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. On May 1, 2002, the Company entered into an agreement to sell substantially all of the assets pertaining to the ISP to Brand X Networks, Inc. On August 16, 2007, the Company exercised its security interests and entered into a foreclosure acquisition agreement with Brand X Networks, Inc., taking possession of its business assets as collateral due to its inability to pay its debt to the Company. These assets were transferred to ProtoSource Acquisition II, Inc., a Nevada corporation (incorporated August 15, 2007) and a wholly owned subsidiary of the Company, on September 1, 2007. Effective September 1, 2007, the Company provides bilingual technical support services, web-hosting, and Internet connectivity (see Note 3).

Effective January 1, 2004, the Company acquired P2i Newspaper, LLC. (see Note 4). P2i Newspaper is principally engaged in the conversion of text and graphics from print to interactive Web content. Its clients include newspaper groups located in the United States and the United Kingdom. P2i Newspaper is headquartered in Bethlehem, Pennsylvania and has a data conversion center located in Kuala Lumpur, Malaysia.

Interim Financial Statements - The accompanying financial statements for the nine months ended September 30, 2009 and 2008 are unaudited, and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles of the United States of America have been condensed or omitted pursuant to those rules and regulations. Accordingly, these interim financial statements should be read in conjunction with the audited financial statements and notes thereto contained in ProtoSource Corporation (the "Company") Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on April 15, 2009. The results of operations for the interim periods shown in this report are not necessarily indicative of results to be expected for other interim periods or for the full fiscal year. In the opinion of management, the information contained herein reflects all adjustments necessary for a fair statement of the interim results of operations. All such adjustments are of a normal, recurring nature. Certain reclassifications have been made to the prior year amounts to conform to the current year presentation.

The year-end condensed balance sheet data was derived from audited financial statements in accordance with the rules and regulations of the SEC, but does not include all disclosures required for financial statements prepared in accordance with generally accepted accounting principles of the United States of America. All intercompany transactions have been eliminated.

The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All of the Company's subsidiaries are wholly owned for the periods presented. All intercompany transactions have been eliminated.

PROTOSOURCE CORPORATION

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

Basis of presentation and management plans - The accompanying unaudited condensed consolidated financial statements of the Company are prepared in conformity with generally accepted accounting principles. The accompanying condensed 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. These measures are essential, as the Company has experienced 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 ProtoSource to successfully implement its strategic plan as follows:

ProtoSource's primary focus is the delivery of ePublishing Solutions and related services, to newspapers, retailers, and magazines, utilizing internally-developed, proprietary applications bridging the divide between traditional print revenue and the opportunities online via a coordinated sales and marketing strategy in the United States and Europe. Secondarily, but of strategic importance, the Company operates a technical support facility in Fresno, CA. These two distinct suites of services and solutions are offered by the Company's two principle operating units: P2i Newspapers and ProtoSource Acquisition II dba BX-Solutions.

P2i Newspaper delivers products and services tailored specifically to create online versions of print content, primarily for the print and publishing industries.

The Company's 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 customers to have their data re-purposed for new revenue generation. It also serves to enhance the customer's own productivity by enabling more effective information management and exchange between themselves and their end customers, who both gain greater satisfaction through the enhanced interactivity.

PROTOSOURCE CORPORATION

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

Every day of the week, 52 weeks a year, P2i receives electronic files from customers at its facility in Cyberjaya, just south of Kuala Lumpur, Malaysia. P2i employs approximately 100 staff in this 4,000 square foot office. This office was reduced in physical size from 6,000 to 4,000 sq ft in July 2009. Incoming data files 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. The combination of low labor costs, a well-educated labor pool fluent in English, and sophisticated technologies makes P2i effective and competitive.

The online presentation and Web enablement of the Company's clients' content is the key to efficient, effective Web presence, and the ensuing revenues and profits such a presence will yield. The Company takes either the same electronic files that generate print output, or existing online content in the public domain and uses that content to deliver a vastly enhanced, user friendly, online presence, adding a myriad of 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.

Services of P2i Newspaper comprise the following:

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

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

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

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

PROTOSOURCE CORPORATION

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

ProtoSource Acquisition II, Inc. dba BX Solutions delivers technical support, hosting and Internet access to telephone and Internet companies.

The Company's second facility in Fresno, CA, operated by, and branded as, BX-Solutions, is wholly-owned subsidiary and employs approximately 30 staff providing 24/7 English and Spanish technical support via incoming telephone calls to the customers of technology companies. These comprise small and mid-size Internet service providers and telcos in the United States. This facility also houses and manages servers for its own customers.

