Our future success depends in significant part upon the continued services of our key technical and senior management personnel. The competition for highly qualified personnel is intense, and there can be no assurance that we 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 are represented by a labor union, and we consider our relations with our employees to be good. None of our employees are covered by key man life insurance policies.

We urge you to carefully consider the following discussion of risks as well as other information contained in this Form 10-K. We believe the following to be our most significant risk factors as of the date this report is being filed. The risks and uncertainties described below are not the only ones we face.

During fiscal 2008, 2007 and 2006, weWe have entered into license agreements directly and through our joint venture with TPL.TPL and have reported licensing income as a result of this activity for the fiscal years 2006 to 2011. Because of the uncertain nature of the negotiations that lead to license revenues, pending litigation with companies which we allege have infringed on our patent portfolio, the possibility of legislative action regarding patent rights, petitionspotential adverse outcomes associated with the U. S. Patent and Trademark Office to re-examine certain(“USPTO”) re-examinations, our litigation with TPL, the litigation initiated by an inventor of our patents,the microprocessor portfolio with TPL, and the possible effect of new judicial interpretationinterpretations of patent laws, we cannot predict the amount of futuremay not receive revenues from such agreements or whether there will bein the future consistent with amounts received in the past, and we may not receive future revenues from license agreements at all.

In June of 2005, we entered into a joint venture with TPL, pursuant to which TPL is responsible for the licensing and enforcement of our microprocessor patent portfolio. This joint venture has been the source of virtuallysubstantially all of our income since June of 2005. Therefore, in light of the absence of significant revenue from other sources, we should be regarded as entirely dependent on the success or failure of the licensing and prosecution efforts of TPL on behalf of the joint venture. Sales of our microprocessor products and data security products have resulted in limited revenues. Our microprocessor product lines are no longer being actively marketed, and only generate limited and sporadic sales.

A successful challenge to our ownership of our technology or the proprietary nature of our intellectual property wouldcould materially damage our business prospects. We rely on a combination of patents, trademarks, copyrights, trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. WeWith respect to our core technologies, we currently have seven U.S. patents, one European patent, and one Japanese patent issued. Any issued patent may be challenged and invalidated. Patents may not be issued for any of our pending applications. Any claims allowed from existing or pending patents may not be of sufficient scope or strength to provide significant protection for our products. Patents may not be issued in all countries where our products can be sold so as to provide meaningful protection or any commercial advantage to us. Our competitors may also be able to design around our patents.

Vigorous protection and pursuit of intellectual property rights or positions characterize the fiercely competitive semiconductor industry, which has resulted in significant and often protracted and expensive litigation. Therefore, our competitors and others may assert that our technologies or products infringe on their patents or proprietary rights. Persons we believe are infringing our patents are likely to vigorously defend their actions and assert that our patents are invalid. Problems with patents or other rights could result in significant costs, limit future license revenue, and impair or hinder our acquisition strategy. If infringement claims against us are deemed valid or if our infringement claims are successfully opposed, we may not be able to obtain appropriate licenses on acceptable terms or at all. Litigation could be costly and time-consuming but may be necessary to protect our future patent and/or technology license positions or to defend against infringement claims.  PartiesFrom time to time parties have petitioned the U. S. Patent and Trademark OfficeUSPTO to re-examine certain of our patents. An adverse decision in litigation or in the re-examination process wouldcould have a very significant and adverse effect on our business.

Shareholders who acquired common stock through the exercise of warrantsOur shareholders are not restricted in the price at which they can sell their shares. Shares sold at a price below the current market price at which the common stockour Common Stock is trading may cause the market price of our Common Stock to decline.

