(760) 547-2700 REFERENCE . Patriot Scientific Corporation was organized under Delaware law on March 24, 1992, $219,000. agreements to protect our proprietary technologies. Our policy is to seek the issuance of patents that we consider important to our business to protect inventions and technology that support our microprocessor technology. to domestic customers. i) selective expansion of our IP portfolio, ii) pursuit of strategic minority investments in certain early-stage revenue or technology ventures that represent a technology or capability of interest to us, and iii) full M&A transactions. needed. will be able to retain our key managerial and technical employees or that we will be able to attract and retain additional highly qualified technical and managerial personnel in the future. None of our employees PROPERTIES defense. AND ISSUER PURCHASES OF EQUITY SECURITIES comparability of the information provided in the charts below. our technology. We believe that utilizing the fiscal year ended May 31, 2007. Our revenue evenly over the four year period of the license. In addition during the 2007 fiscal year, we recorded sales of approximately $55,000 from the sale of microprocessor chips that we no longer market. Inventory associated with the sales of these microprocessor chips is carried at zero value. PDS. At May 31, adopting FIN 48. Interest and penalties, if any, related to unrecognized tax benefits are recorded in income tax expense. As of June 1, 2007, we are subject to U.S. Federal income tax examinations for the tax years May 31, 1991 through May 31, 2007, and we are subject to state and local income tax examinations for the tax years May 31, 1999 through May 31, 2007 due to the carryover of net operating losses from previous years. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. consolidated financial statements. securities. As of May 31, DATA Section 16(a) of the Exchange Act, Equity Compensation Plan Information 2008 definitive proxy statement. audits. We have also audited, in accordance with the Income Comprehensive Income Cash Flows, continued Significant Accounting Policies eliminated. excess of the underlying obligations, are insured by the various state educational agencies, and are guaranteed by the Department of Education as an insurer of last resort. Marketable Securities assets, ranging from two to five years. Major betterments and renewals are capitalized, while routine repairs and maintenance are charged to expense when incurred. available-for-sale. The amount is presented net of tax-related effects of $151,708. 2006. positions that meet a “more likely than not” threshold. At May 31, 2008, 2007 and 2006, potential common shares of 2,645,000, 330,000 and 2,295,000, respectively, related to our outstanding warrants and options were not included in the calculation of diluted income per share as they had an anti-dilutive effect. On an ongoing basis we evaluate our estimates, including, but not limited to: the realizability of accounts and notes receivable, valuation of inventory, fair values of investments in marketable securities, the use, recoverability, and /or realizability of certain assets, including investments in affiliated companies, deferred tax assets, and stock-based compensation. exercise. This reduction in the deferred income tax asset resulted in a reduction to our APIC pool of $25,645. The remaining reduction in the deferred income tax asset in excess of our APIC pool of $414,782 resulted in an increase in our effective income tax rate for the year ended May 31, 2008 and an increase in our income taxes payable of $195,818. June 1, 2007, we are subject to U.S. Federal income tax examinations for the tax years May 31, 1991 through May 31, 2007, and we are subject to state and local income tax examinations for the tax years May 31, 1999 through May 31, 2007 due to the carryover of net operating losses from previous years. 159, consolidated financial statements. the note will automatically be converted into shares of Crossflo’s Series F convertible preferred stock equal to 4% of Crossflo’s then issued and outstanding equity securities. 2008. $46,361. 2008. As a result of temporary declines in the fair value of our auction rate securities, which we attribute to liquidity issues rather than credit issues, we have recorded an unrealized loss of $220,617 in other comprehensive income at May 31, 2008, which represents the gross valuation adjustment of $372,325, net of the related tax benefit of $151,708. federal funds rate plus 3%. technologies 2006. In connection with entering into the license agreement and forming PDS, we incurred various cash and non-cash expenses. Direct, incremental cash costs incurred with the transactions included $170,000 paid to a committee of our board of directors for their efforts in consummating the transactions, approximately $1,328,000 paid to certain of our warrant holders to obtain their approval of the agreement and release of their lien and blocking rights. Additionally, $960,000 was paid to the co-inventor of the technology. 2008. as a result of entering into the convertible debenture agreements, we were required to classify all other non-employee warrants as derivative liabilities and record them at their fair values at each balance sheet date. 2006. We also granted new warrants and agreed to re-price certain outstanding warrants in (i) each of the warrants held by the warrant holders such that the exercise price of the warrants is no longer subject to downward resets based on the trading price of our common stock, and (ii) each of the debentures held by the warrant holders such that the conversion price of the debentures is fixed at its current level. No additional expense was required for the modification of the exercise price of the warrants since the new fixed price of the warrants was equal to the original exercise price at date of issuance or was equal to the then reset price in effect for which we had previously recognized an expense for the modification. Under the terms of the Reset Agreements, we and the warrant holders also agreed to amend all of the agreements entered into between us and the warrant holders that limit the ability of the warrant holders to be the beneficial owner of more than 4.99% of our common stock to be amended to provide that the warrant holders may not, through the exercise of warrants, the conversion of debentures, or otherwise, be the beneficial owner of more than 9.99% of our common stock. directors. (continued) 2012. Some of those outstanding warrants were not exercisable as of May 31, 2007 as they were subject to meeting vesting criteria. During are outstanding under the 1996 Stock Option Plan. The options outstanding continue to be governed by the terms of the 1996 Stock Option Plan. above referenced plans. 2008: May 31: losses from previous years. continuous employment, he is entitled to receive an amount equal to 12 months of his annual base salary. Mr. Flowers is also entitled to certain payments upon a change of control of the Company if the surviving corporation does not retain him. All such payments are conditional upon the execution of a general release. Contingencies (continued) facility. Future minimum lease payments required under the operating lease are $73,710 in fiscal year 2009. Rent expense for operating lease are $75,432 in fiscal year 2009 and $31,430 in fiscal year 2010. Rent expense for the fiscal year ended May 31, 2008 and the fourth quarter of fiscal 2007 was $58,800 and $14,700, respectively. capital invested. Allocation of profits, losses and distributions is in accordance with the terms as defined in the operating agreement. the Company. During the years ended May 31, 2008, 2007 and 2006, the Company paid $2,952,362, $3,871,602 and $2,500,000, respectively, to TPL pursuant to the agreement. The Company is also required to reimburse TPL for payment of all legal and third-party expert fess and other related third party costs and expenses. During the years ended May 31, 2008, 2007 and 2006, the Company paid $12,894,053, $5,914,000 and $1,021,357, respectively, to TPL pursuant to the agreement. All of the amounts are recorded in general and administrative expense in the accompanying statements of income.U.S.[ X ]X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 2002or2008[ ]_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 __________________________ to _______________84-1070278Empl. Ident.Employer Identification No.)10989 Via Frontera, San Diego,92127(858) 674-5000underpursuant to Section 12(b) of the Exchange Act: NONEunderpursuant to Section 12(g) of the Exchange Act:(1 )(1) has 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][X ] NO [ ] the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ]The aggregatethe voting stockand non-voting common equity held by non-affiliates of the registrant on August 26, 2002November 30, 2007 was $4,821,423$238,797,982 based on a closing bid price of $0.065$0.61 as reported on the OTC Electronic Bulletin Board system.At26, 2002, 81,465,7578, 2008, 387,448,755 shares of common stock, par value $.00001 per share (the registrant’sissuer’s only class of voting stock) were outstanding.REFERENCE:NoneTABLE OF CONTENTS 4 ITEM 1. Business Page4 ITEM 1A. Risk Factors
8 ITEM 1B. Unresolved Staff Comments PART I11 ITEM 1.Description of Business3ITEM 2. Properties Description of Property11 14ITEM 3. Legal Proceedings 11 14ITEM 4. Submission of Matters to a Vote of Security Holders 1511 12 ITEM 5. Market for Registrant’s Common Equity, and Related
Stockholder Matters and Issuer Purchases of Equity Securities12 15ITEM 6. Selected Consolidated Financial Data14 15ITEM 7. Management’s Discussion and Analysis of Financial
Condition and Results of Operations15 16ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk 23 27ITEM 8. Financial Statements and Supplementary Data 24 27ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure24 28ITEM 9A.Controls and Procedures 24 ITEM 9B. Other Information 29 29 ITEM 10. Directors, Executive Officers of the Registrantand Corporate Governance29 29ITEM 11. Executive Compensation 29 30ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 29 34ITEM 13. Certain Relationships and Related Transactions, and Director Independence 29 ITEM 14. 36Principal Accounting Fees and Services29 30 ITEM 14.15.EXHIBITS, AND FINANCIAL STATEMENT SCHEDULES Exhibits, Financial Statement Schedules, and Reports on Form 8-K3730 DISCLOSUREdesire to take advantage ofrely on the “safe harbor” provisions thereof.in those laws. Therefore, we are including this statement for the express purpose of availing ourselves of the protections of such safe harbor with respect to all of such forward-looking statements. The forward-looking statements in this Reportreport reflect our current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties, including specificallyspecifically: the absenceuncertainty of significant revenues, a historythe effect of losses, no assurance that technology can be completed or that our completion will not be delayed, significant competition,pending legislation, the uncertainty of patent and proprietary rights, uncertainty as to royalty payments and indemnification risks, possible adverse effects of future sales of shares on the market, trading risks of low-priced stocks and those other risks and uncertainties discussed herein that could cause our actual results to differ materially from our historical results or those anticipated.we anticipate. In this report, the words “anticipates,” “believes,” “expects,” “intends,” “future” and similar expressions identify certain of the forward-looking statements. Readers are cautioned not to place undue reliance on thethese forward-looking statements, contained herein, which speak only as of the date hereof.made. We undertake no obligation to publicly reviserelease the result of any revision of these forward-looking statements to reflect events or circumstances that may arise after the date hereof. All subsequent writtenthey are made or to reflect the occurrence of unanticipated events.oral forward-looking statements attributablecameras to us or persons actingprinters, automotive and industrial devices.behalfpatents. With the proceeds generated by these licensing efforts, we are expressly qualifiedundertaking to make investments in their entirety by this section.technologies, and acquisitions of companies, operating in the electronics technology market sector. Our business address is 6183 Paseo del Norte, Suite 180, Carlsbad, California 92011; our main telephone number is (760) 547-2700. Our internet website page is located at http://www.ptsc.com. All of our reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available free of charge on our internet website.PART IItem 1. DESCRIPTION OF BUSINESSThe Companyasand is the successor by merger to Patriot Financial Corporation, a Colorado corporation, incorporated on June 10, 1987. Our address is 10989 Via Frontera, San Diego, California 92127,In June 2005, we entered into a joint venture agreement with Technology Properties Limited, Inc. (“TPL”) to form Phoenix Digital Solutions, LLC (“PDS”). During February 2007, we acquired the preferred stock of Scripps Secured Data, Inc. (“SSDI”), a Carlsbad company that develops and our telephone number is (858) 674-5000. Our home page can be located on the World Wide Web at http://www.ptsc.com. We develop, market, and sell microprocessors, our technology behind the microprocessors, and complimentary products which enable computersmanufactures network-security hardware to government, military, and other high-security facilities. During May 2008, we acquired a 15% share in Talis Data Systems, LLC (“Talis”), a Delaware LLC that produces multi-domain computer networking hardware. In August 2008, we increased our investment in Talis to 37.4%.processingnetworks, industrial flow-control valves, sensors, medical devices, weapons, home appliances, robots, security systems, televisions, and much more. These “embedded microprocessors” (so called because they’re embedded into another product) are far more ubiquitous than the chips inside personal computers. It is this huge and growing market that Patriot Scientific’s technology serves.● US 5,809,336. The ’336 patent covers an early and seminal approach to making microprocessor chips go faster. It allows the “core” of the microprocessor to run at a different speed (usually faster) than the rest of the chip. There are many advantages to this, including higher performance, lower power consumption, and simpler manufacturing. ● US 5,784,584. The ’584 patent covers an important method for a microprocessor chip to fetch multiple instructions at once. Like speed reading, multiple-instruction fetch allows a chip to get more done in less time - a valuable technique. ● US 6,598,148. The ’148 patent describes on-chip oscillators (clocks) and covers multi-core and multi-processor implementations - important factors in today’s high-end microprocessor chips. communicate. These products can be used to connectcertain lawsuits filed by us alleging infringement (the “Infringement Litigation”) of our Microprocessor Patents and a lawsuit also filed by us alleging claims for declaratory judgment for determination and correction of inventorship of the Microprocessor Patents (the “Inventorship Litigation”). The transactions described in the Master Agreement and related agreements (the “Transactions”) included the settlement or dismissal of the Inventorship Litigation.Internet or other telecommunication networks. The microprocessor technology product line accounted for approximately 3% of our revenue in fiscal 2002. The balance of our 2002 revenue was generated from a communication product line that, subsequentMaster Agreement we agreed with TPL and Moore as follows:● We entered into a patent license agreement (the “Intel License”) with Intel Corporation (“Intel”) pursuant to which we licensed certain rights in the Microprocessor Patents to Intel. ● We entered into an Escrow Agreement along with TPL pursuant to which the proceeds arising from the Intel License were allocated for the benefit of us and TPL. Pursuant to the Escrow Agreement, the proceeds were allocable equally to PTSC and TPL. Accordingly, when the initial capitalization obligations of PTSC and those of TPL with regard to PDS (defined below) were satisfied, and when our payment obligations and those of TPL with regard to the Rights Holders (defined below) were made, we received $6,672,349, and the remaining proceeds were allocated to or for the benefit of TPL. ● We caused certain of our respective interests in the Microprocessor Patents to be licensed to PDS a limited liability company owned 50% by us and 50% by TPL. ● PDS engaged TPL to commercialize the Microprocessor Patents pursuant to a Commercialization Agreement among PDS, TPL and us (the “Commercialization Agreement”). ● We paid $1,327,651 and TPL paid $1,000,000 to certain holders of rights in the Microprocessor Patents (“Rights Holders”) in exchange for the release of such Rights Holders to the Transactions. ● We agreed with TPL and Moore to settle or cause to be dismissed all litigation pursuant to a stipulated final judgment, including the Inventorship Litigation. ● We issued warrants to TPL to acquire shares of our common stock. 1,400,000 warrants were exercisable upon issue; 700,000 warrants were exercisable when our common stock traded at $0.50 per share; an additional 700,000 warrants were exercisable when our common stock traded at $0.75 per share; and an additional 700,000 warrants were exercisable when our common stock traded at $1.00 per share. As of the date of this filing, all of the common stock trading prices have been met, causing TPL to be fully vested in all 3,500,000 of the above warrants. ● We agreed with TPL and Moore to indemnify each other for, among other things, any inaccuracy or misrepresentation to any representation or warranty contained in the Master Agreement, any breach of the Master Agreement, certain liabilities relating to the respective interests of each of us in the Microprocessor Patents and the Transactions, and certain tax liabilities. a completed last buy program, is generating minimal revenue. We also have a patent for special radar technology which, if fully developed, may allow a potential licenseethe Commercialization Agreement, PDS granted to penetrateTPL the ground or structuresexclusive right to find various objects. We also owned gas plasma antenna technology which we sold for $250,000 in August 1999. We potentially could receive up to an additional $250,000 from the salegrant licenses and sub-licenses of the gas plasma technologyMicroprocessor Patents and to pursue claims against violators of the Microprocessor Patents, in each case, on behalf of PDS, us, TPL and Moore, and TPL agreed to use reasonable best efforts to commercialize the formMicroprocessor Patents in accordance with a mutually agreed business plan. Pursuant to the Commercialization Agreement, PDS agreed to reimburse TPL’s expenses incurred in connection with the commercialization of royalties. Our strategy isthe Microprocessor Patents. All proceeds generated by TPL in connection with the commercialization of the Microprocessor Patents will be paid directly to exploit our microprocessor technologies through product sales, licensing,PDS. From inception of the Commercialization Agreement to May 31, 2008 license revenues to PDS totaled $230,161,956.strategic alliances.3 In 1997,TPL have entered into the Limited Liability Company Operating Agreement of PDS (“LLC Agreement”). We and TPL each own 50% of the membership interests of PDS, and each have the right to appoint one member of the three (3) member management committee. The two (2) appointees are required to select a mutually acceptable third member of the management committee. Pursuant to the LLC Agreement, we emerged fromand TPL must each contribute to the development stage primarilyworking capital of PDS (in addition to the Microprocessor Patent licenses described above), and are obligated to make future contributions in equal amounts in order to maintain a working capital fund. The LLC Agreement provides that PDS shall indemnify its members, managers, officers and employees to the fullest extent permitted by applicable law, for any liabilities incurred as a result of their involvement with PDS, if the person seeking indemnification acted in good faith and in a manner reasonably believed to be in the best interest of PDS.Metacomp Inc. There can be no assurance that we can achieve profitable operations, and we may need additional financial resources during the next twelve months.Background In February 1989, we completed our initial public offering under a registration statement on Form S-18 under the Securities Actall Talis shares previously held by SSDI. The acquisition of 1933. This offering raised gross proceeds of $50,000 and net proceeds of approximately $28,640 upon the sale of 2,500,000 units at $.02 per unit. Each unit soldTalis shares previously owned by SSDI was made for $100,000 in the public offering consisted of one common share and one Class A common stock purchase warrant exercisable to acquire one share of common stock and one Class B common stock purchase warrant. All Class A and Class B warrants have since been exercised or have lapsed. On May 12, 1992, we redomiciled ourselves from Colorado to Delaware by merging into a wholly owned Delaware subsidiary, Patriot Scientific Corporation, organized for that purpose. The reincorporation resulted in a reverse stock split. Three shares of the Colorado corporation, par value $.00001, were converted into one share of the Delaware corporation, par value $.00001. The reincorporation also effected a change in our charter and bylawscash and a name change to Patriot Scientific Corporation. In May 1993, we registered under the Securities Act of 1933 a total of 7,631,606 shares issuable upon the exercise of outstanding Class A and Class B common stock purchase warrants. We received net proceeds of $3,343,915 upon the exercise of those warrants and the issuance of 7,538,102 common shares. None of such warrants remain outstanding. Effective May 31, 1994, we entered into an asset purchase agreement and plan of reorganization with nanoTronics Corporation located in Eagle Point, Oregon and Helmut Falk. We issued a total of 8,500,000 restricted common shares to nanoTronics to acquire certain microprocessor technology of nanoTronics. The technology acquired was used to develop a sophisticated yet low cost microprocessor. 5,000,000 of the shares were issued on a non-contingent basis, and the remaining 3,500,000 shares were issued subject to the terms of an earnout escrow arrangement, which concluded on May 31, 1999. Effective December 26, 1996, we acquired 96.9% of the outstanding shares of Metacomp, Inc., a California corporation, from 56 shareholders in exchange for the issuance of 1,272,068 shares of our common stock. Based on the closing price of our common stock of $1.375 on the date of the acquisition, the price of the acquisition was $1,749,094. This business combination was accounted for as a pooling-of-interests.BusinessOrganization and Corporate Development.Our business involves the following technologies:•Ignite microprocessor technology,•JUICEtechnology,•high-speed data communications technology, and•radar technology. The stages of development of our technologies is as follows:Ignite microprocessor. This technology is generating minor amounts of revenue from the sale of development boards, microprocessors and initial license fees related to the microprocessor application. We run the technology on a 0.35-micron microprocessor, which is in current production. We have ported the WindRiver VxWorks operating system and the Sun Microsystems personalJava virtual machine to the microprocessor. In addition, the technology is available for sale as intellectual property which enables the prospective customer to incorporate the microprocessor functions with other parties’ applications to arrive at a system on a chip solution. Although we anticipate the Ignite technology to be our main product line, it currently accounts for only 3% of our revenue in fiscal year 2002.4•JUICEtechnology. This technology was introduced to address the need to conserve power in embedded applications by varying the speed at which any microprocessor processes data. By varying the speed of the microprocessor, battery life can be significantly expanded thereby enhancing the users internet experience on a variety of handheld devices including cell phones, smart phones, pocket PCs and personal digital assistants. There has been no revenue generated from this product as of yet.•High-speed data communications. Revenue from this technology was phased out during fiscal year 2002 as a result of the products reaching the end of their life cycles. During fiscal 2002 we initiated a last time buy program and except for minor repeat orders have discontinued to sell this product line. We have decided to concentrate our efforts on the Ignite microprocessor and JUICEtechnology. Although the communications product line accounted for approximately 97% of our fiscal year 2002 revenue, we anticipate that the Ignite microprocessor and JUICEtechnology will be our main product lines in the future.•Radar and antenna. We sold the gas plasma antenna technology in August 1999. Our radar technology has not generated any revenue and we have suspended further development of this technology in order to concentrate our resources on our Ignite and JUICEtechnology products. Due to our small size and staffing overlaps among the technologies, certain personnel may work on any or all of our technologies from time to time. During at least the last three years, we have focused the majority of our efforts on the Ignite and high-speed data communications technologies. The Ignite technology is targeted for the embedded controller and Java language processor marketplaces.Internet Growth and the Emergence of the Java Programming Language.The Internet is a global web of computer networks. This “network of networks” allows computers connected to the Internet to “talk” to one another. The Internet provides organizations and individuals with new means to conduct business. Commercial uses of the Internet include business-to-business and business-to-consumer transactions, product marketing, advertising, entertainment, electronic publishing, electronic services and customer support. We believe that organizations will also increasingly use the Internet and private Intranet networks to improve communications, distribute information, lower operating costs and change operations. Use of the Internet has grown rapidly impacting computer hardware, software and peripheral industries. The rapid growth in popularity of the Internet is in part due to continuing penetration of computers and modems into U.S. households, growth of the informational, entertainment and commercial applications and resources of the Internet, the growing awareness of such resources among individuals, and the increasing availability of user-friendly navigational and utility tools which enable easier access to the Internet’s resources. The growth of the Internet and corporate Intranets is creating a demand for hardware, software and peripherals. Software, such as Java, has been developed to serve the requirements of Internet users. Java is a programming language that was originally developed for personal digital assistant devices and television set top boxes. It was formally announced as an object-oriented language for the Internet in May 1995 by Sun Microsystems Inc. A large number of major computer, software, browser and on-line service provider companies have licensed the Java language. Accordingly, Java is a fundamental platform for Internet related applications. A significant number of Java applications, or applets, are now available on the Internet. These applications not only enhance web pages but also perform many functions of traditional computer software programs. Our Ignite technology lends itself to potential markets in which the use of Java is prevalent. With Java, data and programs do not have to be stored on the user’s computer, but can reside anywhere on the Internet to be called upon as needed. Among its various attributes, two key features of Java are (1) its ability to run on a variety of computer operating systems thus avoiding the problem of incompatibility across networks, and (2) security, because Java enables the construction of virus-resistant, tamper-resistant systems by using resource-access control and public-key encryption. Because of Java’s useful features, it has also become a popular programming language for embedded applications.5 Since Java is designed to run on multiple types of devices and operating systems, it allows developers to write a program once for many types of operating systems, instead of having to write new versions for each type. Java does this by interpreting a program’s commands into something that a particular type of computer can understand. This interpretive design runs programs slower than if they were tailored for each type of computer and is resulting in a need for specialized microprocessors and compilers to increase Java’s speed. The growth of Java is causing a number of companies to consider it as a basis for a new style of computing tailored to the Internet and not encumbered by the limitations of, or requiring, traditional computer operating systems. The concept is to design inexpensive access devices to communicate via the Internet.Our Microprocessor Technology. General Background. In 1991, nanoTronics Corporation was formed and acquired a base technology for an advanced microprocessor integrated on a single computer chip. nanoTronics subsequently engaged in substantial technical development and fabricated a first-generation microprocessor in early 1994. Since the acquisition of the technology from nanoTronics, effective May 31, 1994, we have been engaged in enhancing the microprocessor design, adding additional technical features to further modernize the design, and improving and testing the new design. We initially fabricated a prototype 0.8-micron microprocessor in May 1996. The next generation was a 0.5-micron microprocessor that was delivered in September 1997. The 0.5-micron microprocessor was employed in demonstrations for prospective customers and was shipped in limited numbers to customers as an embedded microprocessor. In 1998 we introduced a 0.35-micron microprocessor whose features included a reduction in size and improved performance. In addition, in September 2000 we completed a VHDL model of this technology which enables customers to purchase intellectual property incorporating microprocessor functions with other parties’ applications to arrive at a system on a chip solution. By purchasing this software model, customers can significantly reduce their time to market by simulating results as opposed to trial and error commitment to silicon production. We are currently working on a 0.18-micron enhancement of silicon production for our Ignite microprocessor technology. Industry Background. The semiconductor logic market has three major sectors:•standard logic products,•application specific standard products, and•application specific integrated circuits. Standard logic products, such as the Intel’s X86 and Pentium and Motorola’s 680X0 microprocessor families, are neither application nor customer specific. They are intended to be utilized by a large group of systems designers for a broad range of applications. Because they are designed to be used in a broad array of applications, they may not be cost effective for specific applications. Application specific integrated circuits are designed to meet the specific application of one customer. While cost effective for that application, application specific integrated circuits require large sales volumes of that application to recover their development costs. Application specific standard processors are developed for one or more applications but are not generally proprietary to one customer. Examples of these applications include modems, cellular telephones, wireless communications, multimedia applications, facsimile machines and local area networks. We have designed our microprocessor to be combined with application specific software to serve as an embedded control product for the application specific standard processor market sector. Application specific standard processors are typically used in embedded control systems by manufacturers to provide an integrated solution for application specific control requirements. Such systems usually contain a microprocessor or microcontroller, logic circuitry, memory and input/output circuitry. Electronic system manufacturers combine one or more of these elements to fit a specific application. The microprocessor provides the intelligence to control the system. The logic circuitry provides functions specific to the end application. The input/output circuitry may also be application specific or an industry standard component. The memory element, if not on the microprocessor, is usually a standard product used to store program instructions and data. In the past, these functions have been executed through multiple integrated circuits assembled on a printed circuit board. The requirements for reduced cost and improved system performance have created market opportunities for semiconductor suppliers to integrate some or all of these elements into a single application specific standard processor or chip set, such as the Ignite family of6microprocessors. The Ignite family provides close integration of the microprocessor and input/output function with the logic circuitry, thereby providing an advanced application specific standard processor. Embedded control systems enable manufacturers to differentiate their products, replace less efficient electromechanical control devices, add product functionality and reduce product costs. In addition, embedded control systems facilitate the emergence of completely new classes of products. Embedded control systems have been incorporated into thousands of products and subassemblies worldwide, including automotive systems, remote controls, appliances, portable computers and devices, cordless and cellular telephones, motor controls and many other systems. Microprocessors are generally available in 4-bit through 64-bit architectures, which refers to the amount of data they can process. 4-bit microprocessors are relatively inexpensive, typically less than $1.00 each. Although they lack certain performance and features, they account for more than 40% of worldwide microcontroller volume. Also in general use today are 8-bit architectures, generally costing $1.00 to $10.00 each and accounting for an additional 40% of worldwide microcontroller volume. To date 16-bit, 32-bit and 64-bit architectures, with typical costs of over $10.00 each, have offered very high performance, but are generally considered to be expensive for high-volume embedded control applications. The use of 16-bit, 32-bit and 64-bit architectures offers fewer internal limitations, making programming easier and providing higher performance. Although generally more expensive per unit and requiring more support logic and memory, these devices offer many advantages for more sophisticated embedded control systems. Electronic system designers, driven by competitive market forces, seek semiconductor products with more intelligence, functionality and control that can be used to reduce system costs and improve performance. For these needs, the Ignite product family was designed to be a sophisticated 32-bit microprocessor with advanced features. The Ignite product family uses a smaller number of transistors compared to other RISC processors which results in less power consumption and more economical prices compared to other embedded control applications. This creates the opportunity for the development of new, cost-effective applications. Technology Description. Conventional high-performance microprocessors are register-based with large register sets. These registers are directly addressable storage locations requiring a complex architecture that consumes costly silicon. This conventional architecture provides processing power for computer applications but complicates and slows the execution of individual instructions and increases silicon size, thereby increasing the microprocessor cost. Our technology is fundamentally different from most other microprocessors in that the data is stored in groups. Our microprocessor employs certain features of both register and stack designs. The resultant merged stack-register architecture improves program execution for a wide range of embedded applications. Our design combines two processors in one highly integrated package, a microprocessing unit for performing conventional processing tasks, and an input-output processor for performing input-output functions. This replaces many dedicated peripheral functions supplied with other processors. The microprocessor’s design simplifies the manipulation of data. Our architecture employs instructions that are shrunk from 32-bits to 8-bits. This simplified instruction scheme improves execution speed for computer instructions. Our architecture incorporates many on-chip system functions, thus eliminating the requirement of support microprocessors and reducing system cost to users. The 0.8-micron microprocessor was designed to operate at a speed of 50Mhz; the 0.5-micron microprocessor at a speed of 100Mhz; the 0.35-micron microprocessor at 150MHz; and the 0.18-micron to operate at speeds in excess of 300Mhz. They are all compatible with a wide range of memory technology from low cost dynamic random access memory to high-speed static random access memory. The microprocessors can be packaged in various surface-mount and die-form packaging. There can be no assurance that the designed speed will be achieved with production models of the 0.5 or 0.18-micron microprocessors or future versions or that all of the desired functions will perform as anticipated. Our technology is not designed or targeted to compete with high-end processors for use in personal computers. It is targeted for embedded control applications. We believe that the features described above differentiate the Ignite family from other 8-bit to 64-bit microprocessors targeted for embedded control applications. Considering the reduced requirement for support microprocessors, the Ignite family is intended to be available at a high volume price that should be price competitive with high-end 8-bit microprocessor and general 16-bit microprocessor systems but with higher performance (speed and functional capability). The Ignite family has been designed to allow high-speed and high-yield fabrication using generally available wafer fabrication technology and facilities.7 The Ignite Microprocessor as a Java Processor. We believe the Ignite microprocessor architecture is capable of being an efficient and cost effective Java programming language processor, because Java is designed to run on a stack-oriented architecture and the Ignite architecture executes the virtual stack machine internal to Java efficiently. Many Java operation codes or instructions require only a single 8-bit Ignite family instruction to be executed, providing a performance advantage over other more expensive processors that require six or more 32-bit instructions to do the same task. This feature allows the execution of Java programs with increased speed and reduced code size thereby enabling lower system memory costs. In addition, the incorporation of many on-chip system functions is expected to allow the Ignite family to perform most of the other functions required of an Internet computer device or Java accelerator, thereby eliminating components. Since Internet computers are designed to be inexpensive appliances for Internet access, cost, speed and performance are expected to be key requirements for designers. We believe the Ignite technology can compete favorably on the basis of such requirements, although there can be no assurance we can successfully exploit Java related applications or that competitors will not create superior Java processors. We have ported the Java operating environment to the Ignite family, which currently uses the C programming language for software support. We are a licensee of Sun Microsystems Inc. This enables us to develop and distribute products based on Sun’s personalJava, a platform on which to run Java applications. We have also licensed from Wind River an operating system, VxWorks, and entered into a relationship with Forth Inc. whereby Forth will provide software support and operating system development tools for the Forth Programming language. We expect that successful implementation of this software should result in a microprocessor which is competitive in the Java virtual machine and embedded applications markets. We believe that, if the implementation is successfully completed, the Ignite I family will be competitive with Java microprocessors announced by competitors. However, there can be no assurance of successful implementation of this package of software or of a market for an Ignite family Java microprocessor. Stage of Development. In early 1994, nanoTronics initiated production of a first generation of wafers at a contract fabrication facility using 6 inch wafers employing 0.8-micron double-metal CMOS technology. After the May 31, 1994 acquisition, we improved the original design, added new features and performed simulations and tests of the improved designs. In October 1995, a run of six wafers of second generation 0.8-micron microprocessors was fabricated by a contract fabrication facility. Subsequently, we tested these microprocessors, while completing a C computer language compiler and preparing application development tools. The compiler and application development tools are necessary to enable system designers to program the Ignite family for specific applications. We made corrections to the design suggested by the testing of prototype units and produced an additional run of second generation microprocessors from remaining wafers in May 1996. In July 1996, we employed these microprocessors in demonstration boards for use by developers and prospective customers and licensees. In December 1997, we completed development of and started shipping a 0.5-micron microprocessor based on the Ignite technology and found that 0.5-micron double-metal CMOS technology improved operating speed, reduced power requirements, reduced physical size and reduced fabrication cost. In May 1998, we began a production run of a 0.35-micron microprocessor that further increased operating speed and cost performance over the previous generations of the Ignite family of microprocessors. At each stage of development, microprocessors require extensive testing to ascertain performance limitations and the extent and nature of errors (bugs), if any. When significant limitations or errors are discovered, additional rounds of design modifications and fabrication are required prior to having functional and demonstrable microprocessors for prospective customers and licensees. Although our 0.5 and 0.35-micron microprocessors have been sent to prospective customers in anticipation of production orders, there can be no assurance that we, during our continued testing of these products, will not identify errors requiring additional rounds of design and fabrication prior to commercial production. Additional delays could have an adverse effect on the marketability of our technology and financial condition. In September 2000, we completed the VHDL soft-core version of the Ignite microprocessor family. The hardware design inside a microprocessor, or silicon device, can be represented as a software program. This, in essence, replaces the old style of designing microprocessors using schematics. VHDL is the predominant software language used to design semiconductors. In addition to the design aspects, VHDL also contains sophisticated simulation tools that allow the designer to simulate the functionality of the entire design before committing to silicon. Also VHDL enables a designer to easily modify and enhance the design. A design represented in VHDL goes through a synthesis process8whereby it is converted to the most basic element of a design, logical gates. This gate level representation in turn is used with computer aided engineering tools to translate the design into the most fundamental component of semiconductors, transistors. The characteristics of the transistors can be given as a library to a foundry. Therefore, a design represented in VHDL is technology and foundry independent and can be targeted for any given transistor geometry (such as 0.18, 0.25, or 0.35- micron) for any foundry of choice. We have developed