AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 11, 2003
REGISTRATION NO.
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================================================================================
SECURITIES AND EXCHANGE COMMISSION
FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
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PATRIOT SCIENTIFIC CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 3699 84-1070278
-------- ---- -----------
(State or Jurisdiction of Primary SIC Code (I.R.S. Employer
of Incorporation or Identification Number)
Organization)
10989 VIA FRONTERA
SAN DIEGO, CALIFORNIA 92127
(858) 674-5000
(Address and telephone number of registrant's principal executive offices)
LOWELL W. GIFFHORN, SECRETARY
PATRIOT SCIENTIFIC CORPORATION
10989 VIA FRONTERA
SAN DIEGO, CALIFORNIA 92127
(858) 674-5000
(Name, address and telephone number of agent for service)
-----------
COPIES TO:
OTTO E. SORENSEN, ESQ.
LUCE, FORWARD, HAMILTON & SCRIPPS LLP
600 WEST BROADWAY, SUITE 2600
SAN DIEGO, CALIFORNIA 92101
(619) 236-1414
(619) 232-8311 (FAX)
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED
SALE TO THE PUBLIC: AS SOON AS PRACTICABLE AFTER THE
EFFECTIVE DATE OF THIS REGISTRATION STATEMENT.
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If any of the securities being registered on this Form are to be
offered on a delayed or continuous basis pursuant to Rule 415 under the
Securities Act of 1933 check the following box. |X|
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. |_|
If this Form is a post-effective amendment filed pursuant to Rule
462(c) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. |_|
If this Form is a post-effective amendment filed pursuant to Rule
462(d) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. |_|
If delivery of the prospectus is expected to be made pursuant to Rule
434, please check the following box. |_|
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE
OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
CALCULATION OF REGISTRATION FEE
- -------------------------------------------------------------------------------------------------------------------------------
Proposed Maximum Amount of
Title of Each Class of Proposed Maximum Aggregate Offering Registration
Securities to be Registered Amount to be Registered Offering Price Per Unit(3) Price Fee
- -------------------------------------------------------------------------------------------------------------------------------
Common Stock, $0.00001 18,755,888 $0.06 $1,125,353 $ 91.04
par value (1)
- -------------------------------------------------------------------------------------------------------------------------------
Common Stock, $0.00001
par value (2) 2,337,928 $0.06 $ 140,276 $ 11.35
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL 21,093,816 $0.06 $1,265,629 $102.39
- -------------------------------------------------------------------------------------------------------------------------------
(1) Shares of the Registrant's common stock, $.00001 par value per share, are
being registered for resale on behalf of certain selling security holders.
The common stock being registered is issuable to the selling security
holders on their conversion of the Company's 8% Convertible Debentures
issued on March 24, 2003 through June 10, 2003 (the "Series C Debentures").
The terms of the Series C Debentures do not fix the number of common shares
that may be issuable upon conversion, however, the Company hereby registers
a good faith estimate of the maximum number of shares it anticipates to
issue upon conversion. The Company will not rely on Rule 416 of Regulation
C if the conversion price results in an insufficient number of shares being
registered. In the event that the number of shares actually issued exceeds
the number of shares included in the registration fee table, the Company
will file a new registration statement to cover the resale of any
additional shares.
(2) Shares of the Registrant's common stock, $.00001 par value per share, are
being registered for resale on behalf of certain selling security holders.
The common stock being registered is issuable to the selling security
holders on their conversion of the Company's 8% Convertible Debentures
issued on April 23, 2002 through June 10, 2002 (the "Series A Debentures").
The terms of the Series A Debentures do not fix the number of common shares
that may be issuable upon conversion, however, the Company registered
22,363,391 shares of common stock on Form S-1, file number 333-98871, which
went effective on October 29, 2002. The number of shares registered was a
good faith estimate of the maximum number of shares it anticipated to issue
upon conversion. The number of shares issuable will exceed the original
number registered shares due to a drop in the price of the Company's stock.
The Company is hereby registering an additional number of shares which it
believes is a good faith estimate of the maximum number of shares it
anticipates to issue upon conversion. The Company will not rely on Rule 416
of Regulation C if the conversion price results in an insufficient number
of shares being registered. In the event that the number of shares actually
issued exceeds the number of shares included in the registration fee table
plus the number of shares previously registered, the Company will file a
new registration statement to cover the resale of any additional shares.
(3) Estimated solely for purposes of calculating the registration fee in
accordance with Rule 457(c) under the Securities Act of 1933, as amended
(the "Act"), based on the average of the closing bid and asked prices for
the Registrant's Common Stock (the "Common Stock") as reported on the OTC
Electronic Bulletin Board on June 6, 2003.
THE INFORMATION IN THIS PRELIMINARY PROSPECTUS IS NOT COMPLETE AND MAY BE
CHANGED. THESE SECURITIES MAY NOT BE SOLD UNTIL THE REGISTRATION STATEMENT FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC) IS EFFECTIVE. THIS PRELIMINARY
PROSPECTUS IS NOT AN OFFER TO SELL NOR DOES IT SEEK AN OFFER TO BUY THESE
SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION; AS FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION ON JUNE 11, 2003
P R O S P E C T U S
PATRIOT SCIENTIFIC CORPORATION
10989 Via Frontera
San Diego, California 92127
(858) 674-5000
THE OFFERING
The resale of up to 21,093,816 shares of common stock in the
over-the-counter market at the prevailing market price or in negotiated
transactions.
o up to 21,093,816 shares are issuable to the selling shareholders as
conversion shares upon the conversion of our 8% Convertible
Debentures.
We will receive no proceeds from the sale of the shares by the selling
shareholders.
TRADING SYMBOL
PTSC (Over-the-counter Electronic Bulletin Board)
THIS INVESTMENT INVOLVES A HIGH DEGREE OF RISK.
Please refer to Risk Factors Beginning on Page 8
THE SECURITIES AND EXCHANGE COMMISSION (SEC) AND STATE SECURITIES REGULATORS
HAVE NOT APPROVED THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL
OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THIS
PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN
OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT
permitted.
Please read this prospectus carefully. It describes our company, finances and
products. Federal and state securities laws require that we include in this
prospectus all the material information that you will need to make an investment
decision.
We have not authorized anyone to provide you with information that is different
from what is contained in this prospectus.
The following table of contents has been designed to help you find important
information contained in this prospectus. We have included subheadings to aid
you in searching for particular information you might want to return to. We
encourage you to read the entire prospectus.
TABLE OF CONTENTS
Page
PROSPECTUS SUMMARY 5
About our company 5
About our convertible debentures 5
Additional shares we are registering 6
Key facts 7
RISK FACTORS 8
Related to our business
Our major product line has had limited revenues 8
We have incurred significant losses and may continue to do so 8
Our limited sales and marketing experience has effected our revenue 9
Our products may not be completed on time 9
Related to our industry
The market in which we operate is highly competitive 9
Protection of our intellectual property is limited; there is a risk of
claims for infringement 10
Our products are dependent on the Internet and Java 10
We may be impacted as a result of terrorism 11
Related to our offering and share price
The price and the trading volume of our common stock have an effect on the
amount of capital that can be raised 11
We will require additional financing 11
Large block sales of our stock may decrease the price of our stock 12
Our stock is subject to penny-stock rules which limits our ability to
attract competitive funding 13 The price of our stock could
be subject to short sale pressure 13 On a significant drop in
the price of our stock, we could be subject to a change
in control 13
Our shareholders will need to increase the authorized number of shares 13
Forward-looking statements 15
PLAN OF DISTRIBUTION 15
SELLING SHAREHOLDERS 16
THE COMPANY 17
General 17
Background 18
2
Page
Business 18
Available information 18
Organization and corporate development 19
Internet growth and the emergence of the java programming language 20
Microprocessor technology 21
General background 21
Industry background 21
Technology description 23
The Ignite microprocessor as a java processor 23
Stage of development 24
Business strategy 25
Competition 26
JUICEtechnology 27
High speed data communications products 27
Radar and antenna technology 27
General background 27
Gas antenna technology description 27
Research and development 27
Licenses, patents, trade secrets and other proprietary rights 28
Marketing and distribution 29
Dependence upon single customers 30
Facilities 30
Employees 30
Government regulation 31
USE OF PROCEEDS 31
LITIGATION 31
Page
SELECTED CONSOLIDATED FINANCIAL DATA 31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 32
Critical Accounting Policies 33
Results of operations for the nine months ended February 28, 2003 and 2002 34
Results of operations for the years ended May 31, 2002, 2001 and 2000 35
Supplementary Financial Information 38
Liquidity and capital resources 38
$25 Million Equity Line of Credit 40
Secured Note Payable 42
8% Convertible Debentures 44
New accounting pronouncements 45
Tax loss carryforwards 46
CHANGES IN ACCOUNTANTS 46
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 47
MANAGEMENT 47
Identification of directors and executive officers 47
3
Page
Biographical information 48
Indemnification of officers, directors and others 49
Executive compensation 50
Option grants 51
Aggregated option exercises and fiscal year-end values 51
Compensation of directors 52
Employee contracts 52
PRINCIPAL SHAREHOLDERS 54
CERTAIN TRANSACTIONS 55
TRADING MARKET AND RELATED MATTERS 57
DESCRIPTION OF SECURITIES 58
LEGAL MATTERS 59
EXPERTS 59
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE F-1
4
PROSPECTUS SUMMARY
ABOUT OUR COMPANY
We develop, market, and sell microprocessors, our technology behind the
microprocessors, and complimentary products which enable computers and other
data processing devices to communicate. These products can be used to connect to
the 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, subsequent to 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 licensee to penetrate the ground or structures 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 sale of the gas plasma technology in the form of royalties.
Our strategy is to exploit our microprocessor technologies through product
sales, licensing, and strategic alliances.
Our auditors have stated in their report on our consolidated financial
statements as of and for the year ended May 31, 2002, substantial doubt about
our ability to continue operating as a going concern because of recurring net
losses and negative cash flows from operations. We have an accumulated deficit
of $44,669,131 and negative working capital of $1,343,171 as of February 28,
2003 and a history of substantial operating losses, net losses and negative cash
flow.
We have our principal executive offices at 10989 Via Frontera, San
Diego, California 92127. Our telephone number is (858) 674-5000 and our website
is WWW.PTSC.COM.
ABOUT OUR CONVERTIBLE DEBENTURES
OVERVIEW. From March 24, 2003 through June 10, 2003, we sold to
and received cash from the selling shareholders an aggregate of $510,000 of 8%
convertible debentures with two year maturity dates. The convertible debentures
entitle the debenture holder to convert the principal and unpaid accrued
interest into our common stock on any date up to and including the maturity
date. 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
debentures can be converted into a number of our common shares based on either a
negotiated number of shares or the following calculation: the amount of the
debenture divided by 115% of the volume weighted average price for our common
stock for the ten days previous to the debenture date.
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 to which this prospectus is a part
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.
5
WARRANTS. Concurrent with the issuance of the convertible
debentures, we issued to the selling shareholders warrants to purchase up to
9,377,943 shares of our common stock. These warrants are exercisable for five
years from the date of issuance at initial exercise prices equal to either a
negotiated exercise price or 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 sold. 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 engaging in certain transactions without
obtaining the selling shareholders' prior written approval. These types of
transactions 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.
RIGHT OF FIRST REFUSAL. The selling shareholders have a right of
first refusal to purchase or participate in any 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.
SELLING SHAREHOLDERS' RIGHT OF INDEMNIFICATION. We are obligated
to indemnify the selling shareholders (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 convertible
debenture, our registration rights agreement, other related agreements, or the
registration statement.
ADDITIONAL SHARES WE ARE REGISTERING
From April 23, 2002 through June 10, 2002 we sold to and received
cash from the selling shareholders an aggregate of $1,000,000 of 8% convertible
debentures with two year maturity dates. In October 2002, a registration
statement on Form S-1 went effective for the resale of up to 22,363,391 shares
of our common stock issuable on the conversion of the debentures. Since the
terms of the debentures did not fix the number of shares that may be issuable on
conversion, we registered a good
6
faith estimate of the maximum number of shares we anticipated to issue upon
conversion. On reset dates, as defined in the debentures, the price of our
common stock has been lower than the original anticipated lowest conversion
price. This has resulted in an increase in the number of common shares which may
be issued as a result of conversion to be greater than the original number of
shares registered. Accordingly, we are registering an additional 2,337,930
shares of common stock to cover the shortfall.
KEY FACTS
Shares being offered for resale to the public 21,093,816 (19.8% of our shares currently outstanding)
Total shares outstanding prior to the offering 106,547,807 as of June 6, 2003
Total shares outstanding after the offering 127,641,623
Total shares that would be outstanding assuming
full conversion of the current offering and exercise
of all outstanding debentures, options and warrants 198,214,240
Price per share to the public Market price at time of resale
Total proceeds raised by offering None
Convertible debentures A form of our convertible debenture with the selling
shareholders was included as an exhibit to the S-3
registration statement filed with the SEC on June 27, 2002
Dividend policy We have never paid a dividend and do not anticipate paying
dividend in the foreseeable future
7
RISK FACTORS
Before purchasing any of the common shares, you should carefully
consider the following factors relating to our business and prospects.
RELATED TO OUR BUSINESS
- -----------------------
PATRIOT'S MICROPROCESSOR TECHNOLOGIES HAVE RESULTED IN LIMITED REVENUES AND
SEVERAL RELATED PRODUCTS ARE STILL IN THE DEVELOPMENT STAGE
We are in the development stage on several components of our
microprocessor technology product line, and the products which have been
commercialized have had limited revenues. Our other product lines have not
generated enough revenue to support our company. Therefore, we have limited
financial results upon which you may judge our potential. We may not become
profitable. We have experienced in the past and may experience in the future
many of the problems, delays and expenses encountered by any early stage
business, many of which are beyond our control. These include:
o substantial delays and expenses related to testing and
development of our new products,
o production and marketing problems encountered in connection with
our new and existing products and technologies,
o competition from larger and more established companies, and
o lack of market acceptance of our new products and technologies.
PATRIOT HAS A HISTORY OF LOSSES, EXPECTS FUTURE LOSSES AND MAY NOT ACHIEVE OR
SUSTAIN ANNUAL PROFITABILITY
We expect to incur operating losses in the future. Sales of our
products may never generate sufficient revenues to fund our continuing
operations. We may never generate positive cash flow or attain profitability. To
date, we have incurred significant losses. As of February 28, 2003, our
accumulated deficit was $44,669,131 and we had negative working capital of
$1,343,171. For the fiscal years ended May 31, 2002, 2001 and 2000, we incurred
net losses of $5,487,051, $4,968,903 and $7,488,708. Because of this, there is
substantial doubt about our ability to continue as a going concern. These losses
have resulted primarily from:
o significant costs associated with the development of our
products,
o costs associated with the marketing of those products,
o the interest charges and expenses related to previous equity and
debt financings, and
o compensation costs related to the cashless exercise of options
and to the earnout of escrowed common shares.
Should our losses continue and should we be unable to fund our
operations from external
8
sources, we would need to cease doing business and/or liquidate or sell our
assets.
PATRIOT'S LIMITED SALES AND MARKETING EXPERIENCE HAS AFFECTED OUR REVENUE
Our operating results depend to a large extent on our ability to
successfully market and sell our products. We currently have limited marketing
capabilities and need to hire additional sales and marketing personnel. In part
as a consequence of our limited resources, we may not be able to recruit, train,
or retain qualified personnel to sell and market our products and we may not be
able to develop a successful sales and marketing strategy. We also have very
limited marketing experience. There can be no assurance that any marketing
efforts undertaken by us will be successful or will result in any significant
sales of our products. A continued lack of significant revenues from the sale of
our products would require us to cease doing business and/or liquidate or sell
our assets.
PATRIOT MAY EXPERIENCE DIFFICULTIES IN THE INTRODUCTION OF NEW PRODUCTS THAT
COULD RESULT IN PATRIOT HAVING TO INCUR SIGNIFICANT UNEXPECTED EXPENSES OR DELAY
THE LAUNCH OF NEW PRODUCTS
Our technologies and products are in various stages of development. Our
development stage products may not be completed in time to allow production or
marketing due to the inherent risks of new product and technology development,
limitations on financing, competition, obsolescence, loss of key personnel and
other factors. Although we may license some of our technology at its current
stage of development, there can be no assurance that we will be able to do so or
that any revenues generated from licensing would be sufficient to support
operations at their current level. Unanticipated technical obstacles can arise
at any time and result in lengthy and costly delays or in a determination that
further development is not feasible. Discovery of microprocessor design errors,
frequent in the industry prior to and after production, could result in lengthy
and costly redesign, fabrication (production) and testing in an industry where
new technology rapidly eclipses prior innovations.
