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, 1998 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
- ------------------------------- ---------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2800 28th Street, Suite 170
Santa Monica, California 90405
- ---------------------------------------- --------
(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
(Title of Class)
<PAGE>
Check whether the Registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the Registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days.
Yes X No
----- -----
As of February 28, 1999, 1,787,300 shares of the Registrant's no par value
Common Stock were outstanding. As of February 28, 1999, the market value of the
Registrant's no par value Common Stock, excluding shares held by affiliates, was
$12,511,100 based upon a closing bid price of $7.00 per share of Common Stock on
the Nasdaq SmallCap Market.
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
$882,651.
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, Web development, Web hosting and
related services to individuals, public agencies and businesses on a national
level. The Company operates its own Internet network facilities in Central
California and offers Internet access nationwide through two "backbone"
providers with which it has agreements. As of December 31, 1998, the Company had
approximately 3,700 subscribers for whom it provided Internet access. The
Company seeks to acquire other small Internet providers in markets with
populations less than 500,000. The Company believes that certain of these local
Internet providers currently doing business in the Company's target markets may
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 nationwide, (ii)
developing diversified services similar to its larger competitors, such as
special access packages for business and high speed access, and (iii) investing
in automated billing and administrative systems. The Company believes these
resources will not only allow it to compete effectively with larger access firms
entering the Company's markets, but also will facilitate the Company's efforts
to attract small Internet providers.
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. The Company also designed and sold customized computer
system configurations which integrated hardware and software. The Classic
product line together with the Company's design services and hardware and
software sales is collectively referred to as the "Classic Line."
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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 capacity to offer Internet
services nationwide and increased its subscribers to 3,700 at December 31, 1998.
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, (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.
In May 1998, the Company sold 1,137,000 units of its securities at $5.75
per unit (the "May 1998 Public Offering"). Each unit consisted of one share of
Common Stock and one redeemable Common Stock purchase warrant exercisable at
$6.33 per share until May 13, 2003.
In June 1998, the Company entered into a settlement agreement with SSC and
the SSC Principals pursuant to which it settled certain claims asserted by it
and the SSC Principals by accepting a $275,000 promissory note from the SSC
Principals payable interest only until June 2000. The interest payable portion
of the $275,000 promissory note is currently in default.
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The Company was incorporated in the State of California as SHR Corporation
in July 1988, and changed its name to "ProtoSource Corporation" in October 1994.
The Company's principal executive offices are located at 2800 28th Street, Suite
170, Santa Monica, California 90405, 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) providing Internet
consulting services, and (iii) 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 Company intends to continue to
provide low-priced direct Internet access through the Company's
telecommunication network infrastructure which is comprised of two high speed
dedicated data lines that connect directly to the backbone of the Internet. The
Company plans to add additional high-speed dedicated data lines, enhance
system-wide access software 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.
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.
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Acquisition Strategies
The Company will seek to acquire local Internet access providers in its
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 acquire or enter
into partnership or joint venture agreements with other small computer oriented
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.
Affinity group marketing is conducted through a dedicated sales force consisting
of two salesmen, one responsible for affinity group marketing in central
California, and the other responsible for marketing to affinity groups
nationwide. The Company offers a discount on its monthly rates to affinity group
members and pays a commission to the affinity group itself as a fund raising
function for the affinity group. The Company also seeks customers by direct and
telemarketing techniques, participating in industry trade shows and educational
seminars and through referrals from existing customers. In addition, the Company
seeks strategic alliances with computer retailers who offer Internet access fee
discounts to their customers and through joint advertising efforts with
television and radio stations.
Competition
The Internet services business is highly competitive and there are few
significant barriers to entry. Currently, the Company competes with a number of
national and local California Internet service providers. In addition, a number
of multinational corporations, including giant communications carriers such as
AT&T, MCI, Sprint and some of the regional Bell operating companies, are
offering, or have announced plans to offer, Internet access or on-line services.
The Company also faces significant competition from Internet access
consolidators such as Verio, Earthlink, MindSpring, and from on-line service
firms such as America OnLine (AOL) 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, MCI and PSI offer retail software
packages and AOL and Prodigy bundle their software with new PCs.
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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
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, 1998, the Company employed 19 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.
Year 2000 Issues
The Year 2000 issue revolves around the inability of many computer systems
to correctly process dates after December 31, 1999. In the 1960s and 1970s,
computer storage and memory were very expensive. To conserve resources and
space, programmers stored year information as two digits instead of four (e.g.,
"59" rather than "1959"). Beginning in the year 2000, these date fields will
need to accept four digit entries to distinguish 21st century dates from 20th
century (or earlier) dates. As a result, computer systems and/or software
products used by many companies may need to be upgraded to comply with Year 2000
requirements.
As defined by the Company, Year 2000 compliance refers to applications and
systems which are capable of correct identification, manipulation and
calculation using dates outside the 1900-1999 year range and have been tested as
such. In this regard, the Company recognizes the complexity and significance of
the Year 2000 issue and has created a project team comprised of internal
personnel to identify products and systems where the Year 2000 problem may exist
and to renovate, replace or retire those products or systems. The Company has
set September 30, 1999, as the target date for Year 2000 compliance for all of
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its major systems. The Company's Year 2000 compliance plan consists of four
phases: inventory, assessment, correction and testing. The Company is currently
in the assessment phase.
Taking inventory of the Company's entire business environment is the first
step in determining what additional steps need to be taken to successfully
transition the Company into the year 2000. The information compiled in the
inventory phase will be used to organize the next phase, assessment, in which
manufacturers of all inventoried items will be contacted to ascertain which
elements are Year 2000 compliant and which are not. Additionally, the Company is
gathering information about third party vendors and suppliers regarding their
progress in identifying and addressing problems that their computer systems may
face in correctly processing date information related to the Year 2000. The
assessment phase will in turn define what corrective action is necessary and how
time-consuming it will be.
Correction will consist of upgrading, replacing or repairing hardware and
software as appropriate. Testing and validation of systems will begin
immediately as components are brought into compliance.
