PROTOSOURCE CORPORATION
1,050,000 Units
ProtoSource Corporation (the "Company") is offering (the "Offering")
through Andrew, Alexander, Wise & Company, Inc. as representative of the
underwriters (the "Underwriter"), 1,050,000 Units of the Company's securities
("Units"). Each Unit consists of one share of no par value common stock ("Common
Stock") and one redeemable common stock purchase warrant ("Warrant"), priced at
$5.75 per Unit representing the closing bid price of the Common Stock on the
Electronic Bulletin Board ("Bulletin Board") on the date of this Prospectus. The
Common Stock and Warrants are separately tradeable immediately upon issuance.
Each Warrant is exercisable to purchase one share of Common Stock at an exercise
price of $6.325 per share (110% of the closing bid price of the Common Stock one
day prior to the date hereof on the Bulletin Board) for a period of five years
from the date hereof and may be redeemed by the Company after one year from the
date hereof for $.10 per Warrant on 30 days' written notice to the
Warrantholders if the closing bid price of the Common Stock on the NASDAQ
SmallCap Market or the Bulletin Board (whichever is applicable) is at least
$8.625 per share (150% of the closing bid price of the Common Stock on the
Bulletin Board one day prior to the date hereof) for 20 consecutive trading
days, ending not earlier than 15 days before the Warrants are called for
redemption. See "Risk Factors" and "Underwriting."
The Company's Common Stock currently trades on the Bulletin Board under the
symbol "PSCO". On May 4, 1998, the closing bid price of the Common Stock on the
Bulletin Board was $5.75 per share. The Company has applied to list the Common
Stock and Warrants (but not the Units) on the NASDAQ SmallCap Market but cannot
assure, that it meets the NASDAQ SmallCap Market requirements for listing.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION ("COMMISSION") OR ANY STATE SECURITIES
COMMISSION NOR HAS THE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
THE SECURITIES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK
AND SHOULD BE CONSIDERED ONLY BY PERSONS ABLE TO SUSTAIN
A TOTAL LOSS OF THEIR INVESTMENT. SEE "RISK FACTORS"
COMMENCING ON PAGE 9 OF THIS PROSPECTUS.
--------------------------------------
The Units are offered by the Underwriter on a firm commitment basis,
subject to prior sale, when, as and if delivered to and accepted by the
Underwriter and subject to certain conditions, including the right of the
Underwriter to reject orders in whole or in part. It is anticipated that
delivery of certificates representing the securities will be made against
payment therefor in New York, New York on or about three business days from the
date of this Prospectus.
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Price to Public Underwriting Discounts Proceeds to Company
and Commissions(1) (2)(3)
- --------------------------------------------------------------------------------
Per Unit.............$ 5.75 $ .575 $ 5.175
- --------------------------------------------------------------------------------
Total................$ 6,037,500 $ 603,750 $ 5,433,750
================================================================================
(1) Excludes a nonaccountable expense allowance payable to the Underwriter of
$181,125, a $60,000 one year consulting fee, and the issuance of warrants
to the Underwriter (the "Underwriter's Warrants") to purchase up to 105,000
Units at a price of $9.4875 per Unit, (165% of the Offering price of the
Units). The Company has granted certain registration rights with respect to
the Units underlying the Underwriters' Warrants and has agreed to indemnify
the Underwriter against certain liabilities, including liabilities under
the Securities Act of 1933 (the "1933 Act"). See "Underwriting."
(2) Before deducting costs of the Offering estimated to be $381,125, including
the Underwriter's nonaccountable expense allowance. See "Underwriting."
(3) Does not include the exercise of the Underwriter's option (the
"Overallotment Option"), exercisable within 30 days from the date of this
Prospectus, to purchase from the Company up to 157,500 additional Units on
the same terms as the Units offered hereby solely to cover overallotments,
if any. If the Overallotment Option is exercised in full, the total Price
to Public, Underwriting Discounts and Commissions and Proceeds to Company
will be $6,943,125, $694,312 and $6,248,813, respectively. See
"Underwriting."
[Company Logo Omitted]
Andrew, Alexander, Wise & Company, Inc.
The date of this Prospectus is May 13, 1998.
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AVAILABLE INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission"), Washington, D.C., a Registration Statement on Form SB-2 (the
"Registration Statement") under the 1933 Act with respect to the securities
offered hereby. This Prospectus does not contain all the information set forth
in the Registration Statement, certain items of which are omitted in accordance
with the rules and regulations of the Commission. For further information with
respect to the Company and the securities offered by this Prospectus, reference
is made to such Registration Statement and the exhibits thereto. Statements
contained in this Prospectus as to the contents of any contract or other
documents are not necessarily complete and in each instance reference is made to
the copy of such contract or other document filed as an exhibit to the
Registration Statement for a full statement of the provisions thereof; each such
statement contained herein is qualified in its entirety by such reference.
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "1934 Act") and, in accordance therewith,
files reports, proxy statements and other information with the Commission. Such
reports, proxy statements and other information may be inspected and copied at
public reference facilities of the Commission at 450 Fifth Street N.W.,
Washington, D.C. 20549; 500 West Madison Street, Suite 1400, Chicago, Illinois
60661; 7 World Trade Center, New York, New York 10048; and 5757 Wilshire
Boulevard, Los Angeles, California 90036. Copies of such material can be
obtained from the Public Reference Section of the Commission at 450 Fifth Street
N.W., Washington, D.C. 20549 at prescribed rates. The Commission maintains a Web
site that contains such reports, proxy and information statements and other
information regarding the Company at http://www.sec.gov.
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK AND
WARRANTS INCLUDING OVERALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS IN
SUCH SECURITIES AND THE IMPOSITION OF A PENALTY BID IN CONNECTION WITH THE
OFFERING. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
The Company furnishes annual reports which include audited financial
statements to its stockholders. The Company may also furnish quarterly financial
statements to its stockholders and such other reports as may be authorized by
its Board of Directors.
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PROSPECTUS SUMMARY
The following is a summary of certain information contained in this
Prospectus and is qualified in its entirety by the detailed information and
financial statements that appear elsewhere herein. Except for the historical
information contained herein, the matters set forth in this Prospectus include
forward-looking statements which are subject to risks and uncertainties that may
cause actual results to differ materially. These risks and uncertainties are
detailed throughout the Prospectus 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 Prospectus speak only as of the date
hereof.
The Company
The Company provides Internet access and related services to individuals,
public agencies and businesses in six small Central California cities. As of
December 31, 1997, the Company had 2,800 subscribers for whom it provided
Internet access up from 250 subscribers in July 1995. See "History." The Company
intends to acquire other small Internet providers in markets with populations of
less than 500,000 that are located 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 are
unable 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 has addressed these kinds of financial and
administrative burdens by (i) expanding its operations throughout Central
California, (ii) developing diversified services similar to its larger
competitors, such as hourly-based access services, special access to packages
for business and high speed access, and (iii) investing in automated billing and
administrative systems. The Company believes these resources will not only allow
it to compete effectively with larger access firms entering the Company's
markets, but also will facilitate the Company's efforts to attract small
Internet providers. The Company's long-term plan is to target a select number of
such markets and increase revenues through acquisition in these markets. The
Company is not currently negotiating to acquire, nor has it entered into any
agreement to acquire, any other companies. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations," "Business -
Introduction," and "Risk Factors."
The Company's strategy is to provide low cost direct Internet access and
other Internet related products and services to subscribers or customers in
target markets. The Company will seek to effectuate this strategy by acquiring
small Internet providers, by expanding marketing operations in its existing
markets, by offering Internet related products and services and by acquiring
other computer oriented companies. The Company will also seek to generate
additional revenues by (i) increasing monthly Internet access fees while
offering additional Internet products and services, (ii) offering monthly
community access services, (iii) providing Internet consulting services, and
(iv) generating marketing service fees from businesses seeking a Web site on the
Internet.
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The Offering
Securities offered (1).................... 1,050,000 Units, each Unit consist-
ing of one share of Common Stock
and one Warrant
Offering price............................ $5.75 per Unit
Common Stock outstanding
prior to the Offering (1)................ 665,333 shares
Common Stock Outstanding
After the Offering (1)................... 1,715,333
Use of Proceeds........................... For repayment of debt, acquisition
of small Internet access providers
and other computer oriented
companies, for marketing expenses
and working capital.
See "Use of Proceeds"
Bulletin Board Symbol..................... PSCO - Common Stock
Proposed NASDAQ SmallCap Symbols.......... PSCO - Common Stock
PSCOW - Warrants
Transfer Agent............................ Corporate Stock Transfer, Inc.
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(1) Excludes (i) up to 1,050,000 shares issuable upon exercise of the Warrants,
(ii) up to 315,000 shares issuable upon exercise of the Overallotment
Option and the Warrants included therein, and (iii) up to 407,333 shares
issuable upon exercise of other outstanding warrants and options. See
"Dilution", "Capitalization", "Management-Executive Compensation", "Certain
Transactions", "Description of Securities" and "Underwriting."
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Summary Financial Information
The following financial information is derived from the financial
statements of the Company appearing elsewhere herein and should be read in
conjunction with such financial statements. See "Financial Statements."
Year Ended December 31,
--------------------------------
1997 1996
Income Statement Data:
Revenues $ 749,796 $ 697,581
(Loss) from continuing
operations (1,470,550) (672,791)
Net (loss) (1,470,550) (1,409,800)
Net (loss) per share (2.49) (7.74)
Weighted average number
of shares outstanding 589,702 182,037
December 31,
1997 As Adjusted(1)
Balance Sheet Data:
Working capital (deficit) $ (795,657) $ 4,355,491
Total assets 3,295,734 7,598,359
Long-term debt 1,788,889 1,788,889
Total liabilities 2,772,184 2,022,184
Stockholders' equity 523,550 5,576,175
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(1) As adjusted to give effect to the receipt and application of the estimated
net proceeds of the Offering without giving effect to exercise of the
Warrants, the Underwriter's Warrants or other outstanding warrants or stock
options. See "Use of Proceeds" and "Description of Securities."
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THE COMPANY
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 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 designed and sold customized computer system
configurations 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 46,000 Units to the public at
$82.50 per Unit. Each Unit consisted of one share of Common Stock and one common
stock purchase warrant (the "Prior Warrants") to purchase an additional share of
Common Stock at $97.50 per share until February 1998, when the Prior Warrants
expired unexercised. McClurg Capital Corporation, the Representative of the
Underwriters of the IPO (the "Prior Representative"), received warrants (the
"Prior Representative's Unit Warrants") to purchase 4,000 Units at $99.00 per
Unit until February 2000. In May 1997, the Company registered 186,666 Common
Stock Purchase Warrants and 186,666 shares of Common Stock underlying these
Warrants together with 426,667 shares of Common Stock (collectively the "May
1997 Securities").
In July 1995, the Company acquired ValleyNet Communications ("ValleyNet"),
a small Internet access provider for $50,000 in cash and the issuance of 334
shares of the Company's Common Stock. At the time of its acquisition, ValleyNet
operated out of one location in Fresno, California and had 250 subscribers.
Since that time, the Company has increased its Internet locations to six, and
increased its subscribers to 2800 at December 31, 1997.
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
carried as an asset on its financial statements, due to the high degree of
uncertainty as to the payment of the promissory note. As a part of the
transaction, the Company received an exclusive worldwide license through
December 2006, to market the Classic Line subject to the payment of a royalty of
16% of gross sales to the Canadian company. To date, the Company has not
incurred any liability to pay royalties.
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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 the liabilities of the Classic Line and certain other liabilities,
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 (less $200,000 of liabilities which
were paid by the Company and deducted from the $500,000) 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 part
of the Divestiture Agreement, the SSC Principals also (i) canceled 900,000
shares of Convertible Preferred Stock held by them (and one other individual)
which were previously exercisable into shares of Common Stock on a fifteen for
one basis, (ii) agreed not to sell an aggregate of 30,300 shares of Common Stock
owned by them until October 1999, except with the prior written consent of the
Prior Representative, (iii) agreed to sublease office space from the Company at
a monthly rental of $12,000 until February 28, 1998, (iv) granted to Steven A.
Kriegsman, a former director of the Company, an option to purchase up to 10,000
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. The value of
the Classic Line assets were determined as a result of negotiations between the
Company and the SSC Principals. See "Certain Transactions."
In October 1996, the Company sold 400,000 shares of its Common Stock to a
group of investors for $3.75 per share or a total of $1,500,000 (the "Common
Stock Placement"). 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 26,667 shares of its Common Stock to the bridge lenders as
additional consideration for the $200,000 loan. The Company also issued 186,666
Warrants exercisable at $3.75 per share in connection with the bridge loan and
the private placement. The 426,667 shares, 186,666 Warrants and 186,666 shares
underlying the Warrants were registered with the Commission in May 1997.
Between June and September 1997, the Company issued 150,000 shares of its
Common Stock as additional consideration for a $750,000 bridge loan (the "Bridge
Loan") advanced to it by eight bridge lenders. The Company intends to repay the
Bridge Loan with proceeds of the Offering.
The Company was incorporated in the State of California as SHR Corporation
on July 1, 1988, and changed its name to "ProtoSource Corporation" in October
1994. The Company's principal executive offices are located at 2300 Tulare
Street, Suite 210, Fresno, California 93721, telephone (209) 490-8600.
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RISK FACTORS
In evaluating the Company's business, prospective investors should consider
carefully the following factors in addition to the factors included in the
"Prospectus Summary" on page 4 and the other information presented in this
Prospectus.
