U.S. SECURITIES and EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-KSB


  {X} Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
                                   Act of 1934

                   For the fiscal year ended December 31, 2006

     { } Transition report pursuant to Section 13 or 15(d) of the Securities
                              Exchange Act of 1934

       For the transition period from                to
                                      ---------------   ---------------

                          Commission File No. 000-25594

                             PROTOSOURCE CORPORATION
                  --------------------------------------------
                 (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)

     One Bethlehem Plaza, 4th Floor
        Bethlehem, Pennsylvania                            18018
 --------------------------------------                   --------
(Address of principal executive offices)                 (Zip Code)

                    Issuer's telephone number: (610) 814-0550

        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
                               Class A and Class B

Check whether the issuer is not required to file reports pursuant to Section 13
or 15(d) of the Exchange Act. [ ]

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 [   ]
     ---

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/A or any amendment to
this Form 10-KSB. [ X ]
]

Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the exchange Act). Yes [ ] No [ X ]
                                             ---

The Registrant's revenues for its most recent fiscal year were $2,641,492.

A of December 31, 2006, the market value of the Registrant's no par value Common
Stock, excluding shares held by affiliates, was $378,635 based upon a closing
bid price of $0.04 per share of Common Stock on the OTC Bulletin Board.

      APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING
                           THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant filed all documents and reports
required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act
of 1934 after the distribution of securities under a plan confirmed by a court.
Yes [   ]  No  [   ]


                      APPLICABLE ONLY TO CORPORATE ISSUERS:

As of December 31, 2006, 9,927,329 shares of the Registrant's no par value
Common Stock were outstanding.

DOCUMENTS ARE INCORPORATED BY REFERENCE:
None.

Transitional Small Business Disclosure Format (check one):  Yes [   ]  No [ X ]






                                       2
<PAGE>


                             PROTOSOURCE CORPORATION

                     ANNUAL REPORT UNDER SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006
--------------------------------------------------------------------------------


                                      INDEX
                                      -----
                                                                       Page
                                                                       ----
PART  I

Item  1. Description of Business.                                        4

      2. Description of Property.                                        8

      3. Legal Proceedings.                                              8

      4. Submission of Matters to a Vote of Security Holders.            8

PART  II

Item  5. Market for Common Equity and Related Stockholder Matters
           and Small Business Issuer Purchases of Equity Securities.     9

      6. Management's Discussion and Analysis or Plan of Operation.     10

      7. Financial Statements.                                       F-1 to F22

      8. Changes in and Disagreements with Accountants on
            Accounting and Financial Disclosure.                        15

      8A. Controls and Procedures.                                      15

      8B. Other Information.                                            15

PART  III

Item  9. Directors, Executive Officers, Promoters and Control
           Persons; Compliance with Section 16(a) of
           the Exchange Act.                                           16

     10. Executive Compensation.                                       17

     11. Security Ownership of Certain Beneficial Owners and
            Management and Related Stockholder Matters.                21

     12. Certain Relationships and Related Transactions, and
                  Director Independence.                               22

     13. Exhibits.                                                     23

     14. Principal Accountant Fees and Services.                       24


Signatures, Certifications, and Code of Ethics and Business Conduct:

         Signatures.                                                  25

         Certifications.                                              26

         Exhibit 99.1 - Code of Ethics and Business                   28
         Conduct for Officers, Directors and Employees
         of ProtoSource Corporation.


                                       3
<PAGE>


                                     PART I

ITEM 1. DESCRIPTION OF BUSINESS.

The following is a summary of certain information contained in this Report and
is qualified in its entirety by the detailed information and financial
statements that appear elsewhere herein. 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 periodic reports filed by
ProtoSource Corporation, a California corporation (the "Company"), with the
Securities and Exchange Commission (the "Commission"). The forward-looking
statements included in the Report speak only as of the date hereof.

The Company's reports as filed with the Commission under the Securities Exchange
Act of 1934 are currently under review by the Commission. The Company has made
certain responses to the Commission, but there can be no assurances that
additional changes will not be required to be included in the Company's
previously filed reports or in this Form 10-KSB. Any such changes will be
reflected in amended filings made after the date hereof.


Introduction
------------

ProtoSource's long-term business strategy is to focus on the delivery of
technologically sophisticated, database-driven, business-to-business services
and solutions, capitalizing on the technology acquired through the 2004 merger
with P2i Newspaper and its operational resources at the Company's Malaysian
facility.

ProtoSource's subsidiary, P2i Newspaper LLC (P2i Newspaper) specializes in the
large volume conversion of print and other content into a variety of databased,
digital formats, which can then be distributed or hosted according to customer
needs. Our proprietary system allows for the normalization of diverse forms of
data including text and graphics, which can be integrated by a seamless,
dynamic, and highly customizable front-end interface. This allows our customers
to re-purpose their data for new revenue generation and to enhance productivity
by enabling them to more effectively use, manage and share information, and to
provide an enhanced interactivity with and greater satisfaction to their
customers.

Executing this strategy starts with the state-of-the-art facility owned and
operated by ProtoSource subsidiary P2i Newspaper, located south of Kuala Lumpur,
Malaysia. This facility employs almost 100 staff utilizing proprietary
applications and processes.

The primary business of P2i Newspaper is the mining, management and databasing
of print content for the publishing industry, and its distribution via the
Internet. Every day of the week, 52 weeks a year, electronic files are received
from clients. These are processed overnight for delivery the following morning.
Data is delivered not only to P2i's Web servers for seamless integration into
our clients' existing, hosted Web sites, but also distributed back to clients
and their business partners in a wide range of formats to fit their evolving
needs.

Using the P2i Newspaper acquisition as its cornerstone, ProtoSource continues to
pursue its goal to become a leader in the transfer of print content into
database-driven electronic content. Newspapers, retailers, other publishers and
government offices in the US and UK turn to P2i Newspaper for a variety of
solutions. The online presentation and Web enablement of ProtoSource's client's
content is the key to efficient, effective Web presence, and the ensuing
revenues and profits such a presence will yield. ProtoSource takes the same
electronic files that generate print output, and uses them to publish the
identical content online, adding myriad user-friendly features that are unique
to Web-based presentations. This cost-effective solution perfectly transfers the
client's known brand identity to the Internet, and integrates into the delivery
all the inherent E-commerce, interactive and database features needed to
maximize its impact and benefits.

ProtoSource's primary target client base comprises businesses that create large
volumes of print content as part of their core operations, already recognize the
value of Web-based distribution and either need the tools and support to
implement a Web strategy, or already have one that is too expensive and/or
ineffective. The secondary target client base comprises companies that need
significant numbers of technically-oriented staff to process data, provide tech
support, convert graphics, etc.

                                       4

<PAGE>


History
-------

Through April 2002, the Company operated psnw.com, a full-service Internet
service provider with primary offices in Fresno, California. psnw.com provided
three types of services to business customers:

1. Reselling high-speed Internet access via ADSL/SDSL;
2. Web design, development and hosting services; and
3. Outsourced technical support for other ISPs.

On May 1, 2002, the Company entered into a conditional agreement to sell the
assets of the psnw.com business to Brand X Networks, Inc. ("Brand X"). Brand X
is a privately-held California-based company whose principal shareholders were
former employees of the Company. The Company agreed to lay off the remaining
employees based in Fresno on April 30th, 2002. Most terminated employees were
hired by Brand X. Additionally, Brand X assumed financial and operational
responsibility for the ISP business. On April 14, 2003, the Company completed a
fifth amendment to the purchase agreement with Brand X pursuant to which the
Company agreed to accept an aggregate payment of $632,000 for the ISP Division,
less credits to Brand X of $112,686. Of such amount, $200,000 shall be paid
through the provision of services to the Company from Brand X.

On January 1, 2004, the sale of the ISP business to Brand X closed. Under the
terms of that agreement a promissory note of $284,455 was executed by Brand X to
be paid in 55 equal, monthly installments. This note is secured by a pledge of
shares in Brand X. In addition ProtoSource was entitled to appoint one person to
the board of Brand X for the duration of the agreement.

In February 2006, still within terms of the purchase agreement, Brand X notified
ProtoSource that it would be unable to make its next payment on its note payable
obligation and could not then specify when the next payment(s) would be
forthcoming. Subsequently, ProtoSource discovered that Brand X had become
insolvent and was unable to meet its obligations to ProtoSource and, as a
consequence, was unable to cure its default status on its note payable
obligation and, therefore, of the purchase agreement itself. At December 31,
2005, ProtoSource assessed the collectibility of the remaining note receivable
balance of $162,582 and its unused services credit balance of $151,308 and
determined that collection or realization of any portion of these amounts was
highly doubtful and their values should be written down to $0. As a consequence,
the Company recorded a provision for Brand X's uncollectible note and services
credit in the amount of $313,890 in 2005.

In an agreement dated March 2006, ProtoSource sold, assigned and transferred the
promissory note it held in respect of the January 2004 sale of its ISP business
to Brand X Networks, Inc. to P2i, Inc., a related party. As set forth in this
transaction, a new promissory note, secured by all the assets of Brand X
Networks, inc., was issued to P2i, Inc. in the net amount of $162,582. The
principal with interest shall be paid in 33 equal monthly installments of
$5,172, until completely paid. This arrangement was approved by the Company's
board of directors: The Board decided that, because there are too many unknown
liabilities attachable to Brand X Networks, the Company would not risk bringing
Brand X Networks into ProtoSource. Because regular payments have not been made,
this successor note is in default and has been fully reserved.

A key part of the Company's strategy was the acquisition of P2i Newspaper. On
February 13, 2003, the Company announced an agreement and plan of merger to
acquire all of the outstanding capital stock of P2i Newspaper, Inc., a Delaware
corporation headquartered in Bethlehem, Pennsylvania ("P2i Newspaper") and a
wholly owned subsidiary of P2i, Inc., a Pennsylvania corporation ("P2i"), in
exchange for the issuance of up to 19,383,531 shares of ProtoSource common stock
(the "Agreement").

On January 1, 2004, the acquisition of P2i's newspaper business closed with the
issuance of 193,836 preferred shares of ProtoSource. Each share of preferred
stock is convertible into the right to receive 100 shares of ProtoSource common
stock at any time after the authorized number of shares of common stock is
increased to 500,000,000 shares.

Upon closing of the transaction, ProtoSource appointed Thomas Butera, President
of P2i, as a director of ProtoSource. Mr. Butera, together with Peter Wardle,
President of ProtoSource, shall have the right to appoint three members to the
board of directors of ProtoSource.

                                       5
<PAGE>


P2i Newspaper became a wholly owned subsidiary of the Company on January 1,
2004. P2i Newspaper is a leader in the conversion of print content into Web
content, and its clients include newspapers from the Tribune, McClatchy Copley
and Gannett newspaper groups in the US, Northcliffe and Tindle newspaper groups
in the UK, as well as many others. In addition to its headquarters in
Pennsylvania, P2i Newspaper has a data conversion center located in the
Multimedia Super Corridor in Kuala Lumpur, Malaysia.


Business of ProtoSource
-----------------------

Executing the Company's business strategy starts with the state-of-the-art
facility operated by ProtoSource subsidiary P2i Online Sdn Bhd, located south of
Kuala Lumpur, Malaysia. This business unit employs almost 150 staff utilizing
proprietary applications and processes. Major clients include newspapers from
the Tribune, McClatchy and Gannett publishing organizations, as well as
retailers and government offices in North America and the UK.

The primary business is the mining, management and databasing of print content
for the publishing industry, and its distribution via the Internet. Each day of
the week, 52 weeks a year, the Company receive's electronic files from clients.
These are processed overnight for delivery the following morning. Data is
delivered not only to the Company's Web servers for seamless integration into
clients' existing, hosted Web sites, but also distributed back to clients and
their business partners in a wide range of formats to fit their ever evolving
needs. The combination of low labor costs, a well-educated labor pool fluent in
English, and sophisticated technologies make the Company highly competitive.

Of the 1,600 daily newspapers in the US, almost all are putting content online
to some degree as are many of the approximately 4,500 weekly papers that are
available online. Utilizing proprietary technologies, the Company converts
print-ads and editorial content into interactive, online content that is
seamlessly incorporated into existing newspaper Web sites. All newspaper print
ads are first created electronically at the newspaper, merged with
electronically created editorial, paginated using sophisticated software, edited
on a local or wide area network and transmitted electronically to the printing
presses. At the end of every business day Newspaper customers send to the
Company's processing facility in Malaysia, via FTP, the same electronic versions
of ads and pages that they send to their printing presses. These files are
processed, quality-checked and delivered to the hosting servers by the start of
the following business morning.

The production process uses highly sophisticated, proprietary tools to segment
and database text and graphics that comprise the elements of P2i Newspaper's
dynamic Web page solution. As users click their way through the finished Web
content, pages are built dynamically from the databased content. This
facilitates a range of features including search, sort and browse functionality.
The business model is quite straightforward. Clients pay per ad/page processed,
and are billed monthly.

Through 2007, the Company will continue to focus on increasing market share in
the newspaper vertical and targeting government, retail and manufacturing
verticals. The Company believes it can grow its business over the next five
years from these vertical markets.