The development of our technologies has taken longer than anticipated
and could be additionally delayed. Therefore, there can be no assurance of
timely completion and introduction of improved products on a cost-effective
basis, or that such products, if introduced, will achieve market acceptance such
that, in combination with existing products, they will sustain us or allow us to
achieve profitable operations.
RELATED TO OUR INDUSTRY
- -----------------------
INTENSE COMPETITION IN THE MARKET FOR MICROPROCESSORS COULD PREVENT PATRIOT FROM
INCREASING OR SUSTAINING REVENUE AND PREVENT PATRIOT FROM ACHIEVING OR
SUSTAINING ANNUAL PROFITABILITY
Our products could be rendered noncompetitive or obsolete.
Technological competition from larger and more established microprocessor
companies is significant and expected to increase. Most of the companies with
which we compete and expect to compete have far greater capital resources and
more significant research and development staffs, marketing and distribution
programs and facilities, and many of them have substantially greater experience
in the production and marketing of products. Our ability to compete effectively
may be adversely affected by the ability of these competitors to devote greater
resources to the sale and marketing of their products than we can. In addition,
one or more of our competitors may succeed or may already have
9
succeeded in developing technologies and products that are more effective than
any of those we currently offer or are developing.
PATRIOT'S LIMITED ABILITY TO PROTECT ITS INTELLECTUAL PROPERTY MAY INADVERTENTLY
ADVERSELY AFFECT ITS ABILITY TO COMPETE
A successful challenge to our ownership of our technology could
materially damage our business prospects. Our technologies may infringe upon the
proprietary rights of others. Licenses required by us from others may not be
available on commercially reasonable terms, if at all. We rely on a combination
of patents, trademarks, copyrights, trade secret laws, confidentiality
procedures and licensing arrangements to protect our intellectual property
rights. We currently have eight U.S. patents issued and three U.S. patents
pending. We have one patent issued in Europe and have filed an application for
another patent in Europe, Japan and elsewhere. Any issued patent may be
challenged and invalidated. Patents may not issue from 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 may assert that our technologies or products infringe
on their patents or proprietary rights. Problems with patents or other rights
could increase the cost of our products or delay or preclude new product
development and commercialization by us. If infringement claims against us are
deemed valid, 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.
We did not develop the technology which is the basis for our
products. This technology, which was originally known as the ShBoom technology,
was acquired through a series of agreements from two co- inventors. We have
been, and may again be, subject to claims from such prior parties related to the
technology. Such parties may also attempt to exploit the technology
independently of our rights to do so. One of the co-inventors of this technology
filed a lawsuit against another prior owner and us. The trial judge ruled in
favor of the prior owner and us. However, the co-inventor has filed an appeal
and the trial judge's ruling may be revised in a manner that is detrimental to
us. The asset purchase agreement and plan of reorganization between Patriot,
nanoTronics Corporation and Helmut Falk was the agreement under which we
acquired the basic ShBoom technology. The agreement also contained a number of
warranties and indemnities related to the ownership of the technology and other
matters. We believe nanoTronics Corporation has been liquidated and, due to Mr.
Falk's death in July 1995, our ability to obtain satisfaction for any future
claims as a result of a breach of the agreement may be limited.
PATRIOT IS DEPENDENT ON THE INTERNET AND JAVA FOR ACCEPTANCE OF ITS PRODUCTS
The marketing of our microprocessor products will depend in large
part upon a robust and growing industry and infrastructure for providing
Internet access and carrying Internet traffic
10
and the emergence of Java as a widespread programming language for the Internet
or in embedded applications. The infrastructure or complementary products
necessary to make the Internet a viable commercial marketplace may not be
developed, or, even if they are developed, the Internet may not become a viable
commercial marketplace. Also, Java may not become a widespread programming
language for the Internet or in embedded applications, and a market may not
develop for devices to run Java efficiently. If the Internet does not become a
viable commercial marketplace or if Java does not become a generally accepted
programming language, then our business, operating results and financial
condition will be materially and adversely affected.
PATRIOT MAY FACE INTERRUPTION OF PRODUCTION AND SERVICES DUE TO INCREASED
SECURITY MEASURES IN RESPONSE TO TERRORISM
Our business depends on the free flow of products and services through
the channels of commerce. Recently, in response to terrorists' activities and
threats aimed at the United States, transportation, mail, financial and other
services have been slowed or stopped altogether. Further delays or stoppages in
transportation, mail, financial or other services could have a material adverse
effect on our business, results of operations and financial condition.
Furthermore, we may experience an increase in operating costs, such as costs for
transportation, insurance and security as a result of these activities and
potential activities. We may also experience delays in receiving payments from
payers that have been affected by terrorist activities and potential activities.
The U.S. economy in general is being adversely affected by terrorist activities,
and potential activities and any economic downturn could adversely impact our
results of operations, impair our ability to raise capital or otherwise
adversely affect our ability to grow our business.
RELATED TO OUR OFFERING AND SHARE PRICE
- ---------------------------------------
THE PRICE AND THE TRADING VOLUME OF PATRIOT'S COMMON STOCK HAVE AN EFFECT ON THE
AMOUNT OF CAPITAL THAT CAN BE RAISED
We are exposed to fluctuations in the price and trading volume of our
common stock and the effect on the amount of capital we are able to raise
related to our $25 million line of credit. We registered 15,000,000 shares of
our common stock in November 2001, comprised of 14,100,000 put shares and
900,000 warrant shares which have been issued to Swartz Private Equity LLC under
a three year, $25 million investment agreement. The actual number of shares that
potentially could be issued under the investment agreement is determined by the
price of our stock during the pricing periods and the discount that Swartz
receives and is limited by the trading volume of our stock during the defined
period. We can impose a floor under which we will not be obligated to issue
stock to Swartz, and we set a predetermined number of shares to be issued for
each put. In this manner, we maintain the ability to have an effect on when, how
much and at what price the stock will be issued to Swartz. We ran out of
registered shares related to the $25 million equity line of credit in May 2002.
Before we can make additional use of the $25 million equity line of credit, we
would need to register additional common shares beyond the 15,000,000 shares
previously registered and issued.
PATRIOT MAY NOT BE ABLE TO OBTAIN ADDITIONAL CAPITAL TO FUND ITS OPERATIONS WHEN
NEEDED
A lack of additional funding could force us to substantially curtail or
cease our operations,
11
which would have a material adverse effect on our business. Our ability to raise
additional funds under the debenture agreement is subject to certain conditions.
These conditions include the effectiveness of a registration statement covering
the resale of the shares sold on the conversion of the debentures or the
exercise of the warrants issued concurrently with the debentures. We estimate
our current annual cash requirements to sustain our operations to be $2.4
million. There can be no assurance that any future funds required will be
generated from operations or from other potential sources. Further, any such
required funds may only be available on unattractive terms and may significantly
dilute the value of our existing shares.
IF THE SELLING SHAREHOLDERS SELL A LARGE NUMBER OF PATRIOT SHARES ALL AT ONCE OR
IN BLOCKS, THE MARKET PRICE OF OUR SHARES WOULD MOST LIKELY DECLINE
The selling shareholders are offering all of the common stock offered
through this prospectus. The selling shareholders are not restricted in the
price at which they can sell the common stock. Shares sold at a price below the
current market price at which the common stock is trading may cause the market
price to decline. The shares of common stock that are issuable on the conversion
of the debentures or exercise of the warrants issued concurrent with the
debentures represent 56% of our outstanding shares. However, should the price of
our stock drop, the number of common shares issuable on the conversion of these
debentures, plus the conversion of currently outstanding previously issued
debentures, would be subject to reset provisions which would substantially
increase the number of common shares to be issued. To the extent the selling
shareholders, and shareholders of currently outstanding previously issued
debentures, convert and then sell their common stock, the common stock price may
decrease due to the additional shares in the market. This could allow the
selling shareholders, and shareholders of currently outstanding previously
issued debentures, to convert their convertible debentures into even greater
amounts of common stock, the sales of which would further depress the stock
price. Accordingly, we do not know the exact number of shares that will be
issued on the conversions of the debentures. The following table presents the
potential number of shares that could be issued and the total number of shares
outstanding under several alternative scenarios:
If May 23, 2003 Market Price Decreases
Market Price as of ---------------------------------------------------
May 23,2003 25% 50% 75%
Market price (conversion price) $ 0.080 $ 0.060 $ 0.040 $ 0.020
Common stock currently outstanding 106,547,807 106,547,807 106,547,807 106,547,807
Number of shares issuable on conversion 26,226,915 26,659,607 32,875,000 65,750,000
Number of warrants issuable on exercise 33,471,953 33,471,953 33,471,953 33,471,953
Potential common stock outstanding 166,246,675 166,679,367 172,894,760 205,769,760
Dilutive effect to current shareholders 56% 56% 62% 93%
In addition, at the option of the debenture holder, interest accruing at the
annual rate of 8% can be converted into shares of our common stock at the same
time and at the same conversion price as the principal portion of the debenture.
Should the debenture holders accumulate interest, a larger number of shares
would be issued on conversion and if the price of the common stock declines, the
12
reset provisions which allow greater amounts of shares to be issued would also
be in effect for the interest portion of the debenture. As of April 30, 2003,
$48,817 interest was payable to the debenture holders which could be converted
into 1,034,321 shares of common stock at an average conversion price of $0.05.
THE MARKET FOR PATRIOT'S STOCK IS SUBJECT TO RULES RELATING TO LOW-PRICED STOCK
WHICH LIMITS OUR ABILITY TO ATTRACT COMPETITIVE FUNDING
Our common stock is currently listed for trading in the NASD
Over-The-Counter Bulletin Board Market and is subject to the "penny stock rules"
adopted pursuant to Section 15 (g) of the Securities Exchange Act of 1934, as
amended. 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" to 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 stock and may effect our ability to attract
competitive funding.
OUR SHARE PRICE COULD BE LOWERED AS A RESULT OF SHORT SALES
The significant downward pressure on the price of the common stock as
the selling shareholders convert and sell material amounts of common stock could
encourage short sales by the selling shareholders or others. When an investor
sells stock that he does not own, it is known as a short sale. The seller,
anticipating the price of the stock to go down, will buy the stock at a later
date. If the price of the stock goes down, the seller will profit for the
difference between what he origianally sold it for less what he later had to buy
it for. 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.
ON A SIGNIFICANT DROP IN THE PRICE OF OUR STOCK, WE COULD BE SUBJECT TO A CHANGE
IN CONTROL
There is a possibility that a significant number of shares, the exact
number of which we do not know, of our common stock could be issued on the
conversion of the debentures. This possibly could result in a change in control
of the company. Such a change in control could have a material adverse effect on
our operations and business plans. We are unable to determine the impact such a
change in control could have on our company.
OUR SHAREHOLDERS WILL NEED TO INCREASE THE AUTHORIZED NUMBER OF SHARES
We currently have 200,000,000 shares of common stock authorized for
issuance. The number of common shares currently outstanding plus the number of
common shares reserved for
13
issuance on the conversion of debenture principal and accrued interest, and
exercise of warrants and options as of June 6, 2003 is as follows:
Common stock currently outstanding 106,547,807
Reserved for issuance
Stock option plans 5,304,188
Warrants 41,292,810
Convertible debentures 45,069,435
-----------
Common stock fully diluted 198,214,240
===========
In addition, in March 2003 we negotiated with a major investor, a one-year lock
up of warrants exercisable for up to 20,007,350 shares of our common stock.
These shares are not included in the common stock fully diluted amount of
198,214,240 common shares reflected above. In order to obtain additional equity
financing, provide for reservation of the locked up warrants and to accomplish
other corporate objectives, we will need to obtain the approval of shareholders
owning a majority of our common stock to increase the number of authorized
shares. We anticipate to hold an annual shareholders' meeting during the third
or fourth quarter of this calendar year at which time we will propose an
increase in authorized shares. There can be no assurance that the shareholders
will approve the proposal. Should the shareholders not approve the proposal and
we were unable to fund our operations from external sources, we would need to
cease doing business and/or liquidate or sell our assets.
14
FORWARD-LOOKING STATEMENTS
This prospectus includes "forward-looking" statements within the
meaning of Section 27A of the Securities Act of 1933, Section 21E of the
Securities Exchange Act of 1934, and the Private Securities Litigation Reform
Act of 1995, and we desire to take advantage of the "safe harbor" provisions in
those laws. Therefore, we are including this statement for the express purpose
of availing ourselves of the protections of these safe harbor provisions with
respect to all of the forward-looking statements we make. The forward-looking
statements in this prospectus reflect our current views with respect to possible
future events and financial performance. These forward-looking statements are
subject to certain risks and uncertainties, including specifically the absence
of significant revenues and financial resources, a history of losses, no
assurance that the development of technology can be completed or that its
completion will not be delayed, significant competition, the uncertainty of
patent and proprietary rights, uncertainty as to royalty payments and
indemnification risks, 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 we anticipate. In this
prospectus, the words "anticipates," "believes," "expects," "intends," "future"
and similar expressions identify certain forward-looking statements. You are
cautioned to consider the specific risk factors described in "Risk Factors" and
elsewhere in this prospectus and not to place undue reliance on the
forward-looking statements contained in this prospectus, which speak only as of
the date of this prospectus. We undertake no obligation to publicly revise these
forward-looking statements to reflect the effect of events or circumstances that
may arise after the date of this prospectus. All written and oral
forward-looking statements made subsequent to the date of this prospectus and
attributable to us or persons acting on our behalf are expressly qualified in
their entirety by this section.
PLAN OF DISTRIBUTION
After the effective date of the registration statement of which
this prospectus is a part, each selling shareholder will be free to offer and
sell his or her common shares at such times, in such manner and at such prices
as he or she may determine. The types of transactions in which the common shares
are sold may include transactions in the over-the-counter market (including
block transactions), negotiated transactions, the settlement of short sales of
common shares, or a combination of such methods of sale. The sales will be at
market prices prevailing at the time of sale or at negotiated prices. Such
transactions may or may not involve brokers or dealers. The selling shareholders
have advised us that they have not entered into any agreements, understandings
or arrangements with any underwriters or broker-dealers regarding the sale of
their securities. The selling shareholders do not have an underwriter or
coordinating broker acting in connection with the proposed sale of the common
shares.
The selling shareholders may effect such transactions by selling
common stock directly to purchasers or to or through broker-dealers, which may
act as agents or principals. Such broker-dealers may receive compensation in the
form of discounts, concessions, or commissions from the selling shareholders.
They may also receive compensation from the purchasers of common shares for whom
such broker-dealers may act as agents or to whom they sell as principals, or
both (which compensation as to a particular broker-dealer might be in excess of
customary commissions).
The selling shareholders and any broker-dealer that acts in
connection with the sale of common shares may be "underwriters" within the
meaning of Section 2(11) of the Securities Act. Any commissions received by such
broker-dealers and any profit on the resale of the common shares sold by them
while acting as principals are deemed to be underwriting discounts or
commissions.
15
Because the selling shareholders may be "underwriters" within the
meaning of Section 2(11) of the Securities Act, the selling shareholders will be
subject to prospectus delivery requirements.
Selling shareholders also may resell all or a portion of the
common shares in open market transactions in reliance upon Rule 144 under the
Securities Exchange Act, provided they meet the criteria and conform to the
requirements of such Rule.
SELLING SHAREHOLDERS
SELLING SHAREHOLDERS
The following table sets forth certain information with respect to
the selling shareholders as of June 6, 2003. Except as set forth below, none of
the selling shareholders currently is an affiliate of ours, and none of them has
had a material relationship with us during the past three years. None of the
selling shareholders are or were affiliated with registered broker-dealers.
Amount and
Maximum Number Percentage of
Beneficial of Shares of Common Stock
Ownership of Common Stock After the Sale
Common Stock as Offered -------------------------
Name of June 6, 2003 for Sale Number %
- ---- ---------------- ------------ -------------------------
Lincoln Ventures, LLC 51,269,871 (2) 20,106,357 31,163,514 (2) 24.61%(2)
Victor Gabourel 3,207,909 77,570 3,130,339 (4) 2.94%
Gloria Felcyn, Trustee (1) 18,214,527 (4) 310,305 17,904,222 (5) 16.76%
James and Josephine Zolin 2,917,204 (5) 77,570 2,839,634 (6) 2.66%
Richard Daniels 3,318,334 (6) 77,750 3,240,764 (7) 3.04%
Stan Caplan 2,203,000 (7) 444,444 1,758,556 (9) 1.64%
(1) As trustee of the Helmut Falk Family Trust and executor of the Helmut
Falk estate, Ms. Felcyn effectively controls the shares that were
subject to an escrow arrangement originally issued to nanoTronics in
connection with the ShBoom technology acquisition and shares that
remain from 5,000,000 non-escrowed shares originally issued to
nanoTronics in connection with the ShBoom technology acquisition and
subsequently transferred to the Helmut Falk Family Trust.