marketing materials, product manuals and application development tools for use by licensees and customers. The manuals and tools are necessary to enable system designers to quickly and easily program the Ignite family for specific applications. We believe that the Ignite family is ready for licensing or sale and that any additional changes encountered in current testing will be minor and can be made during subsequent production runs of Ignite family microprocessors for customers, when and if orders are obtained. We also believe the core technology is ready for licensing for use by others to develop custom multiple function microprocessors. Business Strategy. The increasing demand for embedded control has made the market for microprocessors one of the largest segments of the semiconductor logic market. This demand will drive the need for embedded processors. Our strategy does not entail competing directly with suppliers who have multiple microprocessor types addressing all parts of the embedded systems market, but on identifying certain market niches that the Ignite would best address due to its low cost, low power consumption and small number of transistors. Because of the above factors, we intend to focus the majority of our efforts on the embedded microprocessor business, a market without an established base of microprocessor products and for which we believe the Ignite has desirable technical and market advantages. We believe that our architecture is suited for controller applications requiring high performance and low system cost, such as cell phones, printers, video terminals, robotics, motion controllers, industrial controllers, digital communication devices, video games, kiosks, cable and satellite modems and TV set top boxes. We expect that early licensing of the technology and product applications will focus on embedded control. We have three international distributors for foreign markets and are addressing the domestic market with an in-house business development person. We also have a strategic alliance with an outside microprocessor design house. We believe the appropriate approach for us initially lies in a balanced effort of cultivating licensees and developing specific product enhancement partnerships, producing original equipment manufactured products, and providing technical support to third parties on a contract basis. The overall balance of these approaches will be monitored and modified as we attempt to ascertain and capitalize on the highly dynamic and competitive embedded microprocessor market. There can be no assurance that we can successfully exploit our microprocessor technology. Subject to the availability of financial and personnel resources, while we are commercializing the Ignite family and the core technology, our strategy is to also design and develop future versions of the microprocessor with more demanding sub-micron technology and with more features. However, our resources are limited, and there can be no assurance that we will be able to continue microprocessor enhancement. Initial fabrications of the 0.8-micron and 0.5-micron processors were performed by contract fabrication facilities. The 0.35-micron microprocessor was fabricated by a contract fabrication facility that had agreed to provide production quantities for our customers. We are currently working with a contract fabrication facility and our design house partner to produce a 0.18-micron version of the Ignite. There can be no assurance fabrication facilities will be available to produce the Ignite family in the future. However, since there are a large number of fabrication facilities with the capability to produce the Ignite family of microprocessors, we believe microprocessors can be produced on a contract basis. Industry shortages of fabrication facilities that may exist and are predicted to exist in the future are generally limited to the more demanding architectures. If a shortage of fabrication facilities develops, it could have a material adverse effect on our financial condition. Competition. The semiconductor industry is intensely competitive and has been characterized by price erosion, rapid technological change and foreign competition in many markets. The industry consists of major domestic and9international semiconductor companies, most of which have greater financial, technical, marketing, distribution, development and other resources than ours. The market for microprocessors and for embedded control applications is at least as competitive. While our strategy is to target high-volume licensees and microprocessor customers requiring more sophisticated but low-cost, low-power consumption devices, we can still expect significant competition. We may also elect to develop embedded control system products utilizing our own architecture or by contract for other manufacturers. We expect that the Ignite family, if successfully commercialized in the embedded controller market, will compete with a variety of 16/64-bit microprocessors including those based on intellectual property from ARM and MIPS and microprocessors from Hitachi, Motorola and IBM. As a Java processor, we expect our Ignite family will compete with a broad range of microprocessors including those incorporating co-processor accelerator technology. The producers of these microprocessors have significantly greater resources than ours. A new entrant, such as ours, is at a competitive disadvantage compared to these and other established producers. A number of factors contribute to this, including:•the lack of product performance experience,•lack of experience by customers in using application development systems,•no record of technical service and support, and•limited marketing and sales capabilities.JUICEtechnology General Background. During 2001 we introduced a technology to enhance the users experience of the wireless internet by expanding the capabilities of his device (either a cell phone, PDA, smart phone or pocket PC). By varying the speed at which the microprocessor processes information, the device can present information in a richer format than is available from current technologies and, additionally, doing so with less drain on the device’s battery. Industry Background. The wireless industry currently provides voice and text data over airwaves ranging from 8Kbps to 19.6Kbps in North America. Voice transmissions account for the majority of wireless use, however at these band widths data content providers are limited to the type of product they are able to transmit and display on a user’s device. In addition, users are now familiar with the internet content they receive on their desk top and lap top computers provided by land lines and, therefore, may not be overly enthusiastic about inferior products provided by the wireless internet. Eventually the band width is expected to increase to over 2Mbits. When this happens, content providers will be able to transmit information to a user’s device in a way similar to existing land lines thereby meeting the user’s current expectations. These enhanced transmissions may include items such as video streaming, video mail, mobile television, video conferencing and video on demand just to name a few. In North America we are still several years away from this solution. Currently only 4%outstanding line of wireless users are internet connected. Significant funds will need to be expended to procure band width and provide the infrastructure to meet the demandscredit of next generation wireless applications. In the meantime, device manufacturers, wireless data network providers and content providers continue to attempt to attract a larger number of wireless internet subscribers with existing technology. Several areas which are having a dampening effect on attracting internet subscribers are the mobile wireless device’s small screen size and limited battery power, the user’s difficulty in interacting when using small keypads or number pads, and the network carrier’s transmission of text only or limited graphics. Technology Description. JUICEtechnology provides a solution for text only and limited graphics content and limited battery power. Juice allows interaction between the microprocessor contained in the user’s device and the data being transmitted by the content provider. When the content is such that increased processor speed is required to provide a better display, as would be the case in expanded graphics, the microprocessor simply increases its functioning speed. Conversely, if the content is such that the microprocessor can effectively process the content at a lower speed, then the processor slows down, thereby, conserving energy. This combination provides for both expanded battery life for the user’s device and for a richer wireless internet experience for the user.10 Stage of Development. The engineering is complete for JUICEtechnology, however, we are awaiting significant customer interest before we commit to the development of a working model available for demonstrations and commercialization. Business Strategy. To launch JUICEtechnology we will need the support of a major manufacturer, wireless service provider or content supplier who can introduce the product as a defacto standard. Competition. Although we are not aware of any other solutions which condition data in the manner that JUICEtechnology does, there are a variety of companies that are attempting to vary the speed at which a microprocessor processes data including Intel, Hitachi, Transmeta and AMD. Some of our existing and potential competitors have substantially greater financial, technical, marketing and distribution resources than we do. Additionally, many of these companies have greater name recognition and more established relationships with our target customers. Furthermore, these competitors may be able to adopt more aggressive pricing policies and offer customers more attractive terms than we can.High Speed Data Communications Products. The communication products that reached the end of their life cycles are: VME Product Line— a line of intelligent high-speed communications engines in a virtual memory European form factor. Some of our customers for these products included the military as well as large satellite based data communications companies. Atcomm2/4 Product Line— an intelligent two or four channel product that was used for high-speed data communications. Except for minor repeat orders, we no longer are supporting this product line. Our strategy is to sell this product line so we may concentrate our efforts and resources on Ignite and JUICEtechnology.Radar and Antenna Technology. General Background. We commenced active development of our ground penetrating radar technology in April 1992. By May 1993, we were able to demonstrate the sensing, processing and crude visualization of images from our technology, and by May 1994 we had completed our prototype device. Since May 1994, we have focused our efforts and limited financial resources on the microprocessor technology and communication products, effectively suspending development and marketing efforts related to ground penetrating radar. Gas Antenna Technology Description. We sold our gas plasma technology in August 1999.Research and Development.Our current development efforts are focused on improvement of and additional features for the Ignite family microprocessor and developing the JUICEtechnology. The development of these technologies has taken longer than anticipated and could be subject to additional delays. Therefore, there can be no assurance of timely or successful marketing of these technologies. We incurred research and development expenditures of $1,372,421, $2,218,433 and $3,170,166 for our fiscal years ended May 31, 2002, 2001 and 2000. The majority of these expenditures have been devoted to our microprocessor technology. We believe that technical advances are essential to our success and expect that we will continue to expend substantial funds on research and development of our technology. However, there can be no assurance that such research and development efforts will result in the design and development of a competitive technology in a timely manner.Rights.Rights11sixseven U.S. patents issued dating back to 1989 on theour microprocessor technology.technology (the “Microprocessor Patents”). We have one microprocessor technology patent pendingissued in five European countries and one patent issued in Japan andJapan. We may file additional applications under international treaties depending on an evaluation of the costs and anticipated benefits that may be obtained by expanding possible patent coverage. In addition, we have one U.S. patent issued on the ground penetratingground-penetrating radar technology and one U.S. patent issued on one of the communications products. We also have three patents pending related to several other development programs including JUICEtechnology.products;products but, due to the nature of the industry, we may receive such claims in the future. Likewise, we believe that we may have claims against other semiconductor companies should certain of our pending patents be favorably granted. However, there can be no assurance thereof or any assurance that we could successfully exploit any potential patent claims against larger competitors. Based on the asset purchase agreement and plan of reorganization between Patriot, nanoTronics and Mr. Falk, we were the recipients of a number of warranties and indemnities. We believe nanoTronics has been liquidated and, due to Mr. Falk’s death in July 1995, we may be limited in our ability to obtain satisfaction should we have any future claims against nanoTronics or its successor, the Falk Family Estate. We have entered into the following licenses related to the microprocessor technology:•Sierra Systems. In June 1994, we entered into an agreement with Sierra Systems whereby we could provide the C programming language on the Ignite. We currently provide development boards with the C programming language.•Sun Microsystems Inc. In June 1997, we entered into an agreement with Sun Microsystems, Inc. which enabled us to develop and distribute products based on Sun’s Java’s technology. In June 1998, we exercised an option under that agreement to license from Sun, personalJava, a smaller platform on which to run Java applications that did not include an operating system. We determined that personalJava was better suited to the markets available to the Ignite. We have ported personalJava to the Ignite.•Wind River. In July 1997, we entered into an agreement with Wind River that provided us with a license for an operating system, VxWorks, to be used in conjunction with personalJava. We have ported VxWorks to the Ignite.•Forth Inc. In July 1997, we entered into a license agreement with Forth Inc. whereby Forth will provide software support and operating system development tools for the Forth programming language. Several customers are evaluating the Ignite as a microprocessor using the Forth programming language. We had one U.S. patent on our gas plasma antenna technology that was sold in August 1999.ground penetratingground-penetrating radar technology. No foreign application has been made. There are a large number of patents owned by others in the radar field generally and in the field of ground penetratingground-penetrating radar specifically. Accordingly, although we are not aware of any possible infringement and have not received any notices of claimed infringement, we may receive such claims in the future.12Distribution.Our products are marketed throughDistributioncombinationlimited number of directchips from our remaining inventory. All of our sales and distributors. Approximate sales by principal geographic area (as a percentage of sales) for fiscal years ended May 31, 2008, 2007 and 2006 were as follows: 2002 2001 2000 Domestic sales 99 % 75 % 65 % Foreign sales Asia — % 7 % 7 % Europe 1 % 6 % 19 % North America — % 12 % 9 % Total sales 100 % 100 % 100 % havematerially affect our operations.material adverse effectVice-President of Business Development to work as part of the senior management team to identify investment and acquisition candidates. In this area we are utilizing a multi-faceted approach, with a focus on operations.uponUpon Single Customers.Customersnetproduct sales were derived from shipments to the following customers for the fiscal years ended May 31as31 as follows: 2002 2001 2000 Advanced Relay $ 151,000 $ — $ — Schindler 59,000 — — Raytheon — 88,000 — SAIC — 41,000 — Spellcaster — 40,000 — Intermec — — 137,000 Sipex — — 138,000 Miel — — 127,000 All of the above sales were for communication products and were shipped against multiple purchase orders from each customer. 2008 2007 2006 Space and Naval Warfare Systems ----- ----- $262,500 Anixter $1,354,494 $461,494 ----- Graybar Electric Company, Inc. $889,724 ----- ----- Victory Global Solutions $370,301 ----- ----- JulyMay 31, 2002 compared to less than $10,000 as2008, 2007 or 2006.July 31, 2001. The backlog as of July 31, 2001 wasour net income for the final orders relatedyears ended May 31, 2008, 2007 and 2006, was attributable to our equity in the communication products and were shipped by the endearnings of our secondunconsolidated affiliate, PDS.quarter whichyears ended November 30, 2001.Employees.May 31, 2008 and 2007. We incurred research and development expenditures of $225,565 for our fiscal year ended May 31, 2006. The majority of these expenditures have been devoted to our microprocessor technology. As our primary business strategy has been to enforce our intellectual property patents through licensing, we are not currently making expenditures relating to research and development, although future research and development costs may be incurred as a result of our merger and acquisition activities.nine personnel. Four personseighteen employees, five of which are employed in researchPatriot Scientific Corporation employees. All Patriot employees are full time and development, two in marketing and sales and three are engagedemployed in general and administrative activities. We also engage additional consultants and part-time persons, as needed from time to time.serviceservices of our key technical and senior management personnel. The competition for highly qualified personnel is intense, and there can be no assurance that we13isare represented by a labor union, and we consider our relations with our employees to be good. None of our employees isare covered by key man life insurance policies.Government Regulation.Toknowledge, our productsmost significant risk factors as of the date this report is being filed. The risks and uncertainties described below are not subjectthe only ones we face.governmental regulationlicense revenues, pending litigation with companies which we allege have infringed on our patent portfolio, the possibility of legislative action regarding patent rights, petitions with the U. S. Patent and Trademark Office to re-examine certain of our patents, and the possible effect of new judicial interpretation of patent laws, we cannot predict the amount of future revenues from such agreements, or whether there will be future revenues from license agreements at all.any federal, statediverting management attention from day-to-day operations. Acquisitions of businesses or local agenciesother material operations may require debt or equity financing, resulting in leverage or dilution of ownership. We may encounter increased competition for acquisitions, which may increase the price of our acquisitions.affect the manufacture, sale or usedilute our current stockholders’ ownership and incur debt and other costs which may cause our quarterly operating results to vary significantly. The dilution of our products,current stockholders’ ownership may be exacerbated if our per share stock price is depressed and common stock is issued in connection with acquisitions.than occupational healthbusiness purposes. These difficulties of integration may require us to coordinate geographically dispersed organizations, integrate personnel with disparate business backgrounds and safetyreconcile different corporate cultures. In addition, we may not be successful in achieving anticipated synergies from these acquisitions. We may experience increased attrition, including, but not limited to, key employees of the acquired companies, during and following the integration of acquired companies that could reduce our future revenue.labor lawsfailures and may suffer reputational harm or otherwise be adversely affected. The discovery of any material liabilities associated with our acquisitions could cause us to incur additional expenses and cause a reduction in our operating profits.arewe provide financing. Under the applicable provisions of accounting principles generally applicable to most companies. We cannot,accepted in the United States of course, predict what sortAmerica, including FIN 46(R), we currently consolidate the financial statements and results of regulationsoperations of this type may be imposedcompany into our consolidated financial statements and results of operations, and record the equity interest that we do not own as a minority interest. For our other investments (PDS and Talis) accounted for under the equity method, we record as part of other income or expense our share of the increase or decrease in the equity of these companies in which we have invested. It is possible that, in the future, but do not anticipate any unusual difficultiesour relationships and/or our interests in complyingor with governmental regulations whichthis consolidated entity and equity method investees could change. Such potential future changes could result in deconsolidation or consolidation of such entities, as the case may be, adoptedwhich could result in changes in our reported results.future. Were-examination process would have not incurred costs associated with environmental lawsa very significant and do not anticipate such laws will have any significantadverse effect on our business.business.auction of these investments is successful, buyers are found outside of the auction process, or they are redeemed by the issuing agencies. We have partially offset the consequences of this illiquidity by securing a line of credit collateralized by the auction rates securities. In the event these securities are deemed to be permanently impaired, we will be required to take a charge to operations in recognition of this impairment.ItemDESCRIPTION OF PROPERTY10,3003,289 square foot office located at 10989 Via Frontera, San Diego,6183 Paseo Del Norte, Suite 180, Carlsbad, California. The facility is leased under a non-cancelable lease through July 2006. In July 2002, we sublet approximately 5,000 square feet of our facility to an independent third party.February 2009. The term of the sublease coincides with the remaining term of our lease. The reducedcurrent floor space provides adequate and suitable facilities for all of our corporate functions. In addition, we haveemployee, who supports the sales and marketing of our microprocessor, telecommute3,364 square foot office located at 2386 Faraday Avenue, Suite 200, Carlsbad, California. The facility is subleased from her homean unrelated party with a month-to-month option until no later than December 2008.West Virginia.Anaheim, California. The warehouse is leased under a cancelable lease until November 2009.Item In January 1999, we sued in the Superior Court of San Diego County, California by the Fish Family Trust, a co-inventor of the original ShBoom technology. The suit also named as defendants nanoTronicsin three separate lawsuits filed in the United States District Court for the Northern District of California by Asustek Computer, Inc., HTC Corporation, and Gloria Felcyn on behalfAcer, Inc., and affiliated entities of each of them. On February 13, 2008, the Asustek claims were amended to include claims against MCM Portfolio, LLC (Alliacense and MCM Portfolio are TPL-related entities), which do not involve the Company.Falk Family Trust. The suit sought a judgment for damages, a rescissionMMP Portfolio, and as such the Company is not engaged in this aspect of the Technology Transfer Agreementlitigation and a restorationdefense. The Acer case seeks declaratory relief that its products do not infringe enforceable claims of our '336, '584 and '749 patents. The HTC case similarly seeks declaratory relief that its products do not infringe enforceable claims of those three patents and our '148 patent.technologyMMP Portfolio. Motions to dismiss or transfer the Northern District of California actions to the co-inventor. In March 1999,Eastern District of Texas are currently pending with hearings set for August 29, 2008 in the Acer case and September 19, 2008 for the HTC and Asustek cases. At that point we joinedexpect to learn where the T-3 (“Acer, Asustek and HTC”) litigation will proceed. Responsive pleadings in those cases are due at varying times in mid-August and early September 2008. Similar to the actions in the Northern District of California, the Asustek action in the Eastern District of Texas is inclusive of matters with nanoTronics and Gloria Felcyn and filed our response and cross-complaint against the Fish Family Trust. In November 2000, the judge issuedrespect to two patents owned by TPL that are not a summary ruling in favorpart of the defendants on all counts. The Fish Family Trust filed an appealMMP Portfolio, and as such we are not engaged in January 2001. Management believes that it is unlikely that the appellate court will overturn the trial court’s ruling and that the resolutionthis aspect of the appeal process will have no impact on our financial position, income or cash flows. In September 2001, an action was filed against us in the Superior Court of San Diego County, California by Richard G. Blum, our former Chairman, Presidentlitigation and Chief Executive Officer. Mr. Blum contends that he was wrongfully terminated on August 5, 2001 in violation of his employment agreement dated December 1, 2000. He seeks damages for the alleged breach of his employment agreement, age discrimination, as well as other related claims. Management denies Mr. Blum’s claims and contends it exercised its business judgment for legitimate nondiscriminatory reasons. In accordance with his employment agreement, we may be obligated to pay him between $0 and $400,000 as severance pay. We intend to vigorously defend our position in this case. In October 2001, an action was filed against us in the Superior Court of San Diego County, California by Daniel Beach, a former marketing and sales consultant whose contract we terminated in August 2001. Mr. Beach contends that we breached both a written and an oral contract, that we did not perform on certain promises, and that we made false and misleading representations in addition to other claims. In July 2002, we entered into negotiations on a settlement agreement with Mr. Beach. Management believes that it is probable that a settlement will be reached whereby we agree to pay him $50,000 over five months. Accordingly, a liability for $50,000 has been recorded in the financial statements as of May 31, 2002, in connection with this litigation.14Item At a Special Meeting of Shareholders held on May 6, 2002, the following proposal was approved:1.Proposal to approve an amendment to our Certificate of Incorporation to increase the number of authorized shares of our common stock, $.00001 par value, from 100,000,000 to 200,000,000. Votes For Votes Against Votes Abstaining 63,143,334 2,042,889 163,900 ItemAND RELATED STOCKHOLDER MATTERSCommon Stockcommon stock is traded in the over-the-counter market and is quoted on the NASD OTC Bulletin Board system maintained by the National Association of Securities Dealers, Inc. under the symbol PTSC. Prices reported represent prices between dealers, do not include markups, markdowns or commissions and do not necessarily represent actual transactions. The market for our shares has been sporadic and at times very limited.the Common Stockour common stock for the fiscal years ended May 31, 20022008 and 2001. Bid Quotations High Low Fiscal Year Ended May 31, 2002 First Quarter $ 0.53 $ 0.25 Second Quarter $ 0.25 $ 0.10 Third Quarter $ 0.15 $ 0.07 Fourth Quarter $ 0.14 $ 0.07 Fiscal Year Ended May 31, 2001 First Quarter $ 1.72 $ 0.65 Second Quarter $ 1.60 $ 0.78 Third Quarter $ 1.09 $ 0.49 Fourth Quarter $ 0.84 $ 0.50 We have2007. BID QUOTATIONS HIGH LOW Fiscal Year Ended May 31, 2008 First Quarter $0.59 $0.45 Second Quarter $0.62 $0.38 Third Quarter $0.80 $0.36 Fourth Quarter $0.59 $0.27 Fiscal Year Ended May 31, 2007 First Quarter $1.37 $0.79 Second Quarter $1.18 $0.61 Third Quarter $0.77 $0.46 Fourth Quarter $0.70 $0.45 416601 shareholders of record as of May 31, 2002.record. Because most of our common stock is held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholdersbeneficial owners represented by these record holders. We have nevercash$0.02 per common share dividend on March 22, 2006 and paid a $0.04 per common share dividend on April 24, 2006. During the fiscal year ended May 31, 2007 we paid a $0.02 per common share dividend on April 9, 2007. We paid no dividends during the fiscal year ended May 31, 2008. On February 22, 2007, our Board of Directors adopted a semi-annual dividend payment policy, subject to determination by our Board of Directors in light of our financial condition, other possible applications of our available resources, and relevant business considerations.and doissuable under the plan from 5,000,000 to 7,000,000. Shareholders will be asked to ratify the amendment to the plan at our next annual meeting.expect to pay onebeen approved by our stockholders. This item has been segregated in the foreseeable future.table below under the item “Equity compensation plan not approved by security holders”.Item Number of securities remaining available for future issuance under equity compensation plans Equity compensation plans approved by security holders 8,195,000 $ 0.44 3,352,404 Equity compensation plan not approved by security holders 300,000 $ 0.57 — Total 8,495,000 3,352,404 Period March 1 - 31, 2008 - $ - - April 1 - 30, 2008 1,829,200 $ 0.37 1,829,200 May 1 - 31, 2008 568,700 $ 0.32 568,700 Total 2,397,900 $ 0.35 2,397,900 CONSOLIDATED FINANCIAL DATA You should read the selected consolidated financial data set forth below in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the notes to those statements included elsewhere in this report. 2002, 2001, 2000, 1999,2008, 2007 and 1998 have been2006, is derived from our audited consolidated financial statements which have beenincluded elsewhere in this report. This information should be read in conjunction with those consolidated financial statements, the notes thereto, and with the section herein entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The selected consolidated financial data set forth below for the fiscal years ended May 31, 2005 and 2004, are derived from our audited by Nation Smith Hermes Diamond, independent auditors,consolidated financial statements that are contained in reports previously filed with the Securities and Exchange Commission, not included herein. There are no accounting changes, business combinations or dispositions of business operations, other than the consolidation of SSDI for the fiscal years ended May 31, 2008 and 2007 and the inclusion of Talis in the equity in earnings of affiliated companies for the fiscal year ended May 31, 2002 and BDO Seidman, LLP, independent auditors, for2008, that materially affect the preceding four years.15 Fiscal Years Ended May 31, Statement of operations data: 2008 2007 2006 2005 2004 Net sales $ 3,708,218 $ 638,784 $ 10,309,709 $ 2,982,586 $ 76,417 Operating income (loss) $ (5,603,493 ) $ (14,763,839 ) $ 3,911,640 $ 87,421 $ (1,737,370 ) Equity in earnings of affiliated companies $ 19,917,769 $ 48,965,084 $ 27,848,363 $ — $ — Net income (loss) $ 9,388,321 $ 23,691,187 $ 28,672,688 $ (10,518,704 ) $ (5,760,883 ) Basic income (loss) per common share $ 0.02 $ 0.06 $ 0.09 $ (0.05 ) $ (0.04 ) Diluted income (loss) per common share $ 0.02 $ 0.06 $ 0.07 $ (0.05 ) $ (0.04 ) Weighted average number of common shares outstanding - basic 390,956,153 378,036,989 316,100,499 222,495,047 139,767,276 Weighted average number of common shares outstanding - diluted 397,485,699 413,599,373 412,963,173 222,495,047 139,767,276 Cash dividends declared and paid per share $ — $ 0.02 $ 0.06 $ — $ — May 31, Balance sheet data: 2008 2007 2006 2005 2004 Cash and cash equivalents $ 6,424,015 $ 21,605,428 $ 3,984,240 $ 591,426 $ 355,940 Total assets $ 25,431,902 $ 34,414,629 $ 12,071,667 $ 3,724,034 $ 926,228 Long-term obligations $ 1,085,181 $ 12,222,944 $ - $ 9,320,654 $ 6,102,669 Total liabilities $ 2,014,719 $ 14,243,738 $ 1,244,116 $ 10,964,418 $ 6,650,711 Stockholders’ equity (deficit) $ 23,301,777 $ 20,170,891 $ 10,827,551 $ (7,240,384 ) $ (5,724,483 ) Years Ended May 31, 2002 2001 2000 1999 1998 Revenue: Sales $ 358,809 $ 337,384 $ 716,960 $ 1,134,545 $ 1,902,874 Costs and expenses: Cost of sales 393,980 544,320 725,008 711,195 1,163,688 Research and development 1,372,421 2,218,433 3,170,166 2,149,361 1,607,828 Selling, general and administrative 2,708,579 2,588,579 3,501,128 2,015,058 4,090,937 Total costs and expenses 4,474,980 5,351,332 7,396,302 4,875,614 6,862,453 Operating loss (4,116,171 ) (5,013,948 ) (6,679,342 ) (3,741,069 ) (4,959,579 ) Other income (expense), net (1,370,880 ) 45,045 (809,366 ) (535,387 ) (2,555,206 ) Net loss $ (5,487,051 ) $ (4,968,903 ) $ (7,488,708 ) $ (4,276,456 ) $ (7,514,785 ) Basic and diluted loss per common share $ (0.08 ) $ (0.09 ) $ (0.17 ) $ (0.11 ) $ (0.24 ) Weighted average number of shares- basic and diluted 66,810,028 53,433,788 44,156,418 38,042,734 31,016,956 May 31, 2002 2001 2000 1999 1998 Cash and cash equivalents $ 88,108 $ 464,350 $ 2,100,242 $ 35,813 $ 602,456 Working capital (deficiency) (918,768 ) 328,605 1,769,340 (1,545,055 ) 1,011,329 Total assets 934,526 1,543,693 2,733,148 1,145,027 2,189,654 Long-term obligations, net of current maturities 331,929 — — — 508,355 Total stockholders’ equity (deficit) (444,825 ) 922,388 2,209,882 (981,234 ) 1,156,848 Fiscal Quarters Ended Quarterly statement of operations data for August 31, November 30, February 29, May 31, fiscal 2008 (Unaudited): 2007 2007 2008 2008 Net sales $ 521,369 $ 945,830 $ 801,284 $ 1,439,735 Gross profit $ 369,834 $ 589,492 $ 456,200 $ 782,242 Net income (loss) $ (1,962,386 ) $ 2,416,536 $ 6,292,185 $ 2,641,986 Basic income (loss) per common share $ ( 0.01 ) $ 0.01 $ 0.02 $ 0.01 Diluted income (loss) per common share $ (0.01 ) $ 0.01 $ 0.02 $ 0.01 Weighted average number of common shares outstanding - basic 390,455,132 391,245,755 391,472,101 390,660,391 Weighted average number of common shares outstanding - diluted 390,455,132 392,627,522 395,666,621 391,717,950 Cash dividends declared and paid per share $ - $ - $ - $ - Quarterly statement of operations data for fiscal 2007 (Unaudited): Net sales $ 26,375 $ 18,500 $ 22,175 $ 571,734 Gross profit $ 26,375 $ 18,500 $ 22,175 $ 252,360 Net income (loss) $ 5,990,273 $ (1,881,998 ) $ 9,617,559 $ 9,965,353 Basic income per common share $ 0.02 $ — $ 0.03 $ 0.03 Diluted income per common share $ 0.01 $ — $ 0.02 $ 0.02 Weighted average number of common shares outstanding - basic 368,837,051 378,817,682 381,031,577 387,903,643 Weighted average number of common shares outstanding - diluted 420,646,769 378,817,682 410,747,949 407,392,062 Cash dividends declared and paid per share $ — $ — $ 0.02 $ — Item Our ResultsOperations have beenagreements with TPL and mayothers to facilitate the pursuit of infringers of our intellectual property. We intend to continue our joint venture with TPL to be subject to significant variations. The results for a particular period may vary due to a numberpursue license agreements with infringers of factors. These include:•the overall state of the semiconductor and communications segments of the economy,•the development status of and demand for our products,•economic conditions in our markets,•the timing of orders,•the timing of expenditures in anticipation of future sales,•the mix of products sold by us,•the introduction of new products,•product enhancements by us or our competitors, and•pricing and other competitive conditions.16Critical Accounting Policiesfollowing representoption of working through TPL, as compared to creating and using a Company licensing team for those activities, avoids a competitive devaluation of our critical accounting policies:Property, Equipment and Depreciation Property and equipment are stated at cost. Depreciation is computed over the estimated useful life of three to five years using the straight-line method. Long-livedprincipal assets and certain identifiable intangiblesis a prudent way to be held and used byachieve the Company are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We continuously evaluate the recoverabilitydesired results as we seek to obtain fair value from users of our long-lived assets based on estimated future cash flows fromintellectual property.the estimated fair valueacquisitions of such long-lived assets, and provide for impairment if such undiscounted cash flows are insufficient to recover the carrying amount of the long-lived asset.Patents and Trademarks Patents and trademarks are carried at cost less accumulated amortization and are amortized over their estimated useful lives of four years. The carrying value of patents and trademarks is periodically reviewed and impairments, if any, are recognized when the expected future benefit to be derived from an individual intangible asset is less than its carrying value.Revenue Recognition We recognize revenue on the shipment to our customers of communication products, microprocessor integrated chips and evaluation boards. We anticipate thatcompanies operating in the future we will also deriveelectronics technology market sector by way of i) selective expansion of our IP portfolio, ii) pursuit of strategic minority investments in certain early-stage revenue from fees for the transferor technology ventures that represent a technology or capability of proveninterest to us, and reusable intellectual property components or the performance of engineering services. We anticipate to enter into licensing agreements that will provide licensees the right to incorporate our intellectual property components in their products with termsiii) full M&A transactions.conditions that we anticipate to vary by licensee. Generally, we anticipate these payments will include a nonrefundable technology license fee, which will be payable upon the transfer of intellectual property, or a nonrefundable engineering service fee, which generally will be payable upon achievement of defined milestones. In addition, we anticipate these agreements will include royalty payments, which will be payable upon sale of a licensee’s product, and maintenance and limited support fees. We will classify all revenue that involves the future sale of a licensee’s products as royalty revenue. Royalty revenue will be generally recognized in the quarter in which a report is received from a licensee detailing the shipments of products incorporating our intellectual property components (i.e., in the quarter following the sale of licensed product by the licensee). We will classify all revenue that does not involve the future sale of a licensee’s products, primarily license fees and engineering service fees and maintenance and support fees, as contract revenue. License fees will be recognized upon the execution of the license agreement and transfer of intellectual property, provided no further significant performance obligations exist and collectibility is deemed probable. Fees related to engineering services contracts, which will be performed on a best efforts basis and for which we will receive periodic milestone payments, will be recognized as revenue over the estimated development period, using a cost-based percentage of completion method. Annual maintenance and support fees, which will be renewable by the licensee, will be classified as contract revenue and will be amortized over the period of support, generally 12 months.Research and Development Costs Research and development costs are expensed as incurred.Stock Options The Company applies Accounting Principles Board (“APB”) Opinion 25, “Accounting for Stock Issued to Employees,” and related Interpretations in accounting for all stock option plans. Under APB Opinion 25, compensation cost has been recognized for stock options granted to employees when the option price is less than the market price of the underlying common stock on the date of grant. Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” requires the Company to provide pro forma information regarding net income as if compensation cost for the Company’s stock option plans had been determined in accordance with the fair value based method prescribed in SFAS No. 123. To provide the required pro forma information, the Company estimates the fair value of each stock option at the grant date by using the Black-Scholes option-pricing model.17Use of Estimates The preparation ofconformityaccordance with accounting principles generally accepted in the United States of America, requires managementwhich require us to make estimates and assumptionsjudgments that significantly affect the reported amounts of assets, liabilities, revenues and liabilitiesexpenses, and related disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.liabilities. Actual results could differ from those estimates. Duringestimates, and such differences could affect the year ended May 31, 2002, based upon information then available, we revisedresults of operations reported in future periods. We believe the following critical accounting policies affect our most significant estimates regardingand judgments used in the recoverypreparation of our inventories. Asconsolidated financial statements.1. Revenue Recognition 2. Assessment of Contingent Liabilities increased existing reserves for obsolescence by $111,381.Resultscan make a reliable estimate of Operationssuch loss and it is probable that it has been incurred. By their very nature, contingencies are difficult to estimate. We continually evaluate information related to all contingencies to determine that the basis on which we have recorded our estimated exposure is appropriate.3. Stock Options and Warrants Years Ended May 31, 2002, 2001accounting of transactions in which an entity exchanges its equity instruments for goods or services, primarily focusing on accounting for transactions where an entity obtains employee services in share-based payment transactions. SFAS No. 123(R) requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments, including stock options, based on the grant-date fair value of the award and 2000Our net salesto recognize it as compensation expense over the period the employee is required to provide service in fiscal 2002, 2001 and 2000 were as follows: Fiscal Year Amount % Change from the Previous Fiscal Year 2002 $ 358,809 Increase of 6.3% 2001 $ 337,384 Decrease of 52.9% 2000 $ 716,960 Net sales. Total net salesexchange for the year ended May 31, 2002 increased slightly overaward, usually the previous year as a resultvesting period. Stock-based awards to non-employees are accounted for using the fair value method in accordance with SFAS No. 123, Accounting for Stock Based Compensation. our last buy program for the communications products all of which have reached the end of their life cycles. Net sales for the year ended May 31, 2001 decreased from the previous fiscal year. This decrease was due to a lack of follow-on shipments for the matured communication products.Share-Based Payment Awards (“FAS123R-3”). We have stopped productionelected to adopt the alternative transition method provided in FAS 123R-3. The alternative transition method includes a simplified method to establish the beginning balance of our communications products as we are now concentratingthe additional paid-in capital pool (“APIC pool”) related to the tax effects of employee share-based compensation, which is available to absorb tax deficiencies recognized subsequent to the adoption of SFAS No. 123(R).microprocessor product line. We anticipate only minor, if any, communication product revenue since we are attemptingvalue of the portion of share-based payment awards that is ultimately expected to sell this line. Future sales will be derived from salesvest during the period. Stock-based compensation expense recognized in our consolidated statement of microprocessors and licensing of microprocessor technology.Our cost of sales in fiscal 2002, 2001 and 2000 were as follows: % Change from the Fiscal Year Amount Previous Fiscal Year % of Net Sales 2002 $ 393,980 Decrease of 27.6% 109.8 % 2001 $ 544,320 Decrease of 24.9% 161.3 % 2000 $ 725,008 101.1 % Cost of sales. Cost of sales as a percentage of net sales decreased inoperations for the fiscal year ended May 31, 2002 compared2007 included compensation expense for share-based payment awards granted prior to, but not yet vested as of May 31, 2006 based on the previous fiscal year. This decrease was due to a reductiongrant date fair value estimated in fixed manufacturing overhead as a result of cost cutting programs instituted in conjunctionaccordance with the completionpro forma provisions of SFAS No. 123 and compensation expense for the communication product line duringshare-based payment awards granted subsequent to May 31, 2006 based on the current fiscal year. Costgrant date fair value estimated in accordance with the provisions of sales as a percentageSFAS No. 123(R). Stock-based compensation expense recognized in our consolidated statement of net sales increased inoperations for the fiscal year ended May 31, 20012008 included compensation expense for share-based payment awards granted subsequent to May 31, 2007 based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). As stock-based compensation expense recognized in the consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The estimated average forfeiture rate for the fiscal year ended May 31, 2008 and 2007, of approximately 5% was based on historical forfeiture experience and estimated future employee forfeitures.4. Income Taxes 5. Investments in Affiliated Companies 6. Variable Interest Entity previousfourth quarter of the 2007 fiscal year during which we recorded SSDI sales amounting to approximately $559,000 with cost of sales amounting to approximately $308,000. During the 2008 and the 2007 fiscal years we recognized maintenance fee revenues totaling approximately $25,000 per year in connection with an agreement with AMD Corporation during the 2005 fiscal year. This increase wasThe agreement called for maintenance fees totaling $100,000 connected with a license agreement for our Ignite technology; the license fee revenue is being recognized as revenue evenly over the four year period of the license. In addition during the 2008 fiscal year, we recorded sales of approximately $33,000 from the sale of microprocessor chips that we no longer market as compared to approximately $55,000 during the 2007 fiscal year. Inventory associated with the sales of these microprocessor chips is carried at zero value.fixed manufacturing overhead being allocatedsettlement of legal matters during fiscal year 2008 and reduced accounting expenses in fiscal year 2008. Fiscal year 2007 included fees related to a smaller revenue baselegal and accounting matters in connection with the restatement of our financial statements for the fiscal years 2005, 2004, 2003 and 2002 as well as the quarterly reports for the periods ended August 31, 2005 and February 28, 2006 and our required compliance with Sarbanes-Oxley regulations. Salary costs and related expenses included non-cash expenses associated with the fair value of options granted during the fiscal years ended May 31, 2008 and 2007 in accordance with SFAS No. 123(R). Total non-cash compensation for the fiscal year ended 2008 was approximately $502,770 for PTSC as compared to approximately $2,359,036 for PTSC during the fiscal year ended 2007. The decrease is primarily due to the June 5, 2006 grant of 1,500,000 options to our former chief executive officer resulting in non-cash compensation expense amounting to approximately $1,527,000 during the fiscal year ended 2007. Other salary expenses for PTSC increased by approximately $292,000 for the fiscal year ended May 31, 2008 as compared with the fiscal year ended May 31, 2007. The increase is primarily due to the hire of an additional executive position and severance payments to our past chief executive officers. Salaries and related expenses for SSDI during the fiscal year ended 2008 were approximately $1,198,000 as compared to approximately $242,538 for the fourth quarter of the 2007 fiscal year. Public and investor relations expenses decreased by approximately $128,000 for the fiscal year ended May 31, 2008 as compared with the 2007 fiscal year primarily due to one-time contracts with investor relations firms in fiscal year 2007.20012007, relating to the mediation agreement with Russell H. Fish III (“Fish”). During fiscal year 2008 we recorded approximately $836,000 relating to royalty payments due to the Fish parties. In January 2008, we made the final payment under the Fish settlement agreement.$138,000 reductionloss of approximately $8,000. Total other income and expense for the fiscal year ended May 31, 2008 amounted to net other income of approximately $21,533,000 compared with total other income and expense for the fiscal year ended May 31, 2007 of net other income amounting to approximately $49,210,000. Interest income and other income increased from approximately $715,000 for the fiscal year ended May 31, 2007 to approximately $1,470,000 for the fiscal year ended May 31, 2008. The increase is primarily due to the interest earned and accrued on our auction rate securities of approximately $363,000 and an increase in royaltiesother income of approximately $382,000 relating to retainer refunds from legal firms, settlement of a legal matter and reimbursement items billed to PDS for prior fiscal year legal expenses we incurred. During the fiscal year ended May 31, 2007 we recorded an impairment charge on the value of our note receivable from Holocom Networks, Inc. of approximately $340,000. Also, we recorded an impairment charge of approximately $127,000 on the carrying value of SSDI, the successor company to Holocom Networks, Inc., prior to the March 27, 2007 consolidation of SSDI. There was no such impairment charges during the fiscal year ended May 31, 20012008.previousyear ended May 31, 2007. As of May 31, 2008 we have utilized all of our remaining available federal net operating loss carry-forwards of approximately $4,870,000. At May 31, 2007, we had utilized all of our state net operating loss carry-forwards of approximately $17,822,000.negatively impactingended May 31, 2006 to approximately $639,000 for the percentage comparison.researchrevenue amounts do not include approximately $27,848,000 and development expensesapproximately $48,965,000 in income resulting from our investment in Phoenix Digital Solutions, LLC for the fiscal 2002, 2001years ended May 31, 2006 and 2000May 31, 2007, respectively. In the first quarter of the 2006 fiscal year we entered into an agreement with Intel Corporation licensing our intellectual property, in connection with which we received a one-time payment of $10,000,000. The license revenue was recognized during the 2006 fiscal year. In addition, product sales amounting to approximately $310,000 were also recorded during the 2006 fiscal year in connection with communications products that we no longer market. Inventory associated with the sales of these communications products was carried at zero value. Cost of sales of approximately $103,000 consisted of payments made to subcontractors for materials and labor in connection with the product sales. During the fourth quarter of the 2007 fiscal year we recorded sales amounting to approximately $559,000 by our consolidated variable interest entity, SSDI with cost of sales amounting to approximately $308,000. Also during the 2007 fiscal year we recognized maintenance fee revenues totaling approximately $25,000 in connection with an agreement with AMD Corporation during the 2005 fiscal year. The agreement called for maintenance fees totaling $100,000 connected with a license agreement for our Ignite technology; the license fee revenue is being recognized as follows: Fiscal Year Amount % Change from the Previous Fiscal Year 2002 $ 1,372,421 Decrease of 38.1% 2001 $ 2,218,433 Decrease of 30.0% 2000 $ 3,170,166 decreasedfor the fiscal year ended May 31, 2006 amounted to approximately $226,000. Expenses related to salaries, benefits, training and other employee expenses amounted to approximately $152,000 for the 2006 fiscal year. Consultants related to research and development activities amounted to approximately $64,000 for the 2006 fiscal year and remaining expenses of approximately $10,000 connected with travel and overhead costs supporting research and development activities during the 2006 fiscal year. Research and development activities were terminated during the 2006 fiscal year and no such costs were incurred during the 2007 fiscal year.2002 compared2007 in accordance with SFAS No. 123(R). On June 5, 2006, 1,500,000 options were granted to the previous fiscal year. This decrease was due primarily to a reduction of approximately $406,000our former chief executive officer resulting in personnel costs, a $221, 000 reduction in the costs of outside consultants and a reduction in software maintenance costs of $77,000. These reductions in costs were as a result of a cost cutting program initiated during the first half of the current fiscal year.18Research and development expenses decreased during the fiscal year ended May 31, 2001 compared to the previous fiscal year. This decrease was due primarily to non-cash compensation expense of $1,588,960 being recorded the previous fiscal year as a result of the Company providing employees and directors the option of exercising their stock options using a cashless exercise provision compared to no similar expense in the current fiscal year. This decrease was partially offset by an increase in personnel costs of approximately $300,000 and consulting services of $150,000. The increase in personnel and consulting costs was attributable to the introduction of the new soft core version of the microprocessor technology and to accelerate the effort to complete and improve the marketability of the Ignite I and JUICEtechnology. We added four research and development personnel, including one executive, during the fiscal year ended May 31, 2001.Our selling, general and administrative expenses in fiscal 2002, 2001 and 2000 were as follows: Fiscal Year Amount % Change from the Previous Fiscal Year 2002 $ 2,708,579 Increase of 4.6% 2001 $ 2,588,579 Decrease of 26.0% 2000 $ 3,501,128 Selling, general and administrative expenses increased during the fiscal year ended May 31, 2002. This increase was due primarilyamounting to approximately $294,000 of legal, accounting and shareholder costs associated with several registrations of securities and two shareholder meetings, non-cash compensation of $105,000 related$1,527,000. On October 23, 2006, 230,000 options were granted to services provided to support our merger and acquisition activities, offset by reductionsemployees resulting in consulting expenses of $286,000. Selling, general and administrative expenses decreased during the fiscal year ended May 31, 2001, compared to the previous fiscal year. This decrease was due primarily to non-cash compensation expense of approximately $2,150,000 being recorded during the previous fiscal year as a result of the Company providing$184,000. On February 9, 2007, 1,070,000 options were granted to employees and directors the optionresulting in non-cash compensation expense of exercising their stock options using a cashless exercise provision compared to no similar expense in the current fiscal year. This decrease was partially offset by an increase in marketing, employment and consulting costs of approximately $1,174,000. This increase was due to increased marketing expenses related to Ignite I and JUICEtechnology and additional$584,000. Additional non-cash compensation and relocation costs related to changes in several executive level positions. We added six selling, general and administrative personnel, including two executives, during the fiscal year ended May 31, 2001.Our other income (expenses) in fiscal 2002, 2001 and 2000 were as follows: Fiscal Year Amount % Change from the Previous Fiscal Year 2002 $ (1,370,880 ) Not meaningful 2001 $ 45,045 Not meaningful 2000 $ ( 809,366 ) Other income (expense) changed significantly for the fiscal year ended May 31, 2002 compared2007 amounted to $61,000 for vesting of employee stock options in accordance with SFAS No. 123(R). No such compensation expense was incurred for the previous2006 fiscal year. This change resulted primarily from the recognition of non-cash interest expense ofOther salary expenses increased by approximately $1,324,000 related to the amortization of the debt discount associated with the issuance of warrants under the secured note payable, convertible debentures, and equity line of credit and interest expense related to the excess of the market price over the carrying value of the common shares sold to Swartz for which the proceeds were applied to the note payable balance. Other income (expenses) changed significantly$398,000 for the fiscal year ended May 31, 2001,2007 as compared towith the previousfiscal year ended May 31, 2006 including approximately $223,000 in salaries and related expenses for SSDI during the fourth quarter of the 2007 fiscal year. Salary expenses for PTSC including expenses connected with bonuses and 401(k) employer matching of salaries increased by approximately $175,000 in the 2007 fiscal year as compared with the 2006 fiscal year. Marketing related expenses decreased by approximately $139,000 for the fiscal year ended May 31, 2007 as compared with the fiscal year ended May 31, 2006 as product marketing activities were largely discontinued. Public and investor relations expenses increased by approximately $165,000 for the fiscal year ended May 31, 2007 as compared with the 2006 fiscal year as a result of a change in our public relations firm and one-time contracts with investor relations consultants. Insurance expense increased by approximately $158,000 for the fiscal year ended May 31, 2007 as compared with the 2006 fiscal year primarily as a result of increased costs of directors and officers insurance coverage. Travel and related expenses for the 2007 fiscal year increased by approximately $44,000 as expenses for SSDI were combined with travel expenses for PTSC which increased due to travel to attend various lawsuit mediations.2001,2007, we recorded $7,525,000 of settlement and license expense relating to the mediation agreement with Russell H. Fish III (“Fish”).was recognized primarily from interest income as opposed toand expenses for the previous fiscal year whenended May 31, 2007 included equity in the earnings of PDS. The investment is accounted for in accordance with the equity method of accounting for investments. Our investment in the joint venture for the fiscal year ended May 31, 2007 provided income after expenses in the amount of approximately $48,965,000. Our investment in the joint venture provided net income after expenses in the amount of approximately $27,848,000 for the fiscal year ended May 31, 2006. Total other income and expense for the fiscal year ended May 31, 2007 amounted to net other income of approximately $49,210,000 compared with total other income and expense for the fiscal year ended May 31, 2006 of net other income amounting to approximately $24,761,000. Changes in the fair value of warrant and derivative liabilities amounted to net other expense resulted primarily fromfor the recognitionfiscal year ended May 31, 2006 of approximately $996,000 of non-cash$2,457,000 with no corresponding amount for the fiscal year ended May 31, 2007 as all convertible debt had been retired in prior fiscal periods. Non-cash adjustments to interest expense relatedfor the 2006 fiscal year amounted to theexpenses of approximately $471,000 resulting from amortization of debt discount and $51,000 increase in interest expense over 2001conversion of the remaining debentures. During the 2006 fiscal year we recorded a loss on debt extinguishment of $445,000 related to short term notes. The 2000 expenses were partially offset bythe 7,000,000 warrants issued to a gain of $250,000debenture holder as consideration for entering into the reset agreements. Interest income and other income increased from approximately $330,000 for the fiscal year ended May 31, 2006 to approximately $715,000 for the fiscal year ended May 31, 2007 as interest bearing account balances increased from cash received as distributions from our investment in PDS. During the fiscal year ended May 31, 2007 we recorded an impairment charge on the salevalue of our note receivable from Holocom Networks, Inc. of approximately $340,000. Also, we recorded an impairment charge of approximately $127,000 on the carrying value of SSDI, the successor company to Holocom Networks, Inc., prior to the March 27, 2007 consolidation of the gas plasma antenna technology.Liquidity and Capital Resources In connection with their report onVIE (see Note 8 to our consolidated financial statements as of andfor more information).2002, Nation Smith Hermes Diamond,2007 due to recognition of deferred taxes of approximately $9,783,000 and a current tax liability of approximately $972,070. The increase in deferred taxes was due to the release of the valuation allowance as we determined that we would utilize our independent certified public accountants, expressed substantial doubt aboutnet operating loss carryforwards and other deferred tax assets due to our ability to continue as a going concern becauseshare of recurring net losses and negative cash flowincome from operations.192002,2007 we had deficit working capitalhave utilized all of $918,768our state net operating loss carryforwards of approximately $17,822,000 and utilized approximately $29,090,000 of our federal net operating loss carryforwards.and cash equivalents of $88,108. We have historically funded our operations primarily through the issuance ofmarketable securities and debt financings. Cash and cash equivalentsshort-term investment balances decreased $376,242 during the year endedfrom approximately $25,955,000 as of May 31, 2002 due2007 to netapproximately $6,722,000 as of May 31, 2008. We also have restricted cash usedbalances amounting to approximately $51,000 as of May 31, 2008 and approximately $102,000 as of May 31, 2007. Total current assets decreased from approximately $31,399,000 as of May 31, 2007 to approximately $9,851,000 as of May 31, 2008. Total current liabilities amounted to approximately $930,000 and approximately $2,021,000 as of May 31, 2008 and May 31, 2007, respectively. The change in operationsour current position as of $3,632,534 and additions to property, equipment and patents, net of $146,156 offset by funds generatedMay 31, 2008 as compared with the previous year primarily results from the proceeds from a note payable and convertible debentureinvestment of $2,298,000idle cash in auction rate securities which are classified as long-term and the sale of common stock under an investment agreement and to individual investors of $953,438. The net cash used in operations was $3,632,534 for the year ended May 31, 2002 compared to $4,839,180 for the corresponding period of the previous fiscal year. The decrease in cash required in operations was due primarily to a $436,837 difference in net loss as adjusted to reconcile to cashdistributions received from PDS during fiscal year 2008.coupled with a $1,324,431 non-cash interest expense related to convertible debentures, notes payable and warrants and $326,189 difference in the cash generated and sales of inventory between the two periods. Cash used in investing activities was $146,156 for the yearfiscal years ended May 31, 20022008 and 2007 was approximately $19,260,000 and $14,151,000 as compared to $493,557 for the corresponding period of the previous fiscal year. This decrease inwith cash required for investing activities was due primarily to a note receivable for $80,000 coupled with corporate office remodeling costs incurred during the corresponding period of the previous fiscal year. Cash provided by financingoperating activities was $3,402,448 for the year ended May 31, 2002 compared to $3,696,845 for the corresponding period of the previous fiscal year. This decrease was primarily the result of a smaller need for cash as a result of cost cutting programs during the current fiscal period. We estimate our current cash requirements to sustain our operations for the next twelve months through May 2003 to be $2.4 million. Since we are attempting to sell the communications product line, we are assuming that there will be no communications product revenue. We have a note payable to Swartz of $635,276 at May 31, 2002 which is due in October 2002. We also have a convertible debenture with one investor as of May 31, 2002 of $225,000 and have received advances against additional convertible dentures of $283,000. In addition to limitations based on trading volume and market price of the common stock, our ability to obtain equity financing under the $25 million equity line of credit (see Note 7 to the consolidated financial statements) is dependent on our having registered shares of our common stock to sell to Swartz Private Equity, LLC (“Swartz”). As of May 31, 2002, we do not have any registered shares to sell to Swartz. Subsequent to May 31, 2002, we completed the first funding of the convertible debentures by receiving an additional $492,000. At the option of the debenture holders, they may purchase additional debentures up to $1 million at any time during the next two years as long as the price of our common stock is in excess of $0.20 per share. The terms of the $25 million equity line of credit, including limitations on the amount of shares that can be sold to Swartz based on the trading volume and market price of the common stock and the potential additional amounts that may be raised under the convertible debentures may not provide funds sufficient to meet our cash requirements. In order to meet our cash requirements, we may need to receive additional advances from Swartz, secure short-term debt, private placement debt and/or equity financings with individual or institutional investors. In addition to the cost reduction plan implemented during the current fiscal year, including the reduction in personnel, we may need to make additional cost reductions if our cash requirements cannot be met from external sources. We expect that the $2.4 million requirement will be provided by:•the additional funds received subsequent to May 31, 2002, related to the convertible debentures of $492,000;•optional amounts which may received under the convertible debentures of $1,000,000;•additional funds under the $25 million equity line of credit if we are successful in registering additional shares of common stock, limitations based on trading volume and market price of the common stock allow adequate funding, and such available funding exceeds the remaining balance of the note payable to Swartz;•proceeds from the exercise of outstanding stock options and warrants; and•additional debt and/or equity financings.In addition, we have formulated additional cost reduction plans which can be implemented if the required funds are not obtainable. We also have remaining a $400,000 accounts receivable factoring agreement with our bank; however, we have no eligible accounts receivable to factor as of May 31, 2002.20 We anticipate our future revenue to be derived primarily from the sale of licenses and royalties. To receive this revenue, we may require additional equipment, fabrication, components and supplies during the next twelve months to support potential customer requirements and further develop our technologies. Product introductions such as those currently underway for the Ignite I and JUICEtechnology may require significant product launch, marketing personnel and other expenditures that cannot be currently estimated. Further, if expanded development is commenced or new generations of microprocessor technology are accelerated beyond current plans, additional expenditures we cannot currently estimate, may be required. It is possible therefore, that higher levels of expenditures may be required than we currently contemplate resulting from changes in development plans or as required to support new developments or commercialization activities or otherwise. Based on our current plan and assumptions, we anticipate that we will be able to meet our cash requirements for the next twelve months. We anticipate meeting our cash needs as follows: Cash available: Cash available at May 31, 2002 $ 88,108 Subsequent advances Additional amounts under convertible debentures received subsequent to May 31, 2002 492,000 Optional amounts under convertible debentures 1,000,000 Available cash under existing agreements 1,580,108 Cash needs: Estimated needs 2,400,000 Note payable to Swartz at November 5, 2002 635,276 Total 3,035,276 Required funds from external sources $ 1,455,168 As shown above, we need to obtain $3,035,276. Any additional funding under the existing $25 million equity line of credit is dependent on many factors. However, there can be no assurance that any funds required during the next twelve months or thereafter can be generated from sales of common stock under the existing $25 million equity line of credit or that we will be able to secure additional debt or equity financing. The lack of additional capital could force us to substantially curtail or cease operations and would, therefore, have a material adverse effect on our business. Further, there can be no assurance that we will be able to timely receive shareholder approval to increase the number of authorized shares or that required funds, if available, will be available on attractive terms or that they will not have a significantly dilutive effect on our existing shareholders. As such, there is substantial doubt about our ability to continue as a going concern. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from our possible inability to continue as a going concern.$25 Million Equity Line of CreditOverview.On September 17, 2001, we entered into an investment agreement with Swartz. The investment agreement entitles us to issue and sell our common stock to Swartz for up to an aggregate of $25 million from time to time during a three-year period following the effective date of the registration statement. This is also referred to as a put right. We filed a registration statement on Form S-1 on October 11, 2001 that was declared effective on November 5,212001 for 15,000,000 shares of our common stock which we issued to Swartz during the fiscal year ended May 31, 2002. There remains2006 of approximately $24 million available under this line conditioned on us filing one or more additional registration statements. As$6,474,000. The principal components of August 1, 2002,the current year amount were: net income of approximately $9,388,000 adjusted for: minority interest in SSDI of approximately $115,000, non-cash charges of approximately $510,000 related to issuance and vesting of stock options and warrants. These increases were partially offset by: the equity in earnings of our investees of approximately $19,918,000, change in deferred taxes of approximately $9,937,000, and a decrease in trade payables and accrued expenses of approximately $1,091,000 primarily due to our accrual of royalties payable at May 31, 2007 of which we have not filedno obligation at May 31, 2008. The cash provided by operating activities during fiscal year 2006 was primarily due to our one-time license of $10,000,000 from Intel Corporation.statement requestingreduction in distributions from PDS of approximately $29,746,000 from fiscal year 2007 as compared to fiscal year 2008. Additionally we used approximately $8,849,000 of cash in net purchases of investments.registrationfiscal year ended May 31, 2007 from approximately $21,121,000 for the fiscal year ended May 31, 2006. The increase was primarily due to distributions of additional shares to put to Swartz under the $25 million equityapproximately $50,034,000 we received from our investment in an affiliate offset by cash used of approximately $830,000 in net purchases of short-term investments and an issuance of a line of credit.Put Rights.In ordercredit of approximately $590,000 to invoke a put right, we must have an effective registration statement on file with the SEC registering the resale of the common shares which may be issued as a consequence of the invocation of that put right. Additionally, we must give at least ten but not more than twenty business days advance notice to Swartz of the date on which we intend to exercise a particular put right, and we must indicate the number of shares of common stock we intend to sell to Swartz. At our option, we may also designate a maximum dollar amount of common stock (not to exceed $3 million) which we will sell to Swartz during the put and/or a minimum purchase price per common share at which Swartz may purchase shares during the put. The number of common shares sold to Swartz may not exceed 20% of the aggregate daily reported trading volume during each of two consecutive ten business day periods beginning on the business day immediately following the day we invoked the put right. The price Swartz will pay for each share of common stock soldHolocom Networks, Inc.a put is equal to the lesser of (i) the market price for each of the two consecutive ten business day periods beginning on the business day immediately following the day we invoked the put right minus $0.10, or (ii) X percent of the market price for each of the two ten day periods, where, X is equal to 90% if the market price is below $2.00 and 93% if market price is equal to or greater than $2.00. Market price is defined as the lowest closing bid pricefinancing activities for the common stock during eachfiscal year ended May 31, 2008 was approximately $6,647,000 as compared to cash used in financing activities of approximately $16,757,000 for the two consecutive ten business day periods. However, the purchase price may not be less than the designated minimum per share price, if any, that we indicatedfiscal year ended May 31, 2007. Cash used in our notice. We issuedfiscal year 2008 consisted primarily of approximately $2,761,000 to Swartz a commitment warrantrepurchase warrants from an investor and approximately $3,891,000 used to purchase up to 900,000repurchase shares of our common stock concurrent withfor treasury. The cash used in fiscal year 2008 was partially offset by proceeds received of approximately $31,000 from the execution of the investment agreement. This warrant is exercisable through September 17, 2006 at an initial exercise price of $0.22. The commitment warrant exercise price is subject to being reset on each six month anniversary of its issuance.Limitations and Conditions Precedent to Our Put Rights.We may not initiate a put if, as of the proposed date of such put:•we have issued shares of our common stock that have been paid for by Swartz and the amount of proceeds we have received is equal to the maximum offering amount;•the registration statement covering the resale of the shares becomes ineffective or unavailable for use;•our common stock is not actively trading on the OTC Bulletin Board, the Nasdaq Small Cap Market, the Nasdaq National Market, the American Stock Exchange, or the New York Stock Exchange, or is suspended or delisted with respect to the trading on such market or exchange. If any of the following events occur during the pricing period for a put, the volume accrual shall cease. For the put, the pricing period shall be adjusted to end 10 business days after the date that we notify Swartz of the event, and any minimum price per share we specified shall not apply to the put:•we have announced or implemented a stock split or combination of our common stock between the advanced put notice date and the end of the pricing period;•we have paid a common stock dividend or made any other distribution of our common stock between the advanced put notice date and the end of the pricing period;•we have made a distribution to the holders of our common stock or of all or any portion of our assets or evidences of indebtedness between the put notice date and the end of the pricing period;•we have consummated a major transaction (including a transaction, which constitutes a change of control) between the advance put notice date and the end of the pricing period, the registration statement covering the resale of the shares becomes ineffective or unavailable for use, or our stock becomes delisted for trading on our then primary exchange; or22we discover the existence of facts that cause us to believe that the registration statement contains an untrue statement or omits to state a material fact.Short Sales.Swartz and its affiliates are prohibited from engaging in short sales of our common stock unless they have received a put notice and the amount of shares involved in a short sale does not exceed the number of shares specified in the put notice.Shareholder Approval.We may currently issue more than 20% of our outstanding shares under the investment agreement. If we become listed on the Nasdaq Small Cap Market or Nasdaq National Market, then we must get shareholder approval to issue more than 20% of our outstanding shares. Since we are currently a bulletin board company, we do not need shareholder approval.Termination of Investment Agreement.We may also terminate our right to initiate further puts or terminate the investment agreement by providing Swartz with notice of such intention to terminate; however, any such termination will not affect any other rights or obligations we have concerning the investment agreement or any related agreement.Restrictive Covenants.During the term of the investment agreement and for a period of two months thereafter, we are prohibited from certain transactions. These include the issuance of any debt or equity securities in a private transaction which are convertible or exercisable into shares of common stock at a price based on the trading priceoptions and warrants. Cash used in financing activities in fiscal year 2007 consisted primarily of theapproximately $8,115,000 in cash dividends to common stock at any time after the initial issuance of such securities or with a fixed conversion or exercise price subjectshareholders and approximately $8,832,000 used to adjustment without obtaining Swartz’s prior written approval.Right of First Refusal.Swartz has a right of first refusal to purchase any variable priced securities offered by us in any private transaction which closes on or prior to two months after the termination of the investment agreement and a right of participation for any equity securities offered by us in any private transaction which closes on or prior to two months after the termination of the investment agreement.Swartz’s Right of Indemnification.We are obligated to indemnify Swartz (including their stockholders, officers, directors, employees and agents) from all liability and losses resulting from any misrepresentations or breaches we made in connection with the investment agreement, our registration rights agreement, other related agreements, or the registration statement.Waiver and Agreement.On March 12, 2002, we entered into an amended waiver and agreement with Swartz which replaced and superseded all previous waivers and agreements. This amended waiver and agreement extended the time of the put beyond twenty days and redefined the price of the put to be the lesser of the factor of (a) the volume weighted average price per share, as defined by Bloomberg L.P., for each day of the put multiplied by .70 or (b) the volume weighted average price per share minus $0.05 multiplied by 20% of the acceptable daily volume as defined in the waiver. At the discretion of Swartz, the 20% daily volume limitation could be increased up to 30% of the daily volume. In addition, the amended waiver and agreement increased the intended put share amount for the first put to 14,100,000 shares, which is the total number of shares we had registered so far under the $25 million equity line of credit. On May 30, 2002 we closed the first put under the $25 million equity line of credit by applying the proceeds of $926,924 to the secured note payable discussed below.Warrants.In connection with closing the $25 million equity line of credit, we issued to Swartz a commitment warrant to purchase 900,000repurchase shares of our common stock as discussed furtherfor treasury.Note 7 tofinancing activities for the consolidated financial statements. This warrant was valued on the issuance date using the Black-Scholes pricing model and the value was recorded as a debt discount.Secured Note Payable On March 12, 2002, we replaced and superceded a previously issued Secured Promissory Note with Swartz with an Amended Secured Promissory Note and Agreement with an effective date of October 9, 2001 and an Addendum to Amended Secured Promissory Note dated March 12, 2002. The amended note matures on October 9, 2002 and amounts outstanding under the note bear interest at the rate of 5% per annum. Upon mutual agreement between Swartz23and ourselves, Swartz may advance additional amounts under the amended note. Per the addendum to the amended note, principal and interest payments are deferred until October 9, 2002. As part of the consideration for entering into the above amended note, we agreed to issue warrants to Swartz related to each advance against the note. In connection with each advance, we issued to Swartz a warrant to purchase a number of shares of common stock equal to the amount of the advance multiplied by 8.25 at an initial exercise price equal to the lesser of (a) the factor of the average of the volume weighted average price per share, as defined by Bloomberg L.P., for each trading day in the period beginning on the date of the previous advance and ending on the trading day immediately preceding the date of the current advance multiplied by .70 or (b) the volume weighted average price per share minus $0.05. In addition, if after March 12, 2002, we issue common stock to any parties other than Swartz, we are obligated to issue to Swartz warrants equal to 20% of the common stock so issued. The amended note also gives to Swartz the right of first refusal and rights to participate in subsequent debt or equity transactions entered into by us through March 15, 2003. As offiscal year ended May 31, 2002 we issued warrants2007 was approximately $16,757,000 as compared to purchase upapproximately $24,202,000 for the fiscal year ended May 31, 2006 primarily due to 12,188,150payments of approximately $8,115,000 in cash dividends to our common shareholders and qualifying warrant holders for fiscal year 2007 as compared to approximately $24,698,000 in cash dividends paid for fiscal year 2006, and approximately $8,832,000 paid to repurchase shares of our common stock for treasury in accordance withfiscal year 2007. The cash used in fiscal 2007 was partially offset by cash received of approximately $214,000 from the amended note agreement. The warrants issued were valued using the Black-Scholes pricing model based on the expected fair value at issuanceexercise of common stock options and the estimated fair value was also recordedwarrants. debt discount. See Note 7 to the consolidated financial statements for discussion of the terms of the warrants The note is secured by our assets. All debt discounts are to be amortized as additional interest expense over the projected term of the note payable. As of May 31, 2002, $1,107,238 has been reflected as debt discount of which $917,722 was amortized2008 is expected to interest expense duringprovide the funds necessary to support our operations through the fiscal year ended May 31, 2002. Advances against the note $ 1,790,000 Less amount applied against $30 million equity line of credit (227,800 ) Less amount applied against $25 million equity line of credit (926,924 ) Less debt discount Total 1,107,238 Amount amortized to expense (917,722 ) (189,516 ) Note payable at May 31, 2002 $ 445,760 On November 9, 2001, an offset of $227,800 from2009.sale of 2,500,000 shares of common stock was applied against the final put under the $30 million equity line of credit discussed below.funds necessary for our operations. The excess of the market value of the underlying 2,500,000 shares of common stock over the principal reduction of $227,800 was recorded as additional interest expense of $197,250 during the year ended May 31, 2002. On May 30, 2002, an offset of $926,924 from the sale of 14,100,000 shares of common stock was applied against the first put under the $25 million equity line of credit discussed below. The excess of the market value of the underlying 14,100,000 shares of common stock over the principal reduction of $926,924 was recorded as additional interest expense of $201,076 during the year ended May 31, 2002.8% Convertible DebenturesOverview.From April 23, 2002 through June 10, 2002, we sold an aggregate of $1,000,000 of 8% convertible debentures to a group of six investors. The initial funding of $225,000 was completed on April 23, 2002 and we received additional advances of $283,000 as of May 31, 2002 towards the $775,000 closing on June 10, 2002. The convertible debentures entitle the debenture holder to convert the principal and unpaid accrued interest into our common stock through June 10, 2004. In addition, the debenture holder received warrants exercisable into a number of our common shares.Initial Number of Shares Debentures May Be Converted Into.The $225,000 debenture can be converted into a number of our common shares at a conversion price that initially equals $0.10289 per share and the $775,000 debenture can be converted into a number of our common shares at a conversion price that initially equals $0.086 per share.24Resets of Conversion Price and Conversion Shares.A reset date occurs on each three month anniversary of the closing date of each debenture and on the date the registration statement filed in June 2002 becomes effective. If the volume weighted average price for our common stock for the ten days previous to the reset date is less than the conversion price in effect at the time of the reset date, then the number of common shares issuable to the selling shareholder on conversion will be increased. If the conversion price is reset, the debenture can be converted into a number of our common shares based on the following calculation: the amount of the debenture plus any unpaid accrued interest divided by the reset conversion price which shall equal the volume weighted average price for our common stock for the ten days previous to the reset date.Warrants.Concurrent with the issuance of the convertible debentures, we issued to the debenture holders warrants to purchase up to 12,859,175 shares of our common stock. These warrants are exercisable for five years from the date of issuance at initial exercise prices equal to 115% of the volume weighted average price for our common stock for the ten days previous to the debenture date. The warrant exercise price is subject to being reset on each six month anniversary of its issuance.Options to Purchase Additional Debentures.Subject to the price of our common stock being equal to or greater than $0.20 per share and a two year limitation, the debenture holders may purchase additional debentures equal to the value of their initial debentures. The price at which the optional additional debentures could be converted would initially equal 115% of the volume weighted average price for our common stock for the ten days previous to the date on which the optional additional debentures were closed. The optional additional debentures would carry the same warrant amounts and reset privileges as the initial debentures.Shareholder Approval.We may currently issue more than 20% of our outstanding shares under the convertible debentures. If we become listed on the NASDAQ Small Cap Market or Nasdaq National Market, then we must get shareholder approval to issue more than 20% of our outstanding shares. Since we are currently a bulletin board company, we do not need shareholder approval.Restrictive Covenants.For a period of 18 months from the date of the debentures, we are prohibited from certain transactions. These include the issuance of any debt or equity securities in a private transaction which are convertible or exercisable into shares of common stock at a price based on the trading price of the common stock at any time after the initial issuance of such securities; the issuance of any debt or equity securities with a fixed conversion or exercise price subject to adjustment; and any private equity line type agreements without obtaining the debenture holders’ prior written approval.Right of First Refusal.The debenture holders have a right of first refusal to purchase or participate in any equity securities offered by us in any private transaction which closes on or prior to the date that is two years after the issue date of each debenture. As of May 31, 2002 we issued warrants to purchase up to 2,514,809 shares of our common stock outstanding