UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
      D.C. 20549





**FORM
      10-K**


(Mark
      One)




[X]
            ANNUAL
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                EXCHANGE ACT OF 1934





For
      the
      fiscal year ended May 31, 2007




[_]
            TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                EXCHANGE ACT OF 1934





For
      the
      transition period from ___________ to _______________




Commission
      File Number 0-22182




**PATRIOT
      SCIENTIFIC CORPORATION**


(Exact
      name of registrant as specified in its charter)





Delaware
              (State
                or other jurisdiction ofincorporation
                or organization)
            84-1070278
              (I.R.S.
                Employer Identification No.)





6183
                Paseo Del Norte, Suite 180, Carlsbad, California
              (Address
                of principal executive offices)
            92011
              (Zip
                Code)





(Registrant’s
      telephone number, including area code): (760) 547-2700





Securities
      registered pursuant to Section 12(b) of the Act: NONE





Securities
      registered pursuant to Section 12(g) of the Act:





Common
      Stock, $.00001 par value


___________________


(Title
      of
      Class)





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act. YES [  ]  NO [X]




Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act. YES [  ]  NO [X]




Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
      during the preceding 12 months (or for such shorter period that the registrant
      was required to file such reports), and (2) has been subject to such filing
      requirements for the past 90 days. YES [X ]  NO [  ]




Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K ( §229.405
      of this chapter) is not contained herein, and will not be contained, to the best of registrant’s
      knowledge, in definitive proxy or information statements incorporated by
      reference in Part III of this Form 10-K or any amendment to this Form 10-K.
      [  ]




Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
      one):




Large
      accelerated filer  [ 
      ]       Accelerated
      filer
      [X]  Non-accelerated
      filer  [
       ]





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). YES [  ]  NO [X]




Aggregate
      market value of voting and non-voting common equity held by non-affiliates
      of
      the registrant on November 30, 2006 was $242,123,060 based on a closing price
      of
      $0.63 as reported on the OTC Electronic Bulletin Board system.




On
      August
      9, 2007, 389,045,744 shares of common stock, par value $.00001 per share (the
      issuer’s only class of voting stock) were outstanding.




**DOCUMENTS
      INCORPORATED BY REFERENCE**




Certain
      information required to be disclosed in Part III of this report is
      incorporated by reference from the registrant’s definitive Proxy Statement for
      the 2007 annual meeting of shareholders, which will be held in October 2007
      and
      which proxy statement will be filed not later than 120 days after the end
      of the fiscal year covered by this report.








**Table
      of Contents**




**PART
                I**
            
            
            **2**ITEM
                1.
            Business
            2ITEM
                1A.
            Risk
                Factors
            6ITEM
                1B.
            Unresolved
                Staff Comments
            9ITEM
                2.
            Properties
            9ITEM
                3.
            Legal
                Proceedings
            9ITEM
                4.
            Submission
                of Matters to a Vote of Security Holders
            10**PART
                II**
            
            
            **11**ITEM
                5.
            Market
                for Registrant’s Common Equity, Related Stockholder Matters and Issuer
                Purchases of Equity Securities
            11ITEM
                6.
            Selected
                Financial Data
            14ITEM
                7.
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            15ITEM
                7A.
            Quantitative
                and Qualitative Disclosures About Market Risk
            24ITEM
                8.
            Financial
                Statements and Supplementary Data
            24ITEM
                9.
            Changes
                in and Disagreements with Accountants on Accounting and Financial
                Disclosure
            24ITEM
                9A.
            Controls
                and Procedures
            24ITEM
                9B.
            Other
                Information
            28**PART
                III**
            
            
            **28**ITEM
                10.
            Directors,
                Executive Officers and Corporate Governance
            28ITEM
                11.
            Executive
                Compensation
            28ITEM
                12.
            Security
                Ownership of Certain Beneficial Owners and Management and Related
                Stockholder Matters
            28ITEM
                13.
            Certain
                Relationships and Related Transactions, and Director
                Independence
            28ITEM
                14.
            Principal
                Accounting Fees and Services
            28**PART
                IV**
            
            
            **29**ITEM
                15.
            EXHIBITS,
                FINANCIAL STATEMENT SCHEDULES
            29







CAUTIONARY
      NOTE REGARDING FORWARD-LOOKING STATEMENTS




This
      Annual Report on Form 10-K, including all documents incorporated by reference,
      includes “forward-looking” statements within the meaning of Section 27A of
      the Securities Act and Section 21E of the Exchange Act and the Private
      Securities Litigation Reform Act of 1995, and we rely on the “safe harbor”
provisions in those laws. Therefore, we are including this statement for the
      express purpose of availing ourselves of the protections of such safe harbor
      with respect to all of such forward-looking statements. The forward-looking
      statements in this report reflect our current views with respect to future
      events and financial performance. These forward-looking statements are subject
      to certain risks and uncertainties, including specifically: the uncertainty
      of
      the effect of pending legislation, 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 report, the words
“anticipates,” “believes,” “expects,” “intends,” “future” and similar
      expressions identify certain of the forward-looking statements. Readers are
      cautioned not to place undue reliance on these forward-looking statements,
      which
      speak only as of the date made. We undertake no obligation to publicly release
      the result of any revision of these forward-looking statements to reflect events
      or circumstances after the date they are made or to reflect the occurrence
      of
      unanticipated events.




1


**PART
      I**




**ITEM
      1.**  **BUSINESS**




**The
      Company**




Patriot
      Scientific Corporation (“Patriot Scientific”, “Patriot” or “the Company”) has
      developed a number of innovative technologies throughout its 20-year history.
      We
      are primarily an intellectual-property licensing company with several patents
      (described below) covering the design of microprocessor chips. Chips with
      Patriot’s patented technology are used throughout the world in products ranging
      from computers and cameras to printers and industrial devices.





Our
      current business strategy is to commercialize our patented microprocessor
      technologies through broad and open licensing and to litigate against those
      who
      may be infringing on our patents. We also sell Patriot-branded microprocessor
      chips from our existing inventory of products. O ur
      business address is 6183 Paseo del Norte, Suite 180, Carlsbad, California
      92011; our main telephone number is (760) 547-2700. Our internet website page
      is
      located at http://www.ptsc.com. All of our reports filed or furnished pursuant
      to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended
      (the “Exchange Act”), are available free of charge on our internet
      website.





Incorporation
      History .
      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. In 1997, we acquired Metacomp
      Inc, a developer and manufacturer of networking and communications devices.
      In
      June 2005, we entered into a joint venture agreement with Technology Properties
      Limited, Inc. (“TPL”) to form Phoenix Digital Solutions, LLC. During February of
      2007, we acquired the preferred stock of Scripps Secured Data, Inc., a Carlsbad
      company that develops and manufactures network-security hardware to government,
      military, and other high-security facilities.







**Our
      Technology**




General
      Background .
      Throughout our history, Patriot Scientific has developed a number of innovative
      technologies for a variety of industries. We’re best known for our
      microprocessors, including the ShBoom, Ignite, and PSC-1000 families of chips,
      and for the Moore Microprocessor Patent (MMP) portfolio of intellectual property
      surrounding them. These chips and their underlying innovations were created
      through a combination of in-house development and acquired
      technology.




Patriot
      Scientific purchased the assets of nanoTronics (an Oregon corporation),
      including certain microprocessor technologies, on May 31, 1994. Earlier,
      nanoTronics had acquired technology for an advanced microprocessor integrated
      on
      a single chip and had fabricated a first-generation device. We used this
      technology to develop a sophisticated yet low-cost microprocessor by enhancing
      the original design, adding additional technical features to modernize it,
      and
      improving and testing the new microprocessor. This chip became the
      PSC-1000.




We
      fabricated a prototype in 0.8-micron CMOS technology in May 1996. The next
      generation was a 0.5-micron microprocessor, delivered in September 1997.
      The 0.5-micron version was used in demonstrations to prospective customers
      and
      was sold to customers as an embedded microprocessor. In 1998 we introduced
      a
      0.35-micron version of the microprocessor (the PSC-1000A) that was smaller
      in
      size but higher in performance.




In
      September of 2000 we completed a synthesizable VHDL model of our
      microprocessor (called Ignite-1), an important step that enabled customers
      to
      include the design of our microprocessor with other parties’ silicon designs to
      arrive at a custom system-on-chip (SoC) solution. By licensing this software
      model, customers could significantly reduce their time to market by simulating
      results instead of relying on trial-and-error commitments to silicon production.
      In 2003 we further reduced the size of our silicon design to leading-edge
      0.18-micron geometry.


2


Industry
      Background .
      The
      global semiconductor (or silicon “chip”) market has many segments and
      categories. The best-known - and most profitable - of these is the
      microprocessor segment. Microprocessor chips are the “brains” of nearly every
      electronic and electrical device throughout the world. Although microprocessors
      are often closely associated with personal computers, PCs account for only
      2% of
      the microprocessor chips made and sold every year. The vast majority of
      microprocessors are used in everyday items like automobiles, digital cameras,
      cell phones, video game players, data networks, industrial flow-control valves,
      sensors, medical devices, weapons, home appliances, robots, security systems,
      televisions, and much more. These “embedded microprocessors” (so called because
      they’re embedded into another product) are far more ubiquitous than the chips
      inside personal computers. It is this huge and growing market that Patriot
      Scientific’s technology serves.




Patent
      Description .
      Over
      the years we’ve developed a number of innovative technologies that have been
      embodied in our own products and, through licensing, into other companies’
products. Many of these patented technologies are available as a bundle under
      the MMP portfolio. The MMP portfolio includes several U.S. patents as well
      as
      their European and Japanese counterparts. Some highlights of the patent
      portfolio are:




●
            US
                5,809,336. The ’336 patent covers an early and seminal approach to making
                microprocessor chips go faster. It allows the “core” of the microprocessor
                to run at a different speed (usually faster) than the rest of the
                chip.
                There are many advantages to this, including higher performance,
                lower
                power consumption, and simpler
                manufacturing.




●
            US
                5,784,584. The ’584 patent covers an important method for a microprocessor
                chip to fetch multiple instructions at once. Like speed reading,
                multiple-instruction fetch allows a chip to get more done in less
                time - a
                valuable technique.




●
            US
                6,598,148. The ’148 patent describes on-chip oscillators (clocks) and
                covers multi-core and multi-processor implementations - important
                factors
                in today’s high-end microprocessor chips.




**Our
      Partners**




Phoenix
      Digital Solutions .
      On
      June 7, 2005, we entered into a Master Agreement (the “Master Agreement”)
      with Technology Properties Limited Inc., a California corporation (“TPL”), and
      Charles H. Moore, an individual (“Moore” and together with us and TPL, the
“Parties”). We, TPL and Moore were parties to certain lawsuits filed by us
      alleging infringement (the “Infringement Litigation”) of our Microprocessor
      Patents and a lawsuit also filed by us alleging claims for declaratory judgment
      for determination and correction of inventorship of the Microprocessor Patents
      (the “Inventorship Litigation”). The transactions described in the Master
      Agreement and related agreements (the “Transactions”) included the settlement or
      dismissal of the Inventorship Litigation.




Pursuant
      to the Master Agreement we agreed with TPL and Moore as follows:




●
            We
                entered into a patent license agreement (the “Intel License”) with Intel
                Corporation (“Intel”) pursuant to which we licensed certain rights in the
                Microprocessor Patents to Intel.




●
            We
                entered into an Escrow Agreement along with TPL pursuant to which
                the
                proceeds arising from the Intel License were allocated for the benefit
                of
                us and TPL. Pursuant to the Escrow Agreement, our initial capitalization
                obligations and those of TPL with regard to Phoenix Digital Solutions,
                LLC
                (defined below) were satisfied, our payment obligations and those
                of TPL
                with regard to the Rights Holders (defined below) were made, we received
                $6,672,349, and the remaining proceeds were allocated to or for the
                benefit of TPL.




●
            We
                caused certain of our respective interests in the Microprocessor
                Patents
                to be licensed to Phoenix Digital Solutions, LLC a limited liability
                company owned 50% by us and 50% by
                TPL.




●
            Phoenix
                Digital Solutions, LLC engaged TPL to commercialize the Microprocessor
                Patents pursuant to a Commercialization Agreement among Phoenix Digital
                Solutions, LLC, TPL and us (the “Commercialization
                Agreement”).




3


●
            We
                paid $1,327,651 and TPL paid $1,000,000 to certain holders of rights
                in
                the Microprocessor Patents (“Rights Holders”) in exchange for the release
                of such Rights Holders to the
                Transactions.




●
            We
                agreed with TPL and Moore to settle or cause to be dismissed all
                litigation pursuant to a stipulated final judgment, including the
                Inventorship Litigation.




●
            We
                issued warrants to TPL to acquire shares of our common stock. 1,400,000
                warrants were exercisable upon issue; 700,000 warrants were exercisable
                when our common stock traded at $0.50 per share; an additional 700,000
                warrants were exercisable when our common stock traded at $0.75 per
                share;
                and an additional 700,000 warrants were exercisable when our common
                stock
                traded at $1.00 per share. As of the date of this filing, all of
                the
                common stock trading prices have been met, causing TPL to be fully
                vested
                in all 3,500,000 of the above
                warrants.




●
            We
                agreed with TPL and Moore to indemnify each other for, among other
                things,
                any inaccuracy or misrepresentation to any representation or warranty
                contained in the Master Agreement, any breach of the Master Agreement,
                certain liabilities relating to the respective interests of each
                of us in
                the Microprocessor Patents and the Transactions, and certain tax
                liabilities.




Pursuant
      to the Commercialization Agreement, Phoenix Digital Solutions, LLC granted
      to
      TPL the exclusive right to grant licenses and sub-licenses of the Microprocessor
      Patents and to pursue claims against violators of the Microprocessor Patents,
      in
      each case, on behalf of Phoenix Digital Solutions, LLC, us, TPL and Moore,
      and
      TPL agreed to use reasonable best efforts to commercialize the Microprocessor
      Patents in accordance with a mutually agreed business plan. Pursuant to the
      Commercialization Agreement, Phoenix Digital Solutions, LLC agreed to reimburse
      TPL’s expenses incurred in connection with the commercialization of the
      Microprocessor Patents. All proceeds generated by TPL in connection with the
      commercialization of the Microprocessor Patents will be paid directly to Phoenix
      Digital Solutions, LLC.




Pursuant
      to the Master Agreement, we and TPL have entered into the Limited Liability
      Company Operating Agreement of Phoenix Digital Solutions, LLC (“LLC Agreement”).
      We and TPL each own 50% of the membership interests of Phoenix Digital
      Solutions, LLC, and each have the right to appoint one member of the three
      (3) member management committee. The two (2) appointees are required
      to select a mutually acceptable third member of the management committee.
      Pursuant to the LLC Agreement, we and TPL must each contribute to the working
      capital of Phoenix Digital Solutions, LLC (in addition to the Microprocessor
      Patent licenses described above), and are obligated to make future contributions
      in equal amounts in order to maintain a working capital fund. The LLC Agreement
      provides that Phoenix Digital Solutions, LLC shall indemnify its members,
      managers, officers and employees to the fullest extent permitted by applicable
      law, for any liabilities incurred as a result of their involvement with Phoenix
      Digital Solutions, LLC, if the person seeking indemnification acted in good
      faith and in a manner reasonably believed to be in the best interest of Phoenix
      Digital Solutions, LLC.




Scripps
      Secured Data, Inc. On March
      27, 2007 we entered into a revolving line of credit with Scripps Secured Data,
      Inc. (SSDI), a company that manufactures products that protect information
      and
      data transmitted over secured networks. Previously, we maintained an
      unconsolidated equity investment in SSDI. We determined that the line of credit
      transaction caused us to become the primary beneficiary under the Financial
      Accounting Standards Board’s (FASB) guidance in Interpretation No. 46 as amended
      (FIN46R), *Consolidation
      of Variable Interest Entities* .
      Under
      FIN46(R) we are required to consolidate variable interest entities for which
      we
      are deemed to be the primary beneficiary.




SSDI
      is
      an operating segment of our business. Refer to footnote 14 of our consolidated
      financial statements for disclosures about this operating segment.




**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.


4


We
      have
      seven U.S. patents issued dating back to 1989 on our microprocessor technology
      (the “Microprocessor Patents”). We have one microprocessor technology patent
      issued in five European countries and one patent issued in Japan. We may file
      additional applications under international treaties depending on an evaluation
      of the costs and anticipated benefits that may be obtained by expanding possible
      patent coverage. In addition, we have one U.S. patent issued on
      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 we have claims against numerous companies that use semiconductors in
      their products. In December 2003, we initiated legal actions against five
      companies to enforce our patents. We subsequently dismissed that litigation
      in
      2005, at which time legal action was initiated by TPL against four of these
      companies to enforce the patents in our portfolio. All but two of these
      companies, and selected subsidiaries of a third company, involved in the
      litigation we originated have subsequently purchased licenses through Phoenix
      Digital Solutions, LLC and have been excluded from the litigation currently
      pending. There can be no assurance that we will be successful in enforcing
      any
      potential patent claims against these or other companies. See the section
      entitled “Legal Proceedings” for more information.




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.




In
      November, 2004, we filed a patent application for “Remote Power Charging of
      Electronic Devices” with assignment to Patriot Scientific Corporation.




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**




We
      do not
      currently actively market the microprocessor chips in our Ignite product line,
      although we continue to sell a limited number of chips from our remaining
      inventory. All of our sales for fiscal years ended May 31, 2007, 2006 and
      2005 were to domestic customers.




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 materially affect our
      operations.


