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, 2005

     { } 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 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 $1,938,924.

A of December 31, 2005, the market value of the Registrant's no par value Common
Stock, excluding shares held by affiliates, was $306,135 based upon a closing
bid price of $0.04 per share of Common Stock on the OTC Bulletin Board.

<PAGE>



          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, 2005, 8,114,829 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, 2005
--------------------------------------------------------------------------------


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

Item  1. Description of Business.                                             4

      2. Description of Properties.                                           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 F21

      8. Changes in and Disagreements with Accountants on
           Accounting and Fianancial 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.                       20

     12. Certain Relationships and Related Transactions.                     21

     13. Exhibits.                                                           22

     14. Principal Accountant Fees and Services.                             23


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

         Signatures.

         Certifications.

         Exhibit 99.2 - Code of Ethics and Business 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
------------

The merger with P2i, Inc. at the start of 2004 is indicative of ProtoSource's
long-term business strategy: to focus on the delivery of technologically
sophisticated, database-driven, business-to-business services and solutions.

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, we receive electronic files
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 first seeks
to become a leader in the transfer of print content into database-driven
electronic content. Newspapers, retailers and government offices in the US and
UK are turning 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 provides
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 has 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 is 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 is unable to meet its obligations to ProtoSource and, as a
consequence, is unable to cure its now default status on its note payable
obligation and, therefore, of the purchase agreement itself. ProtoSource has
assessed the collectibility of the remaining note receivable balance of $162,582
and its unused services credit balance of $151,308 and has determined that
collection or realization of any portion of these amounts is highly doubtful and
that their values should be written down to $0. As a consequence of these
subsequent events, the Company has recorded a provision for Brand X's
uncollectible note and services credit in the amount of $313,890 in 2005. The
Company is evaluating its options in respect to this event, such that it might
obtain a viable remedy with potential to recover some or all of its investment.

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 100,000,000 shares.

The 193,836 shares of preferred stock will be reduced by the number of shares
equal to the total fees incurred to audit the financial statements of P2i, or
P2i Newspaper, divided by $50 (the "Adjusted Shares"). The Adjusted Shares shall
be subject to a three-year lock-up, which may be released upon the stock price
and volume reaching established thresholds. 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.

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.

                                       5

<PAGE>


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

Executing our 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 100 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. Every day of
the week, 52 weeks a year, we receive 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 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 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'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, and can be viewed
using the links located at the end of this presentation. The business model is
quite straightforward. Clients pay per ad/page processed, and are billed
monthly.

Through 2006, 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.

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.

                                       6
<PAGE>


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 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: sell directly to the
newspapers and deliver 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.

There are many obstacles to newspapers adopting pure software solutions to
compete with P2i Newspaper services. 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

                                       7

<PAGE>


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, 2005, P2i Newspaper had a combination of 111 full-time and
part time employees. Of such employees, 3 were engaged in marketing and sales, 8
were devoted to research, development and technical support, 94 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 PROPERTIES.

The Company occupies 1,500 square feet of office space at One Bethlehem Plaza,
Bethlehem, PA 18018, and 3,000 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
        MALL 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, 2004        $0.08    $0.08       N/A      N/A          N/A     N/A
June 30, 2004         $0.08    $0.08       N/A      N/A          N/A     N/A
September 30, 2004    $0.04    $0.04       N/A      N/A          N/A     N/A
December 31, 2004     $0.04    $0.04       N/A      N/A          N/A     N/A

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

As of March 15, 2006, there were approximately 1,500 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.

                                       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, 2005 vs. Year Ended December 31, 2004

Net Revenues - For the year ended December 31, 2005, net revenues were
$1,938,924 versus $1,639,594 for the year ended December 31, 2004. All revenues
of the Company were attributed to the operations of P2i Newspaper acquired by
the Company on January 1, 2004. The $299,330 increase in revenues over the
previous year is largely attributable to a sales effort that has 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, 2005, operating
costs and expenses totaled $1,845,841 versus $1,845,479 in 2004. Despite a
significant increase in sales over the previous year, the Company's aggregate
cost of revenues, selling, general and administrative expenses were virtually
unchanged, principally due to increased productivity, a reduction in office
facilities, and the elimination of unneeded staffing and related overhead costs.
Administrative costs principally consist of the Company's management office and
personnel, professional fees associated with restructuring and maintenance of
the Company, and officers' and directors' liability insurance costs. In
addition, the Company had impairment charges of $24,000 in 2004 in connection
with the Company's investment in P2i, Inc.


Interest Expense - Interest expense totaled $368,230 for the year ended December
31, 2005 versus interest expense of $1,106,490 in 2004. In the current period,
the interest expense is principally the result of the convertible notes obtained
during 2004, 2003, and 2002 to fund operations of the Company and P2i Newspaper,
pending and post merger. In the preceding year, a significant component of
interest expense included amortization of debt issuance costs incurred during
2004 and 2003. As there have been no new debt issues since April 2004, the
current year reflects a vast reduction of the effect of amortization of residual
historical debt issue costs.


Other Income (Charges) - In 2005, Other Income included a write-off of
approximately $64,000 of open accounts payable, originally recorded prior to
2003 that were found to be invalid. 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 2004, $406,844 of
investment banking fees relating to the acquisition of P2i Newspaper was
recorded.


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 has 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.