Presently, the Company believes that the cost of addressing Year 2000
issues is not material to its future business, operating results or financial
position. However, the Company cannot predict whether third parties' inability
to meet their critical completion dates will adversely impact the Company's
September 30, 1999 target date. Further, in the event that any of the Company's
significant suppliers do not successfully and timely achieve Year 2000
compliance, the Company's business or operations could be adversely affected.
Moreover, the Company's expectations that it will be able to upgrade its systems
to address the Year 2000 issue and its expectation regarding associated costs
are forward-looking statements, and, as such, subject to a number of risks and
uncertainties.
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. In June 1998, the landlord canceled
the lease at the Company's request in exchange for a cash payment of $150,000
and delivery of the Company's 25% Common Stock interest in SSC.
The Company leases approximately 400 square feet for its corporate office
space at 2800 28th Street, Suite 170, Santa Monica, California 90405 on a
month-to-month lease for $1,025 per month. The Company also 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.
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ITEM 3. LEGAL PROCEEDINGS
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Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
Not applicable.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- -----------------------------------------------------------------
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." In May 1998, the Common Stock was again listed on the Nasdaq
SmallCap Market 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
- ----------------- ---- ---
March 31, 1999 (through February 28, 1999) ................ $7.25 $6.25
December 31, 1998 ......................................... $6.75 $5.38
September 30, 1998 ........................................ $5.50 $5.38
June 30, 1998 ............................................. $6.50 $5.38
March 31, 1998 ............................................ $5.81 $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
As of February 28, 1999, the Company had approximately 900 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
- ------- ---------------------------------------------------------
The Company provides Internet access and related services to individuals,
public agencies and businesses nationwide. As of December 31, 1998, the Company
had 3,700 subscribers for whom it provided Internet access.
Results of Operations
Year Ended December 31, 1998 vs. Year Ended December 31, 1997
Net Sales
For calendar 1998, Internet services revenues were $882,651 versus $749,796
in calendar 1997, an increase of 17.7%. The increase in revenue is primarily due
to an increase in the Internet access subscriber base and Web development
projects. Management believes revenues will continue to increase as the Company
(i) develops and implements marketing programs focusing on increasing name brand
recognition and differentiation of service offerings (i.e., Internet access, Web
site development and electronic commerce), and (ii) by entering into agreements
with or acquiring other computer oriented companies.
Operating Expenses
1998 operating expenses totaled $2,068,145 versus $1,818,698 in 1997. This
increase of $249,447 is primarily attributed to higher bad debt expense, network
lines, salary, legal, and advertising costs. The increase in network lines
expense of $81,370 is attributed to the expansion of the local Internet serving
area. Two new points of presence (POPs) were added during the year. Bad debt
expeense totaled $211,628 and was primarily attributed to a note receivable of
$273,000 that was deemed not collectable. The Company incurred approximately
$40,000 of legal fees associated with acquisition activities. In June 1998, the
Company canceled its Shaw Avenue Capital lease and its Visalia, California lease
resulting in lower depreciation, utility and property tax expense in the second
half of the year. Management has implemented several cost reduction or
containment steps but believes that operating expenses will increase as revenues
increase.
Operating Loss
The Company's 1998 operating loss totaled $1,185,494 versus $1,068,902 in
1997. This increase in operating loss of $116,592 is primarily attributed to bad
debt expense of $211,628 and lower than expected Internet access revenue growth.
Management believes that operating results will improve as revenues increase.
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Interest Expense (Net)
Net interest expense for 1998 totaled $577,261 versus $546,607 in 1997.
$561,059 of the 1998 interest expense total of $705,021 is attributable to the
expensing of 1998 debt issuance cost of $527,333 and associated interest expense
in connection with the 1997 Bridge Loan financing of $33,726. The majority of
the remaining 1998 interest expense ($114,143) is associated with the Shaw
Avenue capital lease that was canceled in June 1998. The interest expense was
somewhat offset by the interest earned on cash or short term investments of
$127,760. The Company believes that the cancellation of the capital lease and
the successful May 1998 sale of 1,137,000 units of the Company's securities (one
share of Common Stock and one warrant to purchase one share of Common Stock)
will substantially reduce future interest expense.
Other Income
Net other income decreased from $218,959 in 1997 to $73,479 in 1998. Net
other income for 1998 is comprised entirely of rental income on the sublease of
the Company's office building. The decrease of $145,480 net other income is a
result of the June 1998 cancellation of the Company's Shaw Avenue capital lease.
Management believes that with the cancellation of the Shaw Avenue capital lease
rental income will be eliminated from Other Income in future reporting periods.
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, 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 sub-lease of the Company's office
building. Rental income recognized from SSC totals $144,000, all of which was
collected in 1997.
Liquidity and Capital Resources
For the year ended December 31, 1998, the Company used cash of $798,167 for
operating activities. The Company had a working capital of $3,769,731 at
December 31, 1998. This surplus is primarily attributed to the May 1998 sale of
1,137,000 units of the Company's securities (one share of Common Stock and one
warrant to purchase one share of Common Stock) at $5.75. As of December 31,
1998, the Company had $3,885,884 in cash and cash equivalents and $351,025 of
total liabilities.
Capital expenditures relating primarily to the purchase of computer
equipment, furniture, fixtures and other assets amounted to $54,082 and $77,552
for the years ended December 31, 1998 and 1997, respectively. The capital
investment is mainly in computer equipment to sustain the future growth of the
Company.
The Company acquired computer equipment under capital leases totaling
$80,515 for its Internet operations during the year ended December 31, 1998. The
computer equipment acquired allows the Company to meet the requirements of their
customers.
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In connection with the cancellation of the Shaw Avenue capital lease, the
Company agreed to purchase 15,112 shares of its Common Stock from the landlord.
The stock was purchased in September 1998 for $77,165 ($5.11 per share) and was
subsequently retired to the corporate treasury.