(2) This number includes 7,389,560 shares of common stock issuable upon
the conversion of previously issued convertible debentures. These
shares have been previously registered. This number also includes
23,773,954 shares of common stock issuable upon exercise of
outstanding warrants previously issued to Lincoln which are currently
exercisable, which shares would not be deemed beneficially owned (due
to exercise restrictions within the warrants) within the meaning of
Sections 13(d) and 13(g) of the Exchange Act to the extent that their
acquisition in a warrant exercise by Lincoln would cause Lincoln to
own in excess of 4.99% of our outstanding common stock immediately
following such exercise. By the terms of the Debentures, the 4.99%
limitation may
16
be increased to a maximum of 9.99% if the Company accepts a tender
offer and a change in control takes place. Therefore, it is expected
that Lincoln will not beneficially own more than 9.99% of our
outstanding common stock at any time. Roy Adams has ultimate voting
and/or investment control over the securities owned by Lincoln.
(3) Includes 1,555,735 shares of common stock issuable upon the conversion
of previously issued convertible debentures. These shares have been
previously registered. This number also includes 1,424,604 shares of
common stock issuable upon exercise of outstanding warrants
(4) Includes 7,135,568 shares of common stock issuable upon the conversion
of previously issued convertible debentures. These shares have been
previously registered. This number also includes 4,102,431 of common
stock issuable upon exercise of outstanding warrants and 50,000 shares
of common stock issuable upon exercise of stock options issued to Ms.
Felcyn, as an individual, as a director of the company.
(5) Includes 970,484 shares of common stock issuable upon the conversion
of previously issued convertible debentures. These shares have been
previously registered. This number also includes 1,456,336 shares of
common stock issuable upon exercise of outstanding warrants
(6) Includes 1,555,735 shares of common stock issuable upon the conversion
of previously issued convertible debentures. These shares have been
previously registered. This number also includes 1,650,029 shares of
common stock issuable upon exercise of outstanding warrants
(7) Includes 975,419 shares of common stock issuable upon the conversion
of previously issued convertible debentures. These shares have been
previously registered. This number also includes 783,137 shares of
common stock issuable upon exercise of outstanding warrants
INFORMATION ABOUT US
THE COMPANY
Patriot Scientific Corporation was organized under Delaware law on
March 24, 1992, as 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, 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 computers
and other data processing devices to communicate. These products can be used to
connect to the 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, subsequent to 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 licensee to penetrate the ground or structures
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 sale of the gas plasma technology in the form of
royalties. Our strategy is to exploit our microprocessor technologies through
product sales, licensing, and strategic alliances.
In 1997, we emerged from the development stage primarily as a
result of the acquisition of Metacomp Inc. There can be no assurance that we can
achieve profitable operations, and we may
17
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 Act 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 sold 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 bylaws
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.
BUSINESS
AVAILABLE INFORMATION
We file reports, proxy statements and other information with the SEC,
and these reports may be inspected and copied at the public reference facilities
maintained by the SEC at 450 Fifth Street, N.W., Judiciary Plaza, Washington,
D.C. 20549. You may obtain information on the operation of the public reference
room by calling the SEC at 1-800-SEC-0330. The same information may be obtained
at the following Regional Offices of the SEC: 75 Park Place, New York, New York
10007, and the Northwest Atrium Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60621.
18
Copies of such material may be obtained from the Public Reference Section of the
SEC's Washington, D.C. office at prescribed rates.
We mail a copy of our audited Annual Report on Form 10-K along with a
proxy statement to our shareholders prior to our annual meeting.
We have filed a registration statement on Form S-1, of which this
prospectus is a part, with the SEC. This registration statement or any part
thereof may also be inspected and copied at the public reference facilities of
the SEC.
Our filings may also be accessed through the SEC's web site
(HTTP://WWW.SEC.GOV) or by visiting our web site at (http://www.ptsc.com) and
linking to the SEC's site.
ORGANIZATION AND CORPORATE DEVELOPMENT. Our business involves the
following technologies:
o Ignite microprocessor technology
o high-speed data communications technology, and
o radar technology.
Due to a lack of funds to develop and commercialize JUICEtechnology, a
technology introduced to us in 2001, we assigned our rights in this technology
back to the inventor in April 2003.
The stages of development of our technologies is as follows:
o 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.
o 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
technology. Although the communications product line accounted
for approximately 97% of our fiscal year 2002 revenue, we
anticipate that the Ignite microprocessor will be our main
product line in the future.
o 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
19
development of this technology in order to concentrate our
resources on our Ignite 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.
20
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:
o standard logic products,
o application specific standard products, and
o 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
21
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
of microprocessors. 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
22
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.
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
23
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
24
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 process
whereby 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 representatives 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.
25
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 and
international 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:
26
o the lack of product performance experience,
o lack of experience by customers in using application
development systems,
o no record of technical service and support, and
o limited marketing and sales capabilities.
JUICETECHNOLOGY
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 could have presented
information in a richer format than was available from current technologies and,
additionally, doing so with less drain on the device's battery. Due to a lack of
funds to develop and commercialize JUICEtechnology, we assigned our rights in
this technology back to the inventor in April 2003.
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 support this product
line. We have disposed of or fully reserved the communication product line
inventory and are concentrating our efforts and resources on Ignite.
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. The development of this technology has taken longer than
anticipated and could be subject to additional delays.
27
Therefore, there can be no assurance of timely or successful marketing of this
technology.
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.
LICENSES, PATENTS, TRADE SECRETS AND OTHER PROPRIETARY RIGHTS. We
rely on a combination of patents, copyright and trademark laws, trade secrets,
software security measures, license agreements and nondisclosure 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.
We have six U.S. patents issued dating back to 1989 on the
microprocessor technology. We have one microprocessor technology patent pending
in five European countries and one patent issued in Japan and 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
penetrating radar technology and one U.S. patent issued on one of the
communications products.
In addition to such factors as innovation, technological expertise
and experienced personnel, we believe that a strong patent position is becoming
increasingly important to compete effectively in the semiconductor industry. It
may become necessary or desirable in the future for us to obtain patent and
technology licenses from other companies relating to certain technology that may
be employed in future products or processes. To date, we have not received
notices of claimed infringement of patents based on our existing processes or
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:
o 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.
o Sun Microsystems Inc. In June 1997, we entered into an
agreement with Sun
28
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.
o 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.
o 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.
We have one U.S. patent on our ground 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
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.
There can be no assurance that any patents will be issued from
pending or future applications or that any patents that are issued will provide
meaningful protection or other commercial advantages to us. Although we intend
to protect our rights vigorously, there can be no assurance that these measures
will be successful.
We generally require all of our employees and consultants,
including our management, to sign a non-disclosure and invention assignment
agreement upon employment with us.
MARKETING AND DISTRIBUTION. Our products are marketed through a
combination of direct sales and distributors. Approximate sales by principal
geographic area (as a percentage of sales) for fiscal years ended May 31 were as
follows:
29
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%
==== ==== ====
All of our operating assets are located within the United States.
While sales to certain geographic areas generally vary from year to year, we do
not expect that changes in the geographic composition of sales will have a
material adverse effect on operations.
DEPENDENCE UPON SINGLE CUSTOMERS. Ten percent (10%) or more of our
consolidated net sales were derived from shipments to the following customers
for the fiscal years ended May 31as 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.
We had no backlog as of May 31, 2003 or May 31, 2002.
FACILITIES. We have one 10,300 square foot office located at 10989
Via Frontera, San Diego, California. The facility is leased through July 2006.
In July 2002, we sublet approximately 5,000 square feet of our facility to an
independent third party. The term of the sublease coincides with the remaining
term of our lease. The reduced floor space provides adequate and suitable
facilities for all of our corporate functions.
EMPLOYEES. We currently have eight personnel. Four persons are
employed in research and development, one in marketing and sales and three are
engaged in general and administrative activities. We also engage additional
consultants and part-time persons as needed from time to time.
Our future success depends in significant part upon the continued
service of our key technical and senior management personnel. The competition
for highly qualified personnel is
30
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 is represented by a labor union, and we consider our
relations with our employees to be good. None of our employees is covered by key
man life insurance policies.
GOVERNMENT REGULATION. To our knowledge, our products are not
subject to governmental regulation by any federal, state or local agencies that
would affect the manufacture, sale or use of our products, other than
occupational health and safety laws and labor laws which are generally
applicable to most companies. We cannot, of course, predict what sort of
regulations of this type may be imposed in the future but do not anticipate any
unusual difficulties in complying with governmental regulations which may be
adopted in the future.
We have not incurred costs associated with environmental laws and
do not anticipate such laws will have any significant effect on our future
business.
USE OF PROCEEDS
We will not receive any proceeds from the resale of these securities.
LEGAL PROCEEDINGS
In January 1999, we were 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 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.
SELECTED 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. The
selected unaudited consolidated financial data set forth below for the nine
months ended February 28, 2003 and 2002 have been derived from our unaudited
consolidated financial statements. In the opinion of management, these interim
financial statements reflect all adjustments of a normal recurring nature
necessary for a fair statement of the results for interim periods. Operating
results for the nine month period are not necessarily indicative of the results
that may be expected for the year. The selected consolidated financial data set
forth below for the fiscal years ended May 31, 2002, 2001, 2000, 1999, and 1998
have been derived from our consolidated financial statements which have been
audited by Nation Smith Hermes Diamond, independent auditors, for
31
the year ended May 31, 2002 and BDO Seidman, LLP, independent auditors, for the
preceding four years.
Nine Months Ended February 28, Years Ended May 31,
------------------------------ -----------------------------------------
2003 2002 2002 2001 2000
----------- ------------- ----------- ----------- -----------
(unaudited)
----------------------------
Statements of Operations Data:
Revenue:
Sales $ 86,439 $ 326,509 $ 358,809 $ 337,384 $ 716,960
----------- ----------- ----------- ----------- -----------
Costs and expenses:
Cost of sales
18,660 392,205 393,980 544,320 725,008
Research and development 540,735 1,129,042 1,372,421 2,218,433 3,170,166
Selling, general and administrative 1,446,606 2,101,746 2,708,579 2,588,579 3,501,128
----------- ----------- ----------- ----------- -----------
Total costs and expenses 2,006,001 3,622,993 4,474,980 5,351,332 7,396,302
----------- ----------- ----------- ----------- -----------
Operating loss (1,919,562) (3,296,484) (4,116,171) (5,013,948) (6,679,342)
Other income (expense), net (943,828) (569,764) (1,370,880) 45,045 (809,366)
----------- ----------- ----------- ----------- -----------
Net loss (2,863,390) (3,866,248) (5,487,051) (4,968,903) (7,488,708)
=========== =========== =========== =========== ===========
Basic and diluted loss per common share (0.03) (0.06) (0.08) (0.09) (0.17)
Weighted average number of shares-
basic and diluted 85,711,345 64,288,474 66,810,028 53,433,788 44,156,418
Years Ended May 31,
-------------------------
1999 1998
----------- ----------
Statements of Operations Data:
Revenue:
Sales 1,134,545 1,902,874
----------- -----------
Costs and expenses:
Cost of sales
711,195 1,163,688
Research and development 2,149,361 1,607,828
Selling, general and administrative 2,015,058 4,090,937
----------- -----------
Total costs and expenses 4,875,614 6,862,453
----------- -----------
Operating loss (3,741,069) (4,959,579)
Other income (expense), net (535,387) (2,555,206)
----------- -----------
Net loss (4,276,456) (7,514,785)
=========== ===========
Basic and diluted loss per common share (0.11) (0.24)
Weighted average number of shares-
basic and diluted 38,042,734 31,016,956
May 31,
February 28, -----------------------------------------------------------------
2003 2002 2001 2000 1999 1998
------------- ----------- ----------- ----------- ------------ -----------
(unaudited)
BALANCE SHEET DATA:
Cash and cash equivalents $ 30,256 $ 88,108 $ 464,350 $ 2,100,242 $ 35,813 $ 602,456
Working capital (deficiency)
(1,343,171) (918,768) 328,605 1,769,340 (1,545,055) 1,011,329
Total assets
592,193 934,526 1,543,693 2,733,148 1,145,027 2,189,654
Long-term obligations, net of current
maturities 430,724 331,929 -- -- -- 508,355
Total stockholders' equity (deficit)
(1,298,712) (444,825) 922,388 2,209,882 (981,234) 1,156,848
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Our Results of Operations have been and may continue to be subject to
significant variations. The results for a particular period may vary due to a
number of factors. These include:
o the overall state of the semiconductor and communications segments
of the economy,
o the development status of and demand for our products,
o economic conditions in our markets,
o the timing of orders,
o the timing of expenditures in anticipation of future sales,
o the mix of products sold by us,
o the introduction of new products,
o product enhancements by us or our competitors, and
o pricing and other competitive conditions.
32
CRITICAL ACCOUNTING POLICIES
We believe that the following represent 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-lived assets and certain identifiable intangibles to be held and
used by 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 recoverability of our long-lived
assets based on estimated future cash flows from and the estimated fair value 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
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 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.
33
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.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. During the year ended May 31, 2002, based upon information
then available, we revised our estimates regarding the recovery of our
inventories. As a result, we increased existing reserves for obsolescence by
$111,381.
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED FEBRUARY 28, 2003 AND FEBRUARY
28, 2002
NET SALES. Total net sales for the nine months ended February 28, 2003 decreased
73.5% to $86,439 from $326,509 for the corresponding period of the previous
fiscal year. This decrease was due to the final buys on our matured
communication products having been substantially completed the previous fiscal
year. We are currently expending our efforts on marketing and sale of our
microprocessor technology. The microprocessor technology generated minimal
revenue during the nine months ended February 28, 2003. We anticipate that
future revenue will be derived from up front license fees and royalties as a
result of the shift in focus to the commercialization of our microprocessor and
related technology intellectual property. Previously we focused primarily on the
sale of silicon products. We cannot estimate when significant revenue will be
generated from the microprocessor technology.
COST OF SALES. Cost of sales as a percentage of net sales decreased to 21.6% in
the nine months ended February 28, 2003 compared to 120.1% for the corresponding
period of the previous fiscal year. This significant decrease was due to minor
sales during the first three quarters of 2003 not having associated costs due to
having previously written off the communication product line inventory. A
$149,433 write-down of the inventory to zero during the previous fiscal year was
a result of not being able to find a buyer for the communication product line
and our decision to focus future company revenue on the sale of licenses and
intellectual property related to our
34
microprocessor technology versus the sale of microprocessor silicon and related
products. The winding down of the communication product line did not impair any
of our other assets. Also, as a result of eliminating the communication product
line, overhead expenses charged to cost of sales the previous fiscal year are
now being charged to general and administrative expenses.
RESEARCH AND DEVELOPMENT EXPENSES decreased 52.1% from $1,129,042 for the nine
months ended February 28, 2002 compared to $540,735 for the nine months ended
February 28, 2003. This decrease was due primarily to a reduction in consulting
services compared to the previous fiscal year related to the development of a
new soft core version of the microprocessor technology in the amount of $131,120
and a reduction in payroll expense as a result of downsizing the department by
six individuals during the second and third fiscal quarters of the previous
fiscal year in an amount of $397,773.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES decreased 31.2% to $1,446,606 for
the nine months ended February 28, 2003 compared to $2,101,746 for the nine
months of the previous fiscal year. This decrease was due primarily to a
reduction in executive, marketing and sales personnel in the amount of $485,382
as a result of downsizing the company during the second and third fiscal
quarters of the previous fiscal year and a reduction of $130,579 in professional
fees related to financings and litigation.
OTHER EXPENSES for the nine months ended February 28, 2003, were $943,828
compared to other expenses of $569,764 for the corresponding period of the
previous fiscal year. This change resulted primarily from the recognition of
non-cash interest expense of $837,341 related to the amortization of the debt
discount associated with the issuance of warrants under a secured note payable
and convertible debentures coupled with interest expense of $106,675 related to
the note and debentures for the current fiscal period compared to $544,958 and
$25,184, respectively for the same fiscal period of the previous fiscal year.
RESULTS OF OPERATIONS FOR THE YEARS ENDED MAY 31, 2002, 2001 AND 2000
OUR NET SALES 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 sales for the year ended May 31, 2002 increased
slightly over the previous year as a result of 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. We have stopped production of our communications
products as we are now concentrating on the microprocessor product line. We
anticipate only minor, if any, communication product revenue since we are
attempting to sell this line. Future sales will be derived from sales of
microprocessors and licensing of microprocessor technology.
35
OUR COST OF SALES IN FISCAL 2002, 2001 AND 2000 WERE AS FOLLOWS:
% Change from the
Fiscal 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 in
the fiscal year ended May 31, 2002 compared to the previous fiscal year. This
decrease was due to a reduction in fixed manufacturing overhead as a result of
cost cutting programs instituted in conjunction with the completion of the
communication product line during the current fiscal year. Cost of sales as a
percentage of net sales increased in the fiscal year ended May 31, 2001 compared
to the previous fiscal year. This increase was due to fixed manufacturing
overhead being allocated to a smaller revenue base during the fiscal year ended
May 31, 2001 and a $138,000 reduction in royalties during the fiscal year ended
May 31, 2001 compared to the previous fiscal year negatively impacting the
percentage comparison.