                                       10

<PAGE>


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 is 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 is unable to meet its obligations to ProtoSource and, as a
consequence, is unable to cure its now default status on its note payable
obligation and, therefore, of the purchase agreement itself. ProtoSource has
assessed the collectibility of the remaining note receivable balance of $162,582
and its unused services credit balance of $151,308 and has determined that
collection or realization of any portion of these amounts is highly doubtful and
that their values should be written down to $0. As a consequence of these
subsequent events, the Company has recorded a provision for Brand X's
uncollectible note and services credit in the amount of $313,890 in 2005. The
Company is evaluating its options in respect to this event, such that it might
obtain a viable remedy with potential to recover some or all of its investment.


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.

We generated cash in excess of our working capital requirements for the year
ended December 31, 2005. Our cash flows provided by operations were
approximately $97,000, even though our net loss for the year ended December 31,
2005 was approximately $496,000. This was due to non-cash charges included in
the net loss of approximately $382,000, which consisted primarily of the
provision for the uncollectible note and services credit from Brand X of
$314,000, depreciation and amortization of $132,000, offset by an adjustment to
non-cash income resulting from a decrease in accounts payable by approximately
$64,000. Cash flow from operations was also positively impacted by changes, year
over year, in working capital components of approximately $210,000. Significant
changes in working capital components included an increase in working capital of
$305,000 primarily relating to interest arising from the Company's convertible
debt obligations that was accrued but unpaid, offset by a decrease in available
cash of $76,000 due to an increase in accounts receivable due to the Company's
higher level of revenues. Accounts receivable as reported at year-end are
current.

We had positive cash flows from investing activities of approximately $35,000,
due to collections on the note receivable from Brand X of approximately $55,000,
offset by acquisitions of equipment and advances to directors and officers.

We used approximately $130,000 of cash to advance funds to a related company of
approximately $92,000 and for payments on capital lease obligations of
approximately $38,000.

As of December 31, 2005, we had $40,812 in cash, $423,281 in accounts receivable
and other current assets. Taken together with $3,635,136 of total current
liabilities, this resulted in a negative working capital position of $3,171,043
at December 31, 2005.

On December 14, 2001, after exploring numerous alternatives, the Company entered
into a term sheet to acquire P2i for 22,768,412 shares of our common stock.

In March 2002, the Company entered into an agreement with AAWC to act as
placement agent for the sale of convertible notes aggregating at least $300,000.
The notes are secured by certain assets of the Company and accrue interest at
10% per annum. P2i has agreed to pay all the costs and obligations incurred with
this financing. The funding was completed during March 2002 and AAWC was paid a
10% commission and a 3% non-accountable expense allowance.

                                       11

<PAGE>


On May 1, 2002, the Company entered into a conditional agreement to sell the
assets of the Fresno-based ISP business to Brand X Networks. Brand X Networks 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. Most terminated employees were hired by
Brand X. Additionally, Brand X has 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 has agreed to accept an aggregate payment of $632,000 for the ISP
Division, less credits to Brand X of $112,686, and the transaction closed on
January 1, 2004. Of such amount, $200,000 shall be paid through the provision of
services to the Company from Brand X. The balance shall be paid at the rate of
approximately $5,171 per month, until completely paid.

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 is unable to meet its obligations to ProtoSource and, as a
consequence, is unable to cure its now default status on its note payable
obligation and, therefore, of the purchase agreement itself. ProtoSource has
assessed the collectibility of the remaining note receivable balance of $162,582
and its unused services credit balance of $151,308 and has determined that
collection or realization of any portion of these amounts is highly doubtful and
that their values should be written down to $0. As a consequence of these
subsequent events, the Company has recorded a provision for Brand X's
uncollectible note and services credit in the amount of $313,890 in 2005. The
Company is evaluating its options in respect to this event, such that it might
obtain a viable remedy with potential to recover some or all of its investment.

In July 2002, the Company executed its merger agreement with P2i. Concurrently,
the Company's CEO, Mr. William Conis, resigned his position as both CEO and
Director. Mr. Peter Wardle, CEO of P2i and a ProtoSource Director, became CEO of
the Company.

On September 17, 2002, the Board of Directors approved a revised term sheet
restructuring the P2i acquisition, and on January 1, 2004, this transaction
closed. Under the new terms, ProtoSource will acquire the Newspaper portion of
P2i, Inc.'s business through the acquisition of specific assets which include
the entire newspaper related customer base, technology, intellectual property
and P2i's production company located just south of Kuala Lumpur, Malaysia. In
addition, key P2i employees will transition with the business. These assets and
the key employees have been transferred to P2i Newspaper, Inc. a wholly-owned
subsidiary of P2i formed specifically for this purpose. The acquisition of P2i
Newspaper, Inc. by ProtoSource has been accounted for by the purchase method of
accounting as a reverse acquisition. For accounting purposes, P2i Newspaper,
Inc. is considered to be the acquirer and ProtoSource is the acquiree.

