 1996 is as
follows:
Building $1,348,824
Land 411,176
Equipment 276,441
Less accumulated amortization (252,939)
----------
F-17
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
7. Commitments and Contingencies (Continued)
- --------------------------------------------
Net Property and Equipment Under
Capital Leases $1,783,502
==========
8. Stock Based Compensation Plans
- ---------------------------------
The Company adopted Financial Accounting Standard No. 123, "Accounting for
Stock-Based Compensation" (SFAS 123) during the year ended December 31,
1996. In accordance with the provision of SFAS 123, the Company applies APB
Opinion No. 25, "Accounting for Stock Issued to Employees", and related
interpretations in accounting for its plans and does not recognize
compensation expense for its stock-based compensation plans other than for
options granted to non-employees. If the Company had elected to recognized
compensation expense based upon the fair value at the grant date for awards
under these plans consistent with the methodology prescribed by SFAS 123,
the Company's net income and earning per share would be reduced to the
following pro forma amounts:
1996 1995
---- ----
Net Loss:
As reported $(1,409,800) $(1,816,285)
Pro forma (1,412,843) (1,816,285)
Net Loss Per Share of Common
Stock:
As reported $ (5.16) $ (14.69)
Pro forma $ (5.17) $ (14.69)
These pro forma amounts may not be representative of future disclosures
since the estimated fair value of stock options is amortized to expense
over the vesting period and additional options may be granted in future
years. The fair value for these options was estimated at the date of grant
using the Black-Scholes option pricing model with the following assumptions
for the year ended December 31, 1996:
1996
----
Risk free interest rate 5.97%
Expected life 3.5 years
Expected volatility 129.3%
Expected dividend yield 0%
The Company did not grant any stock options in 1995.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions including the
expected stock price volatility. Because the Company's employee stock
options have characteristics significantly different from those of traded
options, and because changes in subjective
F-18
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
8. Stock Based Compensation Plans (Continued)
- ---------------------------------------------
input assumptions can materially affect the fair value estimates, in
management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock based
compensation plans.
9. Related Party Transactions
- -----------------------------
The Company has entered into transactions with its officers and directors,
as follows.
The Company had a note receivable from its former President of $35,000 at
December 31, 1995. Interest is payable monthly at 9% per annum and the note
is due in April 1997. The note is secured by 50,000 shares of the Company's
common stock which are owned by the Company's former President. The note
receivable and accrued interest were sold in Connection with the
divestiture of three operating divisions (Note 2).
On November 1, 1994, all of the Company's shareholders agreed in writing
with each other and with the Company to contribute pro rata from their
shareholdings up to a total of 20,000 shares of common stock to be used by
the Company (at any time until December 31, 1999) for acquisitions of other
companies or lines of business. The Company in its sole discretion may call
for such contributions at any time and from time to time for these
purposes. The Company will not issue any additional equity securities for
purposes of acquisition of other companies or product lines until all
20,000 shares have been contributed. The shareholders did not receive any
compensation or other form of remuneration for their agreement to
contribute the shares and will have no interest in any of the companies or
product lines which may be acquired. The shareholders agreed to provide the
20,000 shares at the request of the Underwriter of the Company's IPO, in
order to reduce any dilution to existing shareholders if the Company
elected to use common stock for acquisition purposes. In 1995, the
Company's shareholders contributed 500 shares in connection with the
acquisition of ValleyNet Communications (Note 5).
The Company incurred expenses in connection with desktop publishing
services provided by a Corporation controlled by the wife of the Company's
former Chief Executive Officer of $7,800 for the year ended December 31,
1995.
In connection with the divestiture of three divisions (Note 2) the Company
received a note receivable of $770,850 from SSC which is controlled by the
former management of the Company. The note bears interest at 10% per annum
and is payable in monthly principal and interest installments of $10,187
through 2006. The note is collateralized by substantially all assets of SSC
and is guaranteed by the former management of the Company.
F-19
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
9. Related Party Transactions (Continued)
- -----------------------------------------
The Company issued 55,000 warrants to its Chief Executive Officer in
connection with his employment agreement in November 1996. The warrants
vest as to 20,000 warrants in December 1997, 20,000 in December 1998 and
15,000 in December 1999. The warrants are exercisable at $2.50 per share at
anytime through December 2001.