ITEM 7. FINANCIAL STATEMENTS
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PROTOSOURCE CORPORATION
INDEX TO FINANCIAL STATEMENTS
Financial Statements Page
- -------------------- ----
Independent Auditors' Report F-2
Balance Sheet as of December 31, 1998 F-3
Statements of Operations for the years ended
December 31, 1998 and 1997 F-5
Statements of Changes in Stockholders' Equity for the
years ended December 31, 1998 and 1997 F-6
Statements of Cash Flows for the years ended
December 31, 1998 and 1997 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, 1998 and the related statements of operations, changes in
stockholders' equity and cash flows for the years ended December 31, 1998 and
1997. 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, 1998 and the results of its operations and its cash flows for the
years ended December 31, 1998 and 1997 in conformity with generally accepted
accounting principles.
Angell & Deering
Certified Public Accountants
Denver, Colorado
February 18, 1999
F-2
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PROTOSOURCE CORPORATION
BALANCE SHEET
DECEMBER 31, 1998
ASSETS
------
Current Assets:
Cash and cash equivalents $ 3,885,884
Accounts receivable - trade, net of allowance
for doubtful accounts of $7,500 54,099
Prepaid expenses and other 96,258
-----------
Total Current Assets 4,036,241
-----------
Property and Equipment, at cost:
Equipment 944,776
Furniture 122,083
Leasehold improvements 2,956
-----------
1,069,815
Less accumulated depreciation and amortization (655,543)
-----------
Net Property and Equipment 414,272
-----------
Other Assets:
Goodwill, net of accumulated amortization
of $4,839 16,406
Note receivable, net of allowance for uncollectibility
of $273,000 --
Deposits 15,824
-----------
Total Other Assets 32,230
-----------
Total Assets $ 4,482,743
===========
The accompanying notes are an integral
part of these financial statements.
F-3
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PROTOSOURCE CORPORATION
BALANCE SHEET
DECEMBER 31, 1998
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable $ 121,718
Accrued expenses:
Payroll taxes and wages 50,309
Other 10,288
Deferred revenue 13,747
Current portion of long-term debt 70,448
------------
Total Current Liabilities 266,510
------------
Long-Term Debt, net of current portion above:
Obligations under capital leases 154,963
Less current portion above (70,448)
------------
Total Long-Term Debt 84,515
------------
Commitments and contingencies --
Stockholders' 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, 1,787,300 shares issued and outstanding 10,884,194
Additional paid in capital 10,658
Accumulated deficit (6,763,134)
------------
Total Stockholders' Equity 4,131,718
------------
Total Liabilities and Stockholders' Equity $ 4,482,743
============
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, 1998 AND 1997
1998 1997
----------- -----------
Net Revenues:
Internet service fees and other $ 882,651 $ 749,796
----------- -----------
Total Revenues 882,651 749,796
Operating expenses 2,068,145 1,818,698
----------- -----------
Operating Loss (1,185,494) (1,068,902)
----------- -----------
Other Income (Expense):
Interest income 127,760 77,399
Interest expense (705,021) (624,006)
Rent and other income 73,479 218,959
Loss on disposal of assets (6,953) (2,018)
Other, net -- 368
----------- -----------
Total Other Income (Expense) (510,735) (329,298)
----------- -----------
Loss From Operations Before
Provision For Income Taxes (1,696,229) (1,398,200)
Provision for income taxes -- 72,350
----------- -----------
Net Loss $(1,696,229) $(1,470,550)
=========== ===========
Net Loss Per Share of Common Stock:
Basic $ (1.24) $ (2.49)
Diluted $ (1.24) $ (2.49)
Weighted Average Number of
Common Shares Outstanding:
Basic 1,365,484 589,702
Diluted 1,365,484 589,702
The accompanying notes are an integral
part of these financial statements.
F-5
<PAGE>
<TABLE>
<CAPTION>
PROTOSOURCE CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
Common Stock Additional
------------------------ Paid In Accumulated
Shares Amount Capital Deficit
------ ------ ------- -------
<S> <C> <C> <C> <C>
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)
Issuance of common stock and
warrants in public offering
(net of offering costs of
$1,166,846) 1,137,000 5,370,904 -- --
Repurchase of common stock
for cash (15,112) (77,165) -- --
Issuance of fractional shares
from 1997 stock splits 79 -- -- --
Issuance of stock options
to Directors -- -- 10,658 --
Net loss -- -- -- (1,696,229)
------------ ------------ ------------ ------------
Balance at December 31, 1998 1,787,300 $ 10,884,194 $ 10,658 $ (6,763,134)
============ ============ ============ ============
The accompanying notes are an integral
part of these financial statements.
F-6
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
PROTOSOURCE CORPORATION
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
1998 1997
----------- -----------
Cash Flows From Operating Activities:
<S> <C> <C>
Net loss $(1,696,229) $(1,470,550)
Adjustments to reconcile net loss to net cash
provided (used) by operating activities:
Depreciation and amortization 748,917 544,670
Provision for bad debts 173,000 107,500
Deferred income taxes -- 71,550
Compensation from issuance of stock options to Directors 10,658 --
(Gain) loss on disposal of equipment -- 2,018
Loss on termination of capital lease 6,953 --
Changes in operating assets and liabilities:
Accounts receivable (31,609) 20,563
Inventories -- 8,980
Deposits and other assets (34,550) 12,586
Accounts payable 25,611 (99,587)
Accrued liabilities (14,665) (191,966)
Customer deposits -- (1,500)
Deferred revenue 13,747 --
----------- -----------
Net Cash (Used) By Operating Activities (798,167) (995,736)
----------- -----------
Cash Flows From Investing Activities:
Purchase of property and equipment (54,082) (77,552)
Payment for termination of capital lease (150,000) --
Increase in note receivable (24,999) --
Receipt of principal on note receivable 250,817 207,579
----------- -----------
Net Cash Provided By Investing Activities 21,736 130,027
----------- -----------
Cash Flows From Financing Activities:
Payments on notes payable (828,095) (73,447)
Proceeds from borrowing -- 750,000
Issuance of common stock 6,537,750 970
Offering costs incurred (1,068,323) (98,523)
Debt issuance costs incurred -- (97,500)
Purchase of common stock (77,165) --
----------- -----------
Net Cash Provided By Financing Activities 4,564,167 481,500
----------- -----------
The accompanying notes are an integral
part of these financial statements.