Industry and Competition
------------------------

E-commerce overview

For most businesses, the Internet has created a new communication and sales
channel that enables companies to interact with large numbers of geographically
dispersed consumers and businesses. Traditional businesses are implementing
sophisticated Web sites to drive customers to brick-and-mortar stores, effect
electronic commerce initiatives that offer competitive advantages and mine
customer data. These businesses are deploying an expanding variety of
Internet-enabled applications, ranging from Web site marketing and recruiting
programs to on-line customer interaction systems and integrated purchase order
and just-in-time inventory solutions for key customers and suppliers. These
capabilities require increasingly complex Web sites and support operations. In
addition, advances in on-line security and payment mechanisms are alleviating
concerns associated with conducting transactions in an open-platform
environment, thus prompting more consumers and businesses to use the Internet in
conjunction with purchases and more businesses to offer a greater breadth of
electronic commerce services.


                                       6

<PAGE>


More importantly, companies today recognize that the Internet is not going to
replace other media, nor is it going to replace traditional shopping and
purchasing habits. Rather, today, companies are implementing integrated
marketing strategies that tie print, TV, Radio and Internet together to generate
revenues either via mail order, traditional shopping or e-commerce.


Newspapers

Newspapers have been putting virtually all of their classified liner advertising
online for several years, using primarily, software solutions that generate the
online content from the newspaper's own print content.

The online publishing of display advertising, run-of-print advertising ("ROP"),
special sections and free-standing-inserts ("FSIs") has evolved into an
application-service-provider ("ASP") business model whereby newspapers want a
technology driven solution with a high level of service and support from their
vendor. Much of this content is printed in color, has a high profile within the
print publication and is very costly to the advertiser.

The key driver of demand for these services is the statistical data that now
confirms the online readership of newspaper content over and above print
circulation. In addition, traditional newspaper revenues from advertising are
under assault from the new online giants such as Monster.com, eBay and others.
Implementing effective online solutions is perceived as critical by most
newspapers.

Customers demand a high level of interactivity and enhanced features from online
versions of this print advertising. Developing and enabling these solutions
requires a substantial financial investment in both R&D and servers,
connectivity and processes that is best justified when amortized across many
newspapers. Indications are that these costs are deemed prohibitive to
individual newspapers, and even newspaper groups, but that they are keen to use
an outside resource to deliver these solutions. P2i Newspaper has proprietary
processes that position us well to acquire a significant share of this market.

These solutions have become increasingly more sophisticated, evolving into
online shopping centers or channels where newspaper site visitors can search and
browse across many ads from multiple sources: display classified, ROP, FSIs and
special sections. Additionally, newspapers are developing their own platforms,
licensing solutions and looking at partners who provide more than one solution.

Recognizing this, P2i Newspaper has positioned itself to deliver processed
content in a variety of formats so that it can be incorporated into many
solutions, Web sites and platforms at the same time.


Competition

Infosis, a company P2i, Inc. acquired in September 2000, was the first company
to establish a presence in this business space. As the revenue models have
proved to be viable, competitors have emerged. Some, such as Harvest and
Print2Web, adopted very similar strategies to that of P2i pre-2004, selling
directly to the newspapers, delivering ever increasingly sophisticated
solutions. Others, such as WSN and Travidia, are approaching the retailers
directly to convert their FSI content and then act as the distributor of this
content to newspapers.

Companies such as Daily Shopper and Saleshound (now combined as one entity,
ShopLocal) are also moving into this space having been acquired by Tribune,
Gannett and Knight-Ridder in 2004. Their original strategy was to aggregate
sales content from newspaper inserts and stores, publish it online within a
destination site and attract visitors. These original business models are now
gaining traction and newspapers today are looking at ways to commingle online
newspaper ads and inserts.

Secondary competition comes from the software companies that have developed ad
management systems for newspapers, such as Mactive and Olive. Newspapers use
their solutions to manage their ad content and they could include modules that
would publish the content online. There are certainly many applications that can
publish classified liner ads online automatically from the ad management
function, but none that can provide the level of sophistication that ASP
solutions feature.


                                       7
<PAGE>


There are many obstacles to newspapers adopting pure software solutions to
compete with P2i Newspaper's service capabilities. Firstly, ads are created in
many different ways, even within a single newspaper. Some are submitted
electronically from advertising agencies and design firms. Others are created by
the newspaper's own creative departments. Some are in color, some in black and
white. FSI's are usually created by agencies or print companies specializing in
that field, and the newspaper only receives the printed versions, rarely the
electronic versions. The "normalization" of incoming data is a key component of
the proprietary processes P2i Newspaper has developed. Once the content has been
processed, the functionality requires the various applications that power those
features to be running on the host server. Finally there is a human element to
the publishing of this content: every individual ad and page needs to be viewed
by an operator to ensure that the multiple images and text boxes that are
incorporated in a single newspaper page are matched.

As difficult as it would be for a newspaper to take the services and solutions
that P2i Newspaper has available in-house using a software solution only, in the
years ahead, as the volume of online advertising content increases, more and
more newspapers and newspaper groups will look for such a solution. P2i
Newspaper recognizes that it may need to modify its services to meet the
newspaper's evolving needs.


As of December 31, 2006, P2i Newspaper had a combination of 141 full-time and
part time employees. Of such employees, 3 were engaged in marketing and sales, 7
were devoted to research, development and technical support, 125 to production
services and 6 were responsible for management, finance and administration. None
of the Company's employees are covered by a collective bargaining agreement. The
Company considers its relations with its employees to be good.



ITEM 2. DESCRIPTION OF PROPERTY.

The Company occupies 1,500 square feet of office space at One Bethlehem Plaza,
Bethlehem, PA 18018, and 6,400 square feet of office space in an office park
south of Kuala Lumpur, Malaysia.


ITEM 3. LEGAL PROCEEDINGS.

Not applicable.


ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

Not applicable.


                                       8

<PAGE>


                                     PART II

ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS
ISSUER PURCHASES OF EQUITY SECURITIES.

Since March 2002, all of our securities have traded on the OTC Bulletin Board.
The following table sets forth, for the periods indicated, the high and low
sales price per share of our common stock and our common stock purchase
warrants.

For the quarter ended:  Common Stock       Class A Warrants     Class B Warrants
----------------------  ------------       ----------------     ----------------
                        High      Low        High      Low         High    Low
                        ----      ---        ----      ---         ----    ---

March 31, 2005        $0.04    $0.04       N/A      N/A          N/A     N/A
June 30, 2005         $0.05    $0.05       N/A      N/A          N/A     N/A
September 30, 2005    $0.05    $0.05       N/A      N/A          N/A     N/A
December 31, 2005     $0.04    $0.04       N/A      N/A          N/A     N/A

March 31, 2006        $0.06    $0.06       N/A      N/A          N/A     N/A
June 30, 2006         $0.06    $0.06       N/A      N/A          N/A     N/A
September 30, 2006    $0.06    $0.06       N/A      N/A          N/A     N/A
December 31, 2006     $0.04    $0.04       N/A      N/A          N/A     N/A


As of March 15, 2007, there were approximately 466 record and beneficial owners.


DIVIDEND POLICY

We have not paid any cash dividends on our common stock and we currently intend
to retain any future earnings to fund the development and growth of our
business. Any future determination to pay dividends on our common stock will
depend upon our results of operations, financial condition and capital
requirements, applicable restrictions under any credit facilities or other
contractual arrangements and such other factors deemed relevant by our Board of
Directors.


EQUITY COMPENSATION PLAN INFORMATION

The following table sets forth information about the shares of the Company's
common Stock that may be issued upon the exercise of options granted to
employees under option plans which were approved by the Board of Directors, as
well as shares that may be issued upon the exercise of options under the plans
that were issued to consultants, which were not approved by the Board of
Directors.
<TABLE>
<CAPTION>


---------------------------------------- ------------------------ ------------------------ --------------------------
                                          Number of securities       Weighted average        Number of securities
Plan category                               to be issued upon       exercise price of       remaining available for
                                               exercise of          outstanding options,      future issuance under
                                           outstanding options,     warrants and rights       equity compensation
                                           warrants and right                                  plans (excluding
                                                                                             securities reflected in
                                                                                                  column (a)
---------------------------------------- ------------------------ ------------------------ --------------------------
                                                   (a)                      (b)                       (c)
---------------------------------------- ------------------------ ------------------------ --------------------------
<S>                                                 <C>                      <C>                    <C>
Equity compensation plans approved by              -0-                      -0-                     350,000
security holders
---------------------------------------- ------------------------ ------------------------ --------------------------
Equity compensation plans not approved             -0-                      -0-                     150,000
by security holders
---------------------------------------- ------------------------ ------------------------ --------------------------
Total                                              -0-                      -0-                     500,000
---------------------------------------- ------------------------ ------------------------ --------------------------
</TABLE>


                                       9
<PAGE>


ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.

The statements contained in this Form 10-KSB are not purely historical
statements, but rather include what we believe are forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These include
statements about our expectations, beliefs, intentions or strategies for the
future, which are indicated by words or phrases such as anticipate, expect,
intend, plan, will, we believe, the Company believes, management believes and
similar words or phrases. The forward-looking statements are based on our
current expectations and are subject to certain risks, uncertainties and
assumptions, including factors set forth in the following discussion and in the
discussions under Risk Factors and Business. Our actual results could differ
materially from results anticipated in these forward-looking statements. All
forward-looking statements included in this document are based on information
available to us on the date hereof, and we assume no obligation to update any
such forward-looking statements.


RESULTS OF OPERATIONS
---------------------

Year Ended December 31, 2006 vs. Year Ended December 31, 2005

Net Revenues - For the year ended December 31, 2006, net revenues were
$2,641,492 versus $1,938,924 for the year ended December 31, 2005. All revenues
of the Company were attributed to the operations of P2i Newspaper acquired by
the Company on January 1, 2004. The $702,568 increase in revenues over the
previous year is largely attributable to a sales effort that focused on media
companies within the newspaper vertical that have a demand for the conversion of
large volumes.


Operating Costs And Expenses - For the year ended December 31, 2006, operating
costs and expenses totaled $2,581,770 versus $1,845,841 in 2005. Higher
production expenditures necessary to meet the approximately 36% increase in
revenues accounted for much of the increase in operating costs and expenses, but
cost of revenues as a percentage of revenues rose about 8% over its level in
2005. This was due to a combination of factors: An unfavorable change in the
Malaysian Ringgit exchange rate, expansion of plant facility overhead to meet
existing and future anticipated rises in production volumes and new low-margin
service capabilities. In addition to these changes, a larger than needed
production staff was maintained to meet anticipated volumes not fully realized
in 2006 and severance costs were incurred that related to the termination of P2i
Online's general manager.

During 2006, selling, general and administrative expenses increased
approximately $187,000 over the previous year due to the following significant
expenditure components: About $120,000 of officer advances were taken
(reclassified) as compensation, approximately $16,000 of doubtful accounts was
recorded over 2005, approximately $41,000 greater research and development costs
were incurred, and about $17,000 in overseas travel expense was recorded over
the previous year. These increases were offset by reductions in various other
categories, the most significant being the cost of directors and officers
liability insurance. In 2006, operating costs and expenses included a $23,604
loss on disposal of computer equipment. {Administrative costs principally
consist of the Company's management office and personnel, professional fees
associated with maintenance of the Company, and officers' and directors'
liability insurance costs.}


Interest Expense - Interest expense totaled $356,854 for the year ended December
31, 2006 versus interest expense of $368,230 in 2005. Interest expense is
principally the result of the convertible notes obtained during 2004, 2003, and
2002 to fund operations of the Company and that of P2i Newspaper before and
after the January 2004 merger. As there had been no new debt issues since April
2004, the current year reflects no amortization of debt issue costs, while 2005
shows only residual amortization of historical debt issue costs.


Other Income (Charges) - In 2006, other income included a $13,800 recovery of
the Brand X note receivable written off in 2005. In 2005, Other (charges)
included a $313,890 write-down of the balances of both the notes receivable and
services credit relating to the January 1, 2004 sale of the ISP business to
Brand X. (See "Discontinued Operations" for further explanation of this.) In
2005, other income included a write-off of approximately $64,000 of open
accounts payable (originally recorded prior to 2003) found to be invalid.


                                       10
<PAGE>


Discontinued Operations - Effective May 1, 2002, the Company entered into an
agreement to sell substantially all of the assets of the ISP division to Brand X
Networks, Inc., a California Corporation, for $632,000. The assets have been
held and operated by Brand X Networks, Inc. for its purposes since May 1, 2002,
at which time the Company discontinued its ISP operations. On April 14, 2003,
the Company completed a fifth amendment to the purchase agreement with Brand X
pursuant to which the Company agreed to accept an aggregate payment of $632,000
for the ISP Division, less credits to Brand X of $112,686. Of such amount,
$200,000 was to be paid through the provision of services to the Company from
Brand X. And the balance was to be paid at the rate of approximately $5,172 per
month, until completely paid.

On January 1, 2004, the sale of the ISP business to Brand X closed. Under the
terms of that agreement a promissory note of $284,455 was executed by Brand X to
be paid in 55 equal monthly installments. This note is collateralized by a
pledge of shares in Brand X. In addition, ProtoSource was entitled to appoint
one person to the board of directors of Brand X for the duration of the
agreement. The assets sold and liabilities assumed with respect to this sale
were removed from Company's books and a $475,454 gain on disposal of the ISP was
recorded during the quarter ended March 31, 2004.

