| Basis of Presentation and Summary of Significant Accounting Policies | The unaudited
condensed consolidated financial statements of Patriot Scientific Corporation (the “Company”, “PTSC”,
“Patriot”, “we”, “us” or “our”) presented herein have been prepared pursuant to
the rules of the Securities and Exchange Commission (“SEC”) for quarterly reports on Form 10-Q and do not include
all of the information and footnotes required by accounting principles generally accepted in the United States of America. These
unaudited condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements
and notes thereto included in our Report on Form 10-K for our fiscal year ended May 31, 2017. In the opinion
of management, the interim condensed consolidated financial statements reflect all adjustments of a normal recurring nature necessary
for a fair presentation of the results for the interim periods presented. Operating results for the nine month period ended February
28, 2018 are not necessarily indicative of the results that may be expected for the year ending May 31, 2018. Basis
of Consolidation The condensed
consolidated balance sheets at February 28, 2018 and May 31, 2017 and condensed consolidated statements of operations and condensed
consolidated statements of cash flows for the nine months ended February 28, 2018 and 2017 include our accounts and those of our
inactive subsidiaries: Patriot Data Solutions Group, Inc. (“PDSG”) which includes Crossflo Systems, Inc. (“Crossflo”),
and Plasma Scientific Corporation. All significant intercompany accounts and transactions have been eliminated. Liquidity
and Management’s Plans Cash shortfalls
currently experienced by Phoenix Digital Solutions, LLC (“PDS”) will have an adverse effect on our liquidity. To date,
we have determined that it is in the best interests of the Moore Microprocessor Patent (“MMP”) licensing program that
we provide our 50% share of capital to provide for PDS expenses including legal retainers, and litigation related payments in
the event license revenues received by PDS are insufficient to meet these needs. We believe it is likely that contributions to
PDS to fund working capital will continue to be required. PDS has been
incurring significant third-party costs for legal fees, expert testimony, depositions and other related litigation costs. We could
be required to make capital contributions to PDS for any future litigation related costs in the event that PDS does not receive
sufficient licensing revenues to pay these expenses. Our current
liquid cash resources are expected to provide the funds necessary to support our operations through at least the next twelve months
from the date of this report. The cash flows from our interest in PDS represent our only 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. It is highly unlikely that we would be able to obtain any additional sources of financing to supplement our cash and
cash equivalents and short-term investment position. On March
20, 2013, Technology Properties Limited, Inc. (“TPL”) filed a petition under Chapter 11 of the United States Bankruptcy
Code. On March 5, 2018, TPL’s Motion for Entry of Final Decree Closing Chapter 11 was granted. In the event we are required
to provide funding to PDS that is not reciprocated by TPL, our ownership percentage in PDS will increase and we will have a controlling
financial interest in PDS, in which case, we will consolidate PDS in our condensed consolidated financial statements. Investments
in Marketable Securities 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 held-to-maturity based on management’s
investment intentions relating to these securities. Held-to-maturity marketable securities are stated at amortized cost. Unrealized
gains and losses, net of deferred taxes, are recorded as a component of other comprehensive income (loss). We follow the authoritative
guidance to assess whether our investments with unrealized loss positions are other than temporarily impaired. Realized gains
and losses and declines in fair value judged to be other than temporary are determined based on the specific identification method
and are reported in other income (expense), net in the condensed consolidated statements of operations. Investment
in Affiliated Company We have a
50% interest in PDS (see Note 3). 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 condensed consolidated statements of operations
in the caption “Equity in earnings (loss) of affiliated company” and also is adjusted by contributions to and distributions
from PDS. PDS, as an
unconsolidated equity investee, recognizes revenue from technology license agreements at the time a contract is entered into,
the license method is determined (paid-in-advance or on-going royalty), performance obligations under the license agreement are
satisfied, and the realization of revenue is assured, which is generally upon the receipt of the license proceeds. PDS may at
times enter into license agreements whereby contingent revenues are recognized as one or more contractual milestones are met. We review
our investment in PDS to determine whether events or changes in circumstances indicate that the carrying amount may not be recoverable.
The primary factors we consider in our determination are the financial condition, operating performance and near term prospects
of PDS. If a decline in value is deemed to be other than temporary, we would recognize an impairment loss. Earnings
(Loss) Per Share Basic earnings
per share includes no dilution and is computed by dividing earnings available to common stockholders by the weighted average number
of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution of securities that could
share in the earnings of an entity. For the three
and nine months ended February 28, 2018, potential common shares of 2,600,000 related to our outstanding options were not included
in the calculation of diluted loss per share as we recorded a loss. Had we reported net income for the three and nine months ended
February 28, 2018, no shares of common stock would have been included in the calculation of diluted income per share using the
treasury stock method. For the three
months ended February 28, 2017, potential common shares of 2,600,000 related to our outstanding options were not included in the
calculation of diluted loss per share as we recorded a loss. Had we reported
net income for the three months ended February 28, 2017, no shares of common stock would have been included in the calculation
of diluted income per share using the treasury stock method. For the nine
months ended February 28, 2017, potential common shares of 2,600,000 related to our outstanding options were not included in the
calculation of diluted income per share as their inclusion would be anti-dilutive. For the nine months ended February 28, 2017
we included the PDSG escrow shares of 2,844,630 in the calculation of diluted income per share. In connection
with our acquisition of Crossflo, which is part of PDSG, we issued escrow shares that are contingent upon certain representations
and warranties made by Crossflo at the time of the merger agreement (see Note 6). We excluded these escrow shares from the basic
loss per share calculations and would have included the escrowed shares in the diluted income per share calculations if we reported
net income for the three and nine months ended February 28, 2018. Income Taxes We follow
authoritative guidance in accounting for uncertainties in income taxes. This authoritative guidance prescribes a recognition threshold
and measurement requirement for the financial statement recognition of a tax position that has been taken or is expected to be
taken on a tax return and also provides guidance on derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. Under this guidance we may only recognize tax positions that meet a “more likely than
not” threshold. We follow
authoritative guidance to evaluate whether a valuation allowance should be established against our deferred tax assets based on
the consideration of all available evidence using a “more likely than not” standard. In making such judgments, significant
weight is given to evidence that can be objectively verified. We assess our deferred tax assets annually under more likely than
not scenarios in which they may be realized through future income. With the
exception for refundable alternative minimum tax (AMT) credits, we have determined that it was more likely than not that all of
our deferred tax assets will not be realized in the future due to our continuing pre-tax and taxable losses. As a result of this
determination, and with the exception for the aforementioned refundable tax credits, we have recorded a full valuation allowance
against our deferred tax assets. We follow
authoritative guidance to adjust our effective tax rate each quarter to be consistent with the estimated annual effective tax
rate. We are also required to record the tax impact of certain discrete items, unusual or infrequently occurring, including changes
in judgment about valuation allowances and effects of changes in tax laws or rates, in the interim period in which they occur.
