AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 31, 2005
REGISTRATION NO. 333-__________
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM SB-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
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PATRIOT SCIENTIFIC CORPORATION
(Name of small business issuer in its charter)
DELAWARE 3699 84-1070278
(State or Jurisdiction of Primary SIC Code (I.R.S. Employer
Incorporation or Organization) Identification Number)
10989 VIA FRONTERA
SAN DIEGO, CALIFORNIA 92127
(858) 674-5000
(Address and telephone number of 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)
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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 PROPOSED SALE TO
THE PUBLIC: AS SOON AS PRACTICABLE AFTER THE
EFFECTIVE DATE OF THIS REGISTRATION STATEMENT.
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If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) 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(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.
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CALCULATION OF REGISTRATION FEE
- --------------------------------------------------------------------------------------------------------
Proposed Maximum
Title of Each Class of Proposed Maximum Aggregate Amount of
Securities Amount to be Offereing Price Per Offering Registration
to be Registered Registered Unit (6) Price Fee
- --------------------------------------------------------------------------------------------------------
Common Stock, $0.00001 par
value (1) 23,859,897 0.091 2,171,251 255.56
- --------------------------------------------------------------------------------------------------------
Common Stock, $0.00001 par
value (2) 14,681,137 0.091 1,335,983 157.25
- --------------------------------------------------------------------------------------------------------
Common Stock, $0.00001 par
value (3) 3,087,130 0.091 280,929 33.07
- --------------------------------------------------------------------------------------------------------
Common Stock, $0.00001 par
value (4) 5,408,391 0.091 492,164 57.93
- --------------------------------------------------------------------------------------------------------
Common Stock, $0.00001 par
value (5) 796,000 0.091 72,436 8.53
- --------------------------------------------------------------------------------------------------------
TOTAL 47,832,555 0.091 4,352,763 512.32
- --------------------------------------------------------------------------------------------------------
(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 September 28, 2004 through January 17, 2005 (the "Series G
Debentures"). The terms of the SeriesG 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 exercise of warrants issued in conjunction with Series G
Debentures issued between September 28, 2004 and January 17, 2005.
(3) 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 December 1, 2003 through May 11, 2004 (the "Series E
Debentures"). The terms of the Series E Debentures do not fix the number
of common shares that may be issuable upon conversion, however, the
Company registered the resale of 50,479,573 shares of common stock
issuable upon exercise of the Series E Debentures on Form SB-2, file
number 333-115752, which became effective on June 7, 2004. 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.
(4) 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 exercise of warrants which were issued from June 14, 1999
through September 22, 2003, which shares had been previously registered on
Forms S-1 and SB-2, and whose registration statements have since become
stale.
(5) Shares of the Registrant's common stock, $.00001 par value per share, are
being registered for resale on behalf of a security holder. The common
stock being registered was issued to the selling security holder as
payment for services.
(6) 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 January 28, 2005.
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 JANUARY 31, 2005
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 47,832,555 shares of common stock in the
over-the-counter market at the prevailing market price or in negotiated
transactions.
o up to 26,947,027 shares are issuable to the selling shareholders as
conversion shares upon the conversion of our 8% Convertible
Debentures.
o up to 14,681,137 shares are issuable to the selling shareholders as
warrant shares upon the exercise of warrants issued in conjunction
with our 8% Convertible Debentures.
o up to 5,408,391 shares are issuable to the selling shareholders as
warrant shares upon the exercise of warrants previously registered
whose registration statements have gone stale.
o up to 796,000 shares were issued to a selling shareholder as payment
for services it provided.
We will receive no proceeds from the sale of the shares by the selling
shareholders. We may receive proceeds of up to $428,114 from the exercise of
warrants.
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 9
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, NOR IS THE SOLICITATION OF
AN OFFER TO BUY THESE SECURITIES, IN ANY STATE WHERE THE OFFER OR SALE OF THESE
SECURITIES 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 that which 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
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PROSPECTUS SUMMARY 5
About our company 5
About our convertible debentures 5
About our warrant shares we are registering 7
Additional shares we are registering 7
Key facts 7
RISK FACTORS 9
Related to our business
Our major product line has had limited revenues 9
We have incurred significant losses and may continue to do so 9
Our limited sales and marketing experience has effected our revenue 9
Our products may not be completed on time 10
Related to our industry
The market in which we operate is highly competitive 10
Protection of our intellectual property is limited; there is a risk of
claims for infringement 11
We may be impacted as a result of terrorism 12
Related to our offering and share price
We will require additional financing 12
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 14
On a significant drop in the price of our stock, we could be
subject to a change in control 14
We will need to increase our authorized number of common shares 14
Forward-looking statements 16
PLAN OF DISTRIBUTION 16
SELLING SHAREHOLDERS 17
THE COMPANY 18
General 18
2
Page
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Background 19
Business 20
Available information 20
Organization and corporate development 20
Internet growth and the emergence of the java programming language 21
Microprocessor technology 22
General background 22
Industry background 22
Technology description 24
The Ignite microprocessor as a java processor 24
Stage of development 25
Business strategy 26
Competition 27
High speed data communications products 28
Research and development 28
Licenses, patents, trade secrets and other proprietary rights 28
Marketing and distribution 30
Dependence upon single customers 30
Facilities 31
Employees 31
Government regulation 31
USE OF PROCEEDS 31
LITIGATION 31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 32
Critical Accounting Policies 33
Results of operations for the three and six months ended
November 30, 2004 and 2003 36
Results of operations for the years ended May 31, 2004 and 2003 42
Capital resources and liquidity 44
New accounting pronouncements 47
Income taxes 47
CHANGES IN ACCOUNTANTS 47
MANAGEMENT 48
Identification of directors and executive officers 48
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 53
3
Page
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CERTAIN TRANSACTIONS 55
TRADING MARKET AND RELATED MATTERS 56
DESCRIPTION OF SECURITIES 57
LEGAL MATTERS 58
EXPERTS 58
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 complementary 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 18% of our revenue in fiscal 2004. The
balance of our fiscal 2004 revenue was generated from a communications product
line that, subsequent to a completed last buy program, is now 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. In October 2003, we received a final royalty
payment of $75,500 from the sale of the gas plasma technology. Our strategy is
to exploit our microprocessor technologies through product sales, licensing, and
strategic alliances and to litigate against those who may be infringing on our
patents.
Our auditors have stated in their report on our consolidated financial
statements as of and for the year ended May 31, 2004, 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 $52,023,610 as of November 30, 2004 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 September 28, 2004 through January 17, 2005, we sold to and
received cash from certain of the selling shareholders an aggregate of $490,000
of 8% convertible debentures with two year maturity dates. In addition, the
debenture holders received warrants exercisable into up to 21,690,815 shares of
our common stock.
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 prior 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 of 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 warrants to purchase up to 21,690,815 shares of our common stock to the
debenture holders. These warrants are exercisable for from five to seven 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 prior to the debenture date. The warrant exercise
prices are subject to being reset on each six month anniversary of their
issuance for 7,009,678 shares of common stock and are fixed at prices ranging
from $0.0167 to $0.04 per share for the remaining 14,681,137 shares of common
stock. The warrant holders for warrants to purchase up to 7,009,678 shares of
common stock have entered into lock-up agreements whereby they have agreed not
to exercise their warrants until our shareholders approve an increase in the
authorized number of common shares.
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 prior 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 would be required to
obtain shareholder approval to issue more than 20% of our outstanding shares at
less than fair market value. 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 debenture holders' 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. Also, so long as the debentures or
warrants are outstanding, we may not, for less than $250 million, sell, convey,
dispose of, spin off or assign any or all of our intellectual property without
the prior written consent of the debenture or warrant holder.
RIGHT OF FIRST REFUSAL. The debenture holders 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.
DEBENTURE HOLDERS' RIGHT OF INDEMNIFICATION. We are obligated to indemnify
the debenture holders (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 of which this prospectus is a part.
6
WARRANT SHARES WE ARE REGISTERING
In addition to the 14,681,137 shares issuable on the exercise of warrants
issued with fixed conversion prices between September 28, 2004 and January 17,
2005, we are registering an additional 5,408,391 shares issuable on the exercise
of warrants issued prior to September 28, 2004. These warrant shares were
initially registered on Form SB-2 registration statements which went effective
on October 5, 1999 and November 18, 2003 and Form S-1 registration statements
which went effective on November 5, 2001 and March 7, 2003. The financial
statements filed as a part of these registration statements have since become
stale which has necessitated this re-registration.
ADDITIONAL SHARES WE ARE REGISTERING
From December 1, 2003 through May 11, 2004 we sold to and received cash
from selling shareholders an aggregate of $1,527,500 of 8% convertible
debentures with two year maturity dates. In June 2004, a registration statement
on Form SB-2 went effective for the resale of up to 50,479,573 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 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 caused 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
3,087,130 shares of common stock to cover the shortfall.
We are also registering 796,000 shares that were issued as restricted
shares to a vendor in exchange for services it provided.
KEY FACTS
Shares being offered for resale to the public 47,832,555 (20.5% of our shares currently
outstanding)
Total shares outstanding prior to the offering 232,890,435 as of January 31, 2005
Total shares outstanding assuming completion 279,926,990
of the offering
Total shares that would be outstanding assuming
full conversion of the current offering and exercise
of all outstanding debentures, options and warrants 399,984,740
Price per share to the public Market price at time of resale
Total proceeds raised by offering None. However we may receive proceeds of up to
$428,114 on the exercise of warrants
Convertible debentures A form of our convertible debenture is
included as an exhibit to this
registration statement
Dividend policy We have never paid a dividend and do not
anticipate paying a 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 resulted in 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 November 30, 2004, our accumulated deficit
was $52,023,610. For the six months ended November 30, 2004 and the fiscal years
ended May 31, 2004 and 2003, we incurred net losses of $2,179,592, $4,149,978
and $3,888,299, respectively. Because of this record of losses, 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, and
o the interest charges and expenses related to previous equity and
debt financings.
Should our losses continue and should we be unable to fund our operations
from external sources, we would need to cease doing business and/or liquidate or
sell our assets.
8
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 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 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 staff and marketing and distribution
programs and facilities, and many of them have substantially greater experience
in the production and marketing of products. Staff cut backs by us, which have
been occasioned by financial constraints, have increased the differences in
capacity between us and certain of our competitors. 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
succeeded in developing technologies and products that are more effective than
any of those we currently offer or are developing.
9
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. Also, we have initiated legal actions
against companies we believe are infringing on our patents. They in turn have
counter sued and are asking for declaratory relief that their products do not
infringe on our patents. See Legal Proceedings.
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 one of two persons who are shown as
co-inventors or certain patents, Russell Fish. Charles Moore, the other
identified co-inventor, has since assigned his interest in the ShBoom technology
to Daniel Leckrone and Technology Properties Limited. We have filed a legal
action against Charles Moore, Daniel Leckrone and Technolgy Properties Limited
to correct and clarify the inventorship, and therefore ownership, of divisions
of the orginal ShBoom technology. We are contending that Russell Fish was the
sole inventor of the technology covered by three subsequently issued patents,
that Charles Moore was the sole inventor of the technology covered by three
subsequently issued patents and that the two jointly are the inventors of the
technology covered by one subsequently issued patent. In order to prosecute
patent infringement cases, all owners need to participate in and agree to
proceed with the actions. Therefore, if our action against Charles Moore, Daniel
Leckrone and Technology Properties Limited is not successful, our ability to
prosecute patent infringement cases with regard to one of the patents we contend
was invented by Russell Fish, and the resultant monetary damages which may be
awarded as a result of those infringements, may be diluted, if we are able to
proceed with our patent infringement cases at all. Technology Properties Limited
has exploited and may continue to exploit the technology, independently of our
rights to do so, by selling at least one license to a potential infringer. We
are contending that Technology Properties Limited does not own at least three of
the patents they are licensing. There can be no assurance that we will prevail
in the patent litigation efforts against Charles Moore, Daniel Leckrone and
Technology Properties Limited and, if we are not successful, the value of our
patent portfolio would be diminished. See Legal Proceedings.
10
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 at certain times 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
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, 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 $1.8 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 concurrently with the
debentures represent 21% 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 holders 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 holders 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:
11
- ------------------------------------------------------------------------------------------------------------
Market If December 31, 2004 Market Price Decreases
Price as of
December 31, 2004 25% 50% 75%
- ------------------------------------------------------------------------------------------------------------
Market price (conversion price) $ 0.080 $ 0.060 $ 0.040 $ 0.020
- ------------------------------------------------------------------------------------------------------------
Common stock currently outstanding 232,890,435 232,890,435 232,890,435 232,890,435
- ------------------------------------------------------------------------------------------------------------
Number of shares issuable on conversion 43,191,503 43,191,502 43,223,475 68,464,488
- ------------------------------------------------------------------------------------------------------------
Number of warrants issuable on exercise 120,065,478 120,065,478 120,065,478 120,065,478
- ------------------------------------------------------------------------------------------------------------
Potential common stock outstanding 396,147,416 396,147,415 396,179,388 421,420,401
- ------------------------------------------------------------------------------------------------------------
Dilutive effect to current shareholders 70% 70% 70% 81%
- ------------------------------------------------------------------------------------------------------------
In addition, at the option of the debenture holders, 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 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 November 30,
2004, $77,557 interest was payable to the debenture holders which could be
converted into 2,047,381 shares of common stock at an average conversion price
of $0.038.
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.
12
OUR SHARE PRICE COULD BE LOWERED AS A RESULT OF SHORT SALES
The downward pressure on the price of our 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 that
the price of the stock will go down, will buy the stock at a later date. If the
price of the stock goes down, the seller will profit to the extent of the
difference between what he originally 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 our 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 400,000,000 shares of common stock authorized for
issuance. The number of common shares currently outstanding plus the number of
common shares reserved for issuance on the conversion of debenture principal and
accrued interest, and exercise of warrants and options as of January 28, 2005 is
as follows:
Common stock currently outstanding 232,890,435
Reserved for issuance
Stock option plans 8,181,688
Warrants 111,883,790
Convertible debentures 47,028,827
-----------
Common stock fully diluted 399,984,740
-----------
In addition, as of January 17, 2005, we have negotiated with eight
investors a lock up of warrants exercisable for up to 19,009,678 shares of our
common stock. These shares are not included in the common stock fully diluted
amount of 399,984,740 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 second 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.
13
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).
14
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 may be deemed to be underwriting discounts or
commissions.
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 their 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 January 28, 2005. 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.
Beneficial Maximum Number Amount and Percentage of
Ownership of of Shares of Common Stock After the Sale
Common Stock as Common Stock --------------------------------
Name of January 28, 2005 Offered for sale Number %
---- ------------------- ---------------- ------ --------------
Caplan, Stan 6,296,130 (1) 887,097 5,409,033 2.31%
Daniels, Richard 4,895,862 (2) 1,167,568 3,728,294 1.59%
Gabourel, Victor 4,500,915 (3) 1,760,000 2,740,915 1.17%
Haw k Associates Inc. 2,122,496 (4) 796,000 1,326,496 *
Lincoln Ventures LLC 82,730,918 (5) 35,192,108 47,538,810 17.73% (6)
Mt Savage Productions 1,000,000 (7) 873,665 126,335 *
Opperman, Wayne 5,985,000 (8) 4,385,000 1,600,000 *
Nunes, Daniel 1,127,233 (9) 443,549 683,684 *
Yen, Tony 500,000 500,000 - *
Zolin, James & 6,195,408 (10) 1,827,568 4,367,840 1.86%
Josehine
(1) Includes 2,694,444 and 1,908,137 shares of common stock issuable
upon the conversion of previously issued convertible debentures and
the exercise of previously issued warrants, respectively. The resale
of these shares has been previously registered. This number also
includes 806,452 shares of common stock issuable upon the exercise
of a warrant that has been locked up until such time as an increase
in the authorized number of common shares has been approved by our
shareholders.
(2) Includes 2,728,294 shares of common stock issuable upon the exercise
of previously issued warrants. The resale of these shares has been
previously registered. This number also includes 1,000,000 shares of
common stock issuable upon the exercise of a warrant that has been
locked up until such time as an increase in the authorized number of
common shares has been approved by our shareholders.
(3) Includes 1,090,915 shares of common stock issuable upon the exercise
of previously issued warrants. The resale of these shares has been
previously registered. This number also includes 1,600,000 shares of
common stock issuable upon the exercise of a warrant that has been
locked up until such time as an increase in the authorized number of
common shares has been approved by our shareholders.
15
(4) Includes 200,000 shares of common stock issuable upon the exercise
of outstanding stock options. Frank Hawkins has ultimate voting
and/or investment control over the securities owned by Hawk
Associates.
(5) This number includes 992,633 and 19,414,635 shares of common stock
issuable upon the conversion of previously issued convertible
debentures and the exercise of previously issued warrants,
respectively. The resale of these shares has been previously
registered. This number also includes 27,131,542 shares of common
stock issuable on the exercise of outstanding warrants previously
issued to Lincoln which have not been registered but are currently
exercisable.
(6) The shares issuable to Lincoln on the exercise of warrants 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 warrants, the 4.99% limitation may 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.
(7) This number includes 126,335 shares of common stock issuable upon
the exercise of previously issued warrants. The resale of these
shares has been previously registered. Elwood G. Norris has ultimate
voting and/or investment control over the securities owned by Mt.