Prospective purchasers of the Common Stock should carefully consider the
following risk factors and the other information contained in this Prospectus
before making an investment in the Common Stock. Information contained in this
Prospectus contains "forward-looking statements" which can be identified by the
use of forward-looking terminology such as "believes," "expects," "may,"
"should" or "anticipates" or the negative thereof or other variations thereon or
comparable terminology, or by discussions of strategy. See, e.g., "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business - Strategy." No assurance can be given that the future results covered
by the forward-looking statements will be achieved. The following matters
constitute cautionary statements identifying important factors with respect to
such forward-looking statements, including certain risks and uncertainties, that
could cause actual results to vary materially from the future results covered in
such forward-looking statements. Other factors could also cause actual results
to vary materially from the future results covered in such forward- looking
statements.
Limited History of Operations; Significant Losses: Deficit In Working
Capital. The Company was incorporated in July 1988 but has only provided
Internet access services since July 1995. Prior to August 1996, the Company was
engaged primarily in the agricultural software development business and incurred
significant losses of $1,816,285, $1,409,800 and $1,470,550 for the years ended
December 31, 1995, 1996 and 1997, respectively. The Company had a working
capital deficit of $795,657 at December 31, 1997, which could significantly
limit its operations. The Company also had an accumulated deficit of $5,066,905
at that date. See "Financial Statements." There can be no assurance that the
Company will achieve profitability or positive cash flow from operations. The
Company expects to focus in the near term on building and increasing its
Internet subscriber base, which will require it to significantly increase its
expenses for personnel, marketing, network infrastructure and the development of
new services. As a result, the Company believes that it may incur further losses
in the near term. The Company may find it necessary to seek additional equity
capital if its cash flow continues to be insufficient to fund its desired
growth. There can be no assurance that the Company can obtain such additional
capital, and if it is unable to do so, it will be unable to expand its
operations, should it require such capital. (See also "Risk Factors - Need for
Additional Financing.") The Company's prospects must be considered in light of
the risks, expenses and difficulties frequently encountered by companies in
their early stage of development, particularly companies in new and rapidly
evolving markets such as the Internet. To address these risks, the Company must,
among other things, respond to competitive developments, attract, retain and
motivate qualified persons, and continue to upgrade its technologies and
commercialize services incorporating such technologies. There can be no
assurance that the Company will be successful in addressing these and other
risks.
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Risks Associated With Defaults by SSC and the SSC Principals. The Company
is the payee of a promissory note from SSC guaranteed by the SSC principals
which bears interest at 10% per annum and is due January 2007. SSC and the SSC
principals have also agreed (i) to assume certain trade accounts payable
originally incurred by the Company in the approximate amount of $500,000 and
(ii) to sublease from the Company certain office space at a rental of $12,000
per month through February 1998. In the event SSC and the SSC principals default
on, or for any reason elect not to pay, any of these obligations, the Company's
operations would be materially adversely affected. The Company has not received
rental payments on the aforesaid sublease since April 1997 and has been advised
by certain of its trade account creditors that such creditors have not received
payments on the accounts from SSC or the SSC principals. Since these obligations
were originally incurred by the Company, the Company remains liable to the trade
account creditors. Some of these creditors have threatened to bring suit against
the Company and the Company has been required to return possession of the
subject office space to the Company's landlord. The total amount of trade
account debt assumed by SSC and the SSC Principals is approximately $100,000.
See "Business - Properties, "Business - Litigation", and "Certain Transactions."
Litigation. The Company has been threatened with legal action resulting
from defaults by SSC and the SSC Principals (in connection with trade account
obligations originally incurred by the Company and assumed by SSC and the SSC
Principals), and claims against the Company filed by the SSC Principals. Payment
of any judgments or settlements in connection with these litigation matters
together with the costs of defending such matters could materially and adversely
affect the Company's results of operations and financial condition. See
"Business - Litigation."
Risks Associated With Unspecified Acquisitions. Although the Company
intends to increase revenues in part through acquisition of small Internet
access providers and other computer oriented companies using proceeds of the
Offering, it has limited experience in this regard and may acquire companies
with limited operating or negative operating history. Shareholders will not
generally have the right to review or vote upon such acquisitions. Should the
Company acquire other companies that incur operating losses, the Company's
operating results will be further adversely affected. The Company is not
negotiating to acquire nor has it entered into any agreements to acquire any
such companies and there can be no assurance it will complete any such
acquisitions in the future. See "Business-Strategy."
Fluctuations in Operating Results. As a result of the Company's limited
Internet services operating history, the Company has limited historical
financial data on which to predict future operating expenses. Moreover, the
Company may experience fluctuations in operating results in the future caused by
various factors, some of which are outside of the Company's control, including,
but not limited to, general economic conditions, specific economic conditions in
the Internet services industry, user demand for the Internet, the amounts of
capital expenditures and other costs related to the expansion of operations, the
timing of customer subscriptions, the introduction of new Internet services by
the Company or its competitors, the mix of such services sold and the channels
through which those services are sold. As a strategic response to a changing
competitive environment, the Company may elect, from time to time, to make
certain pricing, service or marketing decisions or acquisitions that could have
a material adverse effect on the Company's business, results of operations and
cash flow from quarter to quarter. See "Business" and "Financial Statements."
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Competition. The market for Internet services is new, intensely
competitive, rapidly evolving and subject to rapid technological change. The
Company expects competition to persist and intensify in the future. Almost all
of the Company's current and potential competitors have longer operating
histories, greater name recognition, larger customer bases and significantly
greater financial, technical and marketing resources than the Company. Such
competition could materially adversely affect the Company's business, operating
results or financial condition. Moreover, because many of the Company's
competitors possess financial resources significantly greater than those of the
Company, such competitors could initiate and support prolonged price competition
to gain market share. If significant price competition were to develop, the
Company likely would 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 is likely to encounter consolidation in the near future, which could
result in increased price and other competition in the industry and consequently
have an adverse impact on the Company's business, financial condition and
results of operations. See "Business - Competition."
New and Uncertain Market; New Entrants. The market for local Internet
service providers is in its early stages. Since this market is new, and because
current and future competitors are likely to introduce new products, it is
difficult to predict the forms of competition or the competitors that may
develop. There can be no assurance that the Company's local Internet provider
business can compete against new or developing competitors or that any local
provider can maintain its customer base against formidable national or other new
local competitors, or that Internet access will remain attractive to
subscribers. See "Business - Marketing."
Few Barriers to Entry. There are few significant barriers to entry in the
Internet access business. Accordingly, the Company expects ongoing substantial
competition in its markets from new local Internet service providers, as well as
existing local and national Internet providers. The Company's success will
depend on its ability to compete against these new and existing providers. See
"Busines - Competition."
Importance of Entering New Markets and Identifying Acquisitions. The
Company's business plan calls for it to continue to enter new local markets in
order to grow. Entry into new local markets depends in part on acquiring small
access providers in secondary markets at favorable prices. Because there are a
limited number of small access providers in the Company's target markets, there
can be no assurance that the Company can acquire such companies on favorable
terms, or at all, or that it can obtain financing for such acquisitions. Should
the Company be unable to locate companies in suitable local markets for
acquisitions its growth would be adversely affected. See "Business - Strategy."
Technological Changes. The Internet is characterized by rapidly changing
technology, evolving industry standards, changes in customer needs and frequent
new service and product introductions. The Company's future success will depend,
in part, on its ability to effectively use new technologies, to continue to
enhance its current Internet access and other services, to develop new services
that meet changing customer needs, to advertise and market its services and to
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influence and respond to emerging industry standards and other technological
changes on a timely and cost effective basis. See "Business - The Internet and
the World Wide Web."
Government Regulation and Legal Uncertainties. The Company is not currently
subject to direct regulation by any government agency, other than regulations
applicable to businesses generally, and there are currently few laws or
regulations directly applicable to providing Internet access or other services
on the Internet. However, due to the increasing popularity and use of the
Internet, it is possible that laws and regulations may be adopted with respect
to the Internet which may decrease the demand for Internet access, increase the
Company's cost of doing business or otherwise have an adverse effect on the
Company's operating results or financial condition. See "Business - The Internet
and the World Wide Web."
Dependence on the Internet. The Company's business will depend in large
part upon a robust industry and infrastructure for providing Internet access and
carrying Internet traffic. Notwithstanding current interest and worldwide
subscriber growth, the Internet may not prove to be a viable marketplace because
of inadequate development of the necessary infrastructure or timely development
of complementary products, such as high speed modems. Because global commerce
and on-line exchange of information on the Internet, Web and other open area
networks are new and evolving, it is difficult to predict with any assurance
whether the Internet will prove to be economically viable in the long term. If
the necessary infrastructure or complementary products are not developed, or if
the Internet does not become an economically viable marketplace, the Company's
business, operating results and financial condition will be materially adversely
affected. See "Business - The Internet and the World Wide Web."
Potential Liability for Information Disseminated On-Line. Civil actions
have been brought for libel and negligence in connection with electronic
messages posted through on-line access systems. Such actions seek to impose
liability upon Internet access and service providers for information
disseminated through their systems. Any actions against the Company could
significantly and adversely effect its operations. The Company does not carry
insurance against such actions or liabilities arising thereunder. See "Business
- - The Internet and the World Wide Web."
Risk of System Failure; Limited Insurance. The success of the Company is
dependent upon its ability to offer high quality, uninterrupted access to the
Internet. Any system failure that causes interruptions in the Company's Internet
operations could have a material adverse effect on the Company. If the Company's
subscriber base expands, there will be increased stress placed upon the
Company's server hardware and traffic management systems. The Company's server
hardware is also vulnerable to damage from fire, earthquakes, power loss,
telecommunications failures and similar events. The Company carries property
damage insurance with a basic policy limitation of $250,000, subject to
deductibles and exclusions. Such coverage, however, may not be adequate to
compensate the Company for all losses that may occur. Moreover, significant or
prolonged system failure could damage the reputation of the Company and result
in the loss of subscribers. See "Business."
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Need for Additional Financing. The Company may be required to seek debt or
equity financing in the future to fund expansion activities and acquisitions of
small access providers. There can be no assurance that additional financing will
be available to the Company on acceptable terms, or at all. Any future equity
financing may involve substantial dilution to the interests of the Company's
stockholders. See "Financial Statements."
Dependance Upon Management. The Company's success is dependent in part upon
the continued employment of Raymond J. Meyers, its Chief Executive Officer. The
Company has an employment agreement with Mr. Meyers, and intends to apply for
key man life insurance upon his life in the face amount of $1,000,000, but has
not as yet obtained such insurance. The loss of the services of Mr. Meyers for
whatever reason would have a material adverse effect upon the Company's
operations. See "Management."
No Dividends. The Company does not intend to pay any cash dividends on its
Common Stock in the foreseeable future. Earnings, if any, will be used to
finance growth. See "Description of Securities - Dividends."
Possible Volatility of Securities Prices. The future market price of the
Company's securities may be highly volatile, as has been the case with the
securities of other small capitalization companies. Factors such as the
Company's operating results and public announcements by the Company or its
competitors may have a significant effect on the market price of the Company's
securities. In addition, market prices for securities of many small
capitalization companies have experienced wide fluctuations in response to
variations in quarterly operating results, general economic indicators and other
factors beyond the control of the Company. The registration of the securities
offered hereby coupled with the exercise of the Warrants could further increase
the volatility of the Common Stock by increasing the number of shares of the
Company's publicly traded Common Stock outstanding. See "Description of
Securities."
Shares Eligible for Future Sale. Sales of substantial amounts of Common
Stock in the open market or the availability of such shares for sale could
adversely affect the market price for the Common Stock. As of the date hereof,
there are 665,333 shares of the Company's Common Stock outstanding, of which (i)
46,000 shares were registered for sale in the Company's IPO, (ii) 426,667 shares
and 186,666 shares underlying 186,666 Common Stock Purchase Warrants were
registered in May 1997, (iii) 42,666 shares may currently be sold under Rule
144, and (iv) 150,000 shares may be sold under Rule 144 commencing in July 1998.
The holders of 30,300 shares have agreed to refrain from selling such shares
until October 1999 without the prior written consent of the Underwriter and the
holders of the 150,000 shares have agreed not to sell their shares under any
circumstances for a period of one year from the date hereof. The Underwriter's
Warrants (and the component securities) together with 150,000 shares of Common
Stock issued in connection with the Bridge Loan are subject to piggy-back and
demand registration rights. See "Description of Securities - Common Stock
Eligible for Future Sale" and "Underwriting."
Authorization and Issuance of Preferred Stock; Prevention of Changes in
Control. The Company's Articles of Incorporation authorize the issuance of up to
5,000,000 shares of Preferred Stock with such rights and preferences as may be
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determined from time to time by the Board of Directors. Accordingly, under the
Articles of Incorporation, the Board of Directors may, without shareholder
approval, issue Preferred Stock with dividend, liquidation, conversion, voting,
redemption or other rights which could adversely affect the voting power or
other rights of the holders of the Common Stock. The issuance of any shares of
Preferred Stock having rights superior to those of the Common Stock may result
in a decrease in the value or market price of the Common Stock and could be used
by the Board of Directors as a device to prevent a change in control of the
Company. The Company has no other anti-takeover provisions in its Articles of
Incorporation or Bylaws. Holders of the Preferred Stock, if issued, may be
granted the right to receive dividends, certain preferences in liquidation, and
conversion rights at the discretion of the Board of Directors. See "Description
of Securities - Use of Preferred Stock As Anti-Takeover Device" and "Principal
Stockholders."