10. Concentration of Credit Risk and Major Customers
- ----------------------------------------------------
The Company provides credit, in the normal course of business, to a large
number of companies in the Internet services industry. The Company's
accounts receivable are due from customers located primarily in central
California. The Company performs periodic credit evaluations of its
customers' financial condition and generally requires no collateral. The
Company maintains reserves for potential credit losses, and such losses
have not exceeded management's expectations.
11. Sale of Software
- --------------------
In December 1995, the Company entered into an agreement to sell its
"Classic" Software to a Canadian Limited Partnership (the "Partnership")
for a promissory note in the amount of $8,080,000. The Partnership acquired
all of the Company's interest in the Classic Software defined as follows;
all existing and future updates, upgrades additions, improvements and
enhancements and any new versions of the software. The Partnership is
selling limited partnership units in Canada and the promissory note will be
replaced by cash and promissory notes as the units are sold. If all units
are sold, the Company would receive $1,333,200 cash at closing (less
expenses), $1,333,200 cash on March 21, 1996 (less expenses) and notes
receivable from the limited partners of $5,413,600. The notes bear interest
at 8.5% per annum and are due December 27, 2005 with interest payable
annually. The Partnership closed on December 28, 1995 selling units
representing 18.81% of the purchase price of the software and the Company
received $188,000, net of expenses, and received the second payment of
$188,000 in March 1996. A second partnership was formed in 1996 in Canada
to sell units to acquire the remaining 81.19% of the Software. The Company
received approximately $150,000, net of expenses, on December 31, 1996 for
the sale of software to the second partnership. The $150,000 was paid to
the Company that acquired the software development division pursuant to the
terms of the Divestiture Agreement. The Company also entered into a
Distribution Agreement with the Partnership, whereby the Company was
appointed as the exclusive distributor of the Classic Software throughout
the world for a term of twenty years. Under the terms of the Distribution
Agreement the Company will purchase copies of the Classic Software for
resale to third parties. Until December 31, 2000, the Company shall pay the
following prices for each copy of the Software purchased from the
Partnership:
F-20
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
11. Sale of Software (Continued)
- --------------------------------
(a) until the Company has purchased $475,000 of copies in each year,
100% of the price the Company invoices to its customers for each copy
of the Software; plus
<TABLE>
<CAPTION>
Percentage of Sales
-----------------------------------
Until Below Over
December 31, Sales Benchmark Benchmark Benchmark
------------ --------------- --------- ---------
<S> <C> <C> <C>
1997 $ 8,850,000 5% .1%
1998 10,275,000 4 .1
1999 15,150,000 3 .1
2000 34,000,000 5 .1
Later Years -0- 6 6
</TABLE>
Prior to the repayment of the Promissory Notes, payments to the Partnership
for Software will be applied by the Partnership as follows:
i) first, the Partnership shall pay to the Company on behalf of
each Limited Partner, an amount equal to the interest then
payable in respect of the Promissory Note issued by such Limited
Partner;
ii) second, the balance remaining allocable to each Limited
Partner will be paid (A) 55% to the Limited Partner and (B) 45%
to the Company for repayment of the principal amount then
outstanding on the Limited Partner's Promissory Note.
The Partnership has also entered into an Option Agreement with the Company
whereby the Company may purchase the Software from the Partnership upon
certain triggering events. Upon the occurrence of such triggering events
the Company, at its sole option, may purchase the software from the
Partnership for a purchase price based upon the following.
The purchase price payable by the Company for the Software shall be equal
to the fair market value of the Software on the Exercise Date as determined
by a qualified arm's length appraiser agreed to by the parties, provided
that, if as a result of a Triggering Event, securities are issued by the
Company, or to the Company or its shareholders, the purchase price shall be
satisfied by the transfer by the Company to the Partnership of that number
of securities having a fair market value equal to the lesser of the
purchase price and 22.0% of the securities issued or received, as the case
may be, on a fully diluted basis. The Company agrees to jointly elect under
applicable taxing statutes, with the Partnership to complete the
transaction on a tax deferred basis, with respect to the issuance of
securities to the Partnership by allowing the Partnership to transfer the
Software to a Canadian subsidiary of the Company on a tax deferred basis.