5


**Dependence
      Upon Single Customers**




Ten
      percent (10%) or more of our consolidated product sales were derived from
      shipments to the following customers for the fiscal years ended May 31 as
      follows:




2007
            2006
            2005AMD
                License
            -----
            -----
            $2,956,250Space
                and Naval Warfare Systems
            -----
            $262,500
            -----Anixter
            $461,494
            -----
            -----





We
      had no
      backlog orders as of May 31, 2007, 2006 or 2005.




Most
      of
      our net income for the years ended May 31, 2007 and 2006, was attributable
      to
      our equity in the earnings of our unconsolidated affiliate, Phoenix Digital
      Solutions, LLC.




**Government
      Regulation** **and Environmental Compliance**




We
      believe our products are not subject to governmental regulation by any federal,
      state or local agencies that would materially 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 do not know what
      sort
      of regulations of this type may be imposed in the future, but we do not
      anticipate any unusual difficulties in complying with governmental regulations
      which may be adopted in the future.




We
      have
      not incurred any material costs associated with compliance with environmental
      laws and do not anticipate such laws will have any material effect on our future
      business. ****




**Research
      and Development**




We
      did
      not incur research and development expenditures for our fiscal year ended May
      31, 2007. We incurred research and development expenditures of $225,565 and
      $294,735 for our fiscal years ended May 31, 2006 and 2005, respectively.
      The majority of these expenditures have been devoted to our microprocessor
      technology. As our primary business strategy is to enforce our intellectual
      property patents through licensing, we do not anticipate material expenditures
      relating to research and development in the near future.




**Employees**




We
      currently have nineteen employees, five of which are Patriot Scientific
      Corporation employees. All Patriot employees are full time and are employed
      in
      general and administrative activities. We also engage additional consultants
      and
      part-time persons, as needed.




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


6


**ITEM
        1A.**  **RISK
        FACTORS**
 
 We
        urge
        you to carefully consider the following discussion of risks as well as other
        information contained in this Form 10-K. We believe the following to be our
        most
        significant risk factors as of the date this report is being filed. The risks
        and uncertainties described below are not the only ones we face.
 
 **We
        Have Reported Substantial Income In 2006 and 2007 Which May Not Be Indicative
        Of
        Our Future Income**
  During
        fiscal 2007 and 2006, we entered into license agreements, directly and through
        our joint venture with Technology Properties Limited. Because of the uncertain
        nature of the negotiations that lead to license revenues, pending litigation
        with companies which we allege have infringed on our patent portfolio, the
        possibility of legislative action regarding patent rights, and the possible
        effect of new judicial interpretation of patent laws, we cannot predict the
        amount of future revenues from such agreements, or whether there will be
        future
        revenues from license agreements at all.
 
 **We
        Are Dependent Upon A Joint Venture In Which We Are A Passive Partner For
        Substantially All Of Our Income**
  In
        June
        of 2005, we entered into a joint venture with Technology Properties Limited,
        pursuant to which Technology Properties Limited is responsible for the licensing
        and enforcement of our microprocessor patent portfolio. This joint venture
        has
        been the source of virtually all of our income since June of 2005. Therefore,
        in
        light of the absence of revenue from other sources, we should be regarded
        as
        entirely dependent on the success or failure of the licensing and prosecution
        efforts of Technology Properties Limited on behalf of the joint venture.
        Sales
        of our microprocessor products and data security products have resulted in
        limited revenues. Our other product lines are no longer being actively marketed,
        and also only generate limited and sporadic sales.
  **Our
        Limited Sales And** **Marketing**  **Capabilities
        Have Affected Our Revenue**
  We
        currently have limited marketing capabilities and may need to hire additional
        sales and marketing personnel. We may not be able to recruit, train, or retain
        qualified personnel to sell and market our products. We also may not be able
        to
        develop a successful sales and marketing strategy. We also have very limited
        marketing experience. Any marketing efforts we undertake may not be successful
        and may not result in any significant sales of our products.
  **We
        May Experience Difficulties In The Completion Of Our Development Stage Products**
  Our
        technologies and products are in various stages of development. We do not
        currently have in-house development personnel, nor have we retained independent
        researchers. Therefore, our development stage products may not be completed
        on a
        timely basis or at all. Additionally, even if we do recommence our development
        activities, our development stage products may not be completed due to the
        inherent risks of new product and technology development, limitations on
        financing, competition, obsolescence, the absence or loss of key personnel
        and
        other factors. Although we have licensed some of our technology at its current
        stage of development, we may not continue to be able to do so and any revenues
        generated from licensing may not be sufficient to support operations at their
        current level. Also, 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.
  **Changes
        In Our Relationships With Companies In Which We Hold Less Than A Majority
        Interest Could Change The Way We Account For Such Interests In The
        Future.**
 
 We
        hold a
        minority interest in a company (Scripps Secured Data, Inc.) to which we provide
        financing. Under the applicable provisions of accounting principles generally
        accepted in the United States of America, including FIN 46(R), we currently
        consolidate the financial statements and results of operations of this company
        into our consolidated financial statements and results of operations, and
        record
        the equity interest that we do not own as a minority interest. For our other
        investment (Phoenix Digital Solutions, LLC), accounted for under the equity
        method, we record as part of other income or expense our share of the increase
        or decrease in the equity of the company in which we have invested. It is
        possible that, in the future, our relationships and/or our interests in or
        with
        this consolidated entity and equity method investee could change. Such potential
        future changes could result in deconsolidation or consolidation of such
        entities, as the case may be, which could result in changes in our reported
        results.
  7
  **We
        Have Settled A Legal Dispute Which Could Affect Our Future Results Of Operations
        And Working Capital Position**
  We
        were
        sued by a co-inventor of the technology underlying our microprocessor patent
        portfolio with regard to proceeds we received as a consequence of recently
        signed license agreements. On February 14, 2007, we finalized a settlement
        of
        this litigation. This settlement required us to pay the co-inventor $6,400,000
        and requires us to pay up to $2,000,000 from the proceeds we receive from
        future
        licensing transactions. As of the date of this filing, we have paid $1,164,000
        of the $2,000,000 obligation for future licensing transaction proceeds required
        under the settlement agreement. These payments have resulted, and will result,
        in a reduction of our net income in the current fiscal year and future quarters
        until our obligations under the settlement have been fulfilled.
  **A
        Successful Challenge To The Proprietary Nature Of Our Intellectual Property
        Would Have A Significant And Adverse Effect On Us**
  A
        successful challenge to our ownership of our technology or the proprietary
        nature of our intellectual property would materially damage our business
        prospects. We rely on a combination of patents, trademarks, copyrights, trade
        secret laws, confidentiality procedures and licensing arrangements to protect
        our intellectual property rights. We currently have eight U.S. patents, one
        European patent, and one Japanese patent issued. Any issued patent may be
        challenged and invalidated. Patents may not be issued for any of our pending
        applications. Any claims allowed from existing or pending patents may not
        be of
        sufficient scope or strength to provide significant protection for our products.
        Patents may not be issued in all countries where our products can be sold
        so as
        to provide meaningful protection or any commercial advantage to us. Our
        competitors may also be able to design around our patents.
  Vigorous
        protection and pursuit of intellectual property rights or positions characterize
        the fiercely competitive semiconductor industry, which has resulted in
        significant and often protracted and expensive litigation. Therefore, our
        competitors and others may assert that our technologies or products infringe
        on
        their patents or proprietary rights. Persons we believe are infringing our
        patents are vigorously defending their actions and have asserted that our
        patents are invalid. Problems with patents or other rights could increase
        the
        cost of our products or delay, preclude new product development and
        commercialization by us, and limit future license revenue. If infringement
        claims against us are deemed valid or if our infringement claims are
        successfully opposed, we may not be able to obtain appropriate licenses on
        acceptable terms or at all. Litigation could be costly and time-consuming
        but
        may be necessary to protect our future patent and/or technology license
        positions or to defend against infringement claims. We are currently involved
        in
        patent litigation in the United States District Court for the Eastern District
        of Texas (see the Section entitled “Legal Proceedings”). Additionally, opposing
        parties in the litigation and one other person have petitioned the U. S.
        Patent
        and Trademark Office to re-examine certain of our patents. An adverse decision
        in the litigation or in the re-examination process would have a very significant
        and adverse effect on our business.
 
 **If
        A Large Number Of Our Shares Are Sold All At Once Or In Blocks, The Market
        Price
        Of Our Shares Would** **Most**  **Likely
        Decline**
  Our
        warrant holders are not restricted in the price at which they can sell common
        stock acquired through the exercise of warrants. 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
        exercise of our warrants represent a significant portion of our fully-diluted
        capitalization.
  **The
        Market For Our Stock** **Is** **Subject To Rules Relating To Low-Priced Stock (“Penny Stock”) Which May Limit
        Our Ability To Raise Capital**
  Our
        common stock is currently listed for trading in the National Association
        of
        Securities Dealers (“NASD”) Over-The-Counter Bulletin (“OTC”) Board Market and
        is subject to the “penny stock rules” adopted pursuant to Section 15(g) of the
        Exchange Act. In general, the penny stock rules apply to non-NASDAQ or
        non-national stock exchange companies whose common stock trades at less than
        $5.00 per share or which have tangible net worth of less than $5,000,000
        ($2,000,000 if the company has been operating for three or more years). Such
        rules require, among other things, that brokers who trade “penny stock” on
        behalf of persons other than “established customers” complete certain
        documentation, make suitability inquiries of investors and provide investors
        with certain information concerning trading in the security, including a
        risk
        disclosure document, quote information, broker’s commission information and
        rights and remedies available to investors in penny stocks. Many brokers
        have
        decided not to trade “penny stock” because of the requirements of the penny
        stock rules, and as a result, the number of broker-dealers willing to act
        as
        market makers in such securities is limited. The “penny stock rules,” therefore,
        may have an adverse impact on the market for our common stock and may affect
        our
        ability to raise additional capital if we decide to do so.
  8
  **Our
        Share Price Could Decline As A Result Of Short Sales**
  When
        an
        investor sells stock that he does not own, it is known as a short sale. The
        seller, anticipating that the price of the stock will go down, intends to
        buy
        stock to cover his sale at a later date. If the price of the stock goes down,
        the seller will profit to the extent of the difference between the price
        at
        which he originally sold it less his later purchase price. Short sales enable
        the seller to profit in a down market. Short sales could place significant
        downward pressure on the price of our common stock. Penny stocks which do
        not
        trade on an exchange, such as our common stock, are particularly susceptible
        to
        short sales.
  **Our
        Future Success Depends In Significant Part Upon The Continued Services Of
        Our
        Key Senior Management**
  Our
        future success depends in significant part upon the continued services of
        our
        key senior management personnel. The competition for highly qualified personnel
        is intense, and we may not be able to retain our key managerial employees
        or
        attract and retain additional highly qualified technical and managerial
        personnel in the future. None of our employees are represented by a labor
        union,
        and we consider our relations with our employees to be good. None of our
        employees are covered by key man life insurance policies.
 
 **ITEM
        1B.**  **UNRESOLVED
        STAFF COMMENTS**
 
 None.
 
 **ITEM
        2.**  **PROPERTIES**
 
 We
        have
        one 3,289 square foot office located at 6183 Paseo Del Norte, Suite 180,
        Carlsbad, California. The facility is leased under a non-cancelable lease
        through February 2010. The current floor space provides adequate and
        suitable facilities for all of our corporate functions.
 
 We
        had
        one 10,300 square foot office located at 10989 Via Frontera, San Diego,
        California. The facility was leased under a non-cancelable lease through
        July 2006.
 
 Scripps
        Secured Data, Inc. has one 3,364 square foot office located at 2386 Faraday
        Avenue, Suite 200, Carlsbad, California. The facility is subleased through
        December 2007. Scripps Secured Data, Inc. also leases office space in Annapolis,
        Maryland under a lease expiring February 2008.
 
 Scripps
        Secured Data, Inc. maintains one 8,300 square foot warehouse facility in
        Anaheim, California. The warehouse is leased on a month to month basis.
 
 **ITEM
        3.**  **LEGAL
        PROCEEDINGS**
 
 *Lowell
        Giffhorn Arbitration*
  On
        September 23, 2005, Lowell Giffhorn, a former executive officer
        and a former director of the Company, submitted a demand for arbitration
        with
        the American Arbitration Association related to the termination of
        Mr. Giffhorn's employment with the Company. Mr. Giffhorn asserts that
        the termination of his employment with the Company was unlawful, retaliatory,
        wrongful, violated public policy, violated the covenant of good faith and
        fair
        dealing and violated securities laws. Mr. Giffhorn has demanded damages of
        approximately $4,500,000 (excluding claims for punitive damages and attorneys
        fees). The Company denies the allegations and believes the claims to be
        frivolous and totally devoid of merit. The Company has retained litigation
        counsel and intends to vigorously defend the claims. The amount, if any,
        of
        ultimate liability with respect to the foregoing cannot be determined. Despite
        the inherent uncertainties of litigation, the Company at this time does not
        believe that Mr. Giffhorn's claim will have a material adverse impact on
        its financial condition, results of operations, or cash flows.
  9
  *Patent
        Litigation*
  Pursuant
        to the joint venture that the Company entered into in June 2005 with TPL
        (in
        settlement of inventorship/ownership litigation between the parties, and
        in
        return for a 50-50 sharing of net licensing and enforcement revenues), the
        Company granted TPL the complete and exclusive right to enforce and license
        its
        microprocessor patent portfolio. The Company then dismissed its patent
        infringement claims against Fujitsu Computer Systems, Inc. (“Fujitsu”);
        Matsushita Electric Corporation of America; NEC Solutions (America) Inc.
        (“NEC”); Sony Electronics Inc. (“Sony”); and Toshiba America Inc., and certain
        related entities of these **** defendants
        which had been pending in the Federal District Court for the Northern District
        of California. Thereafter, TPL, on behalf of the TPL/Patriot joint venture,
        filed patent infringement actions against certain of the foregoing defendants
        (except Sony) and their related entities in the Federal District Court for
        the
        Eastern District of Texas, which litigation is currently pending.  Patriot
        was subsequently joined as a party to the litigation. Litigation is not
        currently pending with regard to Fujitsu or NEC and certain of NEC’s
        subsidiaries as listed below.
 
 On
        August
        25 2006, ARM Ltd. and ARM, Inc. intervened as defendants, seeking a declaration
        of non-infringement of our ‘584 patent with respect to ARM processor cores
        contained within some alleged infringing chips of other defendants.
 
 In
        February 2006, a license agreement was entered into with Fujitsu regarding
        the
        Company's patent portfolio, and in connection with that transaction, litigation
        involving Fujitsu and TPL and the Company in both California and Texas was
        dismissed.
 
 In
        February 2007, a license agreement was entered into with: NEC Corporation,
        NEC
        Corporation of America, Inc., NEC Display Solutions of America, Inc. and
        NEC
        Unified Solutions, Inc. In connection with that transaction, the above named
        defendants, excluding NEC Electronics America, Inc., were dismissed from
        the
        lawsuit.
 
 A
        Claims
        Construction Hearing was held May 3, 2007 in The United States District Court
        for the Eastern District of Texas. On June 15, 2007 the court handed down
        claims
        construction of the patents-in-suit, the ‘336, ‘148 and ‘584 patents. Based on
        the claims construction ruling, TPL/Patriot are vigorously proceeding with
        discovery in respect to the ‘336 and ‘148 patents. However, based on the claims
        construction ruling as to the ‘584 patent claims of “instruction groups”,
        TPL/Patriot announced on August 8, 2007, a Stipulation with ARM intended
        to
        expedite an appeal of that claims construction. The Stipulation is a declaration
        of non-infringement by the accused ARM products with respect to the ‘584 patent.
        This is intended to bolster TPL/Patriot’s efforts in the long run to enforce
        rights under the ‘584 patent. A mediation is scheduled September 25 - 27, 2007.
        Trial is scheduled to begin January 7, 2008.


**ITEM
      4.**  **SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS**




At
      our
      fiscal 2006 Annual Meeting of Shareholders held on April 27, 2007, the
      following individuals were elected to the Board of Directors of the Company:
      David H. Pohl, Carlton M. Johnson, Jr., Helmut Falk, Jr., Gloria H. Felcyn
      and
      James L. Turley.




The
      following proposals were approved at our Annual Meeting of
      Shareholders:




1.
            Proposal
                to ratify management’s selection of KMJ Corbin & Company LLP as
                the Company’s independent auditors:




Votes
                For
            
            Votes
                Against
            
            Votes
                Abstaining320,217,254
            
            3,278,468
            
            1,718,217


10


2.  Election
      of Directors:




Director
            
            Votes
                For
            
            Votes
                Abstaining
              and/or
                AgainstDavid
                H. Pohl
            
            318,746,870
            
            6,467,068Carlton
                M. Johnson, Jr.
            
            299,466,140
            
            25,747,798Helmut
                Falk, Jr.
            
            299,251,900
            
            25,962,038Gloria
                H. Felcyn
            
            307,614,966
            
            17,598,972James
                L. Turley
            
            312,813,282
            
            12,400,656






**PART
      II**




**ITEM
      5.**  **MARKET
      FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES
      OF EQUITY SECURITIES**




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 our
      common stock for the fiscal years ended May 31, 2007 and 2006.