F-7
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
PROTOSOURCE CORPORATION
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
1998 1997
---------- ----------
<S> <C> <C>
Net Increase (Decrease) in Cash and Cash Equivalents $3,787,736 $ (384,209)
Cash and Cash Equivalents at Beginning of Year 98,148 482,357
---------- ----------
Cash and Cash Equivalents at End of Year $3,885,884 $ 98,148
========== ==========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the year for:
Interest $ 222,737 $ 258,790
Income taxes 1,600 800
Supplemental Disclosure of Noncash
Investing and Financing Activities:
Acquisition of equipment under capital leases $ 80,515 $ 69,959
Issuance of common stock in connection with financing -- 750,000
</TABLE>
The accompanying notes are an integral
part of these financial statements.
F-8
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
------------------------------------------
Description of Business
-----------------------
ProtoSource Corporation, formerly SHR Corporation, doing business as
Software Solutions Company (the "Company"), was incorporated on July
1, 1988, under the laws of the state of California. The Company is an
Internet service provider.
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 date have been retroactively restated for
all periods presented to reflect the reverse stock splits.
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. Advance payments for web
development services received prior to completion of the services
performed are also recorded as deferred revenue until the services are
completed.
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.
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, 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 $220,168 and $223,086
for the years ended December 31, 1998 and 1997, 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 in 1996.
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
F-9
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies (Continued)
------------------------------------------------------
Investment (Continued)
---------------------
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. The Company disposed of its investment in connection with
the termination of its capital lease for its former office building.
Deferred Offering Costs
-----------------------
In connection with the Company's public offering (Note 4), costs
incurred to complete the offering were deferred and have been offset
against the proceeds of the offering which was completed in May 1998.
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
using the intrinsic value method prescribed by APB Opinion No. 25,
"Accounting for Stock Issued to Employees". See Note 8 for pro forma
disclosures of net income and earnings per share as if the fair
value-based method prescribed by SFAS No. 123 had been applied in
measuring compensation expense.
Long-Lived Assets
-----------------
In accordance with Statement of Financial Accounting Standards (SFAS)
No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of", the Company reviews for the
impairment of long-lived assets, certain identifiable intangibles, and
associated goodwill, whenever events or changes in circumstances
indicate that the carrying value of an asset may not be recoverable.
An impairment loss would be recognized when the estimated future cash
flows is less than the carrying amount of the asset. No impairment
losses have been identified by the Company.
Income Taxes
------------
Deferred income taxes are provided for temporary differences between
the financial reporting and tax bases of assets and liabilities using
enacted tax laws and rates for the years when the differences are
expected to reverse.
Net Income (Loss) Per Share of Common Stock
-------------------------------------------
As of December 31, 1997, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 128, "Earnings Per Share", which
specifies the method of computation, presentation and disclosure for
earnings per share. SFAS No. 128 requires the presentation of two
earnings per share amounts, basic and diluted.
Basic earnings per share is calculated using the average number of
common shares outstanding. Diluted earnings per share is computed on
the basis of the average number of common shares outstanding plus the
dilutive effect of outstanding stock options using the "treasury
stock" method.
The basic and diluted earnings per share are the same since the
Company had a net loss for 1998 and 1997 and the inclusion of stock
options and other incremental shares would be antidilutive. Options
and warrants to purchase 1,673,333 and 277,334 shares of common stock
F-10
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies (Continued)
------------------------------------------------------
Net Income (Loss) Per Share of Common Stock (Continued)
-------------------------------------------------------
at December 1998 and 1997, respectively were not included in the
computation of diluted earnings per share because the Company had a
net loss and their effect would be antidilutive.
Estimates
---------
The preparation of the Company's financial statements in conformity
with generally accepted accounting principles requires the Company's
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the
reported amount of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
3. Long-Term Debt
--------------
Long-term debt consists of the following:
Obligations Under Capital Leases
---------------------------------
11.1% to 23.0% installment notes due in 1999
to 2001, collateralized by equipment. $ 154,963
---------
Total Long-Term Debt 154,963
Less current portion of long-term debt (70,448)
---------
Long-Term Debt $ 84,515
========
Installments due on debt principal, including the capital leases, at
December 31, 1998 are as follows:
Year Ending
December 31,
1999 $ 70,448
2000 63,441
2001 21,074
--------
Total $154,963
========
3. Income Taxes
------------
The components of the provision for income taxes are as follows:
1998 1997
--------- --------
Current:
Federal $ -- $ --
State -- 800
--------- --------
Total -- 800
--------- --------
Deferred:
Federal -- 60,635
State -- 10,915
--------- -------
Total -- 71,550
--------- -------
Total Provision For Income Taxes $ -- $72,350
========= =======
F-11
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
3. Income Taxes (Continued)
------------------------
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:
1998 1997
---- ----
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,
1998 are as follows:
Net operating loss carryforward $ 1,876,900
Vacation accrual 6,500
Allowance for bad debts 96,200
------------
Total deferred tax asset 1,979,600
------------
Accelerated depreciation (32,300)
------------
Total deferred tax liability (32,300)
Less valuation allowance (1,947,300)
------------
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 $1,947,300 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
$516,420. The Company will continue to review this valuation on a
quarterly basis and make adjustments as appropriate.
At December 31, 1998, the Company had federal and California net
operating loss carryforwards of approximately $6,500,000 and
$3,300,000, respectively. Such carryforwards expire in the years 2007
through 2018 and 1999 through 2003 for federal and California
purposes, respectively.
4. Stockholders' Equity
--------------------
Public Stock Offering
---------------------
The closing for the Company's secondary offering occurred on May 20,
1998. The Company sold 1,137,000 units of the Company's securities at
$5.75 per unit and paid the Underwriter a 10% commission and a 3%
non-accountable expense allowance. Each unit consisted of one share of
the Company's common stock and one redeemable common stock purchase
warrant. Each warrant is exercisable to purchase one share of common
stock at $6.33 per share until May 13, 2003 and may be redeemed by the
Company anytime after May 13, 1999 if the closing price of the
Company's common stock is at least $8.63 per share for 20 consecutive
trading days.