The number of shares of restricted common stock to be issued to P2i ("P2i,
Inc.") has subsequently been revised to 19,383,531 shares (after conversion of
the preferred stock issued as merger consideration) which will result in an
ownership of approximately 37% by the stockholders of P2i, on a fully diluted
basis assuming conversion of certain bridge loans into common stock, the balance
being held by the current stockholders of ProtoSource. After the acquisition of
P2i Newspaper, the Board of Directors of ProtoSource consists of seven members.
One member has been appointed by the investment banker, AAWC. (This appointment
must be approved by P2i but can't be unreasonably withheld.) Messrs. Wardle and
Butera will be on the Board and they shall appoint the two independent members
plus one other as long as they hold 25% or more of P2i (see below) collectively,
and P2i owns 25% or more of ProtoSource. In the event that P2i's ownership drops
below 25% but is not less than 10%, P2i shall appoint one board member. In the
event that P2i's ownership drops below 10%, P2i shall not have the right to
appoint any board member. ProtoSource and P2i both used the same investment
banker to represent them in the transaction and each will pay the investment
banker a fee based on the value of the transaction using a pre-set formula. The
investment banking fees to be paid are $406,844 by ProtoSource and $413,422 by
P2i. The amounts paid to the investment banker will be paid through the issuance
of common stock, which is restricted for a three-year period, based on an
agreed-upon value of $.50 per share at the time of signing the term sheet, or
813,688 shares for ProtoSource and 826,844 shares for P2i. The shares to be
issued for P2i's investment banking fees will be subtracted from the shares to
be issued to the P2i stockholders for the acquisition. P2i's remaining catalog
and new media business will stay with P2i. However, ProtoSource will increase
its ownership in P2i from the current 2.18% (506,225 shares) to 19.8%. The
consideration to be paid is the forgiveness of P2i debt to ProtoSource.

                                       12
<PAGE>


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.

The Company did not secure any external funding after April 2004 and through
September 2005.

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 $27,767.70 with monthly lease payments of $1,596.19 each. The
lease term expires September 14, 2007 and the residual maturity date is October
15, 2007 with a $1.00 purchase option. $3,487.38 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.


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

In November 2004, the FASB issued SFAS No. 151, "Inventory Costs". The new
Statement amends Accounting Research Bulletin No. 43, Chapter 4, "Inventory
Pricing," to clarify the accounting for abnormal amounts of idle facility
expense, freight, handling costs, and wasted material. This Statement requires
that those items be recognized as current period charges and requires that
allocation of fixed production overheads to the cost of conversion be based on
the normal capacity of the production facilities. This statement is effective
for fiscal years beginning after June 15, 2005. The Company does not expect
adoption of this Statement to have a material impact on its financial condition
or results of operations.

In December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment". This
Statement replaces SFAS No. 123 and supersedes APB No. 25. SFAS No. 123 (R) will
require the fair value of all stock option awards issued to employees to be
recorded as and expense over the related vesting period. The Statement also
requires the recognition of compensation expense for the fair value of any
unvested stock option awards outstanding at the date of adoption. As permitted
by SFAS No. 123, the Company currently accounts for share-based payments to
employees using the APB No. 25 intrinsic value method and, as such, generally
recognizes no compensation cost for employee stock options. Accordingly, the
adoption of SFAS No. 123(R)'s fair value method will have and impact on the
Company's results of operations. Had the Company adopted SFAS No. 123(R) in
prior periods, the impact of that standard would have approximated the impact of
SFAS No. 123 as described in the disclosure of pro forma net income and earnings
per share above.

                                       13

<PAGE>


In December 2004, the FASB issued SFAS No. 153, "Exchanges of Non-monetary
Assets," which addresses the measurement of exchanges of non-monetary assets.
SFAS No. 153 eliminates the exception from fair value measurement for
non-monetary exchanges of similar productive assets, which was previously
provided by APB No. 29, "Accounting for Non-monetary Transactions," and replaces
it with an exception for exchanges that do not have commercial substance. SFAS
No. 153 specifies that a non-monetary exchange has commercial substance if the
future cash flows of the entity are expected to change significantly as a result
of the exchange. SFAS No. 153 is effective for non-monetary asset exchanges
occurring in fiscal periods beginning after June 15, 2005. We do no expect the
adoption of SFAS No. 153 to have a material impact on the Company's financial
condition or results of operations.

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. We do not expect
adoption of this SFAS No. 154 to have a material impact on the Company's
financial condition or results of operations.


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. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of" (and superceded in 2001 by
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets"),
the Company recorded impairment charges of $24,000 in 2004 to reduce the
carrying value of its investment in P2i, Inc. to zero.

In accordance with SFAS No. 109, "Accounting for Income Taxes", the Company
maintains a valuation allowance of $5,560,000 as of December 31, 2005 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 $7,782 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.

                                       14

<PAGE>


ITEM 7. FINANCIAL STATEMENTS.

The consolidated financial statements of ProtoSource Corporation for the years
ended December 31, 2005 and 2004 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, 2005                         F-3
  Consolidated Statement of Operations for the years ended December 31,
   2005 and 2004.                                                            F-4
  Consolidated Statement of Stockholders' Equity (Deficiency) for the
   years ended December 31, 2005 and 2004                                    F-5
  Consolidated Statement of Cash Flows for the years
   ended December 31, 2005 and 2004.                                  F-6 to F-7
  Notes to Consolidated Financial Statements                         F-8 to F-21


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 significant 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,     51             Chief Executive Officer, President,
                                   Chief Financial Officer and Director
Thomas Butera,    39             Chief Operating Officer and Director
Joseph DiMarino,  63             Director
Mark Blanchard,   53             Director
Stewart Kalter,   35             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 during fiscal 2004
and Forms 5 and amendments thereto furnished to the Company with respect to
fiscal 2003, 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 for the last three fiscal years.
<TABLE>
<CAPTION>

                                                                                            Long Term
Name and                                                                                   Compensation
Principal                                         Other        Annual    All Other      Awards/Securities
Position                   Year    Salary ($)  Compensation    Bonus    Compensation   Underlying Options(#)
--------                   ----    ----------  ------------    -----    ------------   ---------------------

<S>                        <C>      <C>
Peter Wardle, CEO          2005     $125,000         -                 -                 -                -
                           2004      125,000         -                 -                -                 -
                           2003          -           -                 -                -                 -

Thomas Butera, COO         2005     $112,500         -                 -                -                 -
                           2004      112,500         -                 -                -                 -
</TABLE>

----------


Option Grants in Last Year and Stock Option Grant.