Savage Productions.
(8) This number includes 1,600,000 shares of common stock issuable upon
the exercise of a warrant that has been locked up until such time as
an increase in the authorized number of common shares has been
approved by our shareholders.
(9) This number includes 280,458 shares of common stock issuable upon
the exercise of previously issued warrants. The resale of these
shares has been previously registered. This number also includes
403,226 shares of common stock issuable upon the exercise of a
warrant that has been locked up until such time as an increase in
the authorized number of common shares has been approved by our
shareholders.
INFORMATION ABOUT US
THE COMPANY
Patriot Scientific Corporation was organized under Delaware law on March
24, 1992, and is the successor by merger to Patriot Financial Corporation, a
Colorado corporation incorporated on June 10, 1987. 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 complementary 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 18% of our revenue in fiscal 2004. The
balance of our fiscal 2004 revenue was generated from a communications product
line that, subsequent to a completed last buy program, is now 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. In October 2003, we received a final royalty
payment of $75,500 from the sale of the gas plasma technology. Our strategy is
to exploit our microprocessor technologies through product sales, licensing,
strategic alliances and to litigate against those who may be infringing on our
patents.
16
In 1997, we emerged from the development stage primarily as a result of
the acquisition of Metacomp Inc. We merged Metacomp's product line, high speed
communications equipment for the internet market, into Patriot. We have
subsequently reduced the communications product line to minor activity since the
products have reached the end of their life cycles and we were unsuccessful in
developing follow on products.
There can be no assurance that we can achieve profitable operations, and
we may need additional financial resources during the next twelve months.
BACKGROUND
In February 1989, we completed our initial public offering under a
registration statement on Form S-18 under the Securities 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. Upon the exercise of those warrants, we received
net proceeds of $3,343,915 and issued 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.
17
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. 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 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 SB-2, 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, and
o high-speed data communications technology.
The stage of development of each 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 0.18-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
accounted for only about 18% of our revenue in fiscal year 2004.
18
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 this product line. We have decided to
concentrate our efforts on the Ignite microprocessor technology.
Although the communications product line accounted for approximately
82% of our fiscal year 2004 revenue, we anticipate that the Ignite
microprocessor will be our main product line in the future.
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 technology. 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 and has had an impact on many industries, including 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.
19
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.
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 commitments to silicon production. In 2003 we further
reduced the size of our silicon production to 0.18-microns.
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.
20
Standard logic products, such as the Intel's X86 and Pentium and
Motorola's 680X0 microprocessor families, are neither application nor customer
specific. They are intended to be utilized by a large group of systems designers
for a broad range of applications. Because they are designed to be used in a
broad array of applications, they may not be cost effective for specific
applications. Application specific integrated circuits are designed to meet the
specific application of one customer. While cost effective for that application,
application specific integrated circuits require large sales volumes of that
application to recover their development costs. Application specific standard
processors are developed for one or more applications but are not generally
proprietary to one customer. Examples of these applications include modems,
cellular telephones, other wireless communications devices, 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.
21
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 (reduced instruction set computor)
processors, which results in less power consumption and more economical prices
compared to other embedded control applications. This creates the opportunity
for the development of new, cost-effective applications.
Technology Description. Conventional high-performance microprocessors are
register-based with large register sets. These registers are directly
addressable storage locations requiring a complex architecture that consumes
costly silicon. This conventional architecture provides processing power for
computer applications but complicates and slows the execution of individual
instructions and increases silicon size, thereby increasing the microprocessor
cost.
Our technology is fundamentally different from most other microprocessors,
in that the data is stored in groups and certain information is known to be at
the top of a stack as opposed to being stored in a register. 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 the
production model of the 0.18-micron microprocessor 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.
22
The Ignite Microprocessor as a Java Processor. We believe the Ignite
microprocessor architecture is capable of being an efficient and cost effective
Java programming language processor, because Java is designed to run on a
stack-oriented architecture and the Ignite architecture executes the virtual
stack machine internal to Java efficiently. Many Java operation codes or
instructions require only a single 8-bit Ignite family instruction to be
executed, providing a performance advantage over other more expensive processors
that require six or more 32-bit instructions to do the same task. This feature
allows the execution of Java programs with increased speed and reduced code size
thereby enabling lower system memory costs. In addition, the incorporation of
many on-chip system functions is expected to allow the Ignite family to perform
most of the other functions required of an Internet computer device or Java
accelerator, thereby eliminating components. Since Internet computers are
designed to be inexpensive appliances for Internet access, cost, speed and
performance are expected to be key requirements for designers. We believe the
Ignite technology can compete favorably on the basis of such requirements,
although there can be no assurance we can successfully exploit Java related
applications or that competitors will not create superior Java processors.
We have ported the Java operating environment to the Ignite family, which
currently uses the C programming language for software support. We are a
licensee of Sun Microsystems Inc. This enables us to develop and distribute
products based on Sun's personalJava, a platform on which to run Java
applications. We have also licensed from Wind River an operating system,
VxWorks, and entered into a relationship with Forth Inc. whereby Forth will
provide software support and operating system development tools for the Forth
Programming language. We believe this solution is competitive in the Java
virtual machine and embedded applications markets. We believe that, if the
implementation is successfully completed, the Ignite 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.
23
At each stage of development, microprocessors require extensive testing to
ascertain performance limitations and the extent and nature of errors (bugs), if
any. When significant limitations or errors are discovered, additional rounds of
design modifications and fabrication are required prior to having functional and
demonstrable microprocessors for prospective customers and licensees. Although
our 0.5 and 0.35-micron microprocessors have been sent to prospective customers
in anticipation of production orders, there can be no assurance that we, during
our continued testing of these products, will not identify errors requiring
additional rounds of design and fabrication prior to commercial production.
Additional delays could have an adverse effect on the marketability of our
technology and financial condition.
In September 2000, we completed the VHDL soft-core version of the Ignite
microprocessor family. The hardware design inside a microprocessor, or silicon
device, can be represented as a software program. This, in essence, replaces the
old style of designing microprocessors using schematics. VHDL is the predominant
software language used to design semiconductors. In addition to the design
aspects, VHDL also contains sophisticated simulation tools that allow the
designer to simulate the functionality of the entire design before committing to
silicon. Also VHDL enables a designer to easily modify and enhance the design. A
design represented in VHDL goes through a synthesis 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 microprocessors.
Business Strategy. The increasing demand for embedded control has helped
to make 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 microprocessor
would best address due to its low cost, low power consumption, small number of
transistors and higher performance.
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
microprocessor has desirable technical and market advantages.
24
We believe that our architecture is suited for controller applications
requiring high performance and low system cost, such as smart cards, 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 two 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.
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 have completed work with a contract
fabrication facility and our design house partner to produce a 0.18-micron
version of the Ignite family. 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 we do.
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.
25
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 we do.
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:
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.
HIGH SPEED DATA COMMUNICATIONS PRODUCTS.
The communication products that reached the end of their life cycles are:
VME Product Line - a line of high-speed communications products developed
under European standards. 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.
RESEARCH AND DEVELOPMENT. Our current development efforts are focused on
improvement of, and additional features for, the Ignite family of
microprocessors. The development of this technology has taken longer than
anticipated and could be subject to additional delays. Therefore, there can be
no assurance of timely or successful marketing of this technology.
We incurred research and development expenditures of $549,756 and $723,287
for our fiscal years ended May 31, 2004 and 2003, respectively. 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, conditioned on the availability of funds, continue to expend substantial
amounts 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.
26
We have seven U.S. patents issued dating back to 1989 on our
microprocessor technology. We have one microprocessor technology patent issued
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 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.
We believe that we may have claims against numerous companies that use
semiconductors with capabilities in excess of 125 MHz in their products. In
December 2003, we initiated legal actions against five companies to enforce our
patents. In February 2004, Intel initiated a legal action against us and we
filed a counterclaim against them related to the initial five lawsuits. There
can be no assurance that we will be successful in enforcing any potential patent
claims against these or other companies. Also in February 2004, we initiated a
legal action against several entities, one of which was a co-inventor for some
of the technology, to clarify the inventorship and ownership of each of our
granted patents. See Legal Proceedings.
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 microprocessor. We currently provide development
boards with the C programming language.
o Sun Microsystems Inc. In June 1997, we entered into an agreement
with Sun Microsystems, Inc., which enabled us to develop and
distribute products based on Sun's Java 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 is better suited to the markets available to the Ignite
microprocessor. We have ported personalJava to the Ignite
microprocessor.
27
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.
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:
2004 2003
----- -----
Domestic sales 92% 91%
Foreign sales
Europe 8% 9%
----- -----
Total sales 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:
2004 2003
------- -------
nTelesis $25,000 $ --
Blue Tech Inc. 18,000 --
Litton Systems 9,000 --
Long Wave, Inc. -- 43,000
General Dynamics -- 23,000
Centratech -- 15,000
Advanced Relay -- 15,000
28
All of the above sales were shipped against multiple purchase orders from
each customer. nTelesis is owned by an executive officer of the company.
We had no backlog as of May 31, 2004 or 2003.
FACILITIES. We have one 10,300 square foot office located at 10989 Via
Frontera, San Diego, California. The facility is leased through July 2006.
During the period July 2002 through August 2004, we sublet approximately 5,000
square feet of our facility to an independent third party. In August 2004, we
negotiated a termination of the sublease. We are currently looking to
re-sublease the 5,000 square feet. The reduced floor space provides adequate and
suitable facilities for all of our corporate functions.
EMPLOYEES. We currently have five personnel. One person is 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 services
of our key technical and senior management personnel. The competition for highly
qualified personnel is intense, and there can be no assurance that we will be
able to retain our key managerial and technical employees or that we will be
able to attract and retain additional highly qualified technical and managerial
personnel in the future. None of our employees 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. We
may receive proceeds on the exercise of the warrants of up to $428,114.
LEGAL PROCEEDINGS
In December 2003 we filed several lawsuits in United States District
Courts against companies we contend are infringing on our patent number
5,809,336 entitled "High Performance Microprocessor Having Variable Speed
Clock." The defendants and suits are as follows:
29
Defendant U.S. District Court Case Number
- --------- ------------------- -----------
Sony Corporation of America Southern District of New York 03CV10142
Fujitsu Northern District of California C035787
Toshiba America, Inc. Southern District of New York 03CV10180
NEC USA, Inc. Eastern District of New York CV036432
Matsushita District of New Jersey 03CV06210
We are requesting the courts to enjoin the defendants from making use of
our patent and are requesting damages for past infringements. In February, with
the consent of the defendants and ourselves, the above five actions were
consolidated into the Fujitsu action in the Northern District of California
under case number C035787.
In February 2004, Intel Corporation filed a lawsuit against us in the
United States District Court- Northern District of California, case number
C040439, in which they are requesting a declaratory judgment that their
microprocessors, used by the defendants in our consolidated suit, do not
infringe our patent. We filed a counterclaim against Intel contending that they
also are infringing on our patent, and Intel asserted an affirmative defense
that our 5,809,336 patent is invalid.
Also in February 2004, we filed a lawsuit in the United States District
Court- Northern District of California, case number C040618, against Charles H.
Moore, Technology Properties Limited, and Daniel E. Leckrone. Charles Moore, a
co-inventor of the basic ShBoom technology, is listed as an inventor on several
of the issued patents which were divided from the basic ShBoom technology. Moore
transferred his interest in the ShBoom technology to Daniel Leckrone and
Technology Properties Limited. We are contending that Russell Fish, the other
co-inventor from whom we obtained ownership interests in the ShBoom technology,
is the sole inventor of certain of the issued patents. We are requesting the
court to declare inventorship and ownership on each of our granted patents
related to the suits discussed above and other unasserted claims of infringement
Patriot believes it has.
The Intel lawsuit has been stayed pending the results of the Moore
lawsuit.
30
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW
Patriot Scientific Corporation ("the Company") develops, markets, and
sells microprocessors, the technology behind the microprocessors, and
complementary 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 18% of our revenue in fiscal 2004. The balance of our fiscal
2004 revenue was generated from a communications product line that, subsequent
to a completed last buy program, is now 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. In fiscal 2004 we received a final royalty payment of $75,500
from the sale of the gas plasma technology. Our strategy is to exploit our
microprocessor technologies through product sales, licensing, strategic
alliances and to litigate against those who may be infringing on our patents.
Management's discussion and analysis of results of operations and
financial condition are based upon the Company's financial statements. These
statements have been prepared in accordance with accounting principles generally
accepted in the United States of America. These principles require management to
make certain estimates, judgments and assumptions that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, we evaluate our
estimates based on historical experience and various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We have identified nine accounting principles that we believe are key to
an understanding of our financial statements. These important accounting
policies require management's most difficult, subjective judgments.
1. Going Concern
These financial statements are presented on the basis that the Company is
a going concern. Going concern contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business over a reasonable
length of time. The Company has incurred significant operating losses and has
had negative cash flows from operating activities for each of the years ended
May 31, 2004 and 2003, had negative working capital and a stockholders' deficit
for the year ended May 31, 2003 and used convertible debentures for raising
substantially all of its working capital. These factors raise substantial doubt
as to the Company's ability to continue as a going concern. For the years ended
May 31, 2004 and 2003 our independent certified public accountants modified
their opinion as to an uncertainty regarding our ability to continue as a going
concern.
Management's plans to eliminate the going concern situation include, but
are not limited to, the following:
1. Obtain additional equity or debt financing from investors including
the exercise of outstanding warrants.
2. Obtain revenue producing contracts by successfully negotiating
licensing, development and product opportunities within the
microprocessor market place.
31
3. Aggressively pursue patent infringement opportunities by litigating
with companies alleged to be infringing on our issued patents.
4. If funds are not satisfactorily available to continue operations at
our current level, put in place cost reduction programs. Such
reduction programs could include a scale back in the support of the
microprocessor technology with total emphasis being placed on patent
infringement activity. If, in the future, there is patent
infringement success, additional funds would be available for the
microprocessor technology.
2. Marketable Securities
As part of the sale of our gas plasma antenna technology we received
restricted securities in a company that is traded on the OTC bulletin board. The
securities can be traded under Rule 144. We reflect the value of those
securities based on the closing price as of the end of our reporting period. Any
unrealized gain or loss between reporting periods is reflected in our
consolidated statement of operations as non-operating income or loss.
3. 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 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.
4. 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.
5. Revenue Recognition
We recognize revenue on the shipment to our customers of communication
products, microprocessor integrated chips and evaluation boards. We also derive
revenue from fees for the transfer of proven and reusable intellectual property
components or the performance of engineering services. We enter into licensing
agreements that will provide licensees the right to incorporate our intellectual
property components in their products with terms and conditions that will vary
by licensee. Generally, 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.
32
6. Research and Development Costs
Research and development costs are expensed as incurred.
7. 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," and SFAS No. 148,
"Accounting for Stock-Based Compensation-Transition and disclosure," require 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. SFAS No. 148
also provides for alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
The Company has elected to continue to account for stock based compensation
under APB No. 25.
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 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.
8. Income Taxes
Deferred income taxes are provided for by recognizing temporary
differences in 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 $441,000 for
the year ended May 31, 2004, from $14,291,000 at May 31, 2003 to $14,732,000 at
May 31, 2004.
33
9. Debt Discount
We issue warrants as part of our convertible debentures and other
financings. We value the warrants using the Black-Scholes pricing model based on
expected fair value at issuance and the estimated fair value is recorded as debt
discount. The debt discount is amortized to non-cash interest over the life of
the debenture assuming the debenture will be held to maturity which is normally
2 years. If the debenture is converted to common stock previous to its maturity
date, any debt discount not previously amortized is expensed to non-cash
interest.
RESULTS OF OPERATIONS
Three months ended November 30, 2004 compared to three months ended November 30,
2003.
Selected Financial Information
Three Months Ended
Increase
11/30/2004 11/30/2003 (Decrease) %
Statements of Operations
Revenue $ 18,748 $ 51,960 $ (33,212) -63.9%
Cost of revenue -- 4,259 (4,259) -100.0%
% of revenue 0% 8% -8% -100.0%
Gross profit 18,748 47,701 (28,953) -60.7%
% of revenue 100% 92% 8% 8.9%
Operating expenses
Research and development 54,037 112,391 (58,354) -51.9%
General and administrative 392,552 321,132 71,420 22.2%
Total operating expenses 446,589 433,523 13,066 3.0%
Gain (loss) on marketable securities 2,444 (23,234) 25,678 NM
Interest expense (648,223) (539,234) 108,989 20.2%
Gain on sale of technology -- 75,500 75,500 NM
Other income 479 -- 479 NM
Net loss (1,073,141) (872,790) 200,351 23.0%
Net loss per share basic and diluted $ (0.01) $ (0.01) $ -- 0.0%
Revenues
Our revenue decrease of $33,212, or 63.9%, was due to a continuing lack of
significant revenue producing contracts. Our microprocessor product line has
failed to generate any significant contracts. We continue to receive minor
follow-on orders for the communication products that have reached the end of
their life cycle. We no longer market these products but do fill follow-on
orders when economically feasible. We anticipate that future revenue will be
derived from successful microprocessor technology efforts in the form of
licensing and royalties and the successful collection of patent infringement
proceeds from litigation and settlement.