increased from 171,156,363 at May 31, 2004 to 366,199,765 at May 31, 2006, largely as a result of financing activities including sales of common stock, the issuance of convertible debentures and notes payable and related conversions and exercises of common stock warrants. Beginning in accordance withfiscal year 2006, we were able to finance operations utilizing distributions we received from PDS. As we pursue our investment and acquisition strategy, we may use a combination of cash, debt, and common stock to finance these efforts. Operating leases - facilities $ 192,423 $ 192,423 convertible debenture. The warrantsFASB issued were valued usingInterpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (“FIN 48”). This interpretation clarifies the Black-Scholes pricing model based onapplication of SFAS No. 109, Accounting for Income Taxes, by defining criteria that an individual tax position must meet for any part of the expected fair value at issuance and the estimated fair value was also recorded as debt discount. See Note 7benefit of that position to the consolidatedbe recognized in a company’s financial statements for discussion of the terms of the warrants. All debt discounts are to be amortized as additionaland also provides guidance on measurement, derecognition, classification, interest expense over the projected term of the convertible debenture. As of May 31, 2002, $201,185 has been reflected as debt discount of which $8,383 was amortized to interest expense during the year ended May 31, 2002. The convertible debenture is secured by our assets.25 Convertible debenture dated April 23, 2002 $ 225,000 Advances against convertible debenture dated June 10, 2002 as of May 31, 2002 283,000 Less debt discount Total 201,185 Amount amortized to expense ( 8,383 ) (192,802 ) Convertible debenture at May 31, 2002 $ 315,198 New Accounting Pronouncements In June 1998, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” amended by SFAS No. 137, “Accounting for Derivative Instrumentspenalties, accounting in interim periods, disclosure and Hedging Activities- Deferral of the Effective Date of FASB No. 133,” and SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities” which requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair market value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. The key criterion for hedge accounting is that the hedging relationship must be highly effective in achieving offsetting changes in fair value or cash flows. SFAS No. 133 was effective for ustransition. We adopted FIN 48 on June 1, 2001. The adoption2007 and did not record any cumulative effect adjustment to retained earnings as a result of this statement had no material impact on our financial statements.June 2001,September 2006, the FASB issued SFAS No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets”157, Fair Value Measurements. SFAS No. 141 requires157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principals and expands disclosures about fair value measurements. The statement does not require new fair value measurements, but is applied to the extent that other accounting pronouncements require or permit fair value measurements. The statement emphasizes that fair value is a market-based measurement that should be determined based on the assumptions that market participants would use in pricing an asset or liability. Companies that have assets and liabilities measured at fair value will be required to disclose information that enables the users of its financial statements to access the inputs used to develop those measurements. The reporting entity is encouraged, but not required, to combine the fair value information disclosed under this statement with the fair value information disclosed under other accounting pronouncements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We expect to adopt SFAS No. 157 on June 1, 2008. In February 2008, the FASB released FASB Staff Position 157-2, Effective Date of FASB Statement No. 157, which delayed the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) until the fiscal year beginning May 31, 2009. We are in the process of evaluating the provisions of the purchase method of accounting and prohibitsstatement, but do not anticipate that the use of the pooling-of-interests method of accounting for business combinations initiated after June 30, 2001. SFAS No. 141 also requires that companies recognize acquired intangible assets apart from goodwill if the acquired intangible assets meet certain criteria. SFAS No. 141 applies to all business combinations initiated after June 30, 2001 and for purchase business combinations completed on or after July 1, 2001. It also requires, upon adoption of SFAS No. 142, that companies reclassify157 will have a material impact on our consolidated financial statements.carrying amounts of intangible assets and goodwill based on the criteria inFASB issued SFAS No. 141.142 requires, among159 permits entities to choose to measure at fair value many financial instruments and certain other things,items that companies no longer amortize goodwill, but instead test goodwill for impairment at least annually. In addition, SFAS No. 142 requires that companies identify reporting units for the purposes of assessing potential future impairments of goodwill, reassess the useful lives of other existing recognized intangible assets, and cease amortization of intangible assets with an indefinite useful life. An intangible asset with an indefinite useful life should be tested for impairment in accordance with the guidance in SFAS No. 142. SFAS No.142 isare not currently required to be appliedmeasured at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value. SFAS No. 159 does not establish requirements for recognizing and measuring dividend income, interest income, or interest expense. This Statement does not eliminate disclosure requirements included in other accounting standards. SFAS No. 159 is effective in fiscal years beginning after November 15, 2007. We are in the process of evaluating the provisions of the statement, but do not anticipate that the adoption of SFAS No. 159 will have a material impact on our consolidated financial statements.20012008. We expect to all goodwill and other intangible assets recognized at that date, regardless of when those assets were initially recognized.adopt SFAS No. 142 requires companies to complete a transitional goodwill impairment test six months from141(R) on June 1, 2009. We are currently assessing the date of adoption. Companies are also required to reassess the useful lives of other intangible assets within the first interim quarter after adoption of SFAS No. 142. Upon the adoption of this statement no material impact on our financial statements is expected. Our previous business combinations were accounted for using the pooling-of-interests method. The pooling-of-interests method does not result in the recognition of acquired goodwill or other intangible assets. As a result, the adoption of SFAS No. 141 and No. 142141(R) will not affect the results of past acquisition transactions. However, all future business combinations will be accounted for under the purchase method, which may result in the recognition of goodwill and other intangible assets, some of which will be recognized through operations, either by amortization or impairment charges, in the future. We will be required to reassess the useful lives ofhave on our intangible assets within the first fiscal quarter of 2003.June 2001,December 2007, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.”160, Noncontrolling Interests in Consolidated Financial Statements. SFAS No. 143160 requires the fair value of a liability for an asset retirement obligationentities to be recognizedreport noncontrolling (minority) interests in subsidiaries as equity in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset.consolidated financial statements. SFAS No. 143160 is effective for the fiscal year ending May 31, 2003. Upon adoption of this statement no material impact on our financial statements is expected.26 In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 requires that those long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. Therefore, discontinued operations will no longer be measured at net realizable value or include amounts for operating losses that have not yet occurred. SFAS No. 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001 and, generally, is2008. We expect to be applied prospectively. The adoption of this statement mayadopt SFAS No. 160 on June 1, 2009. We are currently assessing the impact the presentation of information in our future financial statements. In April 2002, FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. This statement eliminates the current requirement that gains and losses on debt extinguishment must be classified as extraordinary items in the income statement. Instead, such gains and losses will be classified as extraordinary items only if they are deemed to be unusual and infrequent, in accordance with the current GAAP criteria for extraordinary classification. In addition, SFAS 145 eliminates an inconsistency in lease accounting by requiring that modifications of capital leases that result in reclassification as operating leases be accounted for consistent with sale-leaseback accounting rules. The statement also contains other nonsubstantive corrections to authoritative accounting literature. The changes related to the debt extinguishment will be effective for fiscal years beginning after May 15, 2002. Adoption of this standard will not have any effect on the Company’s consolidated financial statements. In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force (EITF) Issue No. 94-3. The Company will adopt the provisionsadoption of SFAS No. 146 for restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at the date of a company’s commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amount recognized. Adoption of this standard160 will not have any effect on the Company’sour consolidated financial statements.Tax Loss Carryforwards As of May 31, 2002, we had approximately $28,972,000 of tax loss carryforwards. A valuation allowance has been recorded for the net-deferred tax asset of $13,446,000 arising primarily from tax loss carryforwards because we cannot determine that it is more likely than not that the deferred tax asset will be realized. See Note 10 to the Consolidated Financial Statements.ItemDISCLOSUREDISCLOSURES ABOUT MARKET RISK We are exposed to interest on investments of our excess cash. preserve capital. To achieve this objectivemaintain surplus cash in accounts that provide a high level of funds accessibility in large, respected financial institutions with asset safety as a primary consideration. Accordingly, we maintain our cash and minimizecash equivalents with high quality financial institutions. Amounts deposited with these institutions may exceed federal depository insurance limits.due to adverse shiftsmarket risk for changes in interest rates we invest from timerelates primarily to time inour auction rate securities. During the quarter ended February 29, 2008, investment banks were reporting an inability to successfully obtain subscribers for high credit quality short-term maturity commercial paper and money market funds operated by reputable financial institutions in the United States. Due to the nature of our investments, we believe that we do not have a material interestauction rate exposure.2002,2008, we held such auction rate securities with a par value totaling $12.9 million that failed to sell at auction. In the event we need to access funds invested in these auction rate securities we will not be able to liquidate these securities until: a future auction of these securities is successful, they are refinanced and redeemed by the issuers, or a buyer is found outside of the auction process. The investments consist of student loan auction rate instruments issued by various state agencies pursuant to the Federal Family Educational Loan Program (“FFELP”). These investments are of high credit quality and the AAA credit ratings of the investments have been reaffirmed since May 2008. These instruments are collateralized in excess of the underlying obligations, are insured by the various state educational agencies, and are guaranteed by the Department of Education as an insurer of last resort.notes payableauction rate securities was estimated at $12.5 million based on a valuation by Houlihan Smith & Company, Inc. We recorded the net temporary valuation adjustment of $220,617 in other comprehensive income, which represents the gross valuation adjustment of $372,325, net of the related tax benefit of $151,708. We have concluded that the unrealized losses on these investments are temporary because (i) we believe that the decline in market value and absence of liquidity that has occurred is due to corporationsgeneral market conditions, (ii) the auction rate securities continue to be of a high credit quality and individuals totaling $1.1 million boreinterest is paid as due and (iii) we have the intent and ability to hold these investments until a recovery in market value occurs. Since this valuation adjustment is deemed to be temporary, it did not affect our earnings for the fiscal year ended May 31, 2008.fixed rates of 5% to 8%. Our capital lease obligation totaling $21,847 is discounted at a fixedthe federal funds rate of interest of 22.7%plus 3%.ItemDATA. The following table presents selected unaudited quarterly information for fiscal 2002 and 200127 First Second Third Fourth Quarter Quarter Quarter Quarter Fiscal 2002: Total revenues $ 314,500 $ 7,389 $ 4,620 $ 32,300 Operating loss (1,039,217 ) (1,292,564 ) (964,703 ) (819,687 ) Net loss (1,046,970 ) (1,558,602 ) (1,260,676 ) (1,620,803 ) Net loss per basic and diluted share $ (0.02 ) $ (0.02 ) $ (0.02 ) $ (0.02 ) Fiscal 2001: Total revenues $ 119,101 $ 57,623 $ 66,045 $ 94,615 Operating loss (900,412 ) (1,202,001 ) (1,365,203 ) (1,546,332 ) Net loss (886,540 ) (1,186,663 ) (1,352,694 ) (1,543,006 ) Net loss per basic and diluted share $ (0.02 ) $ (0.02 ) $ (0.03 ) $ (0.02 ) Also see Part IV, Item 14(a).Item Effective May 20, 2002,client-auditor relationship between Patriot Scientific Corporation (the “Company”)our reports is recorded, processed, summarized and BDO Seidman, LLP (“BDO”) ceased. The Company dismissed BDO on May 20, 2002 as partreported within the time periods specified in the rules and forms of its cost reduction program which was initiated earlier in this fiscal year. The change in certifying accountants was approved by the Company’s board of directors. BDO’s reports on the consolidated financial statements of the Company for each of the past two years did not contain an adverse opinion or a disclaimer of opinion, or was qualified as to any uncertainty in audit scope or accounting principle; however the audit opinion of BDO on the Company’s most recent consolidated financial statements as of and for the period ending May 31, 2001 was modified to include an explanatory paragraph which contained a statement that the Company’s recurring losses from operations and negative cash flows raised substantial doubt about the Company’s ability to continue as a going concern. During the two years ended May 31, 2001 and the subsequent interim periods preceding the date of the dismissal of BDO on May 20, 2002, there were no disagreements with BDO on any matters of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreement(s), if not resolved to the satisfaction of BDO, would have caused the former accountant to make a reference to the subject matter of the disagreement(s) in connection with its reports covering such periods. During the two years ended May 31, 2001 and the subsequent interim periods preceding the date of the dismissal of BDO on May 20, 2002, there were no “reportable events” (hereinafter defined) requiring disclosure pursuant to Item 304 (a) (1) (v) of Regulation S-K. As used herein, the term “reportable events” means any of the items listed in paragraphs (a) (1) (v) (A) — (D) of Item 304 of Regulation S-K. Effective May 20, 2002, the Company engaged Nation Smith Hermes Diamond, a professional corporation, which is a member of the BDO Seidman Alliance (“Nation”) , as its independent accountants. During the two years ended May 31, 2001 and the subsequent interim periods preceding the effective date of the engagement of May 20,282002, neither the Company nor anyone on its behalf consulted Nation regarding either the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on the Company’s consolidated financial statements, nor has Nation provided to the Company a written report or oral advice regarding such principles or audit opinion. The Company requested that BDO furnish it with a letter addressed to the Securities and Exchange Commission stating whether or not it agrees with the above statements. A copy of the letter from BDO dated June 4, 2002 was filed as Exhibit 16.1and is accumulated and communicated to the Form 8-K/A filed June 5, 2002.PART IIIItem 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The following table and biographical summaries set forth information,our management, including principal occupation and business experience, about our directors and the executive officers at August 1, 2002:NameAgePosition and OfficesDirector SinceDonald R. Bernier60Chairman and DirectorJanuary 1995David H. Pohl65DirectorApril 2001Jeffrey Wallin54President and CEOn/aLowell W. Giffhorn55Executive Vice President, CFO, Secretary and DirectorAugust 1999Carlton M. Johnson, Jr.42DirectorAugust 2001Helmut Falk, Jr.46DirectorDecember 1997Joey Maitra52Vice President Engineeringn/aPatrick Nunally38Vice President and CTOn/aBiographical InformationDonald R. Bernier.Mr. Bernier was appointed Chairman of the Board on August 5, 2001. Since 1971, Mr. Bernier has been the owner and President of Compunetics Incorporated, a Troy, Michigan-based electronics firm of which he is the founder. Compunetics engages in contract research and development, specializing in microelectronics primarily for the automotive industry.David H. Pohl.Mr. Pohl has served on our board of directors since April 2001, and served as an officer of the Company from January 2001 to March 2002. Except for his service with PTSC, Mr. Pohl has been in the private practice of law counseling business clients since 1997, and from 1995 to 1996 was Special Counsel to the Ohio Attorney General. Previously, he was a senior attorney with a large U.S. law firm, and held positions as a senior officer and general counsel in large financial services corporations. Mr. Pohl earned a J.D. degree in 1962 from the Ohio State University College of Law, and also holds a BS in Administrative Sciences from Ohio State.Jeffrey E. Wallin.Mr. Wallin has served as our Chief Executive Officer and President since March 2002. Since 1999, Mr. WallinChief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating these controls and procedures, our management recognizes that any system of controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired objectives and necessarily applies judgment in evaluating the cost-benefit relationship of other possible controls and procedures. In addition, we consolidate SSDI, a variable interest entity as defined in Financial Accounting Standards Board Interpretation (“FIN”) No. 46(R), Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 (“FIN 46(R)”), that we do not control or manage and consequently, our disclosure controls and procedures with respect to this entity are necessarily limited to oversight or monitoring controls that we have implemented to provide reasonable assurance that the objectives of our disclosure controls and procedures as described above are met.presidentnot effective as of SDMCMay 31, 2008.· There is no IT security policy, · There is no change management policy, · There is no evidence of changes which have been performed, · There is no physical security over servers, firewall, router and switches, · There is no documentation of the granting of user access rights process, · There is no documentation of the user access termination process, · The firewall configuration does not reflect SSDI’s current usage, · Remote access is not well controlled, · Two of five systems did not have recent antivirus signature files, · The antivirus software is not installed on the server, · All named users, plus the CIO using the administrator account, have full access to all areas of QuickBooks, · All authenticated users are allowed full access to the files in the Finance directory, · The domain administrator list is not limited to the minimum appropriate personnel, · Passwords are only required to be five characters which is deemed insufficient for good security, · There is no evidence of the CIO’s weekly backup review occurring, and management is not being notified of failures, · There are no stored backup tapes off-site or in a media safe, and · There are no regularly run test restorations. consulting company servingconsolidated variable interest entity. (collectively, the multimedia system integration"Company") as of May 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). The Company's management is responsible for maintaining effective internal control over financial reporting and communications markets. From 1996for its assessment of the effectiveness of internal control over financial reporting , included in the accompanying Management's Report on Internal Control over Financial Reporting included in Item 9A. Our responsibility is to 1999, Mr. Wallin was President and CEO of TV/COM International, a division of Hyundai that developed and manufactured end-to-end digital communications systems. Previously Mr. Wallin held senior level management positions with Snell & Wilcox, General Instrument, now a major division of Motorola, and Teledyne Corporation. Mr. Wallin obtained a B.S. degree from Bemidji State University in 1970.Lowell W. Giffhorn.Mr. Giffhorn wasexpress an opinion on the principal in his ownCompany's internal control over financial management consulting firm from August 1996 until joining Patriot as Chief Financial Officer (CFO) in May 1997. Mr. Giffhorn has servedreporting based on our boardaudit.directors since August 1999. From June 1992the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to August 1996obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and from September 1987evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.June 1990 he wasprovide reasonable assurance regarding the CFOreliability of Sym-Tek Systems, Inc.financial reporting and Vice Presidentthe preparation of Financefinancial statements for its successor, Sym-Tek Inc., a major supplierexternal purposes in accordance with accounting principles generally accepted in the United States of capital equipmentAmerica. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the semiconductor industry. Mr. Giffhorn obtained a M.B.A. degree from National Universitymaintenance of records that, in 1975reasonable detail, accurately and he obtained a B.S.fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in Accountancy from the University of Illinois in 1969.29Carlton M. Johnson, Jr.Mr. Johnson was appointed a Director on August 5, 2001. Mr. Johnson is in-house legal counsel for Swartz Investments, LLC, a position he has held since June 1996. Mr. Johnson has practiced law in Alabama since 1986, Florida since 1988, and Georgia since 1997. He has been a shareholderaccordance with accounting principles generally accepted in the Pensacola, Florida AV rated law firmUnited States of Smith, Sauer, DeMaria & JohnsonAmerica, and as President-Electthat receipts and expenditures of the 500 member Escambia-Santa Rosa Bar Association. He also servedcompany are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the Florida Bar Young Lawyers Division Boardfinancial statements.Governors. Mr. Johnson earned a degree in History/Political Science at Auburn University and Juris Doctor at Samford University — Cumberland Schoolits inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of Law.Helmut Falk, Jr.Since 1992, Dr. Falk has been the Directorany evaluation of Anesthesia for the Johnson Memorial Hospital in Franklin, Indiana. Dr. Falk received his D.O. from the College of Osteopathic Medicine of the Pacific in 1987 and his B.S. in Biology from the University of California, Irvine in 1983. Dr. Falk is the son of the late Helmut Falk, who was the sole shareholder of nanoTronics and the Chairman and CEO of Patriot until his death in July 1995. Dr. Falk is also an heireffectiveness to future periods are subject to the Helmut Falk Estate, whichrisk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.the beneficial ownera control deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s shares held byannual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in management’s assessment:· There is no IT security policy, · There is no change management policy, · There is no evidence of changes which have been performed, · There is no physical security over servers, firewall, router and switches, · There is no documentation of the granting of user access rights process, · There is no documentation of the user access termination process, · The firewall configuration does not reflect SSDI’s current usage, · Remote access is not well controlled, · Two of five systems did not have recent antivirus signature files, · The antivirus software is not installed on the server, · All named users, plus the CIO using the administrator account, have full access to all areas of QuickBooks, · All authenticated users are allowed full access to the files in the Finance directory, · The domain administrator list is not limited to the minimum appropriate personnel, · Passwords are only required to be five characters which is deemed insufficient for good security, · There is no evidence of the CIO’s weekly backup review occurring, and management is not being notified of failures, · There are no stored backup tapes off-site or in a media safe, and · There are no regularly run test restorations. Helmut Falk Family Trust.Patrick O. Nunally.Dr. Nunally joined useffect of the material weakness described above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as Vice President of Business Development and Chief Technical OfficerMay 31, 2008, based on the COSO criteria.June 2001, previous to which he had been providing consulting services to us since May 2000. Dr. Nunally has more than 20 yearsaccordance with the standards of entrepreneurial experience in semiconductor and embedded processor design. From December 1998 to May 2000, he was President and CEO of Intertech, a company he founded specializing in intellectual property development for embedded processor and communications systems. From June 1998 to December 1998, he was President and CEO of Gruppe Telekom, Inc.the Public Company Accounting Oversight Board (United States), a licensee of Interactive Video and Data Service Spectrum. From April 1996 to June 1998, he served as Chief Technical Officer and co-founder of Aristo, now PlayNet Inc., a Java-based games company. Dr. Nunally also held other senior management positions with Wave Interactive Network, Sensormatic Video Products Division, Intellisys Automation Inc., E-Metrics Inc., General Dynamics Corporation and Interstate Electronics. Dr. Nunally received his PhD in Electrical Engineering from the Pacific Western University in 1996, a MBA from the University of LaVerne in 1993 and a BS in Electrical and Electronics Engineering from California State Polytechnic University in 1987.Joey Maitra.Mr. Maitra was Vice President of Engineering for Metacomp since 1990 and was appointed Vice President of Engineeringconsolidated balance sheets of Patriot Scientific Corporation as of May 31, 2008 and 2007, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in December 1996 through February 2001. Mr. Maitrathe period ended May 31, 2008 and our report dated August 14, 2008 expressed an unqualified opinion on those consolidated financial statements and included an explanatory paragraph regarding the Company’s adoption of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, effective June 1, 2006.reappointed toconsidered in determining the same positionnature, timing, and extent of audit tests applied in November 2001. Previously Mr. Maitra held various engineering positionsour audit the 2008 consolidated financial statements, and this report does not affect our report dated August 14, 2008 on those consolidated financial statements. several computer related technology companies. Mr. Maitra obtained a B.S. in Electrical Engineering from the Indian Institute of Technology in 1972 and a M.S. in Electrical Sciences at State University of New York in 1973. There is no family relationship between any of our executive officers.Compliance With Section 16(a) Of The Exchange Actrequiresand Corporate Governance is incorporated by reference to the information contained in our directors, executive officers and persons who beneficially own 10% or more of a class of securities registered under Section 12 of the Exchange Act to file reports of beneficial ownership and changes in beneficial ownershipdefinitive proxy statement which will be filed with the Securities and Exchange Commission. Directors,Commission in connection with our 2008 Annual Meeting of Shareholders.officers and greater than 10% shareholders are required by the rules and regulationsofficer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. Our Code of the Commission to furnish us with copies of all reports filed by them in compliance with Section 16(a). Based solelyEthics is available on our review of copies of the reports we received from persons required to make such filings and our own records, we believe that from the period June 1, 2001 through May 31, 2002, all persons subject to the Section 16(a) reporting requirements timely filed the required reports.website at www.ptsc.com.Item There is shown belowconcerning the compensation of our chief executive officers and the most highly compensated executive officers whose salary and bonus exceeded $100,000 (each a “Named Officer”) for the fiscal years ended May 31, 2002, 2001, and 2000.30SUMMARY COMPENSATION TABLE Annual Cash Compensation Long-Term Compensation Name and Fiscal Repriced All Other Principal Position Year Salary Bonus (# of Shares) Options Compensation Richard G. Blum 2002 $ 34,062 (3) Nil None None None President and CEO (1) 2001 $ 128,862 (3) Nil 325,000 None None Don Bernier 2002 $ 7,500 (3) Nil 350,000 None None CEO (2) Jeff Wallin 2002 $ 68,800 (3) Nil 1,000,000 None None President and CEO (2) Lowell W. Giffhorn 2002 $ 139,908 (3) Nil 255,000 None None Exec. V.P., CFO and Secy 2001 $ 126,650 (3) Nil 125,000 None None 2000 $ 110,000 Nil None 300,000 None Joey Maitra 2002 $ 125,058 (3) Nil 335,000 None None VP Engineering 2001 $ 120,000 Nil None None None 2000 $ 120,000 Nil None 225,000 None Patrick O. Nunally 2002 $ 173,046 (3) Nil 250,000 None $ 105,000 (4) VP and CTO (1)Mr. Blum served as President and CEO from September 25, 2000 until August 5, 2001 when he was relieved of his duties. In September 2001, an action was filed against the Company in the Superior Court of San Diego County, California by Mr. Blum. He contends that he was wrongfully terminated on August 5, 2001 in violation of his employment agreement dated December 1, 2000. He seeks damages for the alleged breach of his employment agreement, age discrimination, as well as other related claims. Management denies the claims and contends it exercised its business judgement for legitimate nondiscriminatory reasons. The Company intends to vigorously defend its position in this case. In accordance with Mr. Blum’s employment agreement, the Company may be obligated to pay him between $0 and $400,000 as severance pay.(2)Mr. Bernier served as CEO from August 5, 2001 until March 18, 2002 when Mr. Wallin was appointed President and CEO under a contract entered into between the Company and SDMC, Inc.(3)Included in Mssr. Blum, Wallin, Giffhorn, Maitra and Nunally is cash compensation of $400 per month for car allowance.(4)Payments to Mr. Nunally for assignments to the Company of intellectual property rights. The Company maintains employee benefits that are generally available to all of its employees, including medical, dental and life insurance benefits and a 401(k) retirement savings plan. The Company did not make any matching contributions under the 401(k) plan for anyregarding Director Compensation, Report of the above named officers during the fiscal years ended May 31, 2002, 2001Compensation Committee, Compensation Discussion and 2000.Option Grants31 Shown belowAnalysis and Executive Compensation is information on grants of stock options pursuantincorporated by reference to the Company’s 1992, 1996 and 2001 Stock Option Plans to the Named Officers reflectedinformation contained in the Summary Compensation Table shown above.Option Grants Table for Fiscal Year Ended May 31, 2002 Potential Realizable Value Percent of Total of Assumed Annual Rates Options Granted of Stock Price Appreciation Number of to Employees in Exercise Expiration for Option Term (1) Name Options Granted Fiscal Year Price Date 5% ($) 10% ($) Jeffrey E. Wallin 1,000,000 24.1 % $ 0.090 4/8/2007 $ 24,865 $ 54,946 Lowell W. Giffhorn 255,000 6.2 % $ 0.110 11/1/2006 $ 7,750 $ 17,125 Joey Maitra 335,000 8.1 % $ 0.133 1/2/2007 $ 12,310 $ 27,201 Donald Bernier 350,000 8.4 % $ 0.110 11/1/2006 $ 10,637 $ 23,505 Patrick Nunally 250,000 6.0 % $ 0.110 11/1/2006 $ 7,598 $ 16,789 Richard Blum — — — — $ — $ — (1)These amounts represent certain assumed rates of appreciation only. Actual gains, if any, on stock option exercises are dependent upon the future performance of the company’s common stock, overall market conditions and the executive’s continued involvement with the company. The amounts represented in this table will not necessarily be achieved.Aggregated Option Exercises and Fiscal Year-End Option Values There were no exercises of stock options for the fiscal year ended May 31, 2002 by any of the officers reflected in the Summary Compensation Table shown above. Shown below is information on fiscal year-end values under the Company’s 1992, 1996 and 2001 Stock Option Plans to the officers reflected in the Summary Compensation Table shown above. Number of Unexercised Value of Unexercised Options Held At In-The-Money Options At May 31, 2002 May 31, 2002 Name Exercisable Unexercisable Exercisable Unexercisable Jeffrey E. Wallin 520,000 500,000 $ — $ — Lowell W. Giffhorn 133,333 246,667 $ — $ — Joey Maitra 210,000 150,000 $ — $ — Donald Bernier 150,000 275,000 $ — $ — Patrick Nunally 195,000 355,000 $ — $ — Richard Blum — — $ — $ — The fair market value of the unexercised in-the-money options at May 31, 2002 was determined by subtracting the option exercise price from the last sale price as reported on the over the counter bulletin board on May 31, 2002, $0.08.32 The Company has not awarded stock appreciation rights to any of its employees. The Company has no long-term incentive plans.Compensation of Directors No direct or indirect remuneration has been paid or is payable by us to the directors in their capacity as directors other than the granting of stock options. We expect that, during the next twelve months, we will not pay any direct or indirect remuneration to any directors of ours in their capacity as directors other than in the form of stock option grants or the reimbursement of expenses of attending directors’ or committee meetings.Employment Contracts The Company entered into a consulting agreement dated as of March 7, 2002, with SDMC, Inc. whereby SDMC would provide the services of Mr. Wallin to be the President and Chief Executive Officer. The agreement is for a term through March 18, 2004 providing for payments of $133,200 per annum. The agreement provides for a bonus up to 50% of the annual base consideration for the applicable year. The agreement also provides for potential bonuses to be paid based on the increase in the price of the Company’s common stock. Should the price of the common stock reach $0.25 for twenty consecutive days, SDMC would receive a cash payment of $10,000, $0.40- $20,000, $0.50- $20,000, $0.60- $30,000, $0.80- $30,000, $1.00- $50,000, $1.50- $100,000, and $2.00- $150,000. The Company may terminate SDMC’s agreement with or without cause, but termination without cause (other than disability or death) would result in severance payments equal to the lesser of (i) four months of the then current compensation or (ii) the balance remaining of the current compensation for the term of his agreement. If a change in control, as defined in the agreement, occurs during the term of his agreement, and if Mr. Wallin refuses to accept or voluntarily resigns from a position other than a qualified position, as that term is defined in the agreement, then SDMC will receive a lump sum severance payment equal to twelve months of the then current compensation. Under the agreement, the Company granted SDMC options to purchase 1,000,000 common shares, 500,000 vesting on March 7, 2002, 250,000 vesting on March 7, 2003 and 250,000 vesting on March 7, 2004. The Company also placed in escrow four months of payments which shall be released to SDMC on the termination of Mr. Wallin’s services for any reason other than cause or his resignation. The Company entered into an employment agreement dated as of November 17, 2001, with Mr. Giffhorn providing for his employment as Executive Vice President and Chief Financial Officer. The agreement is for a term through September 4, 2004 providing for a base salary of $144,000 per annum. The base salary may be increased at the discretion of the Board of Directors. The agreement provides for a bonus up to 50% of the annual base salary for the applicable year. The agreement also provides Mr. Giffhorn a monthly car allowance of $400. The Company may terminate Mr.Giffhorn’s employment with or without cause, but termination without cause (other than disability or death) would result in severance payments equal to the lesser of (i) four months of the then current base salary or (ii) the balance remaining of the current base salary for the term of his agreement. If a change in control, as defined in the agreement, occurs during the term of his agreement, and if Mr. Giffhorn refuses to accept or voluntarily resigns from a position other than a qualified position, as that term is defined in the agreement, then he will receive a lump sum severance payment equal to twelve months of his then current salary. The Company entered into an employment agreement dated as of December 20, 2001, with Mr. Maitra providing for his employment as Vice President of Engineering. The agreement is for a term through January 2, 2003 providing for a base salary initially of $120,000 per annum which was increased to $126,000 in April 2002. The base salary may be increased at the discretion of the Board of Directors. The agreement provides for a bonus up to 50% of the annual base salary for the applicable year. The agreement also provides Mr. Maitra a monthly car allowance of $400. The Company may terminate Mr.Maitra’s employment with or without cause, but termination without cause (other than disability or death) would result in severance payments equal to the lesser of (i) four months of the then current base salary or (ii) the balance remaining of the current base salary for the term of his agreement. If a change in control, as defined in the agreement, occurs during the term of his agreement, and if Mr. Maitra refuses to accept or voluntarily resigns from a position other than a qualified position, as that term is defined in the agreement, then he will receive a lump sum severance payment equal to twelve months of his then current salary. Under the agreement, the Company granted Mr. Maitra options to purchase 335,000 common shares, 185,000 vesting on January 2, 2002 and 150,000 vesting on January 2, 2003.33 The Company entered into a letter of intent dated May 31, 2001 with Dr. Nunally providing for his employment as the Chief Technical Officer of the Company. The terms of the letter provide for a base salary of $180,000 per annum. The letter provides for a bonus up to 50% of the annual base consideration for the applicable year. In addition, the letter provides for monthly payments of $4,500 for the purchase from Dr. Nunally of certain intellectual property assets and assignment of worldwide patent rights. On March 30, 2001, the Company entered into an agreement with Dr. Nunally providing for additional monthly payments of $3,000 for additional intellectual property assets. Mr. Giffhorn was an executive officer and a member of the compensation committee during the fiscal year ended May 31, 2001. Subsequent to May 31, 2001, the entire Board of Directors has served as the compensation committee. Any actions effecting Mr. Giffhorn’s compensation or stock option grants during the period of time he served on the compensation committee were approved by the entire Board of Directors.our 2008 definitive proxy statement.Item The following table sets forth, as of August 23, 2002, the stock ownership of each officer and director of the Company, of all officers and directors of the Company as a group, and of each person known by the Company to be a beneficial owner of 5% or more of its Common Stock. Except as otherwise noted, each person listed below is the sole beneficial owner of the shares and has sole investment and voting power over such shares. No person listed below has any option, warrant or other right to acquire additional securities of the Company, except as otherwise noted. Name and Address Amount & Nature Title of Beneficial of Beneficial Percent of Class Owner Ownership of Class Common stock Gloria Felcyn, CPA 9,111,611 (1) 10.9 % par value $.00001 20440 Williams Ave Saratoga, California 95070 SAME Donald R. Bernier 375,000 (2) * 10989 Via Frontera San Diego, California 92127 SAME Helmut Falk, Jr 124,500 (3) * 10989 Via Frontera San Diego, California 92127 SAME Lowell W. Giffhorn 358,281 (4) * 10989 Via Frontera San Diego, California 92127 SAME SDMC, Inc 520,000 (5) * 10989 Via Frontera San Diego, California 92127 34 Name and Address Amount & Nature Title of Beneficial of Beneficial Percent of Class Owner Ownership of Class SAME David H. Pohl 325,000 (6) * 10989 Via Frontera San Diego, California 92127 SAME Patrick O. Nunally 207,000 (7) * 10989 Via Frontera San Diego, California 92127 SAME Joey Maitra 387,342 (8) * 10989 Via Frontera San Diego, California 92127 SAME Carlton M. Johnson, Jr 50,000 (9) * 10989 Via Frontera San Diego, California 92127 All directors & officers as a group (8 persons) 2,347,123 (10) 2.8 % *Less than 1%.1)As trustee of the Helmut Falk Family Trust and executor of the Helmut Falk estate, Ms. Felcyn effectively controls the shares which were subject to an escrow arrangement (as described in “Certain Transactions” below) originally issued to nanoTronics in connection with the ShBoom technology acquisition and shares that remain from 5,000,000 non-escrowed shares that were originally issued to nanoTronics in connection with the ShBoom technology acquisition and were subsequently transferred to the Helmut Falk Family Trust. Includes 2,495,388 shares that are issuable on the conversion of a 8% Convertible Debenture and the exercise of a warrant into shares of common stock.2)Includes 150,000 shares issuable upon the exercise of outstanding stock options.3)Includes 90,000 shares issuable upon the exercise of outstanding stock options.4)Includes 133,333 shares issuable upon the exercise of outstanding stock options.5)Includes 520,000 shares issuable upon the exercise of outstanding stock options.6)Includes 325,000 shares issuable upon the exercise of outstanding stock options.7)Includes 195,000 shares issuable upon the exercise of outstanding stock options.8)Includes 210,000 shares issuable upon the exercise of outstanding stock options.9)Includes 50,000 shares issuable upon the exercise of outstanding stock options.10)Includes 673,790 shares issued and outstanding and 1,673,333 shares issuable upon exercise of stock options.35 Number of securities remaining available Number of securities for future issuance to be issued upon Weighted average under equity exercise of exercise price of compensation plans outstanding options, outstanding options, (excluding securities warrants and rights warrants and rights reflected in column (a) Plan category (a) (b) (c) Equity compensation plans approved by security holders 4,249,739 $ 0.39 653,783 Equity compensation plans not approved by security holders 24,477,724 $ 0.11 None Total 28,727,463 $ 0.15 653,783 Common shares issuable on is incorporated by reference to the exercise of stock warrants have not been approved by the security holders and, accordingly, have been segregatedinformation contained in the above table.our 2008 definitive proxy statement.Item There were no transactions, or series of transactions, during fiscal 2002, 2001 or 2000, nor are there any currently proposed transactions, or series of transactions, to which the Company AND DIRECTOR INDEPENDENCEa party, in which the amount exceeds $60,000, and in which to its knowledge any director, executive officer, nominee, five percent or greater shareholder, or any member of the immediate family of any of the foregoing persons, has or will have any direct or indirect material interest other than as described below. Based on the asset purchase agreement and plan of reorganization dated June 22, 1994 between Patriot, nanoTronics Corporation and Helmut Falk, we issued a total of 8,500,000 restricted common shares to nanoTronics, 3,500,000 of which were a contingent payment subjectincorporated by reference to the terms of an earnout escrow. These shares were issuedinformation contained in consideration of technology acquired. nanoTronics was formed in 1991our 2008 definitive proxy statement.acquired certain base technology for a simplified 32-bit microprocessor integrated on a single chip with merged stack/register architecture. nanoTronics expended in excess of $1.9 million (unaudited) while engaged in further development of that technology and produced from the basic architecture an enhanced microprocessor (ShBoom-architecture microprocessor). A majority of the expendituresServices is incorporated by nanoTronics consisted of microprocessor and related software development costs. The result of these efforts was a successful initial fabrication of the microprocessor in early 1994 demonstrating technical feasibility of the ShBoom architecture. nanoTronics also expended funds on the preparation and prosecution of patent applications. The shares were initially issued to nanoTronics who on dissolution subsequently transferred the sharesreference to the Helmut Falk Family Trust. Prior to the transaction, Mr. Falk was an unaffiliated person with respect to us. At the time of issuance the common shares represented approximately 36% of our total issued and outstanding shares. Although the transaction did not result in a majority changeinformation contained in our board of directors, or a majority change in our stock ownership, the issuance of new stock resulted in a large percentage ownership controlled by one entity with the ability to have significant influence over our future affairs. Based on the terms of the purchase agreement, 5,000,000 of the common shares were issued to nanoTronics subject to an earnout escrow arrangement as a contingent purchase price. The terms of the escrow arrangement, as defined in the purchase agreement, provided for the earnout from escrow of 500,000 common shares for each $500,000 of Patriot revenues commencing June 1, 1994 and ending May 31, 1999. As of May 31, 2002:3,500,000 shares were released from escrow, and36the remaining 1,500,000 shares were returned to us and cancelled since revenue was not sufficient to earn this portion of the escrowed shares. During January 1999 through April 1999, we entered into four short-term notes with Gloria Felcyn, the trustee for the Falk Family Trust, aggregating $175,000 with maturity dates ranging from October 22, 1999 to January 15, 2000. The short-term notes were paid in December 1999 and January 2000. In June 2000, we entered into a three-year, $80,000 secured promissory note receivable with James T. Lunney, a previous Chairman, President and CEO. The note bears interest at the rate of 6% with interest payments due semi-annually and the principal due at the maturity of the note. Mr. Lunney pledged 100,000 shares of Patriot’s common stock that he held on the date of issuance as security for this note. During the fiscal years ended May 31, 2002 and 2001, we paid $70,292 and $139,253 to Webster Incorporated for design and maintenance of our web site and for marketing support and materials. The principal in Webster Incorporated, Christine Blum, is the daughter of our previous Chairman, President and CEO, Richard Blum. On June 10, 2002, we issued to Gloria Felcyn, Trustee of the Helmut Falk Family Trust, an 8% Convertible Debenture with a principal balance of $100,000 due June 10, 2004. The initial exercise price was $0.08616 and is subject to a downward revision if the price of our stock is lower on any three month anniversary of the debenture or on the date that a statement registering the resale of the common stock issuable upon conversion of the debenture becomes effective. Also, in conjunction with the debenture, we issued a five year warrant to purchase up to 1,334,757 shares of our common stock at an initial exercise price of $0.08616 subject to reset provisions on each six month anniversary of the issuance of the warrant. If the price of our common stock is in excess of $0.20 per share, Ms. Felcyn has a two year option to purchase up to an additional $100,000 of 8% Convertible Debentures on the same terms.Item 14. AND REPORTS ON FORM 8-K 1. Statements.Statements. The following consolidated financial statements and supplementary information of the Company and Report of Independent AuditorsRegistered Public Accounting Firm are included in Part IIstarting on page F-1 of this Report: 2. 