SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 [Fee Required]
For the fiscal year ended December 31, 1997 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 [No Fee Required]
For the transition period from _______________ to ________________
Commission File No. 33-86242
PROTOSOURCE CORPORATION
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(Name of Small Business Issuer in its Charter)
California 77-0190772
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(State or other jurisdiction of I.R. S. Employer
incorporation or organization) Identification Number)
2300 Tulare Street, Suite 210
Fresno, California 93721
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (310) 314-9801
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
No Par Value Common Stock
Redeemable Common Stock Purchase Warrants
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(Title of Class)
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Check whether the Registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the Registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days.
Yes X No
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As of February 28, 1998, 665,333 shares of the Registrant's no par value
Common Stock were outstanding. As of February 28, 1998, the market value of the
Registrant's no par value Common Stock, excluding shares held by affiliates, was
$3,171,663 based upon a closing bid price of $5.50 per share of Common Stock on
the Electronic Bulletin Board.
Check if there is no disclosure contained herein of delinquent filers in
response to Item 405 of Regulation S-B, and will not be contained, to the best
of the Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. X
-----
The Registrant's revenues for its most recent fiscal year were $749,796.
The following documents are incorporated by reference into Part III, Items
9 through 12 hereof: None.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
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The following is a summary of certain information contained in this Report
and is qualified in its entirety by the detailed information and financial
statements that appear elsewhere herein. Except for the historical information
contained herein, the matters set forth in this Report include forward-looking
statements within the meaning of the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995. These forward-looking statements are
subject to risks and uncertainties that may cause actual results to differ
materially. These risks and uncertainties are detailed throughout the Report and
will be further discussed from time to time in the Company's periodic reports
filed with the Commission. The forward-looking statements included in the Report
speak only as of the date hereof.
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 approximately 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
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 will
not be able to effectively manage the financial and administrative burdens
imposed by the continuing consumer demand for local Internet services, unless
these providers are integrated into larger, more diversified Internet products
and services companies. The Company 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.
History
From July 1988 until August 1996, the Company's primary business was to
design, develop and market software programs (and related hardware) for the
agri-business industry including produce broker accounting programs, product
tracking programs, crop chemical usage reports, crop cost and billing systems
and fruit accounting programs. The programs were packaged under the Company's
"Classic" line of products and were divided by function, sophistication and the
size of the customer into "Classic" (appropriate for customers whose annual
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sales are less than $10 million), "Classic Advantage" (appropriate for customers
whose annual sales are between $10 million and $100 million) and "Classic
Custom" (appropriate for customers whose annual sales exceed $100 million).
Prices ranged from $20,000 for a "Classic" program to $200,000 for a "Classic
Custom" program. The Company also sold customized computer system configurations
designed by it which integrated hardware and software. The Classic product line
together with the Company's design services and hardware and software sales is
collectively referred to as the "Classic Line."
In February 1995, the Company completed an initial public offering ("IPO")
of its securities, consisting of the sale of 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. 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 2700 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.
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
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Prior Representative, (iii) agreed to sublease office space from the Company at
a monthly rental of $12,000 through February 28, 1998, (iv) granted to Steven A.
Kriegsman, a 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 "Item 12."
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 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 (310) 314-9801.
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
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continue to provide low-priced direct Internet access through the Company's
telecommunication network infrastructure which is comprised of two high speed
dedicated data lines that connect directly to the backbone of the Internet. The
Company plans to add additional high-speed dedicated data lines, enhance
system-wide access software 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 to customers who are new to the Internet, and
who seek to access information using point-and-click graphical interface.
Marketing is conducted through a small sales force which contacts prospective
customers responding to advertisements in computer, professional and business
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publications. The Company also seeks customers by participating in industry
trade shows and educational seminars and through referrals from existing
customers. In addition, the Company seeks strategic alliances with local
computer retailers who offer Internet access fee discounts to their customers
and through joint advertising efforts with television and radio stations. The
Company may also distribute Internet services through retail channels.
Direct mailings, telemarketing programs, co-marketing agreements and joint
promotional efforts among organizations and individual users are strategies that
the Company may employ in the future. Finally, the Company seeks to retain
business customers and individual users through what it perceives to be
responsive customer support and services programs.
Competition
The Internet services business is highly competitive and there are few
significant barriers to entry. Currently, the Company competes with a number of
national and local California Internet service providers. In addition, a number
of multinational corporations, including giant communications carriers such as
AT&T, 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 consolidates
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
to provide high quality Internet connectivity and value-added Internet services
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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 twelve full-time employees
and two part time employees. The Company believes it maintains good relations
with its employees. None of the Company's employees are represented by a labor
union or covered by a collective bargaining agreement.
ITEM 2. DESCRIPTION OF PROPERTY
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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.
ITEM 3. LEGAL PROCEEDINGS
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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
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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.
In May 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
in May 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.
In February 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 this
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
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Not applicable.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
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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 NASDAQ and commenced trading on the Electronic Bulletin Board under the
symbol "PSCO."