OUR RESEARCH AND DEVELOPMENT EXPENSES IN FISCAL 2002, 2001 AND 2000
WERE 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
Research and development expenses decreased during the fiscal year
ended May 31, 2002 compared to the previous fiscal year. This decrease was due
primarily to a reduction of approximately $406,000 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. Research 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.
36
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 primarily 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 to services provided to support our merger and acquisition
activities, offset by reductions 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 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 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
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 compared to the previous fiscal year. This change resulted
primarily from the recognition of non-cash interest expense of 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 for the fiscal year ended May 31, 2001, compared to the
previous fiscal year. During the fiscal year ended May 31, 2001, other income
was recognized primarily from interest income as opposed to the previous fiscal
year when other expense resulted primarily from the recognition of approximately
$996,000 of non-cash interest expense related to the amortization of debt
discount and $51,000 increase in interest expense over 2001 related to short
term notes. The 2000 expenses were partially offset by a gain of $250,000 on the
sale of the gas plasma antenna technology.
37
SUPPLEMENTARY FINANCIAL INFORMATION
The following table presents unaudited, select information for each of
the eleven fiscal quarters in the period ended February 28, 2003:
First Second Third Fourth
Quarter Quarter Quarter Quarter
----------- ------------ ----------- ----------
Fiscal 2003:
Total revenues $ 39,889 $ 5,160 $ 41,390
Operating loss (661,408) (743,271) (514,883)
Net loss (943,441) (1,077,288) (842,661)
Net loss per basic and diluted share $ (0.01) $ (0.01) $ (0.01)
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)
LIQUIDITY AND CAPITAL RESOURCES
In connection with their report on our consolidated financial
statements as of and for the year ended May 31, 2002, Nation Smith Hermes
Diamond, our independent certified public accountants, expressed substantial
doubt about our ability to continue as a going concern because of recurring net
losses and negative cash flow from operations.
At February 28, 2003, we had deficit working capital of $1,343,171 and
cash and cash equivalents of $30,256. We have historically funded our operations
primarily through the issuance of securities and debt financings. Cash and cash
equivalents decreased $57,852 during the nine months ended February 28, 2003 due
to net cash used in operations of $1,493,590 offset by funds generated primarily
from the issuance of convertible debentures of $1,184,500 and short term notes
payable of $180,000. The net cash used in operations was $1,493,590 for the nine
months ended February 28, 2003 compared to $2,952,871 for the corresponding
period of the previous fiscal year. The decrease in cash required in operations
was due primarily to a $1,152,729 reduction in net loss as adjusted to reconcile
to cash used in operating activities coupled with a $231,041 change in prepaid
expenses and other assets between the two periods. Cash used in investing
activities was $51,761 for the nine months ended February 28, 2003 compared to
$47,429 for the corresponding period of the previous fiscal year. Cash provided
by financing activities was $1,487,499 for the nine months ended February 28,
2003 compared to $2,545,556 for the corresponding period of the previous fiscal
year. This decrease was primarily the result of a reduced issuance of common
stock of $838,588 during the current fiscal period compared to the corresponding
period of the previous fiscal year coupled with a reduction in the sale of
accounts receivable of $142,281.
38
We estimate our current cash requirements to sustain our operations for
the next twelve months through June 2004 to be $2.4 million. Since we are no
longer supporting the communications product line, we are assuming that there
will be no communications product revenue. We have a note payable to Swartz
Private Equity, LLC ("Swartz") of $635,276 at February 28, 2003 which was due in
April 2003 and subsequent to the end of the quarter has been extended to March
1, 2004. We also have convertible debentures with a group of investors as of
February 28, 2003 aggregating $1,230,000 and advances of $87,500 on a
convertible debenture that closed subsequent to February 28, 2003. 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. During the first nine months ended
February 28, 2003, we obtained $114,850 from the sale of equity to several
private investors and $180,000 from short term notes entered into with a related
party. Subsequent to February 28, 2003, we obtained an additional $5,500 from
the sale of equity to a private investor and $422,500 from the issuance of
additional convertible debentures net of advances discussed above.
If the optional amounts under the convertible debentures are not raised
in sufficient amounts, then we may not have funds sufficient to meet our cash
requirements. In such circumstances, we may need to secure additional short-term
debt, private placement debt and/or equity financings with individual or
institutional investors. In addition, 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:
o additional debt and/or equity financings; and
o proceeds from the exercise of outstanding stock options and warrants.
In addition, we have formulated additional cost reduction plans which
can be implemented if the required funds are not obtainable. We also have a
$400,000 accounts receivable factoring agreement with our bank. As of April 30,
2003 there was a balance due under the factoring agreement of $11,172.
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 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.
If we are unable to obtain the necessary funds, we could be forced to
substantially curtail or cease operations which would 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
39
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 CREDIT
OVERVIEW. 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 May 31, 2003, 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. 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 sold in 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 price for the common stock
during each 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.
LIMITATIONS AND CONDITIONS PRECEDENT TO OUR PUT RIGHTS.
We may not initiate a put if, as of the proposed date of such put:
o 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;
40
o the registration statement covering the resale of the shares
becomes ineffective or unavailable for use;
o 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:
o 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;
o 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;
o 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;
o 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
o 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.
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.
41
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 7 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.
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, an Addendum to Amended
Secured Promissory Note dated March 12, 2002 and an Antidilution Agreement and
Addendum to Warrants dated March 19, 2003. The amended note, which originally
was to mature on January 9, 2003, has been extended to March 1, 2004 and amounts
outstanding under the note bear interest at the rate of 5% per annum. Per the
antidilution agreement, principal and interest payments are deferred until March
1, 2004.
42
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, we were obligated under the addendum to the
note to issue to Swartz warrants equal to 20% of the common stock issued between
March 12, 2002 and are obligated under the antidilution agreement to issue to
Swartz warrants equal to 30% of the common stock issued subsequent to April 1,
2003 to any parties other than Swartz. In addition, we agreed to extend the
expiration date to December 31, 2006 on certain warrants that were to expire
previous to December 31, 2006. In exchange for these concessions, Swartz agreed
to extend the due date from April 9, 2003 to March 1, 2004 on a note for
$635,276 net of accrued interest and unreserved, for a period the lesser of 1)
one year, or 2) 90 days after the date on which our common stock exceeds $0.375
for 10 consecutive trading days, 20,007,350 shares that have been reserved for
the exercise of warrants.
As of May 31, 2003 we issued warrants to purchase up to 19,143,712
shares of our common stock in accordance with the amended note agreements and
antidilution 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.
The note is secured by our assets.
All debt discounts were amortized as additional interest expense over
the initial term of the note payable. As of February 28, 2003, $1,107,238 had
been reflected as debt discount of which $917,722 and $189,516 was amortized to
interest expense during the year ended May 31, 2002 and the nine months ended
February 28, 2003, respectively.
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 (1,107,238) --
------------ -----------
Note payable at February 28, 2003 $ 635,276
==========
On November 9, 2001, an offset of $227,800 from the 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.
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 and only put under the $25 million
equity line of credit discussed below.
43
8% CONVERTIBLE DEBENTURES
OVERVIEW. From April 23, 2002 through June 10, 2003, we sold an
aggregate of $2,115,000 of 8% convertible debentures to a group of eleven
investors. The convertible debentures entitle the debenture holder to convert
the principal and unpaid accrued interest into our common stock for two years
from the date of closing. In addition, the debenture holders received warrants
exercisable into a number of our common shares.
NUMBER OF SHARES DEBENTURES MAY BE CONVERTED INTO. The debentures
can be converted into a number of our common shares at conversion prices that
initially equaled $0.041 to $0.10289 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 becomes effective, October 29, 2002 for
the first $1,000,000 of principal and March 7, 2003 for the second $605,000 of
principal. 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. On October 29, 2002, the date the registration statement for the
first $1,000,000 of principal became effective, the conversion prices were reset
to $0.04457 from initial conversion prices ranging from $0.08616 to $0.10289. On
March 7, 2003, the date the registration statement for the second $605,000 of
principal became effective, the conversion prices were reset to $0.04722 from
initial conversion prices ranging from $0.05126 to $0.0727.
WARRANTS. Concurrent with the issuance of the convertible
debentures, we issued to the debenture holders warrants to purchase up to
33,471,953 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
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.
44
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.
REGISTRATION RIGHTS. We are responsible for registering the resale
of the shares of our common stock which will be issued on the conversion of the
debentures. On October 29, 2002, a registration statement covering the first
$1,000,000 of debentures was declared effective by the Securities and Exchange
Commission. On March 7, 2003, a registration statement covering the second
$605,000 of debentures was declared effective by the Securities and Exchange
Commission.
The convertible debentures are secured by our assets.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2002, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standard ("SFAS") No. 148, "Accounting
for Stock-Based Compensation-Transition and Disclosure-an amendment of SFAS No.
123." SFAS No. 148 provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosures in both annual
and interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results.
Management is evaluating the adoption of this statement.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." This interpretation elaborates on the
disclosures required in financial statements concerning obligations under
certain guarantees. It also clarifies the requirements related to the
recognition of liabilities by a guarantor at the inception of certain
guarantees. The disclosure requirements of this interpretation were effective on
December 31, 2002. We adopted the recognition provisions of the interpretation
in the quarter ended February 28, 2003. The adoption of this interpretation did
not impact our financial position or results of operations.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities, an interpretation of ARB No. 51." This
interpretation provides guidance on: 1) the identification of entities for which
control is achieved through means other than through voting rights, known as
"variable interest entities" (VIEs); and 2) which business enterprise is the
primary
45
beneficiary and when it should consolidate the VIE. This new model for
consolidation applies to entities: 1) where the equity investors (if any) do not
have a controlling financial interest; or 2) whose equity investment at risk is
insufficient to finance that entity's activities without receiving additional
subordinated financial support from other parties. In addition, this
interpretation requires that both the primary beneficiary and all other
enterprises with a significant variable interest in a VIE make additional
disclosures. This interpretation is effective for all new VIEs created or
acquired after January 31, 2003. For VIEs created or acquired prior to February
1, 2003, the provisions of the interpretation must be applied no later than the
beginning of the first interim or annual reporting period beginning after June
15, 2003. Certain disclosures are effective immediately. The adoption of this
interpretation did not impact our financial position or results of operations.
TAX LOSS CARRYFORWARDS
Deferred income taxes are provided for temporary differences in
recognizing certain income and expense items for financial and tax reporting
purposes. Deferred tax assets consist primarily of income tax benefits from net
operating loss carry-forwards. A valuation allowance has been recorded to fully
offset the deferred tax asset as it is more likely than not that the assets will
not be utilized. The valuation allowance increased approximately $705,000 in the
first nine months of 2003, from $13,446,000 at May 31, 2002 to $14,151,000 at
February 28, 2003.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Effective May 20, 2002, the client-auditor relationship between Patriot
Scientific Corporation (the "Company") and BDO Seidman, LLP ("BDO") ceased. The
Company dismissed BDO on May 20, 2002 as part 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
46
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, 2002, 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 16.1 to the Form 8-K/A filed June 5, 2002.
QUANITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to interest rate risk on investments of our excess cash.
The primary objective of our investment activities is to preserve capital. To
achieve this objective and minimize the exposure due to adverse shifts in
interest rates, we invest from time to time in high 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 interest rate exposure.
As of February 28, 2003 and May 31, 2002, our notes payable to
corporations and individuals totaling $2.1 million and $1.1 million before
unamortized discounts, respectively, bore interest at fixed rates of 5% to 8%.
Our capital lease obligation totaling $18,119 and $21,847, respectively, is
discounted at a fixed rate of interest of 22.7%.
MANAGEMENT
The following table and biographical summaries set forth information, including
principal occupation and business experience, about our directors and the
executive officers at June 1, 2003:
NAME AGE POSITION AND OFFICES DIRECTOR SINCE
- ---- --- -------------------- --------------
Donald R. Bernier 61 Chairman and Director January 1995
David H. Pohl 65 Director April 2001
Jeffrey Wallin 55 President and CEO n/a
Lowell W. Giffhorn 56 Executive Vice President, CFO, Secretary and August 1999
Director
Carlton M. Johnson, Jr. 43 Director August 2001
Helmut Falk, Jr. 46 Director December 1997
Gloria Felcyn 56 Director October 2002
Joey Maitra 53 Vice President Engineering n/a
Patrick Nunally 39 Vice President and CTO n/a
47
BIOGRAPHICAL INFORMATION
DONALD 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. Wallin was president of SDMC Inc., a
consulting company serving the multimedia system integration and communications
markets. From 1996 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 was the principal in his own financial
management consulting firm from August 1996 until joining Patriot as Chief
Financial Officer (CFO) in May 1997. Mr. Giffhorn has served on our board of
directors since August 1999. From June 1992 to August 1996 and from September
1987 to June 1990 he was the CFO of Sym-Tek Systems, Inc. and Vice President of
Finance for its successor, Sym-Tek Inc., a major supplier of capital equipment
to the semiconductor industry. Mr. Giffhorn obtained a M.B.A. degree from
National University in 1975 and he obtained a B.S. in Accountancy from the
University of Illinois in 1969.
CARLTON 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
shareholder in the Pensacola, Florida AV rated law firm of Smith, Sauer, DeMaria
& Johnson and as President-Elect of the 500 member Escambia-Santa Rosa Bar
Association. He also served on the Florida Bar Young Lawyers Division Board of
Governors. Mr. Johnson earned a degree in History/Political Science at Auburn
University and Juris Doctor at Samford University - Cumberland School of Law.
HELMUT FALK, JR. Since 1992, Dr. Falk has been the Director 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 heir to the Helmut
48
Falk Estate, which is the beneficial owner of the Company's shares held by the
Helmut Falk Family Trust.
GLORIA FELCYN. Ms. Felcyn was appointed a Director and chairman of our
audit committee on October 10, 2002. Since 1982 Ms. Felcyn has been the
principal in her own public accounting firm. Ms. Felcyn received a B.S. degree
in Business Economics for Trinity University in 1968.
PATRICK O. NUNALLY. Dr. Nunally joined us as Vice President of Business
Development and Chief Technical Officer in June 2001, previous to which he had
been providing consulting services to us since May 2000. Dr. Nunally has more
than 20 years 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., 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 Engineering of Patriot in
December 1996 through February 2001. Mr. Maitra was reappointed to the same
position in November 2001. Previously Mr. Maitra held various engineering
positions with 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.
INDEMNIFICATION OF OFFICERS, DIRECTORS AND OTHERS
As permitted by Delaware law, our certificate of incorporation provides
that we will indemnify our officers, directors, employees and agents. This
includes indemnification against attorneys' fees and other expenses and
liabilities they incur to defend, settle or satisfy any civil or criminal action
brought against them arising out of their association with or activities on
behalf of us. However, they will not be indemnified if they are adjudged to have
acted with gross negligence or to have engaged in willful misconduct. We may
also bear the expenses of such litigation for any such persons upon their
promise to repay such sums if it is ultimately determined that they are not
entitled to indemnification. Such expenditures could be substantial and may not
be recouped, even if we are so entitled. We have provided for indemnification
for liabilities arising under the Securities Act of 1933 as they may be
permitted to directors, officers or persons controlling us. The SEC has informed
us that such indemnification is against public policy and may be unenforceable.
49
EXECUTIVE COMPENSATION
There is shown below information concerning 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.
SUMMARY 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 contended that he was
wrongfully terminated on August 5, 2001 in violation of his employment
agreement dated December 1, 2000. He sought damages for the alleged
breach of his employment agreement, age discrimination, as well as
other related claims. In October 2002, we entered into a settlement
agreement with Mr. Blum whereby we agreed to pay him $60,000 over
twelve months and to issue him 400,000 shares of our common stock.
This liability has been recorded in our consolidated financial
statements for the six months ended November 30, 2002.
(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 $400 per month for car allowance.
(4) Payments to Mr. Nunally for assignments to the Company of intellectual
property rights.
The Company maintains employee benefits that are generally available to
all of its employees, including medical, dental and life insurance benefits and
a 401(k) retirement savings plan. The Company did not make any matching
contributions under the 401(k) plan for any of the above named officers during
the fiscal years ended May 31, 2002, 2001 and 2000.
OPTION GRANTS
Shown below is information on grants of stock options pursuant to the
Company's 1992, 1996 and 2001 Stock Option Plans to the Named Officers reflected
in the Summary Compensation Table shown above.
OPTION GRANTS TABLE FOR FISCAL YEAR ENDED MAY 31, 2002
Potential Realizable Value
of Assumed Annual Rates
Percent of Total of Stock Price
Options Granted Appreciation
Number of to Employees in Exercise Expiration for Option Term (1)
Name Options Granted Fiscal Year Price Date 5%($) 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.