Our common stockCommon Stock is currently listed for trading in the National Association of Securities Dealers (“NASD”) Over-The-Counter Bulletin (“OTC”) Board MarketOTCQB operated by OTC Markets, Inc. and is subject to the “penny stock rules” adopted pursuant to Section 15(g) of the Exchange Act. In general, the penny stock rules apply to non-NASDAQ or non-national stock exchange companies whose common stock trades at less than $5.00 per share or which have tangible net worth of less than $5,000,000 ($2,000,000 if the company has been operating for three or more years). Such rules require, among other things, that brokers who trade “penny stock” on behalf of persons other than “established customers” complete certain documentation, make suitability inquiries of investors and provide investors with certain information concerning trading in the security, including a risk disclosure document, quote information, broker’s commission information and rights and remedies available to investors in penny stocks. Many brokers have decided not to trade “penny stock” because of the requirements of the penny stock rules, and as a result, the number of broker-dealers willing to act as market makers in such securities is limited. The “penny stock rules,” therefore, may have an adverse impact on the market for our common stockCommon Stock and may affect our ability to raise additional capital if we decide to do so.

When an investor sells stock that he does not own, it is known as a short sale. The seller, anticipating that the price of the stock will go down, intends to buy stock to cover his sale at a later date. If the price of the stock goes down, the seller will profit to the extent of the difference between the price at which he originally sold it less his later purchase price. Short sales enable the seller to profit in a down market. Short sales could place significant downward pressure on the price of our common stock.Common Stock. Penny stocks which do not trade on an exchange, such as our common stock,Common Stock, are particularly susceptible to short sales.

Our future success depends in significant part upon the continued services of our key senior management personnel. The competition for highly qualified personnel is intense, and we may not be able to retain our key managerial employees or attract and retain additional highly qualified technical and managerial personnel in the future. None of our employees are represented by a labor union, and we consider our relations with our employees to be good. None of our employees are covered by key man life insurance policies.policies

We have one 3,289currently lease 1,371 square footfeet of office space located at 6183 Paseo Del Norte,701 Palomar Airport Road, Suite 180,170, Carlsbad, California. The facility is leased under a non-cancelable lease expires December 31, 2012.

PDSG currently subleases offices located at 11260 El Camino Real, Suites 100 (3,676 square feet) and 102 (2,592 square feet), San Diego, California.  These facilities are subleased through February 2009. December 2011.

The current floor space provides adequate and suitable facilities for all of our corporate functions.

On April 22, 2010, we filed an action against TPL and Alliacense LLC in Santa Clara Superior Court alleging claims for breach of contract, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, and interference with contract, constructive fraud, for preliminary and permanent injunctions and for an accounting.  The Action stemmed from TPL's notification of a license written in April 2010 which included a license of the MMP patents and other patent to use portfolios and technologies co-owned and potentially owned by TPL that are notin the future.  We objected to the amount of license consideration allocated to the MMP patent license as too low relative to the other license components.

On April 26, 2010, the Court granted our application for a partTemporary Restraining Order ("TRO") precluding TPL from executing any license of the MMP Portfolio,patents without providing us five business days' notice of the proposed MMP license and as suchany other proposed license with the licensor, in order to allow us time to seek redress if we are not engaged in this aspectdissatisfied by the proposed licenses.  At that time, TPL filed motions to seal the file and to bar press releases commenting on the contents of the litigationcourt file, and defense.

On April 28, 2006 our Board of Directors authorized a stock repurchase program. We commenced the program in July 2006 and plan to repurchase outstanding shares of our common stockCommon Stock on the open market from time to time. We repurchased common stockCommon Stock during the fourth quarter of fiscal year 20082011 using available cash resources as follows:

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.

THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS CONCERNING FUTURE EVENTS AND PERFORMANCE OF OUR COMPANY. YOU SHOULD NOT RELY ON THESE FORWARD-LOOKING STATEMENTS, BECAUSE THEY ARE ONLY PREDICTIONS BASED ON OUR CURRENT EXPECTATIONS AND ASSUMPTIONS. MANY FACTORS COULD CAUSE OUR ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE INDICATED IN THESE FORWARD-LOOKING STATEMENTS. YOU SHOULD REVIEW CAREFULLY THE RISK FACTORS IDENTIFIED IN THIS REPORT AS SET FORTH BELOW AND UNDER THE CAPTION “RISK FACTORS.” WE DISCLAIM ANY INTENT TO UPDATE ANY FORWARD-LOOKING STATEMENTS TO REFLECT SUBSEQUENT ACTUAL EVENTS OR DEVELOPMENTS.