F-12
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
4. Stockholder's Equity (Continued)
--------------------------------
Public Stock Offering (Continued)
---------------------------------
In connection with the offering, the Company issued the Underwriter a
warrant, for $10, to purchase up to 105,000 units which are
exercisable at $9.49 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 May 13, 1999. The units subject to the
Underwriter's warrant are identical to the units sold to the public.
The Company has also retained the Underwriter as a financial
consultant for a period of one year at a monthly fee of $5,000 (a
total of $60,000) which was paid in full upon completion of the
Offering.
5. Preferred Stock
---------------
The authorized preferred stock of the Company consists of 5,000,000
shares, no par value. The preferred stock may be issued in series from
time to time with such designation, rights, preferences and
limitations as the Board of Directors of the Company may determine by
resolution. The rights, preferences and limitations of separate series
of preferred stock may differ with respect to such matters as may be
determined by the Board of Directors, including without limitation,
the rate of dividends, method and nature of payment of dividends,
terms of redemption, amounts payable on liquidation, sinking fund
provisions (if any), conversion rights (if any), and voting rights.
Unless the nature of a particular transaction and applicable statutes
require approval, the Board of Directors has the authority to issue
these shares without shareholder approval.
6. Stock Options and Warrants
--------------------------
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. The stock
option plan expires in 2004. No options were granted under the Plan
prior to 1998. Under the Company's stock option plan, outstanding
options vest over three years from the grant date.
The following table contains information on the stock options under
the Company's plan for the year ended December 31, 1998. The
outstanding agreements expire from May 2004 to December 2004.
Number of Weighted Average
Shares Exercise Price
Options outstanding at December 31, 1997 -- $ --
Granted 56,750 5.75
Exercised -- --
Canceled (2,750) 5.75
------- -----
Options outstanding at December 31, 1998 54,000 $5.75
======= =====
Financing Warrants
------------------
As a part of a restructuring of its operations in 1996, the Company
granted an Underwriter and a financial consulting firm warrants to
purchase common stock. The warrants are exercisable at $3.75 per share
for a four year period through October 31, 2001. As of December 31,
1998, 186,666 warrants are outstanding.
F-13
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
6. Stock Options and Warrants (Continued)
-------------------------------------
Employment Warrants
-------------------
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 any time through October 2001.
Board of Directors Options
--------------------------
The Company issued 45,000 stock options to its three Non-Employee
Directors in October 1998. The options vest over a three year period
and are exercisable at $6.00 per share and the options are for a five
year term.
Underwriter Warrants
--------------------
In connection with the Company's IPO in 1995, the Company issued the
Underwriter a warrant to purchase 4,000 shares of the Company's
securities. The warrant is exercisable until February 9, 2000 at a
price of $99.00 per share.
Warrants From Secondary Offering
--------------------------------
The Company issued warrants in connection with a secondary offering of
its common stock (Note 4).
7. Commitments and Contingencies
-----------------------------
Leases
------
The Company leases certain computer equipment and furniture and
fixtures under noncancellable capital leases. The Company leases its
facilities and certain computer equipment under noncancellable
operating leases.
The following is a schedule of future minimum lease payments at
December 31, 1998 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
------------ ------ ------ -----
1999 $ 91,856 $ 53,841 $145,697
2000 73,493 54,918 128,411
2001 22,375 56,016 78,391
2002 -- 23,340 23,340
-------- -------- --------
Total Minimum Lease
Payments 187,724 $188,115 $375,839
======== ========
Less amount representing interest (32,761)
--------
Present Value of Net Minimum
Lease Payments $154,963
========
Rent expense amounted to approximately $62,703 and $69,806 for the
years ended December 31, 1998 and 1997, respectively.
F-14
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
7. Commitments and Contingencies (Continued)
-----------------------------------------
Leases (Continued)
------------------
Leased equipment under capital leases as of December 31, 1998 is as
follows:
Equipment $ 281,918
Less accumulated amortization (120,914)
---------
Net Property and Equipment Under Capital Lease $ 161,004
=========
The Year 2000
-------------
The Company is currently working to resolve the potential impact of
the Year 2000 on the processing of date-sensitive information by the
Company's computerized information systems. The Year 2000 problem is
the result of computer programs being written using two digits (rather
than four) to define the applicable year. Any of the Company's
programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000, which could result in
miscalculations or system failures. Costs of addressing potential
problems are expensed as incurred and are not expected to have a
material adverse impact on the Company's financial position, results
of operations or cash flows in future periods. However, if the Company
or its vendors are unable to resolve such processing issues in a
timely manner, it could result in a material financial risk.
Accordingly, the Company plans to devote the necessary resources to
resolve all significant Year 2000 issues in a timely manner. While the
Company does not at this time anticipate significant problems with
suppliers and customers, it is developing contingency plans with these
third parties due to the possibility of compliance issues.
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:
1998 1997
----------- ------------
Net Loss:
As reported $(1,696,229) $(1,470,550)
Pro forma $(1,732,742) $(1,507,063)
Net Loss Per Share of Common Stock:
As reported $ (1.24) $ (2.49)
Pro forma $ (1.27) $ (2.56)
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,
1998:
F-15
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
8. Stock-Based Compensation Plans (Continued)
-----------------------------------------
1998
----
Risk free interest rate 5.28%
Expected life 5.0 years
Expected volatility 41.25%
Expected dividend yield 0%
The Company did not grant any stock options in 1997.
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.
The weighted average fair value price of options granted in 1998 was
$2.48.