F-21
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
11. Sale of Software (Continued)
- --------------------------------
In the event that sales revenue earned by the Partnership in any year
under the terms of the Distribution Agreement are less than $475,000
in any calendar year prior to the Exercise Date, the percentage of the
securities to be transferred by the Company to the Partnership shall
be increased by 1% for each 10% shortfall to a maximum of 5% in any
calendar year, provided that the option of the Partnership to acquire
such additional shares shall not be exercisable by the Partnership
until the promissory notes issued by limited partners to the Company
have been paid in full and until such time, such additional options
may be repurchased by the Company for a price equal to 150% of the
cash shortfalls for which the options were issued.
Since the Company is responsible for maintaining, upgrading and
developing future revisions of the Software, the transaction has not
been accounted for as a sale by the Company. In addition, the notes
receivable have not been recorded by the Company as a result of their
long-term nature and they are primarily expected to be repaid as the
Company sells software to third parties and makes payments to the
Partnership pursuant to terms of the Distribution Agreement.
Therefore, repayment prior to 2005 will only occur out of revenue
generated by the Company. This transaction has been accounted for by
the Company on a cost recovery basis and the cash received from the
Partnership will reduce the capitalized software costs and revenue
will be recognized when the capitalized software costs have been
reduced to zero since the Company has, in essence, retained
substantially all rights of ownership.
The software and all rights to the above agreements were sold by the
Company in connection with the divestiture of the software development
division (Note 2).
F-22
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
- ----------------------------------------------------------
None.
17
<PAGE>
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
- --------------------------------------------------------------------
The name, age and position of each of the Company's executive officers and
directors are set forth below:
<TABLE>
<CAPTION>
Officer/Director
Name Age Position Since
---- --- -------- -----
<S> <C> <C> <C>
Raymond J. Meyers 40 Chief Executive Officer 1996
and Director
Andrew Chu 25 President, Chief Financial Officer 1995
and Director
Steven A. Kriegsman 55 Director 1997
Howard P. Silverman 56 Director 1997
</TABLE>
Directors hold office for a period of one year from their election at the
annual meeting of stockholders or until their successors are duly elected and
qualified. Officers of the Company are elected by, and serve at the discretion
of, the Board of Directors.
In January 1997 in connection with the sale of the Company's Classic Line,
the SSC Principals resigned as officers and directors and the above four
individuals were appointed executive officers and directors of the Company. See
"Item 12."
Background
The following is a summary of the business experience, for at least the
last five years, of each executive officer and director of the Company:
Raymond J. Meyers became the Company's Chief Executive Officer in December
1996. From 1985 to 1996, he was employed by Transamerica Corporation holding a
variety of positions, most recently (from 1991 to 1996) as Director of Business
Services for Transamerica Telecommunications. Mr. Meyers graduated from Rutgers
University in 1979 with a Bachelor of Arts degree in Economics.
Andrew Chu became the Company's Chief Financial Officer in April 1995 and
its President and a director in January 1997. From 1992 to 1994, he was employed
at IDS Financial Services as a Financial Planner. He was the managing partner of
The Pacific Group, a consulting firm engaged in equity financing for small firms
from January 1994 to April 1995. Mr. Chu holds a B.S. degree with emphasis in
Finance from California State University of Fresno.
18
<PAGE>
Steven A. Kriegsman has been President of the Kriegsman Group, a
privately-held Los Angeles, California based investment banking firm since 1989.
He graduated from New York University in 1964 with a Bachelor of Science degree.
Howard P. Silverman has been an independent business consultant with
emphasis on the financing of public and private companies for more than five
years. He earned a Bachelor of Science degree from City College of New York and
an O.D. degree from the Illinois College of Optometry. He is a director of
Incomnet, Inc., a publicly-held reseller of long distance services.