In June 2005, we entered into a series of agreements with TPL and others to facilitate the pursuit of infringersunlicensed users of our intellectual property. We intend to continue our joint venture with TPL to pursue license agreements with infringersunlicensed users of our technology. We believe that utilizing the option of working through TPL, as compared to creating and using a Companyour own licensing team for those activities, avoids a competitive devaluation of our principal assets and is a prudent way to achieve the desired results as we seek to obtain fair value from users of our intellectual property.  In April 2010, we filed an action against TPL regarding TPL’s management of the MMP portfolio.  On August 3, 2011 we issued a press release stating that we cannot come to a settlement with TPL in this matter and are pursuing litigation.

WithDuring fiscal 2010 and through the proceeds generated by these licensing efforts,date of this filing we are undertakingand TPL each contributed $580,000 to make investments in technologies, and acquisitionsfund the working capital of companies operatingPDS.  We expect the contributions to continue in the electronics technology market sectorfuture due to the working capital demands of PDS.  Additionally, we have loaned TPL an aggregate of $1,950,000, evidenced by waya secured note in the principal amount of i) selective expansion$950,000 and an unsecured note in the principal amount of $1,000,000 intended to cover its operating costs including the furtherance of licensing our MMP Portfolio of microprocessor patents.  At February 28, 2010, we reserved $1,013,151 against the unsecured $1,000,000 note receivable which includes accrued interest.  In April 2010, we filed suit against TPL for breach of contract regarding the $1,000,000 note non-payment.  On July 15, 2010, we received $1,003,095 consisting of principal and accrued interest through July 15, 2010 on the $950,000 secured note.  In January 2011, we settled the breach of contract action with respect to the $1,000,000 note and we received $1,098,903 consisting of principal and accrued interest on the unsecured note.

On October 5, 2009, we announced a reorganization of PDSG and our management.  On January 25, 2010, we sold the Iameter assets and during August 2010, we sold the Vigilys business line.  As a result of our IP portfolio, ii) pursuitreorganization and PDSG’s continued inability to meet its business plan, we have incurred impairment charges for our intangibles and goodwill in the PDSG segment of strategic minority investments in certain early-stage revenue or technology ventures that represent a technology or capabilityour business.  We continue to fund the day to day operating costs of interestPDSG while continuing to us,reduce expenses.  Our merger and iii) full M&A transactions.acquisition activities have ceased since our October 2009 reorganization.

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, which require us to make estimates and judgments that significantly affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Actual results could differ from those estimates, and such differences could affect the results of operations reported in future periods. We believe the following critical accounting policies affect our most significant estimates and judgments used in the preparation of our consolidated financial statements.

Accounting for revenue recognition is complex and affected by interpretations of guidance provided by several sources, including the Financial Accounting Standards Board (“FASB”) and the Securities and Exchange Commission (“SEC”). This guidance is subject to change. We follow the guidance established by the SEC in Staff Accounting Bulletin No. 104, as well as generally accepted criteria for revenue recognition, which require that, before revenue is recorded, there is persuasive evidence of an arrangement, the fee is fixed or determinable, collection is reasonably assured, and delivery to our customer has occurred. Applying these criteria to certain of our revenue arrangements requires us to carefully analyze the terms and conditions of our license agreements. Revenue from our technology license agreements is recognized at the time we enter into a contract determineis entered into, the license modelmethod is determined (paid-in-advance or on-going royalty), and provide ourthe customer is provided with the licensed technology, if applicable. These

When a sale involves multiple elements, PDSG allocates the entire fee from the arrangement to each respective element based on VSOE of fair value and recognizes revenue when each element’s revenue recognition criteria are generally met duringmet. VSOE of fair value for each element is established based on the fiscal quarter of license announcementprice charged when the same element is sold separately.  PDSG has established VSOE for paid-in-advanceits CDX software licenses and PCS based on historical stand-alone sales to third parties or from the subsequent quarter immediately following. We believe that thisstated renewal rates contained in the customer contracts.  PCS is the point at which we have performed all of our obligations under the agreement; however, this remains a highly interpretive area of accounting and future license agreements may result in a different method of revenue recognition. To date all of our technology licenses have been paid-in-advance, however, on-going royalty license terms may be opted for by future licensees of our technology. Fees for maintenance or support of our licenses are recordedrecognized on a straight-line basis over the underlying period of performance.support period.