3. Exhibit No. Document Report of Nation Smith Hermes Diamond, Certified Public Accountants3.4 3.5 Certificate of Merger issued by the Delaware Secretary of State on May 8, 1992, incorporated by reference to Exhibit 3.5 to Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW) Report of BDO Seidman, LLP, Certified Public Accountants3.6 Certificate of Merger issued by the Colorado Secretary of State on May 12, 1992, incorporated by reference to Exhibit 3.6 to Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW) Consolidated Balance Sheets- As of May 31, 2002 and 20013.7 Bylaws of the Company, incorporated by reference to Exhibit 3.7 to Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW) 4.1 Consolidated StatementsSpecimen common stock certificate, incorporated by reference to Exhibit 4.1 Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)4.2† Operations- Years Endedthe Company dated March 25, 1996 and approved by the Shareholders on May 31, 2002, 2001 and 200017, 1996, incorporated by reference to Exhibit 10.13 to Pre-Effective Amendment No. 2 to Registration Statement on Form SB-2 filed May 23, 1996 (Commission file No. 333-01765)4.3† 2001 Stock Option Plan of the Company dated February 21, 2001 incorporated by reference to Exhibit 4.19 to Registration Statement on Form S-8 filed March 26, 2001 (Commission file No. 333-57602) Consolidated Statement of Stockholders’ Equity (Deficit)- Years Ended May 31, 2002, 2001 and 20004.4† 2003 Stock Option Plan of the Company dated July 2, 2003 incorporated by reference to Exhibit 4.27 to Registration Statement on Form S-8 filed September 4, 2003 (Commission file No. 333-108489) Consolidated Statements of Cash Flows- Years Ended May 31, 2002, 2001 and 20004.5† 2006 Stock Option Plan of the Company dated March 31, 2006 incorporated by reference to Exhibit 4.19 to Registration Statement on Form S-8 filed June 20, 2006 (Commission file No. 333-135156) Notes to Consolidated Financial Statements4.6 2.Exhibits. The following Exhibits are filed as partApproval Rights Agreement and Termination of orAntidilution Agreement and Addendum to Warrants dated October 10, 2006, incorporated by reference into, this Report:to Exhibit 4.29 to Form 10-KSB for the fiscal year ended May 31, 2006, filed on October 13, 2006 (Commission file No. 000-22182) 10.1 IGNITE License Agreement with Advanced Micro Devices, Inc., dated February 21, 2005, incorporated by reference to Exhibit 10.38 to Form 10-KSB for the fiscal year ended May 31, 2006, filed on October 13, 2006 (Commission file No. DocumentNo.
000-22182) 2.010.2 Patent Portfolio License Agreement with Advanced Micro Devices, Inc., dated February 21, 2005, incorporated by reference to Exhibit 10.39 to Form 10-KSB for the fiscal year ended May 31, 2006, filed on October 13, 2006 (Commission file No. 000-22182) PLAN OF ACQUISITION, REORGANIZATION, ARRANGEMENT, LIQUIDATION OR SUCCESSION. 37 Exhibit No. Document No. 2.1 Agreement to Exchange Technology for Stock in Patriot Scientific Corporation, incorporated by reference to Exhibit 2.1 to Form 8-K dated August 10, 1989 (1 ) 2.2 Assets Purchase Agreement and Plan of Reorganization dated June 22, 1994, among the Company, nanoTronics Corporation and Helmut Falk, incorporated by reference to Exhibit 10.4 to Form 8-K dated July 6, 1994 (1 ) 2.2.1 Amendment to Development Agreement dated April 23, 1996 between the Company and Sierra (1 ) Systems, incorporated by reference to Exhibit 2.2.1 to Pre-Effective Amendment No. 1 to Registration Statement on Form SB-2 dated April 29, 1996 2.3 Form of Exchange Offer dated December 4, 1996 between the Company and certain shareholders of Metacomp, Inc. incorporated by reference to Exhibit 2.3 to Form 8-K dated January 9, 1997 (1 ) 2.4 Letter of Transmittal to Accompany Shares of Common Stock of Metacomp, Inc. Tendered Pursuant to the Exchange Offer Dated December 4, 1996 incorporated by reference to Exhibit 2.4 to Form 8-K dated January 9, 1997 (1 ) 3.0 ARTICLES AND BYLAWS. 3.1 Original Articles of Incorporation of the Company’s predecessor, Patriot Financial Corporation, incorporated by reference to Exhibit 3.1 to registration statement on Form S-18, file no. 33-23143-FW (1 ) 3.2 Articles of Amendment of Patriot Financial Corporation, as filed with the Colorado Secretary of State on July 21, 1988, incorporated by reference to Exhibit 3.2 to registration statement on Form S-18, File No. 33-23143-FW (1 ) 3.3 Certificate of Incorporation of the Company, as filed with the Delaware Secretary of State on March 24, 1992, incorporated by reference to Exhibit 3.3 to Form 8-K dated May 12, 1992 (1 ) 3.3.1 Certificate of Amendment to the Certificate of Incorporation of the Company, as filed with the Delaware Secretary of State on April 18, 1995, incorporated by reference to Exhibit 3.3.1 to Form 10-KSB for the fiscal year ended May 31, 1995 (1 ) 3.3.2 Certificate of Amendment to the Certificate of Incorporation of the Company, as filed with the Delaware Secretary of State on June 19,1997, incorporated by reference to Exhibit 3.3.2 to Form 10-KSB for the fiscal year ended May 31, 1997 (1 ) 3.3.3 Certificate of Amendment to the Certificate of Incorporation of the Company, as filed with the Delaware Secretary of State on April 28, 2000, incorporated by reference to Exhibit 3.3.3 to Registration Statement on Form S-3 dated May 5, 2000 (1 ) 3.3.4 Certificate of Amendment to the Certificate of Incorporation of the Company, as filed with the Delaware Secretary of State on May 6, 2002, incorporated by reference to Exhibit 3.3.4 to Registration Statement on Form S-3 dated June 27, 2002 (1 ) 38 Exhibit No. Document No. 3.4 Articles and Certificate of Merger of Patriot Financial Corporation into the Company (1 ) dated May 1, 1992, with Agreement and Plan of Merger attached thereto as Exhibit A, incorporated by reference to Exhibit 3.4 to Form 8-K dated May 12, 1992 3.5 Certificate of Merger issued by the Delaware Secretary of State on May 8, 1992, (1 ) incorporated by reference to Exhibit 3.5 to Form 8-K dated May 12, 1992 3.6 Certificate of Merger issued by the Colorado Secretary of State on May 12, 1992, (1 ) incorporated by reference to Exhibit 3.6 to Form 8-K dated May 12, 1992 3.7 Bylaws of the Company, incorporated by reference to Exhibit 3.7 to Form 8-K dated May (1 ) 12, 1992 4.0 INSTRUMENTS ESTABLISHING RIGHTS OF SECURITY HOLDERS. 4.1 Specimen common stock certificate, incorporated by reference to Exhibit 4.1 Form 8-K (1 ) dated May 12, 1992 4.2 Form of Stock Purchase Warrant (Labway Corporation) dated February 29, 1996, (1 ) exercisable to purchase 253,166 common shares at $1.58 per share until August 31, 1996, granted to investors in connection with an offering of securities made in reliance upon Regulation S, incorporated by reference to Exhibit 4.2 to Form 10-QSB for fiscal quarter ended February 29, 1996 4.3 Form of 6% Convertible Subordinated Promissory Note due September 30, 1998 aggregating (1 ) $1,500,000 to six investors incorporated by reference to Exhibit 4.3 to Form 10-QSB for fiscal quarter ended August 31, 1996 4.4 Form of 5% Convertible Term Debenture (CC Investments, LDC) due June 2, 1999 (1 ) aggregating $2,000,000 to two investors incorporated by reference to Exhibit 4.4 to Form 8-K dated June 16, 1997 4.5 Form of Stock Purchase Warrant (CC Investments, LDC) dated June 2, 1997 exercisable to (1 ) purchase an aggregate of 400,000 common shares at $1.69125 per share until June 2, 2002, granted to two investors in connection with the offering of securities in Exhibit 4.4 incorporated by reference to Exhibit 4.5 to Form 8-K dated June 16, 1997 4.6 Registration Rights Agreement dated June 2, 1997 by and among the Company and CC (1 ) Investments, LDC and the Matthew Fund, N.V. related to the registration of the common stock related to Exhibits 4.4 and 4.5 incorporated by reference to Exhibit 4.6 to Form 8-K dated June 16, 1997 4.7 Form of Warrant to Purchase Common Stock (Swartz Family Partnership, L.P.) dated June (1 ) 2, 1997 exercisable to purchase an aggregate of 211,733 common shares at $1.69125 per share until June 2, 2002, granted to a group of investors in connection with the offering of securities in Exhibit 4.4 incorporated by reference to Exhibit 4.7 to Form 8-K dated June 16, 1997 4.8 Registration Rights Agreement dated June 2, 1997 by and among the Company and Swartz (1 ) Investments, LLC related to the registration of the common stock related to Exhibit 4.7 incorporated by reference to Exhibit 4.8 to Form 8-K dated June 16, 1997 39 Exhibit No. Document No. 4.9 Form of 5% Convertible Term Debenture (CC Investments, LDC) due June 2, 1999 (1 ) aggregating $1,000,000 to two investors incorporated by reference to Exhibit 4.9 to Form 10-KSB for the fiscal year ended May 31, 1998 4.10 Form of Stock Purchase Warrant (CC Investments, LDC) dated November 24, 1997 (1 ) exercisable to purchase an aggregate of 200,000 common shares at $1.50 per share until June 2, 2002, granted to two investors in connection with the offering of securities described in Exhibit 4.9 incorporated by reference to Exhibit 4.10 to Form 10-KSB for the year ended May 31, 1998 4.11 Form of Warrant to Purchase Common Stock (Swartz Family Partnership, L.P.) dated (1 ) November 24, 1997 exercisable to purchase an aggregate of 105,867 common shares at $1.50 per share until June 2, 2002, granted to a group of investors in connection with the offering of securities described in Exhibit 4.9 incorporated by reference to Exhibit 4.11 to Form 10-KSB for the year ended May 31, 1998 4.12 Form of Warrant to Purchase Common Stock (Investor Communications Group, Inc.) dated (1 ) June 16, 1997 exercisable to purchase an aggregate of 130,000 common shares at prices ranging from $2.50 to $7.50 per share until June 15, 1999 incorporated by reference to Exhibit 4.12 to Form 10-KSB for the year ended May 31, 1998 4.13 Warrant to Purchase Common Stock issued to Spellcaster Telecommunications, Inc. dated (1 ) April 28, 1998 exercisable to purchase an aggregate of 100,000 common shares at $1.25 per share until April 28, 2000 incorporated by reference to Exhibit 4.13 to Form 10-KSB for the year ended May 31, 1998 4.14 Investment agreement dated February 24, 1999 by and between the Company and Swartz (1 ) Private Equity, LLC for a maximum aggregate amount of $5,000,000 incorporated by reference to Exhibit 4.14 to Form 10-QSB/A for the fiscal quarter ended November 30, 1998 4.15 Registration Rights Agreement dated February 24, 1999 by and between the Company and (1 ) Swartz Private Equity, LLC related to the registration of the common stock related to Exhibit 4.14 incorporated by reference to Exhibit 4.15 to Form 10-QSB/A for the fiscal quarter ended November 30, 1998 4.16 Form of Warrant to Purchase Common Stock (Swartz Private Equity, LLC) dated February (1 ) 24, 1999 exercisable to purchase common shares in connection with the offering of securities in Exhibit 4.14 incorporated by reference to Exhibit 4.16 to Form 10-QSB/A for the fiscal quarter ended November 30, 1998 4.17 Amended and Restated Investment Agreement dated July 12, 1999 by and between the (1 ) Company and Swartz Private Equity, LLC for a maximum aggregate amount of $5,000,000 incorporated by reference to Exhibit 4.17 to Pre-Effective Amendment No. 2 to Registration Statement on Form SB-2 dated July 14, 1999 4.18 Investment Agreement dated April 28, 2000 by and between the Company and Swartz (1 ) Private Equity, LLC for a maximum aggregate amount of $30,000,000 incorporated by reference to Exhibit 4.18 to Registration Statement on Form S-3 dated May 5, 2000 4.18.1 Waiver and Agreement dated September 24, 2001 amending the Investment Agreement dated (1 ) April 28, 2000 by and between the Company and Swartz Private Equity, LLC for a maximum aggregate amount of $30,000,000 40 Exhibit No. Document No. incorporated by reference to Exhibit 4.18.1 to Registration Statement on Form S-1 dated October 11, 2001 4.19 2001 Stock Option Plan of the Company dated February 21, 2001 incorporated by reference to Exhibit 4.19 to Registration Statement on Form S-8 dated March 26, 2001 (1 ) 4.20 Investment agreement dated September 17, 2001 by and between the Company and Swartz Private Equity, LLC for a maximum aggregate amount of $25,000,000 incorporated by reference to Exhibit 4.20 to Registration Statement on Form S-1 dated October 11, 2001 (1 ) 4.21 Registration Rights Agreement dated September 17, 2001 by and between the Company and Swartz Private Equity, LLC related to the registration of the common stock related to Exhibit 4.20 incorporated by reference to Exhibit 4.21 to Registration Statement on Form S-1 dated October 11, 2001 (1 ) 4.22 Warrant to Purchase Common Stock dated September 17, 2001 exercisable to purchase common shares in connection with the Offering of securities in Exhibit 4.20 incorporated by reference to Exhibit 4.22 to Registration Statement on Form S-1 dated October 11, 2001 (1 ) 4.23 Financial Consulting Services Agreement between the Company and M. Blaine Riley, Randall Letcavage and Rosemary Nguyen incorporated by reference to Exhibit 4.23 to Registration Statement on Form S-8 dated January 22, 2002 (1 ) 4.24 Form of 8% Convertible Debenture (Lincoln Ventures, LLC) due June 10, 2004 aggregating $1,000,000 to six investors incorporated by reference to Exhibit 4.24 to Registration Statement on Form S-3 dated June 27, 2002 (1 ) 4.25 Form of Stock Purchase Warrant (Lincoln Ventures, LLC) dated June 10, 2002 exercisable to purchase an aggregate of 12,859,175 common shares at initial exercise prices ranging form $0.08616 to $0.10289 per share until June 10, 2007, granted to six investors in connection with the offering of securities described in Exhibit 4.24 incorporated by reference to Exhibit 4.25 to Registration Statement on Form S-3 dated June 27, 2002 (1 ) 4.26 Form of Registration Rights Agreement (Lincoln Ventures, LLC) dated June 10, 2002 by and among the Company and six investors related to the registration of the common stock related to Exhibit 4.24 incorporated by reference to Exhibit 4.26 to Registration Statement on Form S-3 dated June 27, 2002 (1 ) 10.0 MATERIAL CONTRACTS. 10.1 1992 Incentive Stock Option Plan of the Company, incorporated by reference to Exhibit 10.1 to Form 8-K dated May 12, 1992 (1 ) 41 Exhibit No. Document No. 10.1.1 Amendment to 1992 Incentive Stock Option Plan dated January 11, 1995, incorporated by (1 ) reference to Exhibit 10.1.1 to Form S-8 dated July 17, 1996 10.2 1992 Non-Statutory Stock Option Plan of the Company, incorporated by reference to (1 ) Exhibit 10.2 to Form 8-K dated May 12, 1992 10.2.1 Amendment to 1992 Non-Statutory Stock Option Plan dated January 11, 1995 incorporated (1 ) by reference to Exhibit 10.2.1 to Form 10-KSB for fiscal year ended May 31, 1996 10.3 Lease Agreement between the Company’s subsidiary Metacomp, Inc. and Clar-O-Wood (1 ) Partnership, a California limited partnership dated April 11, 1991 as amended November 11, 1992 and November 2, 1995 incorporated by reference to Exhibit 10.3 to Form 10-KSB for fiscal year ended May 31, 1997 10.4 Stock Purchase Agreement dated November 29 and 30, 1995, between the Company and SEA, (1 ) Ltd., incorporated by reference to Exhibit 10.4 to Form 8-K dated December 11, 1995 10.4.1 Letter Amendment to Stock Purchase Agreement dated February 21, 1996, between the (1 ) Company and SEA, Ltd., incorporated by reference to Exhibit 10.4.1 to Form 10-QSB for fiscal quarter ended 2/29/96 10.5 1995 Employee Stock Compensation Plan of the Company, incorporated by reference to (1 ) Exhibit 10.5 to Form 10-QSB for fiscal quarter ended 11/30/95 10.6 Letter Stock and Warrant Agreement dated January 10, 1996 between the Company and (1 ) Robert E. Crawford, Jr., incorporated by reference to Exhibit 10.6 to Form 10-QSB for fiscal quarter ended February 29, 1996 10.7 Non-Exclusive Manufacturing and Line of Credit Agreement dated February 28, 1996, (1 ) between the Company and Labway Corporation, incorporated by reference to Exhibit 10.7 to Form 10-QSB for fiscal quarter ended February 29, 1996 10.8 Distribution and Representation Agreement dated February 28, 1996, between the Company (1 ) and Innoware, Inc., incorporated by reference to Exhibit 10.8 to Form 10-QSB for fiscal quarter ended February 29, 1996 10.9 Employment Agreement dated November 20, 1995 between the Company and Elwood G. Norris, (1 ) incorporated by reference to Exhibit 10.9 to Registration Statement on Form SB-2 dated March 18, 1996 10.9.1 First Amendment to Employment Agreement dated May 17, 1996 between the Company and (1 ) Elwood G. Norris, incorporated by reference to Exhibit 10.9.1 to Pre-Effective Amendment No. 2 to Registration Statement on Form SB-2 dated May 23, 1996 10.10 Employment Agreement dated November 20, 1995 between the Company and Robert Putnam, (1 ) incorporated by reference to Exhibit 10.10 to Registration Statement on Form SB-2 dated March 18, 1996 10.11 Sales Contractual Agreement dated March 19, 1996 between the Company and Evolve (1 ) Software, Inc., incorporated by reference to Exhibit 10.11 to Pre-Effective Amendment No. 1 to Registration Statement on Form SB-2 dated April 29, 1996 10.11.1 Two Year Stock Purchase Warrant dated March 19, 1996 Granted to Evolve Software, Inc (1 ) Providing for the Purchase of up to 50,000 Common Shares at 42 Exhibit No. Document No. $2.85, incorporated by reference to Exhibit 10.11.1 to Pre-Effective Amendment No. 1 to Registration Statement on Form SB-2 dated April 29, 1996 10.12 Employment Agreement dated as of May 8, 1996 between the Company and Michael A (1 ) Carenzo, including Schedule A — Stock Option Agreement, incorporated by reference to Exhibit 10.12 to Pre-Effective Amendment No. 2 to Registration Statement on Form SB-2 dated May 23, 1996 10.12.1 First Amendment to Employment Agreement dated as of May 8, 1996 between the Company (1 ) and Michael A. Carenzo dated September 23, 1996, incorporated by reference to Exhibit 10.12.1 to Form 10-KSB for the fiscal year ended May 31, 1997 10.13 1996 Stock Option Plan of the Company dated March 25, 1996 and approved by the (1 ) Shareholders on May 17, 1996, incorporated by reference to Exhibit 10.13 to Pre-Effective Amendment No. 2 to Registration Statement on Form SB-2 dated May 23, 1996 10.14 Sales Contractual Agreement dated June 20, 1996 between the Company and Compunetics (1 ) Incorporated incorporated by reference to Exhibit 10.14 to Form 10-KSB for fiscal year ended May 31, 1996 10.15 Sales Contractual Agreement dated July 31, 1996 between the Company and Premier (1 ) Technical Sales, Inc. incorporated by reference to Exhibit 10.15 to Form 10-KSB for fiscal year ended May 31, 1996 10.16 Employment Agreement dated January 1, 1997 between the Company and Norman J. Dawson (1 ) incorporated by reference to Exhibit 10.16 to Form 10-KSB for fiscal year ended May 31, 1997 10.17 Employment Agreement dated January 1, 1997 between the Company and Jayanta K. Maitra (1 ) incorporated by reference to Exhibit 10.17 to Form 10-KSB for fiscal year ended May 31, 1997 10.18 Technology License and Distribution Agreement dated June 23, 1997 between the Company (1 ) and Sun Microsystems, Inc. incorporated by reference to Exhibit 10.18 to Form 10-KSB for the fiscal year ended May 31, 1997 10.19 Employment Agreement dated March 23, 1998 between the Company and James T. Lunney (1 ) incorporated by reference to Exhibit 10.19 to Form 10-KSB for the fiscal year ended May 31, 1998 10.20 Employment Agreement dated July 28, 1997 between the Company and Phillip Morettini (1 ) incorporated by reference to Exhibit 10.20 to Form 10-KSB for the fiscal year ended May 31, 1998 10.21 Employment Agreement dated July 23, 1998 between the Company and Lowell W. Giffhorn (1 ) incorporated by reference to Exhibit 10.21 to Form 10-KSB for the fiscal year ended May 31, 1998 10.22 Secured Promissory Note dated June 12, 2000 between the Company and James T. Lunney (1 ) incorporated by reference to Exhibit 10.22 to Form 10-KSB for the fiscal year ended May 31, 2000 43 Exhibit No. Document No. 10.23 Purchase Agreement dated June 29, 2000 between the Company and 4S 37/38, LLC (1 ) incorporated by reference to Exhibit 10.23 to Form 10-KSB for the fiscal year ended May 31, 2000 10.24 Employment Agreement dated October 2, 2000 between the Company and Miklos B. Korodi (1 ) incorporated by reference to Exhibit 10.24 to Form 10-QSB for the fiscal quarter ended November 30, 2000 10.25 Employment Agreement dated December 1, 2000 between the Company and Richard G. Blum (1 ) incorporated by reference to Exhibit 10.25 to Form 10-QSB for the fiscal quarter ended November 30, 2000 10.26 Employment Agreement dated January 29, 2001 between the Company and Serge J. Miller (1 ) incorporated by reference to Exhibit 10.26 to Form 10-KSB for the fiscal year ended May 31, 2001 10.27 Lease Agreement dated February 23, 2001 between the Company and Arden Realty Finance (1 ) IV, LLC incorporated by reference to Exhibit 10.27 to Form 10-KSB for the fiscal year ended May 31, 2001 10.28 Employment Agreement dated January 1, 2001 between the Company and David H. Pohl (1 ) incorporated by reference to Exhibit 10.28 to Form 10-KSB for the fiscal year ended May 31, 2001 10.29 Employment Agreement dated April 26, 2001 between the Company and David H. Pohl (1 ) incorporated by reference to Exhibit 10.29 to Form 10-KSB for the fiscal year ended May 31, 2001 10.30 Employment Agreement dated November 17, 2001 between the Company and Lowell W (1 ) Giffhorn incorporated by reference to Exhibit 10.30 to Registration Statement on Form S-3 dated June 27, 2002 10.31 Employment Agreement dated December 20, 2001 between the Company and Jayanta Maitra (1 ) incorporated by reference to Exhibit 10.31 to Registration Statement on Form S-3 dated June 27, 2002 10.32 Consulting Agreement dated March 7, 2002 between the Company and SDMC, Inc (1 ) incorporated by reference to Exhibit 10.32 to Registration Statement on Form S-3 dated June 27, 2002 23.0 CONSENTS OF EXPERTS AND COUNSEL 23.1 Consent of Nation Smith Hermes Diamond, LLP independent certified public accountants (2 ) 23.2 Consent of BDO Seidman, LLP independent certified public accountants (2 ) 99.0 Additional Exhibits. 99.1 Form of ISO Plan Option (Gaspar) dated May 29, 1992, incorporated by reference to (1 ) Exhibit 28.2 to registration statement on Form SB-2, file no. 33-57858 99.2 Form of NSO Plan Option (Berlin) dated May 29, 1992, incorporated by reference to (1 ) Exhibit 28.3 to registration statement on Form SB-2, file no. 33-57858 44 Exhibit No. Document No. 99.3 Form of Incentive Stock Option Agreement to the Company’s 1996 Stock Option Plan (1 ) (individual agreements differ as to number of shares, dates, prices and vesting), incorporated by reference to Pre-Effective Amendment No. 2 to Registration Statement on Form SB-2 dated May 23, 1996 99.4 Form of NonQualified Stock Option Agreement to the Company’s 1996 Stock Option Plan (1 ) (individual agreement differ as to number of shares, date, prices and vesting), incorporated by reference to Pre-Effective Amendment No. 2 to Registration Statement on Form SB-2 dated May 23, 1996 99.5 Press Release of the Company dated November 4, 1996 incorporated by (1 ) reference to Exhibit 99.5 to Form 8-K dated January 9, 1997 99.6 Form of Incentive Stock Option Agreement to the Company’s 2001 Stock Option Plan (1 ) incorporated by reference to Exhibit 99.6 to Registration Statement on Form S-8 filed March 26, 2001 99.7 Form of Non-Qualified Stock Option Agreement to the Company’s 2001 Stock Option Plan (1 ) incorporated by reference to Exhibit 99.7 to Registration Statement on Form S-8 filed March 26, 2001 99.8 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley (2 ) Act of 2002 99.9 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley (2 ) Act of 2002 (1)10.3Master Agreement, dated as of June 7, 2005, by and among the Company, Technology Properties Limited Inc., a California corporation and Charles H. Moore, an individual, incorporated by reference to Exhibit 10.40 to Form 8-K filed June 15, 2005 (Commission file No. 000-22182) Previously10.4Commercialization Agreement dated as of June 7, 2005 by and among the JV LLC, Technology Properties Limited Inc., a California corporation, and the Company, incorporated by reference to Exhibit 10.41 to Form 8-K filed in indicated registration statement or report.June 15, 2005 (Commission file No. 000-22182)(2) 10.5 herewith this Annual Report onJune 15, 2005 (Commission file No. 000-22182)Agreement for Part-Time Employment dated August 3, 2005 between the Company and Thomas J. Sweeney, incorporated by reference to Exhibit 99.3 to Form 8-K filed August 9, 2005 (Commission file No. 000-22182) 10.7 Settlement Agreement dated February 13, 2007 by and among the Company, Russell H. Fish, III and Robert C. Anderson as trustee of the Fish Family Trust incorporated by reference to Exhibit 10.45 to Registration Statement en Form SB-2 filed March 21, 2007 (Commission file No. 333-134362) 10.8† Employment Agreement dated June 5, 2007 by and between the Company and James Turley, incorporated by reference to Exhibit 10.1 to Form 8-K filed June 8, 2007 (Commission file No. 000-22182) 10.9† Employment Agreement dated September 17, 2007 by and between the Company and Clifford L. Flowers, incorporated by reference to Exhibit 10.1 to Form 8-K filed September 19, 2007 (Commission file No. 000-22182) 10.10† Employment Agreement dated February 29, 2008 by and between the Company and Frederick C. Goerner, incorporated by reference to Exhibit 99.1 to Form 8-K filed May 20, 2008 (Commission file No. 000-22182) Code of Ethics for Senior Financial Officers incorporated by reference to Exhibit 14.1 to Form 10-K for the fiscal year ended May 31, 20022003, filed August 29, 2003 (Commission file No. 000-22182)List of subsidiaries of the Company incorporated by reference to Exhibit 21.1 of the Company’s annual report on Form 10-KSB filed October 13, 2006 (Commission file No. 000-22182) (b) FinancialConsent of Independent Registered Public Accounting Firm Consent of Independent Valuation Firm Certification of Frederick C. Goerner, CEO, pursuant to Rule 13a-14(a)/15d-14(a) Certification of Clifford L. Flowers, CFO, pursuant Rule 13a-14(a)/15d-14(a) Certification of Frederick C. Goerner, CEO, pursuant to Section 1350 Certification of Clifford L. Flowers, CFO, pursuant to Section 1350 Scheduleson Form SB-2 filed May 23, 1996 (Commission file No. 333-01765)Form of Non-Qualified Stock Option Agreement to the Company’s 2003 Stock Option Plan incorporated by reference to Exhibit 99.9 to Registration Statement on Form S-8 filed September 4, 2003 (Commission file No. 333-108489) Page The following financial statement schedule filed herein as a part of this report at F-37 Schedule II- Valuation and Qualifying AccountsReport of Independent Registered Public Accounting Firm All other schedules have been omitted because the information required to be set forth therein is not applicable or is shown in the Consolidated F-2Financial Statements or the Notes thereto.(c) Reports on Form 8-K — The Company did file a report on Form 8-K on May 24, 2002, amended on Form 8K/A on June 5, 2002, announcing a change in the Company’s certifying accountant.45Patriot Scientific CorporationIndex to Consolidated Financial StatementsStatements: Report of Nation, Smith, Hermes, Diamond, Independent Certified Public AccountantsF-2Report of BDO Seidman, LLP, Independent Certified Public AccountantsConsolidated Balance Sheets F-3 Consolidated Balance Sheets asStatements of May 31, 2002 and 2001Income F-4 Consolidated Statements of Operations for the Years Ended May 31, 2002, 2001Stockholders’ Equity and 2000Comprehensive Income F-5 Consolidated Statement of Stockholders’ Equity (Deficit) for the Years Ended May 31, 2002, 2001 and 2000F-6Consolidated Statements of Cash Flows for the Years Ended May 31, 2002, 2001 and 2000 F-7 Summary of Accounting PoliciesF-8-F-14 Notes to Consolidated Financial Statements F-15-F-36Schedule II- Valuation and Qualifying AccountsF-37F-9 Report of Independent Certified Public AccountantsSan Diego, Californiasheetsheets of Patriot Scientific Corporation and subsidiaries (the “Company”) as of May 31, 2002,2008 and 2007, and the related consolidated statements of operations,income, stockholders’ equity (deficit) and cash flowflows for each of the yearyears in the three-year period ended May 31, 2002. We have also audited the schedule listed in the accompanying index.2008. These consolidated financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audit.auditaudits in accordance with auditingthe standards generally accepted inof the United States of America.Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the auditaudits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audit providesaudits provide a reasonable basis for our opinion.consolidated financial position of Patriot Scientific Corporation atand subsidiaries as of May 31, 2002,2008 and 2007, and the consolidated results of itstheir operations and itstheir cash flows for each of the yearyears in the three-year period ended May 31, 20022008 in conformity with accounting principles generally accepted in the United States of America.Also, in our opinion, the schedule presents fairly, in all material respects, the information set forth therein.The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. 12 to the consolidated financial statements, effective June 1, 2006, the Company has suffered recurring losses from operations, has negative cash flows and has negative working capital that raise substantial doubt aboutchanged its abilitymethod of accounting for share-based compensation to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcomeadopt Statement of this uncertainty./s/ Nation Smith Hermes DiamondSan Diego, CaliforniaJuly 19, 2002, except for note 1,Financial Accounting Standards No. 123(R), Share-Based Payment.dated as of August 23, 2002.F-2Report of Independent Certified Public AccountantsTo the Stockholders and Board of DirectorsPatriot Scientific CorporationSan Diego, Californiaaccompanying consolidated balance sheetstandards of Patriot Scientific Corporationthe Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of May 31, 2001 and2008, based on the related consolidated statementscriteria established in Internal Control - Integrated Framework issued by the Committee of operations, stockholders’ equity and cash flows for eachSponsoring Organizations of the years in the two year period ended May 31, 2001. We have also audited the schedule listed in the accompanying index for each of the two years in the period ended May 31, 2001. These financial statementsTreadway Commission, and schedule are the responsibility ofour report dated August 14, 2008 expressed an adverse opinion on the Company’s management. Our responsibility is to express an opinion on theseinternal control over financial statements and schedule based on our audits.We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedule are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedule. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement and schedule 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 consolidated financial position of reporting. at May 31, 2001 and the consolidated results of its operations and its cash flows for each of the years in the two year period ended May 31, 2001 in conformity with accounting principles generally accepted in the United States of America.Also, in our opinion, the schedule presents fairly, in all material respects, the information set forth therein for each of the two years in the period ended May 31, 2001.The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has suffered recurring losses from operations and has negative cash flows that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty./s/ BDO Seidman, LLPDenver, ColoradoAugust 9, 2001, except for Note 1, dated as 2008 2007 ASSETS Current assets: Cash and cash equivalents $ 6,424,015 $ 21,605,428 Restricted cash and cash equivalents 51,122 102,346 Marketable securities and short term investments 298,243 4,349,314 Accounts receivable 538,500 352,390 Accounts receivable – affiliated company 7,501 - Notes receivable 450,115 - Inventory 388,141 46,361 Prepaid income taxes 222,311 2,070,981 Deferred tax assets 1,390,832 2,439,975 Prepaid expenses and other current assets 79,840 431,840 Total current assets 9,850,620 31,398,635 Marketable securities 12,527,675 - Property and equipment, net 68,504 85,518 Other assets 8,190 8,190 Investments in affiliated companies 2,913,614 2,883,969 63,299 38,317 Total assets $ 25,431,902 $ 34,414,629 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable $ 555,690 $ 934,298 Accrued expenses and other 373,848 1,086,496 Total current liabilities 929,538 2,020,794 Deferred tax liabilities 1,085,181 12,222,944 Total liabilities 2,014,719 14,243,738 Commitments and contingencies Minority interest 115,406 - Stockholders’ equity Preferred stock, $.00001 par value; 5,000,000 shares authorized: none outstanding - - Common stock, $.00001 par value: 500,000,000 shares authorized: 410,979,163 shares issued and 389,414,915 shares outstanding at May 31, 2008 and 406,668,661 shares issued and 393,201,134 shares outstanding at May 31, 2007 4,109 4,066 Additional paid-in capital 70,004,814 72,150,581 Accumulated deficit (33,763,357 ) (43,151,678 ) Common stock held in treasury, at cost – 21,564,248 shares at May 31, 2008 and 13,467,527 shares at May 31, 2007 (12,723,172 ) (8,832,078 ) Accumulated other comprehensive loss (220,617 ) - Total stockholders’ equity 23,301,777 20,170,891 Total liabilities and stockholders’ equity $ 25,431,902 $ 34,414,629 of August 15, 2001See accompanying notes to consolidated financial statements Consolidated Balance Sheets May 31, 2002 2001 Cash and cash equivalents $ 88,108 $ 464,350 Accounts receivable, net of allowance of $6,000 and $54,000 for uncollectible accounts 4,797 188,982 Inventories (Note 2) — 223,393 Prepaid expenses 35,749 73,185 Total current assets 128,654 949,910 285,488 423,528 330,863 16,667 189,521 153,588 $ 934,526 $ 1,543,693 Secured note payable, net of debt discount of $189,516 (Note 5) $ 445,760 $ — Accounts payable 385,255 434,838 Accrued liabilities 211,291 186,467 Current portion of capital lease obligation 5,116 — Total current liabilities 1,047,422 621,305 315,198 — 16,731 — Preferred stock, $.00001 par value; 5,000,000 shares authorized: none outstanding — — Common stock, $.00001 par value; 200,000,000 and 100,000,000 shares authorized: 81,465,757 and 57,535,411 issued and outstanding at May 31, 2002 and 2001, respectively 815 575 Additional paid-in capital 41,440,101 37,320,503 Accumulated deficit (41,805,741 ) (36,318,690 ) Note receivable (Note 4) (80,000 ) (80,000 ) Total stockholders’ equity (deficit) (444,825 ) 922,388 $ 934,526 $ 1,543,693 See accompanying reports of independent certified public accountants, summary of accounting policies and notes to consolidated financial statements.F-4Patriot Scientific CorporationOperations Years Ended May 31, 2002 2001 2000 Net sales (Note 14): Product $ 358,809 $ 336,684 $ 553,181 Licenses and royalties — 700 163,779 Net sales 358,809 337,384 716,960 Cost of sales: Product costs 244,547 444,320 455,008 Inventory obsolescence 149,433 100,000 270,000 Cost of sales 393,980 544,320 725,008 Gross loss (35,171 ) (206,936 ) (8,048 ) Operating expenses: Research and development 1,372,421 2,218,433 3,170,166 Selling, general and administrative 2,708,579 2,588,579 3,501,128 Operating expenses 4,081,000 4,807,012 6,671,294 Operating loss (4,116,171 ) (5,013,948 ) (6,679,342 ) Other income (expenses): Gain on sale of technology — — 250,000 Interest income 2,662 48,329 28,014 Interest expense (Notes 5, 6 and 7) (1,373,542 ) (3,284 ) (1,087,380 ) Other income (expenses) (1,370,880 ) 45,045 (809,366 ) Net loss $ (5,487,051 ) $ (4,968,903 ) $ (7,488,708 ) Basic and diluted loss per common share (Note 9) $ (0.08 ) $ (0.09 ) $ (0.17 ) Weighted average number of common shares outstanding during the period (Note 9) 66,810,028 53,433,788 44,156,418 See accompanying reports of independent certified public accountants, summary of accounting policies and notes to consolidated financial statements.F-5Years Ended May 31, 2008 2007 2006 Revenues: Licenses and royalties $ - $ - $ 10,000,000 Product sales and other 3,708,218 638,784 309,709 3,708,218 638,784 10,309,709 Cost of sales 1,510,450 319,374 103,351 Gross profit 2,197,768 319,410 10,206,358 Operating expenses: Research and development - - 225,565 Selling, general and administrative 6,964,861 7,558,712 4,151,099 Settlement and license expense 836,400 7,524,537 1,918,054 Total operating expenses 7,801,261 �� 15,083,249 6,294,718 Operating income (loss) (5,603,493 ) (14,763,839 ) 3,911,640 Other income (expense): Unrealized loss on marketable securities - - (1,466 ) Interest and other income 1,470,008 714,790 330,055 Gain (loss) on sale of assets (4,139 ) (3,163 ) 2,724 Interest expense (389 ) (355 ) (516,465 ) Loss on debt extinguishments - - (445,427 ) Change in fair value of warrant and derivative liabilities - - (2,456,736 ) Impairment of note receivable - (339,551 ) - Impairment of investment in affiliated company - (126,746 ) - Gain on sale of subsidiary interest 150,000 - - Equity in earnings of affiliated companies 19,917,769 48,965,084 27,848,363 Total other income, net 21,533,249 49,210,059 24,761,048 Income before income taxes and minority interest 15,929,756 34,446,220 28,672,688 Provision for income taxes 6,426,029 10,755,033 - Minority interest 115,406 - - Net income $ 9,388,321 $ 23,691,187 $ 28,672,688 Basic income per common share $ 0.02 $ 0.06 $ 0.09 Diluted income per common share $ 0.02 $ 0.06 $ 0.07 Weighted average number of common shares outstanding - basic 390,956,153 378,036,989 316,100,499 Weighted average number of common shares outstanding - diluted 397,485,699 413,599,373 412,963,173 See accompanying notes to consolidated financial statements. (Deficit) Years Ended May 31, 2002, 2001 and 2000 Common Stock Additional Accumulated Stockholders' Shares Amount Paid-in Capital Deficit Equity (Deficit) Balance, June 1, 1999 39,563,915 396 22,879,449 (23,861,079 ) (981,234 ) Issuance of common stock at $.25 to $.98 per share (Note 7) 7,014,796 70 4,999,930 — 5,000,000 Exercise of common stock warrants and options at $.18 to $1.46 per share (Note 8) 3,750,759 37 923,913 — 923,950 Reclassification of stock subject to rescission at $.18 to $.20 per share 400,000 4 74,996 — 75,000 Non-cash compensation expense (Note 8) — — 3,739,267 — 3,739,267 Conversion of notes payable plus interest at $.29 per share (Note 5) 397,205 4 116,178 — 116,182 Value of warrants issued (Note 8) — — 739,037 — 739,037 Non-cash interest on conversion of notes payable (Note 5) — — 86,388 — 86,388 Net loss — — — (7,488,708 ) (7,488,708 ) Balance, May 31, 2000 51,126,675 511 33,559,158 (31,349,787 ) 2,209,882 Issuance of common stock at $.43 to $1.05 per share (Note 8) 5,411,320 54 3,342,143 — 3,342,197 Exercise of common stock warrants and options at $.25 to $.32 per share (Note 8) 997,416 10 289,063 — 289,073 Issuance of options for services — — 130,139 — 130,139 Issuance of note receivable (Note 4) — — (80,000 ) — (80,000 ) Net loss — — — (4,968,903 ) (4,968,903 ) Balance, May 31, 2001 57,535,411 $ 575 $ 37,240,503 $ (36,318,690 ) $ 922,388 Issuance of common stock at $.07 to $.30 per share (Notes 7 and 8) 4,888,680 49 879,556 — 879,605 Exercise of common stock warrants and options at $.25 to $.32 per share (Note 8) 241,666 3 73,830 — 73,833 Issuance of options for services — — 106,926 — 106,926 Issuance of common stock for services