Elimination of Director Liability. The Company's Articles of Incorporation
contain a provision eliminating directors' liability to the Company or to its
stockholders for monetary damages for breach of fiduciary duty, except in
circumstances involving a financial benefit to a director, intentional
infliction of harm to the Company or other wrongful acts, such as the breach of
a director's duty of loyalty or acts or omissions which involve intentional
misconduct or a knowing violation of criminal law. The Company's Bylaws contain
provisions obligating the Company to indemnify its directors and officers to the
fullest extent permitted under California law. These provisions could serve to
insulate officers and directors of the Company against liability for actions
which damage the Company or its stockholders. See "Description of Securities -
Limitation on Liability."
Underwriter's Influence on the Market. A significant amount of the Common
Stock and Warrants offered hereby may be sold to customers of the Underwriter.
Subsequently, such customers may engage in transactions for the sale or purchase
of such securities through or with the Underwriter. Although it has no
obligation to do so, the Underwriter intends to make a market in the Company's
Common Stock and Warrants and may otherwise effect transactions in the Common
Stock and Warrants. This market making activity may terminate at any time. If it
participates in the market, the Underwriter may exert a dominating influence on
the market, if one develops, for the Common Stock and Warrants. The price and
liquidity of the Common Stock and Warrants may be significantly affected by the
degree, if any, of the Underwriter's participation in such market. The
Underwriter may also engage in market making activities and soliciting brokerage
activities with respect to the purchase or sale of the Common Stock and Warrants
on the NASDAQ SmallCap Market where such securities are anticipated to trade.
However, no assurance can be given that the Underwriter will continue to
participate as market maker for the Common Stock and Warrants or that other
broker-dealers will make a market in such securities. See "Underwriting."
Representatives' Lack of Underwriting Experience. The Underwriter commenced
business as a broker-dealer in May 1996, and has not acted as an underwriter in
any prior public offerings, although it has participated as a dealer in
offerings underwritten by others and its Chief Executive Officer has more than
ten years experience in public offering financing. The Underwriter's lack of
underwriting experience may (i) adversely affect the development or continuation
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<PAGE>
of a trading market for the Common Stock and Warrants, (ii) have limited the
effectiveness of the Underwriter in negotiating the offering price of the Units
and the exercise price of the Warrants, and (iii) negatively influence the
market price of the Common Stock and Warrants following the Offering. The
Underwriter assisted the Company in a previous private placement of its
securities and with the Bridge Loan, pursuant to which the Underwriter received
cash commissions and common stock purchase warrants. See "Underwriting."
Non-Registration in Certain Jurisdictions of Shares of Common Stock
Underlying the Warrants. The Warrants are not convertible or exercisable unless,
at the time of exercise, the Company has a current prospectus covering the
shares of Common Stock issuable upon exercise of the Warrants and such shares of
Common Stock have been registered, qualified or deemed to be exempt under the
securities laws of the states of residence of the holders of such Warrants.
There can be no assurance that the Company will have or maintain a current
prospectus or that the securities will be qualified or registered under any
state law. Although the Company has undertaken and intends to use its best
efforts to maintain a current prospectus covering the Common Stock issuable upon
exercise of the Warrants following completion of the Offering to the extent
required by federal securities laws, there can be no assurance that the Company
will be able to do so. The value of the Warrants may be greatly reduced if a
prospectus covering the Common Stock issuable upon exercise of the Warrants is
not kept current or if the Common Stock issuable upon exercise of the Warrants
is not qualified, or exempt from qualification, in the states in which the
holders of the Warrants reside. Persons holding Warrants who reside in
jurisdictions in which such securities are not qualified and in jurisdictions
where there is no exemption will be unable to exercise their Warrants and would
either have to sell their Warrants in the open market or allow them to expire
unexercised. If, and when, the Warrants become redeemable by the terms thereof,
the Company may exercise its redemption right even if it is unable to qualify
the Common Stock issuable upon exercise of the Warrants for sale under
applicable state securities laws. See "Description of Securities Warrants."
Redemption of the Warrants. The Warrants may be redeemed by the Company
under certain circumstances (if there is a current prospectus covering exercise
of the Warrants) upon 30 days' written notice to the Warrantholders at $.10 per
Warrant. In such event, the Warrants will be exercisable until the close of
business on the date fixed for redemption in such notice. Any Warrants not
exercised by such time will cease to be exercisable, and the holders will be
entitled only to the redemption price, which is likely to be substantially less
than the market value of the Warrants. Accordingly, such redemption could force
the Warrantholders to exercise the Warrants and pay the exercise price at a time
when it might be disadvantageous for them to do so or to sell the Warrants at
the then market price when they might otherwise prefer to hold the Warrants. See
"Description of Securities - Warrants."
The Common Stock and the Warrants, which comprise the Units offered hereby,
are detachable and separately transferable immediately upon issuance. Purchasers
may buy Warrants in the aftermarket or may move to jurisdictions in which the
shares of the Common Stock underlying the Warrants are not registered or
15
<PAGE>
qualified during the period that the Warrants are exercisable. In this event,
the Company would be unable to issue Common Stock to those persons desiring to
exercise their Warrants unless and until such shares could be qualified for sale
in jurisdictions in which the purchasers reside, or an exemption from
qualification exists in such jurisdiction. In this event, Warrantholders would
have no choice but to attempt to sell the Warrants in a jurisdiction where such
sale is permissible or allow them to expire unexercised. See "Description of
Securities - Warrants."
Risks Associated With Penny Stocks Such as the Company's; Lack of
Liquidity. The Commission has adopted rules that define "penny stock" and such
definition could in the future include the securities of the Company if its
securities are not listed on the NASDAQ SmallCap Market, if the Offering is not
completed or if its Common Stock trades at less than $5.00 per share. In such
event, broker-dealers dealing in the Company's securities will be subject to
specific disclosure rules for transactions involving penny stocks such as the
Company's which require the broker-dealer among other things to (i) determine
the suitability of purchasers of the securities and obtain the written consent
of purchasers to purchase such securities and (ii) disclose the best (inside)
bid and offer prices for such securities and the price at which the
broker-dealer last purchased or sold the securities. The additional burdens
imposed upon broker-dealers might discourage them from affecting transactions in
the Company's securities, which would reduce the liquidity of the Company's
securities making it more difficult for stockholders to sell the securities
should they desire to do so. See "Price Range of Common Stock."
Maintenance Criteria for the NASDAQ SmallCap Market Securities. The Company
has applied to have the Common Stock and Warrants listed on the NASDAQ SmallCap
Market. The NASD, which administers the NASDAQ SmallCap Market, sets the
criteria for continued eligibility on the NASDAQ SmallCap Market. In order to
continue to be included on the NASDAQ SmallCap Market, a company must maintain
$2 million in net tangible assets, a $1 million market value of its public
float, at least 300 holders of its Common Stock and a minimum bid price of $1
per share. The Company's failure to meet maintenance criteria imposed by the
NASDAQ SmallCap Market resulted in the discontinuance of the inclusion of the
Company's securities in the NASDAQ SmallCap Market in the past. Any future
failure to meet maintenance criteria may result in such a discontinuance in the
future. In such event, trading, if any, in the securities may then continue to
be conducted in the over-the-counter market on the Bulletin Board.
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CAPITALIZATION
The following table sets forth the capitalization of the Company as of
December 31, 1997, and as adjusted to give effect to the sale of the 1,050,000
Units offered hereby and application of the estimated net proceeds without
giving effect to the exercise of the Warrants, the Overallotment Option, the
Underwriter's Warrants, or other outstanding warrants or options. See "Use of
Proceeds" and "Description of Securities."
December 31,
1997 As Adjusted
----------- -----------
Short term debt $ 811,926 $ 61,926
----------- -----------
Long term debt 1,788,889 1,788,889
----------- -----------
Stockholders' equity:
Preferred Stock, 5,000,000 no par value
shares authorized, none
issued and outstanding -- --
Common Stock, 10,000,000 no par value
shares authorized, 665,333 shares
issued and outstanding, 1,715,333 as
adjusted 5,590,455 10,643,080
Accumulated deficit (5,066,905) (5,066,905)
----------- -----------
Total stockholders' equity 523,550 5,576,175
----------- -----------
Total capitalization $ 3,124,365 $ 7,426,990
=========== ===========
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PRICE RANGE OF COMMON STOCK
The Company's Common Stock traded on the NASDAQ SmallCap Market under the
symbol "PSCO" from February 9, 1995, until July 10, 1996, when it was delisted
from the NASDAQ SmallCap Market and commenced trading on the Bulletin Board. The
Company currently trades on the 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 Bulletin Board but does not include retail markup, markdown or
commissions.
Price
----------------
By Quarter Ended: High Low
- ----------------- ----- -----
June 30, 1998 (through May 4, 1998) ......................... $5.75 $5.50
March 31, 1998 .............................................. 5.75 5.25
December 31, 1997 ........................................... 6.50 5.00
September 30, 1997........................................... 6.30 5.25
June 30, 1997................................................ 5.50 3.15
March 31, 1997 .............................................. 4.65 3.15
December 31, 1996............................................ 11.25 3.15
September 30, 1996........................................... 15.00 8.40
June 30, 1996................................................ 26.25 8.40
March 31, 1996............................................... 31.95 14.10
December 31, 1995............................................ 37.50 26.25
September 30, 1995........................................... 60.00 15.00
June 30, 1995................................................ 73.20 50.10
March 31, 1995............................................... 75.00 63.75
As of May 4, 1998, the Company had approximately 365 record and beneficial
stockholders.
USE OF PROCEEDS
The net proceeds of the Offering, estimated to be $5,052,625, will be
applied as follows over the next 12 months:
Percent of
Purpose Amount Net Proceeds
- ------- ------ ------------
Repayment of Bridge Loan (1) ..................... $ 825,000 16.3
Acquisition of Internet Access Providers (2) ..... 2,000,000 39.6
Marketing Expenses ............................... 600,000 11.9
Working Capital (3) .............................. 1,627,625 32.2
---------- ----
Totals ........................................... $5,052,625 100.0%
(1) Includes principal and interest on the Bridge Loan debt which was incurred
by the Company for working capital, bears interest at 12% per annum and is
due the earlier of the closing of the Offering or September 15, 1998.
(2) See "Business - Acquisiton Strategy."
(3) Any funds received by the Company upon exercise of the Overallotment Option
or the Warrants will be added to working capital.
The Company believes that the net proceeds of the Offering together with
its projected cash flow from operations, will be sufficient to finance its
working capital and other requirements for a period of approximately 12 months
from the date of this Prospectus. Pending application, the net proceeds from the
Offering will be invested in interest-bearing government securities. The
management of the Company will have broad discretion as to the application of
the proceeds of the Offering, including using a portion of the proceeds to make
acquisitions as described herein.
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SELECTED FINANCIAL DATA
The selected financial data set forth below for the years ended December
31, 1997 and 1996 is derived from the Company's financial statements which have
been audited by Angell & Deering. The selected financial data is qualified in
its entirety by, and should be read in conjunction with, the financial
statements and the notes thereto included elsewhere herein. See "Financial
Statements."
Year Ended December 31,
--------------------------------
1997 1996
----------- -----------
Income Statement Data:
Revenues $ 749,796 $ 697,581
(Loss) from continuing
operations (1,470,550) (672,791)
Net (loss) (1,470,550) (1,409,800)
Net (loss) per share (2.49) (7.74)
Weighted average number
of shares outstanding 589,702 182,037
December 31,
1997 As Adjusted (1)
----------- ---------------
Balance Sheet Data: (Unaudited)
Working capital (deficit) $ (795,657) 4,355,491
Total assets 3,295,734 7,598,359
Long-term debt 1,788,889 1,788,889
Total liabilities 2,772,184 2,022,184
Stockholders' equity 523,550 5,576,175
- ---------
(1) As adjusted to give effect to the receipt and application of the estimated
net proceeds of the Offering without giving effect to exercise of the
Warrants, the Underwriter's Warrants or other outstanding warrants or stock
options. See "Use of Proceeds" and "Description of Securities."
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<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Background
The Company provides Internet access and related services to individuals,
public agencies and businesses in six small Central California Cities. As of
December 31, 1997, the Company had 2800 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 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 are unable 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 has addressed
these kinds of financial and administrative burdens by (i) expanding its
operations throughout Central California, (ii) developing diversified services
similar to its larger competitors, such as hourly-based access services, special
access packages for business and high speed access, and (iii) investing in
automated billing and administrative systems. The Company believes these
resources will not only allow it to compete effectively with larger access firms
entering the Company's markets, but will also facilitate the Company's efforts
to attract small Internet providers. The Company's long-term plan is to increase
revenues through acquisitions in such markets together with the acquisition of
small companies which provide related Internet products and services. The
Company is not currently negotiating to acquire, nor has it entered into any
agreement to acquire, any other companies.
Results of Operations
Year Ended December 31, 1997 vs. Year Ended December 31, 1996
Net Sales. For calendar 1997, Internet services revenues were $749,796
versus $697,581 in calendar 1996, an increase of 7.5%. The increase in revenue
is primarily due to an increase in the subscriber base. Management believes
revenues will continue to increase as the Company implements marketing programs
focusing on increasing name brand recognition and differentiation of service
offerings (i.e., Internet access, web site development and electronic commerce).