51
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. Walling 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.
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.
52
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.
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. Through October 10, 2002,
the entire Board of Directors 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.
53
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of June 6, 2003, 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 18,214,527 15.4%
par value 20440 Williams Ave.
$ .00001 Saratoga, California 95070
SAME Donald R. Bernier 487,500 ****
10989 Via Frontera
San Diego, California 92127
SAME Helmut Falk, Jr. 149,500 ****
10989 Via Frontera
San Diego, California 92127
SAME Lowell W. Giffhorn 536,614 ****
10989 Via Frontera
San Diego, California 92127
SAME SDMC, Inc. 1,020,000 ****
10989 Via Frontera
San Diego, California 92127
SAME David H. Pohl 325,000 ****
10989 Via Frontera
San Diego, California 92127
SAME Patrick O. Nunally 799,500 ****
10989 Via Frontera
San Diego, California 92127
SAME Joey Maitra 512,342 ****
10989 Via Frontera
San Diego, California 92127
54
Name and Address Amount & Nature
Title of Beneficial of Beneficial Percent
Of Class Owner Ownership of Class
-------- ----- --------- --------
SAME Carlton M. Johnson, Jr. 75,000 ****
10989 Via Frontera
San Diego, California 92127
All directors & officers 22,119,983 18.2%
as a group (8 persons)
* 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 11,548,304 shares
that are issuable on the conversion of 8% Convertible Debentures and the
exercise of warrants into shares of common stock and 50,000 shares
issuable upon the exercise of outstanding stock options.
2) Includes 262,500 shares issuable upon the exercise of outstanding
stock options.
3) Includes 115,000 shares issuable upon the exercise of outstanding
stock options.
4) Includes 311,666 shares issuable upon the exercise of outstanding
stock options.
5) Includes 1,020,000 shares issuable upon the exercise of outstanding
stock options.
6) Includes 325,000 shares issuable upon the exercise of outstanding
stock options.
7) Includes 787,500 shares issuable upon the exercise of outstanding
stock options.
8) Includes 335,000 shares issuable upon the exercise of outstanding
stock options.
9) Includes 75,000 shares issuable upon the exercise of outstanding
stock options.
10) Includes 7,290,013 shares issued and outstanding and 14,829,970
shares issuable upon exercise of stock options, conversion of
convertible debentures and exercise of warrants.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
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 is a 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
55
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 subject to the terms of an earnout escrow. These shares were
issued in consideration of technology acquired. nanoTronics was formed in 1991
and 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
expenditures 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 shares 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 change 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:
o 3,500,000 shares were released from escrow, and
o the 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. Ms. Felcyn was
appointed to our board of directors in October 2002.
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 bore 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. In April 2003, we negotiated an early
payment discount and Mr. Lunney paid $60,000 to retire 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
56
materials. The principal in Webster Incorporated, Christine Blum, is the
daughter of our previous Chairman, President and CEO, Richard Blum.
From June 10, 2002 through August 23, 2002, we issued to Gloria Felcyn,
Trustee of the Helmut Falk Family Trust, two 8% Convertible Debentures with
accumulative principal balances of $275,000 due June 10, 2004 through August 23,
2004. The initial exercise prices ranged from $0.0727 to $0.08616 and are
subject to a downward revisions if the price of our stock is lower on any three
month anniversary of the debentures or on the date that a statement registering
the resale of the common stock issuable upon conversion of the debentures
becomes effective. Also, in conjunction with the debentures, we issued five year
warrants to purchase up to 4,102,431 shares of our common stock at an initial
exercise prices ranging from $0.0727 to $0.08616 subject to reset provisions on
each six month anniversary of the issuance of the warrants. 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 $275,000 of 8% Convertible Debentures on the
same terms.
During October 2002 through December 2002, we entered into three 8%
short-term notes with Gloria Felcyn, the trustee for the Falk Family Trust,
aggregating $180,000 with initial maturity dates ranging from January 1 to
January 31, 2003. The maturity dates of the notes have been extended to dates
ranging from July 1 to July 31, 2003.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common 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. 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 following table sets forth the high and low closing bid quotations
for the Common Stock for the fiscal years ended May 31, 2003, 2002 and 2001.
QUOTATIONS
----------
HIGH LOW
Fiscal Year Ending May 31, 2003
First Quarter $ 0.08 $ 0.06
Second Quarter $ 0.14 $ 0.03
Third Quarter $ 0.09 $ 0.04
Fourth Quarter $ 0.09 $ 0.04
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
57
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 have approximately 416 shareholders of record as of May 31, 2002.
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
stockholders represented by these record holders. We have never paid a cash
dividend on our common stock and do not expect to pay one in the foreseeable
future.
DESCRIPTION OF SECURITIES
Our authorized capital stock consists of 200,000,000 shares of common
stock, $.00001 par value per share. At June 6, 2003, a total of 106,547,807
common shares were issued and outstanding. The holders of common stock are
entitled to one vote for each share held. The affirmative vote of a majority of
votes cast at a meeting which commences with a lawful quorum is sufficient for
approval of most matters upon which shareholders may or must vote, including the
questions presented for approval or ratification at the Annual Meeting. However,
removal of a director from office or repeal of the certificate of incorporation
in its entirety require the affirmative vote of a majority of the total voting
power for approval, and certain other matters (such as shareholder amendment of
the bylaws, and amendment, repeal or adoption of any provision inconsistent with
provisions in the certificate of incorporation regarding indemnification of
directors, officers and others, exclusion of director liability, and our
election not to be governed by statutory provisions concerning business
combinations with interested shareholders) require the affirmative vote of
two-thirds of the total voting power for approval. Common shares do not carry
cumulative voting rights, and holders of more than 50% of the common stock have
the power to elect all directors and, as a practical matter, to control the
company. Holders of common stock are not entitled to preemptive rights, and the
common stock may only be redeemed at our election.
A special meeting of shareholders may be called by or at the request
of:
o the Chairman of the Board,
o the President or any two directors, and
o persons owning in the aggregate not less than 20% of the issued
and outstanding common shares entitled to vote in elections for
directors.
After the satisfaction of requirements with respect to preferential
dividends, if any, holders of common stock are entitled to receive, pro rata,
dividends when and as declared by the board of directors out of funds legally
available therefor. Upon our liquidation, dissolution or winding-up, after
distribution in full of the preferential amount, if any, to be distributed to
holders of the preferred stock, holders of common stock are entitled to share
ratably in our assets legally available for distribution to our shareholders.
Our board of directors is authorized to issue 5,000,000 shares of
undesignated preferred stock, $.00001 par value, without any further action by
the stockholders. The board of directors may also divide any and all shares of
preferred stock into series and fix and determine the relative rights
58
and preferences of the preferred stock, such as the designation of series and
the number of shares constituting such series, dividend rights, redemption and
sinking fund provisions, liquidation and dissolution preferences, conversion or
exchange rights and voting rights, if any. Issuance of preferred stock by the
board of directors will result in such shares having dividend and/or liquidation
preferences senior to the rights of the holders of common stock and could dilute
the voting rights of the holders of common stock. There are currently no shares
of preferred stock issued and outstanding.
We have not paid any cash dividends to date, and no cash dividends will
be declared or paid on the common shares in the foreseeable future. Payment of
dividends is solely at the discretion of our board of directors.
Interwest Transfer Company, Inc., 1981 East 4800 South, Suite 100, Salt
Lake City, Utah 84117, acts as our transfer agent and registrar for our common
stock. Their telephone number is (801) 272-9294.
LEGAL OPINION
Luce, Forward, Hamilton & Scripps LLP, 600 West Broadway Street, Suite
2600, San Diego, California 92101 will pass on the validity of the common stock
offered by us.
EXPERTS
The financial statements and schedule for the year ended May 31, 2002
included in this Prospectus and in the Registration Statement have been audited
by Nation Smith Hermes Diamond independent certified public accountants, to the
extent and for the periods set forth in their report (which contain an
explanatory paragraph regarding the Company's ability to continue as a going
concern) appearing elsewhere herein and in the Registration Statement, and is
included in reliance upon such report given the authority of said firm as
experts in auditing and accounting.
The consolidated balance sheet for the year ended May 31, 2001 and the
consolidated statements of operations, stockholders' equity (deficit) and cash
flows for each of the years ended May 31, 2001 and 2000 and the financial
statement schedule included in this Prospectus and in the Registration Statement
have been audited by BDO Seidman, LLP, independent certified public accountants,
to the extent and for the periods set forth in their report dated August 9,
2001, except for note 1 dated August 15, 2001, (which contain an explanatory
paragraph regarding the Company's ability to continue as a going concern)
appearing elsewhere herein and in the Registration Statement, and is included
in reliance upon such report given the authority of said firm as experts in
auditing and accounting.
59
Index to Consolidated Financial Statements
Report of Nation Smith Hermes Diamond,
Independent Certified Public Accountants......................................... F-2
Report of BDO Seidman, LLP, Independent Certified Public Accountants....... ....... F-3
Consolidated Balance Sheets as of May 31, 2002 and 2001...................... ..... F-4
Consolidated Statements of Operations for the Years Ended May 31,
2002, 2001 and 2000.............................................................. F-5
Consolidated Statement of Stockholders' Equity (Deficit) for the
Years Ended May 31, 2002, 2001 and 2000.......................................... F-6
Consolidated Statements of Cash Flows for the Years Ended
May 31, 2002, 2001 and 2000...................................................... F-7
Summary of Accounting Policies..................................................... F-8 - F-14
Notes to Consolidated Financial Statements........................................ F-15 - F-36
Schedule II- Valuation and Qualifying Accounts..................................... F-37
Consolidated Balance Sheets as of February 28, 2003 (unaudited)
and May 31, 2002................................................ ................ F-38
Consolidated Statements of Operations for the Three and Nine Months
ended February 28, 2003 and 2002 (unaudited)................. ................... F-39
Consolidated Statements of Cash Flows for the Nine Months
ended February 28, 2003 and 2002 (unaudited)............... ..................... F-40
Notes to Unaudited Consolidated Financial Statements........ ...................... F-41 - F-53
F-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors
Patriot Scientific Corporation
San Diego, California
We have audited the accompanying consolidated balance sheet of Patriot
Scientific Corporation as of May 31, 2002, and the related consolidated
statements of operations, stockholders' equity (deficit) and cash flow for the
year ended May 31, 2002. We have also audited the schedule listed in the
accompanying index. These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audit.
We conducted our audit 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 are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides 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 Patriot Scientific
Corporation at May 31, 2002, and the consolidated results of its operations and
its cash flows for the year ended May 31, 2002 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. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations,
has negative cash flows and has negative working capital 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/ Nation Smith Hermes Diamond
San Diego, California
July 19, 2002, except for note 1,
dated as of August 23, 2002
F-2
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors
Patriot Scientific Corporation
San Diego, California
We have audited the accompanying consolidated balance sheet of Patriot
Scientific Corporation as of May 31, 2001 and the related consolidated
statements of operations, stockholders' equity and cash flows for each 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 statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these 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 Patriot Scientific
Corporation 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, LLP
Denver, Colorado
August 9, 2001, except for Note 1, dated as
of August 15, 2001
F-3
PATRIOT SCIENTIFIC CORPORATION
Consolidated Balance Sheets
May 31, 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------
ASSETS (Notes 5 and 6)
CURRENT ASSETS:
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
PROPERTY AND EQUIPMENT, net (Note 3) 285,488 423,528
OTHER ASSETS, net of accumulated amortization of $20,833 and $8,333 330,863 16,667
PATENTS AND TRADEMARKS, net of accumulated amortization
of $400,158 and $337,363 189,521 153,588
- ---------------------------------------------------------------------------------------------------------------------------
$ 934,526 $ 1,543,693
===========================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
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
8% CONVERTIBLE DEBENTURES, net of debt discount of $192,802 (Note 6) 315,198 -
LONG TERM PORTION OF CAPITAL LEASE OBLIGATION 16,731 -
COMMITMENTS AND CONTINGENCIES (Notes 1, 8, 12 and 13)
STOCKHOLDERS' EQUITY (DEFICIT) (Notes 5, 6, 7, 8 and 9):
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-4
PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
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-5
PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (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.
(1) Additional Paid-In Capital includes a note receivable of $80,000 and
additional paid-in capital of $41,440,101.
F-6
PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
- -------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
Years Ended May 31, 2002 2001 2000
- -------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES:
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)
- -------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
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
- -------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
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
- -------------------------------------------------------------------------------------------------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (376,242) (1,635,892) 2,064,429
CASH AND CASH EQUIVALENTS, beginning of year 464,350 2,100,242 35,813
- -------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, end of year $ 88,108 $ 464,350 $ 2,100,242
- -------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
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.
F-7
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS
Patriot Scientific Corporation (the "Company") is engaged in the development,
marketing, and sale of 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.
BASIS OF PRESENTATION AND CONSOLIDATION
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles and include the accounts of the
Company, its majority owned subsidiaries, Metacomp, Inc. ("Metacomp") and Plasma
Scientific Corporation. All material intercompany transactions and balances have
been eliminated in consolidation.
RECLASSIFICATIONS
Certain reclassifications have been made to the 2001 and 2000 financial
statements in order for them to conform to the 2002 presentation. Such
reclassifications have no impact on the Company's financial position or results
of operations.
FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK
The Company's financial instruments that are exposed to concentrations of credit
risk consist primarily of cash and cash equivalents and accounts receivable.
The Company's cash equivalents are placed in high quality money market accounts
with major financial institutions and high grade short-term commercial paper.
The investment policy limits the Company's exposure to concentrations of credit
risk. Money market accounts are federally insured; however, commercial paper is
not insured. The Company has not experienced any losses in such accounts.
Concentrations of credit risk with respect to accounts receivable are limited
due to the wide variety of customers and markets which comprise the Company's
customer base, as well as their dispersion across many different geographic
areas. The Company routinely assesses the financial strength of its customers
and, as a consequence, believes that its accounts receivable credit risk
exposure is limited. Generally, the Company does not require collateral or other
security to support customer receivables.
The carrying amounts of financial instruments including cash and cash
equivalents, accounts receivable, accounts payable and accrued liabilities
approximated fair value because of the immediate or short-term maturity of these
instruments. With respect to the long-term debt, the carrying amounts
approximate fair value because the debt was issued immediately prior to the end
of the fiscal year.
F-8
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
INVENTORIES
Inventories consist of raw materials, work in process and finished goods and are
valued at the weighted average cost method, which approximates cost on a
first-in, first-out basis, not in excess of market value.
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. The
Company follows the provisions of the Financial Accounting Standards Board
("FASB") Statement of Financial Accounting Standards ("SFAS") No. 121,
"Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to
be Disposed Of." Long-lived assets and certain identifiable intangibles to be
held and used by the Company 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 assets based on estimated future cash flows from and the estimated
fair value of such long-lived assets, and provides 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 individual
intangible assets is less than its carrying value determined based on the
provisions of SFAS No. 121 as discussed above.
REVENUE RECOGNITION
We recognize revenue 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
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
F-9
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
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.
ADVERTISING
The Company expenses advertising costs as incurred. Advertising expenses were
approximately $9,000, $7,400 and $2,100 for the years ended May 31, 2002, 2001
and 2000, respectively.
INCOME TAXES
The Company accounts for income taxes under SFAS No. 109, "Accounting for Income
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.
Income tax expense is the combination of the tax payable for the year and the
change during the year in deferred tax assets and liabilities.
NET LOSS PER SHARE
The Company applies SFAS No. 128, "Earnings Per Share" for the calculation of
"Basic" and "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 reflect the potential dilution
of securities that could share in the earnings (loss) of an entity.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the consolidated financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
During the year ended May 31, 2002, based upon information then available, the
Company revised its estimates regarding the recovery of certain inventories. As
a result, the Company increased existing reserves for obsolescence by $111,381.
F-10
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
SALE OF ACCOUNTS RECEIVABLE
The 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 is 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 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.
SFAS 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.
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 as
F-11
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
consulting expense as services are provided. Options granted to consultants 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-
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 us on June 1, 2001. The adoption of this statement had no
material impact on our financial statements.
In June 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No.
142, "Goodwill and Other Intangible Assets". SFAS No. 141 requires the use of
the purchase method of accounting and prohibits 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 reclassify the carrying amounts of intangible assets and goodwill
based on the criteria in SFAS No. 141.
SFAS No. 142 requires, among other things, 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 is required to be
applied in fiscal years beginning after December 15, 2001 to all goodwill and
other intangible assets recognized at that date, regardless of when those assets
were initially recognized. SFAS No. 142 requires companies to complete a
transitional goodwill impairment test six months from 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. 142 will not affect the results of past
acquisition transactions. However, all future business combinations will be
accounted for
F-12
PATRIOT SCIENTIFIC CORPORATION
SUMMARY 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 of our intangible assets within the first fiscal
quarter of 2003.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." SFAS No. 143 requires the fair value of a liability for an asset
retirement obligation to be recognized 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.