at $.09 per share 2,200,000 22 197,978 — 198,000 Conversion of notes payable at $.07 to $.09 per share (Note 5) 16,600,000 166 1,552,885 — 1,553,051 Value of warrants issued — — 1,308,423 — 1,308,423 Net loss — — — (5,487,051 ) (5,487,051 ) Balance, May 31, 2002 81,465,757 $ 815 $ 41,360,101 (1) $ (41,805,741 ) $ (444,825 ) See accompanying reports of independent certified public accountants, summary of accounting policies and notes to consolidated financial statements. Common Stock Accumulated Shares Amounts Accumulated Deficit Treasury Stock Other Comprehensive Loss Stockholders’ Equity (Deficit) Comprehensive Income Balance, June 1, 2005 280,492,013 $ 2,805 $ 55,459,253 $ (62,702,442 ) $ - $ - $ (7,240,384 ) $ - Issuance of common stock for services at $1.53 per share 193,548 2 296,127 - - - 296,129 - Exercise of warrants and options at $.02 to $.69 per share 12,824,544 128 851,070 - - - 851,198 - Conversion of debentures payable plus accrued interest at $.02 and $.04 per share 30,819,187 308 998,729 - - - 999,037 - Cashless exercise of warrants 41,245,473 412 (412 ) - - - - - Issuance of common stock to co-inventor of technology at $.13 per share 625,000 6 81,244 - - - 81,250 - Extension of term of options previously issued to consultant - - 125,000 - - - 125,000 - Repurchase of warrants - - (252,420 ) - - - (252,420 ) - Issuance of warrants to a consultant - - 108,102 - - - 108,102 - Intrinsic value of options issued to employees and directors - - 120,000 - - - 120,000 - Cash dividends at $.02 and $.04 per share - - - (24,698,337 ) - - (24,698,337 ) - Reclassification of derivative value associated with debt conversions and warrant exercises - - 5,021,353 - - - 5,021,353 - Reclassification of warrant and derivative liabilities at settlement date - - 6,743,935 - - - 6,743,935 - Net income 28,672,688 - - 28,672,688 - Balance, May 31, 2006 366,199,765 $ 3,661 $ 69,551,981 $ (58,728,091 ) $ - $ - $ 10,827,551 $ - Exercise of warrants and options at $.05 to $.40 per share 1,787,500 18 213,982 - - - 214,000 - Cashless exercise of warrants 38,681,396 387 (387 ) - - - - - Non-cash compensation - - 2,359,036 - - - 2,359,036 - Extension of stock options previously issued to a consultant - - 324 - - - 324 - Tax effect of exercise of stock options granted under APB 25 - - 25,645 - - - 25,645 - Purchase of common stock for treasury (13,467,527 ) - - - (8,832,078 ) - (8,832,078 ) - Cash dividends at $.02 per share - - - (8,114,774 ) - - (8,114,774 ) - Net income - - - 23,691,187 - - 23,691,187 - - Balance, May 31, 2007 393,201,134 $ 4,066 $ 72,150,581 $ (43,151,678 ) $ (8,832,078 ) $ - $ 20,170,891 $ - (1)Additional Paid-In Capital includes a note receivable of $80,000 and additional paid-in capital of $41,440,101.F-6 Common Stock Shares Amounts Additional Paid-in Capital Accumulated Deficit Treasury Stock Stockholders’ Equity (Deficit) Comprehensive Income Exercise of warrants and options at $.05 to $.10 per share 425,000 $ 4 $ 30,846 $ - $ - $ - $ 30,850 $ - Cashless exercise of options 982,846 10 (10 ) - - - - - Cashless exercise of warrants 2,702,656 27 (27 ) - - - - - Non-cash compensation - - 509,971 - - - 509,971 - Repurchase of warrants - - (2,760,900 ) - - - (2,760,900 ) - Tax effect of exercise of stock options granted under APB 25 - - (25,645 ) - - - (25,645 ) - Issuance of stock in connection with settlement with former CFO 200,000 2 99,998 - - - 100,000 - Purchase of common stock for treasury (8,096,721 ) - - - (3,891,094 ) - (3,891,094 ) - Net income - - - 9,388,321 - - 9,388,321 9,388,321 Unrealized loss on investments, net of tax - - - - - (220,617 ) (220,617 ) (220,617 ) Total comprehensive income $ 9,167,704 Balance, May 31, 2008 389,414,915 $ 4,109 $ 70,004,814 $ (33,763,357 ) $ (12,723,172 ) $ (220,617 ) $ 23,301,777 See accompanying notes to consolidated financial statements. Increase (Decrease) in Cash and Cash Equivalents Years Ended May 31, 2002 2001 2000 Net loss $ (5,487,051 ) $ (4,968,903 ) $ (7,488,708 ) Adjustments to reconcile net loss to cash used in operating activities: Amortization and depreciation 285,759 260,316 367,395 Provision for doubtful accounts 76,000 49,000 41,919 Provision for inventory obsolescence 149,433 100,000 270,000 Common stock, options and warrants issued for services 99,000 119,565 — Non -cash interest expense related to convertible debentures, notes payable and warrants 1,324,431 — 995,651 Gain on sale of technology — — (250,000 ) Non -cash compensation expense — — 3,739,267 Changes in: Accounts receivable (45,973 ) (242,405 ) (159,709 ) Inventories 73,960 (252,229 ) (91,331 ) Prepaid and other assets (83,334 ) (2,563 ) 75,150 Accounts payable and accrued expenses (24,759 ) 98,039 (982,684 ) Net cash used in operating activities (3,632,534 ) (4,839,180 ) (3,483,050 ) Note receivable (Note 4) — (80,000 ) — Web site development costs — (25,000 ) — Purchase of property, equipment and patents, net (146,156 ) (388,557 ) (169,116 ) Proceeds from sale of technology — — 250,000 Net cash (used in) provided by investing activities (146,156 ) (493,557 ) 80,884 Proceeds from issuance of secured note payable 1,790,000 — 410,000 Payments for capital lease obligations (3,148 ) — — Proceeds from issuance of convertible debentures 508,000 — — Principal payments on notes payable and long-term debt — — (720,355 ) Proceeds from issuance of common stock 879,605 3,342,197 5,000,000 Proceeds from exercise of common stock warrants and options 73,833 289,073 634,950 Proceeds from sale of accounts receivable 154,158 65,575 142,000 Net cash provided by financing activities 3,402,448 3,696,845 5,466,595 (376,242 ) (1,635,892 ) 2,064,429 464,350 2,100,242 35,813 $ 88,108 $ 464,350 $ 2,100,242 Convertible debentures, notes payable and accrued interest exchanged for common stock $ 1,154,725 $ — $ 405,182 Cash payments for interest 19,719 — 102,137 Common stock, warrants and options issued for prepaid services 315,500 10,574 — Write-off of inventory 38,052 177,000 347,000 Capital lease obligation 24,996 — — Debt discount 1,308,423 — — See accompanying report of independent certified public accountants, summary of accounting policies and notes to consolidated financial statements.Years Ended May 31, 2008 2007 2006 Operating activities: Net income $ 9,388,321 $ 23,691,187 $ 28,672,688 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Minority interest in variable interest entity 115,406 - - Amortization and depreciation 50,705 64,861 59,415 Non-cash interest expense related to convertible debentures, notes payable and warrants - - 470,736 Expense related to extension of expiration date of stock options - 324 125,000 Net gain related to warrant re-pricing, reconveyance and issuance - - (538,208 ) Loss on extinguishment of debt - - 445,427 Accrued interest income added to investments (1,391 ) (2,026 ) (19,778 ) Equity in earnings of affiliated companies (19,917,769 ) (48,965,084 ) (27,848,363 ) (Gain) loss on sale of assets 4,139 3,163 (2,724 ) Unrealized loss on marketable securities - - 1,466 Issuance of stock, options and warrants for services 100,000 - 554,245 Change in fair value of derivative liabilities - - 2,456,736 Intrinsic value of options issued - - 120,000 Non-cash compensation relating to issuance and vesting of stock options and vesting of warrants 509,971 2,359,036 - Impairment of note receivable - 339,551 - Impairment of investment in affiliated company - 126,746 - Gain on variable interest entity sale of portion of subsidiary interest (150,000 ) - - Deferred taxes (9,936,912 ) 9,782,969 - Changes in operating assets and liabilities: Accounts receivable (186,110 ) (186,560 ) (4,113 ) Receivable from affiliated company (7,501 ) - - Inventory (341,780 ) 1,970 - Prepaid expenses and other current assets 355,990 (24,294 ) (261,769 ) Prepaid income taxes 1,848,670 (2,070,981 ) - Licenses receivable - - 2,000,000 Accounts payable and accrued expenses (1,091,256 ) 1,122,499 194,811 Accrued contested fee payable - (394,063 ) 48,063 Net cash provided by (used in) operating activities (19,259,517 ) (14,150,702 ) 6,473,632 Investing activities: Proceeds from sale of short-term investments 22,076,589 8,832,078 2,027,557 Purchase of short-term investments (30,925,518 ) (9,662,513 ) (4,832,482 ) Proceeds from sale of fixed assets 225 - 6,540 Purchase of restricted investments - - (100,000 ) Proceeds from sale of restricted investments 52,500 - 203,210 Payment for security deposit - - (8,190 ) Purchase of property and equipment (27,699 ) (5,827 ) (71,037 ) Costs incurred for patents and trademarks (39,328 ) - - Proceeds from variable interest entity sale of portion of subsidiary interest 100,000 - - Investment in affiliated companies (400,000 ) (120,000 ) (2,000,000 ) Distributions from affiliated company 20,288,124 50,034,029 25,895,449 Purchase of convertible note receivable (400,000 ) - - Issuance of note receivable - (589,551 ) - Cash received in consolidation of variable interest entity - 40,970 - Net cash provided by investing activities 10,724,893 48,529,186 21,121,047 Financing activities: Payment of cash dividends - (8,114,774 ) (24,698,337 ) Principal payments on notes payable - (50,089 ) (100,000 ) Payments for capital lease obligations - - (2,306 ) Proceeds from exercise of common stock warrants and options 30,850 214,000 851,198 Repurchase of warrants (2,760,900 ) - (252,420 ) Repurchase of common stock for treasury (3,891,094 ) (8,832,078 ) - Tax effect of exercise of options granted under APB 25 (25,645 ) 25,645 - Net cash used in financing activities (6,646,789 ) (16,757,296 ) (24,201,865 ) SummaryAccounting PoliciesYears Ended May 31, 2008 2007 2006 Net increase (decrease) in cash and cash equivalents (15,181,413 ) 17,621,188 3,392,814 21,605,428 3,984,240 591,426 Cash and cash equivalents, end of year $ 6,424,015 $ 21,605,428 $ 3,984,240 Supplemental Disclosure of Cash Flow Information: Cash payments for interest $ 389 $ 355 $ 2,983 Cash payments for income taxes $ 14,528,000 $ 3,017,400 $ - Supplemental Disclosure of Non-Cash Investing and Financing Activities: Convertible debentures, notes payable and accrued interest exchanged for common stock $ - $ - $ 999,037 Reclassification of derivative liabilities associated with debt conversions and warrant exercises $ - $ - $ 5,021,353 Reclassification of warrant and derivative liabilities at settlement date $ - $ - $ 6,743,935 Cashless exercise of warrants $ 27 $ 387 $ 412 Cashless exercise of stock options $ 10 $ - $ - Note receivable issued in connection with variable interest entity sale of portion of subsidiary interest $ 50,000 $ - $ - Reclassification of prepaid software costs to property and equipment $ 3,990 $ - $ - Deferred taxes related to unrealized loss on investments in marketable securities charged to other comprehensive income $ 151,708 $ - $ - Fair market value of assets received in collection of note receivable and subsequently contributed for preferred stock of affiliate $ - $ 250,000 $ - See accompanying notes to consolidated financial statements. (the “Company”(“we”, “us”, or “our”), was organized under Delaware law on March 24, 1992 and is the successor by merger to Patriot Financial Corporation, a Colorado corporation, incorporated on June 10, 1987. In 1997 we acquired Metacomp, Inc. and in June 2005 we entered into a joint venture agreement with Technology Properties Limited, Inc. (“TPL”) is engagedto form Phoenix Digital Solutions, LLC (“PDS”). In March 2007, we became the primary beneficiary of Scripps Secured Data, Inc. (“SSDI”), a variable interest entity and were required to consolidate SSDI effective in March 2007. During May 2008, we acquired a 15% interest in Talis Data Systems, LLC (“Talis”), a Delaware LLC that produces multi-domain hardware. At May 31, 2008, SSDI has a 12% interest in Talis.development, marketing,patent portfolio technology.salemanufactures network-security hardware to government, military, and other high-security facilities.patented microprocessor technology and the sale of high-performance high-speed data communication products. The Company also owns innovative radar technology. The Company sold its antenna technology in August 1999.Presentation and Consolidationfinancial statements have been prepared in accordance with generally accepted accounting principlesstatement of income for the fiscal year ended May 31, 2006 includes our accounts and include the accountsthose of the Company, itsour majority owned inactive subsidiaries, Metacomp, Inc. (“Metacomp”) and Plasma Scientific Corporation. The consolidated balance sheets at May 31, 2008 and 2007 and the statements of income for the fiscal years ended May 31, 2008 and 2007 include our accounts, those of our majority owned inactive subsidiaries that are not considered variable interest entities (“VIE”s) and all VIEs for which we are the primary beneficiary. All materialsignificant intercompany transactionsaccounts and balancestransactions have been eliminated in consolidation.ReclassificationsCertain reclassifications have been made toIn January 2003, the 2001Financial Accounting Standards Board (“FASB”) issued FASB Interpretation 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (“FIN 46”). In December 2003, the FASB modified FIN 46 (“FIN 46(R)”). FIN 46 provides a new framework for identifying VIEs and 2000 financial statements in order for them to conform todetermining when a company should include the 2002 presentation. Such reclassifications have no impact on the Company’s financial position orassets, liabilities, noncontrolling interests and results of activities of a VIE in its consolidated financial statements.The Company’s financialare exposedpotentially subject us to concentrations of credit risk consist primarilyprincipally of cash, cash equivalents, investments in marketable securities, and trade accounts receivable.receivable.The Company’snot subject to FDIC insurance was $6,121,546. We limit our exposure of loss by maintaining our cash with financially stable financial institutions. When we have excess cash, our cash equivalents are placed in high quality money market accounts with major financial institutions and high grade short-term commercial paper. Theinstitutions. We believe this investment policy limits the Company’sour exposure to concentrations of credit risk. Money market accountsfederally insured; however, commercial paper is not insured. The Company has not experienced any lossescollateralized in such accounts.the Company’sour customer base, as well as their dispersion across many different geographic areas. The CompanyWe routinely assessesassess the financial strength of itsour customers and, as a consequence, believesbelieve that itsour accounts receivable credit risk exposure is limited. Generally, the Company doeswe do not require collateral or other security to support customer receivables.The carrying amounts As of May 31, 2008, Anixter accounted for 15.8% of gross accounts receivable and Graybar Electric Company, Inc. accounted for 38% of gross accounts receivable. As of May 31, 2007, Anixter accounted for 80.7% of gross accounts receivable and Graybar Electric Company, Inc. accounted for 11.1% of gross accounts receivable.includingconsist principally of cash and cash equivalents, investments in marketable securities and short-term investments, accounts receivable, accounts payable and accrued liabilities approximatedexpenses. The carrying value of these financial instruments, other than the investments in marketable securities, approximates fair value because of the immediate or short-term maturity of thesethe instruments. With respectlong-term debt,frequent resetting of the interest rate. While we continue to receive interest payments on our auction rate investments despite failed auctions, we believe the carrying amountsvalue of these auction rate securities no longer approximates fair value. We estimated the fair value of these securities at May 31, 2008 based on an independent valuation performed by Houlihan Smith & Company Inc., an independent valuation firm. In determining the estimate of fair value, consideration was given to credit quality, estimated cash flows, and estimated probabilities of default, auction failure and a successful auction at par or repurchase at par. Based on this valuation, we recorded a net temporary impairment of $220,617 in other comprehensive income at May 31, 2008, which represents the gross valuation adjustment of $372,325, net of the related tax benefit of $151,708 (see Note 6).value becausemarket value. At May 31, 2008, PTSC’s short-term investments in the debt was issued immediately prioramount of $288,099 consist of accrued interest receivable on our auction rate securities which is receivable semi-annually according to the endterms specified in each auction rate security instrument. At May 31, 2008, SSDI’s short-term investments consist of a certificate of deposit in the amount of $10,144 with a maturity date of December 11, 2008. These values are reported at cost, which approximate fair market value.fiscal year.F-8Patriot Scientific CorporationSummaryaccounts of Accounting Policies (Continued)InventoriesInventoriesSSDI. SSDI’s accounts receivable consist of trade receivables recorded at the original invoice amount, less an estimated allowance for uncollectible accounts of which there was none at May 31, 2008. Trade receivables are periodically evaluated for collectibility based on past credit histories with customers and their current financial condition. Changes in the estimated collectibility of trade receivables are recorded in the results of operations for the period in which the estimate is revised. Trade receivables that are deemed uncollectible are offset against the allowance for uncollectible accounts. SSDI also calculates a sales returns reserve based on terms of its distribution contracts with Anixter and Graybar Electric Company, Inc.work in process and finished goods manufactured by third party vendors. The cost of inventory is determined using a method that approximates first-in, first-out and are valuedhas been stated at the weighted averagelower of cost method, which approximates cost on a first-in, first-out basis, notor net realizable value.excess of market value.Property, Equipment and DepreciationProperty and equipment are stated at cost. Depreciation is computed over the estimated useful life of three to five years using the straight-line method. The Company follows the provisions of the Financial Accounting Standards Board (“FASB”)We account for our investments in marketable securities in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 121, “Accounting115, Accounting for Certain Investments in Debt and Equity Securities, and FASB Staff Position SFAS No. 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. We determine the appropriate classification of our investments at the time of purchase and reevaluate such designation at each balance sheet date. Our investments in marketable securities have been classified and accounted for as available-for-sale based on management’s investment intentions relating to these securities. Available-for-sale marketable securities are stated at market value based on market quotes. Unrealized gains and losses, net of deferred taxes, are recorded as a component of other comprehensive income (loss). We follow the guidance provided by Emerging Issues Task Force (“EITF”) Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment of Long-lived Assets and for Long-lived AssetsIts Application to Certain Investments, to assess whether our investments with unrealized loss positions are other than temporarily impaired. Realized gains and losses and declines in value judged to be Disposed Of.” Long-lived assets and certain identifiable intangibles to be held and used by the Companyother than temporary are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company continuously evaluates the recoverability of its long-lived assetsdetermined based on estimated future cash flows fromthe specific identification method and are reported in other income (expense), net in the consolidated statements of income.fair value of such long-lived assets, and provides for impairment if such undiscounted cash flows are insufficient to recover the carrying amountuseful lives of the long-lived asset.PatentsThe carrying value ofIn fiscal year 2008 PTSC’s patents were fully amortized.periodically reviewedaccounted for using the equity method of accounting since the investment provides us the ability to exercise significant influence, but not control, over the investee. Significant influence is generally deemed to exist if we have an ownership interest in the voting stock of the investee of between 20% and impairments,50%, although other factors, such as representation on the investee’s board of directors, are considered in determining whether the equity method of accounting is appropriate. Under the equity method of accounting, the investment, originally recorded at cost, is adjusted to recognize our share of net earnings or losses of the investee and is recognized in the consolidated statements of income in the caption “Equity in earnings of affiliated companies”.are recognized whenis measured based on fair value and is charged to operations in the expected future benefitperiod in which long-lived asset impairment is determined by management. At May 31, 2008, management believes there is no impairment of our long-lived assets. There can be no assurance, however, that market conditions will not change or demand for our products will continue, which could result in impairment of long-lived assets in the future.derived from individual intangible assets is less than its carryingvariable. We determined that the reset conversion feature was an embedded derivative instrument and that the conversion option was an embedded put option pursuant to SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, and EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock. The accounting treatment of derivative financial instruments required that we record the derivatives and related warrants at their fair values as of the inception date of the convertible debenture agreements and at fair value determined based onas of each subsequent balance sheet date. In addition, under the provisions of EITF Issue No. 00-19, as a result of entering into the convertible debenture agreements, we were required to classify all other non-employee warrants as derivative liabilities and record them at their fair values at each balance sheet date. Any change in fair value was recorded as non-operating, non-cash income or expense at each balance sheet date. If the fair value of the derivatives was higher at the subsequent balance sheet date, we recorded a non-operating, non-cash charge. If the fair value of the derivatives was lower at the subsequent balance sheet date, we recorded non-operating, non-cash income.May 31, 2006 Estimated dividends None Expected volatility 101 - 229% Risk-free interest rate 3.5 - 5.1% Expected term (years) 2 - 7 121130, Reporting Comprehensive Income. For the fiscal year ended May 31, 2008, this amount included unrealized losses on investments classified as discussed above.on the shipment to our customers of communication products, microprocessor integrated chips and evaluation boards. We anticipate that in the future we will also derive revenue from fees for the transfer of proven and reusable intellectual property components or the performance of engineering services. We anticipate to enter into licensing agreements that will provide licensees the right to incorporate our intellectual property components in their products with terms and conditions that we anticipate to vary by licensee. Generally, we anticipate these payments will include a nonrefundable technology license fee, which will be payable upon the transfer of intellectual property, or a nonrefundable engineering service fee, which generally will be payable upon achievement of defined milestones. In addition, we anticipate these agreements will include royalty payments, which will be payable upon sale of a licensee’s product, and maintenance and limited support fees. We will classify all revenue that involves the future sale of a licensee’s products as royalty revenue. Royalty revenue will be generally recognized in the quarter in which a report is received from a licensee detailing the shipments of products incorporating our intellectual property components (i.e., in the quarter following the sale of our product upon shipment to the customer, at which time title transfers and we have no further obligations. Fees for maintenance or support are recorded on a straight-line basis over the underlying period of performance. Revenue from technology license agreements is recognized at the time we enter into a contract, determine the license method (paid-in-advance or on-going royalty), and provide the customer with the licensed technology, if applicable.byand recognizes revenue on its short-term installation contracts as time and materials costs are incurred.licensee). We will classify all revenue thatdate of sale to the end user. The warranty does not involvecover damage to the future saleproduct after it has been delivered to the distributor. SSDI’s stocking distributor agreements also allow limited rights to periodic stock rotation. These rotation rights allow for the exchange of a licensee’spercentage of distributor inventory for replacement products primarily license fees and engineering service fees and maintenance and support fees, as contract revenue. License fees will be recognized upon the execution of the license agreementdistributor’s choosing. At May 31, 2008, SSDI has evaluated the potential for rotated product and transfer ofF-9Patriot Scientific CorporationSummary of Accounting Policies (Continued)intellectual property,has provided no further significant performance obligations exist and collectibility is deemed probable.Fees related to engineering services contracts, which will be performed on a best efforts basis and for which we will receive periodic milestone payments, will be recognized as revenue over the estimated development period, usingimpact in the accounting records. cost-based percentagemajority of completion method. Annual maintenancesales to Anixter during the fiscal year 2007, and supportAnixter, Graybar Electric Company, Inc. and Victory Global Solutions, Inc. during fiscal year 2008.which will be renewable by the licensee, willbilled to customers to be classified as contract revenue and willshipping and handling costs to be amortized overclassified as either cost of sales or disclosed in the periodnotes to the financial statements. SSDI includes shipping and handling fees billed to customers in net sales. Shipping and handling costs associated with inbound freight are included in cost of support, generally 12 months.Research and Development Costssales.Research and development costs are expensed as incurred. The Company expensesAdvertising expensesFor the fiscal year ended May 31, 2008, we incurred $2,097 of advertising costs. There were approximately $9,000, $7,400 and $2,100no advertising costs for the years ended May 31, 2002, 20012007 and 2000, respectively.The Company accounts “Accounting Accounting for Income Taxes”Taxes. Deferred income taxes are recognized for the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each year end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. tax expense isTaxes – An Interpretation of FASB Statement No. 109, (“FIN 48”), on June 1, 2007, the combinationfirst day of fiscal 2008. FIN 48 seeks to reduce the tax payablediversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. FIN 48 prescribes a recognition threshold and measurement requirement for the yearfinancial statement recognition of a tax position that has been taken or is expected to be taken on a tax return and the change during the yearalso provides guidance on derecognition, classification, interest and penalties, accounting in deferredinterim periods, disclosure and transition. Under FIN 48 we may only recognize tax assets and liabilities.LossIncome Per ShareThe Company applies“EarningsEarnings Per Share”Share, for the calculation of “Basic”"Basic" and “Diluted”"Diluted" earnings (loss) per share. Basic earnings (loss) per share includes no dilution and is computed by dividing income (loss) available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share reflectreflects the potential dilution of securities that could share in the earnings (loss) of an entity. Year Ended May 31, 2008 Numerator (Income) Denominator (Shares) Per Share Amount Basic EPS: Net income $ 9,388,321 390,956,153 $ 0.02 Diluted EPS: Effect of dilutive securities: Options and warrants - 6,529,546 Income available to common shareholders $ 9,388,321 397,485,699 $ 0.02 Year Ended May 31, 2007 Numerator (Income) Denominator (Shares) Per Share Amount Basic EPS: Net income $ 23,691,187 378,036,989 $ 0.06 Diluted EPS: Effect of dilutive securities: Options and warrants - 35,562,384 Income available to common shareholders $ 23,691,187 413,599,373 $ 0.06 Year Ended May 31, 2006 Numerator (Income) Denominator (Shares) Per Share Amount Basic EPS: Net income $ 28,672,688 316,100,499 $ 0.09 Diluted EPS: Interest on convertible debentures 458,467 Effect of dilutive securities: Options and warrants - 80,273,769 Convertible debentures - 16,588,905 Income available to common shareholders $ 29,131,155 412,963,173 $ 0.07 accounting principlesin the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities at the date ofin the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.accompanying footnotes. Actual results could differ from those estimates.2002, based upon information then available,2007, we classified excess tax benefits of $25,645 as financing cash inflows.Company revised its estimates regardingyear ended May 31, 2008 resulted in a net reduction in a deferred income tax asset of $636,245 because the recovery of certain inventories. As a result,share-based compensation cost previously recognized by us was greater than the Company increased existing reservesdeduction allowed for obsolescence by $111,381.F-10Patriot Scientific CorporationSummary of Accounting Policies (Continued)Sale of Accounts ReceivableThe Company has adopted SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”). SFAS 140 provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. A $400,000 factoring line established by the Company with a bank enables the Company to sell selected accounts receivable invoices to the bank with full recourse against the Company. These transactions qualify for a sale of assets since (1) the Company has transferred all of its right, title and interest in the selected accounts receivable invoices to the bank, (2) the bank may pledge, sell or transfer the selected accounts receivable invoices, and (3) the Company has no effective control over the selected accounts receivable invoices since it is not entitled to or obligated to repurchase or redeem the invoices before their maturity and it does not have the ability to unilaterally cause the bank to return the invoices. Under SFAS 140, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. During fiscal 2002 and 2001, the Company sold approximately $193,000 and $82,000, respectively, of its accounts receivable to a bank under a factoring agreement for approximately $177,000 and $66,000, respectively. Pursuant to the provisions of SFAS 140, the Company reflected the transaction as a sale of assets and established an accounts receivable from the bank for the retained amount less the costs of the transaction and less any anticipated future loss in the value of the retained asset. The retained amount is equal to 20% of the total accounts receivable invoice sold to the bank less 1% of the total invoice as an administrative fee and 1.75% per month of the total outstanding accounts receivable invoices as a finance fee. The estimated future loss reserve for each receivable included in the estimated value of the retained asset isincome tax purposes based on the payment history of the accounts receivable customer. The Company collected the entire retained amount and there were no balances for retained amounts outstanding at May 31, 2002. Also, at May 31, 2002, the entire line of $400,000 is available for future factoring of accounts receivable invoices.Stock OptionsThe Company applies Accounting Principles Board (“APB”) Opinion 25, “Accounting for Stock Issued to Employees,” and related Interpretations in accounting for all stock option plans. Under APB Opinion 25, compensation cost has been recognized for stock options granted to employees when the option price is less than the market price of the underlyingour common stock on the date of grant.“Accounting for Stock-Based Compensation,” requires the Company to provideoptions granted under our stock option plans. For purposes of this pro forma information regarding net incomedisclosure, the fair value of the options is estimated using the Black-Scholes option-pricing model and amortized on a straight-line basis to expense over the options' vesting period: Net income - as reported $ 28,672,688 Add: Share-based employee compensation included in net income, net of tax effects 120,000 Deduct: Share-based employee compensation expense determined under fair value method, net of tax effects (1,639,913 ) Net income - pro forma $ 27,152,775 Net income per common share - as reported Basic $ 0.09 Diluted $ 0.07 Net income per common share - pro forma Basic $ 0.09 Diluted $ 0.07 ifof the date of the grant. The expected volatility for the fiscal years ended May 31, 2008, 2007 and 2006 is based on the historical volatilities of our common stock. These factors could change in the future, affecting the determination of stock-based compensation expense in future periods.Expected term 5 yrs 5 yrs 5 yrs Expected volatility 122 - 128% 146 – 156% 115 – 158% Risk-free interest rate 2.23 - 4.96% 4.78 - 5.00% 3.78 - 4.93% Expected dividends 2.82% - - Shares Weighted Average Exercise Price Weighted Average Remaining Contractual Term (Years) Aggregate Intrinsic Value Options outstanding at June 1, 2007 7,245,000 $ 0.40 Options granted 6,625,000 $ 0.43 Options exercised (1,282,846 ) $ 0.15 Options forfeited (4,392,154 ) $ 0.45 8,195,000 $ 0.44 3.79 $ 182,900 7,998,519 $ 0.44 3.77 $ 182,900 4,265,372 $ 0.47 2.95 $ 182,900 Company’sgrants.option plans had been determined in accordance with the fair value based method prescribed inoptions under SFAS No. 123. To provide123(R) for the required pro forma information,fiscal years ended May 31, 2008 and 2007, which was recorded as follows: Year Ended Year Ended May 31, 2008 May 31, 2007 Selling, general and administrative expense $ 502,770 $ 2,356,000 Company estimates the fair valueapplication of each stock option at the grant date by using the Black-Scholes option-pricing model.The Company applies SFAS No. 123 in valuing options granted to consultants and estimates the fair value of such options using the Black-Scholes option-pricing model. The fair value is recorded asF-11Patriot Scientific CorporationSummary of Accounting Policies (Continued)consulting expense as services are provided. Options granted to consultants109 by defining criteria that an individual tax position must meet for which vesting is contingent based on future performance are measured at their then current fair value at each period end, until vested.Recent Accounting Pronouncements In June 1998, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” amended by SFAS No. 137, “Accounting for Derivative Instruments and Hedging Activities- Deferralany part of the Effective Datebenefit of FASB No. 133,”that position to be recognized in a company’s financial statements and SFAS No. 138, “Accounting for Certain Derivative Instrumentsalso provides guidance on measurement, derecognition, classification, interest and Certain Hedging Activities” which requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair market value. Gains or losses resulting from changespenalties, accounting in the valuesinterim periods, disclosure and transition. The adoption of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. The key criterion for hedge accounting is that the hedging relationship must be highly effective in achieving offsetting changes in fair value or cash flows. SFAS No. 133 was effective for usFIN 48 on June 1, 2001. The adoption2007 did not result in any cumulative effect adjustment to retained earnings. Interest and penalties, if any, related to unrecognized tax benefits are recorded in income tax expense. As of this statement had no material impact on our financial statements.June 2001,September 2006, the FASB issued SFAS No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets”157, Fair Value Measurements. SFAS No. 141 requires157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principals and expands disclosures about fair value measurements. The statement does not require new fair value measurements, but is applied to the extent that other accounting pronouncements require or permit fair value measurements. The statement emphasizes that fair value is a market-based measurement that should be determined based on the assumptions that market participants would use in pricing an asset or liability. Companies that have assets and liabilities measured at fair value will be required to disclose information that enables the users of its financial statements to access the inputs used to develop those measurements. The reporting entity is encouraged, but not required, to combine the fair value information disclosed under this statement with the fair value information disclosed under other accounting pronouncements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We expect to adopt SFAS No. 157 on June 1, 2008. In February 2008, the FASB released FASB Staff Position 157-2, Effective Date of FASB Statement No. 157, which delayed the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) until the fiscal year beginning May 31, 2009. We are in the process of evaluating the provisions of the purchase method of accounting and prohibitsstatement, but do not anticipate that the use of the pooling-of-interests method of accounting for business combinations initiated after June 30, 2001. SFAS No. 141 also requires that companies recognize acquired intangible assets apart from goodwill if the acquired intangible assets meet certain criteria. SFAS No. 141 applies to all business combinations initiated after June 30, 2001 and for purchase business combinations completed on or after July 1, 2001. It also requires, upon adoption of SFAS No. 142, that companies reclassify157 will have a material impact on our consolidated financial statements.carrying amounts of intangible assets and goodwill based on the criteria inFASB issued SFAS No. 141.142 requires, among159 permits entities to choose to measure at fair value many financial instruments and certain other things,items that companies no longer amortize goodwill, but instead test goodwill for impairment at least annually. In addition, SFAS No. 142 requires that companies identify reporting units for the purposes of assessing potential future impairments of goodwill, reassess the useful lives of other existing recognized intangible assets, and cease amortization of intangible assets with an indefinite useful life. An intangible asset with an indefinite useful life should be tested for impairment in accordance with the guidance in SFAS No. 142. SFAS No.142 isare not currently required to be appliedmeasured at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value. SFAS No. 159 does not establish requirements for recognizing and measuring dividend income, interest income, or interest expense. This Statement does not eliminate disclosure requirements included in other accounting standards. SFAS No. 159 is effective in fiscal years beginning after November 15, 2007. We are in the process of evaluating the provisions of the statement, but do not anticipate that the adoption of SFAS No. 159 will have a material impact on our consolidated financial statements.20012008. We expect to all goodwill and other intangible assets recognized at that date, regardless of when those assets were initially recognized.adopt SFAS No. 142 requires companies to complete a transitional goodwill impairment test six months from141(R) on June 1, 2009. We are currently assessing the date of adoption. Companies are also required to reassess the useful lives of other intangible assets within the first interim quarter after adoption of SFAS No. 142. Upon the adoption of this statement no material impact on our financial statements is expected. Our previous business combinations were accounted for using the pooling-of-interests method. The pooling-of-interests method does not result in the recognition of acquired goodwill or other intangible assets. As a result, the adoption of SFAS No. 141 and No. 142141(R) will not affect the results of past acquisition transactions. However, all future business combinations will be accounted forF-12Patriot Scientific CorporationSummary of Accounting Policies (Continued)under the purchase method, which may result in the recognition of goodwill and other intangible assets, some of which will be recognized through operations, either by amortization or impairment charges, in the future. We will be required to reassess the useful lives ofhave on our intangible assets within the first fiscal quarter of 2003.June 2001,December 2007, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.”160, Noncontrolling Interests in Consolidated Financial Statements. SFAS No. 143160 requires the fair value of a liability for an asset retirement obligationentities to be recognizedreport noncontrolling (minority) interests in subsidiaries as equity in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset.consolidated financial statements. SFAS No. 143160 is effective for the fiscal year ending May 31, 2003. Upon the adoption of this statement no material impact on our financial statements is expected.In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 requires that those long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. Therefore, discontinued operations will no longer be measured at net realizable value or include amounts for operating losses that have not yet occurred. SFAS No. 