In February 2006, still within terms of the purchase agreement, Brand X notified
ProtoSource that it would be unable to make its next payment on its note payable
obligation and could not then specify when the next payment(s) would be
forthcoming. Subsequently, ProtoSource discovered that Brand X had become
insolvent and was unable to meet its obligations to ProtoSource and, as a
consequence, was unable to cure its default status on its note payable
obligation and, therefore, of the purchase agreement itself. At December 31,
2005, ProtoSource assessed the collectibility of the remaining note receivable
balance of $162,582 and its unused services credit balance of $151,308 and
determined that collection or realization of any portion of these amounts was
highly doubtful and that their values should be written down to $0. As a
consequence, the Company recorded a provision for Brand X's uncollectible note
and services credit in the amount of $313,890 in 2005.

In an agreement dated March 2006, ProtoSource sold, assigned and transferred the
promissory note it held in respect of the January 2004 sale of its ISP business
to Brand X Networks, Inc. to P2i, Inc., a related party. As set forth in this
transaction, a new promissory note, secured by all the assets of Brand X
Networks, Inc., was issued to P2i, Inc. in the net amount of $162,582. The
principal with interest shall be paid in 33 equal monthly installments of
$5,172, until completely paid. Because regular payments have not been made, this
successor note is in default status and has been fully reserved. During the
whole of 2006, ProtoSource recovered $13,800 from the P2i, Inc. / Brand X
Networks, Inc. promissory note arrangement. As the value of this note was
written down to $0 at December 31, 2005, these collected payments were
classified as "other income" in 2006.


Liquidity and Capital Resources
-------------------------------

We assess liquidity by our ability to generate cash to fund our operations.
Significant factors that affect the management of our liquidity include: current
balances of cash, expected cash flows provided by operations, current levels of
our accounts receivable and accounts payable balances, access to financing
sources and our expected investment in equipment.

For the year ended December 31, 2006, we used approximately $36,000 more cash
than was generated or obtained from the Company's working capital resources
during the year. Despite a net loss of approximately $304,000, cash flows
provided by operations for the year ended December 31, 2006 were approximately
$85,000. This was due to non-cash charges of approximately $93,000 included in
the net loss, aided by approximately $296,000 net positive changes in components
of working capital. The non-cash charges consisted chiefly of approximately
$53,000 of depreciation and amortization, approximately $16,000 provision for
bad debts, and approximately $24,000 recorded loss on disposal of property and
equipment. With respect to net positive, year-over-year, changes in working
capital components, the most significant positive contributor to working capital
was approximately $396,000 increase in accrued expenses. The vast portion of
this is attributable to approximately $337,000 of interest arising from the
Company's convertible debt obligations that was accrued but unpaid. About
$43,000 pertained to an increase in accrued payroll and about $24,000 is due to
a rise in accounts payable and miscellaneous accrued items. However,
substantially offsetting these positive components was approximately $107,000
increase in outstanding accounts receivable arising from the Company's higher
level of revenues. Except for about $16,000 reserved as uncollectible, accounts
receivable as reported at year-end are current.

                                       11
<PAGE>


We had negative cash flows from investing activities of approximately $140,000.
There are two substantial reasons for this: approximately $60,000 pertained to
property and equipment purchased for an expanded production facility in Malaysia
and approximately $89,000 was provided to a related party during the year ended
December 31, 2006. These negative cash flows were slightly offset by a net
decrease in officer advances.

In respect to financing activities, during the year ended December 31, 2006, we
used approximately $25,000. This was entirely due to payments on capital lease
obligations.

As of December 31, 2006, we had $4,842 in cash, $397,313 in accounts receivable
and other current assets. Taken together with $4,044,795 of total current
liabilities, this resulted in a negative working capital position of $3,642,640
at December 31, 2006.


During 2002, the Company entered into an agreement with AAWC to act as a
placement agent for the sale of convertible notes aggregating $1,300,000. The
notes are secured by stock in P2i Newspaper, Inc. and accrue interest at 10% per
annum. The Company pays the cost and obligations of the first $200,000 incurred
with this financing and P2i Newspaper, Inc. has agreed to pay all remaining
costs and obligations. Through December 31, 2003, $1,225,000 in funding had been
completed. AAWC was paid a 10% commission and a 3% non-accountable expense.
Substantially all of the proceeds from these notes have been loaned to P2i,
Newspaper Inc. The loans were in the form of demand notes accruing interest at
8% per annum. These loans, with their related interest receivable, were written
off in 2003.

During May 2003, the Company entered into an agreement with Carl R. Butera for
the sale of a convertible note aggregating $200,000. The note is secured by
stock in P2i Newspaper, Inc. and accrues interest at 10% per annum.
Substantially all of the proceeds from this note have been loaned to P2i
Newspaper, Inc. The loans were in the form of a demand notes accruing interest
at 8% per annum. These loans, with their related interest receivable, were
written off in 2003.

During the twelve-month period ended December 31, 2003, the Company entered into
certain agreements with AAWC to act as a placement agent for the sale of
convertible notes aggregating $700,000. The notes are secured by stock in P2i
and accrue interest at 10% per annum. P2i has agreed to pay the related costs
and obligations. Through December 31, 2003, $600,000 in funding had been
completed; an additional $100,000 was completed during January 2004. AAWC was
paid a 10% commission and a 3% non-accountable expense. Substantially all of the
proceeds from these notes have been loaned to P2i Newspaper, Inc. The loans were
in the form of demand notes accruing interest at 8% per annum. These loans, with
their related interest receivable, were written off in 2003.

During 2004, the Company entered into certain agreements with AAWC to act as a
placement agent for the sale of convertible notes aggregating $500,000, of which
$300,000 was raised during the first and second quarters of 2004. These notes
accrue interest at 10% per annum. AAWC was paid a 10% commission and a 3%
non-accountable expense. These notes, and all other notes, are secured by the
assets of ProtoSource and P2i Newspaper.

On October 15, 2005, the Company entered into a 24-month term capital lease
agreement with Bankers Capital for the purchase of computer and computer related
items valued at $27,767 with monthly lease payments of $1,596 each. The lease
term expires September 14, 2007 and the residual maturity date is October 15,
2007 with a $1.00 purchase option. $3,487 was paid to Bankers Capital at the
start of the lease to cover the first payment, one payment held for a security
deposit, and for UCC filing and documentation fees. Company officers, Peter A.
Wardle and Thomas C. Butera, are personal guarantors of this agreement.

On July 15, 2006, the Company entered into a 24-month term capital lease
agreement with Bankers Capital for the purchase of computer and computer related
items valued at $26,827 with monthly lease payments of $1,521 each. The lease
term expires June 14, 2008 and the residual maturity date is July 15, 2008 with
a $1.00 purchase option. $3,438 was paid to Bankers Capital at the start of the
lease to cover the first payment, one payment held for a security deposit, and
for UCC filing and documentation fees. Company officers, Peter A. Wardle and
Thomas C. Butera, are personal guarantors of this agreement.


                                       12
<PAGE>


Recently Issued Accounting Standards
------------------------------------

In March 2005, the FASB issued FASB Interpretation ("FIN") No. 47, "Accounting
for Conditional Asset Retirement Obligations". FIN No. 47 requires an entity to
recognize a liability for a conditional asset retirement obligation when
incurred if the liability can be reasonably estimated. The Interpretation also
clarifies that the term Conditional Asset Retirement Obligation refers to a
legal obligation to perform an asset retirement activity in which the timing
and/or method of settlement are conditional on a future event that may or may
not be within the control of the entity. FIN No. 47 also clarifies when an
entity would have sufficient information to reasonably estimate the fair value
of an asset retirement obligation. FIN No. 47 has not had a material impact on
our financial condition or results of operations.

In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections", which changes the requirements for the accounting and reporting of
a change in accounting principle. The statement requires retrospective
application to prior period financial statements of changes in accounting
principle, unless impracticable to do so. It also requires that a change in the
depreciation, amortization, or depletion method for long-lived non-financial
assets be accounted as a change in accounting estimate, effected by a change in
accounting principle. Accounting for error corrections and accounting estimate
changes will still be handled according to guidance in APB Opinion 20,
"Accounting Changes", as carried forward in this pronouncement. The statement is
effective for fiscal years beginning after December 15, 2005. SFAS No. 154 has
not had a material impact on the Company's financial condition or results of
operations.

In July 2006, the FASB issued FIN No. 48, "Accounting for Uncertainty in Income
Taxes - An Interpretation of SFAS No. 109". FIN No. 48 clarifies the accounting
for uncertainty in income taxes recognized in an enterprise's financial
statements in accordance with SFAS No. 109, "Accounting for Income Taxes." FIN
No. 48 also prescribes a recognition threshold and measurement attribute for
financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. In addition, FIN No. 48 provides guidance
on derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. The provisions of FIN No. 48 are to be
applied to all tax positions upon initial adoption of this standard. Only tax
positions that meet the more-likely-than-not recognition threshold at the
effective date may be recognized or continue to be recognized as an adjustment
to the opening balance of accumulated deficit (or other appropriate components
of equity) for that fiscal year. The provisions of FIN No. 48 are effective for
fiscal years beginning after December 15, 2006. The Company is evaluating the
impact of the adoption of FIN 48 but does not currently expect the adoption of
this new standard to have a material impact on our financial position, results
of operations, or cash flows.

In September 2006, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulleting ("SAB") 108, to address diversity in practice in
quantifying financial statement misstatements. SAB 108 requires that the Company
quantify misstatements based on their impact on each of its financial statements
and related disclosures. SAB 108 is effective for fiscal years ending after
November 15, 2006. The Company has adopted SAB 108 effective as of January 31,
2007. The adoption of this bulletin did not have a material impact on our
financial position, results of operations, or cash flows.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements". SFAS
No. 157 provides guidance for using fair value to measure assets and
liabilities. It also responds to investors' requests for expanded information
about the extent to which companies measure assets and liabilities at fair
value, the information used to measure fair value, and the effect of fair value
measurements on earnings. SFAS No. 157 applies whenever other standards require
(or permit) assets or liabilities to be measured at fair value, and does not
expand the use of fair value in any new circumstances. SFAS No. 157 is effective
for financial statements issued for fiscal years beginning after November 15,
2007 and is required to be adopted by the Company in the first quarter of 2008.
The Company is currently evaluating the effect that the adoption of SFAS No. 157
will have on our financial position, results of operations, or cash flows.


                                       13

<PAGE>


Critical Accounting Policies and Estimates
------------------------------------------

Management's discussion and analysis of its financial position and results of
operations are based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires
management to make estimates and assumptions that affect the reported amounts of
assets, liabilities, revenue and expenses and related disclosure of contingent
assets and liabilities. The significant accounting policies which we believe are
the most critical to aid in fully understanding and evaluating our reported
financial results include the following:

In accordance with SFAS No. 109, "Accounting for Income Taxes", the Company
maintains a valuation allowance of $5,400,000 as of December 31, 2006 on
deferred tax assets relating to its net operating losses which the Company has
not determined to be more likely than not realizable.

In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets",
goodwill is not amortized, rather, management tests goodwill annually for
impairment in the fourth quarter.

The Company considers certain trade accounts receivable to be of doubtful
collection; accordingly, the Company has a $15,892 allowance for doubtful
accounts. The Company considers the balances of its note receivable of $162,582
and its unused services credit of $151,308 as uncollectible or unrealizable;
accordingly, a $313,890 allowance for doubtful accounts was recorded in 2005.

In consideration of SEC Proposed Rule Release 33-8098, the Company does not
maintain estimates for sales returns or credits, cancellations and warranties.
Due to the peculiar nature of the type of services provided and the underlying
processes employed by the Company to create and deliver completed product
(without defect) to its customers, there is no material exposure to what would
be classified as sales returns or credits. Likewise, cancellations and or
warranties are not significantly measurable in respect to the type of electronic
product (internet Website content) deliverable to the Company's customers; and
historically, there has been no basis or need for such.



ITEM 7. FINANCIAL STATEMENTS.

The consolidated financial statements of ProtoSource Corporation for the years
ended December 31, 2006 and 2005 are included in this Report following the
signature page of this Report:

   Cover Page                                                      F-1
   Report of Independent Registered Public Accounting Firm         F-2
   Consolidated Balance Sheet as of December 31, 2006              F-3
   Consolidated Statement of Operations
    for the years ended December 31, 2006 and 2005                 F-4
   Consolidated Statement of Stockholders' (Deficiency)
    for the years ended December 31, 2006 and 2005                 F-5
   Consolidated Statement of Cash Flows
    for the years ended December 31, 2006 and 2005.                F-6 to F-7
   Notes to Consolidated Financial Statements                      F-8 to F-22





                                       14
<PAGE>


ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

None.


ITEM 8A. CONTROLS AND PROCEDURES.

Evaluation of disclosure controls and procedures.