The following table sets forth for the quarters indicated the range of high
and low closing prices of the Company's Common Stock as reported by NASDAQ and
the Electronic Bulletin Board but does not include retail markup, markdown or
commissions.
Price
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By Quarter Ended: High Low
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March 31, 1998 (through February 28, 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
As of February 28, 1998, the Company had approximately 365 record and
beneficial stockholders.
Dividend Policy
The Company has never paid cash dividends on its Common Stock and intends
to retain earnings, if any, for use in the operation and expansion of its
business. The amount of future dividends, if any, will be determined by the
Board of Directors based upon the Company's earnings, financial condition,
capital requirements and other conditions.
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ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
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Background
Operating through its ProtoSource Network ("PSNW") division, the Company
provides Internet access and related services to individuals, public agencies
and businesses in five small Central California cities. As of December 31, 1997,
the Company had 2,700 subscribers for whom it provided Internet access. The
Company intends to acquire other small Internet providers in markets with
populations of less than 500,000 that are located initially in various Central
California cities between Sacramento and Bakersfield. The Company believes that
certain of these local Internet providers currently doing business in the
Company's target markets will not be able to effectively manage the financial
and administrative burdens imposed by the continuing consumer demand for local
Internet services, unless these providers are integrated into larger, more
diversified Internet products and services companies. The Company's long-term
plan is to target a select number of such target markets and increase revenues
through acquisition in such markets. The Company is not negotiating to acquire
nor has it entered into any agreement to acquire any such Internet related
companies.
Results of Operations
Year Ended December 31, 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 vs. Year Ended December 31, 1995
Net Sales. For fiscal 1996, Internet services revenues were $697,581 versus
$100,901 in fiscal 1995, which represents a 591% increase in revenue. The
increases are attributed to increases in the number of Internet users worldwide
and increased market penetration of the Company's Central California area. PSNW
only operated from August to December in 1995 versus a full year in 1996.
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 as a result of reduced personnel and facilities expenses
after the Classic Line sale. The decreases may be somewhat offset by the
increases in operating expenses as the Company's Internet business grows.
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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
the building which the Company acquired under a 20-year capital lease. The net
interest expense is further increased as a result of a decrease in interest
income in 1996.
Financing Costs. Financing costs were $126,000 in 1996 which represented
the commission and expenses related to 400,000 shares of the Company's Common
Stock issued to the investors as additional compensation for the Common Stock
Placement. The Common Stock issued was valued at $3.75 per share and resulted in
a financing expense of $100,000 to the Company.
Liquidity and Capital Resources
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.
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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.
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ITEM 7. FINANCIAL STATEMENTS
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PROTOSOURCE CORPORATION
INDEX TO FINANCIAL STATEMENTS
Financial Statements Page
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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
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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
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 long-term debt 811,926
-----------
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) (272,228)
Financing costs -- (126,000)
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.
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 900,000 units of the Company's securities, each unit consisting
of one share of the Company's common stock and one redeemable common
stock purchase warrant. The offering price per unit will be the
average bid price of the common stock in the over-the-counter market
for the common stock on the day prior to the Offering. Each warrant is
exercisable to purchase one share of common stock at the public
offering price of the Units 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 135,000 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 $100, to purchase up to 90,000
units which shall be exercisable at a price per unit equal to 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. 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 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.
F-21
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- --------------------------------------------------------------------------------
FINANCIAL DISCLOSURE
- --------------------
None.
16
<PAGE>
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
- --------------------------------------------------------------------------------
WITH SECTION 16(a) OF THE EXCHANGE ACT
- --------------------------------------
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 41 Chief Executive Officer 1996
and Director
David A. Appell 34 Director 1997
Dickon Pownall-Gray (1) 43 Director 1997
- ----------
(1) Mr. Pownall-Gray has agreed to become a director of the Company following
completion of a public offering of the Company's securities (the "Offering")
which is currently the subject of a Registration Statement filed with the
Securities and Exchange Commission.
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.
17
<PAGE>
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
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 has agreed to 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) from the
University of Birmingham.
ITEM 10. EXECUTIVE COMPENSATION
- -------------------------------
None of the Company's executive officers or directors currently receive
compensation in excess of $100,000 per year except Mr. Meyers, 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. No executive officer or director received compensation in
excess of $100,000 for the calendar years ended December 31, 1997, 1996 or 1995.
Compensation for all officers and directors as a group for the calendar year
ended December 31, 1997, aggregated $130,008.
18
<PAGE>
The following table discloses certain compensation paid to the Company's
Chief Executive Officer for the calendar years ended December 31, 1997, 1996 and
1995.
<TABLE>
<CAPTION>
Summary Compensation Table
Long Term Compensation
Annual Compensation Awards Payouts
------------------- -----------------------
(a) (b) (c) (d) (e) (f) (g) (h) (i)
Name
and
Prin- Other All
cipal Annual Restricted Other
Posi- Compen- Stock Options/ LTIP Compen-
tion Year Salary($) Bonus($) sation($) Award(s)($) SARS(#) Payout sation($)
- --------- ---- --------- -------- --------- ----------- ------- ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Raymond J.