Services of ProtoSource Acquisition II, Inc. dba BX Solutions comprise the following:

Technical Support - Customers of BX offer their subscribers either Internet access and other related communications services. These include local and regional Internet access for consumers and businesses using dial-up, broadband and wireless connectivity. BX provides Bilingual technical support services on an outsource basis to these subscribers, 24/7/52.

Dial-up Internet Services - BX has a very small local consumer network to which it provides Internet Services including connectivity, email and web hosting. Additionally BX provisions the same services under different brand names for other companies: these would be designated virtual Internet Service Providers as BX provides the entire infrastructure.

Hosting - BX provides some hosting for its own customers. P2i's hosting has been relocated to different facility.

The combination of on-target sales strategies, low labor costs, a well-educated labor pool fluent in English, and sophisticated technologies are key to the Company's competitive strategy. If management cannot sufficiently execute and achieve the above stated objectives, the Company may find it necessary to dispose of assets, or undertake other actions as may be appropriate.

PROTOSOURCE CORPORATION

1. Nature of Operations and 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 weighted average number of basic and diluted common shares outstanding includes:

Actual shares issued and outstanding at September 30, 2009    9,927,329
Stock subscriptions payable - note holders                    2,750,000
Stock subscriptions payable - investment banker                 813,688
Series B convertible preferred stock issued to P2i, Inc.     19,383,531
                                                             ----------
                                                             32,874,548
                                                             ==========

The basic and diluted loss per share are the same since the Company had a net loss for 2009 and 2008 and the inclusion of stock options and other incremental shares would be anti-dilutive. Options and warrants to purchase 1,070,000 shares of common stock at September 30, 2009 and 2008 were not included in the computation of diluted loss per share.

Reclassifications - Certain reclassifications have been made to the 2008 financial statement presentation for comparability with the 2009 financial statements.

PROTOSOURCE CORPORATION

2. Recently Issued Accounting Standards

In June 2009, the FASB issued guidance now codified as FASB ASC Topic 105, "Generally Accepted Accounting Principles," as the single source of authoritative nongovernmental U.S. GAAP. FASB ASC Topic 105 does not change current U.S. GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by providing all authoritative literature related to a particular topic in one place. All existing accounting standard documents will be superseded and all other accounting literature not included in the FASB Codification will be considered non-authoritative. These provisions of FASB ASC Topic 105 are effective for interim and annual periods ending after September 15, 2009 and, accordingly, are effective for the Company for the current fiscal reporting period. The adoption of this pronouncement did not have an impact on the Company's financial condition or results of operations, but will impact the Company's financial reporting process by eliminating all references to pre-codification standards. On the effective date of this Statement, the Codification superseded all then-existing non-SEC accounting and reporting standards, and all other non-grandfathered non-SEC accounting literature not included in the Codification became non-authoritative.

In May 2009, the FASB issued guidance now codified as FASB ASC Topic 855, "Subsequent Events," which establishes general standards of accounting for, and disclosures of, events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This pronouncement is effective for interim or fiscal periods ending after June 15, 2009. Accordingly, the Company adopted these provisions of FASB ASC Topic 855 on April 1, 2009. The adoption of this standard did not have a material impact on the Company's consolidated financial position, results of operations or cash flows.

In March 2008, the FASB issued guidance now codified as FASB ASC Topic 815, "Derivatives and Hedging", which requires enhanced disclosures about an entity's derivative and hedging activities and thereby improves the transparency of financial reporting. This pronouncement is effective for fiscal years and interim periods beginning after November 15, 2008. The adoption of this standard did not have a material effect on the Company's financial position, results of operations, or cash flows.

PROTOSOURCE CORPORATION

2. Recently Issued Accounting Standards - Continued

In December 2007, the FASB issued guidance now codified as FASB ASC Topic 805, "Business Combinations", which significantly changes the accounting for business combinations in a number of areas including the treatment of contingent consideration, contingencies, acquisition costs, research and development assets and restructuring costs. In addition, changes in deferred tax asset valuation allowances and acquired income tax uncertainties in a business combination after the measurement period will impact income taxes. This pronouncement is effective for fiscal years beginning after December 15, 2008. The adoption of this standard will have an impact on the Company's accounting for any future business combinations.