Our consolidated variable interest entity recognizes revenue upon shipmentPDSG has not yet demonstrated VSOE for the professional services that are rendered in conjunction with its software license sales.  In accordance with the hierarchy we attempt to establish the selling price of itsprofessional services using TPE.  PDSG’s product and recognizes revenue on its short-term installation contracts as time and materials costs are incurred.contains significant differentiation such that the comparable pricing of products with similar functionality cannot be obtained.  PDSG is typically not able to obtain TPE for professional services.

We are involved in various legal matters, disputes, and patent infringement claims which arise in the ordinary course of our business. We accrue for any estimated losses at the time when we can make a reliable estimate of such 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.

We must assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not likely, we must increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. We believe that a substantial majority of the deferred tax assets recorded on our balance sheet will ultimately be recovered. However, shouldShould there be a change in our ability to recover the deferred tax assets; the tax provision would increase in the period in which we determined that the recovery was not probable.

We have a 50% interest in PDS.Phoenix Digital Solutions, LLC (“PDS”). We account for our investment 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 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 statementstatements of operations in the caption “Equity in earnings of affiliated companies”.companies.” and also is adjusted by contributions to and distributions from PDS.

On August 1, 2008,We own 100% of the preferred stock of Holocom. During May 31, 2010 we increasedwrote-off our investment in Talisthe preferred stock of Holocom amounting to 37.4% as a resultapproximately $435,000.  Prior to impairment, this investment was accounted for at cost since we did not have the ability to exercise significant influence over the operating and financial policies of purchasing additional shares offered by Talis, as well as acquiring shares from minority shareholders which included the acquisition of all Talis shares previously held by SSDI. The acquisition of Talis shares previously owned by SSDI was made for $100,000 in cash and a reduction on their outstanding line of credit of $219,000.Holocom.

We review our investments in these affiliated companies to determine whether events or changes in circumstances indicate that the carrying amounts may not be recoverable. The primary factors we consider in our determination are the financial condition, operating performance and near term prospects of the investees. If the decline in value is deemed to be other than temporary, we would recognize an impairment loss.

We reevaluate our primary beneficiary positionaccount for business combinations using the purchase method of accounting and accordingly, the assets and liabilities of the acquired entities are recorded at eachtheir estimated fair values at the acquisition date. Goodwill represents the excess of ourthe purchase price over the fair value of net assets, including the amount assigned to identifiable intangible assets. Due to the time it takes to obtain pertinent information to finalize the acquired company’s balance sheet, dates using the guidance in FIN46(R). Ifit may be several quarters before we are no longer deemedable to finalize the initial fair value estimates. Accordingly, it is not uncommon for the initial estimates to be subsequently revised. The results of operations of acquired businesses are included in our consolidated financial statements from the primary beneficiary of the variable interest entity, we will discontinue consolidation.acquisition date.

Revenue consisting of software licenses and associated services relating to PDSG’s CDX product decreased from approximately $639,000$568,000 for the fiscal year ended May 31, 20072010 to approximately $3,708,000$469,000 for the fiscal year ended May 31, 2008. Our2011.  The decrease of approximately $99,000 was primarily due to the fact that revenue amounts do not includeagreements are one time contracts that vary in size and scope depending upon the requirements of the customer.  Cost of sales includes the direct time of PDSG employees on each project. Included in cost of sales is approximately $48,965,000$253,000 and $551,000, respectively, of amortization expense on purchased intangible assets for each of the fiscal years ended May 31, 2011 and 2010.