Cost of Revenue
Our cost of revenue decrease of $4,259, or 100%, was commensurate with the
reduction in revenue. We fully reserved our inventory in fiscal 2002 and,
therefore, minor amounts of existing inventory can be resold at a zero cost
basis. However, in order to fulfill the minor follow-on orders for communication
products, we normally must procure a portion of additional components and
assemblies. We anticipate that future cost of revenue will be commensurate with
the success of receiving microprocessor licenses and royalties and patent
infringement proceeds.
34
Research and Development
Three Months Ended
Increase
11/30/2004 11/30/2003 (Decrease) %
Research and Development
Personnel (including consultants) $ 50,620 $ 99,477 $ (48,857) -49.1%
Facilities 3,407 12,914 (9,507) -73.6%
Other research and development expenses 10 -- 10 NM
--------- --------- ---------
$ 54,037 $ 112,391 $ (58,354) -51.9%
The $58,354, or 51.9%, reduction in research and development was
attributed to a reduction in personnel. In addition, there has been no
significant increase in depreciable equipment related to research and
development for the past three years resulting in a lower depreciation amount
charged to facilities expense. When and if funds become available, we anticipate
an increase in research and development to upgrade the tools which are used by
our potential customers to implement the microprocessor technology and to expand
our offerings on which our microprocessor can run to include additional
operating systems.
General and Administrative
Three Months Ended
Increase
11/30/2004 11/30/2003 (Decrease) %
General and Administrative
Personnel (including consultants) $134,733 $121,094 $ 13,639 11.3%
Professional fees 122,793 44,917 77,876 173.4%
Facilities 65,662 61,759 3,903 6.3%
Other general and administrative expenses 69,364 93,362 (23,998) -25.7%
-------- -------- --------
$392,552 $321,132 $ 71,420 22.2%
The $71,420, or 22.2%, increase in general and administrative expenses was
attributed to an increase in personnel costs as a result of expensing stock
options to consultants. Professional fees increased $77,876 primarily as a
result of patent infringement costs increasing ($84,000) offset by a decrease in
costs associated with registration statements and auditing of our financial
statements ($6,000). Other general and administrative expenses decreased as a
result of licenses and dues increasing ($17,000) offset by a reduction in
shareholder related expenses ($46,000) as a result of not holding an annual
meeting during FY2005. We anticipate general and administrative expenses to
remain stable at the current levels until such time as contract revenue and
patent litigation proceeds are recognized at which time additional personnel and
other fees would be expected to increase.
35
Other Income (expense)
Three Months Ended
11/30/2004 11/30/2003 Change %
Other income (expense)
Gain (loss) on marketable securities $ 2,444 $ (23,234) 25,678 -110.5%
Other income 479 -- 479 NM
Gain on sale of technology -- 75,500 (75,500) NM
Interest expense, paid in cash or accrued (41,070) (38,718) (2,352) 6.1%
Non-cash interest expense (607,153) (500,516) (106,637) 21.3%
---------- ---------- ----------
$(645,300) $(486,968) $(158,332) 32.5%
The increase in other expenses, net of other income, of $158,332, or
32.5%, was primarily attributable to the final payment related to the sale of
our gas plasma antenna technology received during fiscal year 2004 ($75,000) and
by the non-cash interest expense recognized on the amortization and cancellation
of debt discounts related to our convertible debentures and the recognition of
expense on the issuance of warrants related to our financings ($107,000)
partially offset by the reduction of a loss on marketable securities which were
received as partial consideration for the sale of our gas plasma antenna
technology ($26,000). We anticipate that the non-cash interest expense will
remain stable over the balance of fiscal 2005 due to a large debt discount
remaining on our books as of November 30, 2004 ($1,375,000) which will be
recognized as expense via amortization over 24 months if the underlying
debentures are not converted. If the debentures are converted before maturity,
any remaining debt discount will be written off in its entirety at the time of
conversion.
36
Six months ended November 30, 2004 compared to six months ended November 30,
2003.
Selected Financial Information
Six Months Ended
Increase
11/30/2004 11/30/2003 (Decrease) %
Statements of Operations
Revenue $ 21,298 $ 63,200 $ (41,902) -66.3%
Cost of revenue -- 10,472 (10,472) -100.0%
% of revenue 0% 17% -17% -100.0%
Gross profit 21,298 52,728 (31,430) -59.6%
% of revenue 100% 83% 17% 19.9%
Operating expenses
Research and development 182,341 261,513 (79,172) -30.3%
General and administrative 772,954 672,602 100,352 14.9%
Total operating expenses 955,295 934,115 21,180 2.3%
Gain (loss) on marketable securities (12,219) (23,234) 11,015 -47.4%
Interest expense (1,281,128) (1,196,216) 84,912 7.1%
Gain on sale of technology -- 75,500 75,500 NM
Other income 47,752 -- 47,752 NM
Net loss (2,179,592) (2,025,337) 154,255 7.6%
Net loss per share basic and diluted $ (0.01) $ (0.02) $ (0.01) -50.0%
Revenues
Our revenue decrease of $41,902, or 66.3%, was due to a continuing lack of
significant revenue producing contracts. Our microprocessor product line has
failed to generate any significant contracts. We continue to receive minor
follow-on orders for the communication products that have reached the end of
their life cycle. We no longer market these products but do fill follow-on
orders when economically feasible. We anticipate that future revenue will be
derived from successful microprocessor technology efforts in the form of
licensing and royalties and the successful collection of patent infringement
proceeds from litigation and settlement.
Cost of Revenue
Our cost of revenue decrease of $10,472, or 100%, was commensurate with
the reduction in revenue. We fully reserved our inventory in fiscal 2002 and,
therefore, minor amounts of existing inventory can be resold at a zero cost
basis. However, in order to fulfill the minor follow-on orders for communication
products, we normally must procure a portion of additional components and
assemblies. We anticipate that future cost of revenue will be commensurate with
the success of receiving microprocessor licenses and royalties and patent
infringement proceeds.
37
Research and Development
Six Months Ended
Increase
11/30/2004 11/30/2003 (Decrease) %
Research and Development
Personnel (including consultants) $ 171,247 $ 232,691 $ (61,444) -26.4%
Facilities 8,060 28,054 (19,994) -71.3%
Other research and development expenses 3,034 768 2,266 295.1%
--------- --------- ---------
$ 182,341 $ 261,513 $ (79,172) -30.3%
The $79,172, or 30.3%, reduction in research and development was
attributed to a reduction in personnel. In addition, there has been no
significant increase in depreciable equipment related to research and
development for the past three years resulting in a lower depreciation amount
charged to facilities expense. When and if funds become available, we anticipate
an increase in research and development to upgrade the tools which are used by
our potential customers to implement the microprocessor technology and to expand
our offerings on which our microprocessor can run to include additional
operating systems.
General and Administrative
Six Months Ended
Increase
11/30/2004 11/30/2003 (Decrease) %
General and Administrative
Personnel (including consultants) $ 239,402 $ 259,068 $ (19,666) -7.6%
Professional fees 247,852 129,754 118,098 91.0%
Facilities 145,754 147,121 (1,367) -0.9%
Other general and administrative expenses 139,946 136,659 3,287 2.4%
--------- --------- ---------
$ 772,954 $ 672,602 $ 100,352 14.9%
The $100,352, or 14.9%, increase in general and administrative expenses
was attributed to a decrease in personnel costs ($20,000) offset by an increase
in professional fees of $118,098 primarily as a result of patent infringement
costs increasing ($142,000) offset by a decrease in costs associated with
registration statements and auditing of our financial statements ($24,000). We
anticipate general and administrative expenses to remain stable at the current
levels until such time as contract revenue and patent litigation proceeds are
recognized at which time additional personnel and other fees would be expected
to increase.
38
Other income (expense)
Six Months Ended
11/30/2004 11/30/2003 Change %
Other income (expense)
Gain (loss) on marketable $ (12,219) $ (23,234) 11,015 -47.4%
securities
Other income 47,752 -- 47,752 NM
Gain on sale of technology -- 75,500 (75,500) NM
Interest expense, paid in cash or accrued (88,564) (77,632) (10,932) 14.1%
Non-cash interest expense (1,192,564) (1,118,584) (73,980) 6.6%
----------- ----------- -----------
$(1,245,595) $(1,143,950) $ (101,645) 8.9%
The increase in other expenses, net of other income, of $101,645, or 8.9%,
was primarily attributable to the final payment related to the sale of our gas
plasma antenna technology received during fiscal year 2004 ($75,000) and by the
non-cash interest expense recognized on the amortization and cancellation of
debt discounts related to our convertible debentures and the recognition of
expense on the issuance of warrants related to our financings ($74,000)
partially offset by the reduction of a loss on marketable securities which were
received as partial consideration for the sale of our gas plasma antenna
technology ($11,000) and a one-time settlement with a subtenant who abandoned
our adjoining space ($47,000). We anticipate that the non-cash interest expense
will remain stable over the balance of fiscal 2005 due to a large debt discount
remaining on our books as of November 30, 2004 ($1,375,000) which will be
recognized as expense via amortization over 24 months if the underlying
debentures are not converted. If the debentures are converted before maturity,
any remaining debt discount will be written off in its entirety at the time of
conversion.
39
RESULTS OF OPERATIONS FOR THE YEARS ENDED MAY 31, 2004 AND MAY 31, 2003
Selected Financial Information
Year Ended
Increase
5/31/2004 5/31/2003 (Decrease) %
Statements of Operations
Revenue $ 76,417 $ 123,903 $ (47,486) -38.3%
Cost of revenue 10,472 18,660 (8,188) -43.9%
% of revenue 14% 15% -1% -9.0%
Gross profit 65,945 105,243 (39,298) -37.3%
% of revenue 86% 85% 1% 1.6%
Operating expenses
Research and development 549,756 723,287 (173,531) -24.0%
General and administrative 1,253,559 1,821,902 (568,343) -31.2%
Total operating expenses 1,803,315 2,545,189 (741,874) -29.1%
Gain on sale of technology 75,500 -- 75,500 NM
Loss on marketable securities (45,354) -- (45,354) NM
Interest expense (2,443,024) (1,448,544) 994,480 68.7%
Interest income 270 191 79 41.4%
Net loss (4,149,978) (3,888,299) 261,679 6.7%
Net loss per share basic and diluted (0.03) (0.04) (0.01) -25.0%
Revenues
Our revenue decrease of $47,486, or 38.3%, was due to a continuing lack of
significant revenue producing contracts. Although our bid and proposal activity
remains high, our microprocessor product line has failed to generate any
significant contracts. We continue to receive minor follow-on orders for the
communication products that have reached the end of their life cycle. We no
longer market these products but do fill follow-on orders when economically
feasible. During fiscal 2004, we had an engineering design contract for
approximately $25,000 with a company owned by one of our executive officers. We
anticipate that future revenue will be derived from successful microprocessor
technology efforts in the form of licensing and royalties and the successful
collection of patent infringement proceeds from litigation and settlement.
Cost of Revenue
Our cost of revenue decrease of $8,188, or 43.9%, was commensurate with
the reduction in revenue. We fully reserved our inventory in fiscal 2002 and,
therefore, minor amounts of existing inventory can be resold at a zero cost
basis. However, in order to fulfill the minor follow-on orders for communication
products, we normally must procure a portion of additional components and
assemblies. We anticipate that future cost of revenue will be commensurate with
the success of receiving microprocessor licenses and royalties and patent
infringement proceeds.
40
Research and Development
Year Ended
Increase
5/31/2004 5/31/2003 (Decrease) %
Research and Development
Personnel (including consultants) $ 480,967 $ 610,416 $(129,449) -21.2%
Facilities 66,294 104,832 (38,538) -36.8%
Other research and development expenses 2,495 8,039 (5,544) -69.0%
--------- --------- ---------
$ 549,756 $ 723,287 $(173,531) -24.0%
The $173,531, or 24%, reduction in research and development was attributed to a
reduction in personnel costs, primarily consulting costs, as the development of
our softcore microprocessor technology has reached a leveling off point. In
addition, there has been no significant increase in depreciable equipment
related to research and development for the past three years resulting in a
lower depreciation amount charged to facilities expense. When and if funds
become available, we anticipate an increase in research and development to
upgrade the tools which are used by our potential customers to implement the
microprocessor technology and to expand our offerings on which our
microprocessor can run to include additional operating systems.
General and Administrative
Year Ended
Increase
5/31/2004 5/31/2003 (Decrease) %
General and Administrative
Personnel (including consultants) $ 491,898 891,851 $ (399,953) -44.8%
Professional fees 228,935 272,296 (43,361) -15.9%
Facilities 308,207 324,726 (16,519) -5.1%
Other general and administrative expenses 224,519 333,029 (108,510) -32.6%
----------- --------- -------------
$ 1,253,559 1,821,902 $ (568,343) -31.2%
The $568,343, or 31.2%, reduction in general and administrative expenses
was attributed to a reduction in personnel costs, including consulting
($87,000), prior employee legal settlement costs ($76,000), and non-cash
compensation related to investor relations ($207,000). Professional fees
decreased as a result of fewer registration statements being filed during fiscal
2004. Other general and administrative expenses decreased as a result of a one
time write off of prepaid royalties in fiscal 2003 ($48,000), a one time write
off of impaired patent costs in fiscal 2003 ($77,000), and reduced insurance
costs ($35,000) partially offset by an increase in shareholder costs ($112,000)
which includes annual meeting expenses and investor relations. We anticipate
general and administrative expenses to remain stable at the fiscal 2004 levels
until such time as contract revenue and patent litigation proceeds are
recognized at which time additional personnel and other fees would be expected
to increase.
41
Other income (expense)
Year Ended
5/31/2004 5/31/2003 Change %
Other income (expense)
Sale of technology $ 75,500 $ -- $ 75,500 NM
Loss on marketable securities (45,354) -- (45,354) NM
Interest income 270 191 79 41.4%
Interest expense, paid in cash or accrued (149,102) (143,587) (5,515) 3.8%
Non-cash interest expense (2,293,922) (1,304,957) (988,965) 75.8%
----------- ----------- -----------
$(2,412,608) $(1,448,353 $ (964,255) 66.6%
The increase in other expenses, net of other income, of $964,255, or
66.6%, was primarily attributable to the non-cash interest expense recognized on
the amortization and cancellation of debt discounts related to our convertible
debentures and the recognition of expense on the issuance of warrants related to
our financings. We anticipate that the non-cash interest expense will increase
over the fiscal 2004 amount due to a large debt discount remaining on our books
as of May 31, 2004 ($2,075,146) which will be recognized as expense via
amortization over 24 months if the underlying debentures are not converted or
written off in their entirety on the conversion of the underlying debentures.
42
CAPITAL RESOURCES
Working Capital
Increase
11/30/2004 5/31/2004 (Decrease)
Current assets $ 430,746 $ 701,879 $(271,133)
Current liabilities 377,942 548,042 (170,100)
--------- --------- ---------
Working capital $ 52,804 $ 153,837 $(101,033)
========= ========= =========
Long-term debt $ 484,760 $ 230,007 $ 254,753
========= ========= =========
Stockholders' equity (deficit) $(272,234) $ 148,179 $(420,413)
========= ========= =========
Statements of Cash Flows Select Information
Six Months Ended Increase
11/30/2004 11/30/2003 (Decrease)
Net cash provided (used) by:
Operating activities $(799,601) $(859,475) $ 59,874
Investing activities $ -- $ (14,695) $ 14,695
Financing activities $ 616,397 $ 847,897 $(231,500)
Balance Sheet Select Information
Increase
11/30/2004 5/31/2004 (Decrease)
Cash and cash equivalents $ 172,736 $ 355,940 $(183,204)
========= ========= =========
Prepaid expenses $ 243,990 $ 322,068 $ (78,078)
========= ========= =========
Accounts payable and accrued expesnes $ 233,494 $ 294,702 $ (61,208)
--------- --------- ---------
The decrease in working capital of $101,033 and stockholders' equity
(deficit) of $420,413 was attributable to a reduction in cash flows from
financing activities ($231,500) by the company during the six months ended
November 30, 2004. This slow down in financing activities was a result of the
higher than normal cash and cash equivalents available at the beginning of the
year ($355,940).
LIQUIDITY
We estimate our current cash requirements to sustain our operations for
the next twelve months through November 2005 to be $1.8 million. Since we are no
longer supporting the communications product line, we are assuming that there
will be no communications product revenue. We have issued 8% convertible
debentures as our primary source of funding since 2002. At the option of the
debenture holders, they may purchase additional debentures up to $1 million at
any time during the two years following their purchase as long as the price of
our common stock is in excess of $0.20 per share. During the first six months
ended November 30, 2004, we obtained $452,500 from the issuance of 8%
convertible debentures and $164,432 from the exercise of warrants. Subsequent to
November 30, 2004, we obtained $25,000 from the issuance of 8% convertible
debentures and $169,032 from the exercise of warrants.
43
If warrants are not exercised in sufficient amounts, then we may not have
funds sufficient to meet our cash requirements. In such circumstances, we would
need to secure additional debt and/or equity financings with individual or
institutional investors. In addition, we would be required to make additional
cost reductions if our cash requirements cannot be met from external sources. We
expect that the $1.8 million requirement will be provided by:
o additional debt and/or equity financings;
o proceeds from the exercise of outstanding stock options and
warrants; and
o proceeds from revenue contracts and patent enforcement activities.