In December 2007, the FASB issued guidance now codified as FASB ASC Topic 810, "Consolidation", which establishes accounting and reporting standards for any noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary should be reported as a component of equity in the consolidated financial statements and requires disclosure, on the face of the consolidated statement of income, of the amounts of consolidated net income attributable to the parent and to the noncontrolling interests. This standard is effective for fiscal years beginning after December 15, 2008. The adoption of this standard would have an impact on the presentation and disclosure of the noncontrolling interest of any non wholly-owned business acquired in the future.

3. Series B Convertible Preferred Stock

Common stock, holders of 193,836 shares of 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, Series B Stock 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.

                             PROTOSOURCE CORPORATION

        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                                   (unaudited)
--------------------------------------------------------------------------------


4.   Business Segment Data

     The Company has two reportable business segments. The following is a
     description of each operating segment:

     Media & Data Conversion Technologies - These operations are principally
     engaged in the mining and database management of print, graphic and data
     content for the publishing industry, and its distribution via the Internet.
     Data is deliverable to the Company's web servers for seamless integration
     into the clients' hosted web sites, but also is distributed back to the
     client, and their business partners, in a wide range of formats to fit
     continually evolving, highly-diversified applications.

     Technical Support & Hosting Services - These operations are principally
     engaged in providing bilingual technical support services, web-hosting, and
     Internet connectivity.

     Financial information for the two reporting segments for the nine and three
     months ended September 30, 2009 and 2008 is shown below:


                                                          NINE MONTH                   THREE MONTH
                                                         PERIOD ENDED                  PERIOD ENDED
                                                         SEPTEMBER 30,                 SEPTEMBER 30,
                                                  --------------------------    --------------------------
                                                     2009            2008           2009           2008
                                                  -----------    -----------    -----------    -----------

     Net revenues
       Media & Data Conversion Technologies       $ 1,389,367    $ 1,635,461    $   439,861    $   542,681
       Technical Support & Hosting Services           876,988      1,066,247        266,731        376,030
                                                  -----------    -----------    -----------    -----------
                                                  $ 2,266,355    $ 2,701,708    $   706,592    $   918,711
                                                  ===========    ===========    ===========    ===========

     Cost of revenue
       Media & Data Conversion Technologies       $   932,189    $ 1,136,210    $   286,247    $   331,112
       Technical Support & Hosting Services           795,786        836,064        227,900        256,666
                                                  -----------    -----------    -----------    -----------
                                                  $ 1,727,975    $ 1,972,274    $   514,147    $   587,778
                                                  ===========    ===========    ===========    ===========

     Gross margin
       Media & Data Conversion Technologies       $   457,178    $   499,251    $   153,614    $   211,569
       Technical Support & Hosting Services            81,202        230,183         38,831        119,364
                                                  -----------    -----------    -----------    -----------
                                                  $   538,380    $   729,434    $   192,445    $   330,933
                                                  ===========    ===========    ===========    ===========

     Total operating costs and expenses
       Media & Data Conversion Technologies       $ 1,397,955    $ 1,696,291    $   457,185    $   396,466
       Technical Support & Hosting Services           934,490        994,570        268,231        309,197
                                                  -----------    -----------    -----------    -----------
                                                  $ 2,332,445    $ 2,690,861    $   725,416    $   705,663
                                                  ===========    ===========    ===========    ===========

     Operating Income (loss)
       Media & Data Conversion Technologies       ($    8,588)   ($   60,830)   ($   17,324)   $   146,215
       Technical Support & Hosting Services           (57,502)        71,677         (1,500)        66,833
                                                  -----------    -----------    -----------    -----------
                                                  ($   66,090)   $    10,847    ($   18,824)   $   213,048
                                                  ===========    ===========    ===========    ===========

     Interest and other income/(charges), net
       Media & Data Conversion Technologies       ($  179,312)   ($  200,788)   ($   40,237)   ($   65,976)
       Technical Support & Hosting Services          (142,633)      (121,988)       (44,433)       (44,427)
                                                  -----------    -----------    -----------    -----------
                                                  ($  321,945)   ($  322,776)   ($   84,670)   ($  110,403)
                                                  ===========    ===========    ===========    ===========

     Total income (loss)
       Media & Data Conversion Technologies       ($  187,900)   ($  261,618)   ($   57,561)   $    80,239
       Technical Support & Hosting Services          (200,135)       (50,311)       (45,933)        22,406
                                                  -----------    -----------    -----------    -----------
                                                  ($  388,035)   ($  311,929)   ($  103,494)   $   102,645
                                                  ===========    ===========    ===========    ===========