Operating Expenses. 1997 operating expenses totaled $1,818,698 versus
$1,121,773 in 1996. This increase of $696,925 was primarily attributed to costs
associated with the Company's May 1997 Registration Statement covering the May
1997 Securities including $102,971 of legal and accounting fees, increased rent
expense, higher salary expense, and increased bad debt expense. Bad debt expense
was approximately $132,000 and is comprised of write-offs of accounts receivable
of approximately $25,000, establishment of a reserve for uncollectible accounts
receivable of $7,500 and for the uncollectability of a note receivable of
$100,000. Management has implemented several cost reduction or containment steps
but believes that operating expenses will increase as revenues increase. The
Company will also seek to reduce operating expenses by renegotiating or
canceling its Shaw Avenue Capital lease and its Visalia, California lease.
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Operating Loss. The Company's 1997 operating loss totaled $1,068,902 versus
$424,192 in 1996. This increase in operating loss of $644,710 is attributed to a
significant rise in 1997 operating expenses coupled with less than anticipated
Internet service revenue growth. Management believes that operating results will
improve as revenues increase.
Interest Expense (Net). Net interest expense for 1997 totaled $546,607
versus $268,721 in 1996. The increase of $277,886 is attributable to obtaining
bridge loan financing in the amount of $750,000. This net interest expense
includes the amortization of debt issuance costs of $320,167 in connection with
the issuance of 150,000 shares of Common Stock in the Bridge Loan and
commissions of $97,500 and Bridge Loan interest expense of $45,049. The interest
expense was somewhat offset by the interest earned on cash and short term
investments of $77,399.
Other Income. 1997 net other income increased to $218,959 from $146,122 in
1996. This increase of $72,837 is a result of the rental income generated by the
Company's Shaw Avenue office building and miscellaneous sales. Net other income
for 1997 is comprised entirely of rental income on the sublease of the Company's
office building. Rental income recognized from SSC totals $144,000, all of which
was collected in 1997.
Year Ended December 31, 1996 Compared to 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 the Company's increased market penetration in the Central California area.
Management believes that the Company's revenues will continue to increase as it
increases the number of points of presence ("POPS") through which it markets its
Internet services. The number of POPS to be developed in any given geographic
area depends upon the Company's estimate of "demand" in such geographic area. In
turn, demand is based upon the population and rate of population growth, the
number of existing access providers, the number of access subscribers and the
growth rate of such access subscribers in the particular area.
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 expense, 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 due to reduced personnel and facilities expenses as a
result of the Classic Line sale. The decreases may be somewhat offset by the
increases in operating expenses as the Company's Internet business grows.
21
<PAGE>
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.
Interest Expenses. 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 the building which the Company acquired
under a 20-year capital lease. The net interest expense increased as a result of
a decrease in interest income in 1996.
Financing Costs. Financing costs were $126,000 in 1996, which represented
commissions and expenses related to the issuance of 26,667 shares of the
Company's Common Stock to investors. The Common Stock issued was valued at $3.75
per share and resulted in a financing expense of $100,000 to the Company.
Liquidity and Capital Resources
As shown in the Financial Statements, the Company incurred a net loss of
$1,470,550 during the year ended December 31, 1997, and, as of that date had a
working capital deficiency of $795,657. As discussed in Note 1 to the Financial
Statements, the Company's significant operating losses and working capital
deficiency raise substantial doubt about its ability to continue as a going
concern. Management's plans to overcome these difficulties involve consolidating
its operations to reduce general and administrative expenses, reducing operating
expenses and using proceeds of the Offering to acquire other Internet access
providers and small computer oriented companies. These acquisitions are expected
(although there can be no such assurance) to increase revenues without
significantly increasing general and administrative expenses, thereby generating
positive cash flows and earnings. The Financial Statements do not include any
adjustments that might result from the outcome of the uncertainty described
herein.
For the year ended December 31, 1997, the Company used cash of $995,736 for
operating activities. The Company had a working capital deficiency of $795,657
at December 31, 1997 which is primarily attributed to the short term liability
treatment of the Bridge Loan. The Company intends to reduce the working capital
deficit by (i) increasing sales, (ii) reducing certain low margin operations and
(iii) obtaining long-term financing. There can be no assurance that the Company
will be successful in these actions and if unsuccessful, the Company may be
required to substantially reduce its operations.
Capital expenditures relating primarily to the purchase of computer
equipment, furniture and fixtures, and other assets amounted to $77,552 and
$38,421 for the years ended December 31, 1997 and 1996, respectively. In
addition, the Company acquired through lease $69,959 of computer equipment for
its Internet operations during the year ended December 31, 1997.
Between June and September 1997, the Company received $750,000 from
proceeds of the Bridge Loan, which was used for working capital, marketing
expenses and the purchase of capital equipment. In connection with the Bridge
Loan, the Company agreed to issue 150,000 restricted shares of its Common Stock,
subject to certain piggy-back and demand registration rights at the Company's
expense. The fair market value of the Common Stock ($750,000) issued and
commission paid on the Bridge Loan ($97,500) were capitalized as debt issuance
costs and are being amortized over the 15 month loan as interest expense.
In June 1996 the Company's Common Stock was delisted from the NASDAQ
SmallCap Market as a result of the Company's shareholders' equity falling below
the NASDAQ SmallCap Market maintenance requirements.
22
<PAGE>
BUSINESS
Introduction
The Company provides Internet access and related services to individuals,
public agencies and businesses in six small Central California cities. As of
December 31, 1997, the Company had 2,700 subscribers for whom it provided
Internet access up from 250 subscribers in July 1995. The Company intends to
acquire other small Internet providers in markets with populations of less than
500,000 that are located 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 are unable 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 has addressed these kinds of financial and administrative
burdens by (i) expanding its operations throughout Central California, (ii)
developing diversified services similar to its larger competitors, such as
hourly-based access services, special access to packages for business and high
speed access, and (iii) investing in automated billing and administrative
systems. The Company believes these resources will not only allow it to compete
effectively with larger access firms entering the Company's markets, but also
will facilitate the Company's efforts to attract small Internet providers. The
Company's long-term plan is to target a select number of such markets and
increase revenues through acquisition in these markets. The Company is not
currently negotiating to acquire, nor has it entered into any agreement to
acquire, any other companies. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
The Company's strategy is to provide low cost direct Internet access and
other Internet related products and services to subscribers or customers in
target markets. The Company will seek to effectuate this strategy by acquiring
small Internet providers, by expanding marketing operations in its existing
markets, by offering Internet related products and services and by acquiring
other computer oriented companies. The Company will also seek to generate
additional revenues by (i) increasing monthly Internet access fees while
offering additional Internet products and services, (ii) offering monthly
community access services, (iii) providing Internet consulting services, and
(iv) generating marketing service fees from businesses seeking a Web site on the
Internet.
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.
23
<PAGE>
Initially, use of the Internet was limited to governmental, educational and
commercial organizations with a working knowledge of certain computer operating
systems 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 to access information (to "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. However, 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 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
24
<PAGE>
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.
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.
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.
Strategy
The Company's strategy is to provide low cost direct Internet access and
other Internet related products and services to subscribers or customers in
target markets. The Company will seek to effectuate this strategy by acquiring
small Internet providers, by expanding marketing operations in its existing
markets, by offering Internet related products and services and by acquiring
other computer oriented companies. The Company will also seek to generate
additional revenues by (i) increasing monthly Internet access fees while
offering additional Internet products and services, (ii) offering monthly
community access services, (iii) providing Internet consulting services, and
(iv) generating marketing service fees from businesses seeking a Web site on the
Internet. The Company believes that it can increase the profitability of its
monthly access fees by developing economies of scale as a result of increasing
total access subscribers and earning additional revenues from such subscribers
by providing additional access services.
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 to engage in 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
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<PAGE>
Company plans to add additional high-speed dedicated data lines, enhance
system-wide access software in order to offer additional Internet products and
services, and expand the number of POPs in local markets in order to attract and
support additional subscribers. By increasing the number of POPs, the Company
will offer more users access to the Internet through local phone calls 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 its customers
with a number of Internet services such as consulting services for network
setup, Internet application implementation, Intranet design, and Web site
implementation.
Generating Marketing Service Fees. The Company designs and develops 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 to assure subscriber access.
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 with a population
under 500,000; (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 computer oriented companies. The Company is not negotiating to
acquire, nor has it entered into any agreement to acquire, any such companies.
Marketing
The Company primarily markets its products and services 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 through advertisements in
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<PAGE>
computer, professional and business publications. The Company also attracts
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, MCI, Sprint and some of 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 Internet access
consolidators such as Verio, Inc. and from on-line service firms such as America
Online (AOL), CompuServe, 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 service businesses will further consolidate in the future, which
could result in increased price and other competition in the industry and
consequently adversely impact the Company. In the last year, a number of on-line
services have 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
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<PAGE>
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 December 31, 1997, the Company employed 12 full-time and two
part-time individuals of which three employees are engaged in managerial,
accounting and administrative positions, two are engaged in sales and nine are
engaged in operations and customer support. 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.
Properties
In September 1994, the Company acquired, under a 20-year non-cancelable
capital lease, an office building, including land and improvements located at
2580 West Shaw, Fresno, California 93711. The lease requires initial annual
minimum 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
to purchase the building and land for $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 accruing at 9% per annum. The
Company does not occupy any space in the building, although it leased a portion
of it to SSC and the SSC Principals based upon monthly payments to the Company
of $12,000 through February 1998. See "Certain Transactions". In May 1997, as a
result of the Company's default on the lease, the Company agreed to return
possession of the office building to the landlord. Accordingly, the landlord
collects rents directly from the tenants of the office building and the Company
is responsible for the difference between such aggregate rents and the Company's
lease payment to the landlord. As of the date hereof, the landlord is collecting
monthly rents aggregating approximately $9,200 and the Company's monthly
leasehold obligation is approximately $15,600 leaving a monthly balance due from
the Company to the landlord of approximately $6,400.
The Company leases 4,000 square feet of space for its offices and operating
facilities at 2300 Tulare Street, Suite 210, Fresno, California 93721. The lease
term is five years, ending May 2002 and requires minimum annual payments of
$40,250 increasing every year to a maximum of $55,375 in 2002. The Company also
leases approximately 250 square feet for its corporate office space in Santa
Monica, California on a month-to-month lease for $600 per month.
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Litigation
As a result of the failure of SSC and the SSC Principals to pay certain
trade account payables and certain office rent under a sublease from the
Company, the Company has been threatened with litigation from such trade
creditors (currently aggregating approximately $25,000) and has been required to
return possession of the SSC subleased office space to the Company's landlord.
The Company believes that the total contingent liability to trade account
creditors arising from defaults by SSC and the SSC Principals does not exceed
$100,000. Additionally, the total amount due from SSC and the SSC Principals
under the Company's office sublease aggregates approximately $100,000.
On May 14, 1997, the SSC Principals brought an administrative labor claim
against the Company before the California office of the State Labor Commission
seeking unpaid wages in the amount of approximately $160,000. The case was
dismissed by the Labor Commission in December 1997 but may be refiled as a civil
action if the claimants elect to do so. As of this date the case has not been
refiled. This Company believes the claim to be without merit.
The Company is a defendant in a civil action entitled "P/K Associates, Inc.
et al. v. Fresno Business Journal, Inc., et al" civil action number 97-5546
filed in the United State District Court for the Eastern District of California
on May 5, 1997. The suit alleges certain copyright violations against the Fresno
Business Journal and the Company. The Company settled the case in December 1997
for a payment of $5,000 to the plaintiffs.
On February 21, 1997, three of the Company's former employees brought a
civil action against the Company in the California Municipal Court entitled
"David J. Dague, et al. v. ProtoSource Corporation" for back wages aggregating
approximately $45,000. In March 1998 the Company paid $23,000 to settle the
matter.
Payment of any judgments or settlements in connection with these litigation
matters, together with the costs of defending such matters, could adversely
affect the Company's results of operations and financial condition.
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MANAGEMENT
Officers and Directors
The name, age and position of each of the Company's executive officers and
directors are set forth below:
Officer/Director
Name Age Position Since
---- --- -------- -----
Raymond J. Meyers (1) 41 Chief Executive Officer 1996
Chief Financial Officer
and Director
David A. Appell (1) 35 Director 1997
Dickon Pownall-Gray (2) 43 Director 1998
Andrew N. Stathopoulos (1) 48 Director 1998
- ----------
(1) Member of the Audit Committee.
(2) Mr. Pownall-Gray will become a director of the Company at the closing of
the Offering.
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 Raymond J. Meyers, Andrew Chu, Steven A. Kriegsman and Howard P. Silverman
were elected as officers and directors. In May 1997 Mr. Kriegsman resigned and
in August 1997 Messrs. Chu and Silverman resigned. The Company established an
audit committee in January 1998 composed of all three members of its Board of
Directors.
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.
David A. Appell became a Director of the Company in September 1997. Since
January 1997, he has served as an investment banker for the Underwriter, and
since February 1992, he has been engaged in the private practice of law. Mr.