No options were granted during the year ended December 31, 2005.


Aggregate Option Exercise of Last Fiscal year and Fiscal Year-End Option Values

The following table provides information on the value of the named executive
officers' unexercised options at December 31, 2005. No shares of Common Stock
were acquired upon exercise of options during the fiscal year ended December 31,
2005.

                                                         Value of
                  Number of Unexercised          Unexercised In-The-Money
                  Options at Year End              Options at Year End
               ---------------------------     ---------------------------
Name           Exercisable   Unexercisable     Exercisable   Unexercisable
----           -----------   -------------     -----------   -------------

None.


                                       17

<PAGE>


2000 Employee Stock Option Plan
-------------------------------

On May 1, 2001, the Company received shareholder approval to adopt an employee
stock option plan (the Plan). This Plan provides for the grant of options
intended to qualify as incentive stock options and nonqualified stock options
within the meaning of Section 422 of the United States Internal Revenue Code of
1986 (the Code). Incentive stock options are issuable only to eligible officers,
directors, key employees and consultants of the Company.

The Plan is administered by the Board of Directors and terminates in May 2006.
At December 31, 2002, the Company had reserved 350,000 shares of Common Stock
for issuance under the Plan. Under the Plan, the Board of Directors determines
which individuals shall receive options, the time period during which the
options may be partially or fully exercised, the number of shares of Common
Stock that may be purchased under each option and the option price.

The per share exercise price of the Common Stock may not be less than the fair
market value of the Common Stock on the date the option is granted. No person
who owns, directly or indirectly, at the time of the granting of an incentive
stock option, more than 10% of the total combined voting power of all classes of
stock of the Company is eligible to receive incentive stock options under the
Plan unless the option price is at least 110% of the fair market value of the
Common Stock subject to the option on the date of grant.

No options may be transferred by an optionee, other than by will or the laws of
descent and distribution, and during the lifetime of an optionee, the option may
only be exercisable by the optionee. Options may be exercised only if the option
holder remains continuously associated with the Company from the date of grant
to the date of exercise. Options under the Plan must be granted within five
years from the effective date of the Plan and the exercise date of an option
cannot be later than ten years from the date of grant. Any options that expire
unexercised or that terminate upon an optionee's ceasing to be employed by the
Company become available once again for issuance. Shares issued upon exercise of
an option will rank equally with other shares then outstanding.

As of December 31, 2005, no options are outstanding under this Plan.


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, 2004, 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

                                       18

<PAGE>


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.

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, 2004, 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.


                                       19

<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 31, 2006, 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 100,000,000.

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

Peter Wardle                               19,383,600(3)             70.5%
Thomas Butera                              19,383,600(3)             70.5%
Joseph DiMarino                                     -                   -
Mark Blanchard (4)                            461,454                 6.2%
Stewart Kalter                                      -                   -

Kent Spears                                   367,173                 4.9%
Peter J. Pappas (5)                         1,319,748                16.2%

All officers and directors as a group
(5 persons)                                   461,454                 6.2%

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

* 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.


                                       20
<PAGE>


ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

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, during 2004 and 2005, Mr. Wardle
received $111,404 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.

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. Additionally, during 2005, Mr. Butera received
$27,587 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. Also, during 2005, for purposes of providing working
capital to the Company, Mr. Butera advanced $19,000 to the Company for an
indefinite period of time.

As of December 31, 2005, an amount of $103,393 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 2005 and 2004, payments of
approximately $37,600 and $37,400, respectively, were paid to P2i's leaseholder.


                                       21

<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.


                                       22
<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, 2005 and December 31, 2004, and for review of the
financial statements included in the Company's quarterly reports on Form 10-QSB
during such fiscal years, were $36,000 and $35,000, 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 $0 for the years ended December
31, 2005 and 2004, respectively.

Tax Fees. The aggregate fees billed for tax preparation and related services by
our auditors were $3,500 and $3,000 for the years ended December 31, 2005 and
2004, respectively.

All Other Fees. For the fiscal years ended December 31, 2005 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".


                                       23
<PAGE>


                                   SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant has
duly caused this Report to be signed on its behalf by the undersigned, thereunto
duly authorized, in Bethlehem, Pennsylvania, on March 30, 2006.

                                            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, 2006
----------------------------      Chief Financial Officer
     Peter Wardle                (Principal Accounting
                                  Officer), and Director

/s/  Thomas Butera                Chief  Operating Officer       March 30, 2006
----------------------------      Director
     Thomas Butera

/s/  Joseph DiMarino              Director                       March 30, 2006
----------------------------
     Thomas Butera

/s/  Mark Blanchard               Director                       March 30, 2006
----------------------------
     Mark Blanchard

/s/  Stewart Kalter               Director                       March 30, 2006
----------------------------
     Stewart Kalter


                                       24
<PAGE>


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

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



                                                                 Page
                                                                 ----

Financial Statements                                             F-1

Report of Independent Registered Public Accounting Firm          F-2

Consolidated Balance Sheet as of December 31, 2005               F-3

Consolidated Statement of Operations
  for the years ended December 31, 2005 and 2004                 F-4

Consolidated Statement of Stockholders' Equity (Deficiency)      F-5
  for the years ended December 31, 2005 and 2004

Consolidated Statement of Cash Flows
  for the years ended December 31, 2005 and 2004                 F-6 & 7