In addition, we have formulated additional cost reduction plans which can
be implemented if the required funds are not obtainable. As of November 30,
2004, we also have remaining $400,000 under an accounts receivable factoring
agreement with our bank. As of November 30, 2004, we did not have any accounts
receivables eligible for factoring.
We anticipate our future revenue to be derived primarily from the sale of
licenses, royalties and the proceeds from litigation or settlements of patent
infringement cases. 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 and
to fund the expenses of protracted patent enforcement litigation. Product
introductions such as those currently underway for the Ignite microprocessor 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 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.
44
NEW ACCOUNTING PRONOUNCEMENTS
In April 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149
amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SFAS No. 149 requires that contracts with comparable
characteristics be accounted for similarly. SFAS No. 149 is effective for
contracts entered into or modified after June 30, 2003, and for hedging
relationships designated after June 30, 2003. The adoption of this statement did
not impact our financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). SFAS No. 150 is effective
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003, except for mandatorily redeemable financial instruments of
nonpublic entities. The adoption of this statement did not impact our financial
position or results of operations.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123R ("SFAS123R"), Share-Based Payment, an amendment of FASB
Statements Nos. 123 and 95. SFAS 123R eliminates the ability to account for
share-based compensation transaction using APB 25 and would require that such
transactions be accounted for using a fair-value-based method and recognized as
expenses in statement of operations. SFAS 123R allows for the use of a modified
version of prospective application, which requires that the fair value of new
awards granted after the effective date of SFAS 123R, plus unvested awards at
the date of adoption, be expensed over the applicable vesting period. The
provisions of SFAS 123R will be effective for interim or annual reporting
periods beginning after December 15, 2005 for the companies that file as small
business issuers. The Company is currently evaluating the impact the
implementation guidance and revisions included in SFAS 123R will have on its
consolidated financial statements.
INCOME TAXES
Deferred income taxes are provided for by recognizing temporary
differences in 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 $378,000 for
the six months ended November 30, 2004, from $14,732,000 at May 31, 2004 to
$15,110,000 at November 30, 2004.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
45
MANAGEMENT
The following table and biographical summaries set forth information, including
principal occupation and business experience, about our directors and the
executive officers at January 1, 2005:
NAME AGE POSITION AND OFFICES DIRECTOR SINCE
- ---- --- -------------------- --------------
David H. Pohl 67 Director April 2001
Jeffrey Wallin 57 President and CEO n/a
Lowell W. Giffhorn 57 Executive Vice President, CFO, Secretary and August 1999
Director
Carlton M. Johnson, Jr. 45 Director August 2001
Helmut Falk, Jr. 48 Director December 1997
Gloria Felcyn 57 Director October 2002
Patrick Nunally 41 Vice President and CTO n/a
BIOGRAPHICAL INFORMATION
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. Mr. Pohl is also a director of
Peregrine Pharmaceuticals, Inc., a publicly held company.
JEFFREY E. WALLIN. Mr. Wallin has served as our Chief Executive Officer
and President since March 2002. Since 1999, Mr. Wallin has been 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. Mr. Giffhorn is also a director and chairman of
the audit committee of DND Technologies, Inc., a publicly held company.
46
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 been licensed to practice
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 a Juris Doctor degree at Samford University - Cumberland School
of Law. Mr. Johnson is also a director and member of the audit committee of
Peregrine Pharmaceuticals, Inc., a publicly held company.
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 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 from 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.
There is no family relationship between any of our executive officers and
directors.
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.
47
ITEM 10. EXECUTIVE COMPENSATION
There is shown below information concerning the compensation of our chief
executive officer 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, 2004, 2003, and 2002.
Summary Compensation Table
Annual Cash Compensation Long-Term Compensation
Name and Fiscal Repriced All Other
Principal Position Year Salary Bonus (# of Shares) Options Compensation
------------------ ---- ------ ----- ------------- ------- ------------
Jeff Wallin 2004 $145,933(1) Nil 673,000 None None
President and CEO 2003 $127,650(1) Nil 250,000 None None
2002 $ 68,800(1) Nil 1,000,000 None None
Lowell W. Giffhorn 2004 $148,800(1) Nil 239,000 None None
Exec. V.P., CFO and Secy. 2003 $150,779(1) Nil 115,000 None None
2002 $139,908(1) Nil 255,000 None None
Joey Maitra (3) 2004 $131,040(1) Nil 125,000 None None
VP Engineering 2003 $131,040(1) Nil 100,000 None None
2002 $125,058(1) Nil 335,000 None None
Patrick O. Nunally 2004 $180,000(1) Nil 173,000 None None
VP and CTO 2003 $189,521(1) Nil 400,000 None $52,500 (2)
2002 $173,046(1) Nil 250,000 None $105,000 (2)
(1) Included in the salaries of Mssrs. Wallin, Giffhorn, Maitra and
Nunally is cash compensation of $400 per month for a car allowance.
(2) Payments through November 30, 2002 to Dr. Nunally for assignments to
the Company of intellectual property rights. The rights were
returned to Dr. Nunally in April 2003.
(3) Mr. Maitra's employment was terminated in July 2004 per the terms of
his employment contract.
The Company maintains employee benefits that are generally available to
all of its employees, including medical, dental and life insurance benefits and
a 401(k) retirement savings plan. The Company did not make any matching
contributions under the 401(k) plan for any of the above named officers during
the fiscal years ended May 31, 2004, 2003 and 2002.
48
OPTION GRANTS
Shown below is information on grants of stock options pursuant to the
Company's 1992, 1996, 2001 and 2003 Stock Option Plans to the Named Officers
reflected in the Summary Compensation Table shown above.
Option Grants Table for Fiscal Year Ended May 31, 2004
Potential Realizable
Value
Percent of of Assumed Annual
Total Rates
Options of Stock Price
Granted to Appreciation
Number of Employees in Exercise Expiration for Option Term (1)
Name Options Granted Fiscal Year Prices Dates 5% ($) 10% ($)
---- --------------- ----------- ------ ----- ------ -------
Jeffrey E. Wallin 673,000 30.5 $0.035-$0.11 12/18/08-3/18/09 $ 16,844 $37,222
Lowell W. Giffhorn 239,000 10.8 $0.035-$0.05 10/23/08-12/18/08 $ 2,706 $ 5,981
Joey Maitra 125,000 5.7 $ 0.035 12/18/2008 $ 1,191 $ 2,633
Patrick Nunally 173,000 7.8 $ 0.035 12/18/2008 $ 1,649 $ 3,644
(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,
2004 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, 2001 and 2003 Stock Option Plans to the officers reflected in the
Summary Compensation Table shown above.
Number of Unexercised Value of Unexercised
Options Held At In-The-Money Options At
May 31, 2004 May 31, 2004
------------ ------------
Name Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------- ----------- -------------
Jeffrey E. W allin 1,520,000 423,000 $ 7,875 $ 6,834
Lowell W . Giffhorn 565,000 169,000 $ 2,740 $ 5,541
Joey Maitra 385,000 175,000 $ 750 $ 5,688
Patrick Nunally 950,000 173,000 $ 12,600 $ 6,834
The fair market value of the unexercised in-the-money options at May 31,
2004 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, 2004,
$0.074.
The Company has not awarded stock appreciation rights to any of its
employees. The Company has no long-term incentive plans.
49
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 18,
2004, with SDMC, Inc. whereby SDMC will provide the services of Mr. Wallin to be
the President and Chief Executive Officer of the Company. The agreement is for a
term through March 18, 2005 providing for payments of $145,200 per annum and
provides for automatic one year renewals unless either party gives a notice at
least 30 days but not more than 60 days prior to any anniversary date. The
agreement provides for a bonus of 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. Additional payments will be made to
SDMC in the following amounts if the price of the Company's common stock reaches
the following thresholds: $0.40- $20,000, $0.50- $20,000, $0.60- $30,000, $0.80-
$30,000, and $1.00- $50,000. 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
500,000 common shares, 250,000 vesting on March 18, 2004 and 250,000 vesting on
September 18, 2004. The Company also placed in escrow four months of payments
which shall be released to SDMC on the termination of Mr. Wallin's services for
any reason other than cause or his resignation.
The Company entered into an employment agreement dated as of September 1,
2004, with Mr. Giffhorn providing for his employment as Executive Vice President
and Chief Financial Officer. The agreement is for a term through September 1,
2005, 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 of up to 50% of the annual base salary for the applicable year. The
agreement also provides Mr. Giffhorn with 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 four months of the then current base salary. 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. Under the agreement, the Company granted Mr.
Giffhorn a fully vested stock option to purchase up to 300,000 common shares as
of September 1, 2004 and committed to issue additional fully vested stock
options each in the amount of 125,000 common shares on August 31, 2005 and
August 31, 2006.
50
The Company entered into an employment agreement dated June 1, 2004, as
amended on July 12, 2004, with Dr. Nunally providing for his employment as the
Chief Technical Officer of the Company. The agreement is for a term through June
1 2005, providing for a base salary initially of $124,800. The base salary may
be increased at the discretion of the Board of Directors. The agreement provides
for a bonus of up to 50% of the annual base salary for the applicable year. The
agreement also provides Dr. Nunally with a monthly car allowance of $400. The
Company may terminate Dr. Nunally'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) two 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 Dr. Nunally 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 the lesser of (i) two months of the then current base salary or
(ii) the balance remaining of the current base salary for the term of his
agreement.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of January 28, 2005, 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.
51
Name and Address Amount & Nature
Title of Beneficial of Beneficial Percent
of Class Owner Ownership of Class
-------- ----- --------- --------
Common stock Gloria Felcyn, CPA 1,758,000 (1) *
par value 10989 Via Frontera
$0.00001 San Diego, CA 92127
SAME Helmut Falk, Jr. 2,728,231 (2) 1.2%
10989 Via Frontera
San Diego, CA 92127
SAME Lowell W. Giffhorn 1,219,948 (3) *
10989 Via Frontera
San Diego, CA 92127
SAME SDMC, Inc. 1,770,000 (4) *
10989 Via Frontera
San Diego, CA 92127
SAME David H. Pohl 275,000 (5) *
10989 Via Frontera
San Diego, CA 92127
SAME Patrick O. Nunally 962,700 (6) *
10989 Via Frontera
San Diego, CA 92127
SAME Carlton M. Johnson, Jr. 275,000 (7) *
10989 Via Frontera
San Diego, CA 92127
All directors & officers 8,988,879 (8) 3.8%
as a group (9 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, 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 and shares that were obtained on the conversion of 8% Convertible
Debentures and the exercise of warrants. Includes 250,000 shares issuable upon
the exercise of outstanding stock options.
52
2) Includes 315,000 shares issuable upon the exercise of outstanding stock
options.
3) Includes 995,000 shares issuable upon the exercise of outstanding stock
options.
4) Includes 1,770,000 shares issuable upon the exercise of outstanding stock
options.
5) Includes 275,000 shares issuable upon the exercise of outstanding stock
options.
6) Includes 950,000 shares issuable upon the exercise of outstanding stock
options.
7) Includes 275,000 shares issuable upon the exercise of outstanding stock
options.
8) Includes 4,158,879 shares issued and outstanding and 4,830,000 shares
issuable upon exercise of stock options.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
There were no transactions, or series of transactions, during fiscal 2004
and 2003, 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.
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.
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 were
subject to a downward revisions if the price of our stock was 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. Ms. Felcyn converted the debentures into 6,810,102 shares of common
stock in July and November 2003 and exercised the warrants into 4,102,431 shares
of common stock in July 2003 and January 2004.
53
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. In July 2003 we issued a new 8% short-term note in the amount
of $200,354 with a maturity date of October 7, 2003 in exchange for cancellation
of the three 8% short term notes issued in October through December 2002, the
accrued interest on the cancelled notes and an additional $10,000 in cash. In
January 2004, as part of the exercise of the warrants, the $200,354 note was
exchanged for four $25,000 6% notes and shares of common stock which were issued
to the beneficiaries of the trust. The 6% notes have a maturity date of
September 1, 2005.
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 through January 28, 2005 and the fiscal years ended May 31,
2004 and 2003.
BID QUOTATIONS
HIGH LOW
Fiscal Year Ending May 31, 2005
First Quarter $ 0.09 $ 0.03
Second Quarter $ 0.05 $ 0.03
Third Quarter (Through January 28, 2005) $ 0.13 $ 0.05
Fiscal Year Ending May 31, 2004
First Quarter $ 0.07 $ 0.04
Second Quarter $ 0.08 $ 0.04
Third Quarter $ 0.17 $ 0.03
Fourth Quarter $ 0.15 $ 0.08
Fiscal Year Ended May 31, 2003
First Quarter $ 0.08 $ 0.06
Second Quarter $ 0.14 $ 0.04
Third Quarter $ 0.09 $ 0.04
Fourth Quarter $ 0.09 $ 0.04
We have approximately 580 shareholders of record as of January 28, 2005.
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.
54
DESCRIPTION OF SECURITIES
Our authorized capital stock consists of 400,000,000 shares of common
stock, $.00001 par value per share. At January 28, 2005, a total of 232,890,435
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 (if one has been appointed by 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 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.
55
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 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 are included in reliance upon such report
given the authority of said firm as experts in auditing and accounting.
56
Index to Consolidated Financial Statements
Report of Nation Smith Hermes Diamond,
Independent Certified Public Accountants ....................... F-2
Consolidated Balance Sheets as of May 31, 2004 and 2003 .......... F-3
Consolidated Statements of Operations for the Years Ended May 31,
2004 and 2003 .................................................. F-4
Consolidated Statement of Stockholders' Equity (Deficit) for the
Years Ended May 31, 2004 and 2003 .............................. F-5
Consolidated Statements of Cash Flows for the Years Ended
May 31, 2004 and 2003 .......................................... F-6
Summary of Accounting Policies ................................... F-7-F-12
Notes to Consolidated Financial Statements ....................... F-13-F-26
Consolidated Balance Sheets as of November 30, 2004 (unaudited)
and May 31, 2004 ............................................... F-27
Consolidated Statements of Operations for the Three and Six Months
ended November 30, 2004 and 2003(unaudited) .................... F-28
Consolidated Statements of Cash Flows for the Six Months
ended November 30, 2004 and 2003 (unaudited) ................... F-29
Notes to Unaudited Consolidated Financial Statements ............. F-30-F-39
F-1
REPORT OF INDEPENDENT REGISTERED CERTIFIED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors
Patriot Scientific Corporation
San Diego, California
We have audited the accompanying consolidated balance sheets of Patriot
Scientific Corporation as of May 31, 2004 and 2003, and the related consolidated
statements of operations, stockholders' equity (deficit) and cash flows for each
of the years in the two year period ended May 31, 2004. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). 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 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, 2004 and 2003, and the consolidated results of its
operations and its cash flows for each of the years in the two year period ended
May 31, 2004, in conformity with accounting principles generally accepted in the
United States of America.
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 8, 2004
F-2
Patriot Scientific Corporation
Consolidated Balance Sheets
May 31, 2004 2003
- --------------------------------------------------------------------------------------------------
ASSETS (Notes 4 and 5)
Current assets:
Cash and cash equivalents $ 355,940 $ 32,663
Marketable securities 22,646 --
Accounts receivable, net of allowance
of none and $10,000 for uncollectible accounts 1,225 3,866
Prepaid expenses 322,068 93,030
- --------------------------------------------------------------------------------------------------
Total current assets 701,879 129,559
Property and equipment, net (Note 2) 68,389 153,530
Other assets 41,221 53,220
Patents and trademarks, net of accumulated
amortization of $501,235 and $450,926 114,739 128,925
- --------------------------------------------------------------------------------------------------
$ 926,228 $ 465,234
==================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Secured note payable (Note 4) $ -- $ 635,276
Current portion of 8% Convertible Debentures,
net of debt discount of $27,180 and $103,121 (Note 5) 145,320 121,879
Secured notes payable to shareholders 100,000 180,000
Accounts payable 134,600 397,180
Accrued liabilities 160,102 245,822
Current portion of capital lease obligation 8,020 6,405
- --------------------------------------------------------------------------------------------------
Total current liabilities 548,042 1,586,562
8% Convertible Debentures, net of debt discount of
$2,047,966 and $709,890 (Note 5) 227,701 280,110
Long term portion of capital lease obligation 2,306 10,326
Commitments and contingencies (Notes 1, 6 and 10)
Stockholders' equity (deficit) (Notes 5 and 6):
Preferred stock, $.00001 par value;
5,000,000 shares authorized: none outstanding -- --
Common stock, $.00001par value; 400,000,000 shares
authorized: 171,156,363 and 106,547,807 issued and
outstanding at May 31, 2004 and 2003, respectively 1,712 1,066
Additional paid-in capital 49,990,485 44,281,210
Accumulated deficit (49,844,018) (45,694,040)
- --------------------------------------------------------------------------------------------------
Total stockholders' deficit 148,179 (1,411,764)
- --------------------------------------------------------------------------------------------------
$ 926,228 $ 465,234
==================================================================================================
See accompanying report of independent registered certified public accounting
firm, summary of accounting policies and notes to consolidated financial
statements.