Appell also serves as a director of Allied Capital Services, LLC, a consulting
firm which provides financing and real estate development services. From April
1996 to January 1997 he served as Managing Director of Investment Banking for
R.D. White & Co., Inc. Mr. Appell is the General Partner of HPH Capital Growth
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<PAGE>
L.P., a New York Limited Partnership created to raise and manage funds for
equity investments. From December 1993 through April 1996 he served as house
counsel for Comart, Inc., an introducing broker registered with the commodities
futures trading commission. Mr. Appell received a Judicial Doctorate degree from
Cardozo Law School and holds a BBA in Accounting from Pace University. He is a
Member of the New York State Bar and New Jersey State Bar. He is a registered
options principal, general securities representative, uniform securities agent
and general securities principal. He is also registered as a commodity trading
advisor and commodity pool operator.
Dickon Pownall-Gray will become a director of the Company at the closing of
the Offering. Since 1994 he has acted as an independent consultant and an
investment manager for his own account. Since 1995 he has also been a
stockholder and a director of Infosis, Inc. From 1992 to 1993 he served as
Senior Vice President in charge of acquisitions for Preferred Health Care, Inc.
From 1988 to 1991 he was Chief Executive Officer and a founder of CareSys, Inc.,
a medical monitoring and database cost containment company. In 1991 he sold
CareSys, Inc. to Preferred Health Care, Inc. From 1985 to 1987 he served as
Chief Executive Officer of Health Care Systems. From 1982 to 1984 he was a
senior consultant for Bain & Co. in its London office. Mr. Pownall-Gray holds an
MBA from the London Business School, an MA in Sports Science from the University
of California Berkeley, a BA (Honors History and Sports Science) degree from the
University of Birmingham.
Andrew N. Stathopoulos has over 25 years experience in finance, operations,
marketing, mergers and acquisitions, engineering, manufacturing, and consulting.
In March 1998 he joined the Bank of New York as a Vice President to launch a
software and hardware vendor management program. He is also currently involved
in the Bank's efforts to meet Year 2000 compliance. From 1996 to 1997, he was
Vice President of Finance for New Alliance Corp., an emerging markets investment
bank specializing in Eastern Europe. He was responsible for financial reporting;
internal audit and controls; mid-office and back-office operations; information
systems; and management reporting. From 1994 to 1996, he was Vice President of
Business Development for Nautical Technology Corp., an independent software
developer for the maritime industry. He was responsible for developing and
implementing a new marketing and sales program, seeking strategic partners and
providing general business advice. Also, from 1994 to 1996, he was Vice
President of Business Development for Interbank of New York, a Greek commercial
bank where he was responsible for identifying and marketing new products and
pursuing new business opportunities. From 1992 to 1994, he was the Vice
President of Finance and Administration for Societe Generale Energie, an oil
trading products firm. He was responsible for establishing financial controls,
accounting and reporting procedures; monitoring cash flow and working capital
requirements; managing human resources administration; and dealing with
auditors, insurers and vendors. From 1989 to 1991, he was a principal of Forest
Development, a privately held investment and consulting group. From 1985 to
1989, he was the Director of Business Development and Planning for Empire Blue
Cross and Blue Shield, a leading health insurer. From 1977 to 1985, he was
Director of Assets Management for Ogden Corporation, a diversified conglomerate.
From 1973 to 1977, he held positions in finance, planning and engineering for
International Paper, a leading manufacturer of paper and wood products. Mr.
Stathopoulos holds a BS degree in Industrial Engineering and an MBA degree in
Finance and International Business, both from Columbia University.
Executive Compensation
None of the Company's executive officers or directors currently receive
compensation in excess of $100,000 per year except Mr. Meyers, the Company's
Chief Executive Officer, who receives a salary of $130,000 per year pursuant to
an Employment Agreement which expires in January 1999. The Employment Agreement
also provides for cash bonuses ranging from $25,000 (if the Company earns at
least $500,000 before taxes in any year) to $75,000 (if the Company earns at
least $1,250,000 before taxes in any year). In connection with his employment,
Mr. Meyers was also granted options to purchase 36,667 shares of Common Stock
vesting over a three year period at $3.75 per share exercisable at any time
until October 2001. Compensation for all officers and directors as a group for
the calendar year ended December 31, 1997, aggregated $130,000.
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<TABLE>
<CAPTION>
The following table discloses certain compensation paid to the Company's
executive officers for the calendar years ended December 31, 1997, 1996, and
1995.
Summary Compensation Table
Long Term Compensation
Annual Compensation Awards Payouts
------------------- -----------------------
(a) (b) (c) (d) (e) (f) (g) (h) (i)
Name
and
Prin- Other All
cipal Annual Restricted Other
Posi- Compen- Stock Options/ LTIP Compen-
tion Year Salary($) Bonus($) sation($) Award(s)($) SARS(#) Payouts ($) sation($)
- ------------ ---- --------- -------- --------- ----------- ------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Raymond J.
Meyers,
Chief Execu-
tive Officer 1997 $130,008 $ 0 0 0 36,667 0 0
James C.
Robinson
Chief Execu- 1996 61,925 0 0 0 0 0 0
tive Officer 1995 61,425 5,941 0 0 0 0 0
Option Grants in Last Year and Stock Option Grant
The following table provides information on option grants during the year
ended December 31, 1997 to the named executive officer:
Individual Grants
%of Total Options
Granted to
Options Employees
Name Granted In Year Exercise Price Expiration Date
- ---- ------- ------- -------------- ---------------
Raymond J. Meyers 36,667 100.0% $3.75 October 2001
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
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 and terminates in
November 2004. As of December 31, 1997, 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
32
</TABLE>
<PAGE>
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 for reissuance. Shares issued upon exercise of
an option will rank equally with other shares then outstanding.
As of the date of this Prospectus, no options have been granted under the
Plan.
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<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth information concerning the holdings of
Common Stock (without giving effect to any shares issuable upon exercise of the
Warrants, the Overallotment Option, or the Underwriter's Warrants) by each
person who, as of the date of this Prospectus, 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 warrants and options exercisable within 60 days from the date hereof.
The address of all persons listed below is in care of the Company at 2300 Tulare
Street, Suite 210, Fresno, California 93721.
Percent of Percent of
Amount of Class Prior to Class After
Name Ownership Offering Offering
- --------------- --------- ------------- -----------
Raymond J. Meyers (1) 26,667 3.9% 1.5%
Andrew Chu(2) 38,999 5.5% 2.2%
David A. Appell 0 0% 0%
Dickon Pownall-Gray 0 0% 0%
Andrew N. Stathopoulos 0 0% 0%
Steven A. Kriegsman(3) 117,667 15.0% 6.4%
World Spirit, Inc. 50,000 7.5% 2.9%
All officers and directors as
a group (4 persons)(1) 26,667 3.9% 1.5%
- ----------
(1) Represents stock options to purchase 26,667 shares at $3.75 per share at
any time until October 2001. Mr. Meyers holds an additional 10,000 stock
options which vest in 1999.
(2) Represents common stock purchase warrants to purchase 38,999 shares at
$3.75 per share at any time until October 2001.
(3) Represents common stock purchase warrants to purchase 117,667 shares at
$3.75 per share at any time until October 2001. All common stock purchase
warrants are held by the Kriegsman Group ("KG") of which Mr. Kriegsman is
the President and a principal stockholder. KG originally received 146,666
Warrants, but assigned 38,999 of such Warrants to Mr. Chu. See "Certain
Transactions."
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<PAGE>
CERTAIN 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. All 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 November 1994, the Company issued 857,140 shares of its Convertible
Preferred Stock to five of the Company's then officers and directors, (and
42,860 to another individual not otherwise affiliated with the Company) each
share of which was convertible for no additional consideration into one share of
Common Stock for each fifteen shares of Preferred Stock. All 900,000 shares of
Convertible Preferred Stock were canceled and returned to the Company by the
five holders in connection with the Divestiture Agreement described below.
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 was due in
April 1997 and remains unpaid. The promissory note is secured by 3,333 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 October 1996, the Company issued 146,666 common stock purchase warrants
to the Kriegsman Group ("KG") for consulting services. The Company also paid KG
an aggregate of $90,000 for consulting services in connection with the Company's
sale of the Classic Line to a non-affiliated Canadian company. See "Prospectus
Summary - The Company". Steven A. Kriegsman who subsequently became a director
of the Company is the President and controlling stockholder of KG. KG
subsequently assigned 35,666 of such warrants to Andy Chu, the Company's
President and a director. KG also assigned 3,333 of the 10,000 stock options it
received from the SSC Principals to Mr. Chu to provide him with an equity stake
in the Company for a total assignment to Mr. Chu of 38,999 warrants and stock
options. KG believed that the Company's success and therefore the economic
success of its investment in the Company depended in part upon the participation
of Mr. Chu as the Company's then President.
In October 1996, the Company issued 146,667 common stock purchase warrants
to the Underwriter as compensation for it assisting the Company in the private
placement of 400,000 shares of the Company's Common Stock to a group of
investors for $3.75 per share. The Underwriter subsequently assigned 56,667 of
such warrants to Howard P. Silverman, a former director of the Company, for his
assistance to the Underwriter in connection with the private placement. At the
time the subject Warrants were assigned, Mr. Silverman was not a director of the
Company. The Company also paid to the Underwriter 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 June 1997, the Underwriter and Mr.
Silverman returned 106,667 warrants to the Company without consideration.
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 the liabilities of the Classic Line and certain other liabilities,
35
<PAGE>
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 (less $200,000 of liabilities which
were paid by the Company and deducted from the $500,000) 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 part
of the Divestiture Agreement, the SSC Principals also (i) canceled 900,000
shares of Convertible Preferred Stock held by them which were previously
exercisable into shares of Common Stock on a fifteen for one basis, (ii) agreed
to refrain from the sale of an aggregate of 30,300 shares of Common Stock owned
by them until October 1999, except with the prior written consent of the
Underwriter, (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, then a director of the Company, an option to purchase up to 10,000
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. The Classic
Line assets were valued as a result of negotiations between the Company and the
SSC Principals.
DESCRIPTION OF SECURITIES
Common Stock
The Company is authorized to issue 10,000,000 shares of common stock, no
par value (the "Common Stock"), of which 665,333 shares are currently
outstanding. Upon issuance, the shares of Common Stock are not subject to
further assessment or call. The holders of Common Stock are entitled to one vote
for each share held of record on each matter submitted to a vote of
stockholders. Cumulative voting for election of directors is permitted. Subject
to the prior rights of any series of Preferred Stock which may be issued by the
Company in the future, holders of Common Stock are entitled to receive ratably
such dividends that may be declared by the Board of Directors out of funds
legally available therefor, and, in the event of the liquidation, dissolution or
winding up of the Company, are entitled to share ratably in all assets remaining
after payment of liabilities. Holders of Common Stock have no preemptive rights
and have no rights to convert their Common Stock into any other securities. The
outstanding Common Stock is, and the Common Stock to be outstanding upon
completion of the Offering will be, validly issued, fully paid and
non-assessable.
Warrants
Each Warrant represents the right to purchase one share of Common stock at
an initial exercise price of $6.325 per share (110% of the closing bid price of
the Common Stock on the Bulletin Board one day prior to the date hereof) for a
period of five years from the date hereof. The exercise price and the number of
shares issuable upon exercise of the Warrants will be adjusted upon the
occurrence of certain events, including the issuance of Common Stock as a
dividend on shares of Common Stock, subdivisions, reclassifications or
combinations of the Common Stock or similar events. The Warrants do not contain
provisions protecting against dilution resulting from the sale of additional
shares of Common Stock for less than the exercise price of the Warrants or the
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<PAGE>
current market price of the Company's securities and do not entitle Warrant
holders to any voting or other rights as a shareholder until such Warrants are
exercised and Common Stock is issued.
Warrants may be redeemed in whole or in part at the option of the Company
after one year from the date hereof, upon 30 days' notice and with the consent
of the Underwriter, at a redemption price equal to $.10 per Warrant if the
closing price of the Company's Common Stock on the NASDAQ SmallCap Market (or
the Bulletin Board) is at least $8.625 per share (150% of the closing price of
the Common Stock on the Bulletin Board one day prior to the date hereof) for 20
consecutive trading days, ending not earlier than 15 days before the Warrants
are called for redemption.
Holders of Warrants may exercise their Warrants for the purchase of shares
of Common Stock only if a current prospectus relating to such shares is then in
effect and only if such shares are qualified for sale, or deemed to be exempt
from qualification under applicable state securities laws. The Company is
required to use its best efforts to maintain a current prospectus relating to
such shares of Common Stock at all times when the market price of the Common
Stock exceeds the exercise price of the Warrants until the expiration date of
the Warrants, although there can be no assurance that the Company will be able
to do so.
The shares of Common Stock issuable on exercise of the Warrants will be,
when issued in accordance with the Warrants, duly and validly issued, fully paid
and non-assessable. At all times that the Warrants are outstanding, the Company
will authorize and reserve at least that number of shares of Common Stock equal
to the number of shares of Common Stock issuable upon exercise of all
outstanding Warrants.
For the term of the Warrants, the holders thereof are given the opportunity
to profit from an increase in the per share market price of the Company's Common
Stock, with a resulting dilution in the interest of all other stockholders. So
long as the Warrants are outstanding, the terms on which the Company could
obtain additional capital may be adversely affected. The holders of the Warrants
might be expected to exercise the Warrants at a time when the Company would, in
all likelihood, be able to obtain additional capital by a new offering of
securities on terms more favorable than those provided by the Warrants.