Notes to Consolidated Financial Statements                       F-8 to F-21


                                      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, 2005, and the related consolidated
statements of operations, stockholders' equity (deficiency), and cash flows for
the years ended December 31, 2005 and 2004. 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, 2005, and the results of their operations and
their cash flows for the years ended December 31, 2005 and 2004 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 $495,870 and $1,230,227 during
the years ended December 31, 2005 and 2004, 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 28, 2006



                                       F-2


<PAGE>


                     PROTOSOURCE CORPORATION AND SUBSIDIARY

--------------------------------------------------------------------------------
                           CONSOLIDATED BALANCE SHEET
                                DECEMBER 31, 2005


                                     ASSETS


Current assets:
   Cash                                                            $     40,812
   Accounts receivable - trade, net of allowance of $7,782              256,586
   Advances to officers, net of obligations to officers                  63,302
   Amounts due from related party - P2i, Inc.                           103,393
                                                                   ------------

       Total current assets                                             464,093
                                                                   ------------

Property and equipment, at cost, net of
   accumulated depreciation and amortization of $497,582                 61,488
                                                                   ------------

Other assets:
   Goodwill - Acquisition of P2i Newspaper                              375,067
   Deposits                                                               2,359
                                                                   ------------

       Total other assets                                               377,426
                                                                   ------------

       Total assets                                                $    903,007
                                                                   ============


                    LIABILITIES AND STOCKHOLDERS' DEFICIENCY

Current liabilities:
   Notes payable                                                   $  2,425,000
   Current portion of obligations under capital leases                   18,971
   Accounts payable                                                      46,104
   Accrued expenses                                                   1,145,061
                                                                   ------------

       Total current liabilities                                      3,635,136
                                                                   ------------

Obligations under capital leases, non-current portion                    11,830
                                                                   ------------


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, 8,114,829 shares issued and outstanding             25,835,960
   Common stock, to be issued, no par value, 5,376,188 shares           969,345
   Additional paid-in capital                                         2,864,107
   Accumulated deficit                                              (32,829,550)
                                                                   ------------

       Net  stockholders' deficiency                                 (2,743,959)
                                                                   ------------

       Total liabilities and stockholders' deficiency              $    903,007
                                                                   ============



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,
                                                                              2005                    2004
                                                                         ------------            ------------

<S>                                                                      <C>                     <C>
Net revenues                                                             $  1,938,924            $  1,639,594
                                                                         ------------            ------------

Operating costs and expenses:
   Cost of revenues                                                         1,056,411                 916,728
   Selling, general and administrative                                        703,856                 793,429
   Depreciation and amortization                                               85,574                 111,322
   Impairment of investment                                                      --                    24,000
                                                                         ------------            ------------

         Total operating costs and expenses                                 1,845,841               1,845,479
                                                                         ------------            ------------

         Operating income (loss)                                               93,083                (205,885)
                                                                         ------------            ------------

Other income (charges):
   Interest expense                                                          (368,230)             (1,106,490)
   Investment banking fees                                                       --                  (406,844)
   Other expense                                                                 --                   (10,737)
   Loss on disposal of property and equipment                                    (138)                   --
   Provision for uncollectible note and services credit, Brand X             (313,890)                   --
   Interest income                                                              6,669                   6,316
   Other income                                                                86,636                  17,959
                                                                         ------------            ------------

          Net other (charges)                                                (588,953)             (1,499,796)
                                                                         ------------            ------------

Loss from continuing operations                                              (495,870)             (1,705,681)

Discontinued operations:
   Gain on disposal - ISP                                                        --                   475,454
                                                                         ------------            ------------

Net loss                                                                 ($   495,870)           ($ 1,230,227)
                                                                         ============            ============

Net loss per basic and diluted share of common stock:
   Continuing operations                                                 ($       .02)           ($       .05)
   Discontinued operations                                                       --                       .01
                                                                         ------------            ------------

Net loss                                                                 ($       .02)           ($       .04)
                                                                         ============            ============

Weighted average number of basic and
  diluted common shares outstanding                                        32,874,548              31,798,461
                                                                         ============            ============


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' EQUITY (DEFICIENCY)
                                              FOR THE YEARS DECEMBER 31, 2005 AND 2004
---------------------------------------------------------------------------------------------------------------------------

                                                                                                     Common Stock
                                      Preferred Stock                 Common Stock                    to be Issued
                                -------------------------       -----------------------              ------------
                                  Shares          Amount          Shares       Amount           Shares         Amount
                                ---------    ------------       ---------   -----------      -----------     ------------

Balance, December 31, 2003                                       8,114,829    $ 25,835,960       2,737,500   $    700,000

Issuance of preferred
  stock in connection
  with acquisition                193,836    $    416,179
Common stock to be
  issued in connectio
  with investment
  banking fees for
  acquisition                                                                                      813,688         406,844
Common stock to be
 issued in connection
 with financing                                                                                  1,825,000         195,000
Change in estimate
  of share price
  of common stock
  to be issued in
  connection with
  financing                                                                                                       (332,499)
Beneficial conversion
  feature of convertible notes

Net loss
                             ------------    ------------     ------------    ------------    ------------    ------------


Balance, December 31, 2004        193,836         416,170       8,114,829       25,835,960       5,376,188         969,345


Net loss
                             ------------    ------------    ------------     ------------    ------------    ------------


Balance, December 31, 2005        193,836    $    416,179       8,114,829     $ 25,835,960       5,376,188    $    969,345
                             ============    ============    ============     ============    ============    ============