The following table summarizes information about stock-based
compensation plans outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------- -------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life-Years Price Exercisable Price
------ ----------- ---------- ----- ----------- -----
<S> <C> <C> <C> <C> <C> <C>
$5.75 54,000 5.50 $5.75 -- --
===== ====== ==== ===== ==== ====
</TABLE>
Compensation Expense
--------------------
The Company recorded compensation expense of $10,658 and $-0- for the
years ended December 31, 1998 and 1997, respectively, for the value of
certain options granted to Non-Employee Directors of the Company. The
valuation of the options and warrants granted to employees is based on
the difference between the exercise price and the market value of the
stock on the measurement date. The valuation of the options granted to
non-employees is estimated using the Black-Scholes option pricing
model.
9. Concentration of Credit Risk
----------------------------
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of temporary cash
investments and accounts receivable. The Company places its cash
equivalents and short term investments with high credit quality
financial institutions and limits its credit exposure with any one
financial institution. 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-16
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
10. 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 sold limited partnership units in Canada and
the promissory note was replaced by cash and promissory notes as the
units were sold.
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
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 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 since the Company, 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 in 1996.
11. 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 $3,070 and $1,799 for the years ended
December 31, 1998 and 1997, respectively. Company contributions vest
as follows:
Years of Service Percent Vested
---------------- --------------
1 33%
2 66%
3 100%
12. 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
F-17
<PAGE>
PROTOSOURCE CORPORATION
NOTES TO FINANCIAL STATEMENTS
12. Fair Value of Financial Instruments (Continued)
-----------------------------------------------
significantly affect the results. The following table presents a
summary of the Company's financial instruments as of December 31,
1998:
1998
---------------------------
Carrying Estimated
Amount Fair Value
---------- ----------
Financial Assets:
Cash and cash equivalents $3,885,884 $3,885,884
Financial Liabilities:
Long-term debt 154,963 154,963
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-18
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
- ------------------------------------------------------------------------
None.
15
<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 42 Chief Executive Officer 1996
Chief Financial Officer
and Director
David A. Appell 35 Director 1997
Andrew Stathopoulos 49 Director 1998
William Conis 52 Director 1998
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. Board members receive $100 per hour for time
expended on behalf of the Company including attendance at Board meetings. The
Company's audit committee is composed of all four members of its Board of
Directors. The Company's compensation committee is composed of Messrs.
Stathopoulos and Conis.
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.
16
<PAGE>
David A. Appell became a Director of the Company in September 1997. Since
January 1997, he has served as an investment banker first for the underwriter of
the Company's May 1998 public offering and subsequently, for Mercury Equity.
Since February 1992, he has also 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.
Andrew Stathopoulos has over 25 years experience in finance, operations,
marketing, mergers and acquisitions, engineering, manufacturing and consulting.
In March 1998, he joined the Bank of New York as a Vice President to launch a
software and hardware vendor management program. He is also currently involved
in the Bank's efforts to meet Year 2000 compliance. From 1996 to 1997, he was
Vice President of Finance for New Alliance Corp., an emerging markets investment
bank specializing in Eastern Europe. He was responsible for financial reporting,
internal audit and controls, mid-office and back-office operations, information
systems, and management reporting. From 1994 to 1996, he was Vice President of
Business Development for Nautical Technology Corp., an independent software
developer for the maritime industry. He was responsible for developing and
implementing a new marketing and sales program, seeking strategic partners and
providing general business advice. Also, from 1994 to 1996, he was Vice
President of Business Development for Interbank of New York, a Greek commercial
bank where he was responsible for identifying and marketing new products and
pursuing new business opportunities. From 1992 to 1994, he was the Vice
President of Finance and Administration for Societe Generale Energie, an oil
trading products firm. He was responsible for establishing financial controls,
accounting and reporting procedures; monitoring cash flow and working capital
requirements; managing human resources administration; and dealing with
auditors, insurers and vendors. From 1989 to 1991, he was a principal of Forest
Development, a privately-held investment and consulting group. From 1985 to
1989, he was the Director of Business Development and Planning for Empire Blue
Cross and Blue Shield, a leading health insurer. From 1977 to 1985, he was
Director of Assets Management for Ogden Corporation, a diversified conglomerate.
From 1973 to 1977, he held positions in finance, planning and engineering for
International Paper, a leading manufacturer of paper and wood products. Mr.
Stathopoulos holds a BS degree in Industrial Engineering and an MBA degree in
Finance and International Business, both from Columbia University.
17
<PAGE>
William Conis has been Vice President--Eastern Region of Hitachi Data
Systems since July 1997, and was Hitachi's New York-based District Manager from
July 1995 to July 1997. From 1984 to July 1995, Mr. Conis was a senior
consultant for the Kappa Group. He earned a Bachelor's degree and Master's
degree in Electrical Engineering from New York University in 1968 and 1971,
respectively.
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 $140,000 per year pursuant to
an Employment Agreement which expires on June 30, 1999. The Employment Agreement
also provides for (i) a cash bonus to Mr. Meyers of up to 20% of his salary
based upon certain increases in the Company's revenues and (ii) the issuance of
10,000 stock options exercisable at $6.00 per share for each increase of 3,500
in the number of the Company's Internet access subscribers. 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. Other than Mr. Meyers, no executive officer or
director received compensation in excess of $100,000 for the calendar years
ended December 31, 1998 or 1997. Compensation for all officers and directors as
a group for the calendar year ended December 31, 1998, aggregated $158,753.
The following table discloses certain compensation paid to the Company's
Chief Executive Officer for the calendar years ended December 31, 1998 and 1997.
<TABLE>
<CAPTION>
Summary Compensation Table
Long Term Compensation
Annual Compensation Awards Payouts
------------------- ------------------------
(a) (b) (c) (d) (e) (f) (g) (h) (i)
Name
and
Prin- Other All
cipal Annual Restricted Other
Posi- Compen- Stock Options/ LTIP Compen-
tion Year Salary($) Bonus($) sation($) Award(s)($) SARS(#) Payouts($) sation($)
- ----- ---- --------- -------- --------- ----------- ------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Raymond J.