An evaluation was performed under the supervision and with the participation of
our management, including the chief executive officer and the chief financial
officer, of the effectiveness of the design and operation of our disclosure
procedures. Based on management's evaluation as of the end of the period covered
by this Annual Report, our principal executive officer and chief financial
officer have concluded that our disclosure controls and procedures (as defined
in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act") were sufficiently effective to ensure that the
information required to be disclosed by us in the reports that we file under the
Exchange Act is gathered, analyzed and disclosed with adequate timeliness,
accuracy and completeness.


Changes in internal controls.

There have been no changes in our internal controls or in other factors that
could significantly affect these controls subsequent to the date of the
evaluation referred to above, nor were there any significant deficiencies or
material weaknesses in our internal controls. Accordingly, no corrective actions
were required or undertaken except as disclosed.


ITEM 8B. OTHER INFORMATION.

None.



                                       15

<PAGE>


                                    PART III


ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(a) OF THE EXCHANGE ACT.

Executive Officers, Directors, Director Nominees And Key Employees

Our executive officers, directors and key employees and their ages and positions
with us are as follows:

NAME                               POSITION
----                               --------
Peter Wardle,     52             Chief Executive Officer, President,
                                   Chief Financial Officer and Director
Thomas Butera,    40             Chief Operating Officer and Director
Joseph DiMarino,  64             Director
Mark Blanchard,   54             Director
Stewart Kalter,   36             Director


Peter Wardle became a director in December 2001 and was appointed as Chief
Executive Officer, Chief Financial Officer and President in May 2002. Mr. Wardle
was Chief Executive Officer of P2i, Inc. from May 2000 through December 2003.
Mr. Wardle served as Chief Executive Officer of 2020 Marketing and Design from
1993 when he co-founded the company until December 2003. Prior to that, Mr.
Wardle served as a database marketing consultant form 1990 to 1993. From 1987 to
1990, he was Chief Executive Officer of Autoroos, Inc. Mr. Wardle received a
degree in accounting from Stockport College in the UK in 1978.

Thomas C. Butera was appointed as Chief Operating Officer and a director of the
Company in January 2004. From 1993 until December 2003, Mr. Butera was creative
director of 2020 Marketing and Design. From December 2001 through December 2003,
Mr. Butera served as an executive of P2i, Inc. Since May 2003, Mr. Butera has
served as Chief Operating Officer of P2i Newspaper, Inc. Mr. Butera is a
graduate of Parsons School of Design in New York City.

Joseph DiMarino was appointed as a director of the Company in August 2003. Mr.
DiMarino began his newspaper career in 1970 with the Philadelphia Inquirer,
which is a Knight Ridder newspaper. Mr. DiMarino held various executive
positions with Knight Ridder, Inc. from 1970 until June 2002. From August 2002
until May 2003, Mr. DiMarino was Chief Operating Officer of P2i Newspaper, Inc.
Since May 2003, Mr. DiMarino has provided consulting services to the newspaper
industry. Mr. DiMarino is a graduate of Villanova University.

Mark Blanchard has been a member of the Company's Board since May 2002. Mr.
Blanchard was a co-founder and has been President of Resort TV Services since
July 2003. Prior to that he was Vice President and General Manager of
ProtoSource's former Suncoast division, a business he helped founding 1998. From
1995 to 1998 he was founder and President of Internet Stock Market Inc., which
facilitated the promotion of public companies. From 1992 to 1995, Mr. Blanchard
was founder and President of Pension Specialists Management Group, a company
that advised pension funds on investments. From 1979 to 1992, Mr. Blanchard held
several positions with Raymond James and Associates, and Smith Barney, full
service brokerage firms. His final position with Smith Barney was Senior Vice
President of Municipals. He graduated from Rutgers University with a degree in
business in 1976.

Stewart Kalter became a director in October 2001. Since May 2003, Mr. Kalter has
served as President of Vision Securities. From May 2001 through May 2003, Mr.
Kalter served as Director of Corporate Finance and Research of Andrew,
Alexander, Wise & Company, Inc. Prior to that, he was Director of Research at
Global Capital Securities from February 2000 to March 2001. Mr. Kalter was a
Research Analyst with Spencer Clarke from November 1997 to January 2000. From
1995 until 1997, he served as a Research Associate with Bishop Allen. Mr. Kalter
has a BS in Accounting from Widener College and an MBA in Finance and Banking
from Hofstra University.


                                       16
<PAGE>


Section 16(A) Beneficial Ownership Reporting Compliance.

Section 16(a) of the Exchange Act requires the Company's executive officers and
directors and persons who own more than 10% of a registered class of the
Company's equity securities to file reports of their ownership thereof and
changes in that ownership with the Securities and Exchange Commission and the
National Association of Securities Dealers, Inc. Executive officers, directors
and greater than 10% stockholders are required by SEC regulations to furnish the
Company with copies of all such reports they file.

Based solely upon a review of Forms 3 and 4 and amendments thereto furnished to
the Company pursuant to Rule 16a-3(e) under the Exchange Act, no persons during
the last fiscal year failed to file on a timely basis.


Code of Ethics.
The Company has adopted its Code of Ethics and Business Conduct for Officers,
Directors and Employees, that applies to all of the officers, directors and
employees of the Company. The Code of Ethics is filed as an exhibit to this
Report on Form 10-KSB.


ITEM 10. EXECUTIVE COMPENSATION.

The following table discloses certain compensation paid to the Company's Chief
Executive Officers and certain other officers for the last three fiscal years.

<TABLE>
<CAPTION>
T
-------------------------- ------- ---------- -------- ------- -------- ------------- --------------- ------------- ---------

Name & Principal Position   Year   Salary     Bonus    Stock   Option   Non-Equity    Change in       All Other     Total ($)
                                      ($)       ($)    Awards  Awards   Incentive     Pension Value   Compensation
                                                        ($)      ($)    Plan          and             ($)
                                                                        Compensation  Non-Qualified
                                                                        ($)           Deferred
                                                                                      Compensation
                                                                                      Earnings ($)
-------------------------- ------- ---------- -------- ------- -------- ------------- --------------- ------------- ---------
<S>                         <C>     <C>                                                                <C>           <C>
Peter Wardle, CEO           2006    125,000      -       -        -          -              -          150,308(1)    275,308
                            2005    125,000      -       -        -          -              -              -         125,000
                            2004    125,000      -       -        -          -              -              -         125,000
-------------------------- ------- ---------- -------- ------- -------- ------------- --------------- ------------- ---------
Thomas Butera, COO          2006    112,500      -       -        -          -              -           43,384(2)    155,884
                            2005    112,500      -       -        -          -              -              -         112,500
                            2004    112,500      -       -        -          -              -              -         112,500
-------------------------- ------- ---------- -------- ------- -------- ------------- --------------- ------------- ---------
Kenneth DiStefano,          2006    104,808   10,000     -        -          -              -              -         114,808
Controller                  2005    90,000       -       -        -          -              -              -          90,000
                            2004    88,077       -       -        -          -              -              -          88,077
-------------------------- ------- ---------- -------- ------- -------- ------------- --------------- ------------- ---------
</TABLE>


     (1)  This represents amounts advanced to Mr. Wardle through December 31,
          2006. Of this amount, $76,629 relates to amounts advanced prior to
          January 1, 2006, but reclassified (recorded) as compensation to Mr.
          Wardle during 2006. At December 31, 2006, $73,679 is classified as a
          reimbursable advance with potential to be recognized as future
          compensation for Mr. Wardle.

     (2)  This represents amounts advanced to Mr. Butera through Decmebmer 31,
          2006. Of this amount, $5,673 relates to amounts advanced prior to
          January 1, 2006 and $37,711 pertains to amounts advanced during 2006.
          As $43,384, the full amount, had been reclassified (recorded) as
          compensation to Mr. Butera during 2006 there are no outstanding
          advances attributable to Mr. Butera at December 31, 2006.



                                       17
<PAGE>


Option Grants in Last Year and Stock Option Grant.

No options were granted during the year ended December 31, 2006.



Outstanding Equity Awards at Fiscal Year-End.


None.
<TABLE>
<CAPTION>

---------------------------------------------------------------------------------- ----------------------------------------------
                                  Option Awards                                                    Stock Awards
---------------------------------------------------------------------------------- ----------------------------------------------

Name                  Number       Number        Equity       Option    Option     Number     Market      Equity      Equity
                      of           of            Incentive    Exercise  Expiration of         Value of    Incentive   Incentive
                      Securities   Securities    Plan         Price     Date       Shares     Shares or   Plan        Plan
                      Underlying   Underlying    Awards:      ($)                  or Units   Units of    Awards:     Awards:
                      Unexercised  Unexercised   Number                            of Stock   Stock       Number      Market or
                      Options      Options       of                                That       That Have   of          Payout
                      (#)          (#)           Securities                        Have       Not         Unearned    Value
                      Exercisable  Unexercisable Underlying                        Not        Vested      Shares,     of
                                                 Unexercised                       Vested     ($)         Units or    Unearned
                                                 Unearned                          (#)                    Other       Shares,
                                                 Options                                                  Rights      Units or
                                                 (#)                                                      That Have   Other
                                                                                                          Not         Rights
                                                                                                          Vested      That Have
                                                                                                          (#)         Not
                                                                                                                      Vested
                                                                                                                      ($)
--------------------- ------------ ------------- ------------ --------- ---------- ---------- ----------- ----------- -----------
<S>                                                             <C>                               <C>                    <C>
Peter Wardle               -            -             -         $ -         -          -          $ -         -          $ -
--------------------- ------------ ------------- ------------ --------- ---------- ---------- ----------- ----------- -----------
Thomas Butera              -            -             -           -         -          -            -         -            -
--------------------- ------------ ------------- ------------ --------- ---------- ---------- ----------- ----------- -----------
Joseph DiMarino            -            -             -           -         -          -            -         -            -
--------------------- ------------ ------------- ------------ --------- ---------- ---------- ----------- ----------- -----------
Mark Balanchard            -            -             -           -         -          -            -         -            -
--------------------- ------------ ------------- ------------ --------- ---------- ---------- ----------- ----------- -----------
Stewart Kalter             -            -             -           -         -          -            -         -            -
--------------------- ------------ ------------- ------------ --------- ---------- ---------- ----------- ----------- -----------
TOTAL:                     -            -             -         $ -         -          -          $ -         -          $ -
--------------------- ------------ ------------- ------------ --------- ---------- ---------- ----------- ----------- -----------


Director Compensation

None.

----------------------- ------------- ---------- ---------- ---------------- ------------------------ ---------------- -----------
       Name (a)         Fees Earned   Stock       Option      Non-Equity        Change in Pension        All Other       Total
                         or Paid in    Awards     Awards    Incentive Plan   Value and Nonqualified    Compensation       ($)
                            Cash         ($)        ($)      Compensation     Deferred Compensation         ($)           (h)
                            ($)          (c)        (d)           ($)               Earnings                (g)
                            (b)                                   (e)                  (f)
----------------------- ------------- ---------- ---------- ---------------- ------------------------ ---------------- -----------
Peter Wardle                $ -          $ -        $ -           $ -                  $ -                  $ -           $ -
----------------------- ------------- ---------- ---------- ---------------- ------------------------ ---------------- -----------
Thomas Butera                 -            -          -             -                    -                    -             -
----------------------- ------------- ---------- ---------- ---------------- ------------------------ ---------------- -----------
Joseph DiMarino               -            -          -             -                    -                    -             -
----------------------- ------------- ---------- ---------- ---------------- ------------------------ ---------------- -----------
Mark Blanchard                -            -          -             -                    -                    -             -
----------------------- ------------- ---------- ---------- ---------------- ------------------------ ---------------- -----------
Stewart Kalter                -            -          -             -                    -                    -             -
----------------------- ------------- ---------- ---------- ---------------- ------------------------ ---------------- -----------
TOTAL:                      $ -          $ -        $ -           $ -                  $ -                  $ -           $ -
----------------------- ------------- ---------- ---------- ---------------- ------------------------ ---------------- -----------
</TABLE>

Directors may receive compensation for their services and reimbursement for
their expenses as shall be determined from time to time by resolution of the
Board. As of December 31, 2006, none of the Company's directors currently
receive any compensation for their service on the Board of Directors.


                                       18

<PAGE>


1999 Executive Officer Stock Option Plan
----------------------------------------

In May 1999, the Board of Directors approved the 1999 Executive Officer Stock
Option Plan (the 1999 Plan) for the benefit of the executive officers. The 1999
Plan is intended to provide an incentive to individuals to act as executive
officers and to maintain a continued interest in the Company's operations. All
options under the 1999 Plan will be issued under Section 422A of the Internal
Revenue Code, and include qualified and non-qualified stock options.

The terms of the 1999 Plan provide that the Company is authorized to grant
options to purchase shares of common stock to executive officers upon the
majority consent of the Board of Directors. The option price to be paid by
optionees for shares under qualified stock options must not be less than the
fair market value of the shares as reported by the Nasdaq SmallCap Market on the
date of the grant. The option price for nonqualified stock options must not be
less than 85% of such fair market value. Options must be exercised within six
years following the date of grant and the optionee must exercise options during
service to the Company or within three months of termination of such service (12
months in the event of death or disability). The Board of Directors may extend
the termination date of an option granted under the Plan.

A total of 150,000 shares of authorized but unissued common stock have been
reserved for issuance pursuant to the 1999 Plan. As of December 31, 2006, no
options are outstanding under this Plan.