BID QUOTATIONSHIGH
            LOWFiscal
                Year Ended May 31, 2007First
                Quarter
            $1.37
            $0.79Second
                Quarter
            $1.18
            $0.61Third
                Quarter
            $0.77
            $0.46Fourth
                Quarter
            $0.70
            $0.45Fiscal
                Year Ended May 31, 2006First
                Quarter
            $0.18
            $0.11Second
                Quarter
            $0.15
            $0.09Third
                Quarter
            $0.91
            $0.08Fourth
                Quarter
            $1.96
            $0.69





On
      August
      9, 2007 the closing price of our stock was $0.49 and we had approximately 607
      shareholders of record. Because most of our common stock is held by brokers
      and
      other institutions on behalf of stockholders, we are unable to estimate the
      total number of beneficial owners represented by these record
      holders.




**Dividend
      Policy**




During
      the fiscal year ended May 31, 2006, we paid a $0.02 per common share dividend
      on
      March 22, 2006 and paid a $0.04 per common share dividend on April 24,
      2006. During the fiscal year ended May 31, 2007 we paid a $0.02 per common
      share
      dividend on April 9, 2007. On February 22, 2007, our Board of Directors adopted
      a semi-annual dividend payment policy, subject to determination by our Board
      of
      Directors that payment of a dividend would be reasonable and prudent in light
      of
      our financial condition, other possible applications of our available resources,
      and relevant business considerations.


11


**Equity
      Compensation Plan Information**




Our
      stockholders previously approved each of the Company’s 1992, 1996, 2001, 2003
      and 2006 Stock Option Plans. The following table sets forth certain information
      concerning aggregate stock options authorized for issuance under our 1996,
      2001,
      2003 and 2006 Stock Option Plans as of May 31, 2007. For a narrative
      description of the material features of the plans, refer to footnote 11 of
      our
      consolidated financial statements.




Shares
      of
      common stock issuable on the exercise of warrants have not been approved by
      our
      stockholders. Additionally, during the year ended May 31, 2007, we issued
      options to acquire 1,500,000 shares of our common stock at a per share price
      of
      $0.165 to an officer outside of the above referenced stock option plans. The
      sum
      of these two items have been segregated in the table below under the item
“Equity compensation plans not approved by security holders”.




**Plan Category**
            
            
            **Number
                of securities to be issued**
              **upon
                exercise of outstanding**
              **options
                and warrants**
            
            
            **Weighted-average**
              **exercise price of
                outstanding**
              **options
                and warrants**
            
            
            **Number
                of securities remaining available for future issuance under equity
                compensation plans**Equity
                compensation plans
              approved
                by security holders
            
            
            5,745,000
            
            $
            0.46
            
            
            4,429,000Equity
                compensation plans not
              approved
                by security holders
            
            
            13,560,915
            
            $
            0.11
            
            
            —Total
            
            
            19,305,915
            
            
            
            
            
            4,429,000







**Recent
      Sale of Unregistered Securities**


Unless
        otherwise noted, the issuances noted below are all considered exempt from
        registration by reason on Section 4(2) of the Securities Act of 1933, as
        amended.
  On
        August
        14, 2006 warrants to purchase 150,000 shares of our common stock were exercised
        by an investor for proceeds of $60,000.
  The
        exercises listed below were performed on a cashless basis. By exercising
        on a
        cashless basis, the warrant holder authorizes us to withhold from issuance
        shares of common stock that would otherwise be issuable upon exercise of
        the
        warrant which when multiplied by the market price of the common stock as
        of the
        date of exercise is equal to the aggregate exercise price. The market price,
        as
        defined in the warrant, is the volume weighted average price (“VWAP”) of our
        common stock during the 10 consecutive trading day period immediately preceding
        the date of exercise, less the exercise price of the warrant, this product
        is
        then divided by the VWAP and the result is multiplied by the number of shares
        in
        the warrant to arrive at the net number of shares to issue.
  On
        June
        8, 2006 warrants to purchase 1,366,727 shares of our common stock at an exercise
        price of $0.015 were exercised by an investor on a cashless basis. The number
        of
        shares of common stock that would otherwise have been issuable upon the exercise
        of such warrants was reduced by 17,780, an aggregate value of $17,549, based
        on
        a VWAP of $1.153 as of the exercise date. Accordingly, we issued 1,348,947
        shares of our common stock upon the exercise.
  On
        June
        8, 2006 warrants to purchase 690,211 shares of our common stock at an exercise
        price of $0.04 were exercised by an investor on a cashless basis. The number
        of
        shares of common stock that would otherwise have been issuable upon the exercise
        of such warrants was reduced by 25,948, an aggregate value of $24,973, based
        on
        a VWAP of $1.064 as of the exercise date. Accordingly, we issued 664,263
        shares
        of our common stock upon the exercise.
  On
        October 17, 2006 warrants to purchase 6,951,428 shares of our common stock
        at an
        exercise price of $0.03363 were exercised by an investor on a cashless basis.
        The number of shares of common stock that would otherwise have been issuable
        upon the exercise of such warrants was reduced by 219,344, an aggregate value
        of
        $212,423, based on a VWAP of $1.0658 as of the exercise date. Accordingly,
        we
        issued 6,732,084 shares of our common stock upon the exercise.
  On
        October 17, 2006 warrants to purchase 8,035,192 shares of our common stock
        at an
        exercise price of $0.0399 were exercised by an investor on a cashless basis.
        The
        number of shares of common stock that would otherwise have been issuable
        upon
        the exercise of such warrants was reduced by 300,811, an aggregate value
        of
        $289,550, based on a VWAP of $1.0658 as of the exercise date. Accordingly,
        we
        issued 7,734,381 shares of our common stock upon the exercise.
  On
        October 20, 2006 warrants to purchase 2,692,308 shares of our common stock
        at an
        exercise price of $0.015 were exercised by an investor on a cashless basis.
        The
        number of shares of common stock that would otherwise have been issuable
        upon
        the exercise of such warrants was reduced by 37,916, an aggregate value of
        $37,382, based on a VWAP of $1.0651 as of the exercise date. Accordingly,
        we
        issued 2,654,392 shares of our common stock upon the exercise.
  12
  On
        October 20, 2006 warrants to purchase 2,307,692 shares of our common stock
        at an
        exercise price of $0.015 were exercised by an investor on a cashless basis.
        The
        number of shares of common stock that would otherwise have been issuable
        upon
        the exercise of such warrants was reduced by 32,499, an aggregate value of
        $32,041, based on a VWAP of $1.0651 as of the exercise date. Accordingly,
        we
        issued 2,275,193 shares of our common stock upon the exercise.
  On
        March
        19, 2007 warrants to purchase 9,431,137 shares of our common stock at an
        exercise price of $0.0167 were exercised by an investor on a cashless basis.
        The
        number of shares of common stock that would otherwise have been issuable
        upon
        the exercise of such warrants was reduced by 247,681, an aggregate value
        of
        $241,176, based on a VWAP of $0.6359 as of the exercise date. Accordingly,
        we
        issued 9,183,456 shares of our common stock upon the exercise.
  On
        March
        19, 2007 warrants to purchase 1,271,106 shares of our common stock at an
        exercise price of $0.015 were exercised by an investor on a cashless basis.
        The
        number of shares of common stock that would otherwise have been issuable
        upon
        the exercise of such warrants was reduced by 29,984, an aggregate value of
        $29,277, based on a VWAP of $0.6359 as of the exercise date. Accordingly,
        we
        issued 1,241,122 shares of our common stock upon the exercise.
  On
        May
        24, 2007 warrants to purchase 2,142,857 shares of our common stock at an
        exercise price of $0.035 were exercised by an investor on a cashless basis.
        The
        number of shares of common stock that would otherwise have been issuable
        upon
        the exercise of such warrants was reduced by 148,251, an aggregate value
        of
        $137,994, based on a VWAP of $0.5059 as of the exercise date. Accordingly,
        we
        issued 1,994,606 shares of our common stock upon the exercise.
  On
        May
        24, 2007 warrants to purchase 4,000,000 shares of our common stock at an
        exercise price of $0.025 were exercised by an investor on a cashless basis.
        The
        number of shares of common stock that would otherwise have been issuable
        upon
        the exercise of such warrants was reduced by 197,668, an aggregate value
        of
        $187,900, based on a VWAP of $0.5059 as of the exercise date. Accordingly,
        we
        issued 3,802,332 shares of our common stock upon the exercise.




**Issuer
      Purchases of Equity Securities**




On
      April
      28, 2006 our Board of Directors authorized a stock repurchase program. We
      commenced the program in July 2006 and plan to repurchase outstanding shares
      of
      our common stock on the open market from time to time. We repurchased common
      stock during the fourth quarter of fiscal year 2007 using available cash
      resources as follows:




**Period**
            
            **Total**
              **Number
                of**
              **Shares**
              **Purchased**
            
            **Average**
              **Price
                Paid**
              **per
                Share**
            
            **Total
                Number of**
              **Shares
                Purchased as**
              **Part
                of Publicly**
              **Announced
                Plans or Programs**March
                1 - 31, 2007
            
            
            -
            
            $
            -
            
            
            -April
                1 - 30, 2007
            
            
            502,000
            
            $
            0.56
            
            
            502,000May
                1 - 31, 2007
            
            
            2,186,500
            
            $
            0.51
            
            
            2,186,500Total
            
            
            2,688,500
            
            $
            0.52
            
            
            2,688,500




The
      repurchase plan has no maximum number of shares and is solely at the discretion
      of the Board of Directors. The repurchase plan has no set expiration
      date.


13


**ITEM
      6.**  **SELECTED
      FINANCIAL DATA**




The
      selected consolidated financial data set forth below for the fiscal years ended
      May 31, 2007, 2006 and 2005, are derived from our audited consolidated
      financial statements included elsewhere in this report. This information should
      be read in conjunction with those consolidated financial statements, the notes
      thereto, and with the section herein entitled “Management’s Discussion and
      Analysis of Financial Condition and Results of Operations.” The selected
      consolidated financial data set forth below for the fiscal years ended
      May 31, 2004 and 2003, are derived from our audited consolidated financial
      statements that are contained in reports previously filed with the Securities
      and Exchange Commission, not included herein. There are no accounting changes,
      business combinations or dispositions of business operations, other than the
      consolidation of SSDI for the fiscal year ended May 31, 2007, that materially
      affect the comparability of the information provided in the charts
      below.







**Summary
      Consolidated Financial Information**




**Fiscal
                Years Ended May 31,****Statement
                of operations data:**
            
            **2007**
            
            
            **2006**
            
            
            **2005**
            
            
            **2004**
            
            
            **2003**Net
                sales
            
            $
            638,784
            
            
            $
            10,309,709
            
            
            $
            2,982,586
            
            
            $
            76,417
            
            
            $
            123,903Operating
                income (loss)
            
            $
            (14,763,839
            )
            
            $
            3,911,640
            
            
            $
            87,421
            
            
            $
            (1,737,370
            )
            
            $
            (2,439,946
            )Equity
                in earnings of affiliated company
            
            $
            48,965,084
            
            
            $
            27,848,363
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —Net
                income (loss)
            
            $
            23,691,187
            
            
            $
            28,672,688
            
            
            $
            (10,518,704
            )
            
            $
            (5,760,883
            )
            
            $
            (5,319,821
            )Basic
                income (loss) per common share
            
            $
            0.06
            
            
            $
            0.09
            
            
            $
            (0.05
            )
            
            $
            (0.04
            )
            
            $
            (0.06
            )Diluted
                income (loss) per common share
            
            $
            0.06
            
            
            $
            0.07
            
            
            $
            (0.05
            )
            
            $
            (0.04
            )
            
            $
            (0.06
            )Weighted
                average number of common shares outstanding - basic
            
            
            378,036,989
            
            
            
            316,100,499
            
            
            
            222,495,047
            
            
            
            139,767,276
            
            
            
            93,791,470Weighted
                average number of common shares outstanding - diluted
            
            
            413,599,373
            
            
            
            412,963,173
            
            
            
            222,495,047
            
            
            
            139,767,276
            
            
            
            93,791,470Cash
                dividends declared and paid per share
            
            $
            0.02
            
            
            $
            0.06
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —







**May 31,****Balance
                sheet data:**
            
            **2007**
            
            
            **2006**
            
            
            **2005**
            
            
            **2004**
            
            
            **2003**Cash
                and cash equivalents
            
            $
            21,605,428
            
            
            $
            3,984,240
            
            
            $
            591,426
            
            
            $
            355,940
            
            
            $
            32,663Total
                assets
            
            $
            34,414,629
            
            
            $
            12,071,667
            
            
            $
            3,724,034
            
            
            $
            926,228
            
            
            $
            465,234Long-term
                obligations
            
            $
            12,222,944
            
            
            $
            -
            
            
            $
            9,320,654
            
            
            $
            6,102,669
            
            
            $
            3,782,997Total
                liabilities
            
            $
            14,243,738
            
            
            $
            1,244,116
            
            
            $
            10,964,418
            
            
            $
            6,650,711
            
            
            $
            5,369,559Stockholders’
                equity (deficit)
            
            $
            20,170,891
            
            
            $
            10,827,551
            
            
            $
            (7,240,384
            )
            
            $
            (5,724,483
            )
            
            $
            (4,904,325
            )




14






**Fiscal
                Quarters Ended****Quarterly
                statement of operations data for**
            
            
            **August 31,**
            
            
            **November
                30,**
            
            
            **February
                28,**
            
            
            **May 31,****fiscal
                2007 (Unaudited):**
            
            
            **2006**
            
            
            **2006**
            
            
            **2007**
            
            
            **2007**Net
                sales
            
            $
            26,375
            
            $
            18,500
            
            $
            22,175
            
            $
            571,734Gross
                profit
            
            $
            26,375
            
            $
            18,500
            
            $
            22,175
            
            $
            252,360Net
                income (loss)
            
            $
            5,990,273
            
            $
            (1,881,998
            )
            $
            9,617,559
            
            $
            9,965,353Basic
                income (loss) per common share
            
            $
            0.02
            
            $
            —
            
            $
            0.03
            
            $
            0.03Diluted
                income (loss) per common share
            
            $
            0.01
            
            $
            —
            
            $
            0.02
            
            $
            0.02Weighted
                average number of common shares outstanding - basic
            
            
            368,837,051
            
            
            378,817,682
            
            
            381,031,577
            
            
            387,903,643Weighted
                average number of common shares outstanding - diluted
            
            
            420,646,769
            
            
            378,817,682
            
            
            410,747,949
            
            
            407,392,062Cash
                dividends declared and paid per share
            
            $
            -
            
            $
            -
            
            $
            0.02
            
            $
            -






**Fiscal
                Quarters Ended****Quarterly
                statement of operations data for**
            
            **August 31,**
            
            **November
                30,**
            
            **February
                28,**
            
            **May 31,****fiscal
                2006 (Unaudited):**
            
            **2005**
            
            **2005**
            
            **2006**
            
            **2006**Net
                sales
            
            $
            10,010,070
            
            $
            10,202
            
            $
            276,800
            
            $
            12,637Gross
                profit
            
            $
            10,010,070
            
            $
            10,202
            
            $
            173,449
            
            $
            12,637Net
                income (loss)
            
            $
            7,504,552
            
            $
            (100,338
            )
            $
            23,488,416
            
            $
            (2,219,940
            )Basic
                income (loss) per common share
            
            $
            0.03
            
            $
            —
            
            $
            0.08
            
            $
            (
                0.01
            )Diluted
                income (loss) per common share
            
            $
            0.02
            
            $
            —
            
            $
            0.06
            
            $
            (0.01
            )Weighted
                average number of common shares outstanding - basic
            
            
            291,335,488
            
            
            303,431,364
            
            
            307,933,709
            
            
            316,822,515Weighted
                average number of common shares outstanding - diluted
            
            
            367,216,524
            
            
            303,431,364
            
            
            404,508,397
            
            
            316,822,515Cash
                dividends declared and paid per share
            
            $
            -
            
            $
            -
            
            $
            0.02
            
            $
            0.04







**ITEM
      7.**  **MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS**




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





OVERVIEW




In
      June
      2005, we entered into a series of agreements with Technology Properties Limited,
      Inc. (“TPL”) and others to facilitate the pursuit of infringers of our
      intellectual property. We intend to continue our joint venture with TPL to
      pursue license agreements with infringers of our technology. We believe that
      utilizing the option of working through TPL, as compared to creating and using
      a
      Company licensing team for those activities, avoids a competitive devaluation
      of
      our principal assets and is a prudent way to achieve the desired results as
      we
      seek to obtain fair value from users of our intellectual
      property.


15


During
      the fiscal year ended May 31, 2006, we finalized an agreement for the
      licensing of our technology with Intel Corporation. During the fiscal years
      ended May 31, 2006 and 2007, the joint venture entered into licensing agreements
      with Hewlett-Packard, Fujitsu, Casio, Nikkon, Sony, Seiko Epson, Pentax,
      Olympus, Kenwood, Agilent Technologies, Schneider Electric, Lexmark, NEC, Funai
      Electric, SanDisk, Sharp and Nokia through our joint venture entity, Phoenix
      Digital Solutions, LLC (“PDS”). We believe that these agreements represent
      validation of our position that our intellectual property was and is being
      infringed by major manufacturers of microprocessor technology. We believe the
      early stage agreements demonstrate the potential value of our intellectual
      property in that they are "arms length" transactions with major electronics
      manufacturers.