37
<PAGE>
Other Warrants
In October 1996, the Company issued 146,667 Warrants to the Underwriter,
(of which 56,667 Warrants were assigned to Howard P. Silverman) and 146,667
Warrants to KG. The Underwriter and Howard P. Silverman returned 106,667
Warrants and the remaining 186,667 Warrants, along with the underlying 186,667
shares of Common Stock, were registered for public sale by the Company in May
1997. Each Warrant entitles the holder to purchase one share of Common Stock for
$3.75 per share at any time until October 2001. See "Certain Transactions."
Preferred Stock
The Company is authorized to issue 5,000,000 shares of preferred stock, no
par value (the "Preferred Stock"), none of which is currently outstanding. In
December 1994, the Company issued 900,000 shares of Preferred Stock to five of
the Company's then executive officers. All such shares were subsequently
canceled with the agreement of the holders. The Preferred Stock may, without
action by the stockholders of the Company, be issued by the Board of Directors
from time to time in one or more series for such consideration and with such
relative rights, privileges and preferences as the Board may determine.
Accordingly, the Board has the power to fix the dividend rate and to establish
the provisions, if any, relating to voting rights, redemption rates, sinking
fund provisions, liquidation preferences and conversion rights for any series of
Preferred Stock issued in the future.
Use of Preferred Stock As Anti-Takeover Device
It is not possible to state the actual effect of any authorization of
Preferred Stock upon the rights of holders of Common Stock until the Board
determines the specific rights of the holders of any other series of Preferred
Stock. The Board's authority to issue Preferred Stock also provides a convenient
vehicle in connection with possible acquisitions and other corporate purposes,
but could have the effect of making it more difficult for a third party to
acquire a majority of the outstanding voting stock. Accordingly, the future
issuance of Preferred Stock may have the effect of delaying, deferring or
preventing a change in control of the Company without further action by the
stockholders and therefore, may be used as an "anti-takeover" device adversely
affecting the holders of the Common Stock and depressing the value of the Common
38
<PAGE>
Stock. The Company has no current plans to issue any other Preferred Stock. See
"Risk Factors - Control by Management; Authorization and Issuance of Preferred
Stock; Prevention of Changes in Control."
Common Stock Eligible For Future Sale
Sales of substantial amounts of Common Stock in the open market or the
availability of such shares for sale could adversely affect the market price for
the Common Stock. The Company is registering for public sale 1,050,000 Units,
consisting of 1,050,000 shares of Common Stock, 1,050,000 Warrants and 1,050,000
shares of Common Stock underlying the warrants. As of the date hereof, there are
665,333 shares of the Company's Common Stock outstanding, of which (i) 426,667
shares and 186,666 shares underlying 186,666 Common Stock Purchase Warrants were
registered in May 1997, subject to an agreement with the holders not to sell the
186,666 shares underlying the 186,666 Common Stock Purchase Warrants until
September 1999, (ii) 42,666 shares may currently be sold under Rule 144, and
(iii) 150,000 shares may be sold under Rule 144 commencing in July 1998. The
holders of 30,300 shares (of the 42,666 shares) have agreed to refrain from
selling such shares until October 1999, without the prior written consent of the
Underwriter and the holders of the 150,000 shares have agreed not to sell their
shares under any circumstances for a period of one year from the date hereof.
See "Underwriting."
The Company has granted certain demand and piggy-back registration rights
in connection with (i) the Underwriter's Warrants and the component securities,
and (ii) the issuance of 150,000 shares of Common Stock as a part of the Bridge
Loan. See "Underwriting."
Transfer Agent and Warrant Agent
Corporate Stock Transfer, Inc., 370 Seventeenth Street, Suite 2350, Denver,
Colorado 80202, is the Company's transfer agent and warrant agent.
Dividends
The Company has not paid cash dividends on its Common Stock and does not
intend to pay any cash dividends on its Common Stock in the foreseeable future.
Earnings, if any, will be retained to finance growth. The Company has no
financing or other agreements which prohibit payment of dividends.
Limitation on Liability
The Company's Articles of Incorporation provide that liability of directors
to the Company for monetary damages is eliminated to the full extent provided by
California law. Under California law, a director is not personally liable to the
Company or its stockholders for monetary damages for breach of fiduciary duty as
a director except for liability arising from (i) any breach of the director's
duty of loyalty to the Company or its shareholders; (ii) acts or omissions not
in good faith or that involve intentional misconduct or a knowing violation of
law; (iii) authorizing the unlawful payment of a dividend or other distribution
on the Company's capital stock or the unlawful purchases of its capital stock,
or (iv) any transaction from which the director derived any improper personal
benefit.
39
<PAGE>
The effect of this provision in the Articles of Incorporation is to
eliminate the rights of the Company and its stockholders (through stockholders'
derivative suits on behalf of the Company) to recover monetary damages from a
director for breach of the fiduciary duty of care as a director (including
breaches resulting from negligent or grossly negligent behavior) except in the
situations described above. This provision does not limit or eliminate the
rights of the Company or any stockholder to seek non-monetary relief such as an
injunction or rescission in the event of a breach of a director's duty of care
or any liability for violation of the federal securities laws.
UNDERWRITING
Andrew, Alexander, Wise & Company, Inc. (the "Underwriter") has agreed,
subject to the terms and conditions of the Underwriting Agreement, to purchase
from the Company all of the Units offered hereby. The Underwriter commenced
business in May 1996 and has not acted as an Underwriter in any prior public
offerings. The Underwriter's principal business function is to act as a retail
brokerage firm purchasing and selling the securities of publicly traded
companies on behalf of its clients. There are no material relationships between
the promoters of the Company and the Underwriter. David A. Appell, a director of
the Company, has provided investment banking consulting services to the
Underwriter since January 1997.
The Company has been advised by the Underwriter that it proposes to offer
the Units purchased by it directly to the public at the public offering set
forth on the cover page of this Prospectus and to certain dealers at a price
that represents a concession of $.46 per Unit. The Underwriter is committed to
purchase and pay for all of the Units if any Units are taken. After the initial
public offering of the Units, the offering price and the selling terms may be
changed in the sole discretion of the Underwriter. The Underwriter does not
intend to sell any of the Company's securities to accounts for which it
exercises discretionary authority.
The Company has also granted the Underwriter an Overallotment Option,
exercisable within 30 days from the date of this Prospectus, to purchase from
the Company up to 157,500 Units solely to cover overallotments. The Underwriter
is otherwise under no obligation to exercise its Overallotment Option or
purchase any Units subject to the Overallotment Option, although it has agreed
with the Company to purchase at least 86,957 Units in order to support the
Company's application for listing on the NASDAQ SmallCap Market.
The Underwriter will purchase the Units (including Units subject to the
Overallotment Option) from the Company at a price of $5.75 per Unit. In
40
<PAGE>
addition, the Company has agreed to pay the Underwriter a 3% nonaccountable
expense allowance on the aggregate initial public offering price of the Units,
including Units subject to the Overallotment Option.
The Company has agreed to issue the Underwriter's Warrants to the
Underwriter for a consideration of $10. The Underwriter's Warrants are
exercisable at any time in the four-year period commencing one year from the
date of this Prospectus to purchase up to an aggregate of 105,000 Units for
$9.4875 per Unit in cash (165% of the Offering price of the Units)or on a
cashless basis by exchanging the "value" of the existing Underwriter's Warrants
(such "value" based upon the difference between the exercise price and the
market price of the Underwriter's Warrants on the date of exercise). The Units
which may by purchased upon exercise of the Underwriters' Warrants (the
"Underwriters' Units") will be identical to the Units offered to the public,
except that the redeemable common stock purchase warrants included in the
Underwriters' Units will be exercisable to purchase shares of Common Stock at a
purchase price equal to 165% of the initial public offering price for the Units
offered to the public. The Underwriter's Warrants are not transferable for one
year from the date of this Prospectus except (i) to an Underwriter or a partner
or officer of an Underwriter or (ii) by will or operation of law. During the
term of the Underwriter's Warrants, the holder thereof is given the opportunity
to profit from an increase in the per share market price of the Company's
securities. As long as the Underwriter's Warrants are outstanding, the Company
may find it more difficult to raise additional equity capital. At any time at
which the Underwriter's Warrants are likely to be exercised, the Company would
probably be able to obtain additional equity capital on more favorable terms. If
the Company files a registration statement relating to an equity offering under
the provisions of the 1933 Act at any time during the seven-year period
following the date of this Prospectus, the holders of the Underwriter's Warrants
or underlying Units will have the right, subject to certain conditions, to
include in such registration statement, at the Company's expense, all or part of
the underlying Units at the request of the holders. Additionally, the Company
has agreed, for a period of five years commencing on the date of this
Prospectus, on demand of the holders of a majority of the Underwriter's Warrants
or the Units issued or issuable thereunder, to register the Units underlying the
Underwriter's Warrants one time at the Company's expense. The registration of
securities pursuant to the Underwriter's Warrants may result in substantial
expense to the Company at a time when it may not be able to afford such expense
and may impede future financing. The number of Units covered by the
Underwriter's Warrants and the exercise price are subject to adjustment under
certain events to prevent dilution.
In connection with the Offering, the Underwriter and selling group members
(if any) and their respective affiliates may engage in transactions that
stabilize, maintain or otherwise affect the market price of the Common Stock and
Warrants. Such transactions may include stabilization transactions effected in
accordance with Rule 104 of Regulation M, pursuant to which such persons may bid
or purchase Common Stock or Warrants for the purpose of stabilizing their market
prices. The Underwriter may also create a short position for the account of the
Underwriter by selling more securities in connection with the Offering than it
is committed to purchase from the Company and in such case may purchase
securities in the open market following completion of the Offering to cover all
or a portion of such short Overallotment Option. Any of the transactions
described in this paragraph may result in the maintenance of the securities at a
level above that which might otherwise prevail in the open market. None of the
transactions described in this paragraph is required, and, if they are
undertaken, they may be discontinued at any time.
41
<PAGE>
In connection with the Offering, the Underwriters may also purchase and
sell the Common Stock and Warrants in the open market. These transactions may
include overallotment and stabilizing transactions as described above, and
purchases to cover syndicate short positions created in connection with the
Offering. Stabilizing transactions consist of certain bids or purchases for the
purposes of preventing or retarding a decline in the market price of the Common
Stock and Warrants; and syndicate short positions involve the sale by the
Underwriters of a greater number of shares of Common Stock or of Warrants than
they are required to purchase from the Company in the Offering. The Underwriter
also may impose a penalty bid, whereby selling concessions allowed to syndicate
members or other broker-dealers in respect of the Common Stock and Warrants sold
in the Offering for their account may be reclaimed by the Underwriter if such
securities are repurchased by the Underwriter in stabilizing or covering
transactions. These activities may stabilize, maintain or otherwise affect the
market price of the Common Stock and Warrants, which may be higher than the
price that might otherwise prevail in the open market; and these activities, if
commenced, may be discontinued at any time. These transactions may be effected
on the Bulletin Board in the over-the-counter market.
Certain of the Company's shareholders (holding an aggregate of 30,300
shares) have entered into lock-up agreements with the Underwriter pursuant to
which they have agreed not to sell or otherwise dispose of any of their shares
of Common Stock (including shares issuable upon exercise of stock options) for a
period of three years from the date of this Prospectus without the prior written
consent of the Underwriter.
The Company has agreed upon completion of the Offering to retain the
Underwriter as a financial consultant for a period of one year at a monthly fee
of $5,000 (a total of $60,000), payable in full upon the closing of the
Offering. The consulting agreement will not require the Underwriter to devote a
specific amount of time to the performance of its duties thereunder.
The Company has agreed (i) to allow the Underwriter to designate one
director or advisor to the Company's Board of Directors for a period of five
years from the date hereof (ii) not to offer any equity securities or grant
options or warrants to purchase Common Stock without the prior written consent
of the Underwriter for a period of three years from the date hereof, (iii) to
grant the Underwriter a right of first refusal for three years from the date
hereof with respect to any private placement or public offering of the Company's
securities, or its subsidiaries and for sales by 5% or greater stockholders of
the Company's securities under Rule 144 (subject to the Company's right to
terminate the right of first refusal for a $10,000 payment to the Underwriter).
The Company has agreed to indemnify the Underwriter against certain
liabilities including liabilities under the Securities Act and to contribute in
certain events to liabilities incurred by the Underwriter in connection with the
sale of the Units. In the opinion of the Commission, indemnification against
liabilities under the Securities Act is against public policy and is therefore
unenforceable.
42
<PAGE>
LEGAL MATTERS
Certain legal matters in connection with the Offering will be passed upon
for the Company by the Law Office of Gary A. Agron, Englewood, Colorado. Snow
Becker Krauss P.C., New York, New York, has acted as counsel for the Underwriter
in connection with the Offering.
EXPERTS
The financial statements of the Company for the years ended December 31,
1996 and 1997, appearing in the Registration Statement have been audited by
Angell & Deering, independent auditors, as set forth in their report thereon
appearing elsewhere herein, and are included in reliance upon such report given
upon the authority of such firm as experts in accounting and auditing.