F-3
Patriot Scientific Corporation Consolidated
Statements of Operations
Years Ended May 31, 2004 2003
- --------------------------------------------------------------------------------
Net sales (Note 11):
Product $ 74,017 $ 108,403
Licenses and royalties 2,400 15,500
- --------------------------------------------------------------------------------
Net sales 76,417 123,903
- --------------------------------------------------------------------------------
Cost of sales 10,472 18,660
- --------------------------------------------------------------------------------
Gross profit 65,945 105,243
Operating expenses:
Research and development 549,756 723,287
Selling, general and administrative 1,253,559 1,821,902
- --------------------------------------------------------------------------------
Operating expenses 1,803,315 2,545,189
- --------------------------------------------------------------------------------
Operating loss (1,737,370) (2,439,946)
- --------------------------------------------------------------------------------
Other income (expenses):
Sale of technology 75,500 --
Loss on marketable securities (45,354) --
Interest income 270 191
Interest expense (Notes 4, 5 and 6) (2,443,024) (1,448,544)
- --------------------------------------------------------------------------------
Other income (expenses) (2,412,608) (1,448,353)
- --------------------------------------------------------------------------------
Net loss $ (4,149,978 $ (3,888,299)
- --------------------------------------------------------------------------------
Basic and diluted loss
per common share (Note 7) $ (0.03) $ (0.04)
- --------------------------------------------------------------------------------
Weighted average number of
common shares outstanding
during the period (Note 7) 139,767,276 93,791,470
- --------------------------------------------------------------------------------
See accompanying report of independent registered certified public accounting
firm, summary of accounting policies and notes to consolidated financial
statements.
F- 4
Patriot Scientific Corporation
Consolidated Statements of Stockholders' Equity (Deficit)
Years Ended May 31, 2004 and 2003
Common Stock Additional Accumulated Stockholders'
Shares Amount Paid-in Capital Deficit Equity (Deficit)
------ ------ --------------- ------- ----------------
Balance, June 1, 2002 81,465,757 $ 815 $ 41,360,101(1) $(41,805,741) $ (444,825)
====================================================================================================================================
Issuance of common stock at $.03 to $.05
per share (Note 6) 3,765,266 38 120,312 -- 120,350
Collection of note receivable (Note 3) -- -- 80,000 -- 80,000
Issuance of common stock for services
at $.04 to $.06 per share 2,780,000 28 148,772 -- 148,800
Conversion of debentures payable plus accrued
interest at $.04 to $.05 per share (Note 4) 18,536,784 185 836,375 -- 836,560
Value of warrants issued -- -- 1,735,650 -- 1,735,650
Net loss -- -- -- (3,888,299) (3,888,299)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, May 31, 2003 106,547,807 $ 1,066 $ 44,281,210 $(45,694,040) $ (1,411,764)
====================================================================================================================================
Issuance of common stock at $.025 to $.034
per share (Note 6) 1,800,752 18 50,422 -- 50,440
Exercise of warrants and options at $.0172 to
$.04 per share 11,184,175 112 285,832 -- 285,944
Issuance of common stock for services
at $.043 to $.117 per share 1,126,496 11 59,841 -- 59,852
Conversion of debentures payable plus accrued
interest at $.017 to $.064 per share (Note 5) 50,497,133 505 1,757,123 -- 1,757,628
Value of warrants issued -- -- 3,556,057 -- 3,556,057
Net loss -- -- -- (4,149,978) (4,149,978)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, May 31, 2004 171,156,363 $ 1,712 $ 49,990,485 $(49,844,018) $ 148,179
====================================================================================================================================
See accompanying report of independent registered certified public accounting
firm, summary of accounting policies and notes to consolidated financial
statements.
(1) Additional Paid-In Capital included a note receivable of $80,000 and
additional paid-in capital of $41,440,101 at June 1, 2002.
F-5
Patriot Scientific Corporation Consolidated
Statements of Cash Flows
Increase (Decrease) in Cash and Cash Equivalents
Years Ended May 31, 2004 2003
- -------------------------------------------------------------------------------------------
Operating activities:
Net loss $(4,149,978) $(3,888,299)
Adjustments to reconcile net loss
to cash used in operating activities:
Amortization and depreciation 135,450 258,915
Provision for doubtful accounts -- 24,000
Non -cash interest expense related to convertible
debentures, notes payable and warrants 2,293,922 1,304,957
Gain on sale of technology (75,500) --
Unrealized loss on marketable securities 45,354 --
Common stock, options and warrants issued for
services 59,852 148,800
Changes in:
Accounts receivable (18,639) (33,346)
Prepaid and other assets (217,039) 216,195
Accounts payable and accrued expenses (149,394) 83,016
- -------------------------------------------------------------------------------------------
Net cash used in operating activities (2,075,972) (1,885,762)
- -------------------------------------------------------------------------------------------
Investing activities:
Note receivable (Note 3) -- 60,000
Proceeds from sale of technology 7,500 --
Purchase of property, equipment and patents, net (36,123) (62,194)
- -------------------------------------------------------------------------------------------
Net cash used in investing activities (28,623) (2,194)
- -------------------------------------------------------------------------------------------
Financing activities:
Proceeds from issuance of secured notes payable 12,320 180,000
Payments for capital lease obligations (6,405) (5,116)
Proceeds from issuance of convertible debentures 2,175,000 1,507,000
Proceeds from issuance of common stock 50,440 120,350
Proceeds from exercise of common stock warrants
and options 175,237 --
Proceeds from sale of accounts receivable 21,280 30,277
- -------------------------------------------------------------------------------------------
Net cash provided by financing activities 2,427,872 1,832,511
- -------------------------------------------------------------------------------------------
Net decrease in cash and cash equivalents 323,277 (55,445)
Cash and cash equivalents, beginning of year 32,663 88,108
- -------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 355,940 $ 32,663
===========================================================================================
Supplemental Disclosure of Cash Flow Information:
Cash payments for interest $ 17,220 $ 15,083
Convertible debentures, notes payable and accrued
interest exchanged for common stock $ 1,757,628 $ 836,560
Debt discount $ 2,873,167 $ 1,763,816
- -------------------------------------------------------------------------------------------
See accompanying report of independent registered certified public accounting
firm, summary of accounting policies and notes to consolidated financial
statements.
F-6
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 2003 financial statements in
order for them to conform to the 2004 presentation. Such reclassifications have
no impact on the Company's financial position or results of operations.
FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of temporary cash investments and trade accounts
receivable.
When the Company has excess cash, 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 value of financial instruments including cash, cash equivalents,
accounts receivable, accounts payable and accrued liabilities approximate fair
value because of the immediate or short-term maturity of these instruments. With
respect to long-term debt, the carrying amounts approximate fair value due to
the relative consistency in interest rates and the short term nature of the
debt, with all debt maturing within two years of issuance.
MARKETABLE SECURITIES
As part of the sale of our gas plasma antenna technology we received restricted
securities in a company that is traded on the OTC bulletin board. The securities
can be traded under Rule 144 after July 2004. We reflect the value of those
securities based on the closing price as of the end of our
F-7
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
reporting period. Any unrealized gain or loss between reporting periods is
reflected in our consolidated statement of operations as non-operating income or
loss.
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. 144,
"Accounting for the Impairment of Long-lived Assets." 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 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. 144 as discussed above.
REVENUE RECOGNITION
We recognize revenue on the shipment to our customers of communication products,
microprocessor integrated chips and evaluation boards. We also derive revenue
from fees for the transfer of proven and reusable intellectual property
components or the performance of engineering services. We enter into licensing
agreements that will provide licensees the right to incorporate our intellectual
property components in their products with terms and conditions that will vary
by licensee. Generally, 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
F-8
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
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 none and $3,400 for the years ended May 31, 2004 and 2003.
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.
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. As of May 31, 2004 and
2003 both inventory amounts were fully reserved.
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
F-9
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
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 2004 and 2003, the Company sold approximately $27,000 and $38,000,
respectively, of its accounts receivable to a bank under a factoring agreement
for approximately $21,000 and $30,000, 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. At May 31, 2004, there was
no outstanding balance and $400,000 was 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," and SFAS No. 148,
"Accounting for Stock-Based Compensation-Transition and disclosure," require 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. SFAS No. 148
also provides for alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
The Company has elected to continue to account for stock based compensation
under APB No. 25.
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 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.
F-10
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
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:
2004 2003
- --------------------------------------------------------------------------------
Net loss as reported $(4,149,978) $(3,888,299)
Compensation expense (152,074) (289,023)
----------- -----------
Net loss pro forma $(4,302,052) $(4,177,322)
=========== ===========
As reported per share
Basic and diluted loss $ (0.03) $ (0.04)
=========== ===========
Pro forma per share
Basic and diluted loss $ (0.03) $ (0.04)
----------- -----------
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149
amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SFAS No. 149 requires that contracts with comparable
characteristics be accounted for similarly. SFAS No. 149 is effective for
contracts entered into or modified after June 30, 2003, and for hedging
relationships designated after June 30, 2003. The adoption of this statement did
not impact our financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). SFAS No. 150 is effective
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003, except for mandatorily redeemable financial instruments of
nonpublic entities. The adoption of this statement did not impact our financial
position or results of operations.
F-11
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 $4,149,978 and $3,888,299 and negative cash flow from
operations of $2,171,896 and $1,885,762 in the years ended May 31, 2004 and
2003. At May 31, 2004, we had cash and cash equivalents of $355,940. We have
historically funded our operations primarily through the issuance of securities
and debt financings. Cash and cash equivalents increased $323,277 during the
year ended May 31, 2004.
We estimate our current cash requirements to sustain our operations for the next
twelve months through May 2005 to be $1.8 million. Since we are no longer
supporting the communications product line, we are assuming that there will be
no communications product revenue. We have issued 8% convertible debentures as
our primary source of funding since 2002. At the option of the debenture
holders, they may purchase additional debentures up to $1 million at any time
during the two years following their purchase as long as the price of our common
stock is in excess of $0.20 per share. During the year ended May 31, 2004, we
obtained $2,175,000 from the issuance of convertible debentures, $50,440 from
the sale of equity to several private investors, $183,270 from the exercise of
warrants and $12,320 from short term notes entered into with a related party.
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 would need to secure additional debt
and/or equity financings with individual or institutional investors. In
addition, we would be required to make additional cost reductions if our cash
requirements cannot be met from external sources. We expect that the $1.8
million requirement will be provided by:
o additional debt and/or equity financings;
o proceeds from the exercise of outstanding stock options and
warrants; and
o proceeds from revenue contracts and patent enforcement activities.
In addition, we have formulated additional cost reduction plans which can be
implemented if the required funds are not obtainable. As of May 31, 2004, we
also have remaining $400,000 under an accounts receivable factoring agreement
with our bank.
We anticipate our future revenue to be derived primarily from the sale of
licenses, royalties and the proceeds from litigation or settlements of patent
infringement cases. 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 and
to fund the expenses of protracted patent enforcement litigation. Product
introductions such as those
F-12
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 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.
2. PROPERTY AND EQUITMENT
May 31,
-------------------------
2004 2003
================================================================================
Computer equipment and software $1,660,707 $1,660,707
Furniture and fixtures 499,274 499,274
Laboratory equipment 205,594 205,594
---------- ----------
2,365,575 2,365,575
Less accumulated depreciation and amortization 2,297,186 2,212,045
---------- ----------
Net property and equipment $ 68,389 $ 153,530
================================================================================
Depreciation expense was $85,141 and $131,958
for the years ended May 31, 2004 and 2003
3. 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 had an interest 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. In
April 2003, the Company negotiated an early payment discount and the individual
paid $60,000 to retire
F-13
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
this note. The balance of $20,000 was written off to bad debt expense during the
year ended May 31, 2003.
4. SECURED NOTES PAYABLE
We previously 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. On March 23, 2004, the amended note, which had a principal
balance of $635,276 plus accrued interest of $87,891, was exchanged for an 8%
convertible debenture for $723,167 with a maturity date of March 23, 2006.
As part of the consideration for entering into the original 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 April 1, 2003 and we 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 to March 1, 2004 on a note for
$635,276 net of accrued interest and allowed us to unreserve 20,007,350 shares
that had been reserved for the exercise of warrants for a period the sooner of
1) March 19, 2004, or 2) 90 days after the date on which our common stock
exceeded $0.375 for 10 consecutive trading days.
As of May 31, 2004 we issued warrants to purchase up to 28,286,208 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.
As part of the consideration for exchanging the note for an 8% convertible
debenture, we agreed to extend the expiration dates on certain outstanding
warrants to April 1, 2011.
In January 2004, a note held by an affiliate for $200,353 plus accrued interest
of $8,033 was partially used to exercise a warrant with the balance of $100,000
converted into four one year $25,000 notes due January 9, 2005 issued to four
heirs of the estate over which the affiliate is a trustee. The interest rate on
the four notes is 6% and the notes are secured by the assets of the company.
F-14
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. CONVERTIBLE DEBENTURES
Overview. From April 23, 2002 through May 11, 2004, we sold an aggregate of
$4,913,167 of convertible debentures, ranging from 8% to 12%, to a group of
twenty-four 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.
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 $0.0172 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. If the volume weighted average
price for our common stock for the ten days previous to the reset date is less
than the conversion price in effect at the time of the reset date, then the
number of common shares issuable to the selling shareholder on conversion will
be increased. If the conversion price is reset, the debenture can be converted
into a number of our common shares based on the following calculation: the
amount of the debenture plus any unpaid accrued interest divided by the reset
conversion price which shall equal the volume weighted average price for our
common stock for the ten days previous to the reset date.
Warrants. Concurrent with the issuance of the convertible debentures, we issued
to the debenture holders warrants to purchase shares of our common stock. These
warrants are exercisable for five years from the date of issuance at either
initial negotiated exercise prices or prices equal to 115% of the volume
weighted average price for our common stock for the ten days previous to the
debenture date. The warrant exercise price is generally subject to being reset
on each six month anniversary of its issuance, however, if the warrant holder
elects to have the warrant shares registered, then the exercise price is fixed
at the price in effect on the date of the election.
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
F-15
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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. Except for one debenture issued on March 23, 2004, we are
responsible for registering the resale of the shares of our common stock which
will be issued on the conversion of the debentures. As of May 31, 2004, there
have been five registration statements (designated A through E).
Security Interest. The convertible debentures are secured by our assets.
The following tables present the status, as of May 31, 2004, of our convertible
debentures:
Principal Conversion Prices Effective Shares Warrant
Dates of Aggregate Balance ------------------- Registration Converted at Shares
Series Issuance Principal at 5/31/04 Initial Reset Date May 31, 2004 Issued
- ------ -------- --------- ---------- ------- ----- ---- ------------ ------
A 4/23/2002- $1,000,000 $ 25,000 $0.08616- $0.04190- 10/29/2002 23,441,662 12,859,175
6/10/2002 $0.10289 $0.04457
B 8/23/2002- $ 605,000 $ 107,500 $0.05126- $0.04381- 3/7/2003 11,620,528 11,234,835
1/24/2003 $0.0727 $0.04722
C 3/24/2002- $ 510,000 $ 10,000 $0.041- $0.041- 6/26/2003 10,179,007 9,377,943
6/9/2003 $0.065 $0.065
D 8/1/2003- $ 547,500 $ 55,000 $0.0172- $0.0172- 11/18/2003 23,792,725 22,455,355
10/21/2003 $0.048 $0.0477
E 12/1/2003- $1,527,500 $1,527,500 $0.0267- $0.0267- 6/7/2004 -- 30,395,392
5/11/2004 $0.10 $0.10
F 3/23/2004 $ 723,167 $ 723,167 $0.09 $0.09 Not Registered -- 8,035,192
------------------------- -------------------------
Totals $4,913,167 $2,448,167 69,033,922 94,357,892
F-16
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Convertible debentures issued since April 23, 2002 $ 4,913,167
Less amounts converted to common stock (2,465,000)
-----------
2,448,167
Less debt discount (2,075,146)
-----------
Convertible debentures at May 31, 2004 373,021
Less current portion 145,320
-----------
Long term portion $ 227,701
===========
Maturity dates of outstanding convertible debentures
June 10, 2004 $ 25,000
October 29, 2004 107,500
April 15, 2005 10,000
August 1, 2005 25,000
September 30, 2005 30,000
December 1, 2005 25,000
January 23, 2006 275,000
February 2, 2006 325,000
March 23, 2006 723,167
March 24, 2006 315,900
April 26, 2006 100,000
May 11, 2006 486,600
-----------
$ 2,448,167
===========
6. STOCKHOLDERS' EQUITY (DEFICIT)
During fiscal 2004, the Company's shareholders approved an increase in the
authorized number of common shares from 200,000,000 to 400,000,000.
PRIVATE STOCK OFFERINGS
During fiscal 2004, 1,800,752 restricted shares of common stock were issued to a
group of individual investors for $50,440 and 1,126,496 shares of common stock
were issued to a vendor in satisfaction of $59,852 of trade accounts payable.
During fiscal 2003, 3,765,266 restricted shares of common stock were issued to a
group of individual investors for $120,350; 2,000,000 shares of common stock
were issued to a consultant in exchange for services valued at $110,000; and
400,000 shares valued at $16,000 were issued to a former executive of the
company as partial settlement of a legal action. The fair value (as determined
by the quoted market price) for the consulting services and legal settlement
were recorded as additional general and administrative expense during the year
ended May 31, 2003. Also, during fiscal 2003, the Company issued 380,000 shares
of common stock to a vendor in satisfaction of $22,800 of trade accounts
payable.