**Critical
      Accounting Policies and Estimates**




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




1.  Revenue
      Recognition




Accounting
      for revenue recognition is complex and affected by interpretations of guidance
      provided by several sources, including the Financial Accounting Standards Board
      (“FASB”) and the Securities and Exchange Commission (“SEC”). This guidance is
      subject to change. We follow the guidance established by the SEC in Staff
      Accounting Bulletin No. 104, as well as generally accepted criteria for revenue
      recognition, which require that, before revenue is recorded, there is persuasive
      evidence of an arrangement, the fee is fixed or determinable, collection is
      reasonably assured, and delivery to our customer has occurred. Applying these
      criteria to certain of our revenue arrangements requires us to carefully analyze
      the terms and conditions of our license agreements. Revenue from our technology
      license agreements is generally recognized at the time we enter into a contract
      and provide our customer with the licensed technology. We believe that this
      is
      the point at which we have performed all of our obligations under the agreement;
      however, this remains a highly interpretive area of accounting and future
      license agreements may result in a different method of revenue recognition.
      Fees
      for maintenance or support of our licenses are recorded on a straight-line
      basis
      over the underlying period of performance.




Our
      investee recognizes revenue upon receipt of the license proceeds from the
      licensee at which time all obligations of the investee have been performed
      under
      the license agreements.




Our
      consolidated variable interest entity recognizes revenue upon shipment of its
      product and recognizes revenue on its short-term installation contracts as
      time
      and materials costs are incurred.




2.  Assessment
      of Contingent Liabilities




We
      are
      involved in various legal matters, disputes, and patent infringement claims
      which arise in the ordinary course of our business. We accrue for estimated
      losses at the time when we can make a reliable estimate of such loss and it
      is
      probable that it has been incurred. By their very nature, contingencies are
      difficult to estimate. We continually evaluate information related to all
      contingencies to determine that the basis on which we have recorded our
      estimated exposure is appropriate.




3.  Stock
      Options and Warrants




We
      account for equity issuances to non-employees in accordance with Statement
      of
      Financial Accounting Standards ("SFAS") No. 123, *Accounting
      for Stock Based Compensation* ,
      and
      Emerging Issues Task Force ("EITF") Issue No. 96-18, *Accounting
      for Equity Instruments that are Issued to Other Than Employees for Acquiring,
      or
      in Conjunction with Selling, Goods and Services* .
      A ll
      transactions in which goods or services are the consideration received for
      the
      issuance of equity instruments are accounted for based on the fair value of
      the
      consideration received or the fair value of the equity instrument issued,
      whichever is more reliably measurable. The measurement date used to determine
      the fair value of the equity instrument issued is the earlier of the date on
      which the third-party performance is complete or the date on which it is
      probable that performance will occur.


16


Prior
      to
      June 1, 2006, we accounted for stock-based compensation issued to employees
      using the intrinsic value method of accounting prescribed by Accounting
      Principles Board ("APB") Opinion No. 25, *Accounting
      for Stock Issued to Employees* and
      related pronouncements. Under this method, compensation expense was recognized
      over the respective vesting period based on the excess, on the date of grant,
      of
      the fair value of our common stock over the grant price, net of forfeitures.
      Deferred stock-based compensation was amortized on a straight-line basis over
      the vesting period of each grant.




On
      June 1, 2006, we adopted SFAS No. 123(R), *Share-Based
      Payment* ,
      which
      requires the measurement and recognition of compensation expense for all
      share-based payment awards made to our employees and directors related to our
      stock option plans based on estimated fair values. We adopted SFAS
      No. 123(R) using the modified prospective transition method, which requires
      the application of the accounting standard as of June 1, 2006, the first day
      of
      our fiscal year 2007. Our consolidated financial statements for the year ended
      May 31, 2007 reflect the impact of adopting SFAS No. 123(R). In accordance
      with the modified prospective transition method, our consolidated financial
      statements for prior periods have not been restated to reflect, and do not
      include, the impact of SFAS No. 123(R). The value of the portion of the
      award that is ultimately expected to vest is recognized as expense over the
      requisite service periods in our consolidated statement of operations. As
      stock-based compensation expense recognized in the consolidated statement of
      operations for the year ended May 31, 2007 is based on awards ultimately
      expected to vest, it has been reduced for estimated forfeitures. SFAS
      No. 123(R) requires forfeitures to be estimated at the time of grant and
      revised, if necessary, in subsequent periods if actual forfeitures differ from
      those estimates. The estimated average forfeiture rate for the year ended May
      31, 2007 of 5% was based on historical forfeiture experience and estimated
      future employee forfeitures. In our pro forma information required under SFAS
      No. 123 for the periods prior to fiscal 2007, we accounted for forfeitures
      as they occurred.




Employee
      stock-based compensation expense recognized under SFAS No. 123(R) for year
      ended May 31, 2007 was approximately $2,356,000, determined by the Black-Scholes
      valuation model.




4.  Debt
      Discount




We
      have
      issued 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 two 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. As
      of
      May 31, 2006, the debt discount has been fully amortized as the debt instruments
      were settled prior to May 31, 2006.




5.  Derivative
      Financial Instruments




In
      connection with the issuance of certain convertible debentures, the terms of
      the
      debentures included a reset conversion feature which provided for a conversion
      of the debentures into shares of the Company's common stock at a rate which
      was
      determined to be variable. The conversion option was therefore deemed to be
      an
      embedded put option pursuant to SFAS No. 133, *Accounting
      For Derivative Instruments and Hedging Activities* ,
      as
      amended, and EITF Issue No. 00-19, *Accounting
      for Derivative Financial Instruments Indexed to, and Potentially Settled in,
      a
      Company's Own Stock* .
      The
      Company determined that the reset conversion feature was an embedded derivative
      instrument and that the conversion option was an embedded put option pursuant
      to
      SFAS No. 133. The accounting treatment of derivative financial instruments
      required that the Company record the derivatives and related warrants at their
      fair values as of the inception date of the convertible debenture agreements
      and
      at fair value as of each subsequent balance sheet date.  In addition, under
      the provisions of EITF No. 00-19, as a result of entering into the convertible
      debenture agreements, the Company was required to classify all other
      non-employee warrants as derivative liabilities and record them at their fair
      values at each balance sheet date.  Any change in fair value was recorded
      as non-operating, non-cash income or expense at each balance sheet date. 
If the fair value of the derivatives was higher at the subsequent balance sheet
      date, the Company recorded a non-operating, non-cash charge.  If the fair
      value of the derivatives was lower at the subsequent balance sheet date, the
      Company recorded non-operating, non-cash income. As of May 31, 2006, the Company
      does not have any outstanding derivative instruments as the related debt
      instruments were settled prior to May 31, 2006.


17


6.  Patents
      and Trademarks




We
      carry
      our patents and trademarks at cost less accumulated amortization and we amortize
      the patents over their estimated useful lives of four years. We periodically
      review the carrying value of the patents and trademarks for impairment and
      recognize impairment when the expected future benefit to be derived from an
      individual intangible asset is less than its carrying value.




7.  Income
      Taxes




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




8.  Investment
      in Affiliated Company




We
      have a
      50% interest in PDS. We account for our investment using the equity method
      of
      accounting since the investment provides us the ability to exercise significant
      influence, but not control, over the investee. Significant influence is
      generally deemed to exist if we have an ownership interest in the voting stock
      of the investee of between 20% and 50%, although other factors, such as
      representation on the investee’s Board of Directors, are considered in
      determining whether the equity method of accounting is appropriate. Under the
      equity method of accounting, the investment, originally recorded at cost, is
      adjusted to recognize our share of net earnings or losses of the investee and
      is
      recognized in the consolidated statement of operations in the caption “Equity in
      earnings of affiliated company”.




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




9.  Variable
      Interest Entity




We
      own
      100% of the preferred stock of Scripps Secured Data, Inc. (“SSDI”). On March 27,
      2007 we entered into an 18 month revolving line of credit with SSDI for a
      maximum amount of $500,000. The line of credit caused us to have a variable
      interest in SSDI, a variable interest entity, and we have determined that we
      are
      the primary beneficiary as we absorb more than half of the variable interest
      entity’s expected losses. FIN46(R), *Consolidation
      of Variable Interest Entities,* requires
      us to consolidate SSDI as long as we are deemed to be the primary
      beneficiary.




We
      reevaluate our primary beneficiary position at each of our balance sheet dates
      using the guidance in FIN46(R). If we are no longer deemed to be the primary
      beneficiary of the variable interest entity, we will discontinue
      consolidation.




RESULTS
      OF OPERATIONS





*Comparison
      of fiscal 2007 and 2006*





Our
      revenues declined from approximately $10,310,000 for the fiscal year ended
      May
      31, 2006 to approximately $639,000 for the fiscal year ended May 31, 2007.
      Our
      revenue amounts do not include approximately $27,848,000 and approximately
      $48,965,000 in income resulting from our investment in Phoenix Digital
      Solutions, LLC for the fiscal years ended May 31, 2006 and May 31, 2007,
      respectively. In the first quarter of the 2006 fiscal year we entered into
      an
      agreement with Intel Corporation licensing our intellectual property, in
      connection with which we received a one-time payment of $10,000,000. The license
      revenue was recognized during the 2006 fiscal year. In addition, product sales
      amounting to approximately $310,000 were also recorded during the 2006 fiscal
      year in connection with communications products that we no longer market.
      Inventory associated with the sales of these communications products was carried
      at zero value. Cost of sales of approximately $103,000 consisted of payments
      made to subcontractors for materials and labor in connection with the product
      sales. During the fourth quarter of the 2007 fiscal year we recorded sales
      amounting to approximately $559,000 by our consolidated variable interest
      entity, SSDI with cost of sales amounting to approximately $308,000. Also during
      the 2007 fiscal year we recognized maintenance fee revenues totaling
      approximately $25,000 in connection with an agreement with AMD Corporation
      during the 2005 fiscal year. The agreement called for maintenance fees totaling
      $100,000 connected with a license agreement for our Ignite technology; the
      license fee revenue is being recognized as revenue evenly over the four year
      period of the license. In addition during the 2007 fiscal year, we recorded
      sales of approximately $55,000 from the sale of microprocessor chips that we
      no
      longer market. Inventory associated with the sales of these microprocessor
      chips
      is carried at zero value.


18


Research
      and development expenses for the fiscal year ended May 31, 2006 amounted to
      approximately $226,000. Expenses related to salaries, benefits, training and
      other employee expenses amounted to approximately $152,000 for the 2006 fiscal
      year. Consultants related to research and development activities amounted to
      approximately $64,000 for the 2006 fiscal year and remaining expenses of
      approximately $10,000 connected with travel and overhead costs supporting
      research and development activities during the 2006 fiscal year. Research and
      development activities were terminated during the 2006 fiscal year and no such
      costs were incurred during the 2007 fiscal year.





Selling,
      general and administrative expenses increased from approximately $4,151,000
      for
      the fiscal year ended May 31, 2006 to approximately $7,559,000 for the fiscal
      year ended May 31, 2007. Legal and accounting related expenses increased by
      approximately $847,000 for the fiscal year ended May 31, 2007 compared with
      the
      fiscal year ended May 31, 2006 related to legal and accounting matters in
      connection with the restatement of our financial statements for the fiscal
      years
      2005, 2004, 2003 and 2002 as well as the quarterly reports for the periods
      ended
      August 31, 2005 and February 28, 2006 and our required compliance with
      Sarbanes-Oxley regulations. Legal expenses related to a dispute with a former
      officer as well as other legal proceedings involving a co-inventor of a portion
      of our technology and other legal expenses connected with SSDI contributed
      to
      the increase in legal expenses for the 2007 fiscal year. Salary costs and
      related expenses included non-cash expenses associated with the fair value
      of
      options granted during the fiscal year ended May 31, 2007 in accordance with
      SFAS No. 123(R). On June 5, 2006, 1,500,000 options were granted to our former
      chief executive officer resulting in non-cash compensation expense amounting
      to
      approximately $1,527,000. On October 23, 2006, 230,000 options were granted
      to
      employees resulting in non-cash compensation expense of approximately $184,000.
      On February 9, 2007, 1,070,000 options were granted to employees and directors
      resulting in non-cash compensation expense of $584,000. Additional non-cash
      compensation for the fiscal year ended May 31, 2007 amounted to $61,000 for
      vesting of employee stock options in accordance with SFAS No. 123(R). No such
      compensation expense was incurred for the 2006 fiscal year. Other salary
      expenses increased by approximately $398,000 for the fiscal year ended May
      31,
      2007 as compared with the fiscal year ended May 31, 2006 including approximately
      $223,000 in salaries and related expenses for SSDI during the fourth quarter
      of
      the 2007 fiscal year. Salary expenses for the parent company including expenses
      connected with bonuses and 401(k) employer matching of salaries increased by
      approximately $175,000 in the 2007 fiscal year as compared with the 2006 fiscal
      year. Marketing related expenses decreased by approximately $139,000 for the
      fiscal year ended May 31, 2007 as compared with the fiscal year ended May 31,
      2006 as product marketing activities were largely discontinued. Public and
      investor relations expenses increased by approximately $165,000 for the fiscal
      year ended May 31, 2007 as compared with the 2006 fiscal year as a result of
      a
      change in our public relations firm and one-time contracts with investor
      relations consultants. Insurance expense increased by approximately $158,000
      for
      the fiscal year ended May 31, 2007 as compared with the 2006 fiscal year
      primarily as a result of increased costs of directors and officers insurance
      coverage. Travel and related expenses for the 2007 fiscal year increased by
      approximately $44,000 as expenses for SSDI were combined with travel expenses
      for the parent company which increased due to travel to attend various lawsuit
      mediations.





Settlement
      and license expenses amounting to approximately $1,918,000 were recorded during
      the year ended May 31, 2006 in connection with the agreements involving the
      formation of a joint venture and, separately, a license agreement with Intel
      Corporation. The expenses consisted of both cash and non-cash elements related
      to incremental, direct costs of completing the transactions. In connection
      with
      the transactions, it was necessary for us to obtain the consent of certain
      debenture and warrant holders. The necessary consents, together with certain
      warrants held by the debenture holders and the release of their security
      interests in our intellectual property, were obtained in exchange for cash,
      new
      warrants and repriced warrants. The expenses resulted primarily from cash
      payments to debt holders of approximately $1,300,000, to co-owners of various
      intellectual property assets of approximately $960,000 and to a committee of
      our
      board of directors of approximately $170,000. Non-cash expenses totaled
      approximately $82,000 and resulted primarily from the incremental value of
      the
      effect of repricing various warrants and granting other warrants in excess
      of
      the expense previously recognized for warrants granted to these security
      holders. Offsetting the non-cash expenses were non-cash benefits from the
      reconveyance of warrants, amounting to approximately $622,000. During the fiscal
      year ended May 31, 2007, we recorded $7,525,000 of settlement and license
      expense relating to the mediation agreement with Russell H. Fish III (“Fish”)
      (see Note 6 to our consolidated financial statements for more information).


19


Our
      other
      income and expenses for the fiscal year ended May 31, 2007 included equity
      in
      the earnings of PDS. The investment is accounted for in accordance with the
      equity method of accounting for investments. Our investment in the joint venture
      for the fiscal year ended May 31, 2007 provided income after expenses in the
      amount of approximately $48,965,000 resulting from licensing agreements for
      our
      intellectual property with Sony, Nikon, Seiko Epson, Pentax, Olympus, Kenwood,
      Agilent, Lexmark, Schneider Electric, NEC Corporation and its selected
      subsidiaries, Funai Electric, SanDisk, Sharp Corporation and Nokia for one
      time
      payments. Our investment in the joint venture provided net income after expenses
      in the amount of approximately $27,848,000 for the fiscal year ended May 31,
      2006. Total other income and expense for the fiscal year ended May 31, 2007
      amounted to net other income of approximately $49,210,000 compared with total
      other income and expense for the fiscal year ended May 31, 2006 of net other
      income amounting to approximately $24,761,000. Changes in the fair value of
      warrant and derivative liabilities amounted to net other expense for the fiscal
      year ended May 31, 2006 of approximately $2,457,000 with no corresponding amount
      for the fiscal year ended May 31, 2007 as all convertible debt had been retired
      in prior fiscal periods. Non-cash adjustments to interest expense for the 2006
      fiscal year amounted to expenses of approximately $471,000 resulting from
      amortization of debt discount and conversion of the remaining debentures. During
      the 2006 fiscal year we recorded a loss on debt extinguishment of $445,000
      related to the 7,000,000 warrants issued to a debenture holder as consideration
      for entering into the reset agreements. Interest income and other income
      increased from approximately $330,000 for the fiscal year ended May 31, 2006
      to
      approximately $715,000 for the fiscal year ended May 31, 2007 as interest
      bearing account balances increased from cash received as distributions from
      our
      investment in PDS. During the fiscal year ended May 31, 2007 we recorded an
      impairment charge on the value of our note receivable from Holocom Networks,
      Inc. of approximately $340,000. Also, we recorded an impairment charge of
      approximately $127,000 on the carrying value of SSDI, the successor company
      to
      Holocom Networks, Inc., prior to the March 27, 2007 consolidation of the VIE
      (see Note 8 to our consolidated financial statements for more information).





Our
      provision for income taxes was approximately $10,755,000 for the year ended
      May
      31, 2007 due to recognition of deferred taxes of approximately $9,783,000 and
      a
      current tax liability of approximately $972,070. The increase in deferred taxes
      was due to the release of the valuation allowance as we determined that we
      would
      utilize our net operating loss carryforwards and other deferred tax assets
      due
      to our share of income from PDS. At May 31, 2007 we have utilized all of our
      state net operating loss carryforwards of approximately $17,822,000 and utilized
      approximately $29,090,000 of our federal net operating loss
      carryforwards.