                                                 (CONTINUED ON NEXT PAGE)
<PAGE>



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

                                   CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIENCY) (Continued)
                                              FOR THE YEARS DECEMBER 31, 2005 AND 2004
---------------------------------------------------------------------------------------------------------------------------

Balance, December 31, 2003                         $  2,464,107             ($31,103,453)            ($ 2,103,386)

Issuance of preferred
  stock in connection
  with acquisition                                                                                        416,179
Common stock to be
  issued in connectio
  with investment
  banking fees for
  acquisition                                                                                             406,844
Common stock to be
 issued in connection
 with financing                                                                                           195,000
Change in estimate
  of share price
  of common stock
  to be issued in
  connection with
  financing                                                                                              (332,499)
Beneficial conversion
  feature of convertible  notes                        400,000                                            400,000

Net loss                                                                      (1,230,227)              (1,230,227)
                                                   ------------             ------------             ------------


Balance, December 31, 2004                            2,864,107              (32,333,680)              (2,248,089)



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


Balance, December 31, 2005                         $  2,864,107             ($32,829,550)            ($ 2,743,959)
                                                   ============             ============             ============



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,
                                                                              2005                   2004
                                                                           ----------             ----------

                                             INCREASE (DECREASE) IN CASH

Cash flows from operating activities:
  Net loss                                                                ($  495,870)           ($1,230,227)
  Adjustments to reconcile net loss to net cash
       provided by (used in) operating activities:
     Depreciation and amortization                                             85,574                111,322
     Provision (credit) for bad debts                                            --
                                                                                                       7,782
     Gain on disposal -- ISP                                                     --                 (475,454)
     Impairment of investment                                                    --
                                                                                                      24,000
     Loss on disposal of property and equipment                                   138                     29
     Amortization of debt issuance costs                                       47,067                415,062
     Amortization of beneficial conversion
       of notes payable                                                          --                  400,000
     Investment banking fees to be paid by
       issuance of common stock                                                  --                  406,844
     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                                                    (75,877)               (25,333)
       Prepaid expenses and other assets                                       20,183                 22,187
       Accounts payable                                                       (48,367)              (115,221)
       Accrued expenses                                                       313,932                267,859
                                                                          -----------            -----------

              Net cash provided by (used in) operating activities              96,845               (191,150)
                                                                          -----------            -----------

Cash flows from investing activities:
  Cash obtained from acquisition of P2i Newspaper                                --                   56,775
  Acquisitions of property and equipment                                      (10,583)                (6,013)
  Proceeds from sale of property                                                  158                   --
  Collection on notes receivable - Brand X                                     55,394                 45,403
  Increase in directors and employees advances                                (16,172)              (165,755)
  Decrease in deposits                                                          5,904                   --
                                                                          -----------            -----------

              Net cash provided by (used in) investing activities              34,701                (69,590)
                                                                          -----------            -----------


                                                  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,
                                                                               2005                 2004
                                                                             ---------           ---------

Cash flows from financing activities:
  Proceeds from borrowings                                                   $    --             $ 400,000
  Payments on obligations under capital leases                                 (37,973)            (41,104)
  Net change in amount due related company                                     (92,487)            (53,888)
  Debt issuance costs incurred                                                    --               (52,000)
                                                                             ---------           ---------

           Net cash provided by (used in) financing activities                (130,460)            253,008
                                                                             ---------           ---------

Net increase (decrease) in cash                                                  1,086              (7,732)

Cash at beginning of year                                                       39,726              47,458
                                                                             ---------           ---------

Cash at end of year                                                          $  40,812           $  39,726
                                                                             =========           =========


                               SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

Cash paid during the year for:
  Interest                                                                   $  31,275           $  23,199
                                                                             ---------           ---------
  Income taxes                                                               $    --             $    --
                                                                             ---------           ---------


                SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES

Issuance of common stock in connection with financing                        $    --             $ 195,000
Issuance of preferred stock in connection with acquisition                        --               416,179
Acquisition of equipment under capital lease obligation                         26,768                --
Sale of ISP Division in exchange for note receivable
  and credit for future services                                                  --               475,454


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, 2005 AND 2004
--------------------------------------------------------------------------------

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, Inc. (see Note 8). P2i Newspaper, Inc. 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 make P2i Newspaper highly
          competitive. The Company intends leveraging these competitive
          advantages in other markets over the next five years.

          P2i Newspaper is focused on increasing its market share in the
          newspaper vertical and targeting government, retail and manufacturing
          verticals.


                                      F - 8

<PAGE>


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

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                 FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------


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

          Newspaper

          o    In November 2003, P2i Newspaper made the strategic decision to
               withdraw from marketing directly to new newspaper accounts in the
               United States, but instead to focus on building partnerships to
               build sales. The Company recognized that the conversion of print
               content into Internet was viewed by newspapers as an essential
               commodity, and as such they were motivated by price as much as
               product functionality and features.
          o    Through its partners and residual direct accounts, P2i Newspaper
               is supplying or has access to over 1,600 U.S. newspapers.

          Government

          o    The UK government has mandated that all government publications
               must also be available online within the near future. P2i
               Newspaper is working closely to maximize this opportunity.
          o    P2i Newspaper's solution has been evaluated by the city of
               Stockport in the UK and has passed the established Bobby AA
               standards. The Company continues to pursue business in this
               market sector.

          Retail

          o    P2i Newspaper currently processes inserts for several retailers.
          o    In addition, the Company is in talks with retailer groups to
               provide the ad and special section processing that will be
               incorporated into a platform featuring newspaper content and
               retail inserts.
          o    The pricing for converting catalog and retail insert pages has
               fallen dramatically over the past 18 months. P2i Newspaper
               believes it will continue to fall and that the Company is
               perfectly positioned to establish partnerships with media
               companies with a retail focus.