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001 and, generally, is2008. We expect to be applied prospectively. The adoption of this statement mayadopt SFAS No. 160 on June 1, 2009. We are currently assessing the impact the presentation of information in our future financial statements.In April 2002, FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. This statement eliminates the current requirement that gains and losses on debt extinguishment must be classified as extraordinary items in the income statement. Instead, such gains and losses will be classified as extraordinary items only if they are deemed to be unusual and infrequent, in accordance with the current GAAP criteria for extraordinary classification. In addition, SFAS 145 eliminates an inconsistency in lease accounting by requiring that modifications of capital leases that result in reclassification as operating leases be accounted for consistent with sale-leaseback accounting rules. The statement also contains other nonsubstantive corrections to authoritative accounting literature. The changes related to the debt extinguishment will be effective for fiscal years beginning after May 15, 2002. Adoption of this standard will not have any effect on the Company’s consolidated financial statements.In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force (EITF) Issue No. 94-3. The Company will adopt the provisionsadoption of SFAS No. 146160 will have on our consolidated financial statements.restructuring activities initiated after Decemberdoubtful accounts has been recorded for the fiscal years ended May 31, 2002. SFAS No. 146 requires that2008 or 2007.liability for costs associated$50,000 note receivable to us and we agreed to reduce the amount of our line of credit with an exit or disposal activitySSDI by the amount of the note receivable. On June 26, 2008, we were paid in full by the third party debtor.recognized when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was recognizeddue with principal at the dateearlier of (i) September 30, 2008, (ii) consummation of a company’s commitmentequity financing by Crossflo which closes on or before September 30, 2008, in which Crossflo sells and issues shares of its convertible preferred stock resulting in aggregate gross proceeds to Crossflo of at least $2.5 million (a “Qualified Financing”), or (iii) upon or after the occurrence of an exit plan. SFAS No. 146 also establishes thatevent of default, as defined. The note is secured by substantially all assets of Crossflo.liability should initiallyentire principal is automatically convertible into shares of Crossflo’s Series F convertible preferred stock at the closing of a Qualified Financing. The number of shares of Series F convertible preferred stock to be measuredissued upon automatic conversion of the principal amount is the greater of (i) 4% of Crossflo’s then issued and recorded at fair value. Accordingly, SFAS No. 146outstanding equity securities, and (ii) the principal amount divided by the per share purchase price paid by the investors participating in the Qualified Financing. Upon an event of default, as defined, the principal amount of the note may affectbe converted into shares of Crossflo’s Series F convertible preferred stock equal to 4% of Crossflo’s then issued and outstanding equity securities. Upon maturity on September 30, 2008, the timingprincipal amount of recognizing future restructuring costs as wellF-13Summary of Accounting Policies (Continued)as the amount recognized. Adoption of this standard will not have any effect on the Company’s consolidated financial statements.F-14Patriot Scientific Corporation1. Continued Existence and Management’s PlanOur consolidated financial statements are presented on (Continued)going concern basis, which contemplatessecured convertible promissory note from Crossflo, we also received a warrant to purchase 200,000 shares of Crossflo’s common stock at $0.20 per share. Notwithstanding the realization of assets and the satisfaction of liabilitiesforegoing, in the normal courseevent a Qualified Financing is not consummated prior to September 30, 2008, the warrant will instead be exercisable into 1,000,000 shares of business. Our abilityCrossflo’s common stock at $0.20 per share. The warrant is exercisable until the earlier of (i) October 11, 2012, (ii) the closing of an underwritten public offering by Crossflo pursuant to continuea registration statement under the Securities Act, (iii) the closing of a merger or other reorganization by Crossflo with another entity, or (iv) the closing of a sale of all or substantially all of the assets of Crossflo. The value attributed to the warrant was insignificant, and accordingly, the principal amount of the loan has been recorded as a going concern is contingent upon our obtaining sufficient financing to sustain our operations. We incurred a net loss of $5,487,051, $4,968,903 and $7,488,708 and negative cash flow from operations of $3,632,534, $4,839,180 and $3,483,050 in the years endednote receivable at May 31, 2002, 2001 and 2000, respectively. At2008.2002, we had deficit working capital2008, the balance of $918,768 and cash and cash equivalentsthe note receivable is $400,115, including accrued interest receivable of $88,108. We have historically funded our operations primarily through the issuance of securities and debt financings. Cash and cash equivalents decreased $376,242$115 recognized during the year ended May 31, 2002.estimateoriginally accounted for our loan receivable, and related accrued interest, due from Holocom at cost. In accordance with SFAS No. 114, Accounting by Creditors for Impairments of a Loan, based on current cash requirementsinformation and events, we determined that we were unable to sustain our operations forcollect all amounts due from Holocom according to the next twelvecontractual terms of the Line of Credit Agreement. As a result, we determined that the loan receivable was impaired. Accordingly, we recorded an impairment loss of $339,551 during the three months through May 2003ended February 28, 2007. The impairment loss was determined based on an independent valuation of the assets of Holocom acquired in the foreclosure sale and management’s analysis of the fair value of such assets at time of acquisition.be $2.4 million. Since we are attempting to sell the communications product line, we are assuming that there will be no communications product revenue. We have a note payable to Swartz of $635,276SSDI.2002 which is due in November 2002. We also have a convertible debenture with one investor as2008, consisted of raw materials of $142,410 and finished goods of $245,731. Inventory at May 31, 20022007, consisted of $225,000 and have received advances against additional convertible denturesraw materials of $283,000. In addition to limitations based on trading volume and market price of the common stock, our ability to obtain equity financing under the $25 million equity line of credit (see Note 7 to the consolidated financial statements) is dependent on our having registered shares of our common stock to sell to Swartz Private Equity, LLC (“Swartz”). As of May 31, 2002, we do not have any registered shares to sell to Swartz. Subsequent to May 31, 2002, we completed the first funding of the convertible debentures by receiving an additional $492,000. At the option of the debenture holders, they may purchase additional debentures up to $1 million at any time during the next two years as long as the price of our common stock is in excess of $0.20 per share.The terms of the $25 million equity line of credit, including limitations on the amount of shares that can be sold to Swartz based on the trading volume and market price of the common stock and the potential additional amounts that may be raised under the convertible debentures may not provide funds sufficient to meet our cash requirements. In order to meet our cash requirements, we may need to receive additional advances from Swartz, secure short-term debt, private placement debt and/or equity financings with individual or institutional investors. In addition to the cost reduction plan implemented during the current fiscal year, including the reduction in personnel, we may need to make additional cost reductions if our cash requirements cannot be met from external sources. We expect that the $2.4 million requirement will be provided by:•the additional funds received subsequent to May 31, 2002, related to the convertible debentures of $492,000;•optional amounts which may received under the convertible debentures of $1,000,000;F-15•additional funds under the $25 million equity line of credit if we are successful in registering additional shares of common stock, limitations based on trading volume and market price of the common stock allow adequate funding, and such available funding exceeds the remaining balance of the note payable to Swartz;•proceeds from the exercise of outstanding stock options and warrants; and•additional debt and/or equity financings. Short-term Accrued interest - auction rate securities $ 288,099 $ — $ 288,099 Long-term Auction rate securities 12,900,000 (372,325 ) 12,527,675 Total $ 13,188,099 $ (372,325 ) $ 12,815,774 addition,the event we need to access funds invested in these auction rate securities we would not be able to liquidate these securities until (i) a future auction of these securities is successful, (ii) they are refinanced and redeemed by the issuers, or (iii) a buyer is found outside of the auction process. The investments consist of student loan auction rate instruments issued by various state agencies pursuant to the Federal Family Educational Loan Program (“FFELP”). These investments are of high credit quality and the AAA credit ratings of the investments have been reaffirmed since May 2008. These instruments are collateralized in excess of the underlying obligations, are insured by the various state educational agencies, and are guaranteed by the Department of Education as an insurer of last resort. We have the intent and the ability to hold these investments until the anticipated recovery period.formulated additional cost reduction plans which can be implemented if the required funds are not obtainable. We also have remaining a $400,000 accounts receivable factoring agreement withclassified our bank; however, we have no eligible accounts receivable to factorauction rate securities as long- term investments in our consolidated balance sheet as of May 31, 2002.anticipatewill continue to evaluate the fair value of our future revenueinvestments in auction rate securities each reporting period for a potential other-than-temporary impairment.be derived primarily from50% of the salepar value balance of licensesour outstanding auction rate securities. The facility is collateralized by the full value of the outstanding auction rate securities, required no origination fee, and royalties. To receive this revenue, we may require additional equipment, fabrication, components and supplies duringif drawn upon will bear interest at the next twelve months to support potential customer requirements and further develop our technologies. Product introductions such as those currently underway for the Ignite I and JUICEtechnology may require significant product launch, marketing personnel and other expenditures that cannot be currently estimated. Further, if expanded development is commenced or new generations of microprocessor technology are accelerated beyond current plans, additional expenditures we cannot currently estimate, may be required. It is possible therefore, that higher levels of expenditures may be required than we currently contemplate resulting from changes in development plans or as required to support new developments or commercialization activities or otherwise.Based on our current plan and assumptions, we anticipate that we will be able to meet our cash requirements for the next twelve months. We anticipate meeting our cash needs as follows:F-16 Cash available: Cash available at May 31, 2002 $ 88,108 Subsequent advances Additional amounts under convertible debentures received subsequent to May 31, 2002 492,000 Optional amounts under convertible debentures 1,000,000 Available cash under existing agreements 1,580,108 Cash needs: Estimated needs 2,400,000 Note payable to Swartz at November 5, 2002 635,276 Total 3,035,276 Required funds from external sources $ 1,455,168 As shown above, 2008 2007 Computer equipment and software $ 50,802 $ 42,270 Furniture and fixtures 72,981 72,454 Leasehold improvements 5,046 - 128,829 114,724 Le LLess: accumulated depreciation and amortization (60,325 ) (29,206 ) Net property and equipment $ 68,504 $ 85,518 need to obtain $3,035,276. Any additional fundingentered into two separate licensing agreements with one customer for our patent portfolio and Ignite microprocessor technology. The aggregate amount of the two licenses was $3,050,000, of which $2,950,000 was for licensing fees and $100,000 was for maintenance services. Maintenance under the existing $25 million equity line of creditagreement is dependent on many factors. However, there canexpected to be no assurance that any funds requiredprovided over a period not to exceed four years. Maintenance revenue recognized during the next twelve months or thereafter can be generated fromfiscal years ended May 31, 2008, 2007 and 2006 was $25,000 per year. The payment terms of the agreements required aggregate payments of $300,000 at the time of execution, three quarterly payments of $750,000 each on April 1, August 15, and November 15, 2005 and one final payment of $500,000 on February 15, 2006. The $500,000 payment due on February 15, 2006 was paid in March 2006. Total payments received in fiscal 2005 amounted to $1,050,000, and total payments received in fiscal 2006 amounted to $2,000,000. The agreements also provide for the future payment of royalties to us based on sales of common stockproduct using the Ignite licensed technology. In connection with this license agreement, we became obligated to the co-inventor of the patent portfolio technology for $207,600 pursuant to a July 2004 agreement under which we were obligated to pay a percentage of all patent portfolio licensing proceeds to the co-inventor. The amount due under that license was payable in four installments of $51,900. The co-inventor of the patent portfolio technology filed a lawsuit against us seeking damages and/or enforcement of the July 2004 agreement. We challenged the enforceability of the agreement by counterclaim in that action. On February 14, 2007, a settlement of the litigation was finalized. Terms of the settlement required us to pay $3,400,000 in cash on February 14, 2007 and $3,000,000 on May 1, 2007, which amounted to approximately the debt claimed by the co-inventor to be owed to him under the existing $25 million equity line of credit or that we will be able to secure additional debt or equity financing. The lack of additional capital could forceJuly 2004 agreement. In addition, the settlement required us to substantially curtail or cease operationsmake a donation of $15,000 on February 14, 2007 on behalf of Russell H. Fish III (“Fish”) to Maasai Power and would, therefore, haveEducation Project, Inc., and to pay Fish the equivalent of 4% of 50% of the next $100 million of gross license fees as they are collected by PDS and as distributions are made to us, after excluding the first $20 million collected by PDS after December 1, 2006. Our commitment to make payments to Fish related to such future license revenues was limited to $2 million. During the fiscal years ended May 31, 2008 and 2007, we recorded $836,400 and $7,524,537, respectively in settlement and license expenses relating to royalty payments due to the Fish parties. In January 2008, we made the final payment under the Fish settlement agreement.material adverse effect onMaster Agreement (the “Master Agreement”) with TPL, and Charles H. Moore (“Moore”), the co-inventor of certain of our business. Further, there can be no assurance thattechnology, pursuant to which we, will be ableTPL and Moore resolved all legal disputes between us. Pursuant to timely receive shareholder approvalthe Master Agreement, we and TPL entered into the Limited Liability Company Operating Agreement of PDS (the “LLC Agreement”) into which we and Moore contributed our rights to increase the numbercertain of authorized shares or that required funds, if available, will be available on attractive terms or that they will not have a significantly dilutive effect on our existing shareholders. As such, there is substantial doubt about our ability to continue as a going concern. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from our possible inability to continue as a going concern.F-172.Inventories Inventories consisted the following: May 31, 2002 2001 Component parts $ 301,548 $ 343,430 Work in process — 20,000 Finished goods 71,833 121,963 373,381 485,393 Reserve for obsolescence (373,381 ) (262,000 ) $ — $ 223,393 3.Property and Equipment Property and equipment consisted of the following: May 31, 2002 2001 Computer equipment and software $ 1,660,707 $ 1,593,907 Furniture and fixtures 499,274 493,649 Laboratory equipment 205,594 205,594 2,365,575 2,293,150 Less accumulated depreciation and amortization 2,080,087 1,869,622 Net property and equipment $ 285,488 $ 423,528 Depreciation expense was $211,850, $186,621 and $283,952 for the years ended May 31, 2002, 2001 and 2000 4.Note Receivable In June 2000, the Companymembership interests of PDS, and each of us has the right to appoint one member of the three member management committee. The two appointees are required to select a mutually acceptable third member of the management committee. Pursuant to the LLC Agreement, we and TPL agreed to establish a working capital fund for PDS of $4,000,000, of which our contribution was $2,000,000. The working capital fund increases to a maximum of $8,000,000 as license revenues are achieved. We and TPL are obligated to fund future working capital requirements at the discretion of the management committee of PDS in order to maintain working capital of not more than $8,000,000. Neither we nor TPL are required to contribute more than $2,000,000 in any fiscal year. Distributable cash and allocation of profits and losses will be allocated to the members in the priority defined in the LLC Agreement. PDS has committed to pay a quarterly amount ranging between $500,000 and $1,000,000 (based upon a percentage of the working capital fund balance of PDS) for supporting efforts to secure licensing agreements by TPL on behalf of PDS. During the fiscal years ended May 31, 2008, 2007 and 2006, PDS paid $2,952,362, $3,871,602 and $2,500,000, respectively, to TPL pursuant to this commitment.three-year, $80,000 Secured Promissory Note Receivablelicense agreement with an individual whoa third party pursuant to which we received $10,000,000. This amount was at the time of the issuance of the note, an executive officer of the Company. The note is due on June 12, 2003. On September 25, 2000, he requested and was relieved of his duties as an executive officer and director of the Company. The note bears interest at the rate of 6% per annum with interest payments due semi-annually and the principal due at the maturity of the note. The individual pledged 100,000 shares of the Company’s common stock that he held on the date of issuance as security for this note.F-18Patriot Scientific CorporationNotes to Consolidated Financial Statements (Continued)5.Secured Note PayableOn March 12, 2002, we replaced and superceded a previously issued Secured Promissory Note with Swartz with an Amended Secured Promissory Note and Agreement with an effective date of October 9, 2001 and an Addendum to Amended Secured Promissory Note dated March 12, 2002. The amended note matures on October 9, 2002 and amounts outstanding under the note bear interest at the rate of 5% per annum. Upon mutual agreement between Swartz and us, Swartz may advance additional amounts under the amended note. Per the addendum to the amended note, principal and interest payments are deferred until October 9, 2002.As part of the consideration for entering into the above amended note, we agreed to issue warrants to Swartz related to each advance against the note. In connection with each advance, we issued to Swartz a warrant to purchase a number of shares of common stock equal to the amount of the advance multiplied by 8.25 at an initial exercise price equal to the lesser of (a) the factor of the average of the volume weighted average price per share, as defined by Bloomberg L.P., for each trading day in the period beginning on the date of the previous advance and ending on the trading day immediately preceding the date of the current advance multiplied by .70 or (b) the volume weighted average price per share minus $0.05. In addition, if after March 12, 2002, we issue common stock to any parties other than Swartz, we are obligated to issue to Swartz warrants equal to 20% of the common stock so issued. The amended note also gives to Swartz the right of first refusal and rights to participate in subsequent debt or equity transactions entered into by us through March 15, 2003.As of May 31, 2002 we issued warrants to purchase up to 12,188,150 shares of our common stock in accordance with the amended note agreement. The warrants issued were valued using the Black-Scholes pricing model based on the expected fair value at issuance and the estimated fair value was also recorded as debt discount. See Note 7 to the consolidated financial statements for discussion of the terms of the warrantsThe note is secured by our assets.All debt discounts are to be amortized as additional interest expense over the projected term of the note payable. As of May 31, 2002, $1,107,238 has been reflected as debt discount of which $917,722 was amortized to interest expenselicense revenue during the year ended May 31, 2002. Advances against the note $ 1,790,000 Less amount applied against $30 million equity line of credit (227,800 ) Less amount applied against $25 million equity line of credit (926,924 ) Less debt discount Total 1,107,238 Amount amortized to expense (917,722 ) (189,516 ) Note payable at May 31, 2002 $ 445,760 F-19 2008 2007 Cash and cash equivalents $ 8,260,288 $ 6,989,847 Prepaid expenses - 175,000 Total assets $ 8,260,288 $ 7,164,847 Accounts payable and accrued expenses $ 3,204,519 $ 1,385,118 Income taxes payable 11,790 11,790 Members’ equity 5,043,979 5,767,939 Total liabilities and members’ equity $ 8,260,288 $ 7,164,847 2008 2007 2006 License revenues $ 59,282,971 $ 110,878,985 $ 60,000,000 Operating expenses 18,627,032 12,189,575 4,486,955 Operating income 40,655,939 98,689,410 55,513,045 Interest income 216,902 421,407 183,682 Income before income taxes 40,872,841 99,110,817 55,696,727 Provision for income taxes 11,790 11,790 - Net income $ 40,861,051 $ 99,099,027 $ 55,696,727 November 9, 2001, an offsetMay 16, 2008, we paid $400,000 to acquire a 15.09% share in Talis, a company that produces multi-domain computer and network security products to government, military, and enterprise customers. Talis develops and markets PCs incorporating the company's Datagent security device, a patented, hardware based data security solution that avoids the vulnerability of $227,800software–based approaches.saleacquisition of 2,500,000all Talis shares previously held by SSDI. The acquisition of common stockSSDI’s Talis shares was applied against the final put under the $30 million equitymade for $100,000 in cash and a reduction on their outstanding line of credit discussed below. The excess of $219,000.market valueequity method of accounting, as our limited liability company share is deemed more than minor. We have recorded our share of Talis’ net loss of $8,376 during the underlying 2,500,000 shares of common stock over the principal reduction of $227,800 wasperiod ended May 31, 2008 as a decrease in our investment. Our investment in Talis is $391,624 at May 31, 2008 and has been recorded as additional interest expense“Investments in Affiliated Companies”. We have recorded our share of $197,250 duringTalis’ net loss as “Equity in Earnings of Affiliated Companies” in the accompanying consolidated statement of income for the year ended May 31, 2002.May 30, 2002,February 2, 2007, we invested an offsetaggregate of $926,924 from the sale of 14,100,000$370,000 in SSDI for 2,100,000 shares of convertible preferred stock. This represents all of SSDI’s preferred stock and a 46% ownership interest in SSDI, a California corporation that manufactures products that protect information transmitted over secure networks. The investment consisted of certain assets contributed by us to SSDI valued at $250,000 and cash of $120,000. The shares are convertible at our option into shares of SSDI’s common stock was applied againston a one-to-one basis. The convertible preferred stock entitles us to receive non-cumulative dividends at the first put underper annum rate of $0.04 per share, when and if declared by the $25 million equityBoard of Directors of SSDI. The investment in SSDI’s convertible preferred stock also entitles us to a liquidation preference of $0.40 per share, plus an amount equal to all declared but unpaid dividends.discussed below.with SSDI for a maximum amount of $500,000. The line of credit matures on September 27, 2008. If we do not provide notice to SSDI at least 90 days prior to the maturity date, the maturity date automatically extends 12 months. The line of credit is collateralized by all assets presently owned or hereafter acquired by SSDI. The carrying value of the collateral is approximately $765,861 at May 31, 2008. The creditors of SSDI do not have recourse to our other assets. During the fiscal years ended May 31, 2008 and 2007 we advanced $250,000 and $250,000, respectively, under terms of the agreement. The total amount drawn on the line of credit at May 31, 2008 is $500,000 of which $100,000 has been repaid. On June 18, 2008, we gave SSDI notice under terms of the line of credit that we would not be extending the maturity date by the additional twelve month period provided for in the line of credit. As a result, the line of credit will terminate, and full payment of any outstanding balance will be due on September 27, 2008.market value of the underlying 14,100,000 sharesnoncontrolling interest’s equity. For the period in which we were initially required to consolidate, March 27, 2007 through May 31, 2007 we absorbed $169,913 of common stock overSSDI’s losses as we are the principal reduction of $926,924 was recorded as additional interest expense of $201,076 duringprimary beneficiary. For the fiscal year ended May 31, 2002.6. 8% Convertible DebenturesOverview.From April 23, 20022008, SSDI had net income of $285,319 after taxes. Under the provisions of FIN 46 (R), we are able to recover our absorbed losses before allocating income to the noncontrolling interest. At May 31, 2008 the minority interest presented in our consolidated financial statements is $115,406, the amount of SSDI’s fiscal 2008 net income after taxes less our absorbed losses during fiscal 2007.10, 2002, we sold an aggregate of $1,000,000 of 8% convertible debentures1, 2008. On June 1, 2008, SSDI assigned this note receivable to a group of six investors. The initial funding of $225,000 was completed on April 23, 2002us and we received additional advancesagreed to reduce the amount of $283,000 asour line of credit with SSDI by the amount of the note. On June 26, 2008 we were paid in full by the third party debtor. 2008 2007 Accrued lease obligation $ 4,006 $ 7,279 Deferred maintenance fee 18,750 43,750 Compensation and benefits 210,153 75,068 Deferred material credit 95,377 163,399 Accrued expenses 45,562 - Royalties payable - 797,000 $ 373,848 $ 1,086,496 towardsthrough fiscal 2005, we raised approximately $5,400,000 through the $775,000 closing on June 10, 2002.issuance of convertible debentures, having stated interest rates ranging from 8% to 12%, to a limited group of investors. The convertible debentures entitleentitled the debenture holderholders to convert the principal, and unpaidany accrued interest thereon, into our common stock through June 10, 2004. In addition, the debenture holder received warrants exercisable into a numbershares of our common shares.Initial Number of Shares Debentures May Be Converted Into.The $225,000 debenture can be converted into a number of our common shares at a conversion price that initially equals $0.10289 per share and the $775,000 debenture can be converted into a number of our common shares at a conversion price that initially equals $0.086 per share.Resets of Conversion Price and Conversion Shares.A reset date occurs on each three month anniversary of the closing date of each debenture and on the date the registration statement filed in June 2002 becomes effective. If the volume weighted average price for our common stock for up to two years from the ten days previousdate of issuance.reset date isconversion price of the debentures. On the measurement dates when the market price was less than the conversion price in effect at the timerate, a new conversion rate was set based on a weighted average of the reset date, then the number of common shares issuable to the selling shareholder on conversion will be increased. If the conversionmarket price is reset, the debenture can be converted into a number of our common shares based on the following calculation: the amount of the debenture plus any unpaid accrued interest divided by the reset conversion price which shall equal the volume weighted average price for our common stock for the ten days previousprior to the reset measurement date.Warrants.to the debenture holders warrants to purchase up to 12,859,175 shares of our common stock. These warrants are exercisable for five years from the date of issuance at either initial negotiated exercise prices or prices equal to 115% of the volume weighted average price for our common stock for the ten days previous to the debenture date. The warrant exercise price is generally subject to being reset on each six monthsix-month anniversary of its issuance.issuance; however, if the warrant holder elects to have the warrant shares registered, then the exercise price is fixed at the price in effect on the date of the election.F-20Options to Purchase Additional Debentures.Subject to the pricebeing equalfrom time to or greater than $0.20time on the open market. The repurchase plan has no maximum number of shares and is solely at the discretion of the Board of Directors. The repurchase plan has no set expiration date. 2008 2007 Number of shares repurchased 8,096,721 13,467,527 Aggregate cost $ 3,891,094 $ 8,832,078 two year limitation, the debenture holders may purchase additional debentures equal to the valuesemi-annual dividend policy contingent upon our financial condition, other possible applications of their initial debentures. The price at which the optional additional debentures could be converted would initially equal 115%available resources, and relevant business considerations.the volume weighted average price for our$0.02 per share of common stock for the ten days previous to the date on which the optional additional debentures were closed.stockholders of record and qualified warrant holders as of February 24, 2006. The optional additional debentures would carry the samedividend of $8,114,378 was paid in March 2006. In March 2006, we announced a dividend of $0.04 per share of common stock for stockholders of record and qualified warrant amounts and reset privilegesholders as the initial debentures.Shareholder Approval.We may currently issue more than 20% of our outstanding shares under the convertible debentures. If we become listed on the NASDAQ Small Cap Market or NASDAQ National Market, then we must get shareholder approval to issue more than 20%March 31, 2006. The dividend of our outstanding shares. Since we are currently a bulletin board company, we do not need shareholder approval.Restrictive Covenants.For a period of 18 months from the date of the debentures, we are prohibited from certain transactions. These include the issuance of any debt or equity securities$16,583,959 was paid in a private transaction which are convertible or exercisable intoApril 2006a price based$0.13 per share (based on the trading pricefair value on the date of issuance) were issued to the common stock at any time after the initial issuanceco-inventor of such securities;certain technology. We recorded an expense of $81,250 in connection with the issuance of any debt or equity securitiesthese shares.fixed conversion or exercise price subjectdispute regarding the number of shares of common stock issued upon conversion. We recorded an expense of $296,129 in connection with the issuance of these shares.adjustment; and any private equity line type agreements without obtaininga former officer in connection with a legal settlement. We recorded an expense of $100,000 in connection with the debenture holders’ prior written approval.Rightissuance of First Refusal.The debenture holders have a right of first refusalthese shares.or participate in any equity securities offered by us in any private transaction which closes on or prior53,349,220 common shares at exercise prices ranging from $0.02 to the date that is two years after the issue date$1.00 per share, expiring at various dates through 2012. Some of each debenture.Asthose outstanding warrants were not exercisable as of May 31, 20022006 as they were subject to meeting vesting criteria. During the year ended May 31, 2006, we issued warrants to purchase up12,457,049 shares of common stock, investors exercised warrants to 2,514,809purchase 8,728,544 shares of common stock for proceeds of $470,657 and investors exercised warrants of 44,110,139 to purchase 41,245,473 shares of common stock on a cashless basis. During the year ended May 31, 2006, we cancelled warrants to purchase 13,391,727 shares of our common stockstock. Included in accordance with the convertible debenture. Theaforementioned warrants issued during the year ended May 31, 2006 were valued using the Black-Scholes pricing model based on the expected fairwarrants to purchase 300,000 shares of common stock issued to a consultant. The value at issuance and the estimated fair valueof these warrants of $176,866 was also recorded as debt discount. See Note 8 to the consolidated financial statements for discussion of the terms of the warrants.All debt discounts are to be amortized as additional interest expense over the projected term of the convertible debenture. As of May 31, 2002, $201,185 has been reflected as debt discount of which $8,383 was amortized to interestan expense during the year ended May 31, 2002.The convertible debenture is secured by our assets.F-21 Convertible debenture dated April 23, 2002 $ 225,000 Advances against convertible debenture dated June 10, 2002 as of May 31, 2002 283,000 Less debt discount Total 201,185 Amount amortized to expense (8,383 ) (192,802 ) Convertible debenture at May 31, 2002 $ 315,198 7. Investment$5 Million Equity Line we and the warrant holders agreed to amend the terms of Credit AgreementFebruary 1999,consideration for entering into the Companyagreements, we issued warrants for the right to acquire 7,000,000 shares of our common stock to one warrant holder and recognized a loss on debt extinguishment of $445,427 (see Note 12).investment agreementAntidilution Agreement (the “Antidilution Agreement”) with Swartz Private Equity, LLC (“Swartz”). The investment agreement entitled the Company, at the Company’s option, wherein we were obligated to issue and sell its common stock for up to an aggregate of $5 million from time to time during a three-year period through February 24, 2002, subject to certain conditions including (1) an effective registration statement must be on file with the SEC registering the resale of the common shares, and (2) a limitation on the number of common shares which could be sold to Swartz within a 30 day time period based on the trading volume of the stock, among others. Swartz could purchase the common stock from the Company at a discount ranging from 10%warrants equal to 20% depending on the price of the common stock. In addition to the common stock purchased, Swartz received warrants to purchase an additional 15%11% of the common stock equal to 110% of the market price as determined during the pricing period, subject to further semi-annual price adjustments if the priceissued between January 28, 2002 and March 11, 2002, 20% of the common stock goes down.In July 1999, the Company amendedissued between March 12, 2002 and restated the investment agreement with Swartz to eliminate the discretion of Swartz as to the timing of its purchaseApril 1, 2003, and after April 1, 2003, 30% of the Company’s common stock.The amended and restated investment agreement required Swartz, after the Company put shares of common stock issued to it, to purchase the Company’s common stock on the twentieth day following the put. The previous agreement enabled Swartz, in its sole discretion, to purchase the Company’s common stock at any time during a twenty-day period following the Company’s put to it.The registration statement went effective on October 5, 1999. As a result of an increase in the market price and trading volume of the Company’s common stock, the Company completed the $5 million placement of shares in February 2000. The total number of shares placed with Swartz was 13.9% of the total number of shares outstanding at the time or 7,014,796 common shares at prices ranging from $0.248 to $0.9775. The average price per share paid by Swartz was $0.71 compared to the average closing priceparties other than Swartz. There were no warrants issued during the twenty day pricing periods of $1.34 per share.F-22Patriot Scientific CorporationNotes to Consolidated Financial Statements (Continued)An additional 1,052,219 shares of common stock at exercise prices ranging initially from $0.341 to $1.265 are issuable to Swartz upon the exercise of warrants issued under the investment agreement. The warrants contain a reset provision which may reduce the exercise price if the price, as defined in the agreement, is lower on any subsequent six month anniversary. As a result of the reset provision, the exercise prices have been reduced to a range of $0.072 to $0.08 as ofyears ended May 31, 2002. None of2007 or 2006 in connection with the warrants had been exercised as of May 31, 2002.$30 Million Equity Line of Credit AgreementIn May 2000,Antidilution agreement. On October 10, 2006, we entered into an investment agreementApproval Rights Agreement and Termination of Antidilution Agreement and Addendum to Warrants (the “Termination Agreement”) with Swartz. The investment agreement entitled us , at our option,Swartz to issue and sell our common stockterminate the Antidilution Agreement. In consideration for up to an aggregate of $30 million from time to time during a three-year period, subject to certain conditions including among other items (1) an effective registration statement must be on file withentering into the SEC registering the resale of the common shares, and (2) a limitation on the number of common sharesTermination Agreement, we agreed that can be sold to Swartz within a 30 day time period based on the trading volume of the stock. Swartz could purchase the common stock from us at a discount. If the market price was less than $1.00 per share, the discount was $.10 per share; if the market price was between $1.00 to $1.99 per share, the discount was 10%; and if the market price was $2.00 or greater, the discount was 7%. In addition to the common stock purchased, Swartz received warrants to purchase an additional 15% of the common stock equal to 110% of the market price as determined during the pricing period, subject to further semi-annual price adjustments if the price of our common stock goes down.The registration statement went effective on June 23, 2000. In May 2001, we issued 588,680 shares of common stock in excess of the required shares under the May 30, 2001 put. These shares were applied to puts subsequent to May 31, 2001 and, accordingly, were not included as issued or outstanding in the May 31, 2001 consolidated financial statements. Since the inception of the agreement through May 31, 2002,2008 we received proceeds of $4,381,601 from the sale of 12,000,000 shares of common stock . Per the terms of the investment agreement, through May 31, 2002, we issued ten five-year warrants for 1,800,000 shares of common stock exercisable initiallywould obtain Swartz’s written approval at prices ranging from $0.091 to $1.562. The warrants contain a reset provision which may reduce the exercise price if the price, as defined in the agreement, is lower on any subsequent six month anniversary. As a result of the reset provision, the exercise prices have been reduced to a range of $0.072 to $0.132 as of May 31, 2002. None of the warrants had been exercised as of May 31, 2002.On September 17, 2001, we entered into a $25 million equity line of credit agreement with Swartz, thereby, effectively concluding the $30 million equity line of credit at the conclusion of the put in effect on that date.On September 24, 2001, we entered into a waiver and agreement with Swartz whereby Swartz was able to advance us $227,800least 30 days prior to entering into (i) any acquisition of any business entity or asset of any kind where the close of the final put under the $30 million equity line of credit. The waiver and agreement extended the time of the put beyond twenty days and redefined the price of the put to be the lesser of the factor of (a) the volume weighted average price per share, as defined by Bloomberg L.P., for each day of the put multiplied by .70 or (b) the volume weighted average price per share minus $0.05 multiplied by 20% of the acceptable daily volume as defined inF-23Patriot Scientific CorporationNotes to Consolidated Financial Statements (Continued)the waiver. At the discretion of Swartz the 20% daily volume limitation could be increased up to 30% of the daily volume. In addition, the waiver included the issuance of a purchase warrant to purchase 2,125,000 shares of common stock at an initial exercise price of $0.0911. The purchase warrant shares were issued to Swartz as restricted shares subject to “piggyback’ registration rights and are subject to repricings on each six month anniversary if 110% of the lowest closing bid price for the five days previous to the anniversary date is less than the initial or subsequent reset exercise prices. See Note 8 for further information on the warrants.