*Comparison
      of fiscal 2006 and 2005*





Our
      total
      revenues increased from approximately $2,983,000 for the fiscal year ended
      May
      31, 2005 to approximately $10,310,000 (which amount does not include
      approximately $27,848,000 in income resulting from our investment in PDS) for
      the fiscal year ended May 31, 2006. In the third quarter of fiscal year 2005
      we
      entered into an agreement with AMD Corporation that granted licenses for our
      Ignite microprocessor and for our patent portfolio of microprocessor
      technologies. The Ignite license called for payments totaling $1,220,000 with
      $300,000 paid upon closing of the agreement, $292,500 to be paid in the fourth
      quarter of fiscal 2005 and the remaining balance to be paid during fiscal 2006.
      The revenues associated with the Ignite license were all recognized in fiscal
      2005. The agreement also called for a maintenance fee totaling $100,000
      connected with the Ignite license. That fee is considered to support the Ignite
      license over a period of four years and is being recognized as revenue evenly
      over the four year period. The Ignite license contains provisions for royalties
      based upon deliveries of products using the technology. However we cannot make
      reliable projections of quantities or the timing of shipments that could lead
      to
      royalty payments resulting from this agreement. The agreement with AMD also
      included a non-exclusive license for our portfolio of intellectual property.
      A
      one-time license fee amounting to $1,730,000 was agreed upon with four equal
      payments of $432,500 to be paid during fiscal 2005 and 2006. The entire amount
      of the license fee was recognized as revenue in fiscal 2005. In June 2005,
      we
      entered into an agreement with Intel Corporation licensing our intellectual
      property, in connection with which we received a one-time payment of
      $10,000,000. The license revenue was
      recognized during fiscal 2006. In connection with entering into the agreement
      with Intel Corporation, we entered into an agreement with the co-owner of our
      patented technologies, through which we settled all legal disputes between
      us
      and agreed to jointly pursue others who have infringed upon our joint rights.
      Product sales amounting to approximately $310,000 were also recorded during
      the
      2006 fiscal year in connection with communications products that we no longer
      market. Inventory associated with the sales of these communications products
      is
      carried at zero value. Cost of sales of approximately $103,000 consists of
      payments made to sub contractors for materials and labor in connection with
      the
      products sales. Sales of communications and microprocessor products that have
      been discontinued amounted to approximately $25,000 for the 2005 fiscal year.





Research
      and development expenses declined from approximately $295,000 for the fiscal
      year ended May 31, 2005 to approximately $226,000 for the fiscal year ended
      May
      31, 2006. Expenses related to salaries, benefits, training and other employee
      expenses declined approximately $114,000 resulting from staff reductions.
      Consulting and related support expenses increased from approximately $15,000
      during fiscal 2005 to approximately $65,000 for fiscal 2006 as research and
      development activities moved to outside contractors. Costs of components,
      supplies and equipment increased by approximately $5,000 for the 2006 fiscal
      year as compared with the 2005 fiscal year connected with product development
      and support of the Ignite product line. Depreciation for fixed assets associated
      with research and development activities declined from approximately $11,000
      for
      the fiscal year ended May 31, 2005 to less than $1,000 for the fiscal year
      ended
      May 31, 2006 as equipment became fully depreciated and was not replaced.


20


Selling,
      general and administrative expenses increased from approximately $2,600,000
      for
      the fiscal year ended May 31, 2005 to approximately $4,151,000 for the fiscal
      year ended May 31, 2006. Legal and accounting related expenses increased by
      approximately $997,000 for the 2006 fiscal year compared with the 2005 fiscal
      year related to legal matters in connection with intellectual property and
      formation of a limited liability company, the license agreement with Intel
      Corporation, and legal issues related to former employees and other corporate
      matters. In addition, salary costs increased approximately $605,000 for the
      2006
      fiscal year compared with the 2005 fiscal year as a result of changes in
      management personnel that included severance costs. Other increases for the
      2006
      fiscal year as compared with the 2005 fiscal year included public relations
      and
      consultant expenses of approximately $308,000, insurance expenses of
      approximately $73,000 and travel expenses of approximately $85,000. Offsetting
      these increases were decreases in legal contingency fees of approximately
      $560,000 and decreases in patent enforcement expenses of approximately $290,000.





Settlement
      and license expenses amounting to approximately $1,918,000 were recorded during
      the fiscal year May 31, 2006 in connection with the agreements involving the
      formation of a limited liability company and, separately, a license agreement
      with Intel Corporation. The expenses consisted of both cash and non-cash
      elements related to incremental, direct costs of completing the transactions.
      In
      connection with the transactions, it was necessary for us to obtain the consent
      of certain debenture and warrant holders. The necessary consents, together
      with
      certain warrants held by the debenture holders and the release of their security
      interests in our intellectual property, were obtained in exchange for cash,
      new
      warrants and repriced warrants. The expenses resulted primarily from cash
      payments to debt holders of approximately $1,328,000, to co-owners of various
      intellectual property assets of approximately $960,000 and to a committee of
      our
      board of directors of approximately $170,000. Non-cash expenses totaled
      approximately $82,000 and resulted primarily from the incremental value of
      the
      effect of repricing various warrants and granting other warrants in excess
      of
      the expense previously recognized for warrants granted to these security
      holders. Offsetting the non-cash expenses were non-cash benefits to us from
      the
      reconveyance of warrants, amounting to approximately $622,000.





Our
      other
      income and expenses for the fiscal year ended May 31, 2006 included equity
      in
      the earnings of PDS, a joint venture entity. The investment is accounted for
      in
      accordance with the equity method of accounting for investments. Our investment
      in the joint venture for the fiscal year ended May 31, 2006 provided income
      in
      the amount of approximately $27,848,000 resulting from licensing agreements
      for
      our intellectual property with Hewlett-Packard, Fujitsu and Casio for one time
      payments. Total other income and expense for the fiscal year ended May 31,
      2006
      amounted to approximately $24,761,000 compared with total other income and
      expense for the fiscal year ended May 31, 2005 of net expenses amounting to
      approximately $10,606,000. Changes in the fair value of warrant and derivative
      liabilities amounted to net expense in the 2005 fiscal year of approximately
      $7,564,000 and net expense of approximately $2,457,000 in the 2006 fiscal year.
      Expenses were incurred during the 2006 fiscal year of approximately $445,000
      in
      connection with debt extinguishment and no such expenses were incurred during
      the 2005 fiscal year. Interest expense amounted to approximately $3,082,000
      for
      the 2005 fiscal year and approximately $517,000 for the 2006 fiscal year. The
      non-cash portion of interest expense amounted to approximately $2,941,000 for
      the 2005 fiscal year and approximately $471,000 for the 2006 fiscal year
      associated primarily with convertible debenture debt discount amortization
      and
      write-off of debt discount upon conversion of convertible debentures. Interest
      income and other income increased from approximately $56,000 for the 2005 fiscal
      year to approximately $330,000 for the 2006 fiscal year, as interest bearing
      account balances increased from license revenues. Gain on sale of assets
      amounted to approximately $4,000 for the 2005 fiscal year and approximately
      $3,000 for the 2006 fiscal year. Unrealized loss on marketable securities
      amounted to approximately $21,000 for the 2005 fiscal year and $1,000 for the
      2006 fiscal year.





Our
      net
      income for the fiscal year ended May 31, 2006 amounted to approximately
      $28,673,000 compared with a loss of approximately $10,519,000 for the fiscal
      year ended May 31, 2005.





LIQUIDITY
      AND CAPITAL RESOURCES





*Liquidity*





Our
      cash,
      marketable securities and short-term investment balances increased from
      approximately $7,503,000 as of May 31, 2006 to approximately $25,955,000 as
      of
      May 31, 2007. We also have restricted cash balances amounting to approximately
      $100,000 as of May 31, 2006 and approximately $102,000 as of May 31, 2007.
      Total
      current assets increased from approximately $8,015,000 as of May 31, 2006 to
      approximately $31,399,000 as of May 31, 2007. Total current liabilities amounted
      to approximately $1,244,000 and approximately $2,021,000 as of May 31, 2006
      and
      May 31, 2007, respectively. The improvement in the Company’s current position as
      of May 31, 2007 as compared with the previous year primarily results from
      increased licensing revenues received from our equity investee during the 2007
      fiscal year.


21


*Cash
      Flows From Operating Activities*





Cash
      used
      in operating activities for the fiscal year ended May 31, 2007 was approximately
      $14,151,000 as compared with cash provided by operating activities for the
      fiscal year ended May 31, 2006 of approximately $6,474,000. The principal
      components of the current year amount were: net income of approximately
      $23,691,000 adjusted for: non-cash charges of approximately $2,359,000 related
      to issuance and vesting of stock options and warrants, trade payables and
      accrued expenses of approximately $1,122,000 primarily relating to: the
      inclusion of the trade payables of our consolidated variable interest entity
      of
      approximately $147,000, inclusion of the accrued expenses of our consolidated
      variable interest entity of approximately of $173,000 and royalties payable
      of
      $797,000 and approximately $9,783,000 of deferred taxes. These increases were
      partially offset by: the equity in earnings of our investee of approximately
      $48,965,000, and an increase in refundable income taxes of approximately
      $2,071,000.





Cash
      provided by operating activities for the fiscal year ended May 31, 2006 was
      approximately $6,474,000 as compared with cash used in operating activities
      for
      the fiscal year ended May 31, 2005 of approximately $628,000. The principal
      components were: net income of approximately $28,673,000 adjusted for: the
      change in fair value of warrant and derivative liabilities of approximately
      $2,457,000 and license fees received from AMD of $2,000,000. These increases
      were partially offset by the equity in earnings of our investee of approximately
      $27,848,000.




*Cash
      Flows From Investing Activities*





Cash
      provided by investing activities increased to approximately $48,529,000 for
      the
      fiscal year ended May 31, 2007 from approximately $21,121,000 for the fiscal
      year ended May 31, 2006. The increase was primarily due to distributions of
      approximately $50,034,000 we received from our investment in an affiliate offset
      by cash used of approximately $830,000 in net purchases of short-term
      investments and an issuance of a line of credit of approximately $590,000 to
      Holocom Networks, Inc.





Cash
      provided by investing activities for the fiscal year ended May 31, 2006 was
      approximately $21,121,000 as compared to cash used in investing activities
      of
      approximately $893,000 for the fiscal year ended May 31, 2005. The increase
      was
      primarily due to distributions of approximately $25,895,000 we received from
      our
      investment in an affiliate offset by cash used of approximately $2,000,000
      to
      invest in our affiliate and approximately $2,805,000 in net purchases of
      short-term investments. Cash used in the fiscal year ended May 31, 2005
      primarily consisted of purchases of short-term investments.





*Cash
      Flows From Financing Activities*





Cash
      used
      in financing activities for the fiscal year ended May 31, 2007 was approximately
      $16,757,000 as compared to approximately $24,202,000 for the fiscal year ended
      May 31, 2006 primarily due to payments of approximately $8,115,000 in cash
      dividends to our common shareholders and qualifying warrant holders for fiscal
      year 2007 as compared to approximately $24,698,000 in cash dividends paid for
      fiscal year 2006, and approximately $8,832,000 paid to repurchase shares of
      our
      common stock for treasury in fiscal year 2007. The cash used in fiscal 2007
      was
      partially offset by cash received of approximately $214,000 from the exercise
      of
      common stock options and warrants.





Cash
      used
      in financing activities for the fiscal year ended May 31, 2006 was approximately
      $24,202,000 as compared to cash provided by financing activities of
      approximately $1,757,000 for the fiscal year ended May 31, 2005. Cash used
      in
      fiscal year 2006 consisted primarily of approximately $24,698,000 in cash
      dividends to our common shareholders and qualifying warrant holders, and
      approximately $252,000 paid to repurchase warrants. The cash used in fiscal
      year
      2006 was partially offset by proceeds received of approximately $851,000 from
      the exercise of common stock options and warrants. Cash provided by financing
      activities in fiscal year 2005 consisted primarily of approximately $1,765,000
      from the exercise of common stock options and warrants, issuance of common
      stock
      and issuance of convertible debentures, offset by payments for capital lease
      obligations of approximately $8,000.





*Capital
      Resources*





Our
      current position as of May 31, 2007 is expected to provide the funds necessary
      to support our operations through the fiscal year ended May 31,
      2008.


22


MANAGEMENT
      OUTLOOK





During
      recent years we have relied upon financing activities to provide the funds
      necessary for our operations. The number of shares of our common stock
      outstanding increased from 171,156,363 at May 31, 2004 to 366,199,765 at May
      31,
      2006, largely as a result of financing activities including sales of common
      stock, the issuance of convertible debentures and notes payable and related
      conversions and exercises of common stock warrants. Beginning in fiscal year
      2006, we were able to finance operations utilizing distributions we received
      from PDS.





CONTRACTUAL
      OBLIGATIONS AND COMMITMENTS




A
      summary
      of our outstanding contractual obligations at May 31, 2007 is as
      follows:




Contractual
              Cash
                Obligations
            
            Total
                Amounts
              Committed
            
            
            1-3
              YearsOperating
                leases - facilities
            
            $
            229,644
            
            
            $
            229,644






**RECENT
      ACCOUNTING PRONOUNCEMENTS**




In
      July
      2006, the Financial Accounting Standards Board (FASB) issued Interpretation
      No.
      48, *Accounting
      for Uncertainty in Income Taxes - an interpretation of FASB Statement No.
      109* (“FIN
      48”). This interpretation clarifies the application of SFAS No. 109, *Accounting
      for Income Taxes* ,
      by
      defining criteria that an individual tax position must meet for any part of
      the
      benefit of that position to be recognized in a company’s financial statements
      and also provides guidance on measurement, derecognition, classification,
      interest and penalties, accounting in interim periods, disclosure and
      transition. FIN 48 is effective for fiscal years beginning after December 15,
      2006. We expect to adopt FIN 48 on June 1, 2007. We are currently assessing
      the
      impact the adoption of FIN 48 will have on our consolidated financial
      statements.




In
      September 2006, the FASB issued SFAS No. 157, *Fair
      Value Measurements* (“SFAS
      No. 157”).  SFAS No. 157 defines fair value, establishes a framework for
      measuring fair value in generally accepted accounting principals and expands
      disclosures about fair value measurements.  The statement does not require
      new fair value measurements, but is applied to the extent that other accounting
      pronouncements require or permit fair value measurements.  The statement
      emphasizes that fair value is a market-based measurement that should be
      determined based on the assumptions that market participants would use in
      pricing an asset or liability.  Companies that have assets and liabilities
      measured at fair value will be required to disclose information that enables
      the
      users of its financial statements to access the inputs used to develop those
      measurements.  The reporting entity is encouraged, but not required, to
      combine the fair value information disclosed under this statement with the
      fair
      value information disclosed under other accounting pronouncements.  SFAS
      No. 157 is effective for fiscal years beginning after November 15, 2007. We
      expect to adopt SFAS No. 157 on June 1, 2008.  We are currently assessing
      the impact the adoption of SFAS No. 157 will have on our consolidated financial
      statements.




In
      September 2006, the SEC staff issued SAB No. 108, *Considering
      the Effects of Prior Year Misstatements when Quantifying Misstatements in
      Current Year Financial Statements.* SAB
      No.
      108 was issued in order to eliminate the diversity in practice surrounding
      how
      public companies quantify financial statement misstatements. SAB No. 108
      requires that registrants quantify errors using both a balance sheet and income
      statement approach and evaluate whether either approach results in a misstated
      amount that, when all relevant quantitative and qualitative factors are
      considered, is material. The adoption of this statement did not have a
      significant impact on our consolidated financial condition or results of
      operations.




In
      February 2007, the FASB issued SFAS No. 159, *The
      Fair Value Option for Financial Assets and Financial Liabilities* (“SFAS
      No. 159”). SFAS No. 159 permits entities to choose to measure at fair value many
      financial instruments and certain other items that are not currently required
      to
      be measured at fair value. The objective is to improve financial reporting
      by
      providing entities with the opportunity to mitigate volatility in reported
      earnings caused by measuring related assets and liabilities differently without
      having to apply complex hedge accounting provisions. SFAS No. 159 also
      establishes presentation and disclosure requirements designed to facilitate
      comparisons between entities that choose different measurement attributes for
      similar types of assets and liabilities. SFAS No. 159 does not affect
      any existing accounting literature that requires certain assets and liabilities
      to be carried at fair value. SFAS No. 159 does not establish
      requirements for recognizing and measuring dividend income, interest income,
      or
      interest expense. This Statement does not eliminate disclosure requirements
      included in other accounting standards. SFAS No. 159 is effective in
      fiscal years beginning after November 15, 2007. We are in the process of
      evaluating the provisions of the statement, but do not anticipate that the
      adoption of SFAS No. 159 will have a material impact on our consolidated
      financial statements.


23


**ITEM
      7A.**  **QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**




*Interest
      rate risk*




The
      primary objective of our investment activities is to maintain surplus cash
      in
      accounts that provide a high level of funds accessibility in large, respected
      financial institutions with asset safety as a primary consideration.
      Accordingly, we maintain our cash, cash equivalents and short-term investments
      with high quality financial institutions. Amounts deposited with these
      institutions may exceed federal depository insurance limits.




We
      maintain our marketable securities and short term investments in institutional
      money market accounts. In general, money market funds are not subject to
      interest rate risk because the interest paid on these funds fluctuates with
      the
      prevailing interest rate.





Our
      commercial checking account is linked to a sweep account. This sweep account
      is
      maintained by our financial institution in an offshore account located in the
      Cayman Islands. This sweep account is a deposit liability of our financial
      institution, the funds are not insured by the Federal Deposit Insurance
      Corporation (FDIC), in liquidation the funds have a lesser preference than
      deposits held in the United States, and the funds are subject to cross-border
      risks.