          Manufacturing

          o    P2i Newspaper solutions are applicable for any business with
               large volumes of frequently updated print content that is
               appropriate for Internet distribution.
          o    Manufacturing companies are generally putting all technical
               manuals online in crude PDF format.
          o    The potential revenue opportunity is being quantified, but is
               believed to be substantial.

     If management cannot achieve the above 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 - CONTINUED
                 FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
-------------------------------------------------------------------------------


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, Inc., 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 - CONTINUED
                 FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------


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 - 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 being amortized using the
     straight-line method over the one-year term of the notes (see Note 3).

     Impairment - With respect to the Company's investment in P2i, Inc., an
     impairment charge of $24,000 was recognized for the year ended December 31,
     2004, as there was a decline in the fair value of the investment below its
     cost, which was considered other than temporary. As of December 31, 2004,
     the investment in P2i, Inc. has 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 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.


                                      F-11


<PAGE>


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

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                 FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------


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.

     If the Company had elected to recognize compensation expense based upon the
     fair value at the grant date for awards under these plans consistent with
     the methodology prescribed by SFAS No. 123, the Company's net loss and loss
     per share would be increased to the following pro forma amounts for the
     years ended December 31, 2005 and 2004:

                                                       2005             2004
                                                    -----------     -----------
Net loss:
  As reported                                       ($  495,870)    ($1,230,227)
  Deduct:
    Total stock-based compensation
      determined under Black-Scholes
      option valuation model for all awards,
      net of income taxes                                 (--)          (35,000)
                                                    -----------     -----------

Pro forma                                           ($  495,870)    ($1,265,227)
                                                    ===========     ===========

Net loss per share of common stock:
  As reported                                       ($         .02) ($      .04)
  Pro forma                                         ($         .02) ($      .04)


     These pro forma amounts may not be representative of future disclosures
     since the estimated fair value of stock options is amortized to expense
     over the vesting period and additional options may be granted in future
     years. The fair value for these options was estimated at the date of grant
     using the Black-Scholes option-pricing model with the following
     assumptions:

         Risk free interest rate                                  4.95%
         Expected life                                            5 years
         Expected volatility                                      76.5%
         Expected dividend yield                                  None


     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.


                                      F-12
<PAGE>


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

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                 FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------


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

     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 basic and diluted loss per share are the same since the Company had a
     net loss for 2005 and 2004 and the inclusion of stock options and other
     incremental shares would be anti-dilutive. Options and warrants to purchase
     2,225,000 shares of common stock at December, 2005 and 2004 were not
     included in the computation of diluted earnings 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 2004
     financial statement presentation for comparability with the 2005 financial
     statements.


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

     In November 2004, the FASB issued SFAS No. 151, "Inventory Costs". The new
     Statement amends Accounting Research Bulletin No. 43, Chapter 4, "Inventory
     Pricing," to clarify the accounting for abnormal amounts of idle facility
     expense, freight, handling costs, and wasted material. This Statement
     requires that those items be recognized as current period charges and
     requires that allocation of fixed production overheads to the cost of
     conversion be based on the normal capacity of the production facilities.
     This statement is effective for fiscal years beginning after June 15, 2005.
     The Company does not expect adoption of this Statement to have a material
     impact on its financial condition or results of operations.

     In December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment".
     This Statement replaces SFAS No. 123 and supersedes APB No. 25. SFAS No.
     123 (R) will require the fair value of all stock option awards issued to
     employees to be recorded as an expense over the related vesting period. The
     Statement also requires the recognition of compensation expense for the
     fair value of any unvested stock option awards outstanding at the date of
     adoption. As permitted by SFAS No. 123, the Company currently accounts for
     share-based payments to employees using the APB No. 25 intrinsic value
     method and, as such, generally recognizes no compensation cost for employee
     stock options. Accordingly, the adoption of SFAS No. 123(R)'s fair value
     method will have an impact on the Company's results of operations. Had the
     Company adopted SFAS No. 123(R) in prior periods, the impact of that
     standard would have approximated the impact of SFAS No. 123 as described in
     the disclosure of pro forma net income and earnings per share above.

                                      F-13

<PAGE>


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

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                 FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------

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

     In December 2004, the FASB issued SFAS No. 153, "Exchanges of Non-monetary
     Assets," which addresses the measurement of exchanges of non-monetary
     assets. SFAS No. 153 eliminates the exception from fair value measurement
     for non-monetary exchanges of similar productive assets, which was
     previously provided by APB No. 29, "Accounting for Non-monetary
     Transactions," and replaces it with an exception for exchanges that do not
     have commercial substance. SFAS No. 153 specifies that a non-monetary
     exchange has commercial substance if the future cash flows of the entity
     are expected to change significantly as a result of the exchange. SFAS No.
     153 is effective for non-monetary asset exchanges occurring in fiscal
     periods beginning after June 15, 2005. We do no expect the adoption of SFAS
     No. 153 to have a material impact on the Company's financial condition or
     results of operations.

     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. We do not expect adoption of this SFAS
     No. 154 to have a material impact on the Company's financial condition or
     results of operations.



                                      F-14
<PAGE>


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

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                 FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------

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 has 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. The balance shall be paid at the rate
     of approximately $5,171 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
     is entitled to appoint one person to the board of directors of Brand X for
     the duration of the agreement.