SFAS No. 143 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, is to be applied prospectively. The
adoption of this statement may 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
provisions 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
F-13
PATRIOT SCIENTIFIC CORPORATION
SUMMARY 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-14
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. CONTINUED EXISTENCE AND MANAGEMENT'S PLAN
Our consolidated financial statements are presented on the going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities
in the normal course of business. Our ability to continue 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 ended
May 31, 2002, 2001 and 2000, respectively. At May 31, 2002, we had deficit
working capital of $918,768 and cash and cash equivalents 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 during the
year ended May 31, 2002.
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 November 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:
o the additional funds received subsequent to May 31, 2002, related to
the convertible debentures of $492,000;
o optional amounts which may received under the convertible debentures
of $1,000,000;
F-15
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
o 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;
o proceeds from the exercise of outstanding stock options and warrants;
and
o 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.
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 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
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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
-------------------
Total 580,108
-------------------
Cash needs:
Estimated needs 2,400,000
Note payable to Swartz at October 9, 2002 635,276
-------------------
Total 3,035,276
-------------------
Required funds from external sources $ 2,455,168
===================
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.
F-17
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. INVENTORIES Inventories consisted of 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 Property and equipment consisted of the following:
EQUIPMENT
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 Company entered into a three-year, $80,000 Secured Promissory
Note Receivable with an individual who was, at the time of the issuance of the
note, an executive officer of the Company. The note is due 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-18
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. 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 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 warrants
The note is secured by our assets.
All debt discounts are to be amortized as additional interest expense over the
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 expense 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
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
On November 9, 2001, an offset of $227,800 from the 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. 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.
6. 8% CONVERTIBLE DEBENTURES
OVERVIEW. 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.
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 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 selling shareholders 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.
F-20
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 selling shareholders' prior written
approval.
RIGHT OF FIRST REFUSAL. The selling shareholders 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 in accordance with the convertible debenture. 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 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
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.
F-21
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 AGREEMENTS
$5 Million Equity Line of Credit Agreement
In February 1999, the Company entered into an investment agreement with Swartz
Private Equity LLC ("Swartz"). The investment agreement entitled the Company, at
the Company's option, 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% 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% 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 the common stock goes down.
In July 1999, the Company amended and restated the investment agreement with
Swartz to eliminate the discretion of Swartz as to the timing of its purchase of
the Company's common stock.
The amended and restated investment agreement required Swartz, after the Company
put shares of common stock 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 price during the twenty day pricing periods of $1.34 per
share.
F-22
PATRIOT SCIENTIFIC CORPORATION
NOTES 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 of May 31, 2002. None of the warrants had been exercised as of May 31,
2002.
$30 Million Equity Line of Credit Agreement
In May 2000, we entered into an investment agreement with Swartz. The investment
agreement entitled us , at our option, to issue and sell our common stock 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 with the SEC registering the resale of
the common shares, and (2) a limitation on the number of common shares 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, 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 initially 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 $227,800 prior to 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,
F-23
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 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 Agreement
Overview. 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. 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 sold in 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 price for the common stock during
each 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-24
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
We 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:
o 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;
o the registration statement covering the resale of the shares
becomes ineffective or unavailable for use;
o 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:
o 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;
o 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;
o 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;
o 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
o 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-25
PATRIOT SCIENTIFIC CORPORATION
NOTES 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-26
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. STOCKHOLDERS' EQUITY (DEFICIT)
PRIVATE OFFERINGS AND WARRANTS
During 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.
At May 31, 2002, the Company had warrants outstanding to purchase 24,477,724
common shares at exercise prices ranging from $0.048 to $1.12 per share expiring
beginning in 2002 through 2007.
During fiscal 2002, the Company issued warrants to purchase 23,197,201 common
shares of stock at exercise prices ranging from $0.048 to $0.54 per share. Of
this amount, warrants to purchase 3,113,302 common shares of stock were issued
to Swartz related to the $30 million investment agreement, a warrant to purchase
900,000 common shares of stock was issued to Swartz related to the $25 million
investment agreement, warrants to purchase 16,519,090 common shares of stock
were issued to Swartz related to 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 INCENTIVE 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, options to purchase up to 45,834 shares of common stock remained
outstanding and will expire starting in 2002 through 2005.
F-27
PATRIOT SCIENTIFIC CORPORATION
NOTES 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 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 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 PLAN
Effective 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 Company granted
options to purchase 1,000,000 shares of stock at market value. During the fiscal
year ended May 31, 2001, the Company granted options to purchase 1,860,000
shares of stock at market value.
2001 STOCK OPTION PLAN
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. The 2001 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 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 year ended May 31, 2002, the Company granted options to purchase
3,145,000 shares of stock at market value.
F-28
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
During fiscal 2000, the Company repriced stock options to purchase 2,706,000
shares of common stock at exercise prices originally ranging from $.3625 to
$2.30 using fixed accounting rules in effect at the time. The stock options were
repriced to an exercise price of $.32 and no additional compensation expense was
recorded. Subsequent to the repricing, the Company adopted accounting principles
generally accepted in the United States of America that require stock options
that have been modified to reduce the exercise price to be accounted for using
variable accounting. Accordingly, if the market price of the Company's stock
increases subsequent to July 1, 2000, it will recognize additional compensation
expense that it otherwise would not have incurred. As of May 31, 2002, there was
no additional compensation expense recorded because the market price of the
Company's common stock was lower than 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 in the fiscal year
ended May 31, 2000 as a result of employees and directors exercising their stock
options using a cashless exercise provision. Generally accepted accounting
principles require that such exercises must be recorded using variable
accounting which reflect the incremental difference between the exercise price
and the market price on the date of exercise as though it were additional
compensation. Since no cash is exchanged in the transaction, a like amount was
recorded as additional paid-in capital.
SFAS No. 123, "Accounting for Stock-Based Compensation," requires the Company to
provide pro forma information regarding net loss and net loss per share as if
compensation costs for the Company's stock option plans and other stock awards
had been determined in accordance with the fair value based method prescribed in
SFAS No. 123. The Company estimates 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 three years ended May 31, 2002, 2001
and 2000, respectively: dividend yield of zero percent for all years; expected
volatility of 90, 90 and 50 percent; risk-free interest rates of 3.5 to 4.8, 4.8
to 6.4, and 5.6 to 6.1 percent; and expected lives of 3 to 5 years for all
years.
Under the accounting provisions for SFAS No. 123, the Company's net loss per
share would have been increased by 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-29
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
A summary of the status of the Company's stock option plans and warrants as of
May 31, 2002, 2001 and 2000 and changes during the years ending 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
- --------------------------------------------------------------------------------------------------------------------------------
Included in the above table are certain options for which vesting is contingent
based on various future performance measures.
F-30
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes information about stock options and warrants
outstanding at May 31, 2002:
Outstanding Exercisable
---------------------------------------------- -------------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
- -----------------------------------------------------------------------------------------------------
OPTIONS
$ 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
WARRANTS
$ 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 SHARE
The Company has implemented Statement of Financial Accounting Standards ("SFAS")
No. 128, "Earnings Per Share." SFAS No. 128 provides 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, 2001 and 2000,
common stock options and warrants convertible or exercisable into approximately
28,727,463, 7,539,287 and 6,187,505 shares of common stock were not included in
diluted loss per share as the effect was antidilutive due to the Company
recording losses in each of those years.
F-31
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES 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 May 31, 2002 and 2001, valuation allowances equal to the net deferred tax
asset recognized have been recorded, as Management has not determined that it is
more likely than not that the deferred tax asset will be realized. No current
tax provision was recorded for fiscal 2002, 2001 and 2000 due to reported
losses. The valuation allowance increased $1,457,000 for the year ended May 31,
2002 and $1,863,00 for the year ended May 31, 2001.
At May 31, 2002, the Company has federal net operating loss carryforwards of
approximately $28,972,000 that expire through 2021 and are subject to certain
limitations under the Internal Revenue Code of 1986, as amended. As such,
certain federal net operating loss carryforwards may expire unused.
F-32
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
At May 31, 2002, the Company has state net operating loss carryforwards of
approximately $19,671,000 that expire through 2008.
11. PROFIT-SHARING PLAN
Effective July 1, 1993, the Company adopted a savings and profit-sharing plan
that allows participants to make contributions by salary reduction pursuant to
Section 401(k) of the Internal Revenue Code. At the Company's discretion, the
Company may match contributions at 20% of the employee's contribution up to 6%
of the employee's salary. The Company contributions are vested 20% per year
beginning with the first year of service. The Company made no matching
contribution in fiscal 2002, 2001 or 2000.
12. CONTINGENCIES
In January 1999, we were 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 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 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 will 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.
F-33
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. COMMITMENTS AND LEASE OBLIGATIONS
The Company is obligated under employment contracts with certain key employees
to pay severance upon termination under certain defined conditions. Generally,
unless relieved of their duties for cause, the executive officers are entitled
to severance pay equal to four months of their then current monthly salary. In
the case of a change in control, generally, the executive officers are entitled
to severance pay equal to twelve months of their then current monthly salary
unless they continue to work for the new controlling interest in the same
function as previous to the change.
The Company granted a lien and security interest in substantially all of its
assets to the bank under the accounts receivable factoring line.
The Company has a non-cancellabe operating lease for its office and
manufacturing facilities located in San Diego, California.
Future minimum lease payments required under the operating lease are 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
- ------------------------------------------------------------------------------------------
Rent expense for 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-34
PATRIOT SCIENTIFIC CORPORATION
NOTES 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 INFORMATION
EXPORT SALES
The 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, 2001 and
2000, the 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. During the fiscal years
ended May 31, 2002, 2001 and 2000, the Company's sales by geographic location
consisted of the 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-35
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company has no foreign assets.
SALES TO MAJOR CUSTOMERS
During the fiscal years ended May 31, 2002, 2001 and 2000, revenues from
significant customers consisted of the 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 TRANSACTIONS
During 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. SUBSEQUENT EVENTS
Subsequent to year end, we 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 10,344,366 shares of our common stock at an initial
exercise price of $0.08616 per share, subject to being reset at each six month
anniversary to the closing.
F-36
PATRIOT SCIENTIFIC CORPORATION
SCHEDULE II- VALUATION AND QUALIFYING ACCOUNTS
Allowance for 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
Reserve 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-37
PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED BALANCE SHEETS
February 28, May 31,
2003 2002
-------------------- --------------------
(Unaudited)
ASSETS (Notes 4 and 5)
Current assets:
Cash and cash equivalents $ 30,256 $ 88,108
Accounts receivable, net of allowance
of $10,000 and $6,000 for uncollectible accounts (Note 1) 1,945 4,797
Prepaid expenses 84,809 35,749
-------------------- --------------------
Total current assets 117,010 128,654
Property and equipment, net 186,519 285,488
Other assets, net 100,121 330,863
Patents and trademarks, net 188,543 189,521
-------------------- --------------------
$ 592,193 $ 934,526
==================== ====================
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Note payable, net of unamortized debt discount
of $0 and $189,516 (Notes 3 and 4) $ 635,276 $ 445,760
Notes payable to a related party 180,000 -
Accounts payable 410,309 385,255
Accrued liabilities 228,541 211,291
Current portion of capital lease obligation 6,055 5,116
-------------------- --------------------
Total current liabilities 1,460,181 1,047,422
8% Convertible debentures, net of debt discount of $898,840 418,660 315,198
and $192,802 (Notes 3 and 5)
Long term portion of capital lease obligation 12,064 16,731
Commitments and contingencies (Notes 3, 6, 7 and 9)
Stockholders' deficit: (Note 7)
Preferred stock, $.00001 par value; 5,000,000 shares
authorized none outstanding - -
Common stock, $.00001 par value; 200,000,000 shares
authorized; issued and outstanding 96,650,153 and 81,465,757 967 815
Additional paid-in capital 43,449,452 41,440,101
Accumulated deficit (44,669,131) (41,805,741)
Note receivable (Note 8) (80,000) (80,000)
-------------------- --------------------
Total stockholders' deficit (1,298,712) (444,825)
-------------------- --------------------
$ 592,193 $ 934,526
==================== ====================
See accompanying summary of accounting policies and notes to unaudited
consolidated financial statements.
F-38
PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine Months Ended
------------------------------------- -------------------------------------
February 28, February 28, February 28, February 28,
2003 2002 2003 2002
----------------- ----------------- ------------------ -----------------
Net sales $ 41,390 $ 4,620 $ 86,439 $ 326,509
Cost of sales:
Product costs 6,671 2,194 18,660 242,772
Inventory obsolescence - - - 149,433
----------------- ----------------- ------------------ -----------------
Cost of sales 6,671 2,194 18,660 392,205
Gross profit (loss) 34,719 2,426 67,779 (65,696)
Operating expenses:
Research and development 167,230 257,795 540,735 1,129,042
Selling, general and
administrative 382,372 709,334 1,446,606 2,101,746
----------------- ----------------- ------------------ -----------------
549,602 967,129 1,987,341 3,230,788
----------------- ----------------- ------------------ -----------------
Operating loss (514,883) (964,703) (1,919,562) (3,296,484)
----------------- ----------------- ------------------ -----------------
Other income (expenses):
Interest income 3 15 188 378
Interest expense (327,781) (295,988) (944,016) (570,142)
----------------- ----------------- ------------------ -----------------
(327,778) (295,973) (943,828) (569,764)
----------------- ----------------- ------------------ -----------------
Net loss $ (842,661) $ (1,260,676) $ (2,863,390) $ (3,866,248)
================= ================= ================== =================
Basic and diluted loss
per common share $ (0.01) $ (0.02) $ (0.03) $ (0.06)
================= ================= ================== =================
Weighted average number of
common shares outstanding
during the period (Note 1) 91,726,851 71,500,223 85,711,345 64,288,474
================= ================= ================== =================
See accompanying summary of accounting policies and notes to unaudited
consolidated financial statements.
F-39
PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Nine Months Ended
---------------------------------------------
February 28, 2003 February 28, 2002
--------------------- ---------------------
Decrease in Cash and Cash Equivalents
Operating activities:
Net loss $ (2,863,390) $ (3,866,248)
Adjustments to reconcile net loss
to cash used in operating activities:
Amortization and depreciation 155,875 180,187
Provision for doubtful accounts 4,000 70,600
Provision for inventory obsolescense - 149,433
Non-cash interest expense related to convertible
debentures, notes payable and warrants 837,341 546,425
Issuance of common stock and options for services
and litigation settlements 148,800 49,500
Changes in:
Accounts receivable (13,025) (46,614)
Inventories - 73,960
Prepaid expenses and other assets 177,515 (53,526)
Accounts payable and accrued liabilities 59,294 (56,588)
---------------------------------------------
Net cash used in operating activities (1,493,590) (2,952,871)
---------------------------------------------
Investing activities:
---------------------------------------------
Purchase of property, equipment and patents (51,761) (47,429)
---------------------------------------------
Financing activities:
Proceeds from the issuance of short term notes payable 180,000 1,440,000
Proceeds from the issuance of convertible debentures 1,184,500 -
Proceeds from the issuance of common stock 114,850 879,605
Principal payments for capital lease obligations (3,728) (2,040)
Proceeds from sales of accounts receivable 11,877 154,158
Proceeds from exercise of common stock
warrants and options - 73,833
---------------------------------------------
Net cash provided by financing activities 1,487,499 2,545,556
---------------------------------------------
Net decrease in cash and cash equivalents (57,852) (454,744)
Cash and cash equivalents, beginning of period 88,108 464,350
---------------------------------------------
Cash and cash equivalents, end of period $ 30,256 $ 9,606
---------------------------------------------
Supplemental Disclosure of Cash Flow Information:
Cash payments for interest $ 12,301 $ 17,232
Warrants and options issued for prepaid services $ - $ 57,500
Common stock issued for prepaid services $ - $ 198,000
Capital lease obligation $ - $ 24,996
Common stock issued on conversion of debentures,
notes payable and accrued interest $ 391,990 $ 227,800
Debt discount $ 1,403,815 $ 834,929
Debt discount cancelled $ 248,948 $ -
-------------------------------------------
See accompanying summary of accounting policies and notes to unaudited
consolidated financial statements.
F-40
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The consolidated financial statements of Patriot Scientific Corporation
("Patriot") presented herein have been prepared pursuant to the rules of the
Securities and Exchange Commission 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 statements should be
read in conjunction with our audited consolidated financial statements and notes
thereto for the year ended May 31, 2002.
In the opinion of management, the interim consolidated financial statements
reflect all adjustments of a normal recurring nature necessary for a fair
statement of the results for interim periods. Operating results for the three
and nine month periods are not necessarily indicative of the results that may be
expected for the year.