$25 Million Equity Line of Credit AgreementOverview.On September 17, 2001, we entered into an investment agreement with Swartz. The investment agreement entitles us to issue and sell our common stock to Swartz for up to an aggregate of $25 million from time to time during a three-year period following the effective date of the registration statement. This is also referred to as a put right. We filed a registration statement on Form S-1 on October 11, 2001 that was declared effective on November 5, 2001 for 15,000,000 shares of our common stock which we issued to Swartz during the fiscal year ended May 31, 2002. There remains approximately $24 million available under this line conditioned on us filing one or more additional registration statements. As of August 1, 2002, we have not filed a statement requesting the registration of additional shares to put to Swartz under the $25 million equity line of credit.Put Rights.In order to invoke a put right, we must have an effective registration statement on file with the SEC registering the resale of the common shares which may be issued as a consequence of the invocation of that put right. Additionally, we must give at least ten but not more than twenty business days advance notice to Swartz of the date on which we intend to exercise a particular put right, and we must indicate the number of shares of common stock we intend to sell to Swartz. Atand derivative securities (on a fully diluted basis) issued as consideration for the acquisition equals or exceeds 10% of the number of shares of our option, we may also designate a maximum dollar amount of common stock (not to exceed $3 million) which we will sell to Swartz duringoutstanding at the put and/or a minimum purchase price per common share at which Swartz may purchase shares during the put. The number of common shares sold to Swartz may not exceed 20%time of the aggregate daily reported trading volume during each of two consecutive ten business day periods beginning on the business day immediately following the day we invoked the put right.The price Swartz will pay for each share of common stock sold inacquisition (on a put is equal to the lesser of (i) the market price for each of the two consecutive ten business day periods beginning on the business day immediately following the day we invoked the put right minus $0.10,fully diluted basis) or (ii) X percentany acquisition (regardless of the market price for eachsize) by us of the two ten day periods, where, Xany business entity or asset of any kind that is equal to 90% if the market price is below $2.00 and 93% if market price is equal to or greater than $2.00. Market price is defined as the lowest closing bid price for the common stock during eachnot unanimously approved by our board of the two consecutive ten business day periods. However, the purchase price may not be less than the designated minimum per share price, if any, that we indicated in our notice.F-24We issued to Swartz a commitment warrant to purchase up to 900,000 shares of our common stock concurrent with the execution of the investment agreement. This warrant is exercisable through September 17, 2006 at an initial exercise price of $0.22. The commitment warrant exercise price is subject to being reset on each six month anniversary of its issuance.Limitations and Conditions Precedent to Our Put Rights.We may not initiate a put if, as of the proposed date of such put:•we have issued shares of our common stock that have been paid for by Swartz and the amount of proceeds we have received is equal to the maximum offering amount;•the registration statement covering the resale of the shares becomes ineffective or unavailable for use;•our common stock is not actively trading on the OTC Bulletin Board, the NASDAQ Small Cap Market, the NASDAQ National Market, the American Stock Exchange, or the New York Stock Exchange, or is suspended or desisted with respect to the trading on such market or exchange.If any of the following events occur during the pricing period for a put, the volume accrual shall cease. For the put, the pricing period shall be adjusted to end 10 business days after the date that we notify Swartz of the event, and any minimum price per share we specified should not apply to the put:•we have announced or implemented a stock split or combination of our common stock between the advanced put notice date and the end of the pricing period;•we have paid a common stock dividend or made any other distribution of our common stock between the advanced put notice date and the end of the pricing period;•we have made a distribution to the holders of our common stock or of all or any portion of our assets or evidences of indebtedness between the put notice date and the end of the pricing period;•we have consummated a major transaction (including a transaction, which constitutes a change of control) between the advance put notice date and the end of the pricing period, the registration statement covering the resale of the shares becomes ineffective or unavailable for use, or our stock becomes delisted for trading on our then primary exchange; or•we discover the existence of facts that cause us to believe that the registration statement contains an untrue statement or omits to state a material fact.Short Sales.Swartz and its affiliates are prohibited from engaging in short sales of our common stock unless they have received a put notice and the amount of shares involved in a short sale does not exceed the number of shares specified in the put notice.Shareholder Approval. We may currently issue more than 20% of our outstanding shares under the investment agreement. If we become listed on the Nasdaq Small Cap Market or Nasdaq National Market, then we must get shareholder approval to issue more than 20% of our outstanding shares.F-25Patriot Scientific CorporationNotes to Consolidated Financial Statements (Continued)Since we are currently a bulletin board company, we do not need shareholder approval.Termination of Investment Agreement. We may also terminate our right to initiate further puts or terminate the investment agreement by providing Swartz with notice of such intention to terminate; however, any such termination will not affect any other rights or obligations we have concerning the investment agreement or any related agreement.Restrictive Covenants.During the term of the investment agreement and for a period of two months thereafter, we are prohibited from certain transactions. These include the issuance of any debt or equity securities in a private transaction which are convertible or exercisable into shares of common stock at a price based on the trading price of the common stock at any time after the initial issuance of such securities or with a fixed conversion or exercise price subject to adjustment without obtaining Swartz’s prior written approval.Right of First Refusal.Swartz has a right of first refusal to purchase any variable priced securities offered by us in any private transaction which closes on or prior to two months after the termination of the investment agreement and a right of participation for any equity securities offered by us in any private transaction which closes on or prior to two months after the termination of the investment agreement.Swartz’s Right of Indemnification.We are obligated to indemnify Swartz (including their stockholders, officers, directors, employees and agents) from all liability and losses resulting from any misrepresentations or breaches we made in connection with the investment agreement, our registration rights agreement, other related agreements, or the registration statement.Waiver and Agreement.On March 12, 2002, we entered into an amended waiver and agreement with Swartz which replaced and superseded all previous waivers and agreements. This amended waiver and agreement extended the time of the put beyond twenty days and redefined the price of the put to be the lesser of the factor of (a) the volume weighted average price per share, as defined by Bloomberg L.P., for each day of the put multiplied by .70 or (b) the volume weighted average price per share minus $0.05 multiplied by 20% of the acceptable daily volume as defined in the waiver. At the discretion of Swartz, the 20% daily volume limitation could be increased up to 30% of the daily volume. In addition, the amended waiver and agreement increased the intended put share amount for the first put to 14,100,000 shares, which is the total number of shares we had registered so far under the $25 million equity line of credit. On May 30, 2002 we closed the first put under the $25 million equity line of credit by applying the proceeds of $926,924 to the secured note payable discussed below.Warrants.In connection with closing the $25 million equity line of credit, we issued to Swartz a commitment warrant to purchase 900,000 shares of our common stock as discussed further in Note 8 to the consolidated financial statements. This warrant was valued on the issuance date using the Black-Scholes pricing model and the value was recorded as a debt discount.F-26Patriot Scientific CorporationNotes to Consolidated Financial Statements (Continued)8. (Deficit)Private Offerings and WarrantsDuring fiscal 2002, 2,200,000 shares of common stock were issued to an investment bank in exchange for services. The fair value (as determined by the quoted market price) of the common stock of $198,000 is being amortized over the life of the contract and $99,000 was recorded as additional general and administrative expense during the year ended May 31, 2002. Also, during fiscal 2002, the Company issued 800,000 shares of common stock to two individual investors for cash of $68,000.2002, the Company2007, we had warrants outstanding to purchase 24,477,72412,060,915 common shares at exercise prices ranging from $0.048$0.02 to $1.12$1.00 per share, expiring beginning in 2002at various dates through 2007.fiscal 2002, the Company issuedyear ended May 31, 2007, investors exercised warrants to purchase 23,197,201 common1,272,500 shares of common stock for proceeds of $172,250 and investors exercised warrants of 40,000,805 to purchase 38,681,396 shares of common stock on a cashless basis. During the year ended May 31, 2007, 15,000 warrants expired and 1,319,409 warrants were cancelled due to cashless exercises.$0.048$0.20 to $0.54$1.00 per share. Of this amount,share, expiring at various dates through 2011. During the year ended May 31, 2008, we issued no warrants to purchase 3,113,302 common shares of common stock, an investor exercised warrants to purchase 125,000 shares of common stock for proceeds of $6,250, 1,933,259 warrants expired or were issuedcancelled due to Swartz related tocashless exercises, 3,700,000 warrants were exercised utilizing the $30 million investmentcashless method of exercise for 2,702,656 shares, and we repurchased 7,000,000 warrants for $2,760,900 under terms of our warrant repurchase agreement with Lincoln Ventures, LLC.900,000 common250,000 shares of our common stock was issuedfor $0.23 per share to Swartz relatedour institutional investor relations firm. The warrant is subject to vesting provisions. 2008 2007 Issued in conjunction with: Convertible debentures - 560,915 Anti-dilution agreements - - Equity lines of credit - - Waiver agreements - 7,000,000 Other 300,000 4,500,000 Total warrants outstanding 300,000 12,060,915 $25 million investment agreement, warrants to purchase 16,519,090 common shares of stock were issued to Swartz related to1996 Stock Option Plan. Under the 5% Secured Note Payable of which 3,630,940 were cancelled, a warrant to purchase 2,514,809 common shares of stock was issued to Lincoln Ventures LLC related to the first funding under the 8% Convertible Debenture and a warrant to purchase 150,000 common shares of stock was issued to a consultant. See Notes 5 and 6 for further discussion.During fiscal 2001, the Company issued warrants to purchase 836,698 common shares of stock at initial exercise prices ranging from $0.65 to $1.09 per share. Of this amount, warrants to purchase 811,698 common shares of stock were issued to Swartz related to the $30 million investment agreement and a warrant to purchase 25,000 common shares of stock was issued to the bank related to a $400,000 factoring agreement.Also, during fiscal 2002, the Company’s shareholders approved an increase in the authorized number of common shares from 100,000,000 to 200,000,000.1992 Incentive1996 Stock Option Plan, (“ISO”)The Company has an ISO Plan which expired May 20, 2002. The ISO Plan provided for grants to either full or part time employees, at the discretion of the board of directors, to purchase common stock of the Company at a price not less than the fair market value of the shares on the date of grant. In the case of a significant stockholder, the option price of the share could not be less than 110 percent of the fair market value of the share on the date of grant. Any options granted under the ISO Plan must be exercised within ten years of the date they were granted (five years in the case of a significant stockholder). At May 31, 2002,March 24, 2006, options to purchase up to 45,8344,000,000 shares of our common stock remained outstanding and will expire starting in 2002 through 2005.F-27Patriot Scientific CorporationNotes to Consolidated Financial Statements (Continued)1992 Non-Statutory Stock Option Plan(“NSO”)The Company has an NSO Plan which expired May 20, 2002. The NSO Plan provided, at the discretion of the board of directors, for grantsmay be granted to either full or part time employees, directors and our consultants of the Company to purchase common stock of the Company at a price not less than the fair market value of the shares on the date of grant. Any options granted under the NSO Plan must be exercised within ten years of the date they were granted. At May 31, 2002, options to purchase up to 50,000 shares of common stock remained outstanding and will expire in 2005.1996 Stock Option PlanEffective March 1996, the Company adopted the 1996 Stock Option Plan, which was amended by the Stockholders in December 1997, expiring March 24, 2006, reserving for issuance 4,000,000 shares of the Company’s common stock. The 1996 Stock Option Plan provides, at the discretion of the board of directors, for grants to either full or part time employees, directors and consultants of the Company to purchase common stock of the Company at a price not less than the fair market value on the date of grant for incentive stock options or not less than 85% of the fair market value on the date of grant for non-qualified stock options. In the case of a significant stockholder, the option price of the share is not less than 110 percent of the fair market value of the shares on the date of grant. Any option granted under the 1996 Stock Option Plan must be exercised within ten years of the date they are granted (five years in the case of a significant stockholder). During the fiscal year ended May 31, 2002, the Company2006, we granted options to purchase 1,000,00050,000 shares of common stock at market value. Duringvalue, under the fiscal year ended1996 Stock Option Plan. As of May 31, 2001, the Company granted2008, options to purchase 1,860,000100,000 shares of common stock at market value.Effective February 2001, the Company adopted the 2001 Stock Option Plan, expiring February 21, 2011, reserving for issuance 3,000,000 shares of the Company’s common stock. atfor the discretiongranting of the boardoptions to purchase up to 3,000,000 shares of directors, for grantsour common stock to either full or part time employees, directors and our consultants of the Company to purchase common stock of the Company at a price not less than the fair market value on the date of grant for incentive stock options or not less than 85% of the fair market value on the date of grant for non-qualified stock options. In the case of a significant stockholder, the option price of the share is not less than 110 percent of the fair market value of the shares on the date of grant. Any option granted under the 2001 Stock Option Plan must be exercised within ten years of the date they are granted (five years in the case of a significant stockholder). During the fiscal yearyears ended May 31, 2002, the Company2008, 2007 and 2006, we granted options to purchase 3,145,000699,000, 230,000 and 145,000 shares of our common stock, respectively, at market value.F-28Patriot Scientific CorporationNotes to Consolidated Financial Statements (Continued)During fiscal 2000, the Company repriced stockvalue, under this plan. As of May 31, 2008, options to purchase 2,706,000874,000 shares of common stock are outstanding under the 2001 Stock Option Plan.exercise prices originally ranging from $.3625 to $2.30 using fixed accounting rules in effect ata price not less than the time. Thefair market value on the date of grant for incentive stock options were repriced to an exercise priceor not less than 85% of $.32 and no additional compensation expense was recorded. Subsequent to the repricing,fair market value on the Company adopted accounting principles generally accepted indate of grant for non-qualified stock options. In the United Statescase of America that require stock options that have been modified to reducea significant stockholder, the exercise price to be accounted for using variable accounting. Accordingly, if the marketoption price of the Company’s stock increases subsequent to July 1, 2000, it will recognize additional compensation expense that it otherwise wouldshare is not have incurred. Asless than 110 percent of the fair market value of the shares on the date of grant. Any option granted under the 2003 Stock Option Plan must be exercised within ten years of the date they are granted (five years in the case of a significant stockholder). During the fiscal years ended May 31, 2002, there was no additional compensation expense recorded because the market price2008 and 2006, we granted options to purchase 3,723,000 and 1,550,000 shares of the Company’sour common stock, was lower thanrespectively, at market value, under this plan. There were no grants made under the price at July 1, 2000. However, the ultimate impact cannot be determined as it is dependent on the change in the market price of the stock from July 1, 2000 until the stock options are exercised, forfeited or expire unexercised.Non-cash compensation expense of $3,739,267 was recorded in2003 Stock Option Plan during the fiscal year ended May 31, 2000 as2007. As of May 31, 2008, options to purchase 2,973,000 shares of common stock are outstanding under the 2003 Stock Option Plan.resultlimit of 3,000,000 Incentive Stock Option (“ISO”) shares of our common stock to either full or part time employees, directors and directors exercising their stock options usingour consultants at a cashless exercise provision. Generally accepted accounting principles require that such exercises must be recorded using variable accounting which reflectprice not less than the incremental difference between the exercise price and thefair market pricevalue on the date of exercise as though it were additional compensation. Since no cashgrant. In the case of a significant stockholder, the option price of the share is exchangednot less than 110 percent of the fair market value of the shares on the date of grant. Any option granted under the 2006 Stock Option Plan must be exercised within ten years of the date they are granted (five years in the transaction,case of a like amount was recorded as additional paid-in capital.SFAS No. 123, “Accounting for Stock-Based Compensation,” requiressignificant stockholder). On March 11, 2008 we amended our 2006 Stock Option Plan to increase the Companytotal number of shares of our common stock issuable under the plan from 5,000,000 to provide pro forma information regarding net loss and net loss per share as if compensation costs for7,000,000. Shareholders will be asked to ratify the Company’s stock option plans and other stock awards had been determined in accordance withamendment to the fair value based method prescribed in SFAS No. 123. The Company estimatesplan at our next annual meeting. During the fair value of each stock award at the grant date by using the Black-Scholes option-pricing model with the following weighted-average assumptions used for the threefiscal years ended May 31, 2002, 20012008, 2007 and 2000 respectively: dividend yield2006, we granted options to purchase 2,203,000, 1,070,000 and 2,050,000 shares of zero percent for all years; expected volatilityour common stock, respectively, under this plan, 200,000, 70,000 and 192,857 shares, respectively, of 90, 90 and 50 percent; risk-free interest rateswhich were ISOs. In connection with May 31, 2006 option grants, we recognized compensation expense of 3.5$120,000 related to 4.8, 4.8options granted below the fair market value of our common stock at the date of grant. As of May 31, 2008, options to 6.4, and 5.6purchase 4,248,000 shares of common stock are outstanding under the 2006 Stock Option Plan.6.1 percent; and expected livesacquire 1,500,000 shares of 3 to 5 years for all years.Under the accounting provisions for SFAS No. 123, the Company’s net lossour common stock at a per share would have been increased byprice of $0.165 to an officer outside of the pro forma amounts indicated below: 2002 2001 2000 As reported Net loss $ (5,487,051 ) $ (4,968,903 ) $ (7,488,708 ) Pro forma Net loss $ (6,054,061 ) $ (5,348,529 ) $ (7,492,658 ) As reported per share Basic and diluted loss $ (0.08 ) $ (0.09 ) $ (0.17 ) Pro forma per share Basic and diluted loss $ (0.09 ) $ (0.10 ) $ (0.17 ) F-29the Company’sour stock option plans and warrants as of May 31, 2002, 20012008, 2007 and 20002006 and changes during the years endingended on those dates is presented below: Options Warrants Weighted Weighted Average Average Exercise Exercise Shares Price Shares Price Outstanding, June 1, 1999 3,723,444 $ 0.83 2,141,062 $ 0.36 Granted 2,856,000 0.32 4,834,009 0.40 Cancelled (3,516,251 ) 0.84 (100,000 ) 1.25 Exercised (1,631,869 ) 0.37 (2,118,890 ) 0.31 Outstanding, May 31, 2000 1,431,324 0.38 4,756,181 0.40 Granted 2,092,500 1.16 836,698 0.74 Cancelled (580,000 ) 0.72 — — Exercised (366,000 ) 0.32 (631,416 ) 0.27 Outstanding, May 31, 2001 2,577,824 $ 0.92 4,961,463 $ 0.42 Granted 4,145,000 0.21 23,197,201 0.09 Cancelled (2,281,419 ) 0.67 (3,630,940 ) 0.10 Exercised (191,666 ) 0.32 (50,000 ) 0.25 Outstanding, May 31, 2002 4,249,739 $ 0.39 24,477,724 $ 0.11 Exercisable, May 31, 2000 851,824 $ 0.32 4,756,181 $ 0.40 Exercisable, May 31, 2001 1,200,158 $ 0.68 4,961,463 $ 0.42 Exercisable, May 31, 2002 2,418,072 $ 0.48 24,477,724 $ 0.11 Weighted average fair value of options and warrants granted during the year ended May 31, 2000 $ 0.22 $ 0.68 Weighted average fair value of options and warrants granted during the year ended May 31, 2001 $ 0.86 $ 0.44 Weighted average fair value of options and warrants granted during the year ended May 31, 2002 $ 0.07 $ 0.11 Options Warrants Shares Weighted Average Exercise Price Shares Weighted Average Exercise Price Outstanding, June 1, 2005 7,148,000 $ 0.13 109,122,581 $ 0.04 Granted 3,795,000 0.46 12,457,049 0.09 Cancelled/Expired (1,387,000 ) 0.30 (13,391,727 ) 0.05 Repurchased - - (2,000,000 ) 0.02 Exercised (4,096,000 ) 0.09 (52,838,683 ) 0.03 Outstanding, May 31, 2006 5,460,000 0.34 53,349,220 0.05 Granted 2,800,000 0.39 - - Cancelled/Expired (500,000 ) 0.09 (1,334,409 ) 0.03 Exercised (515,000 ) 0.08 (39,953,896 ) 0.03 Outstanding, May 31, 2007 7,245,000 0.40 12,060,915 0.10 Granted 6,625,000 0.43 - - Cancelled/Expired (4,392,154 ) 0.45 (1,933,259 ) 0.09 Repurchased - - (7,000,000 ) 0.08 Exercised (1,282,846 ) 0.15 (2,827,656 ) 0.12 Outstanding, May 31, 2008 8,195,000 $ 0.44 300,000 $ 0.57 Exercisable, May 31, 2006 5,115,000 $ 0.35 52,849,220 $ 0.05 Exercisable, May 31, 2007 7,245,000 $ 0.40 11,685,915 $ 0.10 Exercisable, May 31, 2008 4,265,372 $ 0.47 300,000 $ 0.57 Weighted average fair value of options and warrants granted during the year ended May 31, 2006 $ 0.49 $ 0.19 Weighted average fair value of options granted during the year ended May 31, 2007 $ 0.82 $ - Weighted average fair value of options granted during the year ended May 31, 2008 $ 0.32 $ - 2002:F-30 Outstanding Exercisable Number Outstanding Options $ 0.05-0.20 1,350,000 1.82 $0.13 1,350,000 $0.13 0.30-0.50 4,625,000 4.66 0.41 695,372 0.43 0.60-0.90 2,220,000 3.16 0.68 2,220,000 0.68 $ 0.05-0.90 8,195,000 3.79 $0.44 4,265,372 $0.47 Warrants $ 0.20-1.00 300,000 2.72 $0.57 300,000 $0.57 2008 2007 2006 Current: Federal $ 12,540,914 $ - $ - State 3,973,734 972,064 - Total current 16,514,648 972,064 - Deferred: Federal (7,615,720 ) 7,767,761 - State (2,472,899 ) 2,015,208 - Total deferred (10,088,619 ) 9,782,969 - Total provision $ 6,426,029 $ 10,755,033 $ - Outstanding Exercisable Weighted Average Weighted Weighted Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life Price Exercisable Price $0.09-0.11 2,600,000 4.50 $ 0.10 1,200,000 $ 0.10 0.1275-.032 461,000 3.64 0.18 311,000 0.21 0.60-0.69 320,000 1.44 0.67 300,000 0.68 1.16-1.20 435,000 2.48 1.18 255,000 1.19 1.325-1.615 433,739 2.72 1.33 352,072 1.33 $0.09-1.615 4,249,739 3.79 $ 0.39 2,418,072 $ 0.48 $0.048-0.099 16,769,358 4.45 $ 0.08 16,769,358 $ 0.08 0.103-0.132 4,510,820 4.40 0.11 4,510,820 0.11 0.25 2,155,000 0.36 0.25 2,155,000 0.25 0.30-0.32 652,168 0.17 0.32 652,168 0.32 0.40-1.12 390,378 2.37 0.48 390,378 0.48 $0.048-1.12 24,477,724 3.93 $ 0.11 24,477,724 $ 0.11 9. Net Loss Per ShareCompany has implemented Statementreconciliation of Financial Accounting Standards (“SFAS”) No. 128, “Earnings Per Share.” SFAS No. 128 providesthe effective income tax rate to the Federal statutory rate is as follows for the calculation of “Basic” and “Diluted” earnings per share (“EPS”). Basic EPS includes no dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution of securities that could share in the earnings of an entity. The Company’s net losses for the periods presented cause the inclusion of potential common stock instruments outstanding to be antidilutive and, therefore, in accordance with SFAS No. 128, the Company is not required to present a diluted EPS. During the years ended May 31, 2002, 200131: 2008 2007 2006 Statutory federal income tax rate 35.0 % 34.0 % 34.0 % State income tax rate, net of Federal effect 6.1 % 5.7 % - % Change in tax rate 1.3 % - % - % Change in deferred tax related to non cash compensation 2.2 % - % - % Foreign tax credit (3.7 ) % - % - % Other - % 0.3 % - % (Decrease) increase in valuation allowance (0.6 ) % (8.7 ) % (34.0 ) % Effective income tax rate 40.3 % 31.0 % - % 2000, common stock optionsliabilities reflect the net tax effect of temporary differences between the carrying amount of asset and warrants convertible or exercisable into approximately 28,727,463, 7,539,287liabilities for financial reporting purposes and 6,187,505 sharesamounts used for income tax purposes. Significant components of common stock were not included in diluted loss per shareour deferred tax assets are as the effect was antidilutive due to the Company recording losses in eachfollows as of those years.F-31 2008 2007 Current deferred tax assets (liabilities): Net operating loss carryforwards $ - $ 1,894,097 Accruals and state taxes 1,412,500 376,257 Basis difference in fixed assets - - Basis difference in intangibles - - Investment in affiliated companies - - Credits - 242,411 Less: valuation allowance (21,668 ) (72,790 ) Total net deferred tax asset 1,390,832 2,439,975 Long-term deferred tax assets (liabilities): Investment in affiliated company (2,682,823 ) (14,128,084 ) Basis difference in fixed assets (1,918 ) (2,870 ) Basis difference in intangibles 927,088 1,072,117 Stock based compensation expense 235,779 835,893 Impairment of note receivable 148,859 - Deferred state taxes 94,796 - Other comprehensive loss 163,227 - Capital loss carryover 29,811 - Total net long-term deferred tax liability (1,085,181 ) (12,222,944 ) Net deferred tax asset (liability) $ 305,651 $ (9,782,969 ) 10. The net deferred tax asset recorded and its approximate tax effect consisted of the following: May 31, 2002 2001 Net operating loss carryforwards $ 11,030,000 $ 9,309,000 Purchased technology 470,000 519,000 Depreciation and amortization 1,754,000 1,982,000 Other, net 192,000 179,000 13,446,000 11,989,000 Valuation allowance 13,446,000 11,989,000 Net deferred tax asset $ — $ — A reconciliation of the income taxes at the federal statutory rate to the effective tax rate is as follows: May 31, 2002 2001 2000 Federal income tax benefit computed at the Federal statutory rate $ (1,866,000 ) $ (1,689,000 ) $ (2,546,000 ) State income tax benefit net of Federal benefit (211,000 ) (298,000 ) (449,000 ) Other- permanent differences 502,000 43,000 (265,000 ) Exercise of stock options using a cashless exercise provision — — (1,496,000 ) Expiration of state net operating loss carryforwards 118,000 81,000 — Change in valuation allowance 1,457,000 1,863,000 4,756,000 Income tax benefit $ — $ — $ — As of(continued)2002 and 2001,2008, the $21,668 valuation allowances equalallowance above relates entirely to the net deferred tax asset recognized have been recorded,SSDI as Managementmanagement has not determined that it is more likely than not that the deferred tax asset relating to various accruals will be realized. No currentFor federal and state tax provision was recorded forpurposes, SSDI is not consolidated with our corporate income tax filings. SSDI is consolidated however, in the components of our net deferred tax assets and liabilities as indicated above.2002, 2001 and 2000 due to reported losses. Theyear 2007, the valuation allowance increased $1,457,000 forof $2,872,255 relating to our deferred tax assets was released as we determined that we would utilize our net operating loss carryforwards and other deferred tax assets. For federal and state tax purposes, SSDI is not consolidated with our corporate income tax filings. SSDI is consolidated however, in the components of our net deferred tax assets and liabilities as indicated above. The $72,790 valuation allowance above relates entirely to SSDI as management has not determined that it is more likely than not that the deferred tax asset relating to net operating loss carryforwards will be realized.ended May 31, 2002 and $1,863,00 for the year ended May 31, 2001.At May 31, 2002, the Company has2008, we have utilized our remaining federal net operating loss carryforwardscarryforward of approximately $28,972,000$4,870,000 and our general business credit carryforward of $242,411.expire through 2021an individual tax position must meet for any part of the benefit of that position to be recognized in a company’s financial statements and also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The adoption of FIN 48 on June 1, 2007 did not result in any cumulative effect adjustment to retained earnings. Interest and penalties, if any, related to unrecognized tax benefits are recorded in income tax expense. As of June 1, 2007, we are subject to certain limitations underU.S. Federal income tax examinations for the Internal Revenue Codetax years May 31, 1991 through May 31, 2007, and we are subject to state and local income tax examinations for the tax years May 31, 1999 through May 31, 2007 due to the carryover of 1986, as amended. As such, certain federal net operating loss carryforwards may expire unused.F-32At action in the Eastern District of Texas is inclusive of matters with respect to two patents owned by TPL that are not a part of the MMP Portfolio, and as such we are not engaged in this aspect of the litigation and defense.2002, the Company has state net operating loss carryforwards of approximately $19,671,000 that expire through 2008.11. Profit-SharingEffective July 1, 1993, the Company adoptedsavings and profit-sharingretirement plan that allows participants to make contributions by salary reduction pursuant tocomplies with Section 401(k) of the Internal Revenue Code. AtAll employees are eligible to participate in the Company’s discretion, the Company mayplan. We match 50% of each participant’s voluntary contributions, at 20%subject to a maximum contribution of the employee’s contribution up to 6% of the employee’s salary. The Company contributions are vested 20%participant’s compensation. Participants vest 33% per year beginningover a three year period in our contributions. Our matching contributions during the fiscal years ended May 31, 2008, 2007 and 2006 were $9,596, $11,397 and $1,833, respectively.first yearofficers agreed to accept as severance approximately $150,000 and to have the maturity date of service. The Company made no matching contribution in fiscal 2002, 2001 or 2000.12. ContingenciesIn January 1999,options held by him extended for one year. Further, we were suedagreed to accelerate the vesting of all outstanding options held by the officer and to extend their term to June 2006. We recorded an expense of approximately $125,000 related to this option modification in the Superior Courtyear ended May 31, 2006.San Diego County, California by the Fish Family Trust, a co-inventor$100,000 based on terms of the original ShBoom technology. The suit also namedhis employment agreement which provided for salary continuation. defendants nanoTronics and Gloria Felcyn on behalf of the Falk Family Trust. The suit sought a judgment for damages, a rescission of the Technology Transfer Agreement and a restoration of the technology to the co-inventor. In March 1999, we joined with nanoTronics and Gloria Felcyn and filed our response and cross-complaint against the Fish Family Trust. In November 2000, the judge issued a summary ruling in favor of the defendants on all counts. The Fish Family Trust filed an appeal in January 2001. Management believes that it is unlikely that the appellate court will overturn the trial court’s ruling and that the resolution of the appeal process will have no impact on our financial position, income or cash flows.In September 2001, an action was filed against us in the Superior Court of San Diego County, California by Richard G. Blum, our former Chairman, President and Chief Executive Officer. Mr. Blum contends that he was wrongfully terminatedOfficer, and commencing on AugustJune 5, 2001 in violation of his employment agreement dated December 1, 2000. He seeks damages for the alleged breach of his employment agreement, age discrimination, as well as other related claims. Management denies Mr. Blum’s claims and contends it exercised its business judgment for legitimate nondiscriminatory reasons. In accordance with his employment agreement, we may be obligated to pay him between $0 and $400,000 as severance pay. We intend to vigorously defend our position in this case.In October 2001, an action was filed against us in the Superior Court of San Diego County, California by Daniel Beach, a former marketing and sales consultant whose contract we terminated in August 2001. Mr. Beach contends that we breached both a written and an oral contract, that we did not perform on certain promises, and that we made false and misleading representations in addition to other claims. In July 2002,2007, we entered into negotiations on a settlementan employment agreement with Mr. Beach. Management believes that itTurley for a one-year term. Pursuant to the agreement, if Mr. Turley was terminated without cause, he was entitled to his then current salary level for the remaining term of his agreement conditional upon the execution of a general release. On February 28, 2008, Mr. Turley resigned. As a result, we recorded a one-time severance charge of $95,192 during the fiscal year 2008 in full discharge of all remaining obligations to Mr. Turley.probable that a settlement will be reached whereby we agreeterminated without cause or resigns with good reason within the first two years of employment, he is entitled to pay him $50,000 over five months. Accordingly, a liabilityreceive an amount equal to his annual base salary for $50,000 has been recordedthe greater of (i) 6 months or (ii) the period remaining in the financial statements asextended one-year term. If Mr. Flowers is terminated without cause or resigns with good reason any time after two years of May 31, 2002, in connection with this litigation.F-3313. Lease ObligationsCompanyagreement is obligated underfor an initial 120-day term if not terminated pursuant to the agreement, with an extension period of one year and on a continuing basis thereafter. Pursuant to the Agreement, Mr. Goerner is to receive a base salary of $250,000 per year and is eligible to receive a bonus of 100% of his base salary at the time his position is converted by the Board of Directors to standing President/CEO or nine months from the effective date of the agreement. If Mr. Goerner is terminated without cause during the nine month period after the effective date he shall receive a pro-rata portion of the bonus based on the term of his actual employment contracts with certain key employeesus. Also pursuant to pay severancethe Agreement and on the date of the Agreement, Mr. Goerner received a grant of incentive stock options to purchase 250,000 shares of our common stock and non-qualified stock options to purchase 50,000 shares of our common stock. Mr. Goerner also received a grant of non-qualified stock options to purchase 700,000 shares of our common stock to vest upon termination under certain defined conditions. Generally, unless relievedconversion of their dutieshis position to standing President/CEO or nine months from the effective date of the agreement, whichever is first to occur and Mr. Goerner also received a grant of non-qualified stock options to purchase 2,000,000 shares of our common stock to vest upon meeting performance conditions outlined in the grant. The Agreement also provides for Mr. Goerner to receive customary employee benefits, including health, life and disability insurance, and an automobile allowance.executive officers arefirst year of employment, after the initial 120-day term, he is entitled to severance payreceive an amount equal to four months of their then current monthly salary. Inhis base salary for the caseperiod remaining in the agreement. Payments are conditional upon the execution of a changegeneral release.control, generally,many cases is indefinite. These guarantees and indemnities do not provide for any limitation of the executive officers are entitledmaximum potential future payments we could be obligated to severance pay equalmake. Historically, we have not been obligated to twelve months of their then current monthly salary unless they continue to workmake any payments for the new controlling interestthese obligations and no liabilities have been recorded for these guarantees and indemnities in the same function as previous to the change.The Company grantedaccompanying consolidated balance sheets.lien and security interest in substantially all of its assets to the bank under the accounts receivable factoring line.The Company has a non-cancellablenon-cancelable operating lease agreement for itsour Carlsbad, California office and manufacturing facilities located in San Diego, California.as follows: Years ending May 31, Gross Sublease Net Payments Income Payments 2003 $ 123,046 $ 56,250 $ 66,796 2004 129,250 68,850 60,400 2005 135,454 70,470 64,984 2006 141,658 72,540 69,118 2007 23,782 12,150 11,632 Total minimum lease payments $ 553,190 $ 280,260 $ 272,930 fiscal 2002, 2001 and 2000 was $147,373, $149,494, and $105,964, respectively.The Company has one capital lease at May 31, 2002.F-34Patriot Scientific CorporationNotes to Consolidated Financial Statements (Continued)Future minimum lease payments are as follows: Year ending May 31, 2003 $ 9,562 2004 9,562 2005 9,562 2006 2,391 Total minimum lease payments 31,077 Amount representing interest 9,230 Present value of minimum lease payments 21,847 Total obligation 21,847 Less current portion (5,116 ) Long-term portion $ 16,731 �� Capital leases included in fixed assets at May 31, 2002, were $20,135 net of an allowance for depreciation of $4,860. Depreciation expense related to the capitalized lease was $4,860 for the year ended May 31, 2002.14. Segment InformationExport SalesThe Company is engaged in one business segment, the development and marketing of microprocessor technology related products and licenses. Telecommunication products have reached the end of their life cycles and will no longer provide any significant sales. During the fiscal years ended May 31, 2002, 20012008, 2007 and 2000,2006 was $113,734, $92,928 and $30,976, respectively.Company’s product sales of high technology computer products and licenses were $9,625, $50,511 and $63,088 and telecommunication products and licenses were $349,184, $286,173 and $653,872.For the purpose of allocating revenues by geographic location, the Company uses the physical location of its customers as its basis. Duringoperating lease are $7,351 in fiscal year 2009. Rent expense for the fiscal yearsyear ended May 31, 2002, 20012008 and 2000, the Company’s sales by geographic location consistedfourth quarter of fiscal 2007 was $89,082 and $15,138, respectively.following: 2002 2001 2000 Domestic sales $ 355,000 $ 253,000 $ 469,000 Foreign sales: Europe 4,000 19,000 136,000 North America — 40,000 64,000 Asia — 25,000 47,000 Other — — 1,000 Total foreign sales 4,000 84,000 248,000 Total net product sales $ 359,000 $ 337,000 $ 717,000 F-35Company has no foreign assets.Salesagreement required the former debt holder to Major CustomersDuringrelease all of his rights to any Holocom collateral in exchange for receiving 3% of the net sales (defined as cash revenues actually received less credits or discounts and other claims of customers) of SSDI’s protected distribution system products for a period of 48 months from the foreclosure sale date of February 2, 2007. The earn-out is to be paid each calendar quarter. A liability for payment under this agreement of $29,747 is included in accounts payable in the accompanying consolidated balance sheet at May 31, 2008. Amounts paid under the earn-out agreement for the fiscal year ended May 31, 2008 and the fourth quarter of fiscal 2007 were $62,570 and $6,783, respectively.2002, 2001were as follows: 2008 2007 2006 Net revenue: SSDI $ 3,649,898 $ 558,484 $ - All other 58,320 80,300 10,309,709 Total net revenue $ 3,708,218 $ 638,784 $ 10,309,709 Operating income (loss): SSDI $ 146,131 $ (176,432 ) $ - All other (5,749,624 ) (14,587,407 ) 3,911,640 Total operating income (loss) $ (5,603,493 ) $ (14,763,839 ) $ 3,911,640 2008 2007 2006 Income (loss) before taxes: SSDI $ 297,235 $ (169,913 ) $ - All other 15,632,521 34,616,133 28,672,688 Total income (loss) before taxes $ 15,929,756 $ 34,446,220 $ 28,672,688 2000, revenues from significant customers consistedaccounts receivable concentration information for SSDI for the years ended May 31 were as follows: 2008 2007 Sales % of sales % of A/R Sales % of sales % of A/R Anixter $1,354,494 37% 16% $461,494 85% 85% Graybar Electric Company, Inc. $889,724 24% 38% ----- ---- ----- Victory Global Solutions $370,301 10% 6% ----- ---- ----- following: 2002 2001 2000 Customer Sales Percent Sales Percent Sales Percent A $ 151,000 42.0 % $ — — $ — — B 59,000 16.4 % — — — — C — — 88,000 26.1 % — — D — — 41,000 12.2 % — — E — — 40,000 11.9 % — — F — — — — 138,000 19.2 % G — — — — 137,000 19.1 % H — — — �� — 127,000 17.8 % 15. Related Party TransactionsDuring fiscal years 2002 and 2001, the Company contracted with a company, which was owned by the daughter of our previous President, Chairman and CEO, for web site development, marketing support and other various services. The Company paid $70,292 and $139,253, respectively, in fiscal years 2002 and 2001 to the related party for these services. No such related party transactions occurred during fiscal year 2000.16.ended May 31and total assets at May 31 were as follows: 2008 2007 2006 Depreciation and amortization: SSDI $ 21,877 $ 22,740 $ - All other 28,828 42,121 59,415 Total depreciation and amortization $ 50,705 $ 64,861 $ 59,415 2008 2007 Total assets: SSDI $ 1,383,941 $ 642,871 All other 24,047,961 33,771,758 Total assets $ 25,431,902 $ 34,414,629 Subsequent to year end,concluded the second funding of our 8% Convertible Debenture. We received advances against the second closing of $283,000 as of May 31, 2002 and the balance of $492,000 subsequent to year end from a group of six investors. In conjunction with the debentures, in June 2002, we also issued warrants to purchase up to 10,344,366purchased 1,966,160 shares of our common stock at an initial exercise priceaggregate cost of $0.08616$400,906 pursuant to our stock buyback program.being reset atvesting provisions.Page Report of Independent Registered Public Accounting Firm F-43 Financial Statements: Balance Sheets F-44 Statements of Income F-45 Statements of Members’ Equity F-46 Statements of Cash Flows F-47 Notes to Financial Statements F-48 six month anniversaryof the years in the three-year period ended May 31, 2008. 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.May 31, 2008 2007 ASSETS Current assets: Cash and cash equivalents $ 8,260,288 $ 6,989,847 Prepaid expenses - 175,000 Total current assets $ 8,260,288 $ 7,164,847 LIABILITIES AND MEMBERS’ EQUITY Current liabilities: Accounts payable $ 3,204,519 $ 1,225,118 Accrued expenses - 160,000 Income tax payable 11,790 11,790 Total current liabilities 3,216,309 1,396,908 Commitments and Contingencies Members’ equity 5,043,979 5,767,939 Total liabilities and members’ equity $ 8,260,288 $ 7,164,847 Phoenix Digital Solutions, LLC Years Ended May 31, 2008 2007 2006 License revenues $ 59,282,971 $ 110,878,985 $ 60,000,000 Operating expenses: General and administrative 18,627,032 12,189,575 4,486,955 Operating income 40,655,939 98,689,410 55,513,045 Other income: Interest income 216,902 421,407 183,682 Income before income taxes 40,872,841 99,110,817 55,696,727 Provision for income taxes 11,790 11,790 - Net income $ 40,861,051 $ 99,099,027 $ 55,696,727 Balance June 1, 2005 $ - Contributions 4,000,000 Net income 55,696,727 Distributions (52,064,781 ) Balance May 31, 2006 7,631,946 Contributions - Net income 99,099,027 Distributions (100,963,034 ) Balance May 31, 2007 5,767,939 Contributions - Net income 40,861,051 Distributions (41,585,011 ) Balance May 31, 2008 $ 5,043,979 Years Ended May 31, 2008 2007 2006 Operating activities: Net income $ 40,861,051 $ 99,099,027 $ 55,696,727 Adjustments to reconcile net income to net cash provided by operating activities: Changes in operating assets and liabilities: Prepaid expenses 175,000 (160,000 ) (15,000 ) Accounts payable and accrued expenses 1,819,401 1,236,356 148,762 Income tax payable - 11,790 - Net cash provided by operating activities 42,855,452 100,187,173 55,830,489 Financing activities: Contributions from members - - 4,000,000 Distributions to members (41,585,011 ) (100,963,034 ) (52,064,781 ) Net cash used in financing activities (41,585,011 ) (100,963,034 ) (48,064,781 ) Net increase (decrease) in cash and cash equivalents 1,270,441 (775,861 ) 7,765,708 6,989,847 7,765,708 - Cash and cash equivalents, end of year $ 8,260,288 $ 6,989,847 $ 7,765,708 Supplemental Disclosure of Cash Flow Information Cash payments for income taxes $ 12,590 $ 13,390 $ 12,590 closing.F-36Schedule II—Valuation (“PTSC”). Each member owns 50% of the membership interests of the Company. Each member has the right to appoint one member of the three member management committee. The two appointees are required to select a mutually acceptable third member of the management committee. Pursuant to the LLC Agreement, the members agreed to establish a working capital fund for the Company of $4,000,000, of which each member contributed $2,000,000. The working capital fund increases to a maximum of $8,000,000 as license revenues are achieved. The members are obligated to fund future working capital requirements at the discretion of the management committee of the Company in order to maintain working capital of not more than $8,000,000. Neither member is required to contribute more than $2,000,000 in any fiscal year. Distributable cash and Qualifying AccountsAllowanceallocation of profits and losses will be allocated to the members in the priority defined in the LLC Agreement.Doubtful Accounts Balance at Charged to Balance at beginning of costs and end of Description period expenses Deductions period Year ended May 31, 2002 $ 54,000 $ 76,027 $ 124,027 $ 6,000 Year ended May 31, 2001 $ 5,000 $ 49,000 $ — $ 54,000 Year ended May 31, 2000 $ 22,000 $ 41,919 $ 58,919 $ 5,000 ReserveTPL’s supporting efforts to secure licensing agreements for Inventory Obsolescence Balance at Charged to Balance at beginning of costs and end of Description period expenses Deductions period Year ended May 31, 2002 $ 262,000 $ 149,433 $ 38,052 $ 373,381 Year ended May 31, 2001 $ 339,000 $ 100,000 $ 177,000 $ 262,000 Year ended May 31, 2000 $ 416,000 $ 270,000 $ 347,000 $ 339,000 F-37registrantRegistrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.DATED: August 27, 200214, 2008By: /s/ LOWELL W. GIFFHORNLowell W. GiffhornVice President,Chief Financial Officer and SecretaryregistrantRegistrant and in the capacities and on the dates indicated.Signature Title Date Signature TitleDate/s/ JEFFREY E. WALLINJeffrey E. Wallin27, 200214, 2008/s/ LOWELL W. GIFFHORNLowell W. GiffhornChief Financial Officer, Principal Financial Officer, Principal Accounting Officer, Secretary and DirectorAugust 27, 2002/s/ DAVID POHLDirectorAugust 27, 2002 David Pohl s/S/ CARLTON M. JOHNSON 27, 200214, 2008 Carlton Johnson s/ DONALD BERNIERS/ HELMUT FALK, JR Chairman of the Board and 27, 200214, 2008 Donald Bernier s/ HELMUT FALK JR.S/ DONALD E. SCHROCK 27, 200214, 2008Helmut Falk Jr. F-38