43
<PAGE>
PROTOSOURCE CORPORATION
INDEX TO FINANCIAL STATEMENTS
Financial Statements Page
- -------------------- ----
Independent Auditors' Report F-2
Balance Sheet as of December 31, 1997 F-3
Statements of Operations for the years ended
December 31, 1997 and 1996 F-5
Statements of Changes in Shareholders' Equity for the
years ended December 31, 1997 and 1996 F-6
Statements of Cash Flows for the years ended
December 31, 1997 and 1996 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, 1997 and the related statements of operations, changes in
shareholders' equity and cash flows for the years ended December 31, 1997 and
1996. 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, 1997 and the results of its operations and its cash flows for the
years ended December 31, 1997 and 1996 in conformity with generally accepted
accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As shown in the financial statements,
the Company incurred a net loss of $1,470,550 during the year ended December 31,
1997, and, as of that date had a working capital deficiency of $795,657. As
discussed in Note 1 to the financial statements, the Company's significant
operating losses and working capital deficiency raise substantial doubt about
its ability to continue as a going concern. Management's plans in regard to
these matters are also discussed in Note 1. The financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
Angell & Deering
Certified Public Accountants
Denver, Colorado
February 13, 1998, except for
Note 6 as to which the date
is April 7, 1998
F-2
<PAGE>
PROTOSOURCE CORPORATION
BALANCE SHEET
DECEMBER 31, 1997
ASSETS
------
Current Assets:
Cash and cash equivalents $ 98,148
Accounts receivable - trade net of allowance
for doubtful accounts of $7,500 22,490
Current portion of note receivable 67,000
-----------
Total Current Assets 187,638
-----------
Property and Equipment, at cost:
Land 411,176
Building and improvements 1,381,816
Equipment 821,876
Furniture 110,387
-----------
2,725,255
Less accumulated depreciation and amortization (701,455)
-----------
Net Property and Equipment 2,023,800
-----------
Other Assets:
Goodwill, net of accumulated amortization
of $3,423 17,822
Debt issuance costs, net of accumulated amortization
of $320,167 527,333
Note receivable, net of allowance for uncollectibility
of $100,000 and net of current portion above 396,271
Deposits and other assets 44,347
Deferred offering costs 98,523
-----------
Total Other Assets 1,084,296
-----------
Total Assets $ 3,295,734
===========
The accompanying notes are an integral
part of these financial statements.
F-3
<PAGE>
PROTOSOURCE CORPORATION
BALANCE SHEET
DECEMBER 31, 1997
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable $ 96,107
Accrued expenses:
Payroll taxes, wages and other 30,213
Interest 45,049
Current portion of bridge loans 750,000
Current portion of long-term debt 61,926
-----------
Total Current Liabilities 983,295
-----------
Long-Term Debt, net of current portion above:
Individuals and other 750,000
Obligations under capital leases 1,850,815
Less current portion above (811,926)
-----------
Total Long-Term Debt 1,788,889
-----------
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, 665,333 shares issued and outstanding 5,590,455
Accumulated deficit (5,066,905)
-----------
Total Shareholders' Equity 523,550
-----------
Total Liabilities and Shareholders' Equity $ 3,295,734
===========
The accompanying notes are an integral
part of these financial statements.
F-4
<PAGE>
PROTOSOURCE CORPORATION
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
1997 1996
---- ----
Net Revenues:
Internet service fees $ 749,796 $ 697,581
----------- -----------
Total Revenues 749,796 697,581
Operating expenses 1,818,698 1,121,773
----------- -----------
Operating Loss (1,068,902) (424,192)
----------- -----------
Other Income (Expense):
Interest income 77,399 3,507
Interest expense (624,006) (398,228)
Rent and other income 218,959 146,122
Loss on disposal of assets (2,018) --
Other, net 368 --
----------- -----------
Total Other Income (Expense) (329,298) (248,599)
----------- -----------
Loss From Continuing Operations Before
Provision For Income Taxes (1,398,200) (672,791)
Provision for income taxes 72,350 --
----------- -----------
Loss From Continuing Operations (1,470,550) (672,791)
----------- -----------
Discontinued Operations:
Loss from discontinued operations (Note 2) -- (532,663)
Loss on disposal (Note 2) -- (204,346)
----------- -----------
Loss From Discontinued Operations -- (737,009)
----------- -----------
Net Loss $(1,470,550) $(1,409,800)
=========== ===========
Net Loss Per Share of Common Stock:
Basic:
Loss from continuing operations $ (2.49) $ (3.69)
Discontinued operations -- (4.05)
----------- -----------
Net Loss $ (2.49) $ (7.74)
=========== ===========
Diluted:
Loss from continuing operations $ (2.49) $ (3.69)
Discontinued operations -- (4.05)
----------- -----------
Net Loss $ (2.49) $ (7.74)
=========== ===========
Weighted Average Number of
Common Shares Outstanding:
Basic 589,702 182,037
Diluted 589,702 182,037
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, 1997 AND 1996
Series A
Preferred Stock Common Stock
------------------- --------------------- Accumulated
Shares Amount Shares Amount Deficit
------ ------ ------ ------ -------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995 900,000 $-- 88,666 $ 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 -- -- 26,667 100,000 --
Issuance of common stock in private
offering (net of offering costs of
$224,801) -- -- 400,000 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 -- -- 515,333 4,839,485 (3,596,355)
Issuance of common stock -- -- -- 970 --
Issuance of common stock in connection
with bridge loans -- -- 150,000 750,000 --
Net loss -- -- -- -- (1,470,550)
----------- ----- ----------- ----------- -----------
Balance at December 31, 1997 -- $-- 665,333 $ 5,590,455 $(5,066,905)
=========== ===== =========== =========== ===========
The accompanying notes are an integral
part of these financial statements.
F-6
</TABLE>
<PAGE>
PROTOSOURCE CORPORATION
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
1997 1996
---- ----
Cash Flows From Operating Activities:
Net loss $(1,470,550) $(1,409,800)
Adjustments to reconcile net loss to net cash
provided (used) by operating activities:
Depreciation and amortization 544,670 367,049
Provision for bad debts 107,500 --
Deferred income taxes 71,550 --
Assets and liabilities disposed of in
divestiture and note receivable received -- 17,176
(Gain) loss on disposal of equipment 2,018 (4,607)
Issuance of common stock for costs of financing -- 100,000
Changes in operating assets and liabilities:
Accounts receivable 20,563 163,556
Inventories 8,980 7,079
Deposits and other assets 12,586 15,441
Accounts payable (99,587) 32,536
Accrued liabilities (191,966) 344,284
Customer deposits (1,500) (4,000)
Unearned customer support revenue -- (34,542)
----------- -----------
Net Cash (Used) By Operating Activities (995,736) (405,828)
----------- -----------
Cash Flows From Investing Activities:
Purchase of property and equipment (77,552) (38,421)
Proceeds from disposal of equipment -- 10,536
Software development costs capitalized -- (442,100)
Receipt of principal on notes receivable 207,579 --
----------- -----------
Net Cash Provided (Used) By Investing Activities 130,027 (469,985)
----------- -----------
Cash Flows From Financing Activities:
Payments on notes payable (73,447) (55,675)
Proceeds from borrowing 750,000 200,000
Issuance of common stock 970 1,300,000
Offering costs incurred (98,523) (224,801)
Debt issuance costs incurred (97,500) --
----------- -----------
Net Cash Provided By Financing Activities 481,500 1,219,524
----------- -----------
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, 1997 AND 1996
1997 1996
---- ----
<S> <C> <C>
Net Increase (Decrease) in Cash and Cash Equivalents $(384,209) $ 343,711
Cash and Cash Equivalents at Beginning of Year 482,357 138,646
--------- ---------
Cash and Cash Equivalents at End of Year $ 98,148 $ 482,357
========= =========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the year for:
Interest $ 258,790 $ 272,228
Income taxes 800 --
Supplemental Disclosure of Noncash
Investing and Financing Activities:
Acquisition of equipment under capital leases $ 69,959 $ 90,349
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
Issuance of common stock in connection with financing 750,000 --
The accompanying notes are an integral
part of these financial statements.
F-8
</TABLE>
<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 service provider.
Basis of Presentation
---------------------
The accompanying financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The
financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the
amount and classification of liabilities that might be necessary
should the Company be unable to continue as a going concern. The
Company's continuation as a going concern is dependent upon its
ability to generate sufficient cash flow to meet its obligations on a
timely basis, to obtain additional financing as may be required, and
to increase sales to a level where the Company becomes profitable.
Additionally, the Company has experienced extreme cash liquidity
shortfalls from operations.
The Company's continued existence is dependent upon its ability to
achieve its operating plan. Management's plan consist of the
following:
1. In 1996, the Company restructured its operations and divested
three divisions (Note 2). The Company currently operates solely
as an Internet service provider. The Company has reduced its
general and administrative expenses and continues to consolidate
its operations and reduce its operating costs.
2. Obtaining additional equity through the sale of securities in a
secondary stock offering (the "Offering") (Note 6). The Company
has a letter of intent with an Underwriter for the offering on a
firm commitment basis. The Company has filed a Registration
Statement with the Securities and Exchange Commission for the
Offering. The Offering is expected to raise gross proceeds of
approximately $6,000,000, which would result in net proceeds to
the Company of approximately $5,100,000. There can be no
assurance that the Offering will be successfully completed.
3. Sale of certain assets of the Company.
If management cannot achieve its operating plan because of sales
shortfalls, lack of ability to complete the Offering, or other
unfavorable events, the Company may find it necessary to dispose of
assets, or undertake other actions as may be appropriate.
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.
On April 25, 1997, the Company's shareholders adopted a resolution
approving a three for two reverse stock split of the issued and
outstanding common shares, effective April 25, 1997. All share
information and per share data have been retroactively restated for
all periods presented to reflect the reverse stock splits.
F-9
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies (Continued)
------------------------------------------------------
Revenue Recognition
-------------------
Revenue from the Internet operations is recognized over the period the
services are provided. Deferred revenue consists primarily of monthly
subscription fees billed in advance.
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
at the date of purchase to be cash equivalents.
Inventories
-----------
Inventories, consisting of computer supplies held for resale, are
stated at the lower of cost (determined on the first in, first out
method) or market.
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 $223,086 and $233,201 for the years ended December 31, 1997 and
1996, respectively.
Amortization
------------
Goodwill is being amortized using the straight-line method over an
estimated useful life of 15 years.
Debt issuance costs are being amortized using the straight-line method
over the fifteen month term of the loans.
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 $-0-, 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 the cost of the
investment.
Deferred Offering Costs
-----------------------
In connection with the Company's proposed public offering (Note 6),
costs incurred to complete the offering have been deferred and will be
offset against the proceeds of the offering if completed, or charged
to expense if the offering is not completed.
Stock-Based Compensation
------------------------
During the year ended December 31, 1996, the Company adopted Statement
of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation". The Company will continue to measure
compensation expense for its stock-based employee compensation plans
F-10
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies (Continued)
------------------------------------------------------
Stock-Based Compensation (Continued)
------------------------------------
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 No. 123 had been applied in
measuring compensation expense.
Long-Lived Assets
-----------------
In accordance with Statement of Financial Accounting Standards (SFAS)
No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of", the Company reviews for the
impairment of long-lived assets, certain identifiable intangibles, and
associated goodwill, whenever events or changes in circumstances
indicate that the carrying value of an asset may not be recoverable.
An impairment loss would be recognized when the estimated future cash
flows is less than the carrying amount of the asset. No impairment
losses have been identified by the Company.
Income Taxes
------------
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.
Net Income (Loss) Per Share of Common Stock
-------------------------------------------
As of December 31, 1997, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 128, "Earnings Per Share", which
specifies the method of computation, presentation and disclosure for
earnings per share. SFAS No. 128 requires the presentation of two
earnings per share amounts, basic and diluted.
Basic earnings per share is calculated using the average number of
common shares outstanding. Diluted earnings per share is computed on
the basis of the average number of common shares outstanding plus the
dilutive effect of outstanding stock options using the "treasury
stock" method.
The basic and diluted earnings per share are the same since the
Company had a net loss for 1997 and 1996 and the inclusion of stock
options and other incremental shares would be antidilutive. Options
and warrants to purchase 277,334 and 384,001 shares of common stock at
December 31, 1997 and 1996, respectively were not included in the
computation of diluted earnings per share because the Company had a
net loss and their effect would be antidilutive.
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 (Notes 9
and 12).
F-11
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
2. Discontinued Operations (Continued)
-----------------------------------
Also included in the assets of the divested divisions 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
included 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 office
space from the Company for a period of fourteen months at the rate of
$12,000 per month through February 1998.
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 26,667 shares of common stock
to the bridge lenders as additional consideration for the $200,000
loan. In October and November 1996 the Company sold 400,000 shares of
its common stock at $3.75 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 146,667 warrants to each which are exercisable at
$3.75 per share for a four year period through October 31, 2001. In
June 1997, the Underwriter returned 106,667 warrants to the Company
without consideration. 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. The Registration Statement was filed and
declared effective in May 1997.
Revenues applicable to the Company's discontinued operations were
$540,112 for the year ended December 31, 1996.