Options under the 1999 Plan may not be transferred, except by will or by the
laws of intestate succession. The number of shares and price per share of the
options under the Plan will be proportionately adjusted to reflect forward and
reverse stock splits. The holder of an option under the 1999 Plan has none of
the rights of a shareholder until shares are issued.

The 1999 Plan is administered by the Board of Directors, which has the power to
interpret the 1999 Plan, determine which persons are to be granted options and
the amount of such options. The provisions of the Federal Employee Retirement
Income Security Act of 1974 do not apply to the 1999 Plan. Shares issuable upon
exercise of options will not be purchased in open market transactions but will
be issued by us from authorized shares. Payment for shares must be made by
optionees in cash from their own funds. No payroll deductions or other
installment plans have been established.

Shares issuable under the 1999 Plan may be sold in the open market, without
restrictions, as free trading securities. No options may be assigned,
transferred, hypothecated or pledged by the option holder. No person may create
a lien on any securities under the 1999 Plan, except by operation of law.
However, there are no restrictions on the resale of the shares underlying the
options. The 1999 Plan will remain in effect until May 2009 but may be
terminated or extended by the Board of Directors.


2000 Executive Officer Stock Option Plan
----------------------------------------

On May 1, 2001, the Company received shareholder approval for an additional
Executive Officer Stock Option Plan (the 2000 Plan) for the benefit of the
executive officers. The 2000 Plan is intended to provide an incentive to
individuals to act as executive officers and to maintain a continued interest in
the Company's operations. All options under the 2000 Plan will be issued under
Section 422A of the Internal Revenue Code, and include qualified and
non-qualified stock options.

The terms of the 2000 Plan provide that the Company is authorized to grant
options to purchase shares of common stock to executive officers upon the
majority consent of the Board of Directors. The option price to be paid by
optionees for shares under qualified stock options must not be less than the
fair market value of the shares as reported by the OTC Bulletin Board on the
date of the grant. The option price for nonqualified stock options must not be
less than 85% of such fair market value. Options must be exercised within six
years following the date of grant and the optionee must exercise options during
service to the Company or within three months of termination of such service (12
months in the event of death or disability). The Board of Directors may extend
the termination date of an option granted under the Plan.

                                       19
<PAGE>


A total of 350,000 shares of authorized but unissued common stock have been
reserved for issuance pursuant to the 2000 Plan. As of December 31, 2006, no
options are outstanding under this Plan.

Options under the 2000 Plan may not be transferred, except by will or by the
laws of interstate succession. The number of shares and price per share of the
options under the Plan will be proportionately adjusted to reflect forward and
reverse stock splits. The holder of an option under the 2000 Plan has none of
the rights of a shareholder until shares are issued.

The 2000 Plan is administered by the Board of Directors, which has the power to
interpret the 2000 Plan, determine which persons are to be granted options and
the amount of such options. The provisions of the Federal Employee Retirement
Income Security Act of 1974 do not apply to the 2000 Plan. Shares issuable upon
exercise of options will not be purchased in open market transactions but will
be issued by us from authorized shares. Payment for shares must be made by
optionees in cash from their own funds. No payroll deductions or other
installment plans have been established.

Shares issuable under the 2000 Plan may be sold in the open market, without
restrictions, as free trading securities. No options may be assigned,
transferred, hypothecated or pledged by the option holder. No person may create
a lien on any securities under the 2000 Plan, except by operation of law.
However, there are no restrictions on the resale of the shares underlying the
options. The 2000 Plan will remain in effect until May 2010 but may be
terminated or extended by the Board of Directors.



                                       20
<PAGE>


ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.

The following table sets forth information concerning the holdings of Common
Stock by each person who, as of March 30, 2007, 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. Such amounts also include shares of common stock
issuable upon conversion of the 193,836 shares of preferred stock which are each
convertible into 100 shares of common stock at any time after the authorized
number of shares of common stock is increased to 500,000,000.

                                         Amount and Nature
                                           of Beneficial        Percent of Class
Name of Beneficial Owner (1)               Ownership (2)               (%)

Peter Wardle                               19,383,600(3)             66.1%
Thomas Butera                              19,383,600(3)             66.1%
Joseph DiMarino                                     -                   -
Mark Blanchard (4)                            461,454                 4.6%
Stewart Kalter                                      -                   -

Peter J. Pappas (5)                         1,319,748                12.5%

All officers and directors as a group
(5 persons)                                19,845,054                67.7%

--------------------

* Less than 1%

(1) Except as otherwise indicated, the address of each beneficial owner is c/o
ProtoSource Corporation, One Bethlehem Plaza, 4th Floor, Bethlehem, PA 18018.

(2) Beneficial ownership is determined in accordance with the rules of the
Commission and generally includes voting or investment power with respect to the
shares shown. Except where indicated by footnote and subject to community
property laws where applicable, the persons named in the table have sole voting
and investment power with respect to all shares of voting securities shown as
beneficially owned by them.

(3) Each of Messrs. Wardle and Butera may be deemed control persons of P2i,
Inc., the registered owner of 193,836 shares of preferred stock convertible into
19,383,600 shares of common stock.

(4) Includes 43,310 shares owned by his wife, Virginia M. Blanchard.

(5) Includes 612,986 shares issuable upon exercise of warrants or conversion of
convertible promissory notes.



                                       21

<PAGE>


ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
         INDEPENDENCE.

In February 2003, the Company signed an agreement and Plan of Merger with P2i to
acquire P2i's Print-to-Internet business in exchange for a controlling interest
in the Company and satisfaction of the existing P2i debt to the Company. The
Company loaned P2i $50,000 in 2001, $995,280 in 2002 and $597,023 in 2003. The
loans to P2i were in the form of demand notes, which in the event that the
merger did not get completed, would have been due on demand.

In May 2002 Peter Wardle, CEO and a principal stockholder of P2i, Inc. and a
director of the Company, assumed the duties and responsibilities of CEO of the
Company. As of January 2004, Mr. Wardle draws a salary from the Company and his
expenses are being reimbursed. Additionally, between 2004 and 2006, Mr. Wardle
received $150,308 in advances to be reimbursed, in accordance with a
note-holders' security agreement, to the Company by sale of ProtoSource common
stock that is to be issued to P2i, Inc. in accordance with the merger agreement
of Company with P2i Newspaper, Inc. $76,629 of the $150,308 relates to amounts
advanced to Mr. Wardle prior to January 1, 2006, but reclassified (recorded) as
compensation to Mr. Wardle during 2006. At December 31, 2006, $73,679 is
classified as a reimbursable advance with potential to be recognized as future
compensation for Mr. Wardle.

In January 2004 Thomas Butera, COO and a principal stockholder of P2i, Inc. and
a director of the Company, assumed the duties and responsibilities of COO of the
Company. As of January 2004, Mr. Butera draws a salary from the Company and his
expenses are being reimbursed. During 2005 and 2006, for purposes of providing
working capital to the Company, Mr. Butera advanced $24,000 to the Company for
an indefinite period of time. Additionally, between 2005 and 2006, Mr. Butera
received $43,384 in advances to be reimbursed, in accordance with a
note-holders' security agreement, to the Company by sale of ProtoSource common
stock that is to be issued to P2i, Inc. in accordance with the merger agreement
of Company with P2i Newspaper, Inc. $5,673 of the $43,384 relates to amounts
advanced to Mr. Butera prior to January 1, 2006. During 2006, $43,384, the full
amount, had been reclassified (recorded) as compensation to Mr. Butera.

As of December 31, 2006, an amount of $192,244 is due from P2i, Inc. As CEO and
principal stockholder of P2i, Inc. and a director of the Company, Peter Wardle
has pledged that any such funds provided to P2i, Inc. by the Company will be
reimbursed by sale of ProtoSource common stock that is to be issued to P2i, Inc.
in accordance with the agreement of merger of Company with P2i Newspaper, Inc.

P2i, through its infrastructure, provides office space to the Company. For
periods commencing after January 1, 2004, the Company has been making direct
payments to P2i's office space leaseholder. During 2006 and 2005, payments of
approximately $35,300 and $37,400, respectively, were paid to P2i's leaseholder.



                                       22

<PAGE>


ITEM 13. EXHIBITS.

a. EXIBITS

EXHIBIT
NUMBER                           DESCRIPTION
------                           -----------

3.01      Restated Articles of Incorporation of the Registrant (1)

3.02      By-laws of the Registrant (1)

3.03      Class A warrant agreement

3.04      Class B warrant agreement (6)

10.01     1995 Incentive Stock Option Plan (2)

10.02     2001 Employee Stock Option Plan

10.03     1999 Executive Officer Option Plan (5)

10.04     2001 Executive Officer Option Plan

10.05     Agreement and Plan of Merger, dated as of February 13, 2003, by and
              among ProtoSource Corporation, ProtoSource Acquisition LLC,
              P2i, Inc. and P2i Newspaper, Inc. (6)

31.1      Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
              to Section 906 of the Sarbanes-Oxley Act of 2002.

32.1      Certification Of Principal Executive Officer and Principal Financial
              Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

99.1      Code of Ethics and Business Conduct of Officers, Directors and
              Employees (7)

----------

(1) Incorporated by reference to the Company's Registration Statement on Form
SB-2/A, as filed with the Securities and Exchange Commission on May 5, 1998.

(2) Incorporated by reference to the Company's Registration Statement on Form
SB-2, declared effective by the Securities and Exchange Commission on February
9, 1995, file number 333-56242.

(3) Incorporated by reference to the Company's Form 8-K, as filed with the
Securities and Exchange Commission on November 9, 1999.

(4) Incorporated by reference to the Company's Form 8-K, as filed with the
Securities and Exchange Commission on August 31, 2000.

(5) Incorporated by reference to the Company's Registration Statement on Form
S-8, as filed with the Securities and Exchange Commission on May 14, 1999, file
number 333-78497.

(6) Incorporated by reference from the Company Form 8-K, as filed with the
Securities and Exchange Commission on February 19, 2003

(7) Incorporated by reference from the Company's Form 10-KSB for the year ended
December 31, 2002.



                                       23
<PAGE>


Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.

Audit Fees. The aggregate fees billed by our auditors to date, for professional
services rendered for the audit of the Company's annual financial statements for
the years ended December 31, 2006 and December 31, 2005, and for review of the
financial statements included in the Company's quarterly reports on Form 10-QSB
during such fiscal years, were $34,000 and $32,500, respectively.

Audit-Related Fees. The aggregate fees billed for assurance and related services
by our auditors that are reasonably related to the performance of the audit or
review of our financial statements were $0 and $8,400 for the years ended
December 31, 2006 and 2005, respectively.

Tax Fees. The aggregate fees billed for tax preparation and related services by
our auditors were $3,900 and $3,500 for the years ended December 31, 2005 and
2004, respectively.

All Other Fees. For the fiscal years ended December 31, 2006 and 2004, the
Company incurred no fees to auditors for services rendered to the Company, other
than the services covered in "Audit Fees", "Audit-Related Fees" or "Tax Fees".



                                       24




<PAGE>


                                   SIGNATURES


In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant has
duly caused this Report to be signed on its behalf by the undersigned, thereunto
duly authorized, in Bethlehem, Pennsylvania, on March 30, 2007.

                                               PROTOSOURCE CORPORATION





                                               By: /s/ Peter Wardle
                                                   -----------------------------
                                                       Peter Wardle
                                                       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/  Peter Wardle                 Chief  Executive Officer       March 30, 2007
----------------------------      Chief Financial Officer
     Peter Wardle                (Principal Accounting
                                  Officer), and Director

/s/  Thomas Butera                Chief  Operating Officer       March 30, 2007
----------------------------      Director
     Thomas Butera

/s/  Joseph DiMarino              Director                       March 30, 2007
----------------------------
     Thomas Butera

/s/  Mark Blanchard               Director                       March 30, 2007
----------------------------
     Mark Blanchard

/s/  Stewart Kalter               Director                       March 30, 2007
----------------------------
     Stewart Kalter


                                       25

<PAGE>


ITEM 7.  FINANCIAL STATEMENTS
-----------------------------

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



                                                                     Page
                                                                     ----

Financial Statements Index                                           F-1

Report of Independent Registered Public Accounting Firm              F-2

Consolidated Balance Sheet as of December 31, 2006                   F-3

Consolidated Statement of Operations
  for the years ended December 31, 2006 and 2005                     F-4

Consolidated Statement of Stockholders' (Deficiency)                 F-5
  for the years ended December 31, 2006 and 2005

Consolidated Statement of Cash Flows
  for the years ended December 31, 2006 and 2005                     F-6 & 7

Notes to Consolidated Financial Statements                           F-8 to F-22




                                      F-1


<PAGE>


             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Directors and Stockholders
ProtoSource Corporation

We have audited the accompanying consolidated balance sheet of ProtoSource
Corporation and Subsidiary as of December 31, 2006, and the related consolidated
statements of operations, stockholders' (deficiency), and cash flows for the
years ended December 31, 2006 and 2005. 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 the standards of the Public Company
Accounting Oversight Board (United States). 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 and
Subsidiary as of December 31, 2006, and the results of their operations and
their cash flows for the years ended December 31, 2006 and 2005 in conformity
with accounting principles generally accepted in the United States.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As shown in the accompanying financial
statements, the Company incurred net losses of $303,697 and $495,870 during the
years ended December 31, 2006 and 2005, respectively. As discussed in Note 1 to
the financial statements, the Company's significant operating losses raise
substantial doubt about its ability to continue as a going concern. Management's
plans in regard to these matters are also discussed in Note 1. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.