Meyers 1998 $140,003 -0- -0- -0- -0- -0- -0-
1997 $130,000 -0- -0- -0- 36,667 -0- -0-
</TABLE>
18
<PAGE>
Option Grants in Last Year and Stock Option Grant
The following table provides information on option grants during the year
ended December 31, 1998, 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 -0- 0% ----- ----
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, 1998. No shares of
Common Stock were acquired upon exercise of options during the fiscal year ended
December 31, 1998.
Value of
Number of Unexercised Unexercised In-The-Money
Options at Year End (1) Options at Year End (1)
Name Exercisable Unexercisable Exercisable Unexercisable
---- --------------------------- ---------------------------
Raymond J. Meyers 26,666 10,001 $66,665 $25,003
(1) The closing price of the Common Stock on December 31, 1998, as reported by
on the Nasdaq SmallCap Market was $6.25.
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, 1998, 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.
19
<PAGE>
The per share exercise price of the Common Stock may not be less than the
fair market value of the Common Stock on the date the option is granted. No
person who owns, directly or indirectly, at the time of the granting of an
incentive stock option, more than 10% of the total combined voting power of all
classes of stock of the Company is eligible to receive incentive stock options
under the Plan unless the option price is at least 110% of the fair market value
of the Common Stock subject to the option on the date of grant.
No options may be transferred by an optionee other than by will or the laws
of descent and distribution, and during the lifetime of an optionee, the option
may only be exercisable by the optionee. Options may be exercised only if the
option holder remains continuously associated with the Company from the date of
grant to the date of exercise. Options under the Plan must be granted within
five years from the effective date of the Plan and the exercise date of an
option cannot be later than ten years from the date of grant. Any options that
expire unexercised or that terminate upon an optionee's ceasing to be employed
by the Company become available once again for issuance. Shares issued upon
exercise of an option will rank equally with other shares then outstanding.
As of the date of this Report, 54,000 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 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 2800 28th Street, Suite 170, Santa Monica, California
90405.
Amount of Percent of
Name Ownership Class
- --------------- ---------- ------------
Raymond J. Meyers (1) 36,667 2.0%
David A. Appell (2) 5,000 .3%
Andrew Stathopoulos (3) 5,000 .3%
William Conis -0- 0.0%
All officers and
directors as a
group (4 persons)(1)(2)(3) 46,667 2.5%
(1) Represents stock options to purchase 26,666 shares at $3.75 per share at
any time until October 2001. Mr. Meyers holds an additional 10,001 stock
options which vest in 1999.
20
<PAGE>
(2) Represents stock options to purchase 5,000 shares at $6.00 per share at any
time until November 2003.
(3) Represents stock options to purchase 5,000 shares at $6.00 per share at any
time until November 2003.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
Management of the Company believes that the transactions described below
were no less fair than the terms of transactions which the Company might
otherwise have entered into with third party nonaffiliated entities. All related
party transactions must 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 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 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. ("AAWC") 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. AAWC
subsequently assigned 56,667 of such warrants to Howard P. Silverman, a former
director of the Company, for his assistance to AAWC 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 AAWC a cash
commission of 10% of the gross proceeds raised ($150,000) and a nonaccountable
expense allowance of 3% of such gross proceeds ($45,000). In June 1997, AAWC and
Mr. Silverman returned 106,667 warrants to the Company without consideration.
In January 1997, the Company sold the remaining assets of the Classic Line
to SSC Technologies, Inc. ("SSC") for $770,850 evidenced by a promissory note
bearing interest at 10% per annum payable in January 2007, and the assumption by
SSC of all the liabilities of the Classic Line and certain other liabilities,
aggregating approximately $500,000. Under the terms of the asset sales agreement
21
<PAGE>
(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. 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 AAWC, (iii) agreed to sublease office
space from the Company at a monthly rental of $12,000 through February 28, 1998,
(iv) granted to Steven A. Kriegsman, 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.
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)
10.17 Employment Agreement with Mr. Meyers (3)
10.18 Bridge Loan Agreement (3)
10.19 Incentive Compensation Plan (Mr. Meyers)
22
<PAGE>
(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.
23
<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 Santa Monica, California, on March 26, 1999.
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 March 26, 1999
- -------------------------- Chief Financial Officer
Raymond J. Meyers (Principal Accounting
Officer), and Director
/s/ David A. Appell Director March 26, 1999
- --------------------------
David A. Appell
/s/ Andrew Stathopoulos Director March 26, 1999
- --------------------------
Andrew Stathopoulos
/s/ William Conis Director March 26, 1999
- --------------------------
William Conis
24
Exhibit 10.19
ProtoSource Corporation
CEO Incentive Compensation Plan
December, 1998
-------------------------------------------------------
There are two components to the CEO Incentive Compensation Plan. These two
components consist of first, the growth in the subscriber base and second, the
growth of the top line gross revenue of the Company. The current CEO employment
agreement is extended until June 30, 1999. The terms of the Incentive
Compensation Plan are described as follows:
1. Growth of Subscriber Base.
--------------------------
A. December 1, 1998 through June 30, 1999. If by June 30, 1999, the
subscriber base of the Company increases from the November 30, 1998, base as set
forth below, then the CEO will receive:
(1) If the subscriber base increases by 3,500 during this period,
an extension of his current employment agreement to December 31, 1999, on the
same terms and conditions as now in effect;
(2) If the subscriber base increases by 3,500 during this period,
options to purchase 10,000 shares of
the common stock of ProtoSource at a purchase price of $6.00 per share. The
options shall be granted effective as of the date that the subscriber base is
increased by 3,500 subscribers (the ?Effective Date?). The options shall be
fully vested if on the date 90 days following the Effective Date, the net
increase in the subscriber base remains at 3,500 or greater.
(3) If the subscriber base increases by 7,000 during this period,
in addition to the options set forth above in Section A(2), options to purchase
an additional 20,000 shares of the common stock of ProtoSource at a purchase
price of $6.00 per share (for a total of 30,000 options). The options shall be
granted effective as of the Effective Date. These additional options shall be
fully vested if on the date 90 days following the Effective Date, the net
increase in the subscriber base remains at 7,000 or greater.