3. Long-Term Debt
--------------
Long-term debt consists of the following:
Individuals and Other
---------------------
12% unsecured Bridge Loans from a group of eight
lenders due on the earlier of the closing of a public
or private offering of securities by the Company for at
least $1,000,000 or fifteen months from the date of the
Bridge Loans. As additional compensation for the Bridge
Loans, the Company issued an aggregate of 150,000
shares of common stock to the lenders, one share for
each $5 loaned to the Company. $750,000
Obligations Under Capital Leases
--------------------------------
11.1% to 25.1% installment notes due in 1998 to 2001,
collateralized by equipment. 172,882
F-12
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
3. Long-Term Debt (Continued)
--------------------------
Obligations Under Capital Leases (Continued)
--------------------------------------------
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). 1,677,933
----------
Total Long-Term Debt 2,600,815
Less current portion of long-term debt (811,926)
----------
Long-Term Debt $1,788,889
==========
Installments due on debt principal, including the capital leases, at
December 31, 1997 are as follows:
Year Ending
December 31,
------------
1998 $ 811,926
1999 19,902
2000 42,023
2001 10,504
2002 9,382
Later years 1,707,078
----------
Total $2,600,815
==========
4. Income Taxes
------------
The components of the provision for income taxes are as follows:
1997 1996
---- ----
Current:
Federal $ -- $ --
State 800 --
------- -------
Total 800 --
------- -------
Deferred:
Federal 60,635 --
State 10,915 --
------- -------
Total 71,550 --
------- -------
Total Provision For Income Taxes $72,350 $ --
======= =======
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)
------------------------
1997 1996
---- ----
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,
1997 are as follows:
Net operating loss carryforward $ 1,413,700
Vacation accrual 2,070
Allowance for bad debts 36,870
-----------
Total deferred tax asset 1,452,640
-----------
Accelerated depreciation (21,760)
-----------
Total deferred tax liability (21,760)
Less valuation allowance (1,430,880)
-----------
Net Deferred Tax Asset $ --
===========
The Company has assessed its past earnings history and trends,
budgeted sales, and expiration dates of carryforwards and has
determined that it is more likely than not that no deferred tax assets
will be realized. The valuation allowance of $1,430,880 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
$494,180. The Company will continue to review this valuation on a
quarterly basis and make adjustments as appropriate.
At December 31, 1997, the Company had federal and California net
operating loss carryforwards of approximately $5,000,000 and
$2,500,000, respectively. Such carryforwards expire in the years 2007
through 2012 and 1998 through 2002 for federal and California
purposes, respectively.
5. 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, 1997, no options have been granted under the Plan.
F-14
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
5. Shareholders' Equity (Continued)
--------------------------------
Preferred Stock
---------------
In December 1994, the Company issued to six individuals, including the
Company's five former executive officers, for no consideration, a
total of 900,000 shares of Series A Convertible Preferred Stock, no
par value. Such shares were automatically convertible, in varying
amounts per year, into shares of common stock on a fifteen for one
basis through 2003 if certain revenue and net income milestones were
met.
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 46,000 units at $82.50 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
consisted of one share of the Company's common stock and one warrant
to purchase an additional share of common stock at $97.50 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 $112.50
or more for 30 consecutive days. The warrants were not exercised and
all 46,000 warrants expired on February 9, 1998. 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 $99.00 per Unit. The Units subject to the Underwriter's
Warrant are identical to the Units sold to the public.
6. Proposed Public Stock Offering
------------------------------
The Company has executed a letter of intent with an Underwriter to
offer 1,050,000 units of the Company's securities at $5.75 per unit.
Each unit consists of one share of the Company's common stock and one
redeemable common stock purchase warrant. Each warrant is exercisable
to purchase one share of common stock at the closing bid price of the
common stock on the day prior to the effective date of the
Registration Statement for a period of five years from the effective
date of the Company's Registration Statement and may be redeemed by
the Company. The Company will also grant the Underwriter an option to
purchase an additional 157,500 units from the Company to cover
over-allotments for a period of thirty days from the effective date of
the Registration Statement.
The Company will pay the Underwriter a commission equal to ten percent
of the gross proceeds of the offering and a non-accountable expense
allowance equal to three percent of the gross proceeds of the
offering. In connection with the offering, the Company has agreed to
issue the Underwriter a warrant, for $10, to purchase up to 105,000
units which shall be exercisable at 9.4875 per unit (165% of the
public offering price of the Units). The Underwriter's warrant is
exercisable for a period of four years beginning one year from the
effective date of the Registration Statement. The units subject to the
Underwriter's warrant will be identical to the units sold to the
public except that the redeemable warrants included in the
Underwriter's Units will be exercisable to purchase shares of common
stock at $9.4875 (165% of the initial public offering price of the
Units offered to the public). The Company has also agreed upon
completion of the Offering to retain the Underwriter as a financial
consultant for a period of one year at a monthly fee of $5,000 (a
total of $60,000) payable in full upon completion of the Offering.
There can be no assurance that the Offering will be successfully
completed.
F-15
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
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 previously occupied approximately half of
the space as its corporate office facility and 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 option at any time through April 30, 1998, to purchase the building
and land for $1,900,000. 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 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 $24,000 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, 1997 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:
Year Ending Capital Operating
December 31, Leases Leases Total
------------ ------ ------ -----
1998 $ 273,922 $ 52,785 $ 326,707
1999 252,176 53,841 306,017
2000 265,984 54,918 320,902
2001 230,047 56,016 286,063
2002 228,252 23,340 251,592
Later years 3,477,321 -- 3,477,321
----------- --------- ----------
Total Minimum Lease
Payments 4,727,702 $ 240,900 $4,968,602
========= ==========
Less amount representing
interest (2,876,887)
-----------
Present Value of Net Minimum
Lease Payments $ 1,850,815
===========
Rent expense amounted to approximately $69,806 and $120,100 for the
years ended December 31, 1997 and 1996, respectively.
Leased equipment under capital leases as of December 31, 1997 is as
follows:
F-16
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
7. Commitments and Contingencies (Continued)
-----------------------------------------
Building $1,348,824
Land 411,176
Equipment 346,398
Less accumulated amortization (386,417)
----------
Net Property and Equipment Under Capital Leases $1,719,981
==========
In May 1997, as a result of the Company's default on its capital
lease, the Company agreed to return legal possession of the office
building to the landlord. The Company does not occupy any space in the
building, although it leased a portion of it to SSC and the SSC
Principals based upon monthly payments to the Company of $12,000
through February 1998. Accordingly, the landlord collects rents
directly from the tenants of the office building and the Company is
responsible for the difference between such aggregate rents and the
Company's lease payment to the landlord. The landlord is currently
collecting monthly rents aggregating approximately $9,200 and the
Company's monthly leasehold obligation is approximately $15,600
leaving a monthly balance due from the Company to the landlord of
approximately $6,400.
8. Stock Based Compensation Plans
------------------------------
The Company adopted SFAS No. 123 during the year ended December 31,
1996. In accordance with the provisions of SFAS No. 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 recognize compensation expense based upon
the fair value at the grant date for awards under these plans
consistent with the methodology prescribed by SFAS No. 123, the
Company's net income and earnings per share would be reduced to the
following pro forma amounts:
1997 1996
---- ----
Net Loss:
As reported $(1,470,550) $(1,409,800)
Pro forma (1,507,063) (1,412,843)
Net Loss Per Share of Common Stock:
As reported $ (2.49) $ (7.74)
Pro forma $ (2.56) $ (7.76)
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 1997.
F-17
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
8. Stock Based Compensation Plans (Continued)
------------------------------------------
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 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.
On November 1, 1994, all of the Company's former shareholders agreed
in writing with each other and with the Company to contribute pro rata
from their shareholdings up to a total of 13,334 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 13,334 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
13,334 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 334 shares in connection with
the acquisition of ValleyNet Communications.
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. SSC was behind on the payments
under the terms of the note and the Company has withheld certain
payments it received from the sale of software (Note 11) which were
owed to SSC and reduced the note receivable by such amounts (Note 12).
The Company received payments from the Canadian Limited Partnership
("Partnership") as a result of the sale of the software. The Company
entered into an agreement with SSC at the time of the divestiture
whereby all amounts received from the Partnership would be paid to
SSC. When SSC defaulted on the payments of the note receivable to the
Company, the Company notified SSC that the payments received from the
Partnership would be offset against the note receivable which was in
default for nonpayment.
The Company issued 36,667 warrants to its Chief Executive Officer in
connection with his employment agreement in November 1996. The
warrants vest as to 13,333 warrants on January 1, 1997, 13,334 on
January 1, 1998 and 10,000 on January 1, 1999. The warrants are
exercisable at $3.75 per share at anytime through October 2001.
10. Concentration of Credit Risk
----------------------------
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.
F-18
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
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, 1996 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 various
percentage of sales for each copy of the Software purchased from the
Partnership.
Since the Company was responsible for maintaining, upgrading and
developing future revisions of the Software, the transaction was not
been accounted for as a sale by the Company. In addition, the notes
receivable were not 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 was accounted for by the
Company on a cost recovery basis and the cash received from the
Partnership reduced 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).
12. Litigation
----------
As a result of the failure of SSC and the SSC Principals to pay
certain trade account payables and certain office rent under a
sublease from the Company, the Company has been threatened with
litigation from such trade creditors and has been required to return
possession of the SSC subleased office space to the Company's landlord
(Note 7). The Company believes that the total contingent liability to
trade account creditors arising from defaults by SSC and the SSC
Principals does not exceed $100,000.
F-19
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
12. Litigation (Continued)
----------------------
The Company has paid certain amounts to trade creditors of SSC which
arose prior to the divestiture of three of the Company's divisions to
SSC in 1996. The Company filed suit against SSC and the SSC Principals
in December 1997 to recover the amounts it paid and to accelerate
payment of the Company's note receivable from SSC.
In February 1997, three of the Company's former employees brought a
civil action against the Company for back wages aggregating
approximately $45,000 which was incurred prior to the divestiture of
the three divisions. The Company alleges that these amounts, if due,
are the responsibility of SSC and the SSC Principals under the
Divestiture Agreement. The Company is unable to predict the outcome to
the litigation.
Payment of any judgements or settlements in connection with these
litigation matters, together with the costs of defending such matters,
could adversely affect the Company's results of operations and
financial condition.
13. Employee Benefit Plan
---------------------
Effective May 29, 1997, the Company adopted a 401(K) savings plan for
employees who are not covered by any collective bargaining agreement,
have attained age 21 and have completed one year of service. Employee
and Company matching contributions are discretionary. The Company made
matching contributions of $1,799 for the year ended December 31, 1997.
Company contributions vest as follows:
Years of Service Percent Vested
---------------- --------------
1 33%
2 66%
3 100%
14. Fair Value of Financial Instruments
-----------------------------------
Disclosures about Fair Value of Financial Instruments for the
Company's financial instruments are presented in the table below.
These calculations are subjective in nature and involve uncertainties
and significant matters of judgment and do not include income tax
considerations. Therefore, the results cannot be determined with
precision and cannot be substantiated by comparison to independent
market values and may not be realized in actual sale or settlement of
the instruments. There may be inherent weaknesses in any calculation
technique, and changes in the underlying assumptions used could
significantly affect the results. The following table presents a
summary of the Company's financial instruments as of December 31,
1997:
1997
-----------------------------
Carrying Estimated
Amount Fair Value
----------- ----------
Financial Assets:
Cash and cash equivalents $ 98,148 $ 98,148
Note receivable 463,271 463,271
Financial Liabilities:
Long-term debt 2,600,815 2,600,815
F-20
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
14. Fair Value of Financial Instruments (Continued)
-----------------------------------------------
The carrying amounts for cash and cash equivalents, receivables,
accounts payable and accrued expenses approximate fair value because
of the short maturities of these instruments. The fair value of
long-term debt, including the current portion, approximates fair value
because of the market rate of interest on the long-term debt and the
interest rate implicit in the obligations under capital leases.
15. Subsequent Events (Unaudited)
-----------------------------
In March 1998, the Company settled the civil action brought by former
employees for back wages aggregating approximately $45,000. The
Company paid $23,000 to settle this matter. The Company seeks to
recover the $23,000 from SSC and the SSC principals as the matter
arose prior to the divestiture of the three divisions and the Company
believes it is the responsibility of SSC.
F-21
<PAGE>
- --------------------------------------------------------------------------------
No dealer, salesman or other person
has been authorized to give any
information or to make any
representations other than contained in
this Prospectus in connection with the
Offering described herein, and if given
or made, such information or
representations must not be relied upon
as having been authorized by the
Company. This Prospectus does not
constitute an offer to sell, or the
solicitation of an offer to buy, the
securities offered hereby to any person
in any state or other jurisdiction in 1,050,000 Units
which such offer or solicitation is
unlawful. Neither the delivery of this
Prospectus nor any sale hereunder shall,
under any circumstances, create any
implication that there has been no
change in the affairs of the Company
since the date hereof.
PROTOSOURCE CORPORATION
------------
TABLE OF CONTENTS
Page
---- ---------------
Available Information................ 3
Prospectus Summary................... 4 PROSPECTUS
The Company ......................... 7
Risk Factors......................... 9 ---------------
Capitalization....................... 17
Price Range of Common Stock.......... 18
Use of Proceeds...................... 18
Selected Financial Data.............. 19
Management's Discussion and
Analysis of Financial Condition
and Results of Operations.......... 20
Business............................. 23
Management........................... 30
Principal Stockholders............... 34
Certain Transactions................. 35
Description of Securities............ 36
Underwriting......................... 40
Legal Matters........................ 43
Experts.............................. 43
Financial Statements.................F-1
Until June 7, 1998 (25 days after [Underwriter logo omitted]
the date of this Prospectus), all
dealers effecting transactions in the ANDREW, ALEXANDER,
registered securities, whether or not WISE & COMPANY, INC.
participating in this distribution, may 17 State Street
be required to deliver a Prospectus. New York, New York 10004
This is in addition to the obligation of (800) 303-5424
dealers to deliver a Prospectus when
acting as underwriters and with respect
to their unsold allotments or May 13, 1998
subscriptions.