**ITEM
      8.**  **FINANCIAL
      STATEMENTS** **AND SUPPLEMENTARY DATA**




The
      financial statements required by this item begin on page F-1 with the index
      to
      consolidated financial statements.




**ITEM
      9.**  **CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE**




None.




**ITEM
      9A. CONTROLS AND PROCEDURES**




**Evaluation
      of Disclosure Controls and Procedures**





Our
      chief
      executive officer and chief financial officer, after evaluating the
      effectiveness of our disclosure controls and procedures (as defined in the
      Securities Exchange Act of 1934, Rules 13a-15(e) and 15d-15(e)), as of the
      end of the period covered by this report, have concluded that, based on such
      evaluation, as of May 31, 2007 our disclosure controls and procedures were
      effective and designed to provide reasonable assurance that the information
      required to be disclosed is recorded, processed, summarized and reported within
      the time periods specified in the SEC‘s rules and forms. For the purpose of this
      review, disclosure controls and procedures means controls and procedures
      designed to ensure that information required to be disclosed by us in the
      reports that we file or submit is recorded, processed, summarized and reported
      within the time periods specified in the SEC’s rules and forms. These disclosure
      controls and procedures include, without limitation, controls and procedures
      designed to ensure that information required to be disclosed by us in the
      reports that we file or submit is accumulated and communicated to management,
      including our principal executive officer and principal financial officer,
      as
      appropriate to allow timely decisions regarding required disclosure. In
      designing and evaluating the disclosure controls and procedures, our management
      recognized that any controls and procedures, no matter how well designed and
      operated, can provide only reasonable assurance of achieving the desired control
      objectives, and our management necessarily was required to apply its judgment
      in
      evaluating the cost-benefit relationship of possible controls and
      procedures.





**Changes
      in Internal Controls over Financial Reporting**




There
      has
      been no change in our internal control over financial reporting (as defined
      in
      Rule 13a-15(f) under the Exchange Act) during our fourth fiscal quarter
      ended May 31, 2007, that has materially affected, or is reasonably likely
      to materially affect our internal control over financial reporting.


24


**Management’s
      Report on Internal Control Over Financial Reporting**




Our
      management is responsible for establishing and maintaining adequate internal
      control over financial reporting, as such term is defined in Exchange Act
      Rules 13a-15(f) and 15d-15(f).




Under
      the
      supervision and with the participation of our management, including our
      principal executive officer and principal financial officer, we conducted an
      evaluation of the effectiveness of our internal control over financial reporting
      based on the framework in *Internal Control — Integrated Framework* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission
      (“COSO”). Based on our evaluation under the framework in *Internal Control — Integrated Framework* , our
      management concluded that our internal control over financial reporting was
      effective as of May 31, 2007.





We
      have
      not evaluated the internal controls of the consolidated entity Scripps Secured
      Data, Inc. (SSDI), a variable interest entity. Furthermore, management's
      conclusion regarding the effectiveness of its internal control over financial
      reporting does not extend to the internal controls of SSDI.




SSDI
      was consoliated pursuant to FIN 46(R), and, as
      such, management has been unable to assess the effectiveness of SSDI's internal
      control due to the fact that management does not have the right or authority
      to
      assess, dictate or modify the controls of SSDI at this time. SSDI was
      consolidated on March 27, 2007, with its financial statements reflecting total
      assets and revenues constituing 1.9% and 87.4% respectively, of the related
      consolidated financial statement amounts as of and for the year ended May 31,
      2007.


25


**Report
      of Independent Registered Public Accounting Firm**








To
      the
      Board of Directors and Stockholders of Patriot Scientific Corporation





We
      have
      audited Patriot Scientific Corporation’s (the "Company") internal control over
      financial reporting as of May 31, 2007, based on criteria established in *Internal
      Control - Integrated Framework* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
      The Company's management is responsible for maintaining effective internal
      control over financial reporting and for its assessment of the effectiveness
      of
      internal control over financial reporting. Management's assessment that the
      Company maintained effective internal control over financial reporting as of
      May
      31, 2007, based on criteria established in *Internal
      Control - Integrated Framework* issued
      by COSO, is included in the accompanying Management's Report on Internal Control
      over Financial Reporting included in Item 9A. Our
      responsibility is to express an
      opinion on the effectiveness of the Company's internal control over financial
      reporting based on our audit.





We
      conducted our audit 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 effective
      internal control over financial reporting was maintained in all material
      respects. Our audit included obtaining an understanding of internal control
      over
      financial reporting, assessing the risk that a material weakness exists, testing
      and evaluating the design and operating effectiveness of internal control based
      on the assessed risk, and performing such other procedures as we considered
      necessary in the circumstances. We believe that our audit provides a reasonable
      basis for our opinion.





As
      described in Management’s Report on Internal Control over Financial Reporting,
      management excluded from their assessment the internal control over financial
      reporting at Scripps Secured Data, Inc., a variable interest entity, which
      was
      consolidated on March 27, 2007 and whose financial statements reflect total
      assets and revenues constituting 1.9% and 87.4%, respectively, of the related
      consolidated financial statement amounts as of and for the year ended May 31,
      2007. Accordingly, our audit did not include the internal control over financial
      reporting at Scripps Secured Data, Inc.





A
      company's internal control over financial reporting is a process designedby,
      or
      under the supervision of, the company's principal executive and principal
      financial officers, or persons performing similar functions, and effected by
      the
      company's board of directors, management, and other personnel,to
      provide reasonable assurance regarding the reliability of financial reporting
      and the preparation of financial statements for external purposes in accordance
      with accounting principles generally accepted in the United States of America.
      A
      company's internal control over financial reporting includes those policies
      and
      procedures that (1) pertain to the maintenance of records that, in reasonable
      detail, accurately and fairly reflect the transactions and dispositions of
      the
      assets of the company; (2) provide reasonable assurance that transactions are
      recorded as necessary to permit preparation of financial statements in
      accordance with accounting principles generally accepted in the United States
      of
      America, and that receipts and expenditures of the company are being made only
      in accordance with authorizations of management and directors of the company;
      and (3) provide reasonable assurance regarding prevention or timely detection
      of
      unauthorized acquisition, use, or disposition of the company's assets that
      could
      have a material effect on the financial statements.


26


Because
      of its inherent limitations, internal control over financial reporting
      may not prevent or detect misstatements. Also, projections of any evaluation
      of
      effectiveness to future periods are subject to the risk that controls may become
      inadequate because of changes in conditions, or that the degree of compliance
      with the policies or procedures may deteriorate.





In
      our
      opinion, Patriot Scientific Corporation maintained, in all material respects,
      effective internal control over financial reporting as of May 31, 2007, based
      on
      criteria established in *Internal
      Control - Integrated Framework* issued
      by the Committee of Sponsoring Organizations of the Treadway
      Commission.





We
      also
      have audited, in accordance with the standards of the Public Company
      Accounting Oversight Board (United States), the consolidated balance sheets
      of
      Patriot Scientific Corporation as of May 31, 2007 and 2006, and the related
      consolidated statements of operations, stockholders' equity and cash flows
      for
      each of the three years in the period ended May 31, 2007 and our report dated
      August 14, 2007 expressed an unqualified opinion on those consolidated financial
      statements.











/s/
      KMJ
      Corbin & Company LLP


Irvine,
      California


August
      14, 2007


27




**ITEM
      9B. OTHER INFORMATION**




None.





**PART
      III**






**ITEM
      10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE**




The
      information regarding Directors, Executive Officers, Promoters and Control
      Persons, Compliance with Section 16(a) of the Exchange Act, and Corporate
      Governance is incorporated by reference to the information contained in our
      definitive proxy statement which will be filed with the Securities and Exchange
      Commission in connection with our 2007 Annual Meeting of
      Shareholders.




**CODE
      OF ETHICS**




We
      have
      adopted a Code of Ethics that applies to our principal executive officer,
      principal financial officer, principal accounting officer or controller, or
      persons performing similar functions.




**ITEM
      11. EXECUTIVE COMPENSATION**




The
      information regarding Director Compensation, Report of the Compensation
      Committee, Compensation Discussion and Analysis and Executive Compensation
      is
      incorporated by reference to the information contained in our 2007 definitive
      proxy statement.




**ITEM
      12.**  **SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
      MATTERS**




The
      information regarding Security Ownership of Certain Beneficial Owners and
      Management and Equity Compensation Plan Information is incorporated by reference
      to the information contained in our 2007 definitive proxy statement.




**ITEM
      13.**  **CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE**




The
      information regarding Certain Relationships and Related Transactions and
      Corporate Governance is incorporated by reference to the information contained
      in our 2007 definitive proxy statement.




**ITEM
      14.**  **PRINCIPAL
      ACCOUNTING FEES AND SERVICES**




The
      information regarding Principal Accounting Fees and Services is incorporated
      by
      reference to the information contained in our 2007 definitive proxy statement.


28


**PART
      IV**




**ITEM
      15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES**




(a) The
      following documents are filed as a part of this Report:




1.
            *Financial
                Statements*.
                The following consolidated financial statements and Report of Independent
                Registered Public Accounting Firm are included starting on page F-1
                of
                this Report:




Patriot
      Scientific Corporation




Report
      of
      KMJ Corbin & Company LLP, Independent Registered Public Accounting
      Firm




Consolidated
      Balance Sheets as of May 31, 2007 and 2006




Consolidated
      Statements of Operations for the Years Ended May 31, 2007, 2006 and 2005




Consolidated
      Statements of Stockholders’ Equity for the Years Ended May 31, 2007, 2006 and
      2005




Consolidated
      Statements of Cash Flows for the Years Ended May 31, 2007, 2006 and
      2005




Notes
      to
      Consolidated Financial Statements




Phoenix
      Digital Solutions, LLC




Report
      of
      KMJ Corbin & Company LLP, Independent Registered Public Accounting
      Firm




Balance
      Sheets as of May 31, 2007 and 2006




Statements
      of Operations for the Years Ended May 31, 2007 and 2006




Statement
      of Members’ Equity for the Years Ended May 31, 2007 and 2006




Statements
      of Cash Flows for the Years Ended May 31, 2007 and 2006




Notes
      to
      Financial Statements




2.
            *Financial
                Statement Schedules*.
                All financial statement schedules have been omitted since the information
                is either not applicable or required or is included in the financial
                statements or notes thereof.




3.
            *Exhibits*.
                Those exhibits marked with a (*) refer to exhibits filed herewith.
                The
                other exhibits are incorporated herein by reference, as indicated
                in the
                following list. Those exhibits marked with a (†) refer to management
                contracts or compensatory plans or
                arrangements.


29




**Exhibit No.**
            **Document**2.1
            Agreement
                to Exchange Technology for Stock in the Company, incorporated by
                reference
                to Exhibit 2.1 to Form 8-K dated August 10, 1989 (Commission
                file No. 33-23143-FW)2.2
            Assets
                Purchase Agreement and Plan of Reorganization dated June 22, 1994,
                among the Company, nanoTronics Corporation and Helmut Falk, incorporated
                by reference to Exhibit 10.4 to Form 8-K dated July 6, 1994
                (Commission file No. 000-22182)2.2.1
            Amendment
                to Development Agreement dated April 23, 1996 between the Company and
                Sierra Systems, incorporated by reference to Exhibit 2.2.1 to
                Pre-Effective Amendment No. 1 to Registration Statement on Form SB-2
                filed April 29, 1996 (Commission file No. 333-01765)2.3
            Form
                of Exchange Offer dated December 4, 1996 between the Company and
                certain shareholders of Metacomp, Inc., incorporated by reference
                to
                Exhibit 2.3 to Form 8-K filed January 9, 1997 (Commission file
                No. 000-22182)2.4
            Letter
                of Transmittal to Accompany Shares of Common Stock of Metacomp, Inc.
                Tendered Pursuant to the Exchange Offer Dated December 4, 1996,
                incorporated by reference to Exhibit 2.4 to Form 8-K filed
                January 9, 1997 (Commission file No. 000-22182)3.1
            Original
                Articles of incorporation of the Company’s predecessor, Patriot
                Financial Corporation, incorporated by reference to Exhibit 3.1 to
                registration statement on Form S-18, (Commission file No.
                33-23143-FW)3.2
            Articles of
                Amendment of Patriot Financial Corporation, as filed with the Colorado
                Secretary of State on July 21, 1988, incorporated by reference to
                Exhibit 3.2 to registration statement on Form S-18, (Commission file
                No. 33-23143-FW)3.3
            Certificate
                of Incorporation of the Company, as filed with the Delaware Secretary
                of
                State on March 24, 1992, incorporated by reference to
                Exhibit 3.3 to Form 8-K dated May 12, 1992 (Commission file No.
                33-23143-FW)




3.3.1
            Certificate
                of Amendment to the Certificate of Incorporation of the Company,
                as filed
                with the Delaware Secretary of State on April 18, 1995, incorporated
                by reference to Exhibit 3.3.1 to Form 10-KSB for the fiscal year
                ended May 31, 1995 (Commission file No. 000-22182)3.3.2
            Certificate
                of Amendment to the Certificate of Incorporation of the Company,
                as filed
                with the Delaware Secretary of State on June 24, 1997, incorporated
                by reference to Exhibit 3.3.2 to Form 10-KSB for the fiscal year
                ended May 31, 1997, filed July 18, 1997 (Commission file No.
                000-22182)3.3.3
            Certificate
                of Amendment to the Certificate of Incorporation of the Company,
                as filed with the Delaware Secretary of State on April 28, 2000,
                incorporated by reference to Exhibit 3.3.3 to Registration Statement
                on Form S-3 filed May 5, 2000 (Commission file No.
                333-36418)3.3.4
            Certificate
                of Amendment to the Certificate of Incorporation of the Company,
                as filed
                with the Delaware Secretary of State on May 6, 2002, incorporated by
                reference to Exhibit 3.3.4 to Registration Statement on Form S-3
                filed June 27, 2002 (Commission file No. 333-91352)3.3.5
            Certificate
                of Amendment to the Certificate of Incorporation of the Company,
                as 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 filed May 21, 2004 (Commission file No.
                333-115752)


30


3.4
              Articles and
                  Certificate of Merger of Patriot Financial Corporation into the
                  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 (Commission file No.
                  33-23143-FW)3.5
              Certificate
                  of Merger issued by the Delaware Secretary of State on May 8, 1992,
                  incorporated by reference to Exhibit 3.5 to Form 8-K dated
                  May 12, 1992 (Commission file No. 33-23143-FW)3.6
              Certificate
                  of Merger issued by the Colorado Secretary of State on May 12, 1992,
                  incorporated by reference to Exhibit 3.6 to Form 8-K dated
                  May 12, 1992 (Commission file No. 33-23143-FW)3.7
              Bylaws
                  of the Company, incorporated by reference to Exhibit 3.7 to Form 8-K
                  dated May 12, 1992 (Commission file No.
                  33-23143-FW)4.1
              Specimen
                  common stock certificate, incorporated by reference to Exhibit 4.1
                  Form 8-K dated May 12, 1992 (Commission file No.
                  33-23143-FW)4.2†
              1996
                  Stock Option Plan of the Company dated March 25, 1996 and approved by
                  the 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 filed May 23, 1996 (Commission file No.
                  333-01765)4.3†
              2001
                  Stock Option Plan of the Company dated February 21, 2001 incorporated
                  by reference to Exhibit 4.19 to Registration Statement on Form S-8
                  filed March 26, 2001 (Commission file No.
                  333-57602)4.4†
              2003
                  Stock Option Plan of the Company dated July 2, 2003 incorporated by
                  reference to Exhibit 4.27 to Registration Statement on Form S-8 filed
                  September 4, 2003 (Commission file No. 333-108489)4.5†
              2006
                  Stock Option Plan of the Company dated March 31, 2006 incorporated by
                  reference to Exhibit 4.19 to Registration Statement on Form S-8 filed
                  June 20, 2006 (Commission file No. 333-135156)4.6
              Approval
                  Rights Agreement and Termination of Antidilution Agreement and
                  Addendum to
                  Warrants dated October 10, 2006, incorporated by reference to
                  Exhibit 4.29 to Form 10-KSB for the fiscal year ended May 31,
                  2006, filed on October 13, 2006 (Commission file No. 000-22182)10.1
              IGNITE
                  License Agreement with Advanced Micro Devices, Inc., dated
                  February 21, 2005, incorporated by reference to Exhibit 10.38 to
                  Form 10-KSB for the fiscal year ended May 31, 2006, filed on October
                  13, 2006 (Commission file No. 000-22182)10.2
              Patent
                  Portfolio License Agreement with Advanced Micro Devices, Inc.,
                  dated
                  February 21, 2005, incorporated by reference to Exhibit 10.39 to
                  Form 10-KSB for the fiscal year ended May 31, 2006, filed on October
                  13, 2006 (Commission file No. 000-22182)10.3
              Master
                  Agreement, dated as of June 7, 2005, by and among the Company,
                  Technology Properties Limited Inc., a California corporation and
                  Charles
                  H. Moore, an individual, incorporated by reference to Exhibit 10.40
                  to Form 8-K filed June 15, 2005 (Commission file No.
                  000-22182)10.4
              Commercialization
                  Agreement dated as of June 7, 2005 by and among the JV LLC,
                  Technology Properties Limited Inc., a California corporation, and
                  the
                  Company, incorporated by reference to Exhibit 10.41 to Form 8-K filed
                  June 15, 2005 (Commission file No. 000-22182)10.5
              Limited
                  Liability Company Operating Agreement of JV LLC, a Delaware limited
                  liability company, dated as of June 7, 2005, incorporated by
                  reference to Exhibit 10.42 to Form 8-K filed June 15, 2005
                  (Commission file No.
                  000-22182)