(4) If the subscriber base increases by 10,500 during this
period, in addition to the options set forth above in Sections A(2) and A(3), an
extension of his current employment agreement to December 31, 2000, on the same
terms and conditions as now in effect. In addition to the options set forth
above in Section A(2) and A(3), options to purchase an additional 20,000 shares
of the common stock of ProtoSource at a purchase price of $6.00 per share (for a
total of 50,000 options). The options shall be granted effective as of the
Effective Date. These additional options shall be fully vested if on the date 90
days following the Effective Date, the net increase in the subscriber base
remains at 10,500 or greater.
3
<PAGE>
(5) For each additional block of 3,500 subscribers over 10,500,
options to purchase an additional 20,000 shares of the common stock of
ProtoSource at a purchase price of $6.00 per share on the same terms and
conditions described above.
B. December 1, 1998 through December 31, 1999. The bonuses described
above will be effective if they are achieved by June 30, 1999, and will be paid
only if the targets are achieved by that date. However, for those targets that
are met after June 30, 1999 but before December 31, 1999, then the following
bonuses will be earned by the CEO:
(1) If the subscriber base increases by 3,500 during this period,
options to purchase 10,000 shares of the common stock of ProtoSource at a
purchase price of $6.00 per share. The options shall be granted effective as of
the Effective Date. The options shall be fully vested if on the date 90 days
following the Effective Date, the net increase in the subscriber base remains at
3,500 or greater; and
(2) If the subscriber base increases by 7,000 during this period,
in addition to the options set forth above in Section B(1), options to purchase
an additional 10,000 shares of the common stock of ProtoSource at a purchase
price of $6.00 per share (for a total of 20,000 options). The options shall be
granted effective as of the Effective Date. These additional options shall be
fully vested if on the date 90 days following the Effective Date, the net
increase in the subscriber base remains at 7,000 or greater.
(3) If the subscriber base increases by 10,500 during this
period, in addition to the options set forth above in Sections B(1) and B(2), an
extension of his current employment agreement to December 31, 2000, on the same
terms and conditions as now in effect. In addition to the options set forth
above in Section B(1) and B(2), options to purchase an additional 20,000 shares
of the common stock of ProtoSource at a purchase price of $6.00 per share (for a
total of 40,000 options). The options shall be granted effective as of the
Effective Date. These additional options shall be fully vested if on the date 90
days following the Effective Date, the net increase in the subscriber base
remains at 10,500 or greater.
(4) For each additional block of 3,500 subscribers over 10,500,
options to purchase an additional 10,000 shares of the common stock of
ProtoSource at a purchase price of $6.00 per share on the same terms and
conditions described above.
<PAGE>
2. Growth of Top Line Corporate Gross Revenue. It is anticipated that
1998 gross revenue for the ProtoSource will be approximately $1,000,000. During
calendar year 1999, so long as CEO does not voluntarily resign at any time
during the applicable quarter, CEO will be paid a quarterly performance bonus
based on overall ISP related gross revenue growth on an accrual basis. All bonus
amounts are payable within 30 days after the end of the quarter.
If, in any quarter, corporate gross revenue increases by 30% from the
previous quarter, the CEO will be paid a cash bonus of 5% of his
annual salary.
If, in any quarter, corporate gross revenue increases by 40% from the
previous quarter, the CEO will be paid a cash bonus of 7.5% of his
annual salary.
If, in any quarter, corporate gross revenue increases by 50% from the
previous quarter, the CEO will be paid a cash bonus of 10% of his
annual salary.
If, in any quarter, corporate gross revenue increases by 60% from the
previous quarter, the CEO will be paid a cash bonus of 12.5% of his
annual salary.
If, in any quarter, corporate gross revenue increases by 70% from the
previous quarter, the CEO will be paid a cash bonus of 15% of his
annual salary.
If, in any quarter, corporate gross revenue increases by 80% from the
previous quarter, the CEO will be paid a cash bonus of 17.5% of his
annual salary.
If, in any quarter, corporate gross revenue increases by 90% from the
previous quarter, the CEO will be paid a cash bonus of 18.75% of his
annual salary.
If, in any quarter, corporate gross revenue increases by 100% from the
previous quarter, the CEO will be paid a cash bonus of 20% of his
annual salary.
<PAGE>
The Company and the CEO agree that in order for the CEO to have a
reasonable opportunity to meet the bonus schedules set forth in this
Agreement, the Company will have to engage in various acquisitions and
expanded marketing efforts. The CEO agrees to present opportunities
that he reasonably believes are in the best interests of the Company.
The Company agrees that it will proceed in good faith to pursue
business proposals that the CEO presents to the Company. So long as
the proposals make reasonable business sense for the Company in
fulfilling its corporate objectives, the Company will make the funding
available to allow the Company to accomplish these goals.
Authorized on behalf of the Board of Directors of ProtoSource
Corporation:
/s/ William Conis 1/20/99
------------------------------- --------
William Conis, Director Date
/s/ A. Stathopolus 1/20/99
------------------------------- --------
Andrew Stathopolus, Director Date
Employee:
/s/ Raymond Meyers 1/20/99
------------------------------- --------
Raymond Meyers, CEO Date
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 3,885,884
<SECURITIES> 0
<RECEIVABLES> 61,599
<ALLOWANCES> 7,500
<INVENTORY> 0
<CURRENT-ASSETS> 4,036,241
<PP&E> 1,069,815
<DEPRECIATION> 655,543
<TOTAL-ASSETS> 4,482,743
<CURRENT-LIABILITIES> 266,510
<BONDS> 84,515
0
0
<COMMON> 10,884,194
<OTHER-SE> (6,752,476)
<TOTAL-LIABILITY-AND-EQUITY> 4,482,743
<SALES> 0
<TOTAL-REVENUES> 882,651
<CGS> 0
<TOTAL-COSTS> 2,068,145
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 211,628
<INTEREST-EXPENSE> 705,021
<INCOME-PRETAX> (1,696,229)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,696,229)
<EPS-PRIMARY> (1.24)
<EPS-DILUTED> (1.24)
</TABLE>