WARRANTS
At May 31, 2004, the Company had warrants outstanding to purchase 121,349,420
shares of common stock at exercise prices ranging from $0.0172 to $0.65 per
share expiring beginning in
F-17
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2004 through 2011. During fiscal 2004, the Company issued warrants to purchase
73,436,127 shares of common stock at exercise prices ranging from $0.0172 to
$0.10 per share and issued 11,079,175 shares of common stock on the exercise of
warrants at exercise prices ranging from $0.0172 to $0.04 per share.
At May 31, 2003, the Company had warrants outstanding to purchase 58,992,468
shares of common stock at exercise prices ranging from $0.033 to $1.12 per share
expiring beginning in 2004 through 2008. During fiscal 2003, the Company issued
warrants to purchase 35,005,013 shares of common stock at exercise prices
ranging from $0.04 to $0.065 per share.
The following table presents the outstanding warrants at May 31:
2004 2003
----------- ----------
Issued in conjunction with
Convertible debentures 83,278,716 31,164,260
Anti-dilution agreements 15,398,058 5,355,562
Equity lines of credit 18,765,369 18,765,369
Other 3,907,277 3,707,277
----------- ----------
Total warrants outstanding 121,349,420 58,992,468
----------- ----------
1992 INCENTIVE STOCK OPTION PLAN ("ISO")
The Company has an ISO Plan which expired March 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, 2004, options to purchase up to 17,500 shares of common stock remained
outstanding and will expire in July 2004.
1992 NON-STATUTORY STOCK OPTION PLAN("NSO")
The Company has an NSO Plan which expired March 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, 2004,
options to purchase up to 50,000 shares of common stock remained outstanding and
will expire in 2005.
F-18
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 years ended May 31, 2004 and 2003, the Company
granted options to purchase none and 340,500 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 years ended May 31, 2004 and 2003, the Company granted options to
purchase none and 875,000 shares of stock at market value.
2003 STOCK OPTION PLAN
Effective July 2003, the Company adopted the 2003 Stock Option Plan, expiring
July 2, 2013, reserving for issuance 6,000,000 shares of the Company's common
stock. The 2003 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 2003 Stock
Option Plan must be exercised within ten years of the date they are granted
(five years in the case of a significant stockholder). During the fiscal year
ended May 31, 2004, the Company granted options to purchase 2,210,000 shares of
stock at market value.
F-19
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 two years ended May 31, 2004 and 2003,
respectively: dividend yield of zero percent for both years; expected volatility
of 107 to 127 and 100 to 120, risk-free interest rates of 2.1 to 3.9 and 2.3 to
4.3; and expected lives of 3 to 5 years for both years.
A summary of the status of the Company's stock option plans and warrants as of
May 31, 2004, 2003 and 2002 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, 2002 4,249,739 $ 0.39 24,477,724 $ 0.11
===============================================================================================================
Granted 1,215,500 0.05 35,005,013 0.05
Cancelled (411,239) 0.81 (490,269) 0.30
Exercised 0 --
- ---------------------------------------------------------------------------------------------------------------
Outstanding, May 31, 2003 5,054,000 $ 0.28 58,992,468 $ 0.06
===============================================================================================================
Granted 2,210,000 0.06 73,436,127 0.05
Cancelled (156,000) 0.13 --
Exercised (105,000) 0.05 (11,079,175) 0.03
- ---------------------------------------------------------------------------------------------------------------
Outstanding, May 31, 2004 7,003,000 $ 0.21 121,349,420 $ 0.05
===============================================================================================================
- ---------------------------------------------------------------------------------------------------------------
Exercisable, May 31, 2003 4,138,633 $ 0.29 57,992,468 $ 0.06
===============================================================================================================
Exercisable, May 31, 2004 5,904,434 $ 0.24 120,149,420 $ 0.05
===============================================================================================================
Weighted average fair value of options and warrants
granted during the year ended May 31, 2003 $ 0.04 $ 0.05
Weighted average fair value of options and warrants
granted during the year ended May 31, 2004 $ 0.05 $ 0.06
===============================================================================================================
Included in the above table are certain options for which vesting is contingent
based on various future performance measures.
F-20
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes information about stock options and warrants
outstanding at May 31, 2004:
Outstanding Exercisable
------------------------------------------------ ---------------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
=========================================================================================================
Options
$ 0.0345-0.059 2,380,000 4.24 $ 0.04 1,370,000 $ 0.05
0.07-0.09 1,365,500 2.96 0.08 1,526,934 0.08
0.11-0.1325 2,340,000 2.93 0.11 2,090,000 0.11
0.61-1.18 525,000 1.02 0.93 525,000 0.93
1.325 392,500 1.00 1.33 392,500 1.33
- ---------------------------------------------------------------------------------------------------------
$ 0.0345-1.325 7,003,000 3.13 $ 0.21 5,904,434 $ 0.24
Warrants
$ 0.0172-0.039 29,634,938 6.79 $ 0.03 29,634,938 $ 0.03
0.04-0.044 39,156,429 6.26 0.04 39,156,429 0.04
0.045-0.049 21,057,218 5.95 0.05 21,057,218 0.05
0.05-0.094 27,793,558 6.32 0.08 26,593,558 0.08
0.10-0.65 3,707,277 2.87 0.13 3,707,277 0.13
- ---------------------------------------------------------------------------------------------------------
$ 0.0172-0.65 121,349,420 6.25 $ 0.05 120,149,420 $ 0.05
7. 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, 2004 and 2003, common
stock options and warrants convertible or exercisable into approximately
128,352,420 and 64,046,468 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-21
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES
The net deferred tax asset recorded and its approximate tax effect consisted of
the following:
May 31,
------------------------------
2004 2003
================================================================================
Net operating loss carryforwards $12,873,000 $12,073,000
Purchased technology 371,000 420,000
Depreciation and amortization 1,434,000 1,607,000
Other, net 54,000 191,000
- ---------------------------------------------------------------- -------------
14,732,000 14,291,000
Valuation allowance 14,732,000 14,291,000
- ---------------------------------------------------------------- -------------
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, 2004 2003
=========================================================================================================
Federal income tax benefit computed at the Federal statutory rate $(1,411,000) $(1,322,000)
State income tax benefit net of Federal benefit (242,000) (139,000)
Other- permanent differences 1,212,000 521,000
Expiration of state net operating loss carryforwards -- 95,000
Change in valuation allowance 441,000 845,000
- ---------------------------------------------------------------------------------------------------------
Income tax benefit $ -- $ --
=========================================================================================================
As of May 31, 2004 and 2003, 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 2004 and 2003 due to reported losses. The
valuation allowance increased $441,000 for the year ended May 31, 2004 and
$845,000 for the year ended May 31, 2003.
At May 31, 2004, the Company has federal net operating loss carryforwards of
approximately $34,290,000 that expire through 2023 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.
At May 31, 2004, the Company has state net operating loss carryforwards of
approximately $20,244,000 that expire through 2011. The state of California
suspended the utilization of net
F-22
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
operating losses for 2002 and 2003.
9. 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 2004 or 2003.
10. COMMITMENTS AND CONTINGENCIES
LITIGATION
In December 2003, the Company filed several lawsuits in United States District
Courts against companies it contends are infringing on its patent number
5,809,336 entitled "High Performance Microprocessor Having Variable Speed
Clock." The defendants and suits are as follows:
Defendant U.S. District Court Case Number
- --------- ------------------- -----------
Sony Corporation of America Southern District of New York 03CV10142
Fujitsu Northern District of California C035787
Toshiba America, Inc. Southern District of New York 03CV10180
NEC USA, Inc. Eastern District of New York CV036432
Matsushita District of New Jersey 03CV06210
The Company is requesting the courts to enjoin the defendants from making use of
our patent and are requesting damages for past infringements. In February, with
the consent of the defendants and the Company, the above five actions were
consolidated into the Fujitsu action in the Northern District of California
under case number C035787.
In February 2004, Intel Corporation filed a lawsuit against the Company in the
United States District Court- Northern District of California, case number
C040439, in which they are requesting a declaratory judgment that their
microprocessors, used by the defendants in our consolidated suit, do not
infringe the Company's patent. The Company filed a counterclaim against Intel
contending that they also are infringing on its patent, and Intel asserted an
affirmative defense that the Company's 5,809,336 patent is invalid.
Also in February 2004, the Company filed a lawsuit in the United States District
Court- Northern
F-23
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
District of California, case number C040618, against Charles H. Moore,
Technology Properties Limited, and Daniel E. Leckrone. The Company is requesting
the court to declare inventorship and ownership on each of its granted patents
related to the suits discussed above and other unasserted claims of infringement
Patriot believes it has.
The Intel lawsuit has been stayed pending the results of the Moore lawsuit.
OPERATING AND CAPITAL LEASES
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 two 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 and to investors
under its notes payable and convertible debentures.
The Company has one capital lease at May 31, 2004.
Future minimum lease payments are as follows:
Year ending May 31,
2005 $ 9,562
2006 2,391
- --------------------------------------------------------------------------------
Total minimum lease payments 11,953
Amount representing interest 1,627
- --------------------------------------------------------------------------------
Present value of minimum lease payments 10,326
Total obligation 10,326
Less current portion (8,020)
- --------------------------------------------------------------------------------
Long-term portion $ 2,306
================================================================================
Capital leases included in fixed assets at May 31, 2004 and 2003, were $3,471
and $11,803, net of an allowance for depreciation of $21,524 and $13,192.
Depreciation expense related to the capitalized lease was $8,332 and $8,332 for
the years ended May 31, 2004 and 2003.
F-24
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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
2005 $135,454 $ 70,470 $ 64,984
2006 141,658 72,540 69,118
2007 23,782 12,150 11,632
Thereafter -- -- --
- --------------------------------------------------------------------------------
Total minimum lease payments $300,894 $155,160 $145,734
================================================================================
Rent expense for fiscal 2004 and 2003 was $181,135 and $189,423, respectively.
11. 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 no longer provide any
significant sales. During the fiscal years ended May 31, 2004 and 2003, the
Company's product sales of high technology computer products and licenses were
$13,615 and $31,340 and telecommunication products and licenses were $62,802 and
$92,563.
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, 2004 and 2003, the Company's sales by geographic location
consisted of the following:
F-25
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2004 2003
------------ ----------
Domestic sales $ 70,000 $113,000
Foreign sales:
Europe 6,000 11,000
---------------------------
Total foreign sales 6,000 11,000
---------------------------
Total net product sales $ 76,000 $124,000
===========================
The Company has no foreign assets.
SALES TO MAJOR CUSTOMERS
During the fiscal years ended May 31, 2004 and 2003, revenues from significant
customers consisted of the following:
2004 2003
------------------- ---------------------
Customer Sales Percent Sales Percent
- -------- ----- ------- ----- -------
A $25,000 33.2% $ -- --
B 18,000 22.9% -- --
C 9,000 11.9% -- --
D -- -- 43,000 34.3%
E -- -- 23,000 18.6%
F -- -- 15,000 11.9%
G -- -- 15,000 11.9%
12. RELATED PARTY TRANSACTIONS
During fiscal year 2004, we sold services totaling $25,352 to a company owned by
one of our officers.
F-26
PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED BALANCE SHEETS
November 30, May 31,
2004 2004
------------ ------------
(Unaudited)
ASSETS (Notes 4 and 5)
Current assets:
Cash and cash equivalents $ 172,736 $ 355,940
Marketable securities 10,427 22,646
Accounts receivable 3,593 1,225
Prepaid expenses 243,990 322,068
------------ ------------
Total current assets 430,746 701,879
Property and equipment, net 45,256 68,389
Other assets 23,891 41,221
Patents and trademarks, net of accumulated
amortization of $525,399 and $501,235 90,575 114,739
------------ ------------
$ 590,468 $ 926,228
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current portion of convertible debentures, net of debt
discount of $2,093 and $27,180 (Note 5) $ 37,907 $ 145,320
Secured notes payable to shareholders (Note 4) 100,000 100,000
Accounts payable 101,349 134,600
Accrued liabilities 132,145 160,102
Current portion of capital lease obligation 6,541 8,020
------------ ------------
Total current liabilities 377,942 548,042
Convertible debentures, net of debt discount of $1,372,907
and $2,047,966 (Note 5) 484,760 227,701
Long term portion of capital lease obligation -- 2,306
Stockholders' equity (deficit) (Notes 5 and 6)
Preferred stock, $.00001 par value; 5,000,000 shares
authorized none outstanding -- --
Common stock, $.00001 par value; 400,000,000 shares
authorized; issued and outstanding 210,916,855 and 171,156,363 2,109 1,712
Additional paid-in capital 51,749,267 49,990,485
Accumulated deficit (52,023,610) (49,844,018)
------------ ------------
Total stockholders' equity (deficit) (272,234) 148,179
------------ ------------
$ 590,468 $ 926,228
============ ============
See accompanying summary of accounting policies and notes to unaudited
consolidated financial statements.
F-27
PATRIOT SCIENTIFIC CORPORATION CONSOLIDATED
STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Six Months Ended
-------------------------------- --------------------------------
November 30, November 30, November 30, November 30,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Net sales $ 18,748 $ 51,960 $ 21,298 $ 63,200
Cost of sales -- 4,259 -- 10,472
------------- ------------- ------------- -------------
Gross profit 18,748 47,701 21,298 52,728
Operating expenses:
Research and development 54,037 112,391 182,341 261,513
Selling, general and
administrative 392,552 321,132 772,954 672,602
------------- ------------- ------------- -------------
446,589 433,523 955,295 934,115
------------- ------------- ------------- -------------
Operating loss (427,841) (385,822) (933,997) (881,387)
------------- ------------- ------------- -------------
Other income (expenses):
Unrealized gain (loss) on marketable
securities 2,444 (23,234) (12,219) (23,234)
Gain on sale of technology -- 75,500 -- 75,500
Other income 479 -- 47,752 --
Interest expense (648,223) (539,234) (1,281,128) (1,196,216)
------------- ------------- ------------- -------------
(645,300) (486,968) (1,245,595) (1,143,950)
------------- ------------- ------------- -------------
Net loss $ (1,073,141 $ (872,790) $ (2,179,592) $ (2,025,337)
============= ============= ============= =============
Basic and diluted loss
per common share $ (0.01) $ (0.01) $ (0.01) $ (0.02)
============= ============= ============= =============
Weighted average number of
common shares outstanding
during the period (Note 1) 198,970,399 129,716,912 190,971,852 121,738,543
=========== =========== =========== ===========
See accompanying summary of accounting policies and notes to unaudited
consolidated financial statements.
F-28
PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Six Months Ended
----------------------------------------
November 30, 2004 November 30, 2003
----------------- -----------------
Decrease in Cash and Cash Equivalents
Operating activities:
Net loss $(2,179,592) $(2,025,337)
Adjustments to reconcile net loss
to cash used in operating activities:
Amortization and depreciation 47,297 67,726
Non-cash compensation 22,175 --
Non-cash interest expense related to convertible
debentures, notes payable and warrants 1,192,563 1,118,584
Gain on sale of technology -- (75,500)
Unrealized loss on marketable securities 12,219 23,234
Common stock issued for services 14,800 --
Changes in:
Accounts receivable (2,368) (52,836)
Prepaid expenses and other assets 95,408 3,443
Accounts payable and accrued liabilities (2,103) 81,211
--------------------------------------
Net cash used in operating activities (799,601) (859,475)
--------------------------------------
Investing activities:
Proceeds from sale of technolgy -- 7,500
Purchase of property, equipment and patents -- (22,195)
--------------------------------------
Net cash used for investing activities -- (14,695)
--------------------------------------
Financing activities:
Proceeds from the issuance of short term notes payable -- 10,000
Proceeds from the issuance of convertible debentures 452,500 722,500
Proceeds from the issuance of common stock 3,250 47,040
Principal payments for capital lease obligations (3,785) (3,023)
Proceeds from sales of accounts receivable -- 21,280
Proceeds from exercise of common stock warrants 164,432 50,100
--------------------------------------
Net cash provided by financing activities 616,397 847,897
--------------------------------------
Net increase (decrease) in cash and cash equivalents (183,204) (26,273)
Cash and cash equivalents, beginning of period 355,940 32,663
--------------------------------------
Cash and cash equivalents, end of period $ 172,736 $ 6,390
======================================
Supplemental Disclosure of Cash Flow Information:
Cash payments for interest $ 2,226 $ 6,303
Convertible debentures, notes payable and accrued
interest exchanged for common stock $ 1,062,104 $ 1,268,259
Debt discount $ 452,500 $ 622,500
======================================
See accompanying summary of accounting policies and notes to unaudited
consolidated financial statements.
F-29
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-QSB 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 included in Form 10-KSB for the year ended May 31, 2004.
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
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 140,221,312 and
90,525,744 for the six months ended November 30, 2004 and 2003, 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.
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," and SFAS No. 148,
"Accounting for Stock-Based Compensation-Transition and disclosure," require 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. SFAS No. 148
also
F-30
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
provides for alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation. The
Company has elected to continue to account for stock based compensation under
APB No. 25.
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 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.