LOSS PER SHARE
We follow Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings per Share." Under SFAS No. 128, basic loss per share is calculated as
loss available to common stockholders divided by the weighted average number of
common shares outstanding. Diluted loss per share is calculated as net loss
divided by the diluted weighted average number of common shares. The diluted
weighted average number of common shares is calculated using the treasury stock
method for common stock issuable pursuant to outstanding stock options and
common stock warrants. Common stock options and warrants of 55,684,705 and
13,840,170 for the nine months ended February 28, 2003 and 2002, respectively,
were not included in diluted loss per share for the periods as the effect was
antidilutive due to our recording losses in each of those periods. See Notes 5
and 7 for discussion of commitments to issue additional shares of common stock
and warrants.
SALE OF ACCOUNTS RECEIVABLE
We follow SFAS No. 140, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities," a replacement of SFAS No. 125. SFAS
No. 140 provides consistent standards for distinguishing transfers of financial
assets that are sales from transfers that are secured borrowings. A $400,000
factoring line we established with a bank enables us to sell selected accounts
receivable invoices to the bank with full recourse against us. These
transactions qualify for a sale of assets since (1) we have transferred all of
our rights, 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) we have no effective control over the selected
accounts receivable invoices since we are not entitled to or obligated to
repurchase or redeem the invoices before their maturity and we do not have the
ability to unilaterally cause the bank to return the invoices. Under SFAS
No.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 the first nine months of
fiscal 2003, we sold $14,846 of our accounts receivable to a bank under the
F-41
PATRIOT SCIENTIFIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
factoring agreement for $11,877. Pursuant to the provisions of SFAS No. 140, we
reflected the transactions as sales of assets and established a receivable from
the bank for the retained amount less the costs of the transactions and less any
anticipated future loss in the value of the retained asset. The retained amount
was equal to 20% of the total accounts receivable invoices sold to the bank less
1% of the total invoices 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 was based on the payment history of the accounts receivable
customer. As of February 28, 2003, there were no qualifying accounts receivable
invoices available to factor resulting in no balance outstanding under the
factoring line and $400,000 remaining available for future factoring of accounts
receivable invoices.
RECLASSIFICATIONS
Certain items in the unaudited February 28, 2002 consolidated financial
statements have been reclassified to conform to the current presentation.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In December 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure-an amendment of SFAS No.
123." SFAS No. 148 provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosures in both annual
and interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results.
Management is evaluating the adoption of this statement.
3. CONTINUED EXISTENCE AND MANAGEMENT'S PLAN
Our consolidated financial statements are presented on the going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities
in the normal course of business. Our ability to continue as a going concern is
contingent upon our obtaining sufficient financing to sustain our operations. We
incurred a net loss of $2,863,390, $5,487,051 and $4,968,903 and negative cash
flow from operations of $1,493,590, $3,632,534 and $4,839,180 in the nine months
ended February 28, 2003 and the years ended May 31, 2002 and 2001, respectively.
At February 28, 2003, we had deficit working capital of $1,343,171 and cash and
cash equivalents of $30,256. We have historically funded our operations
primarily through the issuance of securities and debt financings. Cash and cash
equivalents decreased $57,852 during the nine months ended February 28, 2003.
We estimate our current cash requirements to sustain our operations for the next
twelve months through February 2004 to be $2.4 million. Since we are no longer
supporting the communications
F-42
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
product line, we are assuming that there will be no communications product
revenue. We have a note payable to Swartz Private Equity, LLC ("Swartz") of
$635,276 at February 28, 2003 which was due in April 2003 and subsequent to the
end of the quarter has been extended to March 1, 2004. We also have convertible
debentures with a group of investors as of February 28, 2003 aggregating
$1,605,000 and advances of $87,500 on a convertible debenture that closed
subsequent to February 28, 2003. 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. During the first nine months ended February 28, 2003, we obtained
$114,850 from the sale of equity to several private investors and $180,000 from
short term notes entered into with a related party. Subsequent to February 28,
2003, we obtained an additional $5,500 from the sale of equity to a private
investor and $112,500 from the issuance of additional convertible debentures net
of advances discussed above.
If the optional amounts under the convertible debentures are not raised in
sufficient amounts, then we may not have funds sufficient to meet our cash
requirements. In such circumstances, we may need to secure additional short-term
debt, private placement debt and/or equity financings with individual or
institutional investors. In addition, 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:
o additional debt and/or equity financings; and
o proceeds from the exercise of outstanding stock options and warrants.
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 February 28, 2003.
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 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.
If we are unable to obtain the necessary funds, we could be forced to
substantially curtail or cease operations which would 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
F-43
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
4. 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, which originally
was to mature on April 9, 2003, has been extended to March 1, 2004 and amounts
outstanding under the note bear interest at the rate of 5% per annum. Per the
addendum to the amended note, principal and interest payments are deferred until
March 1, 2004.
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 gave to Swartz
the right of first refusal and rights to participate in subsequent debt or
equity transactions had we entered into any through March 15, 2003.
As of February 28, 2003 we issued warrants to purchase up to 17,622,200 shares
of our common stock in accordance with the amended note agreements. 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 warrants
The note is secured by our assets.
All debt discounts were amortized as additional interest expense over the term
of the note payable. As of February 28, 2003, $1,107,238 had been reflected as
debt discount of which $917,722 and $189,516 was amortized to interest expense
during the year ended May 31, 2002 and the nine months ended February 28, 2003,
respectively.
F-44
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 (1,107,238) -
------------ ----------
Note payable at February 28, 2003 $ 635,276
==========
On November 9, 2001, an offset of $227,800 from the 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.
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 and only put under the $25 million
equity line of credit discussed below.
5. 8% CONVERTIBLE DEBENTURES
OVERVIEW. From April 23, 2002 through February 28, 2003, we sold an aggregate of
$1,605,000 of 8% convertible debentures to a group of eleven investors. In
addition, at February 28, 2003, we have received advances totaling $87,500
against a convertible debenture that closed subsequent to the quarter. The
convertible debentures entitle the debenture holder to convert the principal and
unpaid accrued interest into our common stock for two years from the date of
closing. In addition, the debenture holders received warrants exercisable into a
number of our common shares.
NUMBER OF SHARES DEBENTURES MAY BE CONVERTED INTO. The debentures can be
converted into a number of our common shares at conversion prices that initially
equaled $0.05126 to $0.10289 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 becomes effective, October 29, 2002 for the first
$1,000,000 of principal and March 7, 2003 for the second $605,000 of principal.
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. On October 29, 2002, the date the registration statement for the
first $1,000,000 of principal became effective, the conversion price for
debentures dated April 23, 2002 in an amount of $225,000 and June 10, 2002 in
amounts accumulating $775,000 were reset to $0.04457 from initial conversion
prices of $0.10289 and $0.08616. On March 7, 2003, the date the registration
statement for the second $605,000 of principal became effective, the conversion
price for debentures dated
F-45
PATRIOT SCIENTIFIC CORPORATION NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
August 23, October 29 and December 16, 2002 and January 24, 2003 in the amounts
of $175,000, $180,000, $100,000 and $150,000, respectively, were reset to
$0.04722 from initial conversion prices ranging from $0.05126 to $0.0727.
WARRANTS. Concurrent with the issuance of the convertible debentures, we issued
to the debenture holders warrants to purchase up to 24,094,009 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. For the nine months ended February 28, 2003, warrants to
purchase up to 15,626,849 shares of our common stock had their exercise prices
reset from a range of $0.073 to $0.103 to a range of $0.047 to $0.073.
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.
REGISTRATION RIGHTS. We are responsible for registering the resale of the shares
of our common stock which will be issued on the conversion of the debentures. On
October 29, 2002 and March 7, 2003, registration statements covering $1,000,000
and $605,000 of debentures were declared effective by the Securities and
Exchange Commission.
As of February 28, 2003 we issued warrants to purchase up to 24,094,009 shares
of our common
F-46
PATRIOT SCIENTIFIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (CONTINUED)
stock in accordance with the convertible debentures. 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 warrants. Debt discounts related to the warrant valuations are to be
amortized as additional interest expense over the term of the convertible
debenture. As of February 28, 2003, $1,141,697 has been reflected as debt
discount of which $123,480, $326,584 and $8,383 was amortized to interest
expense during the three and nine months ended February 28, 2003 and the year
ended May 31, 2002, respectively.
In addition, the convertible debentures contain beneficial conversion features.
Such features require us to allocate the proceeds received to both the warrants
and the debt and to calculate an intrinsic value for the debt portion if the per
share price allocated to debt is less than the fair market per share price as of
the first date the debenture is sold. Accordingly, during the three and nine
months ended February 28, 2003, we recorded $58,571 and $463,303 to additional
paid in capital to reflect the intrinsic value of the convertible debentures.
The intrinsic value of the beneficial conversion feature of the convertible
debenture is amortized to non-cash interest expense over the life of the
convertible debenture. Accordingly, we amortized to non-cash interest expense
$51,106 and $122,245 during the three and nine months ended February 28, 2003.
During the nine months ended February 28, 2003, holders converted debentures
accumulating $375,000 of principal and $16,990 of accrued interest into
8,794,937 shares of our common stock. The balance of unamortized debt discount
related to the beneficial conversion features and debt discount on the date of
conversion of $248,948 was charged to additional paid in capital.
The convertible debentures are secured by our assets.
Convertbile debenture dated April 23, 2002 $ 225,000
Convertbile debentures dated June 10, 2002 775,000
Convertbile debenture dated August 23, 2002 175,000
Convertbile debentures dated October 29, 2002 180,000
Convertbile debenture dated December 16, 2002 100,000
Convertbile debenture dated January 24, 2003 150,000
Advances against debenture issued subsequent to Febrary 28, 2003 87,500
Less amounts converted to common stock (375,000)
Less debt discount
Total $ 1,605,000
Amount amortized to expense (457,212)
Amount cancelled on conversion (248,948) (898,840)
------------- -------------
Convertible debentures at February 28, 2003 $ 418,660
================
F-47
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. INVESTMENT AGREEMENTS
$5 MILLION EQUITY LINE OF CREDIT AGREEMENT
- ------------------------------------------
In February 1999, the Company entered into an investment agreement with Swartz.
The investment agreement entitled the Company, at the Company's option, 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% 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% 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 the common
stock goes down.
In July 1999, the Company amended and restated the investment agreement with
Swartz to eliminate the discretion of Swartz as to the timing of its purchase of
the Company's common stock.
The amended and restated investment agreement required Swartz, after the Company
put shares of common stock 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 price during the twenty day pricing periods of $1.34 per
share.
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 $0.053 to
$0.068 as of February 28, 2003. None of the warrants had been exercised as of
February 28, 2003.
$30 MILLION EQUITY LINE OF CREDIT AGREEMENT
- -------------------------------------------
In May 2000, we entered into an investment agreement with Swartz. The investment
agreement entitled us , at our option, to issue and sell our common stock for up
to an aggregate of $30 million
F-48
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
from time to time during a three-year period, subject to certain conditions
including among other items (1) an effective registration statement being on
file with the SEC registering the resale of the common shares, and (2) a
limitation on the number of common shares that could have been 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 and we received a
total of $4,381,601 from the sale of 12,000,000 shares of common stock . Per the
terms of the investment agreement, we issued ten five-year warrants for
1,800,000 shares of common stock exercisable initially 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 $0.033 to $0.0858 as of February
28, 2003. None of the warrants had been exercised as of February 28, 2003.
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 $227,800 prior to 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 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 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. As a result of the reset provision, the exercise price has been
reduced to $0.0858 as of February 28, 2003. None of the warrants had been
exercised as of February 28, 2003.
See Note 7 for further information on the warrants.
$25 MILLION EQUITY LINE OF CREDIT AGREEMENT
- -------------------------------------------
On September 17, 2001, we entered into an investment agreement with Swartz. The
investment
F-49
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
agreement entitled 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. We filed a registration
statement on Form S-1 that was declared effective on November 5, 2001 for
15,000,000 shares of our common stock. We issued the 15,000,000 shares of common
stock to Swartz during the fiscal year ended May 31, 2002 to be applied against
a note payable that Swartz had issued to us.
We 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. As a result of the reset provision,
the exercise price has been reduced to $0.0495 as of February 28, 2003. None of
the warrants had been exercised as of February 28, 2003.
RESTRICTIVE COVENANTS. For a period of two years after the termination of the
agreeement, 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 years 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 years after the termination of the
investment agreement.
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 under the $25 million equity line of credit. On May 30,
2002 we closed the first put and effectively 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 7 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-50
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' DEFICIT
The following table summarizes equity transactions during the nine months ended
February 28, 2003:
STOCK OPTIONS
At February 28, 2003, we had 17,500 options outstanding pursuant to our 1992 ISO
Stock Option Plan exercisable at $1.325 per share expiring in 2005; 50,000
options outstanding pursuant to our 1992 NSO Stock Option Plan exercisable at
$1.325 per share expiring in 2005; 1,976,500 options outstanding pursuant to our
1996 Stock Option Plan exercisable at a range of $0.0575 to $1.325 per share
expiring beginning in 2004 through 2007; and 2,340,000 options outstanding
pursuant to our 2001 Stock Option Plan exercisable at a range of $0.059 to $0.69
per share expiring beginning in 2004 through 2007.
Some of the options outstanding under these plans are not presently exercisable
and are subject to meeting vesting criteria.
WARRANTS
At February 28, 2003, we had warrants outstanding exercisable into 51,300,705
common shares at exercise prices ranging from $0.033 to $1.12 per share expiring
beginning in 2004 through 2007. During the nine months ended February 28, 2003,
we issued warrants to purchase 21,579,200 shares of common stock which are
subject to repricings at the six month anniversary of the issuance of the
warrant. At each anniversary date the warrants will be repriced to the lesser of
the initial exercise price or 110% of the lowest closing bid price of our common
stock for the five trading days ending on such six month anniversary date.
During the nine months ended February 28, 2003, warrants to purchase 15,456,937
shares of common stock with initial or reset exercise prices ranging from
$0.0571 to $0.1320 have been repriced to exercise prices ranging from $0.033 to
$0.0715.
F-51
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
During the nine months ended February 28, 2003, we issued to two individuals
warrants exercisable for five years into 1,000,000 common shares at an exercise
price of $0.05 per share. These individuals are acting as our marketing
representatives and the warrants are scheduled to vest based on sales activity
as defined in their contracts.
Also, during the nine months ended February 28, 2003, we issued to Swartz snap
shot warrants exercisable for five years into 4,734,050 common shares at
exercise prices, after reset provisions, ranging from $0.047 to $0.0592 per
share. These snap shot warrants were issued under an agreement with Swartz
whereby we will issue to Swartz warrants to purchase common shares equal to 20%
of any common stock or warrants we issue to parties other than Swartz or their
affiliates after March 12, 2002.
COMMON STOCK
During the nine months ended February 28, 2003, we sold to a group of individual
private investors a total of 3,609,459 shares of common stock at prices ranging
from $0.025 to $0.051 for an accumulated total of $114,850. The investors have
agreed to hold these shares for a minimum of one year.
In October 2002, we entered into an agreement with Barry Clark whereby he will
provide consulting services through April 2003 to help structure financing,
provide innovative capital resources and advise us on other strategic decisions.
In October 2002 we issued to Mr. Clark 2,000,000 shares of our common stock as
compensation for the consulting services. We recorded $110,000, the value of the
common stock on the day it was issued, as a prepaid expense and additional
paid-in capital of which, during the nine months ended February 28, 2003, we
amortized to expense $91,667 as non-cash compensation.
In October 2002, we entered into a settlement agreement with a former executive
officer of the Company. As part of the agreement, we issued to him 400,000
shares of our common stock. During the nine months ended February 28, 2003, we
recorded $16,000, the value of the common stock on the day of the settlement, as
litigation expense. The shares are subject to registration and were included in
our registration statement that went effective on March 7, 2003.
In December 2001, we entered into a series of agreements with iCapital
Corporation ("iCapital") and several principals of iCapital whereby they
provided consulting services through December 2002 to help structure financing,
provide innovative capital resources, identify and assist with merger and
acquisition opportunities and advise us on other strategic decisions. In January
2002, based on meeting several performance criteria, we issued to iCapital and
the principals of iCapital 2,200,000 shares of our common stock as compensation
for the consulting services. During our previous fiscal year, we recorded
$198,000, the value of the common stock on the day it was issued, as a prepaid
expense and additional paid-in capital of which, during the nine months ended
February 28, 2003, we amortized to expense $99,000 as non-cash compensation.
F-52
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. NOTE RECEIVABLE
In June 2000, we entered into a three-year, $80,000 Secured Promissory Note
Receivable with an individual who was, at the time of the issuance of the note,
an executive officer of Patriot. On September 25, 2000, he requested and was
relieved of his duties as an executive officer and director of Patriot. 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 our common stock that he held on the date of issuance
as security for this note.
9. LEGAL PROCEEDINGS
In January 1999, we were 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 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.