- 15 -

                                                    SEPTEMBER 30,   DECEMBER 31,
                                                        2009           2008
                                                      --------       --------

     Identifiable assets
       Media & Data Conversion Technologies           $985,800       $787,701
       Technical Support & Hosting Services               --          169,005
                                                      --------       --------
                                                      $985,800       $956,706
                                                      ========       ========


5.   Subsequent Event

Management has evaluated subsequent events to determine if events or transactions occurring through November 16, 2009, require potential adjustment to or disclosure in the financial statements. As a result of this review, no subsequent events, other than those disclosed in the financial statements, were deemed to impact the Company's financial position, results of operations and cash flows.

PROTOSOURCE CORPORATION

Certain statements in this section and elsewhere in this quarterly report on Form 10-Q are forward-looking in nature and relate to the Company's plans, objectives, estimates and goals. Words such as "expects," "anticipates," "intends," "plans," "projects," "forecasts," "believes," and "estimates," and variations of such words and similar expressions, identify such forward-looking statements. Such statements are made pursuant to the safe harbor provisions of the private securities litigation reform act of 1995 and speak only as of the date of this report. The statements are based on current expectations, are inherently uncertain, are subject to risks and uncertainties and should be viewed with caution. Actual results and experience may differ materially from those expressed or implied by the forward-looking statements as a result of many factors, including, without limitation, those set forth under "Description of Business" in the Company's most recent Annual Report on Form 10-K. The Company makes no commitment to update any forward-looking statement or to disclose any facts, events, or circumstances after the date hereof that may affect the accuracy of any forward-looking statement.

Net Revenues - For the nine months ended September 30, 2009 and 2008, net revenues were $2,267,000 and $2,702,000 respectively. In the current year, $1,389,000 of these revenues are attributed to the operations of P2i Newspaper (acquired January 1, 2004) and $878,000 are attributed to the operations of ProtoSource Acquisition II (established August 15, 2007, d.b.a. "BX-Solutions" with operations commencing September 1, 2007). This represents a combined decrease of $435,000 in revenues compared to the previous year.

P2i Newspaper's net revenues are attributable to Media and Data Conversion Technologies and BX-Solutions' (ProtoSource Acquisition II) net revenues are attributable to Technical Support and Hosting Services operations.

BX-Solutions contributed $878,000 of revenues for the first nine months of 2009 versus $1,066,000 for 2008. P2i Newspaper recorded $1,635,000 during the same period in 2008; its current year revenues of $1,389,000 represent a decrease over last year of $246,000. This is attributable to multiple factors: the continuing decline in print advertising resulting in fewer ads to be processed for online publishing; the deteriorating newspaper industry and in particular the bankruptcies of Tribune Group and Minneapolis Star Tribune, both of which are customers of P2i. Additionally the state of the economy is driving down both unit pricing and volume.

Operating Costs and Expenses - For the nine months ended September 30, 2009, combined total operating costs and expenses totaled $2,332,000 versus $2,691,000 in 2008, a $359,000 reduction from the previous year. $60,000 of reduced costs were directly attributable to the operations of ProtoSource Acquisition II, Inc. (d.b.a. BX-Solutions). Additionally, there was a $299,000 reduction of total operating costs and expenses over the prior year for P2i Newspaper.

Total operating costs and expenses in the amount of $1,398,000 were related to the operations of P2i Newspaper: For P2i Newspaper, this is a reduction of approximately $298,000 over the preceding year and breaks down as follows:
Approximately $203,000 less in production expenditures, approximately $12,000 less in selling expenses, and approximately $83,000 less in general and administrative costs. The decrease in selling and general & administrative costs is the result of a restructuring of the US management team in the latter part of 2008. This included the elimination of the Group Financial Manager's position, those responsibilities being assumed in part by the CEO and in part by a consultant. This has yielded savings in excess of $100,000 and resulted in greater efficiencies. Additionally the US-based position of Chief Technology Officer was eliminated and those duties are now shared between the SVP of Product Development and the Lead Developer at P2i in Malaysia.

PROTOSOURCE CORPORATION

Total operating costs and expenses in the amount of $934,000 are related to the operations of ProtoSource Acquisition II, Inc. (d.b.a. BX-Solutions): These costs break down as follows: Approximately $795,000 in production expenditures and approximately $139,000 in sales, general and administrative costs.