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:
Three Months Ended Six Months Ended
---------------------------- -----------------------------
November 30, November 30, November 30, November 30,
2004 2003 2004 2003
- --------------------------------------------------------- -----------------------------
Net loss as reported $(1,073,141) $ (872,790) $(2,179,592) $ 2,025,337)
Compensation expense (10,110) (64,400) (12,993) (150,074)
----------- ----------- ----------- -----------
Net loss pro forma $(1,083,251) $ (937,190) $(2,192,585) $ 2,175,411)
=========== =========== =========== ===========
As reported per share
Basic and diluted loss $ (0.01) $ (0.01) $ (0.01) $ (0.02)
=========== =========== =========== ===========
Pro forma per share
Basic and diluted loss $ (0.01) $ (0.01) $ (0.01) $ (0.02)
----------- ----------- ----------- -----------
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. Pursuant to the provisions of SFAS
No. 140, whenever we sell accounts receivable invoices to the bank, we reflect
the transactions as sales of assets and establish 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
F-31
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
retained asset. The retained amount equals 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 is based on the payment history of the
accounts receivable customer. At November 30, 2004, there were no accounts
receivable invoices outstanding under the factoring line and $400,000 was
available for future factoring of accounts receivable invoices.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In April 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149
amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SFAS No. 149 requires that contracts with comparable
characteristics be accounted for similarly. SFAS No. 149 is effective for
contracts entered into or modified after June 30, 2003, and for hedging
relationships designated after June 30, 2003. The adoption of this statement did
not impact our financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). SFAS No. 150 is effective
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003, except for mandatorily redeemable financial instruments of
nonpublic entities. The adoption of this statement did not impact our financial
position or results of operations.
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 123R ("SFAS123R"), Share-Based Payment, an amendment of FASB Statements Nos.
123 and 95. SFAS 123R eliminates the ability to account for share-based
compensation transaction using APB 25 and would require that such transactions
be accounted for using a fair-value-based method and recognized as expenses in
statement of operations. SFAS 123R allows the use of a modified version of
prospective application, which requires that the fair value of new awards
granted after the effective date of SFAS 123R, plus unvested awards at the date
of adoption, be expensed over the applicable vesting period. The provisions of
SFAS 123R will be effective for interim or annual reporting periods beginning
after December 15, 2005 for the companies that file as small business issuers.
The Company is currently evaluating the impact the implementation guidance and
revisions included in SFAS 123R will have on its consolidated financial
statements.
F-32
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 $2,179,592, $4,149,978 and $3,888,299 and negative cash
flow from operations of $799,601, $2,075,972 and $1,885,762 in the six months
ended November 30, 2004 and the years ended May 31, 2004 and 2003, respectively.
At November 30, 2004, we had working capital of $52,804 and cash and cash
equivalents of $172,736. We have historically funded our operations primarily
through the issuance of securities and debt financings. Cash and cash
equivalents decreased $183,204 during the six months ended November 30, 2004.
We estimate our current cash requirements to sustain our operations for the next
twelve months through November 2005 to be $1.8 million. Since we are no longer
supporting the communications product line, we are assuming that there will be
no communications product revenue. We have issued 8% convertible debentures as
our primary source of funding since 2002. At the option of the debenture
holders, they may purchase additional debentures up to $1 million at any time
during the two years following their purchase as long as the price of our common
stock is in excess of $0.20 per share. During the first six months ended
November 30, 2004, we obtained $452,500 from the issuance of 8% convertible
debentures and $164,432 from the exercise of warrants. Subsequent to November
30, 2004, we obtained $25,000 from the issuance of 8% convertible debentures and
$169,032 from the exercise of warrants.
If exercise of warrants are not in sufficient amounts, then we may not have
funds sufficient to meet our cash requirements. In such circumstances, we would
need to secure additional debt and/or equity financings with individual or
institutional investors. In addition, we would be required to make additional
cost reductions if our cash requirements cannot be met from external sources. We
expect that the $1.8 million requirement will be provided by:
o additional debt and/or equity financings;
o proceeds from the exercise of outstanding stock options and
warrants; and
o proceeds from revenue contracts and patent enforcement activities.
In addition, we have formulated additional cost reduction plans which can be
implemented if the required funds are not obtainable. As of November 30, 2004,
we also have remaining $400,000 under an accounts receivable factoring agreement
with our bank.
We anticipate our future revenue to be derived primarily from the sale of
licenses, royalties and the proceeds from litigation or settlements of patent
infringement cases. 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 and
to fund the expenses of protracted patent enforcement litigation. Product
introductions such as those
F-33
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
currently underway for the Ignite microprocessor 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 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
In January 2004, a note held by an affiliate for $200,353 plus accrued interest
of $8,033 was partially used to exercise a warrant with the balance of $100,000
converted into four one year $25,000 notes due September 1, 2005 issued to four
heirs of the estate over which the affiliate is a trustee. The interest rate on
the four notes is 6% and the notes are secured by the assets of the company.
5. CONVERTIBLE DEBENTURES
Overview. From April 23, 2002 through November 18, 2004, we sold an aggregate of
$5,365,667 of convertible debentures, ranging from 8% to 12%, to a group of
twenty-four 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.
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 $0.0167 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. 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
F-34
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
on the following calculation: the amount of the debenture plus any unpaid
accrued interest divided by the reset conversion price which shall equal the
volume weighted average price for our common stock for the ten days previous to
the reset date.
Warrants. Concurrent with the issuance of the convertible debentures, we issued
to the debenture holders warrants to purchase shares of our common stock. These
warrants are exercisable for five to seven years from the date of issuance at
either initial negotiated exercise prices or prices equal to 115% of the volume
weighted average price for our common stock for the ten days previous to the
debenture date. The warrant exercise price is generally subject to being reset
on each six month anniversary of its issuance, however, if the warrant holder
elects to have the warrant shares registered, then the exercise price is fixed
at the price in effect on the date of the election.
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. Except for one debenture issued on March 23, 2004, we are
responsible for registering the resale of the shares of our common stock which
will be issued on the conversion of the debentures. As of November 30, 2004,
there have been five registration statements (designated A through E).
Debentures issued from September 28, 2004 through November 18, 2004 (designated
G) have registration rights but have not been registered as of November 30,
2004.
Security Interest. The convertible debentures are secured by our assets.
F-35
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following tables present the status, as of November 30, 2004, of our
convertible debentures:
Principal Conversion Prices Effective Shares Warrant
Dates of Aggregate Balance ------------------- Registration Converted at Shares
Series Issuance Principal at 11/30/04 Initial Reset Date 11/30/04 Issued
- ------ -------- --------- ----------- ------- ----- ---- ------------ ------
A 4/23/2002- 1,000,000 $ -- 0.08616- $0.04190- 10/29/2002 24,099,548 12,859,175
6/10/2002 0.10289 $0.04457
B 8/23/2002- 605,000 $ -- 0.05126- $0.03007- 3/7/2003 14,777,350 11,234,835
1/24/2003 0.0727 $0.04722
C 3/24/2003- 510,000 $ 10,000 0.041- $0.03968- 6/26/2003 10,179,007 9,377,943
6/9/2003 0.065 $0.06346
D 8/1/2003- 547,500 $ 30,000 0.0172- $0.0172- 11/18/2003 24,353,803 22,455,355
10/21/2003 0.048 $0.0477
E 12/1/2003- 1,527,500 $ 682,000 0.0267- $0.0267- 6/7/2004 26,880,016 30,395,392
5/11/2004 0.10 $0.04105
F 3/23/2004 723,167 $ 723,167 0.09 $0.0399 Not Registered -- 8,035,192
G 9/28/2004- 452,500 $ 452,500 0.0167- $0.0167- Not Registered -- 20,481,137
11/18/2004 0.04 $0.04
-------------------------- ----------------------------
Totals $5,365,667 $1,897,667 100,289,724 114,839,029
F-36
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Convertible debentures issued since April 23, 2002 $ 5,365,667
Less amounts converted to common stock (3,468,000)
-----------
1,897,667
Less debt discount (1,375,000)
-----------
Convertible debentures at November 30, 2004 522,667
Less current portion 37,907
-----------
Long term portion $ 484,760
===========
Maturity dates of outstanding convertible debentures
April 15, 2005 $ 10,000
September 30, 2005 30,000
December 1, 2005 25,000
February 2, 2006 77,000
March 23, 2006 723,167
March 24, 2006 200,000
April 26, 2006 100,000
May 11, 2006 280,000
September 28, 2006 50,000
November 16, 2006 145,000
November 17, 2006 157,500
November 18, 2006 100,000
-----------
$ 1,897,667
-----------
6. STOCKHOLDERS' DEFICIT
The following table summarizes equity transactions during the six months ended
November 30, 2004:
Common
Shares Dollars
----------- -----------
Balance June 1, 2004 171,156,363 $49,992,197
Sale of common stock 125,000 3,250
Exercise of common stock warrants 8,083,689 164,432
Stock issued on conversion of
debentures and accrued interest 31,255,803 1,062,104
Stock issued for services 296,000 14,800
Non-cash compensation -- 22,175
Non-cash interest and debt discount
related to warrants and debentures -- 492,418
----------- -----------
Balance November 30, 2004 210,916,855 $51,751,376
=========== ===========
F-37
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
STOCK OPTIONS
At November 30, 2004, we had 50,000 options outstanding pursuant to our 1992 NSO
Stock Option Plan exercisable at $1.325 per share expiring in 2005; 1,948,000
options outstanding pursuant to our 1996 Stock Option Plan exercisable at a
range of $0.0425 to $1.325 per share expiring beginning in 2005 through 2008;
2,230,000 options outstanding pursuant to our 2001 Stock Option Plan exercisable
at a range of $0.0425 to $0.1275 per share expiring beginning in 2005 through
2008; and 2,205,000 options outstanding pursuant to our 2003 Stock Option Plan
exercisable at a range of $0.0345 to $0.11 per share expiring in 2005 through
2009.
Some of the options outstanding under these plans are not presently exercisable
and are subject to meeting vesting criteria.
WARRANTS
At November 30, 2004, we had warrants outstanding exercisable into 133,788,312
common shares at exercise prices ranging from $0.0167 to $0.65 per share
expiring beginning in 2006 through 2011. During the six months ended November
30, 2004, we issued warrants to purchase 21,282,581 shares of common stock which
are subject to repricings at the six month anniversary of the issuance of the
warrant; had investors exercise warrants to purchase 8,083,689 shares of our
common stock; and cancelled warrants to purchase 760,000 shares of our common
stock. For warrants issued in conjunction with the 8% convertible debentures, at
each anniversary date the warrants will be repriced to the lesser of the initial
exercise price or the volume weighted average price for our common stock for the
ten days previous to the reset date. For warrants issued in conjunction with the
equity lines of credit and snap shot warrants, 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 six months ended November
30, 2004, warrants to purchase 41,188,105 shares of common stock with initial or
reset exercise prices ranging from $0.0408 to $0.0938 have been repriced to
exercise prices ranging from $0.0319 to $0.0451.
During the six months ended November 30, 2004, we issued to Swartz snap shot
warrants exercisable for five years into 801,444 common shares at an exercise
price of $0.0672. The snap shot warrant was issued under an agreement with
Swartz whereby we will issue to Swartz warrants to purchase common shares equal
to 30% of any common stock or warrants we issue to parties other than Swartz or
their affiliates after April 1, 2003.
During the six months ended November 30, 2004, six warrant holders agreed to
lock up agreements which allowed us to unreserve warrants exercisable into
18,606,452 shares of our common stock until the earlier of an increase in the
authorized number of common shares or April 30, 2005. In exchange for this
agreement, we agreed to extend their warrants by two years.
F-38
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
COMMON STOCK
During the six months ended November 30, 2004, 296,000 shares of common stock
were issued to a vendor in satisfaction of $14,800 of trade accounts payable and
125,000 shares of one-year restricted common stock were sold to one individual
investor at a price of $0.026 per share for a total of $3,250.
F-39
================================================================= =================================================================
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 The Resale of
required to deliver a prospectus. This is in addition to the 47,832,555 Shares
dealers' obligation to deliver a prospectus when acting as of
underwriters and with respect to their unsold allotments or Common Stock
subscriptions. Offered by
Selling Shareholders
Table of Contents
Prospectus Summary .................................... 5
Risk Factors .......................................... 9
Plan of Distribution .................................. 16
Selling Shareholders .................................. 17
The Company ........................................... 18 PATRIOT SCIENTIFIC
Use of Proceeds ....................................... 31 CORPORATION
Litigation ............................................ 31
Management's Discussion and
Analysis of Financial Condition ....................... 32
Changes in Accountants ................................ 47
Management ............................................ 48
Principal Shareholders ................................ 53 PROSPECTUS
Certain Transactions .................................. 55
Trading Market and Related Matters 56
Description of Securities ............................. 57 Subject to Completion, January 31, 2005
Legal Matters ......................................... 58
Experts ............................................... 58
Index to Financial Statements ......................... F-1
================================================================= =================================================================
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. 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 25. 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 ........ $ 512
Printing and Engraving ....................................... 1,000*
Legal Fees and Expenses ...................................... 15,000*
Accounting Fees .............................................. 15,000*
Blue Sky Fees and Expenses ................................... 1,000*
-------
Total ............................................... $32,512*
* Estimated
ITEM 26. 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, and common stock warrants
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.