Research and development costs consist of PDSG’s payroll and related expenses for software engineers as well as outside contractors retained to assist in income resulting from our investmentthe development of PDSG’s software product.  The primary decreases in PDSresearch and development costs for the fiscal year ended May 31, 20072011 as compared to 2010 were approximately $396,000 in outside contractor costs due to completion of CDX4 and approximately $19,918,000$338,000 in income resulting from our investmentssalaries and related costs due to management’s restructuring plan implemented in PDS and Talis forOctober of 2009.  For the fiscal yearyears ended May 31, 2008.  During the 2008 fiscal year we2011 and 2010, approximately $2,000 and $20,000, respectively, of share-based compensation was recorded sales amounting to approximately $3,650,000 by our consolidated variable interest entity, SSDI, with cost of sales amounting to approximately $1,510,000 as compared to the fourth 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. 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 revenue evenly over the four year periodvesting 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.employee stock options.

Selling, general and administrative expenses decreased from approximately $7,559,000$2,715,000 for the fiscal year ended May 31, 20072010 to approximately $6,965,000$1,163,000 for the fiscal year May 31, 2011, due to management’s restructuring plan to reduce expenses.  Decreases consisted primarily of approximately $1,038,000 in salaries and related expenses and approximately $254,000 in marketing expenses.  For fiscal years ended May 31, 2011 and 2010, approximately $18,000 and $49,000, respectively, of share-based compensation was recorded in connection with vesting of employee stock options.

Selling, general and administrative expenses decreased from approximately $3,816,000 for the fiscal year ended May 31, 2008. Legal and accounting related expenses decreased by2010 to approximately $668,000$2,551,000 for the fiscal year ended May 31, 2008 compared with2011.  The decrease consisted primarily of approximately $546,000 in payroll and related expenses due to management’s plan of restructuring implemented in October 2009, approximately $250,000 in consulting fees, approximately $155,000 in legal and accounting fees, and approximately $79,000 in public and investor relations expenses.  For the fiscal year ended May 31, 2007 due to settlement2011 and 2010, approximately $56,000 and $153,000, respectively, of legal matters during fiscal year 2008 and reduced accounting expenses in fiscal year 2008.  Fiscal year 2007 included fees related to legal and accounting mattersshare-based compensation was recorded in connection with the restatementvesting of our financial statementsemployee stock options.

Selling, general and administrative expenses decreased from approximately $6,531,000 for the fiscal years 2005, 2004, 2003 and 2002 as well as the quarterly reportsyear ended May 31, 2010 to approximately $3,713,000 for the periodsfiscal year ended AugustMay 31, 20052011 primarily due to management’s plan of restructuring implemented in October 2009.

Management’s plan of restructuring on October 5, 2009 and February 28, 2006 andthe continuing inability of PDSG to meet its business plan were indicators of potential impairment on our required compliance with Sarbanes-Oxley regulations. Salary costs and related expenses included non-cash expenses associated with the fair value of options grantedgoodwill. Accordingly, during the fiscal years ended May 31, 20082011 and 2007 in accordance with SFAS No. 123(R). Total non-cash compensation for the fiscal year ended 20082010, management determined that goodwill 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 increasedimpaired by approximately $292,000$643,000 and $1,096,000, respectively.

Operating loss decreased from approximately $8,948,000 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 compared2010 to approximately $242,538 for the fourth quarter of the 2007 fiscal year. Public and investor relations expenses decreased by approximately $128,000$3,888,000 for the fiscal year ended May 31, 2008 as compared with the 2007 fiscal year2011 primarily due to one-time contracts with investor relations firmsdecreases in impairments of goodwill and intangibles in the current fiscal year 2007.as compared to the prior fiscal year and management’s plan of restructuring implemented in October 2009 which reduced salaries and related expenses.