ITEM 10. EXECUTIVE COMPENSATION
- --------------------------------
None of the Company's executive officers or directors currently receive
compensation in excess of $100,000 per year except Mr. Meyers who receives a
salary of $130,000 per year. In connection with his employment, Mr. Meyers was
also granted options to purchase 550,000 shares of Common Stock vesting over a
three-year period at $.25 per share at any time until October 2001. No executive
officers or directors as a group received compensation in excess of $100,000 for
the calendar years ended December 31, 1996, 1995 or 1994. Compensation for all
officers and directors as a group for the calendar year ended December 31, 1996
aggregated $64,000.
The following table discloses certain compensation paid to the Company's
executive officers for the calendar years ended December 31, 1996, 1995 and
1994.
<TABLE>
<CAPTION>
Summary Compensation Table
Long Term Compensation
Annual Compensation Awards Payouts
------------------- -----------------------
(a) (b) (c) (d) (e) (f) (g) (h) (i)
Name
and
Prin- Other All
cipal Annual Restricted Other
Posi- Compen- Stock Options/ LTIP Compen-
tion Year Salary($) Bonus($) sation($) Award(s)($) SARS(#) Payouts($) sation($)
- ---- ---- --------- -------- --------- ----------- ------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
James C. 1996 $61,925 $ 0 0 0 0 0 0
Robinson 1995 61,425 5,941 0 0 0 0 0
Chief Execu- 1994 57,226 25,000 0 0 0 0 0
tive Officer
</TABLE>
1995 Stock Option Plan
In November 1994, the Company adopted a stock option plan (the "Plan")
which provides for the grant of options intended to qualify as "incentive stock
options" and "nonqualified stock options" within the meaning of Section 422 of
19
<PAGE>
the United States Internal Revenue Code of 1986 (the "Code"). Incentive stock
options are issuable only to eligible officers, directors, key employees and
consultants of the Company.
The Plan is administered by the Board of Directors. At December 31, 1996,
the Company had reserved 150,000 shares of Common Stock for issuance under the
Plan. Under the Plan, the Board of Directors determines which individuals shall
receive options, the time period during which the options may be partially or
fully exercised, the number of shares of Common Stock that may be purchased
under each option and the option price.
The per share exercise price of the Common Stock may not be less than the
fair market value of the Common Stock on the date the option is granted. No
person who owns, directly or indirectly, at the time of the granting of an
incentive stock option, more than 10% of the total combined voting power of all
classes of stock of the Company is eligible to receive incentive stock options
under the Plan unless the option price is at least 110% of the fair market value
of the Common Stock subject to the option on the date of grant.
No options may be transferred by an optionee other than by will or the laws
of descent and distribution, and during the lifetime of an optionee, the option
may only be exercisable by the optionee. Options may be exercised only if the
option holder remains continuously associated with the Company from the date of
grant to the date of exercise. Options under the Plan must be granted within
five years from the effective date of the Plan and the exercise date of an
option cannot be later than ten years from the date of grant. Any options that
expire unexercised or that terminate upon an optionee's ceasing to be employed
by the Company become available once again for issuance. Shares issued upon
exercise of an option will rank equally with other shares then outstanding.
As of the date of this Report, no options have been granted under the Plan.
20
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- -----------------------------------------------------------------------
The following table sets forth information concerning the holdings of
Common Stock (without giving effect to any shares issuable upon exercise of the
Public Warrants or the Prior Representative's Unit Warrants) by each person who,
as of the date of this Report, holds of record or is known by the Company to
hold beneficially or of record, more than 5% of the Company's Common Stock, by
each director, and by all directors and executive officers as a group. All
shares are owned beneficially and of record and all share amounts include stock
options and common stock purchase warrants exercisable within 60 days from the
date hereof. The address of all persons is in care of the Company at 2300 Tulare
Street, Suite 210, Fresno, California 93721.