31





10.6†
            Agreement
                for Part-Time Employment dated August 3, 2005 between the Company and
                Thomas J. Sweeney, incorporated by reference to Exhibit 99.3 to Form
                8-K filed August 9, 2005 (Commission file No.
                000-22182)10.7
            Settlement
                Agreement dated February 13, 2007 by and among the Company, Russell
                H.
                Fish, III and Robert C. Anderson as trustee of the Fish Family Trust
                incorporated by reference to Exhibit 10.45 to Registration Statement
                en
                Form SB-2 filed March 21, 2007 (Commission file No.
                333-134362)10.8†
            Employment
                Agreement dated June 5, 2007 by and between the Company and James
                Turley,
                incorporated by reference to Exhibit 10.1 to Form 8-K filed June
                8, 2007
                (Commission file No. 000-22182)14.1
            Code
                of Ethics for Senior Financial Officers incorporated by reference
                to
                Exhibit 14.1 to Form 10-K for the fiscal year ended May 31,
                2003, filed August 29, 2003 (Commission file No.
                000-22182)21.1
            List
                of subsidiaries of the Company incorporated by reference to Exhibit
                21.1
                of the Company’s annual report on Form 10-KSB filed October 13, 2006
                (Commission file No. 000-22182)23.1*
            Consent
                of Independent Registered Public Accounting Firm31.1*
            Certification
                of James L. Turley, CEO, pursuant to Rule
                13a-14(a)/15d-14(a)31.2*
            Certification
                of Thomas J. Sweeney, CFO, pursuant Rule
                13a-14(a)/15d-14(a)32.1*
            Certification
                of James L. Turley, CEO, pursuant to Section 135032.2*
            Certification
                of Thomas J. Sweeney, CFO, pursuant to Section
                135099.1
            Form
                of ISO Plan Option (Gaspar) dated May 29, 1992, incorporated by
                reference to Exhibit 28.2 to registration statement on
                Form SB-2, 1996 (Commission file No. 33-57858)99.2
            Form
                of NSO Plan Option (Berlin) dated May 29, 1992, incorporated by
                reference to Exhibit 28.3 to registration statement on
                Form SB-2, 1996 (Commission file No. 33-57858)99.3
            Form
                of Incentive Stock Option Agreement to the Company’s 1996 stock Option
                Plan (individual agreements differ as to number of shares, dates,
                prices
                and vesting), incorporated by reference to Pre-Effective Amendment
                No. 2 to Registration Statement on Form SB-2 filed May 23, 1996
                (Commission file No. 333-01765)99.4
            Form
                of Non-Qualified Stock Option Agreement to the Company’s 1996 Stock Option
                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 filed May 23, 1996
                (Commission file No. 333-01765)99.5
            Press
                Release of the Company dated November 4, 1996 incorporated by
                reference to Exhibit 99.5 to Form 8-K filed January 9, 1997
                (Commission file No. 000-22182)99.6
            Form
                of Incentive Stock Option Agreement to the Company’s 2001 Stock Option
                Plan incorporated by reference to Exhibit 99.6 to Registration
                Statement on Form S-8 filed March 26, 2001 (Commission file No.
                333-57602)99.7
            Form
                of Non-Qualified Stock Option Agreement to the Company’s 2001 Stock Option
                Plan incorporated by reference to Exhibit 99.7 to Registration
                Statement on Form S-8 filed March 26, 2001 (Commission file No.
                333-57602)99.8
            Form
                of Incentive Stock Option Agreement to the Company’s 2003 Stock Option
                Plan incorporated by reference to Exhibit 99.8 to Registration
                Statement on Form S-8 filed September 4, 2003 (Commission file No.
                333-108489)99.9
            Form
                of Non-Qualified Stock Option Agreement to the Company’s 2003 Stock Option
                Plan incorporated by reference to Exhibit 99.9 to Registration
                Statement on Form S-8 filed September 4, 2003 (Commission file
                No. 333-108489)


32





**Patriot
      Scientific Corporation**




**INDEX
      TO CONSOLIDATED FINANCIAL STATEMENTS**




**Page**Report
                of Independent Registered Public Accounting Firm
            
            
            F-2Financial
                Statements:Consolidated
                Balance Sheets
            
            
            F-3Consolidated
                Statements of Operations
            
            
            F-4Consolidated
                Statements of Stockholders’ Equity
            
            
            F-5Consolidated
                Statements of Cash Flows
            
            
            F-7Notes
                to Consolidated Financial Statements
            
            
            F-9


F-1




**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





To
      the
      Stockholders and Board of Directors


Patriot
      Scientific Corporation





We
      have
      audited the accompanying consolidated balance sheets of Patriot Scientific
      Corporation (the “Company”) as of May 31, 2007 and 2006, and the related
      consolidated statements of operations, stockholders’ equity and cash flows for
      each of the years in the three year period ended May 31, 2007. These
      consolidated financial statements are the responsibility of the Company’s
      management. Our responsibility is to express an opinion on these consolidated
      financial statements based on our audits.





We
      conducted our audits in accordance with standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audits to obtain reasonable assurance about whether the
      consolidated financial statements are free of material misstatement. An audit
      includes examining, on a test basis, evidence supporting the amounts and
      disclosures in the consolidated financial statements. An audit also includes
      assessing the accounting principles used and significant estimates made by
      management, as well as evaluating the overall consolidated financial statement
      presentation. We believe that our audits provide a reasonable basis for our
      opinion.





In
      our
      opinion, the consolidated financial statements referred to above, present
      fairly, in all material respects, the financial position of Patriot Scientific
      Corporation as of May 31, 2007 and 2006, and the results of its operations
      and
      its cash flows for each of the years in the three year period ended May 31,
      2007
      in conformity with accounting principles generally accepted in the United States
      of America.





We
      have
      also audited, in accordance with standards of the Public Company Accounting
      Oversight Board (United States), the effectiveness of the Company’s internal
      control over financial reporting as of May 31, 2007, based on the criteria
      established in *Internal Control - Integrated Framework* issued by the
      Committee of Sponsoring Organizations of the Treadway Commission, and our report
      dated August 14, 2007 expressed an unqualified opinion on the effectiveness
      of
      the Company’s internal control over financial reporting.





As
      discussed in Note 2 to the consolidated financial statements, effective June
      1,
      2006, the Company changed its method of accounting for share-based compensation
      to adopt Statement of Financial Accounting Standards No. 123(R), *Share-Based
      Payment*.











/s/
      KMJ
      Corbin & Company LLP


Irvine,
      California


August
      14, 2007


F-2


**Patriot
      Scientific Corporation**


**Consolidated
      Balance Sheets**







****May
                31,
            
            2007
            
            2006**ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            21,605,428
            
            $
            3,984,240Restricted
                cash and cash equivalents
            
            
            102,346
            
            
            100,320Marketable
                securities and short term investments
            
            
            4,349,314
            
            
            3,518,879Accounts
                receivable
            
            
            352,390
            
            
            4,113Inventory
            
            
            46,361
            
            
            -Prepaid
                income taxes
            
            
            2,070,981
            
            
            -Deferred
                tax assets
            
            
            2,439,975
            
            
            -Prepaid
                expenses and other current assets
            
            
            431,840
            
            
            407,418Total
                current assets
            
            
            31,398,635
            
            
            8,014,970**Property
                and equipment, net**
            
            
            85,518
            
            
            64,006**Other
                assets**
            
            
            8,190
            
            
            8,190**Investment
                in affiliated company**
            
            
            2,883,969
            
            
            3,952,914**Patents
                and trademarks**,
                net of accumulated amortization of $607,657 and $584,387
            
            
            38,317
            
            
            31,587$
            34,414,629
            
            $
            12,071,667**LIABILITIES
                AND STOCKHOLDERS’ EQUITY**Current
                liabilities:Accounts
                payable
            
            $
            934,298
            
            $
            695,323Accrued
                expenses and other
            
            
            1,086,496
            
            
            154,730Accrued
                contingency fee payable
            
            
            -
            
            
            394,063Total
                current liabilities
            
            
            2,020,794
            
            
            1,244,116**Deferred
                tax liabilities**
            
            
            12,222,944
            
            
            -Total
                liabilities
            
            
            14,243,738
            
            
            1,244,116**Commitments
                and contingencies****Minority
                interest**
            
            
            -
            
            
            -**Stockholders’
                equity**Preferred
                stock, $.00001 par value; 5,000,000 shares authorized: none
                outstanding
            
            
            -
            
            
            -Common
                stock, $.00001 par value: 500,000,000 shares authorized: 406,668,661
                shares issued and 393,201,134 shares outstanding at May 31, 2007
                and
                366,199,765 shares issued and outstanding at May 31, 2006
            
            
            4,066
            
            
            3,661Additional
                paid-in capital
            
            
            72,150,581
            
            
            69,551,981Accumulated
                deficit
            
            
            (43,151,678
            )
            
            (58,728,091
            )Common
                stock held in treasury, at cost - 13,467,527 shares and no shares
                at May
                31, 2007 and 2006, respectively
            
            
            (8,832,078
            )
            
            -Total
                stockholders’ equity
            
            
            20,170,891
            
            
            10,827,551$
            34,414,629
            
            $
            12,071,667







*See
      accompanying notes to consolidated financial statements*


F-3


**Patriot
      Scientific Corporation**


**Consolidated
      Statements of Operations**







**Years
                Ended May 31,**
            
            2007
            
            2006
            
            2005Revenues:Licenses
                and royalties
            
            $
            -
            
            $
            10,000,000
            
            $
            2,957,509Product
                sales and other
            
            
            638,784
            
            
            309,709
            
            
            25,077638,784
            
            
            10,309,709
            
            
            2,982,586Cost
                of sales
            
            
            319,374
            
            
            103,351
            
            
            -Gross
                profit
            
            
            319,410
            
            
            10,206,358
            
            
            2,982,586Operating
                expenses:Research
                and development
            
            
            -
            
            
            225,565
            
            
            294,735Selling,
                general and administrative
            
            
            7,558,712
            
            
            4,151,099
            
            
            2,600,430Settlement
                and license expense
            
            
            7,524,537
            
            
            1,918,054
            
            
            -Total
                operating expenses
            
            
            15,083,249
            
            
            6,294,718
            
            
            2,895,165Operating
                income (loss)
            
            
            (14,763,839
            )
            
            3,911,640
            
            
            87,421Other
                income (expense):Unrealized
                loss on marketable securities
            
            
            -
            
            
            (1,466
            )
            
            (21,180
            )Interest
                and other income
            
            
            714,790
            
            
            330,055
            
            
            56,251Gain
                (loss) on sale of assets
            
            
            (3,163
            )
            
            2,724
            
            
            4,128Interest
                expense
            
            
            (355
            )
            
            (516,465
            )
            
            (3,081,760
            )Loss
                on debt extinguishments
            
            
            -
            
            
            (445,427
            )
            
            -Change
                in fair value of warrant and derivative liabilities
            
            
            -
            
            
            (2,456,736
            )
            
            (7,563,564
            )Impairment
                of note receivable
            
            
            (339,551
            )
            
            -
            
            
            -Impairment
                of investment in affiliated company
            
            
            (126,746
            )
            
            -
            
            
            -Equity
                in earnings of affiliated company
            
            
            48,965,084
            
            
            27,848,363
            
            
            -Total
                other income (expense), net
            
            
            49,210,059
            
            
            24,761,048
            
            
            (10,606,125
            )Income
                (loss) before income taxes and minority interest
            
            
            34,446,220
            
            
            28,672,688
            
            
            (10,518,704
            )Provision
                for income taxes
            
            
            10,755,033
            
            
            **-**
            
            
            **-**Minority
                interest
            
            
            **-**
            
            
            **-**
            
            
            **-**Net
                income (loss)
            
            **$**
            23,691,187
            
            **$**
            28,672,688
            
            **$**
            (10,518,704
            )Basic
                income (loss) per common share
            
            **$**
            0.06
            
            **$**
            0.09
            
            $
            (0.05
            )Diluted
                income (loss) per common share
            
            **$**
            0.06
            
            **$**
            0.07
            
            $
            (0.05
            )Weighted
                average number of common shares outstanding - basic
            
            
            378,036,989
            
            
            316,100,499
            
            
            222,495,047Weighted
                average number of common shares outstanding - diluted
            
            
            413,599,373
            
            
            412,963,173
            
            
            222,495,047







*See
      accompanying notes to consolidated financial statements.*


F-4




**Patriot
      Scientific Corporation**


**Consolidated
      Statements of Stockholders’ Equity**






Common
                Stock
            
            
            Additional
            
            
            Accumulated
            
            
            Stockholders’Shares
            
            
            Amounts
            
            
            Paid-in
                Capital
            
            
            Deficit
            
            
            Equity
                (Deficit)Balance,
                May 31, 2004
            
            
            171,156,363
            
            
            1,712
            
            
            46,457,543
            
            
            (52,183,738
            )
            
            (5,724,483
            )Issuance
                of common stock at $.03 and $.10 per share
            
            
            4,625,000
            
            
            46
            
            
            453,204
            
            
            -
            
            
            453,250Exercise
                of warrants and options at $.02 to $.06 per share
            
            
            39,028,511
            
            
            390
            
            
            820,899
            
            
            -
            
            
            821,289Issuance
                of common stock for services at $.05 and $.09 per share
            
            
            796,000
            
            
            8
            
            
            58,792
            
            
            -
            
            
            58,800Conversion
                of debentures payable plus accrued interest at $.02 and $.05 per
                share
            
            
            64,886,139
            
            
            649
            
            
            2,169,287
            
            
            -
            
            
            2,169,936Non-cash
                compensation
            
            
            -
            
            
            -
            
            
            59,675
            
            
            -
            
            
            59,675Reclassification
                of derivative value associated with debt conversions and warrant
                exercises
            
            
            -
            
            
            -
            
            
            5,439,853
            
            
            -
            
            
            5,439,853Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            (10,518,704
            )
            
            (10,518,704
            )Balance,
                May 31, 2005
            
            
            280,492,013
            
            
            2,805
            
            
            55,459,253
            
            
            (62,702,442
            )
            
            (7,240,384
            )Issuance
                of common stock for services at $1.53 per share
            
            
            193,548
            
            
            2
            
            
            296,127
            
            
            -
            
            
            296,129Exercise
                of warrants and options at $.02 to $.69 per share
            
            
            12,824,544
            
            
            128
            
            
            851,070
            
            
            -
            
            
            851,198Conversion
                of debentures payable plus accrued interest at $.02 and $.04 per
                share
            
            
            30,819,187
            
            
            308
            
            
            998,729
            
            
            -
            
            
            999,037Cashless
                exercise of warrants
            
            
            41,245,473
            
            
            412
            
            
            (412
            )
            
            -
            
            
            -Issuance
                of common stock to co-inventor of technology at $.13 per
                share
            
            
            625,000
            
            
            6
            
            
            81,244
            
            
            -
            
            
            81,250Extension
                of term of options previously issued to consultant
            
            
            -
            
            
            -
            
            
            125,000
            
            
            -
            
            
            125,000Repurchase
                of warrants
            
            
            -
            
            
            -
            
            
            (252,420
            )
            
            -
            
            
            (252,420
            )Issuance
                of warrants to a consultant
            
            
            -
            
            
            -
            
            
            108,102
            
            
            -
            
            
            108,102Intrinsic
                value of options issued to employees
              and
                directors
            
            
            -
            
            
            -
            
            
            120,000
            
            
            -
            
            
            120,000Cash
                dividends at $.02 and $.04 per share
            
            
            -
            
            
            -
            
            
            -
            
            
            (24,698,337
            )
            
            (24,698,337
            )Reclassification
                of derivative value associated with debt conversions and warrant
                exercises
            
            
            -
            
            
            -
            
            
            5,021,353
            
            
            -
            
            
            5,021,353Reclassification
                of warrant and derivative liabilities at settlement date
            
            
            -
            
            
            -
            
            
            6,743,935
            
            
            -
            
            
            6,743,935Net
                income
            
            
            
            
            
            
            
            
            
            
            
            28,672,688
            
            
            28,672,688Balance,
                May 31, 2006
            
            
            366,199,765
            
            $
            3,661
            
            $
            69,551,981
            
            $
            (58,728,091
            )
            $
            10,827,551




F-5


**Patriot
      Scientific Corporation**


**Consolidated
      Statements of Stockholders’ Equity, continued**






Common
                Stock
            
            
            Additional
            
            
            Accumulated
            
            
            Treasury
            
            
            Stockholders’Shares
            
            
            Amounts
            
            
            Paid-in
                Capital
            
            
            Deficit
            
            
            Stock
            
            
            Equity
                (Deficit)Exercise
                of warrants and options at $.05 to $.40 per share
            
            
            1,787,500
            
            
            18
            
            
            213,982
            
            
            -
            
            
            -
            
            
            214,000Cashless
                exercise of warrants
            
            
            38,681,396
            
            
            387
            
            
            (387
            )
            
            -
            
            
            -
            
            
            -Non-cash
                compensation
            
            
            -
            
            
            -
            
            
            2,359,036
            
            
            -
            
            
            -
            
            
            2,359,036Extension
                of stock options previously issued to a consultant
            
            
            -
            
            
            -
            
            
            324
            
            
            -
            
            
            -
            
            
            324Tax
                effect of exercise of stock options granted under APB 25
            
            
            -
            
            
            -
            
            
            25,645
            
            
            -
            
            
            -
            
            
            25,645Purchase
                of common stock for treasury
            
            
            (13,467,527
            )
            