                                                   /s/ Margolis & Company P.C.
                                                   Certified Public Accountants

Bala Cynwyd, Pennsylvania
February 22, 2007



                                       F-2


<PAGE>


                     PROTOSOURCE CORPORATION AND SUBSIDIARY
                     ======================================
                           CONSOLIDATED BALANCE SHEET
                                DECEMBER 31, 2006
--------------------------------------------------------------------------------

                                     ASSETS

Current assets:
   Cash                                                            $      4,842
   Accounts receivable, net of allowance of $15,892                     347,339
   Advances to officers, net of obligations to officers                  49,091
   Prepaid expenses and other                                               883
                                                                   ------------

       Total current assets                                             402,155
                                                                   ------------

Property and equipment, at cost, net of
   accumulated depreciation and amortization of $500,028                 71,387
                                                                   ------------

Other assets:
   Amounts due from related party - P2i, Inc.                           192,244
   Goodwill - acquisition of P2i Newspaper                              375,067
   Deposits                                                               7,774
                                                                   ------------

       Total other assets                                               575,085
                                                                   ------------

       Total assets                                                $  1,048,627
                                                                   ============


                    LIABILITIES AND STOCKHOLDERS' DEFICIENCY

Current liabilities:
   Notes payable                                                   $  2,425,000
   Current portion of obligations under capital leases                   24,819
   Accounts payable                                                      53,505
   Accrued interest                                                   1,133,986
   Accrued expenses - other                                             407,485
                                                                   ------------

       Total current liabilities                                      4,044,795
                                                                   ------------

Obligations under capital leases, non-current portion                     7,956
Stock subscriptions payable                                             661,844
                                                                   ------------

       Total non-current liabilities                                    669,800
                                                                   ------------

Commitments and contingencies

Stockholders' deficiency:
   Preferred stock, Series B, no par value; 5,000,000 shares
     authorized, 193,836 shares issued and outstanding                  416,179
   Common stock, no par value; 10,000,000 shares
     authorized, 9,927,329 shares issued and outstanding             26,143,461
   Additional paid-in capital                                         2,291,607
   Accumulated other comprehensive income                                43,532
   Accumulated deficit                                              (32,560,747)
                                                                   ------------

       Net  stockholders' deficiency                                 (3,665,968)
                                                                   ------------

       Total liabilities and stockholders' deficiency              $  1,048,627
                                                                   ============

The notes to consolidated financial statements are an integral part of the above
statement.

                                       F-3

<PAGE>

<TABLE>
<CAPTION>

                                         PROTOSOURCE CORPORATION AND SUBSIDIARY
                                         ======================================

                                         CONSOLIDATED STATEMENT OF OPERATIONS
--------------------------------------------------------------------------------------------------------------

                                                                                     YEAR ENDED
                                                                                     DECEMBER 31,
                                                                             2006                    2005
                                                                         ------------            ------------

<S>                                                                      <C>                     <C>
Net revenues                                                             $  2,641,492            $  1,938,924
                                                                         ------------            ------------

Operating costs and expenses:
   Cost of revenues                                                         1,637,235               1,056,411
   Selling, general and administrative                                        891,130                 703,856
   Depreciation and amortization                                               53,405                  85,574
   Loss on disposal of property and equipment                                  23,604                     138
                                                                         ------------            ------------

         Total operating costs and expenses                                 2,605,374               1,845,979
                                                                         ------------            ------------

         Operating income                                                      36,118                  92,945
                                                                         ------------            ------------

Other income (charges):
   Interest expense                                                          (356,854)               (368,230)
   Other expense                                                               (4,203)                   --
   Provision for uncollectible note and services credit, Brand X                 --                  (313,890)
   Recovery of amounts previously written off                                  13,800                    --
   Interest income                                                               --                     6,669
   Other income                                                                 7,442                  86,636
                                                                         ------------            ------------

          Net other (charges)                                                (339,815)               (588,815)
                                                                         ------------            ------------

Net loss                                                                 ($   303,697)           ($   495,870)
                                                                         ============            ============


Net loss per basic and diluted share of common stock:                    ($       .01)           ($       .02)
                                                                         ============            ============

Weighted average number of basic and
  diluted common shares outstanding                                        32,874,548              32,874,548
                                                                         ============            ============


The notes to consolidated financial statements are an integral part of the above statement.


                                             F-4


<PAGE>


                                                  PROTOSOURCE CORPORATION AND SUBSIDIARY
                                                  ======================================

                                            CONSOLIDATED STATEMENT OF STOCKHOLDERS' (DEFICIENCY)
                                                   FOR THE YEARS DECEMBER 31, 2006 AND 2005

------------------------------------------------------------------------------------------------------------------------------------

                                                                                  Accumulated
                          Preferred Stock           Common Stock        Additional  Other
                          ---------------           ------------         Paid-In Comprehensive Accumulated             Comprehensive
                        Shares       Amount      Shares      Amount      Capital    Income     Deficit         Total       (Loss)
                        ------    ----------   ---------   ------------  ---------  ------     -------         -----       -----


Balance,
December 31, 2004       193,836   $  416,179   8,114,829   $25,835,960   $2,291,607          ($31,761,180)  ($ 3,217,434)

Net loss                                                                                         (495,870)      (495,870) ($495,870)
                       --------   ----------  ----------   -----------   ----------           -----------   ------------  ---------

Total comprehensive
(loss)                                                                                                                    ($495,870)
                                                                                                                          =========

Balance,
December 31, 2005       193,836      416,179   8,114,829    25,835,960    2,291,607           (32,257,050)    (3,713,304)


Issuance of common
stock in
connection with
financing                                      1,812,500       307,501                                           307,501

Net loss                                                                                         (303,697)      (303,697) ($303,697)

Other comprehensive
  income, net of tax:
    Foreign currency
     translation
     adjustments                                                                     $ 43,532                     43,532     43,532
                       --------   ----------  ----------   ------------   ---------- --------  -----------   -----------  ---------


Total comprehensive
(loss)                                                                                                                    ($260,165)
                                                                                                                          =========

Balance,
December 31, 2006       193,836   $  416,179   9,927,329   $26,143,461   $2,291,607  $ 43,532 ($32,560,747)  ($ 3,665,968)
                       ========   ==========  ==========  ============   ==========  ========  ===========   ============



The notes to consolidated financial statements are an integral part of the above statement.


                                                                        F-5


<PAGE>


                                  PROTOSOURCE CORPORATION AND SUBSIDIARY
                                  ======================================

                                  CONSOLIDATED STATEMENT OF CASH FLOWS
-----------------------------------------------------------------------------------------------

                                                                          YEAR ENDED
                                                                          DECEMBER 31,
                                                                 2006                    2005
                                                               --------               ---------

                                        INCREASE (DECREASE) IN CASH

Cash flows from operating activities:
  Net loss                                                    ($303,697)              ($495,870)
  Adjustments to reconcile net loss to net cash
       provided by operating activities:
     Depreciation and amortization                               53,405                  85,574
     Provision for bad debts                                     15,892                    --
     Loss on disposal of property and equipment                  23,604                     138
     Amortization of debt issuance costs                           --                    47,067
     Non-cash adjustment to accounts payable                       --                   (63,825)
     Provision for uncollectible note and
         services credit, Brand X                                  --                   313,890
     Changes in operating assets and liabilities:
       Accounts receivable                                     (106,645)                (75,877)
       Prepaid expenses and other assets                           (883)                 20,183
       Accounts payable                                           7,401                 (48,367)
       Accrued expenses                                         396,410                 313,932
                                                              ---------               ---------

              Net cash provided by operating activities          85,487                  96,845
                                                              ---------               ---------

Cash flows from investing activities:
  Acquisitions of property and equipment                        (60,081)                (10,583)
  Proceeds from sale of property                                   --                       158
  Collection on notes receivable - Brand X                         --                    55,394
  (Increase) decrease in advances to officers                    14,211                 (16,172)
  (Increase) in amount due from related party                   (88,851)                (92,487)
  (Increase) decrease in deposits                                (5,415)                 (5,904
                                                              ---------               ---------

              Net cash (used in) investing activities          (140,136)                (57,786)
                                                              ---------               ---------


                              CONTINUED ON NEXT PAGE


The notes to consolidated financial statements are an integral part of the above statement.






                                                         F-6



<PAGE>


                               PROTOSOURCE CORPORATION AND SUBSIDIARY
                               ======================================

                         CONSOLIDATED STATEMENT OF CASH FLOWS - CONTINUED
------------------------------------------------------------------------------------------------


                                                                          YEAR ENDED
                                                                          DECEMBER 31,
                                                                2006                    2005
                                                              ---------               ---------

Cash flows from financing activities:
  Payments on obligations under capital leases                  (24,853)                (37,973)
                                                              ---------               ---------

           Net cash (used in) financing activities              (24,853)                (37,973)
                                                              ---------               ---------

Effect of exchange rate changes on cash                          43,532                     --
                                                              ---------               ---------

Net increase (decrease) in cash                                 (35,970)                  1,086

Cash at beginning of year                                        40,812                  39,726
                                                              ---------               ---------

Cash at end of year                                           $   4,842               $  40,812
                                                              =========               =========




                              SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

Cash paid during the year for:
  Interest                                                    $  19,506               $  31,275
                                                              ---------               ---------
  Income taxes                                                $    --                 $    --
                                                              ---------               ---------




                 SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES

Issuance of common stock in connection with financing         $ 307,501               $    --
Acquisition of equipment under capital lease obligation          26,827                  26,768



The notes to consolidated financial statements are an integral part of the above statement.





                                                       F-7
</TABLE>


<PAGE>


                     PROTOSOURCE CORPORATION AND SUBSIDIARY
                     ======================================

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------


1.        Nature of Operations and Summary of Significant Accounting Policies
          -------------------------------------------------------------------

          Nature of operations - ProtoSource Corporation, formerly SHR
          Corporation doing business as Software Solutions Company (the
          Company), was incorporated on July 1, 1988, under the laws of the
          state of California. Until May 1, 2002, the Company was an Internet
          service provider (ISP). The Company provided dial-up Internet access,
          web hosting services and web development services. The Company entered
          into an agreement on May 1, 2002 to sell substantially all of the
          assets pertaining to the ISP to Brand X Networks, Inc. (see Note 2).
          Effective January 1, 2004, the Company acquired P2i Newspaper, LLC.
          (see Note 8). P2i Newspaper is principally engaged in the conversion
          of text and graphics from print to interactive Web content. Its
          clients include newspaper groups located in the United States and the
          United Kingdom. P2i Newspaper is headquartered in Bethlehem,
          Pennsylvania and has a data conversion center located in Kuala Lumpur,
          Malaysia.

          Basis of presentation - The accompanying consolidated financial
          statements have been prepared on a going concern basis, which
          contemplates the realization of assets and the satisfaction of
          liabilities in the normal course of business. The financial statements
          do not include any adjustments relating to the recoverability and
          classification of recorded asset amounts or the amount and
          classification of liabilities that might be necessary should the
          Company be unable to continue as a going concern. The Company's
          continuation as a going concern is dependent upon its ability to
          generate sufficient cash flows to meet its obligations on a timely
          basis, to obtain additional financing as may be required, and to
          generate revenues to a level where the Company becomes profitable.
          Additionally, the Company has experienced extreme cash liquidity
          shortfalls from operations.

          The Company's continued existence is dependent upon its ability to
          achieve its operating plan. Management's plans include the following:

               o    Obtaining additional working capital through the sale of
                    common stock or debt securities

               o    The ability of P2i Newspaper to successfully implement its
                    strategic plan as follows:

          P2i Newspaper's long-term business strategy is to focus on the
          processing of print content into Web content using technologically
          sophisticated, database-driven, services and solutions across multiple
          business-to-business verticals. The combination of on-target sales
          strategies, low labor costs, a well-educated labor pool fluent in
          English, and sophisticated technologies (the Company's core
          competencies) make P2i Newspaper highly competitive. P2i Newspaper is
          focused on increasing its market share in the newspaper vertical while
          targeting magazines, retailers and government offices verticals. The
          Company intends to leverage its competitive advantages, which include
          its technology, labor and customer base resources, in these markets
          over the next five years and will continue to add services that are
          synergistic with its core competencies.



                                      F - 8
<PAGE>



                     PROTOSOURCE CORPORATION AND SUBSIDIARY
                     ======================================

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------


1.        Nature of Operations and Summary of Significant Accounting Policies -
          Continued
          ----------------------------------------------------------------------

          The primary business is to mine, manage and database print content for
          the publishing industry, and its distribution via the Internet. Each
          day, 52 weeks a year, electronic files can be received from the
          Company's clients. Once received, these are to be processed overnight
          for delivery the following morning. Data is deliverable not only to
          the Company's web servers for seamless integration into clients'
          existing, hosted web sites, but can also be distributed back to
          clients and to their business partners in a wide range of formats to
          fit their ever evolving needs.