Amount of Percent of
Name Ownership Class
- ---- --------- -----
Raymond J. Meyers(1) 200,000 2.5%
Andrew Chu(2) 585,000 7.0%
Steven A. Kriegsman(3) 1,765,000 18.6%
Howard P. Silverman(4) 850,000 9.9%
Andrew, Alexander, Wise &
Company, Incorporated(5) 1,370,000 15.1%
Gloria Ippolito 600,000 7.8%
Anaka Parkash 700,000 9.1%
Isaac Paschaldis 900,000 11.6%
John Benedetto 700,000 9.1%
Matthew Mulhern 400,000 5.2%
All officers and directors as
a group (4 persons)(1)(2)(3)(4) 3,400,000 30.5%
- ----------
(1) Represents stock options to purchase 200,000 shares at $.25 per share at
any time until October 2001. Mr. Meyers holds an additional 350,000 stock
options which vest in 1998 and 1999.
(2) Represents common stock purchase warrants to purchase 585,000 shares at
$.25 per share at any time until October 2001 including 535,000 Warrants
which are being registered in the SB-2 Filing.
(3) Represents common stock purchase warrants to purchase 1,765,000 shares at
$.25 per share at any time until October 2001 including 1,665,000 Warrants
which are being registered in the SB-2 Filing. All common stock purchase
warrants are held by the Kriegsman Group of which Mr. Kriegsman is the
President and a principal stockholder.
(4) Represents common stock purchase warrants to purchase 850,000 shares at
$.25 per share at any time until October 2001, all of which are being
registered in the SB-2 Filing.
21
<PAGE>
(5) Represents common stock purchase warrants to purchase 1,370,000 shares at
$.25 per share at any time until October 2001, all of which are being
registered in the SB-2 Filing.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------------------------------------------------------
Management of the Company believes that the transactions described below
were no more or less fair than the terms of transactions which the Company might
otherwise have entered into with third party nonaffiliated entities. Any related
party transactions have been and will continue to be approved by a majority of
the disinterested members of the Company's Board of Directors.
In February 1995, the Company loaned $35,000 to Charles T. Howard, the
Company's then President. Interest on the loan is payable monthly at the rate of
9% per annum and the promissory note evidencing the indebtedness is due in April
1997. The promissory note is secured by 50,000 shares of the Company's Common
Stock owned by Mr. Howard and was transferred to SSC as a part of the
Divestiture Agreement described below.
In November 1994, the Company issued 857,140 shares of its Convertible
Preferred Stock to five of the Company's then officers and directors, each share
of which was convertible for no additional consideration into one share of
Common Stock under certain circumstances. The Convertible Preferred Stock was
cancelled and returned to the Company by the five holders in connection with the
Divestiture Agreement described below.
In January 1997, the Company sold the remaining assets of the Classic Line
to SSC Technologies, Inc. ("SSC") for $770,850 evidenced by a promissory note
bearing interest at 10% per annum payable in January 2007 and the assumption by
SSC of all of the liabilities of the Classic Line, aggregating approximately
$500,000. Under the terms of the asset sales agreement (the "Divestiture
Agreement"), the Company acquired 25% of the outstanding common stock of SSC for
$500,000 in cash and the remaining 75% of the outstanding common stock was
issued to other stockholders including Charles T. Howard, David L. Green, Ding
Yang and Steven L. Wilson who were previously officers and directors of the
Company (the "SSC Principals"). As a part of the Divestiture Agreement, the SSC
Principals also (i) cancelled 900,000 shares of Convertible Preferred Stock held
by them which were previously exercisable into an equal number of shares of
Common Stock, (ii) agreed not to sell an aggregate of 454,494 shares of Common
Stock owned by them until October 1999 except with the prior written consent of
Andrew, Alexander, Wise & Company, Incorporated ("AAWC"), (iii) agreed to
sublease office space from the Company at a monthly rental of $12,000 through
February 28, 1998, (iv) granted to Steven A. Kriegsman, a director of the
Company, an option to purchase up to 150,000 shares of Common Stock held by the
SSC principals at any time until October 2001, and (v) personally guaranteed on
a joint and several basis the $770,850 promissory note and all other obligations
of SSC to the Company.