     There were no operations of the discontinued ISP business during the years
     ended December 31, 2005 and 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 is unable to meet its obligations to
     ProtoSource and, as a consequence, is unable to cure its now default status
     on its note payable obligation and, therefore, of the purchase agreement
     itself. ProtoSource has assessed the collectibility of the remaining note
     receivable balance of $162,582 and its unused services credit balance of
     $151,308 and has determined that collection or realization of any portion
     of these amounts is highly doubtful and their values should be written down
     to $0. As a consequence of these subsequent events, the Company has
     recorded a provision for Brand X's uncollectible note and services credit
     in the amount of $313,890 in 2005.


                                      F-15

<PAGE>


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

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                 FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------


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, 2005,
     the Company has recognized $2,425,000 (the full amount of the loan
     proceeds) 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.

     In respect to the notes (as discussed in the preceding paragraph) during
     the years ended December 31, 2005 and 2004, the Company issued $0 and
     $400,000, respectively, of promissory notes in exchange for amounts
     borrowed from individuals. As the result of the beneficial conversion
     feature of these notes, in 2005 and 2004, $0 and $400,000, respectively,
     has been recognized as interest expense and additional paid-in capital.
     Additionally, in connection with the issuance of these particular notes,
     the Company issued or will issue 0 and 1,825,000 shares of common stock for
     2005 and 2004, respectively. These shares are valued at approximately $0
     for 2005 and $195,000 for 2004 and have been amortized to interest expense
     on a monthly basis over the one-year term of the notes. Additionally, as a
     further requirement pertaining to the issuance of these notes, the Company
     will issue 0 and 550,000 warrants pertaining to 2005 and 2004,
     respectively, to the underwriter. The value of the warrants is considered
     to have a deminimus value for 2004.

     During 2004, the Company changed the estimate of the share price for
     certain of the shares to be issued. This change resulted in a reduction of
     interest expense and the value of common stock to be issued by $332,499.


                                      F-16

<PAGE>


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

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                 FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------

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

     Significant components of deferred income taxes as of December 31, 2005 are
     as follows:

           Net operating loss carryforward                       $5,560,000
           Less valuation allowance                              (5,560,000)
                                                                  ---------
           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 $5,560,000 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 $340,000. The Company will continue to review this valuation
     on a quarterly basis and make adjustments as appropriate.

     At December 31, 2005, the Company had federal and state net operating loss
     carryforwards of approximately $15,800,000 and $2,100,000, respectively.
     Such carryforwards expire in the years 2014 through 2025 and 2012 through
     2025 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. 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 - CONTINUED
                 FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------

6.   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, 2005.


     Board of Directors Options
     --------------------------

     The Company issued 115,000 stock options to its Non-Employee Directors from
     October 1998 to December 31, 2001. The options vest immediately, or over a
     three-year period, and are exercisable at $1.36 to $6.00 per share and the
     options are for a five-year term. As of December 31, 2005, 92,500 options
     are outstanding.


                                      F-18


<PAGE>


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

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                 FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------

7.   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, 2005 under the Company's capital leases (together with the present
     value of minimum lease payments).

                        2006                                        $25,511
                        2007                                         13,553
                                                                     ------
            Total minimum lease payments                             39,064
         Less amount representing interest                           (8,263)
                                                                    -------
         Present value of net minimum lease payments                 30,801
         Less current portion                                       (18,971)
                                                                     ------
                                                                    $11,830
                                                                    =======

     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 $37,000 of rent expense for each of the years
     ended December 31, 2005 and 2004.

     As of December 31, 2005, the Company had no future operating lease
     commitments.


8.   Acquisition
     -----------

     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").

     The 19,383,531 shares will be reduced by the number of shares equal to the
     total fees incurred to audit the financial statements of P2i, or P2i
     Newspaper, divided by $0.50 (the "Adjusted Shares"). The Adjusted Shares
     shall be subject to a three-year lock-up, which may be released upon the
     stock price and volume reaching established thresholds.

     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 will issue 193,836 shares of series B preferred stock (the
     "Preferred Stock"), which shares shall be reduced by the total fees
     incurred to audit the financial statements of P2i or P2i Newspaper, divided
     by $50. Each share of Preferred Stock is exchangeable for 100 shares of the
     Company's common stock at any time after the Company increases its
     authorized number of shares of common stock to 100,000,000 shares.


                                      F-19

<PAGE>


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

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                 FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------

8.   Acquisition - Continued
     -----------------------

     As part of this transaction, the Company will also acquire an additional
     interest in P2i's new media business which will bring its total ownership
     in P2i to 19.8%.

     The acquisition of P2i Newspaper became effective on January 1, 2004, at
     which time P2i Newspaper became a wholly-owned subsidiary of the Company.
     P2i Newspaper is a leader in the conversion of previously created print
     advertising into interactive Web products for newspaper, magazine and mail
     order/retail catalog advertising. Clients include newspapers from the
     Gannett, Tribune and McClatchy Newspaper groups. The Company is
     headquartered in Bethlehem, PA, and has a data conversion facility in Kuala
     Lumpur, Malaysia.

     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
                                                                     =========



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, 2005 and 2004. Company contributions 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 - CONTINUED
                 FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
--------------------------------------------------------------------------------


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, 2005:

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

         Financial liabilities:
           Notes payable                            $2,425,000       $2,425,000
           Capital lease obligations                    30,801           30,801


     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, 2005 and 2004 include revenues
     from one major customer that accounted for 29% and 20%, respectively, of
     total Company revenues. Accounts receivable from this customer amounted to
     33% and 18% of the Company's total accounts receivable at December 31, 2005
     and 2004, respectively.


                                      F-21