          Services comprise the following:

          Hosted Solutions -- Publishers large and small may use the Company's
          array of customizable, turnkey, hosted products for entire
          publications, sections and vertical-specific solutions. Utilizing
          proprietary technology, the Company converts print content comprising
          editorial and media ads into interactive, online content that is
          seamlessly incorporated into existing newspaper/publisher web sites.
          At the end of every business day, publishing clients transmit to the
          Company the same electronic versions of ads and pages that go to
          press. These files are received by the Company's production group,
          processed, quality checked, and delivered to the hosting servers by
          the start of the following business day.

          Data Extraction -- Customers utilizing in-house or third party
          solutions may rely upon the Company's ability to database incoming
          content down to the minutest subset. The Company has solutions that
          will convert multiple forms of disparate electronic content and
          process them into one constant data flow as one of its specialties.
          Extracting relevant data points, merging consistencies and fielding
          content to produce a data feed, per the client's or third party's
          specifications, is at the core of the Company's technology. The
          ensuing data enables tight search functions and powers retail
          advertising web sites.

          Content Review - Because online content needs to reflect the values,
          relevance and accuracy that print institutions have embodied for
          centuries, the Company's Content Review team functions to examine
          thousands of items a day for retailers and newspapers, editing,
          proofing and determining relevancy. The staff reviews pricing,
          language, brand names, and scores of other specifics, delivering a
          critical component in the online publishing of user-generated content.

          Technical Support -- The Company has also launched a poly-lingual
          Technical Support team. Unlike a traditional call center that scripts
          its responses, this functional group separates itself from the
          competition by providing a highly trained, technically skilled support
          person that is trained to understand the idiosyncrasies of customers'
          products and services to ensure each caller gets the best possible
          service.

          If management cannot sufficiently execute and achieve the above stated
          objectives, the Company may find it necessary to dispose of assets, or
          undertake other actions as may be appropriate.


                                       F-9

<PAGE>


                     PROTOSOURCE CORPORATION AND SUBSIDIARY
                     ======================================

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------


1.        Nature of Operations and Summary of Significant Accounting Policies -
          Continued
          ----------------------------------------------------------------------

          Principles of consolidation - The consolidated financial statements
          include the accounts of the Company and P2i Newspaper, LLC, its
          wholly-owned subsidiary. All significant intercompany accounts and
          transactions have been eliminated.

          Revenue recognition - In accordance with the SEC's Staff Accounting
          Bulletin No. 104, the Company recognizes service revenue when
          persuasive evidence of an arrangement exists, services are performed
          and delivered without defect, the price of the transaction is fixed
          and determinable, and collectibility is reasonably assured.

          In general, no matter the nature of a customer's business, the
          Company, through its software technology at its production facilities,
          converts any manner of print text and print graphics to interactive
          web content accessible via the Internet. This most often is in the
          form of online advertising. (i.e., A visitor to a customer's website
          can, if he so chooses, interact with the ad because the Company's
          technology has made that possible. The interactivity often involves
          various links to additional information and possible other pertinent
          or interested parties or sources behind the genesis and purpose of the
          ad.) This electronically processed service is objective and readily
          verifiable by both parties immediately upon delivery to a customer's
          website.

          Only after the Company completes its conversion processing of specific
          digital data (printable text and/or graphic image files) provided by
          the customer and delivers the results as interactive, online web
          content directly to the customer's Internet website(s) does the
          Company identify a measurable event for purposes of revenue
          recognition. The measurable, delivered event or unit is typically
          identified as a "page" (or "pages") of service provided to the
          customer, immediately usable by the customer and its clients at their
          website(s). This process service takes place daily, 52 weeks a year,
          whereupon, digital files are received and processed overnight for
          morning delivery. Through contractual agreement, a price is determined
          and the customer is billed for each unit of service provided at the
          agreed upon price. Although the Company accumulates billable
          revenue-recognizable events daily, it typically waits until month end
          to bill for all units delivered during the course of that month as a
          convenience to its customers.

          If there are any identifiable problems or defect with any "page"
          content, it is typically fixed by the Company within a matter of
          hours. With respect to sales returns or credits, cancellations and
          warranties, the inherent nature of the type of services provided and
          the underlying processes employed by the Company to create and deliver
          completed product to its customers, there is no material exposure to
          what would be classified as sales returns or credits. Likewise,
          cancellations and or warranties are not significantly measurable in
          respect to the type of electronic product (Internet website content)
          deliverable to the Company's customers. Historically, there has been
          little to no applicable sales returns or credits. For these reasons,
          the Company has no material need or basis to make estimates for
          returns and allowances.


                                      F-10

<PAGE>


                     PROTOSOURCE CORPORATION AND SUBSIDIARY
                     ======================================

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------


1.        Nature of Operations and Summary of Significant Accounting Policies -
          Continued
          ----------------------------------------------------------------------

          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.

          Accounts receivable - Trade accounts receivable are stated at the
          amount management expects to collect from outstanding balances. It is
          the policy of management to review the outstanding accounts receivable
          at the end of each reporting period, as well as the bad debt
          write-offs experienced in the past, and establish an allowance for
          doubtful accounts for uncollectable amounts.

          Property and equipment - Depreciation of property and equipment is
          provided by the straight-line method over the estimated useful lives
          of the assets. 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.

          Amortization - Debt issuance costs are amortized using the
          straight-line method over the one-year term of the notes (see Note 3).

          Impairment - As of December 31, 2004, the investment in P2i, Inc. had
          been effectively written down to $0. The fair value was based on
          financial projections, consultation with the Company's investment
          banker and an outside consultant, and management's estimates.
          Effective January 1, 2004, the Company acquired P2i's
          Print-to-Internet business (see Note 8).

          Goodwill - In connection with the Company's acquistion of P2i
          Newspaper, the Company realized approximately $375,000 of goodwill. In
          accordance with Statement of Financial Accounting Standards ("SFAS")
          No. 142, Goodwill and Other Intangible Assets, goodwill is not
          amortized; however, it is tested annually for impairment.

          Foreign currency translation - Assets and liabilities of the Company's
          foreign operations are translated into U.S dollars at the exchange
          rate in effect at the balance sheet date. Revenue is eliminated in
          consolidation. Expenses are translated at average rates in effect
          during the period. The resulting translation adjustment is reflected
          as accumulated other comprehensive income on the consolidated balance
          sheet.


                                      F-11


<PAGE>


                     PROTOSOURCE CORPORATION AND SUBSIDIARY
                     ======================================

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------


1.        Summary of Significant Accounting Policies - Continued
          -------------------------------------------------------

          Stock-based compensation - The Company adopted SFAS No. 123,
          "Accounting for Stock-Based Compensation," for its stock-based
          compensation plans. Through 2004, the Company continued 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," and related
          interpretations. The Company adopted SFAS No. 123(R) in 2005, which
          requires the fair value of all stock option awards issued to employees
          to be recorded as an expense over the related vesting period.

          Income taxes - Deferred income taxes are provided for temporary
          differences between the financial reporting and tax basis of assets
          and liabilities using enacted tax laws and rates for the years when
          the differences are expected to reverse.

          Net (loss) per basic and diluted share of common stock - Basic loss
          per share is calculated using the weighted average number of common
          shares outstanding. Diluted loss per share is computed on the basis of
          the weighted average number of common shares outstanding during the
          period increased by the dilutive effect of outstanding stock options
          using the "treasury stock" method. The weighted average number of
          basic and diluted common shares outstanding includes:
<TABLE>
<CAPTION>

<S>                                                                                  <C>
           Actual shares issued and outstanding at December 31, 2006                 9,927,329
           Stock subscriptions payable - note holders (see Note 3)                   2,750,000
           Stock subscriptions payable - investment banker (see Note 6)                813,688
           Series B convertible preferred stock issued to P2i, Inc. (see Note 13)   19,383,531
                                                                                    ----------
                                                                                    32,874,548
                                                                                    ==========
</TABLE>

          The basic and diluted loss per share are the same since the Company
          had a net loss for 2006 and 2005 and the inclusion of stock options
          and other incremental shares would be anti-dilutive. Options and
          warrants to purchase 1,070,000 and 2,225,000 shares of common stock at
          December, 2006 and 2005, respectively, were not included in the
          computation of diluted loss per share.

          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.

          Reclassifications - Certain reclassifications have been made to the
          2005 financial statement presentation for comparability with the 2006
          financial statements.


                                      F-12
<PAGE>


                     PROTOSOURCE CORPORATION AND SUBSIDIARY
                     ======================================

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------


1.        Summary of Significant Accounting Policies - Continued
          ------------------------------------------------------

          Recently Issued Accounting Standards
          ------------------------------------

          In March 2005, the FASB issued FASB Interpretation ("FIN") No. 47,
          "Accounting for Conditional Asset Retirement Obligations". FIN No. 47
          requires an entity to recognize a liability for a conditional asset
          retirement obligation when incurred if the liability can be reasonably
          estimated. The Interpretation also clarifies that the term Conditional
          Asset Retirement Obligation refers to a legal obligation to perform an
          asset retirement activity in which the timing and/or method of
          settlement are conditional on a future event that may or may not be
          within the control of the entity. FIN No. 47 also clarifies when an
          entity would have sufficient information to reasonably estimate the
          fair value of an asset retirement obligation. FIN No. 47 has not had a
          material impact on our financial condition or results of operations.

          In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
          Error Corrections", which changes the requirements for the accounting
          and reporting of a change in accounting principle. The statement
          requires retrospective application to prior period financial
          statements of changes in accounting principle, unless impracticable to
          do so. It also requires that a change in the depreciation,
          amortization, or depletion method for long-lived non-financial assets
          be accounted as a change in accounting estimate, effected by a change
          in accounting principle. Accounting for error corrections and
          accounting estimate changes will still be handled according to
          guidance in APB Opinion 20, "Accounting Changes", as carried forward
          in this pronouncement. The statement is effective for fiscal years
          beginning after December 15, 2005. SFAS No. 154 has not had a material
          impact on the Company's financial condition or results of operations.

          In July 2006, the FASB issued FIN No. 48, "Accounting for Uncertainty
          in Income Taxes - An Interpretation of SFAS No. 109". FIN No. 48
          clarifies the accounting for uncertainty in income taxes recognized in
          an enterprise's financial statements in accordance with SFAS No. 109,
          "Accounting for Income Taxes." FIN No. 48 also prescribes a
          recognition threshold and measurement attribute for financial
          statement recognition and measurement of a tax position taken or
          expected to be taken in a tax return. In addition, FIN No. 48 provides
          guidance on derecognition, classification, interest and penalties,
          accounting in interim periods, disclosure and transition. The
          provisions of FIN No. 48 are to be applied to all tax positions upon
          initial adoption of this standard. Only tax positions that meet the
          more-likely-than-not recognition threshold at the effective date may
          be recognized or continue to be recognized as an adjustment to the
          opening balance of accumulated deficit (or other appropriate
          components of equity) for that fiscal year. The provisions of FIN No.
          48 are effective for fiscal years beginning after December 15, 2006.
          The Company is evaluating the impact of the adoption of FIN 48 but
          does not currently expect the adoption of this new standard to have a
          material impact on our financial position, results of operations, or
          cash flows.


                                      F-13
<PAGE>


                     PROTOSOURCE CORPORATION AND SUBSIDIARY
                     ======================================

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------


1.        Summary of Significant Accounting Policies - Continued
          ------------------------------------------------------

          In September 2006, the Securities and Exchange Commission ("SEC")
          issued Staff Accounting Bulleting ("SAB") 108, to address diversity in
          practice in quantifying financial statement misstatements. SAB 108
          requires that the Company quantify misstatements based on their impact
          on each of its financial statements and related disclosures. SAB 108
          is effective for fiscal years ending after November 15, 2006. The
          Company has adopted SAB 108 effective as of December 31, 2006. The
          adoption of this bulletin did not have a material impact on our
          financial position, results of operations, or cash flows.

          In September 2006, the FASB issued SFAS No. 157, "Fair Value
          Measurements". SFAS No. 157 provides guidance for using fair value to
          measure assets and liabilities. It also responds to investors'
          requests for expanded information about the extent to which companies
          measure assets and liabilities at fair value, the information used to
          measure fair value, and the effect of fair value measurements on
          earnings. SFAS No. 157 applies whenever other standards require (or
          permit) assets or liabilities to be measured at fair value, and does
          not expand the use of fair value in any new circumstances. SFAS No.
          157 is effective for financial statements issued for fiscal years
          beginning after November 15, 2007 and is required to be adopted by the
          Company in the first quarter of 2008. The Company is currently
          evaluating the effect that the adoption of SFAS No. 157 will have on
          our financial position, results of operations, or cash flows.


                                      F-14
<PAGE>


                     PROTOSOURCE CORPORATION AND SUBSIDIARY
                     ======================================

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------


2.        Discontinued Operations
          -----------------------

          Sale of ISP Division
          --------------------

          Effective May 1, 2002, the Company entered into an agreement to sell
          substantially all of the assets of the ISP division to Brand X
          Networks, Inc., a California Corporation, for $632,000. The assets
          have been held and operated by Brand X Networks, Inc. for its purposes
          since May 1, 2002, at which time the Company discontinued its ISP
          operations. On April 14, 2003, the Company completed a fifth amendment
          to the purchase agreement with Brand X pursuant to which the Company
          agreed to accept an aggregate payment of $632,000 for the ISP
          Division, less credits to Brand X of $112,686. Of such amount,
          $200,000 was to be paid through the provision of services to the
          Company from Brand X. And the balance was to be paid at the rate of
          approximately $5,172 per month, until completely paid.