For the nine months ended September 30, 2009, combined cost of revenues -- as a percentage of combined revenues -- were 76.2% versus 73.0% for the same period in 2008.

P2i Newspaper's cost of revenues as a percentage of revenues were 67.1% and 69.5% in 2009 and 2008, respectively.

BX-Solutions cost of revenues as a percentage of revenues for the nine months ended September 30 were 90.7% for 2009 and 78.4% for 2008. This increase in cost of revenues is largely attributable to a shift in the mix of products and services sold: revenues from dial-up Internet services declined and was replaced by the more labor-intensive Technical Support revenues. BX-Solutions will not see a decline in the cost of revenues as a percentage of revenues until revenues increase and the Company can enjoy economies of scale within BX-Solutions.

For the nine months ended September 30, 2009, combined selling, general and administrative expenses posted a decrease of approximately $98,000 over the previous year due to the following significant components: In respect to BX-Solutions, a $2,000 decrease is attributable to a $3,000 increase in general and administrative costs (for the facility in Fresno, CA) and a $5,000 decrease in bad debt expense. In respect to P2i Newspaper, approximately $13,000 less in selling expenses is entirely attributable to decrease in expense. And for P2i Newspaper, approximately $83,000 less in general and administrative expenses, largely attributable to reductions in the Company's liability insurance, salaries and local taxes was realized this year over last for the nine months ended September 30, 2009.

Administrative costs principally consist of the Company's management office and personnel, professional fees associated with maintenance of the Company, and officers' and directors' liability insurance costs.

Interest Expense - Interest expense totaled $357,000 for the nine-month period ended September 30, 2009 versus $321,000 in the same period in 2008. The interest expense is predominantly due to the convertible notes obtained during 2002, 2003, and 2004 to fund the operations of the Company and P2i Newspaper -- pending and post merger -- with approximately $14,000 and $9,000 attributable to equipment lease financing in 2009 and 2008, respectively.

Net Revenues - For the three months ended September 30, 2009 and 2008, net revenues were $707,000 and $920,000, respectively. In the current year, $440,000 of these revenues is attributed to the operations of P2i Newspaper and $267,000 are attributed to the operations of ProtoSource Acquisition II (d.b.a. "BX-Solutions"). This represents a combined decrease of $213,000 in revenues over the previous year.

P2i Newspaper's net revenues are attributable to Media and Data Conversion Technologies and BX-Solutions' (ProtoSource Acquisition II) net revenues are attributable to Technical Support and Hosting Services operations.

PROTOSOURCE CORPORATION

Operating Costs and Expenses - For the three months ended September 30, 2009, combined total operating costs and expenses totaled $725,000 versus $705,000 in 2008, a $20,000 increase over the previous year. $41,000 of reduced costs attributable to the operations of ProtoSource Acquisition II, Inc. offset $61,000 of increased costs attributable to the operations of P2i Newspaper.

For the three months ended September 30, 2009, $457,000 of total operating costs and expenses are related to the operations of P2i Newspaper: For P2i Newspaper, this is an increase of approximately $61,000 over the same quarter in the preceding year and breaks down as follows: Approximately $45,000 less production expenditures, approximately $33,000 more in selling expenses, approximately $73,000 more in general and administrative costs, and approximately $100 more in depreciation expense.

For the three months ended September 30, 2009, approximately $268,000 of total operating costs and expenses are related to the operations of ProtoSource Acquisition II, Inc. These costs break down as follows: Approximately $228,000 in production expenditures and approximately $40,000 in selling, general and administrative costs.

For the three months ended September 30, 2009, combined cost of revenues -- as a percentage of combined revenues -- were 72.8% versus 64.9% for the same period in 2008.

For the three months ended September 30, 2008, P2i Newspaper's cost of revenues as a percentage of revenues were 65.1% and 61.0% in 2009 and 2008, respectively.

BX-Solutions cost of revenues for the three months ended September 30, 2009 were 85.4% vs. 68.3% in 2008.

For the three months ended September 30, 2009, combined selling, general and administrative expenses posted a net increase of approximately $99,000 over the same quarter in the previous year due to the following significant components:
In respect to P2i Newspaper, approximately $33,000 more in selling expenses, approximately $73,000 more in general and administrative expenses. In respect to BX-Solutions, an approximate offset of $7,000 less in general and administrative.