Operating loss decreased from approximately $7,525,000 were recorded during$3,816,000 for the fiscal year ended May 31, 2007, relating2010 to approximately $2,551,000 for the mediation agreement with Russell H. Fish III (“Fish”).  During fiscal year 2008 we recorded approximately $836,000 relating to royalty paymentsended May 31, 2011 primarily due to the Fish parties.  In January 2008, we made the final payment under the Fish settlement agreement.management’s plan of restructuring implemented in October 2009 which reduced salaries and related expenses.

Our other income and expenses for the fiscal years ended May 31, 20082011 and 2007 include2010 included equity in the earnings of PDS.  For the fiscal year ended May 31, 2008 our other income and expense also includes our sharePDS consisting of loss in Talis. Our investments are accounted for in accordance with the equity method of accounting. Our investment in PDS for the fiscal year ended May 31, 2008 providednet income after expenses in the amount of approximately $19,926,000 as compared to income after expenses in the amount of$600,000 and approximately $48,965,000 for the fiscal year ended May 31, 2007.  For the fiscal year ended May 31, 2008 our investment in Talis generated a loss 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.$4,462,000, respectively.  The increasedecrease is primarily due to the interest earnedPDS’ lack of license revenues and accrued on our auction rate securities of approximately $363,000 and an increase in other income of approximately $382,000 relating to retainer refunds fromincreased 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, 2008.

Loss before income taxes decreased from approximately $8,756,000 for the fiscal year ended May 31, 2007 provided income after expenses in the amount of2010 to approximately $48,965,000. Our investment in the joint venture provided net income after expenses in the amount of approximately $27,848,000$3,828,000 for the fiscal year ended May 31, 2006. Total other2011 primarily due to decreases in impairments of goodwill and intangibles in the current fiscal year as compared to the prior fiscal year and management’s plan of restructuring implemented in October 2009 which reduced salaries and related expenses.

Loss before income and expensetaxes decreased from approximately $1,852,000 for fiscal year ended May 31, 2010 to approximately $1,450,000 for the fiscal year ended May 31, 2007 amounted2011 primarily due to net othermanagement’s plan of restructuring implemented in October 2009 which primarily reduced salaries and related expenses.

Provision (benefit) for 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 for the fiscal year ended May 31, 2006 of approximately $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 for the 2006 fiscal year amounted to expenses of approximately $471,000 resulting from amortization of debt discount and conversion of the remaining debentures. During the 2006 fiscal year we recorded a loss on debt extinguishment of $445,000 related to the 7,000,000 warrants issued to a debenture 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. taxes

During the fiscal year ended May 31, 20072011, 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 the VIE (see Note 8 to our consolidated financial statements for more information).

During the fiscal year ended May 31, 2007 due to recognition of deferred2010, we recorded a benefit for income taxes of approximately $9,783,000$3,928,000 related to federal and California taxes.

We recorded a current tax liability of approximately $972,070. The increase in deferred taxes was due tonet loss for the release of the valuation allowance as we determined that we would utilize our net operating loss carryforwards and other deferred tax assets due to our share of income from PDS. Atfiscal years ended May 31, 2007 we have utilized all2011 and 2010 of our state net operating loss carryforwards of approximately $17,822,000$11,515,390 and utilized approximately $29,090,000 of our federal net operating loss carryforwards.$6,679,821, respectively.

Our cash and short-term marketable securities and short-term investment balances decreasedincreased from approximately $25,955,000$10,352,000 as of May 31, 20072010 to approximately $6,722,000$10,661,000 as of May 31, 2008.2011. We also have a restricted cash balancesbalance amounting to approximately $51,000$21,000 as of May 31, 20082011 and approximately $102,000 as of May 31, 2007.2010. Total current assets decreased from approximately $31,399,000$13,417,000 as of May 31, 20072010 to approximately $9,851,000$12,196,000 as of May 31, 2008.2011. Total current liabilities amounted to approximately $930,000$942,000 and approximately $2,021,000$576,000 as of May 31, 20082010 and May 31, 2007,2011, respectively. The change in our current position as of May 31, 20082011 as compared with the previous yearMay 31, 2010 results primarily results from the investmentcollection of idleour note receivable issuance during the fiscal year ended May 31, 2011 and the valuation allowance placed on the current portion of our deferred tax assets during the current fiscal year ended May 31, 2011 .