In addition, jurisdictions with a projected loss for the year or a year-to-date loss where no tax benefit can be recognized are
excluded from the estimated annual effective tax rate. The impact of such an exclusion could result in a higher or lower effective
tax rate during a particular quarter, based upon the mix and timing of actual earnings or losses versus annual projections. On December
22, 2017, the United States Government passed new tax legislation that, among other provisions, will lower the corporate tax rate
from 35% to 21%. In addition to applying the new lower corporate tax rate in 2018 and thereafter to any taxable income we may
have, the legislation affects the way we can use and carryforward net operating losses previously accumulated and results in a
revaluation of deferred tax assets and liabilities recorded on our condensed consolidated balance sheet. Given that our current
deferred tax assets, with the exception of those representing certain refundable tax credits, are offset by a full valuation allowance,
these changes will have no net impact on our condensed consolidated balance sheet. However, if we become profitable, we will receive
a reduced benefit from such deferred tax assets. Assessment of Contingent Liabilities 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. Intellectual
Property Rights PDS, our
investment in affiliated company, relies on a combination of patents, trademarks, copyrights, trade secret laws, confidentiality
procedures and licensing arrangements to protect our intellectual property rights. We have seven U.S., nine European, and three
Japanese patents all of which expired between August 2009 and October 4, 2016. These patents, while expired, may have certain
retrospective statutory benefits that will fully diminish six years after the patent expiration dates. The patent useful life
for purposes of negotiating licenses is finite and these patents are subject to legal challenges, which in combination with the
limited life, could adversely impact the stream of revenues. A successful challenge to the ownership of the technology or the
proprietary nature of the intellectual property would materially damage business prospects. Any issued patent may be challenged
and invalidated. Recent Accounting Pronouncements
In May 2014,
the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09,
“Revenue from Contracts with Customers,” which was subsequently amended by ASUs 2015-14, 2016-08, 2016-10, 2016-12,
and 2016-20. ASU 2014-09, as amended, supersedes the revenue recognition requirements in ASC Topic 605, “Revenue Recognition”,
and creates a new ASC Topic 606 (“ASC 606”). ASU 2014-09, as amended, implements a five-step process for customer
contract revenue recognition that focuses on transfer of control, as opposed to transfer of risk and rewards. The amendment also
requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenues and cash flows from contracts with
customers. Other major provisions include the capitalization and amortization of certain contract costs, ensuring the time value
of money is considered in the transaction price, and allowing estimates of variable consideration to be recognized before contingencies
are resolved in certain circumstances. Entities can transition to the standard either retrospectively or as a cumulative-effect
adjustment as of the date of adoption. The new revenue standards are effective for annual reporting periods beginning after December
15, 2017, including interim reporting periods within that reporting period (fiscal year 2019 for the Company). Early adoption
is permitted. We are currently assessing the potential impact of this standard on the revenues generated by PDS. In August
2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows – Classification of Certain Cash Receipts and Cash
Payments.” ASU 2016-15 provides guidance intended to reduce diversity in practice in how certain transactions are classified
in the statement of cash flows. The issue addressed in ASU 2016-15 that will affect the Company is classifying distributions received
from equity method investments. The guidance provides an accounting policy election for classifying distributions received from
equity method investments using either a cumulative earnings approach or a nature of distributions approach. ASU 2016-15 is effective
for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years
(fiscal 2019 for the Company). Early adoption is permitted. We have not yet determined the potential effects of the adoption of
ASU 2016-15 on our condensed consolidated financial statements. In November
2016, the FASB issued ASU No. 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash”. ASU 2016-18 requires
that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally
described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted
cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period
total amounts shown on the statement of cash flows. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017,
and interim periods within those fiscal years (fiscal 2019 for the Company), with early adoption permitted. We are currently evaluating
the effect ASU 2016-18 will have on our condensed consolidated statements of cash flows. On December
22, 2017, the date the Tax Cuts and Jobs Act (“Tax Cuts Act”) was signed into law, the Securities and Exchange Commission
staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) which provides guidance regarding accounting for the income
tax effects of the Tax Cuts Act, including the impact of the Tax Cuts Act on deferred tax assets and liabilities for financial
statements issued in the reporting period that includes the enactment date of December 22, 2017. Given that our current deferred
tax assets are offset by a full valuation allowance, these changes will have no net impact on our condensed consolidated financial
statements. However, if we become profitable, we will receive a reduced benefit from such deferred tax assets. |