Meyers 1997 $130.008 $ 0 0 0 36,667 0 0
James C. 1996 61,925 0 0 0 0 0 0
Robinson 1995 61,425 5,941 0 0 0 0 0
</TABLE>
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 officers:
Individual Grants
% of Total Options
Granted to
Options Employees
Name Granted in Year Exercise Price Expiration Date
---- ------- ------- -------------- ---------------
Raymond J. Meyers 36,667 100% $3.75 October 2001
19
<PAGE>
Aggregate Option Exercise of Last Fiscal year and Fiscal Year-End Option Values
The following table provides information on the value of the named
executive officers' unexercised options at December 31, 1997. No shares of
Common Stock were acquired upon exercise of options during the fiscal year ended
December 31, 1997.
Value of
Number of Unexercised Unexercised In-The-Money
Options at Year End (1) Options at Year End (1)
Name Exerciable Unexercisable Exercisable Unexercisable
---- --------------------------- ---------------------------
Raymond J. Meyers 13,333 23,334 20,000 35,001
- -------------
(1) The closing price of the Common Stock on December 31, 1997 as reported by
on the Electronic Bulletin Board was $5.25.
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. At 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
20
<PAGE>
five years from the effective date of the Plan and the exercise date of an
option cannot be later than ten years from the date of grant. Any options that
expire unexercised or that terminate upon an optionee's ceasing to be employed
by the Company become available once again for issuance. Shares issued upon
exercise of an option will rank equally with other shares then outstanding.
As of the date of this Report, no options have been granted under the Plan.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- -----------------------------------------------------------------------
The following table sets forth information concerning the holdings of
Common Stock (without giving effect to any shares issuable upon exercise of the
Public Warrants or the Prior Representative's Unit Warrants) by each person who,
as of the date of this Report, holds of record or is known by the Company to
hold beneficially or of record, more than 5% of the Company's Common Stock, by
each director, and by all directors and executive officers as a group. All
shares are owned beneficially and of record and all share amounts include stock
options and common stock purchase warrants exercisable within 60 days from the
date hereof. The address of all persons is in care of the Company at 2300 Tulare
Street, Suite 210, Fresno, California 93721.
Amount of Percent of
Name Ownership Class
- --------------- ----------------- -----------------
Raymond J. Meyers (1) 13,333 2.0%
Andrew Chu(2) 38,999 5.5%
David A. Appell 0 0%
Dickon Pownall-Gray 0 0%
Steven A. Kriegsman(3) 117,667 15.0%
Anaka Prakash 38,667 5.8%
World Spirit, Inc. 50,000 7.5%
All officers and
directors as a
group (3 persons)(1) 13,333 2.0%
- ----------
(1) Represents stock options to purchase 13,333 shares at $3.75 per share at any
time until October 2001. Mr. Meyers holds an additional 23,334 stock options
which vest in 1998 and 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 "Item 12".
21
<PAGE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------------------------------------------------------
Management of the Company believes that the transactions described below
were no more or less fair than the terms of transactions which the Company might
otherwise have entered into with third party nonaffiliated entities. Any related
party transactions have been and will continue to be approved by a majority of
the disinterested members of the Company's Board of Directors.
In 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. 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. 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 Andrew, Alexander, Wise & Company, Inc. (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.
22
<PAGE>
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 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.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------
a. Exhibits:
Exhibit No. Title
- ----------- -----
2.01 Restated Articles of Incorporation of the Registrant (1)
2.02 Bylaws of the Registrant (1)
10.01 1995 Incentive Stock Option Plan (1)
10.02 Capitalized Lease Agreement (1)
10.12 Divestiture Agreement (2)
10.13 Selling Agreement with AAWC (2)
10.14 Warrant Agreement with AAWC (2)
10.15 Lock-up Agreement (2)
10.16 Registration Rights Agreement (2)
23
<PAGE>
10.17 Employment Agreement with Mr. Meyers (3)
10.18 Bridge Loan Agreement (3)
- ---------
(1) Incorporated by reference to the Registrant's Registration Statement on Form
SB-2 declared effective by the Commission on February 9, 1995, file number
33-86242.
(2) Incorporated by reference to the Registrant's Registration Statement on Form
SB-2, file number 333-20543, declared effective on May 14, 1997.
(3) Incorporated by reference to the Registrant's Registration Statement on Form
SB-2, file number 333-40743, filed February 10, 1998.
24
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
has duly caused this Report to be signed on its behalf by the undersigned,
thereunto duly authorized, in Fresno, California, on March 26, 1998.
PROTOSOURCE CORPORATION
By /s/ Raymond J. Meyers
-----------------------------------
Raymond J. Meyers
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Report has been signed below by the following persons on the dates
indicated.
Signature Title Date
--------- ----- ----
/s/ Raymond J. Meyers Chief Executive Officer, Chief March 24, 1998
- ------------------------ Financial Officer (Principal
Raymond J. Meyers Accounting Officer), and Director
/s/ David A. Appell Director March 24, 1998
- ------------------------
David A. Appell
25
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<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
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0
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