II-1
Common Stock
Purchase
Number of Aggregate 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
Lyle Armstrong August 1, 2003 $ 44,118 $ 1,500 0.03 Cash
Red Oak Inc. August 1, 2003 $ 44,118 $ 1,500 0.03 Cash
Red Oak Inc. August 20, 2003 $ 100,000 $ 3,000 0.03 Cash
REC Music Foundation August 26, 2003 $ 1,000,000 $ 25,000 0.03 Cash
Red Oak Inc. September 16, 2003 $ 64,516 $ 2,000 0.03 Cash
Dean Gullick September 23, 2003 $ 181,333 $ 5,440 0.03 Cash
Lydon Inc. September 30, 2003 $ 67,667 $ 2,000 0.03 Cash
Red Oak Inc. October 31, 2003 $ 100,000 $ 3,300 0.03 Cash
Red Oak Inc. November 25, 2003 $ 100,000 $ 3,300 0.03 Cash
Red Oak Inc. January 27, 2004 $ 100,000 $ 3,400 0.03 Cash
Hawk Associates, Inc January 5, 2004 $ 700,000 $ 30,252 0.04 Services
Hawk Associates, Inc February 3, 2004 $ 300,000 $ 14,800 0.05 Services
Hawk Associates, Inc April 21, 2004 $ 126,496 $ 14,800 0.12 Services
Hawk and Associates August 2, 2004 $ 296,000 $ 14,800 0.05 Services
Red Oak Inc October 20, 2004 $ 125,000 $ 3,250 0.03 Cash
Hawk and Associates January 10, 2005 $ 500,000 $ 44,000 0.09 Services
II-2
Warrants
Number of Initial Exercise Expiration
Name Date of Issuance Shares Price Per Share Date
- --------------------- -------------------- ---------- ----------------- -------------
Swartz Private Equity January 14, 2002 1,237,500 $ 0.05720 April 1, 2011
Swartz Private Equity January 28, 2002 825,000 $ 0.05390 April 1, 2011
Swartz Private Equity February 12, 2002 618,750 $ 0.04760 April 1, 2011
Swartz Private Equity February 15, 2002 206,250 $ 0.04510 April 1, 2011
Swartz Private Equity February 25, 2002 618,750 $ 0.04400 April 1, 2011
Swartz Private Equity March 12, 2002 1,650,000 $ 0.04840 April 1, 2011
Swartz Private Equity March 25, 2002 1,237,500 $ 0.03300 April 1, 2011
Lincoln Ventures April 23, 2002 2,514,809 $ 0.04685 April 1, 2011
Lincoln Ventures June 10, 2002 7,674,853 $ 0.06422 April 1, 2011
Charles Moore June 10, 2002 333,689 $ 0.06422 June 10, 2007
Victor Gabourel June 10, 2002 333,689 $ 0.06422 June 10, 2007
James Zolin June 10, 2002 333,689 $ 0.06422 June 10, 2007
Richard Daniels June 10, 2002 333,689 $ 0.06422 June 10, 2007
Swartz Private Equity July 1, 2002 635,318 $ 0.05400 April 1, 2011
Gloria Felcyn, TEE August 23, 2002 2,767,674 $ 0.04381 August 23, 2007
Swartz Private Equity October 1, 2002 1,294,013 $ 0.04000 April 1, 2011
Cliff Koerner October 29, 2002 448,732 $ 0.05126 October 29, 2007
Frederick Feck, Trustee October 29, 2002 560,915 $ 0.05126 October 29, 2007
Stan Caplan October 29, 2002 560,915 $ 0.05126 October 29, 2007
Dan Nunes October 29, 2002 280,458 $ 0.05126 October 29, 2007
Leo Correia October 29, 2002 280,458 $ 0.05126 October 29, 2007
Victor Gabourel October 29, 2002 560,915 $ 0.05126 October 29, 2007
Richard Daniels October 29, 2002 560,915 $ 0.05126 October 29, 2007
Cliff Koerner October 29, 2002 560,915 $ 0.05126 October 29, 2007
James Zolin October 29, 2002 224,366 $ 0.05126 October 29, 2007
Lincoln Ventures December 16, 2002 1,428,571 $ 0.06233 April 1, 2011
Swartz Private Equity January 1, 2003 2,804,719 $ 0.05400 April 1, 2011
Lincoln Ventures January 24, 2003 3,000,000 $ 0.05444 April 1, 2011
Lincoln Ventures March 24, 2003 3,963,414 $ 0.04100 April 1, 2011
Swartz Private Equity April 1, 2003 621,512 $ 0.04080 April 1, 2011
Lincoln Ventures April 15, 2003 222,222 $ 0.04500 April 1, 2011
Lincoln Ventures May 20, 2003 2,884,615 $ 0.06500 April 1, 2011
Lincoln Ventures June 9, 2003 2,307,692 $ 0.06500 April 1, 2011
Hawk Associates June 16, 2003 200,000 $ 0.06000 June 16, 2008
Swartz Private Equity July 1, 2003 193,333 $ 0.05720 April 1, 2011
James Zolin August 1, 2003 520,833 $ 0.04800 August 1, 2008
Victor Gabourel August 1, 2003 520,833 $ 0.04800 August 1, 2008
Richard Daniels August 1, 2003 520,833 $ 0.04800 August 1, 2008
Lincoln Ventures October 21, 2003 2,142,857 $ 0.03500 April 1, 2011
II-3
Number of Initial Exercise Expiration
Name Date of Issuance Shares Price Per Share Date
- --------------------- -------------------- ---------- ----------------- -------------
Swartz Private Equity October 1, 2003 1,557,653 $ 0.04360 April 1, 2011
Charles Merk December 1, 2003 641,026 $ 0.03900 December 1, 2008
Swartz Private Equity January 1, 2004 3,051,299 $ 0.04600 April 1, 2011
Lincoln Ventures LLC January 23, 2004 10,311,211 $ 0.02667 April 1, 2011
Stan Caplan February 2, 2004 375,000 $ 0.04000 February 2, 2009
Wayne Opperman February 2, 2004 1,250,000 $ 0.04000 February 2, 2009
James Gamble February 2, 2004 125,000 $ 0.04000 February 2, 2009
Steven Pratt February 2, 2004 250,000 $ 0.04000 February 2, 2009
Donald Opperman February 2, 2004 250,000 $ 0.04000 February 2, 2009
Gary Leikam February 2, 2004 125,000 $ 0.04000 February 2, 2009
Adnan Aladray February 2, 2004 250,000 $ 0.04000 February 2, 2009
Nazeah Aladray February 2, 2004 125,000 $ 0.04000 February 2, 2009
LaRiccia Trust February 2, 2004 250,000 $ 0.04000 February 2, 2009
James & Josephine Zolin February 2, 2004 750,000 $ 0.04000 February 2, 2009
James Zolin February 2, 2004 125,000 $ 0.04000 February 2, 2009
Victor Gabourel February 2, 2004 625,000 $ 0.04000 February 2, 2009
Ed Kashou February 2, 2004 500,000 $ 0.04000 February 2, 2009
Ed Kashou February 2, 2004 1,000,000 $ 0.04000 February 2, 2009
Dan Vincent February 2, 2004 125,000 $ 0.04000 February 2, 2009
Richard Daniels February 2, 2004 750,000 $ 0.04000 February 2, 2009
Stan Caplan February 2, 2004 750,000 $ 0.04000 February 2, 2009
Barbara Opperman February 2, 2004 250,000 $ 0.04000 February 2, 2009
Leo Correia February 2, 2004 250,000 $ 0.04000 February 2, 2009
Swartz Private Equity March 23, 2004 8,035,192 $ 0.09000 April 1, 2011
Lincoln Ventures LLC March 24, 2004 3,366,727 $ 0.09383 April 1, 2011
Swartz Private Equity April 1, 2004 5,240,211 $ 0.08090 April 1, 2009
Mt. Savage Productions April 26, 2004 1,000,000 $ 0.10000 April 26, 2009
Lincoln Ventures LLC May 11, 2004 6,951,428 $ 0.07000 April 1, 2011
Swartz Private Equity July 1, 2004 801,444 $ 0.06720 July 1, 2009
Wayne Opperman September 28, 2004 1,250,000 $ 0.04000 September 28, 2009
Wayne Opperman November 16, 2004 1,600,000 $ 0.02500 November 16, 2011
James & Josephine Zolin November 16, 2004 1,600,000 $ 0.02500 November 16, 2011
Victor Gabourel November 16, 2004 1,600,000 $ 0.02500 November 16, 2011
Richard Daniels November 16, 2004 1,000,000 $ 0.02500 November 16, 2011
Lincoln Ventures LLC November 17, 2004 9,431,137 $ 0.01670 April 1, 2011
Lincoln Ventures LLC November 18, 2004 4,000,000 $ 0.02500 April 1, 2011
Stan Caplan December 9, 2004 806,452 $ 0.03100 December 9, 2011
Daniel Nunes January 17, 2005 403,226 $ 0.03100 January 17, 2012
ITEM 27. 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.
II-4
ITEM 28. 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.
(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.
II-5
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements of filing on Form SB-2 and authorized this registration
statement to be signed on its behalf by the undersigned, in the City of San
Diego, State of California, on January 31, 2005
PATRIOT SCIENTIFIC CORPORATION
By: /s/ LOWELL W. GIFFHORN
-------------------------------
Lowell W. Giffhorn
Executive Vice President, Chief
Financial Officer, Secretary and
Director
In accordance with the requirements of the Securities Act of 1933, this
registration statement was signed by the following persons in the capacities and
on the dates stated:
Signature Title Date
--------- ----- ----
/s/JEFFREY E. WALLIN President and Chief Executive January 31, 2005
- -------------------- Officer
Jeffrey E. Wallin
/s/LOWELL W. GIFFHORN Chief Financial Officer, Principal January 31, 2005
- --------------------- Financial Officer, Principal
Lowell W. Giffhorn Accounting Officer, Secretary
and Director
/s/DAVID POHL Director January 31, 2005
- -------------
David Pohl
/s/CARLTON JOHNSON Director January 31, 2005
- --------------------------
Carlton Johnson
/s/HELMUT FALK JR. Director January 31, 2005
- ------------------
Helmut Falk Jr.
/s/GLORIA H. FELCYN Director January 31, 2005
- -------------------
Gloria H. Felcyn
II-6
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM SB-2
Registration Statement
Under The Securities Act of 1933
EXHIBITS
PATRIOT SCIENTIFIC CORPORATION
(Exact name of registrant as specified in its charter)
II-7
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, among (1)
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 Financial (1)
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 Colorado (1)
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 Secretary (1)
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
II-8
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
3.3.5 Certificate of Amendment to the Certificate of Incorporation of the Company, as (1)
filed with the Delaware Secretary of State on October 16, 2003, incorporated by
reference to Exhibit 3.3.5 to Registration Statement on Form SB-2 dated May 21,
2004+B96
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, 1992, (1)
incorporated by reference to Exhibit 3.5 to Form 8-K dated May 12, 1992
3.6 Certificate of Merger issued by the Colorado Secretary of State on May 12, 1992, (1)
incorporated by reference to Exhibit 3.6 to Form 8-K dated May 12, 1992
3.7 Bylaws of the Company, incorporated by reference to Exhibit 3.7 to Form 8-K dated (1)
May 12, 1992
4.0 INSTRUMENTS ESTABLISHING RIGHTS OF SECURITY HOLDERS.
4.1 Specimen common stock certificate, incorporated by reference to Exhibit 4.1 Form (1)
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
II-9
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 CC (1)
Investments, LDC and the Matthew Fund, N.V. related to the registration of the
common stock related to Exhibits 4.4 and 4.5 incorporated by reference to Exhibit
4.6 to Form 8-K dated June 16, 1997
4.7 Form of Warrant to Purchase Common Stock (Swartz Family Partnership, L.P.) dated (1)
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 (1)
Swartz Investments, LLC related to the registration of the common stock related to
Exhibit 4.7 incorporated by reference to Exhibit 4.8 to Form 8-K dated June 16,
1997
4.9 Form of 5% Convertible Term Debenture (CC Investments, LDC) due June 2, 1999 (1)
aggregating $1,000,000 to two investors incorporated by reference to Exhibit 4.9
to Form 10-KSB for the fiscal year ended May 31, 1998
4.10 Form of Stock Purchase Warrant (CC Investments, LDC) dated November 24, 1997 (1)
exercisable to purchase an aggregate of 200,000 common shares at $1.50 per share
until June 2, 2002, granted to two investors in connection with the offering of
securities described in Exhibit 4.9 incorporated by reference to Exhibit 4.10 to
Form 10-KSB for the year ended May 31, 1998
4.11 Form of Warrant to Purchase Common Stock (Swartz Family Partnership, L.P.) dated (1)
November 24, 1997 exercisable to purchase an aggregate of 105,867 common shares at
$1.50 per share until June 2, 2002, granted to a group of investors in connection
with the offering of securities described in Exhibit 4.9 incorporated by reference
to Exhibit 4.11 to Form 10-KSB for the year ended May 31, 1998
4.12 Form of Warrant to Purchase Common Stock (Investor Communications Group, Inc.) (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
II-10
4.14 Investment agreement dated February 24, 1999 by and between the Company and Swartz (1)
Private Equity, LLC for a maximum aggregate amount of $5,000,000 incorporated by
reference to Exhibit 4.14 to Form 10-QSB/A for the fiscal quarter ended November
30, 1998
4.15 Registration Rights Agreement dated February 24, 1999 by and between the Company (1)
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 the (1)
Company and Swartz Private Equity, LLC for a maximum aggregate amount of
$5,000,000 incorporated by reference to Exhibit 4.17 to Pre-Effective Amendment
No. 2 to Registration Statement on Form SB-2 dated July 14, 1999
4.18 Investment Agreement dated April 28, 2000 by and between the Company and Swartz (1)
Private Equity, LLC for a maximum aggregate amount of $30,000,000 incorporated by
reference to Exhibit 4.18 to Registration Statement on Form S-3 dated May 5, 2000
4.18.1 Waiver and Agreement dated September 24, 2001 amending the Investment Agreement (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
4.21 Registration Rights Agreement dated September 17, 2001 by and between the Company (1)
and Swartz Private Equity, LLC related to the registration of the common stock
related to Exhibit 4.20 incorporated by reference to Exhibit 4.21to Registration
Statement on Form S-1 dated October 11, 2001
4.22 Warrant to Purchase Common Stock dated September 17, 2001 exercisable to purchase (1)
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 Riley, (1)
Randall Letcavage and Rosemary Nguyen incorporated by reference to Exhibit 4.23 to
Registration Statement on Form S-8 dated January 22, 2002
II-11
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) dated June 10, 2002 (1)
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
4.27 2003 Stock Option Plan of the Company dated July 2, 2003 incorporated by reference (1)
to Exhibit 4.27 to Registration Statement on Form S-8 dated September 4, 2003
4.28 Form of 8% Convertible Debenture, Stock Purchase Warrant, Registration Rights (2)
Agreement and Securities Purchase Agreement for financings entered into between
September 28, 2004 and January 17, 2005
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, incorporated (1)
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 to (1)
Exhibit 10.2 to Form 8-K dated May 12, 1992
10.2.1 Amendment to 1992 Non-Statutory Stock Option Plan dated January 11, 1995 (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 Clar-O-Wood (1)
Partnership, a California limited partnership dated April 11, 1991 as amended
November 11, 1992 and November 2, 1995 incorporated by reference to Exhibit 10.3
to Form 10-KSB for fiscal year ended May 31, 1997
10.4 Stock Purchase Agreement dated November 29 and 30, 1995, between the Company and (1)
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 the (1)
Company and SEA, Ltd., incorporated by reference to Exhibit 10.4.1 to Form 10-QSB
for fiscal quarter ended 2/29/96
II-12
10.5 1995 Employee Stock Compensation Plan of the Company, incorporated by reference to (1)
Exhibit 10.5 to Form 10-QSB for fiscal quarter ended 11/30/95
10.6 Letter Stock and Warrant Agreement dated January 10, 1996 between the Company and (1)
Robert E. Crawford, Jr., incorporated by reference to Exhibit 10.6 to Form 10-QSB
for fiscal quarter ended February 29, 1996
10.7 Non-Exclusive Manufacturing and Line of Credit Agreement dated February 28, 1996, (1)
between the Company and Labway Corporation, incorporated by reference to Exhibit
10.7 to Form 10-QSB for fiscal quarter ended February 29, 1996
10.8 Distribution and Representation Agreement dated February 28, 1996, between the (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 and (1)
Elwood G. Norris, incorporated by reference to Exhibit 10.9.1 to Pre-Effective
Amendment No. 2 to Registration Statement on Form SB-2 dated May 23, 1996
10.10 Employment Agreement dated November 20, 1995 between the Company and Robert (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
10.11.1 Two Year Stock Purchase Warrant dated March 19, 1996 Granted to Evolve Software, (1)
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
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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. Lunney (1)
incorporated by reference to Exhibit 10.19 to Form 10-KSB for the fiscal year
ended May 31, 1998
10.20 Employment Agreement dated July 28, 1997 between the Company and Phillip Morettini (1)
incorporated by reference to Exhibit 10.20 to Form 10-KSB for the fiscal year
ended May 31, 1998
10.21 Employment Agreement dated July 23, 1998 between the Company and Lowell W. (1)
Giffhorn incorporated by reference to Exhibit 10.21 to Form 10-KSB for the fiscal
year ended May 31, 1998
10.22 Secured Promissory Note dated June 12, 2000 between the Company and James T. (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
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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. Pohl (1)
incorporated by reference to Exhibit 10.28 to Form 10-KSB for the fiscal year
ended May 31, 2001
10.29 Employment Agreement dated April 26, 2001 between the Company and David H. Pohl (1)
incorporated by reference to Exhibit 10.29 to Form 10-KSB for the fiscal year
ended May 31, 2001
10.30 Employment Agreement dated November 17, 2001 between the Company and Lowell W. (1)
Giffhorn incorporated by reference to Exhibit 10.30 to Registration Statement on
Form S-3 dated June 27, 2002
10.31 Employment Agreement dated December 20, 2001 between the Company and Jayanta (1)
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 and SDMC, Inc. (1)
incorporated by reference to Exhibit 10.32 to Registration Statement on Form S-3
dated June 27, 2002
10.33 Employment Agreement dated January 2, 2004 between the Company and Jayanta Maitra (1)
incorporated by reference to Exhibit 10.33 to Registration Statement on Form SB-2
dated May 21, 2004
10.34 Consulting Agreement dated March 18, 2004 between the Company and SDMC, Inc. (1)
incorporated by reference to Exhibit 10.34 to Registration Statement on Form SB-2
dated May 21, 2004
10.35 Employment Agreement dated June 1, 2004 between the Company and Patrick Nunally (1)
incorporated by reference to Exhibit 10.35 to Form 10-K for the fiscal year ended
May 31, 2004
10.36 Amendment No. 1 to Employment Agreement dated July 12, 2004 between the Company (1)
and Patrick Nunally
10.37 Employment Agreement dated September 1, 2004 between the Company and Lowell W. (2)
Giffhorn
14.0 CODE OF ETHICS.
14.1 Code of Ethics for Senior Financial Officers incorporated by reference to Exhibit (1)
14.1 to Form 10-K for the fiscal year ended May 31, 2003
21.0 SUBSIDIARIES OF THE SMALL BUSINESS ISSUER.
21.1 Subsidiaries of the small business issuer incorporated by reference to Exhibit (1)
21.1 to Form 10-K for the fiscal year ended May 31, 2004
23.0 CONSENTS OF EXPERTS AND COUNSEL.
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23.1 Consent of Nation Smith Hermes Diamond, LLP independent registered certified (2)
public accounting firm
99.0 ADDITIONAL EXHIBITS.
99.1 Form of ISO Plan Option (Gaspar) dated May 29, 1992, incorporated by reference to (1)
Exhibit 28.2 to registration statement on Form SB-2, file no. 33-57858
99.2 Form of NSO Plan Option (Berlin) dated May 29, 1992, incorporated by reference to (1)
Exhibit 28.3 to registration statement on Form SB-2, file no. 33-57858
99.3 Form of Incentive Stock Option Agreement to the Company's 1996 Stock Option Plan (1)
(individual agreements differ as to number of shares, dates, prices and vesting),
incorporated by reference to Pre-Effective Amendment No. 2 to Registration
Statement on Form SB-2 dated May 23, 1996
99.4 Form of NonQualified Stock Option Agreement to the Company's 1996 Stock Option (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 reference to (1)
Exbibit 99.5 to Form 8-K dated January 9, 1997
99.6 Form of Incentive Stock Option Agreement to the Company's 2001 Stock Option Plan (1)
incorporated by reference to Exhibit 99.6 to Registration Statement on Form S-8
filed March 26, 2001
99.7 Form of Non-Qualified Stock Option Agreement to the Company's 2001 Stock Option (1)
Plan incorporated by reference to Exhibit 99.7 to Registration Statement on Form
S-8 filed March 26, 2001
99.8 Form of Incentive Stock Option Agreement to the Company's 2003 Stock Option Plan (1)
incorporated by reference to Exhibit 99.8 to Registration Statement on Form S-8
filed September 4, 2003
99.9 Form of Non-Qualified Stock Option Agreement to the Company's 2003 Stock Option (1)
Plan incorporated by reference to Exhibit 99.9 to Registration Statement on Form
S-8 filed September 4, 2003
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(1) Previously filed in indicated registration statement or report.
(2) Exhibit filed herewith this Registration Statement on Form SB-2.
(b) Reports on Form 8-K - A report on Form 8-K was filed on December 22,
2004, related to the resignation of a director and chairman of the
board.
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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.
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