Administrative costs principally consist of the Company's management office and personnel, professional fees associated with maintenance of the Company, and officers' and directors' liability insurance costs.

Interest Expense - Interest expense totaled $122,000 for the three-month period ended September 30, 2009 versus $108,000 in the same period in 2008. The interest expense is predominantly due to the convertible notes obtained during 2002, 2003, and 2004 to fund the operations of the Company and P2i Newspaper -- pending and post merger -- with approximately $14,000 attributable to equipment lease financing recorded in each of the three-month periods.

PROTOSOURCE CORPORATION

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

For the nine-month period ended September 30, 2009, the Company generated approximately $ 4,000 more cash than was used.

Even though the Company's net loss for the nine-month period ended September 30, 2009 was approximately $388,000, cash flows provided by operations approximated $181,000. In part, this was due to non-cash charges totaling approximately $347,000 consisting of approximately $39,000 of depreciation and accrued interest on convertible debt obligations of $338,000, which was offset by a decrease in allowance for bad debt of $30,000. Operating assets decreased by approximately $65,000 as a result of a decrease in accounts receivable of approximately $68,000, offset by an increase in prepaid expenses and other assets of $13,000. Operating liabilities increased approximately $158,000.

During the nine-month period ended September 30, 2009, the Company had net negative cash flows from investing activities of approximately $140,000. This was primarily due to an approximately $7,000 increase in property and equipment acquisition, $91,000 increase in advances to officers, $41,000 increase in amounts due from related parties, and a $1,000 increase in deposits.

During the nine-month period ended September 30, 2009, the Company used approximately $33,000 through its financing activities for payments on its capital lease obligations.

As of September 30, 2009, the Company had a $16,679 balance in cash and $531,460 in accounts receivable and other current assets. Taken together with $5,797,471 of total current liabilities, this resulted in a negative working capital position of $5,249,332 at September 30, 2009, of which $4,680,915 of this amount pertains to the Company's obligations to its convertible debt holders.

PROTOSOURCE CORPORATION

In July 2007, the Company entered into an investment banking agreement with Colebrooke Capital, Inc. The fees under this arrangement were $7,500 down and $3,500 for the first 90 days of the agreement. Under this arrangement the Company will be required to a pay a 7% financing fee on any funds raised by Colebrooke Capital. Furthermore, in respect to capital transactions introduced by Colebrooke Capital, there will be a 5% transaction fee requirement, but no fees on any Company generated deals. On December 10, 2008 the board ratified a Company proposal to compensate Colebrook Capital in full with 250,000 common shares. This is in respect of an investment banking relationship entered into by the Company in 2007. The goal was to raise funds to make an acquisition but the deterioration of the equities markets has made this untenable and the relationship has been terminated. The Company anticipates issuing these shares in Q4 of 2009.

At a meeting held on December 11, 2007, the Company's shareholders approved an increase in authorized shares of common stock to 500,000,000. At September 30, 2009, 9,927,329 of common shares were issued and outstanding and the Company had obligations to issue an additional 22,947,219 shares of common with a further 33,945,000 shares committed for issuance.

PROTOSOURCE CORPORATION

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 ASC 740, "Income Taxes", the Company maintains a valuation allowance of $5,600,000 as of December 31, 2008 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 ASC 350, "Intangibles - Goodwill and Other", goodwill is not amortized, rather, management tests goodwill annually for impairment in the fourth quarter. In August 2007 in connection with a foreclosure acquisition agreement with Brand X Networks, Inc., the Company recognized $566,186 of goodwill related to the transaction but deemed it fully impaired.

In accordance with ASC 855, "Subsequent Events", management has evaluated subsequent events to determine if events or transactions occurring through November 16, 2009, require potential adjustment to or disclosure in the financial statements. No adjustments or disclosures were deemed to be necessary.

The Company considers certain trade accounts receivable to be of doubtful collection; accordingly, the Company has an $50,000 allowance for doubtful accounts.

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

N/A

PROTOSOURCE CORPORATION

As of September 30, 2009, an evaluation was performed under the supervision and with the participation of our management, including the chief executive officer, or CEO, who is also the acting chief financial officer, or CFO, 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 Report, our principal executive officer has 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 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.

There were no changes to our internal control over financial reporting during the quarterly period ended September 30, 2009 that have materially affected, or that are reasonable likely to materially affect, our internal control over financial reporting.

PROTOSOURCE CORPORATION

PART II - OTHER INFORMATION