In October 1996, the Company issued 2,200,000 Warrants to the Kriegsman
Group ("KG") for consulting services. Steven A. Kriegsman who subsequently
became a director of the Company is the President and controlling stockholder of
22
<PAGE>
KG. KG subsequently assigned 535,000 of such Warrants to Andy Chu, the Company's
President and a director. The Warrants and underlying shares are being
registered in the SB-2 Filing. KG also assigned 50,000 of the 150,000 stock
options it received from the SSC Principals to Mr. Chu.
In October 1996, the Company issued 2,200,000 Warrants to AAWC as
additional compensation for AAWC assisting the Company in the private placement
of 6,000,000 shares of the Company's Common Stock to a group of investors for
$.25 per share. AAWC subsequently assigned 850,000 Warrants to Howard P.
Silverman, a director of the Company. The Warrants and underlying shares are
being registered in the SB-2 Filing. The Company also paid to AAWC a cash
commission of 10% of the gross proceeds raised ($150,000) and a nonaccountable
expense allowance of 3% of such gross proceeds ($45,000). In September 1996,
AAWC and KG entered into an agreement not to sell the 2,200,000 Warrants and
underlying shares owned by each party for a period of three years without the
consent of the other party.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------
a. Exhibits:
Exhibit No. Title
----------- -----
2.01 Restated Articles of Incorporation of the Registrant(1)
2.02 Bylaws of the Registrant(1)
10.01 1995 Incentive Stock Option Plan(1)
10.02 Capitalized Lease Agreement(1)
10.03 Employment Agreement (Mr. Howard)(1)
10.04 Employment Agreement (Mr. Green)(1)
10.05 Employment Agreement (Mr. Yang)(1)
10.06 Employment Agreement (Mr. Wilson)(1)
10.07 Real Estate Lease and Amendments thereto(1)
10.08 Form of Bridge Loan Promissory Note(1)
10.09 Form of Bridge Loan Subscription Agreement(1)
10.10 Share Contribution Agreement(1)
23
<PAGE>
10.12 Divestiture Agreement(2)
10.13 Selling Agreement with AAWC(2)
10.14 Warrant Agreement with AAWC(2)
10.15 Lock-up Agreement(2)
10.16 Registration Rights Agreement(2)
- ----------
(1) Incorporated by reference to the Registrant's Registration Statement on
Form SB-2 declared effective by the Commission on February 9, 1995, file
number 33-86242.
(2) Incorporated by reference to the Registrant's Registration Statement on
Form SB-2, file number 333-20543, filed January 26, 1997.
24
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
has duly caused this Report to be signed on its behalf by the undersigned,
thereunto duly authorized, in Fresno, California, on March 28, 1997.
PROTOSOURCE CORPORATION
By /S/ RAYMOND J. MEYERS
--------------------------------------
Raymond J. Meyers
Chief Executive Officer
Signature Title Date
--------- ----- ----
/S/ RAYMOND J. MEYERS
- -------------------------- Chief Executive Officer and March 28, 1997
Raymond J. Meyers Director
/S/ ANDREW CHU
- -------------------------- President, Chief Financial March 28, 1997
Andrew Chu Officer, (Principal Accounting
Officer) and Director
/S/ STEVEN A. KRIEGSMAN
- -------------------------- Director March 28, 1997
Steven A. Kriegsman
/S/ HOWARD P. SILVERMAN
- -------------------------- Director March 28, 1997
Howard P. Silverman
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 482,357
<SECURITIES> 0
<RECEIVABLES> 50,553
<ALLOWANCES> 0
<INVENTORY> 8,980
<CURRENT-ASSETS> 603,762
<PP&E> 2,587,834
<DEPRECIATION> 486,441
<TOTAL-ASSETS> 3,561,855
<CURRENT-LIABILITIES> 503,780
<BONDS> 0
0
0
<COMMON> 4,839,485
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 3,561,855
<SALES> 697,581
<TOTAL-REVENUES> 697,581
<CGS> 0
<TOTAL-COSTS> 1,121,773
<OTHER-EXPENSES> 248,599
<LOSS-PROVISION> (672,791)
<INTEREST-EXPENSE> 272,228
<INCOME-PRETAX> (672,791)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> (737,009)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,409,800)
<EPS-PRIMARY> (5.16)
<EPS-DILUTED> (5.16)
</TABLE>