10. SUBSEQUENT EVENT
In March 2003, we entered into an Antidilution Agreement and Addendum to
Warrants with Swartz whereby we agreed to increase the number of common shares
issuable to Swartz on the exercise of warrants from 20% to 30% of any equity
shares issued to parties other than Swartz or its affiliates subsequent to March
24, 2003. The number of shares issuable by the exercise of the warrant continues
to be calculated on the first day of each calendar quarter. In addition, we
agreed to extend the expiration date to December 31, 2006 on certain warrants
that were to expire previous to December 31, 2006. In exchange for these
concessions, Swartz agreed to extend the due date from April 9, 2003 to March 1,
2004 on a note for $635,276 net of accrued interest and unreserved, for a period
the lesser of 1) one year, or 2) 90 days after the date on which our common
stock exceeds $0.375 for 10 consecutive trading days, 20,007,350 shares that
have been reserved for the exercise of warrants.
F-53
- ------------------------------------------------------------ ---------------------------------------------------------
=========================================================== ========================================================
Until the completion of the resale of the common stock
included in this prospectus, all dealers that effect
transactions in these securities, whether or not
participating in this offering, may be required to
deliver a prospectus. This is in addition to the dealers'
obligation to deliver a prospectus when acting as
underwriters and with respect to their unsold allotments The Resale of
or subscriptions. 21,093,816 Shares
of
Table of Contents Common Stock
Offered by
Prospectus Summary.................... 5 Selling Shareholders
Risk Factors.......................... 8
Plan of Distribution ................. 15
Selling Shareholders................. 16
The Company........................... 17
Use of Proceeds....................... 31
Litigation............................ 31
Selected Financial Data............... 31 PATRIOT SCIENTIFIC
Management's Discussion and CORPORATION
Analysis of Financial Condition....... 32
Changes in Accountants................ 46
Quantitative and Qualitative
Disclosure About Market Risk.......... 47
Management............................ 47
Principal Shareholders................ 54 PROSPECTUS
Certain Transactions.................. 55
Trading Market and Related Matters 57
Description of Securities ........... 58
Legal Matters........................ 59
Experts .............................. 59
Index to Financial Statements......... F-1 Subject to Completion, June 11, 2003
============================================================ ========================================================
- ------------------------------------------------------------ --------------------------------------------------------
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
Expenses payable in connection with the registration and distribution
of the securities being registered hereunder, all of which will be borne by the
Registrant, are as follows:
Registration Fee - Securities and Exchange Commission.......... $ 102
Printing and Engraving.......................................... 1,000*
Legal Fees and Expenses......................................... 15,000*
Accounting Fees................................................. 15,000*
Blue Sky Fees and Expenses...................................... 1,000*
------
Total.................................................. $32,102*
* Estimated
ITEM 14. INDEMNIFICATION OF OFFICERS AND DIRECTORS.
Pursuant to the Company's Certificate of Incorporation, and as
permitted by Section 145 of the General Corporation Law of Delaware, the Company
may indemnify its directors and officers under certain circumstances against
reasonable expenses (including court costs and attorney's fees), judgments,
penalties, fines, and amounts paid in settlement actually and reasonably
incurred in connection with any action, suit or proceeding, whether civil,
criminal, administrative or investigative, to which any of them is a party by
reason of his being a director, officer, employee, or agent of the Company if it
is determined that he acted in accordance with the applicable standard of
conduct set forth in such statutory provisions. Thus, the indemnification
provisions will protect officers and directors from liability only if the
officer or director meets the applicable standard of conduct and the Company has
the financial ability to honor the indemnity.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
We offered and sold the following common stock, either for cash or in
consideration of services rendered as indicated below, without registration
under the Securities Act of 1933, as amended, and exemption for such sales from
registration under the Act is claimed in reliance upon the exemption provided by
Section 4(2) thereof on the basis that such offers and sales were transactions
not involving any public offering. Appropriate precautions against transfer have
been taken, including the placing of a restrictive legend on all certificates
evidencing such securities. All such sales were effected without the aid of
underwriters, and no sales commissions were paid.
i
Number of Aggregate Purchase Price Per
Name Date of Sale Shares Purchase Price Share
---- ------------ ------ -------------- -----
Robert Crawford January 22, 2002 400,000 $34,000 $0.08 Cash
William Crawford January 22, 2002 400,000 $34,000 $0.08 Cash
iCapital January 25, 2002 1,000,000 $90,000 $0.09 Services
Robert Crawford September 24, 2002 1,000,000 $25,000 $0.03 Cash
REC Music Foundation September 24, 2002 600,000 $15,000 $0.03 Cash
Donald Logo October 28, 2002 166,000 $5,000 $0.03 Cash
Red Oak Inc. October 28, 2002 166,000 $5,000 $0.03 Cash
Donald Logo December 6, 2002 111,111 $5,000 $0.04 Cash
Red Oak Inc. December 6, 2002 111,111 $5,000 $0.04 Cash
Don Riley December 9, 2002 118,889 $5,350 $0.04 Cash
Greg Erickson December 16, 2002 100,000 $5,000 $0.05 Cash
Dean Gullick December 19, 2002 102,459 $5,000 $0.05 Cash
Robert Vincent December 19, 2002 61,475 $3,000 $0.05 Cash
John Laws January 21, 2003 98,039 $5,000 $0.05 Cash
REC Music Foundation February 3, 2003 400,000 $12,000 $0.03 Cash
John Castellano February 3, 2003 138,889 $5,000 $0.04 Cash
Lyle Armstrong February 7, 2003 125,000 $4,500 $0.04 Cash
Lyle Armstrong February 13, 2003 88,889 $3,000 $0.03 Cash
Red Oak Inc. February 13, 2003 59,259 $2,000 $0.03 Cash
Orrin Noling February 24, 2003 162,338 $5,000 $0.03 Cash
Michael Korbiak March 3, 2003 155,807 $5,500 $0.04 Cash
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
The Exhibits and Financial Statement Schedules to this Registration
Statement are listed in the Exhibit Index commencing at page EX-1 hereof.
ITEM 17. UNDERTAKINGS.
The undersigned Registrant hereby undertakes the following:
(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this Registration Statement:
(i) to include any prospectus required by Section 10(a)(3) of
the Securities Act of 1933;
(ii) to reflect in the prospectus any facts or events arising
after the effective date of this Registration Statement (or the most recent
post-effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information in this Registration
Statement; and
(iii) to include any material information with respect to the
plan of distribution not previously disclosed in this registration, or any
material change to such information in the Registration Statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed to be
a new registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
ii
(3) To remove from registration by means of a post-effective
amendment to this Registration Statement any of the securities being registered
which remain unsold at the termination of this offering.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers or persons controlling the
Registrant pursuant to the General Corporation Law of Delaware, the Certificate
of Incorporation, or otherwise, the Registrant has been advised that, in the
opinion of the Securities and Exchange Commission, such indemnification is
against public policy as expressed in such Act, and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer or person controlling the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or person controlling the Registrant in connection with any
securities being registered, the Registrant will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a court
of appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in such Act and will be governed by the final
adjudication of such issue.
iii
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the
registrant has duly caused this registration statement to be signed on its
behalf by the undersigned, thereunto duly authorized in the City of San Diego,
State of California, on June 11, 2003
PATRIOT SCIENTIFIC CORPORATION
By: /s/ LOWELL W. GIFFHORN
----------------------
Lowell W. Giffhorn
Executive Vice President, Chief Financial Officer,
Secretary and Director
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
Signature Title Date
/s/JEFFREY E. WALLIN President and Chief Executive June 11, 2003
-------------------- Officer
Jeffrey E. Wallin
/s/LOWELL W. GIFFHORN Chief Financial Officer, Principal June 11, 2003
--------------------- Financial Officer, Principal
Lowell W. Giffhorn Accounting Officer, Secretary
and Director
/s/DAVID POHL Director June 11, 2003
-------------
David Pohl
/s/CARLTON JOHNSON Director June 11, 2003
-------------------
Carlton Johnson
/s/DONALD BERNIER Chairman of the Board and June 11, 2003
----------------- Director
Donald Bernier
/s/HELMUT FALK JR. Director June 11, 2003
------------------
Helmut Falk Jr.
/s/GLORIA H. FELCYN Director June 11, 2003
-------------------
Gloria H. Felcyn
iv
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM S-1
Registration Statement
Under The Securities Act of 1933
EXHIBITS
PATRIOT SCIENTIFIC CORPORATION
(Exact name of registrant as specified in its charter)
Ex-1
PATRIOT SCIENTIFIC CORPORATION
(a) Exhibits
The following exhibits are included as part of this registration
statement, except those exhibits marked (1), which have previously been filed
with the Securities and Exchange Commission and are incorporated by reference to
another registration statement, report or document. References to the "Company"
in this Exhibit Index mean PATRIOT SCIENTIFIC CORPORATION, a Delaware
corporation.
Exhibit No. Document No.
- ----------- -------- ---
2.0 PLAN OF ACQUISITION, REORGANIZATION, ARRANGEMENT, LIQUIDATION OR SUCCESSION.
2.1 Agreement to Exchange Technology for Stock in Patriot Scientific Corporation, (1)
incorporated by reference to Exhibit 2.1 to Form 8-K dated August 10, 1989
2.2 Assets Purchase Agreement and Plan of Reorganization dated June 22, 1994, (1)
among the Company, nanoTronics Corporation and Helmut Falk,
incorporated by reference to Exhibit 10.4 to Form 8-K dated
July 6, 1994
2.2.1 Amendment to Development Agreement dated April 23, 1996 between the Company and (1)
Sierra 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 (1)
shareholders of Metacomp, Inc. incorporated by reference to Exhibit 2.3 to Form
8-K dated January 9, 1997
2.4 Letter of Transmittal to Accompany Shares of Common Stock of Metacomp, Inc. (1)
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
3.0 ARTICLES AND BYLAWS.
3.1 Original Articles of Incorporation of the Company's predecessor, Patriot (1)
Financial Corporation, incorporated by reference to Exhibit
3.1 to registration statement on Form S-18, file no.
33-23143-FW
3.2 Articles of Amendment of Patriot Financial Corporation, as filed with the (1)
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
3.3 Certificate of Incorporation of the Company, as filed with the Delaware (1)
Secretary of State on March 24, 1992, incorporated by
reference to Exhibit 3.3 to Form 8-K dated May 12, 1992
3.3.1 Certificate of Amendment to the Certificate of Incorporation of the Company, as (1)
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
Ex-2
Exhibit No. Document No.
- ----------- -------- ---
3.3.2 Certificate of Amendment to the Certificate of Incorporation of the Company, as (1)
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
3.3.3 Certificate of Amendment to the Certificate of Incorporation of the Company, as (1)
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
3.3.4 Certificate of Amendment to the Certificate of Incorporation of the Company, as (1)
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
3.4 Articles and Certificate of Merger of Patriot Financial Corporation into the (1)
Company 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, (1)
1992, 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, (1)
1992, 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 (1)
dated May 12, 1992
4.0 INSTRUMENTS ESTABLISHING RIGHTS OF SECURITY HOLDERS.
4.1 Specimen common stock certificate, incorporated by reference to Exhibit 4.1 (1)
Form 8-K 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 (1)
aggregating $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
Ex-3
Exhibit No. Document No.
- ----------- -------- ---
4.5 Form of Stock Purchase Warrant (CC Investments, LDC) dated June 2, 1997 (1)
exercisable to 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 (1)
CC 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.) (1)
dated June 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 Investments, LLC related to the registration of the common stock related (1)
to Exhibit 4.7 incorporated by reference to Exhibit 4.8 to Form 8-K dated June
16, 1997
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.) (1)
dated 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.) (1)
dated 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. (1)
dated 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
Ex-4
Exhibit No. Document No.
- ----------- -------- ---
4.14 Investment agreement dated February 24, 1999 by and between the Company and (1)
Swartz 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 (1)
Company and 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 (1)
February 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 (1)
the 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 (1)
dated April 28, 2000 by and between the Company and Swartz Private Equity, LLC
for a maximum aggregate amount of $30,000,000 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 (1)
reference to Exhibit 4.19 to Registration Statement on Form S-8 dated March 26,
2001
4.20 Investment agreement dated September 17, 2001 by and between the Company and (1)
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
Ex-5
Exhibit No. Document No.
- ----------- -------- ---
4.21 Registration Rights Agreement dated September 17, 2001 by and between the (1)
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
4.22 Warrant to Purchase Common Stock dated September 17, 2001 exercisable to (1)
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
4.23 Financial Consulting Services Agreement between the Company and M. Blaine (1)
Riley, Randall Letcavage and Rosemary Nguyen incorporated by reference to
Exhibit 4.23 to Registration Statement on Form S-8 dated January 22, 2002
4.24 Form of 8% Convertible Debenture (Lincoln Ventures, LLC) due June 10, 2004 (1)
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
4.25 Form of Stock Purchase Warrant (Lincoln Ventures, LLC) dated June 10, 2002 (1)
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
4.26 Form of Registration Rights Agreement (Lincoln Ventures, LLC) (1)
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
5.0 OPINION RE LEGALITY.
5.1 Legal opinion of Luce, Forward, Hamilton & Scripps LLP, attorney (2)
10.0 MATERIAL CONTRACTS.
10.1 1992 Incentive Stock Option Plan of the Company, incorporated by reference to (1)
Exhibit 10.1 to Form 8-K dated May 12, 1992
10.1.1 Amendment to 1992 Incentive Stock Option Plan dated January 11, 1995, (1)
incorporated by 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 (1)
to Exhibit 10.2 to Form 8-K dated May 12, 1992
Ex-6
Exhibit No. Document No.
- ----------- -------- ---
10.2.1 Amendment to 1992 Non-Statutory Stock Option Plan dated January 11, 1995 (1)
incorporated 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 (1)
Clar-O-Wood 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 (1)
and SEA, 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 (1)
the 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 (1)
to 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 (1)
and 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, (1)
1996, 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 (1)
Company 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. (1)
Norris, 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 (1)
and 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 (1)
Putnam, 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
Ex-7
Exhibit No. Document No.
- ----------- -------- ---
10.11.1 Two Year Stock Purchase Warrant dated March 19, 1996 Granted to Evolve (1)
Software, Inc. Providing for the Purchase of up to 50,000 Common Shares at
$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 (1)
Company 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 (1)
Compunetics 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. (1)
Dawson 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. (1)
Maitra 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 (1)
Company 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. (1)
Lunney 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 (1)
Morettini 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. (1)
Giffhorn incorporated by reference to Exhibit 10.21 to Form
10-KSB for the fiscal year ended May 31, 1998
Ex-8
Exhibit No. Document No.
- ----------- -------- ---
10.22 Secured Promissory Note dated June 12, 2000 between the Company and James T. (1)
Lunney incorporated by reference to Exhibit 10.22 to Form
10-KSB for the fiscal year ended May 31, 2000
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. (1)
Korodi 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. (1)
Blum 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. (1)
Miller 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 (1)
Finance 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. (1)
Pohl 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 (1)
Company and Jayanta Maitra 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 (1)
and SDMC, Inc. incorporated by reference to Exhibit 10.32 to Registration
Statement on Form S-3 dated June 27, 2002
Ex-9
Exhibit No. Document No.
- ----------- -------- ---
23.0 CONSENTS OF EXPERTS AND COUNSEL
23.1 Consent of Luce, Forward, Hamilton & Scripps LLP, attorneys at law ( included (2)
in Exhibit 5.1)
23.2 Consent of BDO Seidman, LLP independent certified public accountants (2)
23.3 Consent of Nation Smith Hermes Diamond, LLP independent certified public (2)
accountants
99.0 ADDITIONAL EXHIBITS.
99.1 Form of ISO Plan Option (Gaspar) dated May 29, 1992, incorporated by reference (1)
to 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 (1)
to Exhibit 28.3 to registration statement on Form SB-2, file no. 33-57858
99.3 Form of Incentive Stock Option Agreement to the Company's 1996 Stock Option (1)
Plan (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 (1)
Plan (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 (1)
Plan 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 (1)
Plan incorporated by reference to Exhibit 99.6 to Registration Statement on
Form S-8 filed March 26, 2001
99.8 Certification of Chief Executive Officer pursuant to Section 906 of the (2)
Sarbanes-Oxley Act of 2002
99.9 Certification of Chief Financial Officer pursuant to Section 906 of the (2)
Sarbanes- Oxley Act of 2002
Ex-10
(1) Previously filed in indicated registration statement or report.
(2) Exhibit filed herewith this Registration Statement on Form S-1.
(b) Financial Statement Schedule
The following financial statement schedule filed herein as a part of this report
at F-37
Schedule II- Valuation and Qualifying Accounts
(c) Reports on Form 8-K - None.
All other schedules have been omitted because the information required to be set
forth therein is not applicable or is shown in the Consolidated Financial
Statements or the Notes thereto.
Ex-11