Cash shortfalls currently experienced by PDS and TPL, and continued negative cash flows incurred by PDSG, will have an adverse effect on our liquidity.  Accordingly, we have and may continue to examine alternatives that could allow for the partnering or divestiture of PDSG.  If successful, these measures may provide for a further reduction in expenses and cash use, or additionally in the event of divestiture, cash proceeds, although given the operational history of PDSG to date there can be no guarantee that a divestiture will result in the realization of material consideration.  With respect to PDS and TPL, we do not intend to fund any cash requirements of these entities.

While our current liquid cash resources as of May 31, 2011, are expected to provide the funds necessary to support our operations through at least the next twelve months, the cash flows from our interest in PDS represents our primary significant source of cash generation.  In the event of a continued decrease or interruption in MMP Portfolio licensing we will incur a significant reduction to our cash position as the revenues from our PDSG subsidiary are insufficient to cover the costs of their operations and the costs of Patriot Scientific Corporation as a whole.  While our cash position has been enhanced as a result of our September 2010 auction rate securities which are classified as long-termsettlement with Deutsche Bank, it is highly unlikely that we would be able to obtain any additional sources of financing to supplement our cash and the decrease in distributions received from PDS during fiscal year 2008.short-term investment position of $10,660,674 at May 31, 2011.

Cash used in operating activities for the fiscal years ended May 31, 20082011 and 20072010 was approximately $19,260,000$4,321,000 and $14,151,000 as compared with cash provided by operating activities for the fiscal year ended May 31, 2006 of approximately $6,474,000.$7,317,000, respectively. The principal non-cash components of the current fiscal year amount were: deferred taxes of approximately $6,215,000 and impairment of intangibles and goodwill of approximately $2,113,000.  These items were offset by: net loss of approximately $11,515,000, and recovery of loan loss of approximately $1,013,000.

Decreases in our 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,affiliates for the fiscal years ended May 31, 2011 and a decrease in trade payables and accrued expenses of approximately $1,091,0002010 are primarily due to the decrease in our accrualshare of royalties payable at May 31, 2007 of which we have no obligation at May 31, 2008.  The cash provided by operating activities during fiscal year 2006 was primarily due toearnings in our one-time license of $10,000,000 from Intel Corporation.affiliate PDS.

Cash provided by investing activities for the fiscal yearyears ended May 31, 20082011 and 2010 was approximately $10,725,000 as compared$5,698,000 and $11,674,000, respectively.  Decreases were primarily due to cash provided by investing activities of approximately $48,529,000 fordecreases in distributions received from PDS.  Cash used during the fiscal year ended May 31, 2007. The decrease was primarily due to a reduction2011 included approximately $2,205,000 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.

Cash used in financing activities for the fiscal yearyears ended May 31, 20082011 and 2010 was approximately $6,647,000 as compared to cash used in financing activities of approximately $16,757,000 for$3,264,000 and $223,000, respectively.   For the fiscal year ended May 31, 2007. Cash used in fiscal year 2008 consisted primarily2011, cash of approximately $2,761,000$3,122,000 was used to repurchase warrants from an investorrepay our line of credit with Wedbush and cash of approximately $3,891,000$138,000 was used to repurchase shares of our common stock for treasury.  The cash used inFor the fiscal year 2008 was partially offset by proceeds receivedended May 31, 2010 cash of approximately $31,000 from the exercise of common stock options and warrants. Cash used in financing activities in fiscal year 2007 consisted primarily of approximately $8,115,000 in cash dividends to common shareholders and approximately $8,832,000$234,000 was used to repurchase shares of our common stock for treasury.

OurWhile our current positionliquid cash resources as of May 31, 2008 is2011, are expected to provide the funds necessary to support our operations through at least the fiscal year ended May 31, 2009.

The financial statements and supplementary data required by this item are included in Part IV, Item 15 of this Report and begin on page F-1 with the index to consolidated financial statements.

None.