          On January 1, 2004, the sale of the ISP business to Brand X closed.
          Under the terms of that agreement a promissory note of $284,455 was
          executed by Brand X to be paid in 55 equal monthly installments. This
          note is collateralized by a pledge of shares in Brand X. In addition,
          ProtoSource was entitled to appoint one person to the board of
          directors of Brand X for the duration of the agreement.

          In February 2006, still within terms of the purchase agreement, Brand
          X notified ProtoSource that it would be unable to make its next
          payment on its note payable obligation and could not then specify when
          the next payment(s) would be forthcoming. Subsequently, ProtoSource
          discovered that Brand X had become insolvent and was unable to meet
          its obligations to ProtoSource and, as a consequence, was unable to
          cure its default status on its note payable obligation and, therefore,
          of the purchase agreement itself. At December 31, 2005, ProtoSource
          assessed the collectibility of the remaining note receivable balance
          of $162,582 and its unused services credit balance of $151,308 and
          determined that collection or realization of any portion of these
          amounts was highly doubtful and their values should be written down to
          $0. As a consequence, the Company recorded a provision for Brand X's
          uncollectible note and services credit in the amount of $313,890 in
          2005.

          In an agreement dated March 2006, ProtoSource sold, assigned and
          transferred the promissory note it held in respect of the January 2004
          sale of its ISP business to Brand X Networks, Inc. to P2i, Inc., a
          related party. As set forth in this transaction, a new promissory
          note, secured by all the assets of Brand X Networks, Inc., was issued
          to P2i, Inc. in the net amount of $162,582. The principal with
          interest shall be paid in 33 equal monthly installments of $5,172,
          until completely paid. Because regular payments have not been made,
          this successor note is in default status and has been fully reserved.
          During the whole of 2006, ProtoSource recovered $13,800 from the P2i,
          Inc. / Brand X Networks, Inc. promissory note arrangement. As the
          value of this note was written down to $0 at December 31, 2005, these
          payments were classified as "other income" in 2006.


                                      F-15
<PAGE>


                     PROTOSOURCE CORPORATION AND SUBSIDIARY
                     ======================================

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------


3.        Notes Payable
          -------------

          Notes payable of $2,425,000 is composed of 32 individual notes
          executed during the period beginning March 2002 and continuing through
          April 2004. These notes, which are secured by the assets of
          ProtoSource and P2i Newspaper, range between $25,000 and $200,000 on
          their face. All notes are one-year renewable 10% interest (per annum)
          convertible promissory notes. Each note can be prepaid, in whole or in
          part, without premium or penalty, at any time. Upon prepayment of the
          entire principle amount of a note, all accrued, but unpaid interest
          shall be paid to the holder on the date of prepayment. At any time
          prior to or at the time of repayment, the holder may elect to convert
          some or all of the principal and interest owing into shares of the
          Company's common stock. The conversion rate shall equal the amount to
          be converted, divided by each note's predetermined conversion price
          established at note issuance or renewal. {Conversion prices, after a
          series of renewals, range between $0.0667 and $0.10.} As a result of
          the beneficial conversion feature of these notes, through December 31,
          2006, the Company has recognized $1,852,500 as interest expense and
          additional paid-in capital. Also in connection with the issuance of
          these notes, as an added inducement to loan to the Company, the
          Company entered into accompanying subscription agreements to provide
          each note-holder shares of its no par value common stock. As a result,
          the Company issued or will issue a total of 7,006,226 shares of common
          stock valued at approximately $1,844,168.

          As of December 31, 2006, there were $255,000 of stock subscriptions
          payable (2,750,000 common shares) related to this obligation.

          There were no notes issued during the years ended December 31, 2006
          and 2005.


                                      F-16
<PAGE>


                     PROTOSOURCE CORPORATION AND SUBSIDIARY
                     ======================================

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------


4.        Income Taxes
          ------------

          Significant components of deferred income taxes as of December 31,
          2006 are as follows:

                 Net operating loss carryforward                 $5,400,000
                 Less valuation allowance                        (5,400,000)
                                                                  ---------
                 Net deferred tax asset                          $    --
                                                                  =========


          The Company has assessed its past earnings history and trends 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 $5,400,000 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 a decrease of $160,000. The Company will
          continue to review this valuation on a quarterly basis and make
          adjustments as appropriate.

          At December 31, 2006, the Company had federal and state net operating
          loss carryforwards of approximately $15,400,000 and $1,900,000,
          respectively. Such carryforwards expire in the years 2014 through 2026
          and 2012 through 2026 for federal and state purposes, respectively.


5.        Preferred Stock
          ---------------

          The authorized preferred stock of the Company consists of 5,000,000
          shares, no par value Series B Convertible Preferred Stock. {193,836
          shares are issued and outstanding.} 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.

          Upon authorization of sufficient shares of common stock, holders of
          the Series B Convertible Preferred Stock ("Series B Stock") are
          entitled to convert each share of Series B Stock into 100 shares of
          common stock. Series B stockholders are not entitled to receive
          dividends. In a liquidation, the holders would be treated as if they
          were owners of the number of shares of common stock into which the
          Series B Stock is convertible.


                                      F-17

<PAGE>


                     PROTOSOURCE CORPORATION AND SUBSIDIARY
                     ======================================

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------

6.        Stock Subscriptions Payable
          ---------------------------

          In addition to the obligations to note holders described in Note 3,
          stock subscriptions payable includes 813,688 shares of common stock,
          valued at $406,844, to be exchanged with an investment banker in
          connection with the acquisition of P2i Newspaper, LLC which occurred
          in January 2004.


7.        Stock Options and Warrants
          --------------------------
          1999 Executive Officers Stock Option Plan
          -----------------------------------------

          In May 1999, the Company's Board of Directors authorized a stock
          option plan that provides for the grant of incentive and nonqualified
          options to eligible officers and directors 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 2009. There are currently
          no outstanding options under this plan.


          2000 Stock Option Plans
          -----------------------

          In May 2001, the Company's shareholders approved the Company's 2000
          Employee Stock Option Plan and the 2000 Executive Stock Option Plan.
          Each Plan has 350,000 shares reserved for issuance and no stock
          options have been granted under either plan as of December 31, 2006.


                                      F-18


<PAGE>


                     PROTOSOURCE CORPORATION AND SUBSIDIARY
                     ======================================

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------


8.        Commitments and Contingencies
          -----------------------------

          Leases
          ------

          The Company leases certain computer equipment under noncancellable
          capital leases.

          The following is a schedule of future minimum lease payments at
          December 31, 2006 under the Company's capital leases (together with
          the present value of minimum lease payments).

                        2007                                      $30,775
                        2008                                        8,611
                                                                 --------
            Total minimum lease payments                           39,386
         Less amount representing interest                      (   6,611)
                                                                  -------
         Present value of net minimum lease payments               32,775
         Less current portion                                    ( 24,819)
                                                                   ------
                                                                 $  7,956


          The Company occupies office space leased by P2i, Inc. and is making
          direct payments to P2i, Inc.'s leaseholder. Under this arrangement,
          the Company has recorded approximately $35,000 of rent expense for
          each of the years ended December 31, 2006 and 2005.

          The Company's expected commitment in respect to this arrangement is as
          follows for the years ended December 31:

                        2007                                      $35,775
                        2008                                       36,266


          Through June 2006, the Company leased 3,200 square feet of office
          space at its facility in Cyberjaya, Selangor Malaysia. Beginning July
          1, 2006 the Company entered into a new lease agreement with the same
          leaseholder adding 3,200 square feet of additional space, bringing the
          total leased space to 6,400 square feet. The term of the tenancy
          agreement is for two years. The agreement states that either party can
          terminate the agreement by giving written notice of 90 days to the
          other party. Under this arrangement, the Company has recorded
          approximately $65,800 and $40,400 of rent expense for each of the
          years ended December 31, 2006 and 2005, respectively.

          The Company's commitment under this lease is as follows for the years
          ended December 31:

                        2007                                      $87,800
                        2008                                       43,900


                                      F-19
<PAGE>


                     PROTOSOURCE CORPORATION AND SUBSIDIARY
                     ======================================

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------


8.        Commitments and Contingencies - Continued
          -----------------------------------------

          Contingencies
          -------------

          At various times, the Company is subject to various claims from former
          employees for potential damages relating to wrongful dismissal or
          other causes. The Company currently has three such cases, none of
          which management believes will further materially adversely affect the
          Company's financial condition.


9.        Concentrations of Credit Risk
          -----------------------------

          Financial instruments, which potentially subject the Company to
          concentrations of credit risk, consist principally of cash and notes
          receivable. The Company places its cash and short-term investments
          with high credit quality financial institutions, and limits its credit
          exposure with any one financial institution.


10.       Employee Benefit Plan
          ---------------------

          The Company has 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 no contributions for
          the years ended December 31, 2006 and 2005. Company contributions, if
          any, vest as follows:

                       Years of Service                Percent Vested
                       ----------------                --------------

                              1                              33%
                              2                              66%
                              3                             100%


                                      F-20
<PAGE>


                     PROTOSOURCE CORPORATION AND SUBSIDIARY
                     ======================================

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------

11.       Fair Value of Financial Instruments
          -----------------------------------

          Disclosures about the fair value of financial instruments, for the
          Company's financial instruments, are presented in the table below.
          These calculations are subjective in nature and involve uncertainties
          and significant matters of judgment and do not include income tax
          considerations. Therefore, the results cannot be determined with
          precision and cannot be substantiated by comparison to independent
          market values and may not be realized in actual sale or settlement of
          the instruments. There may be inherent weaknesses in any calculation
          technique, and changes in the underlying assumptions used could
          significantly affect the results. The following table presents a
          summary of the Company's financial instruments as of December 31,
          2006:

                                               Carrying          Estimated
                                                Amount          Fair Value
                                                ------          ----------

         Financial liabilities:
           Notes payable                       $2,425,000       $2,425,000
           Capital lease obligations               32,775           32,775


          The carrying amounts for cash, accounts payable and accrued expenses
          approximate fair value because of the short maturities of these
          instruments. The fair value of notes payable and the capital lease
          obligations, including the current portion, approximates fair value
          because of the market rate of interest on the notes payable and the
          interest rate implicit in the obligations under capital leases.


12.       Concentrations
          --------------

          Revenues for the years ended December 31, 2006 and 2005 include
          revenues from one major customer that accounted for 35% and 29%,
          respectively, of total Company revenues. Accounts receivable from this
          customer amounted to 30% and 33% of the Company's total accounts
          receivable at December 31, 2006 and 2005, respectively.


13.       P2i Newspaper
          -------------

          On February 13, 2003, the Company announced an agreement and Plan of
          Merger to acquire all of the outstanding capital stock of P2i
          Newspaper, Inc., a Delaware corporation ("P2i Newspaper") and a
          wholly-owned subsidiary of P2i, Inc., a Pennsylvania corporation
          ("P2i"), in exchange for the issuance of up to 19,383,531 shares of
          ProtoSource common stock and satisfaction of the existing P2i debt to
          the Company (the "Agreement").

          On January 1, 2004, the Company, P2i Newspaper and P2i amended the
          terms of the Agreement (the "Amendment"). Pursuant to the terms of the
          Amendment, in exchange for all of the issued and outstanding shares of
          P2i Newspaper, the Company issued 193,836 shares of series B preferred
          stock (the "Preferred Stock").


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<PAGE>


                     PROTOSOURCE CORPORATION AND SUBSIDIARY
                     ======================================

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005
--------------------------------------------------------------------------------


13.       P2i Newspaper - Continued
          -------------------------

          Upon authorization of sufficient shares of common stock, holders of
          the Series B Convertible Preferred Stock ("Series B Stock") are
          entitled to convert each share of Series B Stock into 100 shares of
          common stock. Series B stockholders are not entitled to receive
          dividends. In a liquidation, the holders would be treated as if they
          were owners of the number of shares of common stock into which the
          Series B Stock is convertible.

          The acquisition of P2i Newspaper became effective on January 1, 2004,
          at which time P2i Newspaper became a wholly-owned subsidiary of the
          Company. The cost was as follows:

            Market value of preferred stock to be issued              $ 416,179
            Fair market value of net assets of P2i Newspaper             41,112
                                                                      ---------

            Goodwill                                                  $ 375,067
                                                                      =========


          The acquisition of P2i Newspaper was the central component of the
          transaction between the Company and P2i; however, in further
          accordance to the agreement, as a consideration for the satisfaction
          of P2i's existing debt to the Company (i.e., $1,705,062 in notes
          receivable plus accrued interest), the Company acquired an additional
          interest in P2i's new media business, bringing the Company's total
          ownership in P2i to 19.8%. However, despite the increased ownership of
          P2i, the ownership in P2i is considered to be of deminimus value and
          therefore has no classification within the Company's financial
          statements.


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