            -
            
            
            -
            
            
            -
            
            
            (8,832,078
            )
            
            (8,832,078
            )Cash
                dividends at $.02 per share
            
            
            -
            
            
            -
            
            
            -
            
            
            (8,114,774
            )
            
            -
            
            
            (8,114,774
            )Net
                income
            
            
            
            
            
            
            
            
            
            
            
            23,691,187
            
            
            
            
            
            23,691,187Balance,
                May 31, 2007
            
            
            393,201,134
            
            $
            4,066
            
            $
            72,150,581
            
            $
            (43,151,678
            )
            $
            (8,832,078
            )
            $
            20,170,891






*See
      accompanying notes to consolidated financial statements.*


F-6


**Patriot
      Scientific Corporation**


**Consolidated
      Statements of Cash Flows**





*Years
                Ended May 31,*
            
            2007
            
            2006
            
            2005**Operating
                activities:**Net
                income (loss)
            
            $
            23,691,187
            
            $
            28,672,688
            
            $
            (10,518,704
            )Adjustments
                to reconcile net income (loss) to net cash provided by (used in)
                operating
                activities:Amortization
                and depreciation
            
            
            64,861
            
            
            59,415
            
            
            94,353Non-cash
                interest expense related to convertible debentures, notes payable
                and
                warrants
            
            
            -
            
            
            470,736
            
            
            2,940,608Expense
                related to extension of expiration date of stock options
            
            
            324
            
            
            125,000
            
            
            -Net
                gain related to warrant re-pricing, reconveyance and
                issuance
            
            
            -
            
            
            (538,208
            )
            
            -Loss
                on extinguishment of debt
            
            
            -
            
            
            445,427
            
            
            -Accrued
                interest income added to investments
            
            
            (2,026
            )
            
            (19,778
            )
            
            -Equity
                in earnings of affiliated company
            
            
            (48,965,084
            )
            
            (27,848,363
            )
            
            -(Gain)
                loss on sale of assets
            
            
            3,163
            
            
            (2,724
            )
            
            (4,012
            )Unrealized
                loss on marketable securities
            
            
            -
            
            
            1,466
            
            
            21,180Issuance
                of stock, options and warrants for services
            
            
            -
            
            
            554,245
            
            
            118,476Change
                in fair value of derivative liabilities
            
            
            -
            
            
            2,456,736
            
            
            7,563,564Intrinsic
                value of options issued
            
            
            -
            
            
            120,000
            
            
            -Non-cash
                compensation relating to issuance and vesting of stock options and
                vesting
                of warrants
            
            
            2,359,036
            
            
            -
            
            
            -Impairment
                of note receivable
            
            
            339,551
            
            
            -
            
            
            -Impairment
                of investment in affiliated company
            
            
            126,746
            
            
            -
            
            
            -Deferred
                taxes
            
            
            9,782,969
            
            
            -
            
            
            -Changes
                in operating assets and liabilities (net of effects of consolidation
                of
                variable interest entity):Accounts
                receivable
            
            
            (186,560
            )
            
            (4,113
            )
            
            -Inventory
            
            
            1,970
            
            
            -
            
            
            -Prepaid
                expenses and other assets
            
            
            (24,294
            )
            
            (261,769
            )
            
            218,865Prepaid
                income taxes
            
            
            (2,070,981
            )
            
            -
            
            
            -Licenses
                receivable
            
            
            -
            
            
            2,000,000
            
            
            (2,000,000
            )Accounts
                payable and accrued expenses
            
            
            1,122,499
            
            
            194,811
            
            
            435,644Accrued
                contested fee payable
            
            
            (394,063
            )
            
            48,063
            
            
            501,700Net
                cash provided by (used in) operating activities
            
            
            (14,150,702
            )
            
            6,473,632
            
            
            (628,326
            )**Investing
                activities:**Proceeds
                from sale of short-term investments
            
            
            8,832,078
            
            
            2,027,557
            
            
            **-**Purchase
                of short-term investments
            
            
            (9,662,513
            )
            
            (4,832,482
            )
            
            (897,706
            )Proceeds
                from sale of fixed assets
            
            
            -
            
            
            6,540
            
            
            5,000Purchase
                of restricted investments
            
            
            -
            
            
            (100,000
            )
            
            -Proceeds
                from sale of restricted investments
            
            
            -
            
            
            203,210
            
            
            -Payment
                for security deposit
            
            
            -
            
            
            (8,190
            )
            
            -Purchase
                of property and equipment
            
            
            (5,827
            )
            
            (71,037
            )
            
            -Investment
                in affiliated companies
            
            
            (120,000
            )
            
            (2,000,000
            )
            
            -Distributions
                from affiliated company
            
            
            50,034,029
            
            
            25,895,449
            
            
            -Issuance
                of note receivable
            
            
            (589,551
            )
            
            -
            
            
            -Cash
                received in consolidation of variable interest entity
            
            
            40,970
            
            
            -
            
            
            -Net
                cash provided by (used in) investing activities
            
            
            48,529,186
            
            
            21,121,047
            
            
            (892,706
            )**Financing
                activities:******Payment
                of cash dividends
            
            
            (8,114,774
            )
            
            (24,698,337
            )
            
            -Payment
                of shareholder note
            
            
            -
            
            
            -
            
            
            (100,000
            )Proceeds
                from line of credit
            
            
            -
            
            
            -
            
            
            100,000Principal
                payments on notes payable
            
            
            (50,089
            )
            
            (100,000
            **)**
            
            -Payments
                for capital lease obligations
            
            
            -
            
            
            (2,306
            )
            
            (8,020
            )Proceeds
                from issuance of convertible debentures
            
            
            -
            
            
            -
            
            
            490,000Proceeds
                from issuance of common stock
            
            
            -
            
            
            -
            
            
            453,250Proceeds
                from exercise of common stock warrants and options
            
            
            214,000
            
            
            851,198
            
            
            821,288Repurchase
                of warrants
            
            
            -
            
            
            (252,420
            )
            
            -Repurchase
                of common stock for treasury
            
            
            (8,832,078
            )
            
            **-**
            
            
            -Tax
                effect of exercise of options granted under APB 25
            
            
            25,645
            
            
            **-**
            
            
            -Net
                cash provided by (used in) financing activities
            
            
            (16,757,296
            )
            
            (24,201,865
            )
            
            1,756,518


F-7


**Patriot
      Scientific Corporation**


**Consolidated
      Statements of Cash Flows, continued**






*Years
                Ended May 31,*
            
            2007
            
            2006
            
            2005**Net
                increase in cash and cash equivalents**
            
            
            17,621,188
            
            
            3,392,814
            
            
            235,486**Cash
                and cash equivalents,**beginning
                of year
            
            
            3,984,240
            
            
            591,426
            
            
            355,940**Cash
                and cash equivalents, end of year**
            
            $
            21,605,428
            
            **$**
            3,984,240
            
            $
            591,426**Supplemental
                Disclosure of Cash Flow Information:**Cash
                payments for interest
            
            $
            355
            
            $
            2,983
            
            $
            15,406Cash
                payments for income taxes
            
            $
            3,017,400
            
            $
            -
            
            $
            4,800**Supplemental
                Disclosure of Non-Cash Investing and Financing
                Activities:**Convertible
                debentures, notes payable and accrued interest exchanged for common
                stock
            
            $
            -
            
            $
            999,037
            
            $
            2,169,936Debt
                discount arising from issuance of detachable warrants
            
            $
            -
            
            $
            -
            
            $
            490,000Reclassification
                of derivative liabilities associated with debt conversions and warrant
                exercises
            
            $
            -
            
            $
            5,021,353
            
            $
            5,439,853Reclassification
                of warrant and derivative liabilities at settlement date
            
            $
            -
            
            $
            6,743,935
            
            $
            -Cashless
                exercise of warrants
            
            $
            387
            
            $
            412
            
            $
            -Fair
                market value of assets received in collection of note receivable
                and
                subsequently contributed for preferred stock of affiliate
            
            $
            250,000
            
            $
            -
            
            $
            -





*See
      accompanying notes to consolidated financial statements.*


F-8


**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements**






**1.
      Organization and Business**





Patriot
      Scientific Corporation (“we”, “us”, or “our”), was organized under Delaware law
      on March 24, 1992 and is the successor by merger to Patriot Financial
      Corporation, a Colorado corporation, incorporated on June 10, 1987. In 1997
      we
      acquired Metacomp, Inc. and in June 2005 we entered into a joint venture
      agreement with Technology Properties Limited, Inc. to form Phoenix Digital
      Solutions, LLC (“Phoenix Digital”). In March 2007, we became the primary
      beneficiary of Scripps Secured Data, Inc. (“SSDI”), a variable interest entity
      and were required to consolidate SSDI effective in March 2007.





We
      are an
      intellectual property company that licenses our jointly held patent portfolio
      technology to others and litigates against those who infringe upon the patent
      portfolio technology.





SSDI develops
      and manufactures network-security hardware to government, military, and other
      high-security facilities





**2.
      Summary of Significant Accounting Policies**





**Basis
      of Consolidation**


The
      consolidated financial statements as of May 31, 2006 include our accounts and
      those of our majority owned subsidiaries, Metacomp, Inc. and Plasma Scientific
      Corporation. The consolidated financial statements as of May 31, 2007 include
      our accounts, those of our majority owned subsidiaries that are not considered
      variable interest entities (“VIE”s) and all VIEs for which we are the primary
      beneficiary. All significant intercompany accounts and transactions have been
      eliminated.





**Consolidation
      of Affiliate**


In
      January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB
      Interpretation 46, *Consolidation
      of Variable Interest Entities, an Interpretation of ARB No. 51* (“FIN
      46”). In December 2003, the FASB modified FIN 46. FIN 46 provides a new
      framework for identifying VIEs and determining when a company should include
      the
      assets, liabilities, noncontrolling interests and results of activities of
      a VIE
      in its consolidated financial statements.





A
      VIE is
      a corporation, partnership, limited liability corporation, trust or any other
      legal structure used to conduct activities or hold assets that either (1) has
      an
      insufficient amount of equity to carry out its principal activities without
      additional subordinated financial support, (2) has a group of equity owners
      that
      are unable to make significant decisions about its activities, or (3) has a
      group of equity owners that do not have the obligation to absorb losses or
      the
      right to receive returns generated by its operations.





FIN
      46
      requires a VIE to be consolidated if a party with an ownership, contractual
      or
      other financial interest in the VIE is obligated to absorb a majority of the
      risk of loss from the VIE’s activities, is entitled to receive a majority of the
      VIE’s residual returns (if no party absorbs a majority of the VIE’s losses), or
      both. A variable interest holder that consolidates the VIE is called the primary
      beneficiary. Upon consolidation, the primary beneficiary generally must
      initially record all of the VIE’s assets, liabilities, and noncontrolling
      interests at fair value and subsequently account for the VIE as if it were
      consolidated based on majority voting interest.





FIN
      46
      was effective immediately for VIEs created after January 31, 2003. The
      provisions of FIN 46, as revised, were adopted as of December 31, 2003, for
      our
      interests in all VIEs. During the quarter ended May 31, 2007, we
      consolidated SSDI as SSDI was deemed a VIE and we determined that we were the
      primary beneficiary of SSDI.




F-9


**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





**Financial
      Instruments and Concentrations of Credit Risk**


Financial
      instruments that potentially subject us to concentrations of credit risk consist
      principally of cash, short-term investments and trade accounts
      receivable.





At
      times,
      our balance of cash maintained with our bank may exceed the Federal Deposit
      Insurance Corporation’s (“FDIC”) insured limit of $100,000. At May 31, 2007, our
      cash and cash equivalents balance exceeding the FDIC limit was $4,628. Certain
      other cash equivalents are not insured by the FDIC. We limit our exposure of
      loss by maintaining our cash with financially stable financial institutions.
      When we have excess cash, our cash equivalents are placed in high quality money
      market accounts with major financial institutions. We believe this investment
      policy limits our exposure to concentrations of credit risk.





Concentrations
      of credit risk with respect to accounts receivable are limited due to the wide
      variety of customers and markets which comprise our customer base, as well
      as
      their dispersion across many different geographic areas. We routinely assess
      the
      financial strength of our customers and, as a consequence, believe that our
      accounts receivable credit risk exposure is limited. Generally, we do not
      require collateral or other security to support customer receivables.





The
      carrying value of financial instruments, including cash, cash equivalents, short-term
      investments, accounts
      receivable, accounts payable and accrued liabilities, approximate fair value
      because of the immediate or short-term maturity of these instruments.





**Cash
      Equivalents, Marketable Securities, and Short-Term
      Investments**


For
      purposes of balance sheet classification and the statements of cash flows,
      we
      consider all highly liquid investments acquired with a maturity of three months
      or less to be cash equivalents.


Restricted
      cash and cash equivalents at May 31, 2007and 2006 consist of two savings
      accounts required to be held as collateral for corporate credit card
      accounts.





Our
      short-term investments consist primarily of money market mutual funds and
      accounts, and are reported at cost, which approximate fair market
      value.





**Accounts
      Receivable**


Our
      accounts receivable consists primarily of the accounts of SSDI. This entity
      provides an allowance for doubtful accounts based on its continuing evaluation
      of its customers’ credit risk.





**Inventory**


Inventory
      of SSDI consists of raw materials and finished goods manufactured by third
      party
      vendors. Inventory is valued using a method that approximates first-in,
      first-out and has been stated at the lower of cost or net realizable
      value.





**Property,
      Equipment and Depreciation**


Property
      and equipment are stated at cost and are depreciated using the straight-line
      method over the estimated useful lives of the assets, ranging from three to
      five
      years.  Major betterments and renewals are capitalized, while routine
      repairs and maintenance are charged to expense when incurred.





**Patents
      and Trademarks**


Patents
      and trademarks are carried at cost less accumulated amortization and are
      amortized over their estimated useful lives of four years. Estimated future
      annual amortization expense arising from the patents is approximately $9,000
      in
      fiscal year 2008. In fiscal year 2008 our patents will be fully amortized.





SSDI
      holds patents expiring in 14 years. Estimated future annual amortization expense
      arising from these patents is approximately $2,150 per
      year.


F-10


**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





**Investment
      in Affiliated Company**


We
      have a
      50% interest in Phoenix Digital (see Note 7). This investment is accounted
      for
      using the equity method of accounting since the investment provides us the
      ability to exercise significant influence, but not control, over the investee.
      Significant influence is generally deemed to exist if we have an ownership
      interest in the voting stock of the investee of between 20% and 50%, although
      other factors, such as representation on the investee’s board of directors, are
      considered in determining whether the equity method of accounting is
      appropriate. Under the equity method of accounting, the investment, originally
      recorded at cost, is adjusted to recognize our share of net earnings or losses
      of the investee and is recognized in the consolidated statements of operations
      in the caption “Equity in earnings of affiliated company”.





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





**Long-Lived
      Assets**


Our
      management assesses the recoverability of our long-lived assets by determining
      whether the depreciation and amortization of long-lived assets over their
      remaining lives can be recovered through projected undiscounted future cash
      flows.  The amount of long-lived asset impairment, if any, is measured
      based on fair value and is charged to operations in the period in which
      long-lived asset impairment is determined by management.  At May 31, 2007,
      our management believes there is no impairment of our long-lived assets. 
There can be no assurance, however, that market conditions will not change
      or
      demand for our products will continue, which could result in impairment of
      long-lived assets in the future.





**Treasury
      Stock**


We
      account for treasury stock under the cost method and include treasury stock
      as a
      component of stockholders’ equity.





**Derivative
      Financial Instruments**


In
      connection with the issuance of certain convertible debentures (see Note 10),
      the terms of the debentures included an embedded reset conversion feature which
      provided for a conversion of the debentures into shares of our common stock
      at a
      rate which was determined to be variable. We determined that the reset
      conversion feature was an embedded derivative instrument and that the conversion
      option was an embedded put option pursuant to Statement of Financial Accounting
      Standards (“SFAS”) No. 133, *Accounting
      for Derivative Instruments and Hedging Activities* ,
      as
      amended, and Emerging Issues Task Force (“EITF”) Issue No. 00-19, *Accounting
      for Derivative Financial Instruments Indexed to, and Potentially Settled in,
      a
      Company's Own Stock* .
      The
      accounting treatment of derivative financial instruments required that we record
      the derivatives and related warrants at their fair values as of the inception
      date of the convertible debenture agreements and at fair value as of each
      subsequent balance sheet date.  In addition, under the provisions of EITF
      Issue No. 00-19, as a result of entering into the convertible debenture
      agreements, we were required to classify all other non-employee warrants as
      derivative liabilities and record them at their fair values at each balance
      sheet date.  Any change in fair value was recorded as non-operating,
      non-cash income or expense at each balance sheet date.  If the fair value
      of the derivatives was higher at the subsequent balance sheet date, we recorded
      a non-operating, non-cash charge.  If the fair value of the derivatives was
      lower at the subsequent balance sheet date, we recorded non-operating, non-cash
      income.




During
      the years ended May 31, 2006 and 2005, we recognized other expense of
      approximately $2,457,000 and $7,564,000, respectively, related to recording
      the
      warrant and derivative liabilities at fair value. At May 31, 2006, there are
      no
      derivative liabilities since the related variable debt instruments were settled
      in full during fiscal 2006. At the settlement date, the remaining warrant
      liabilities with a value of approximately $6,744,000 were reclassified to
      additional paid-in capital.


F-11


**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





Our
      derivative instruments were valued using a Monte Carlo simulation model
      incorporating the instruments’ multiple reset dates.





The
      following assumptions were used for valuing the embedded derivatives during
      the
      years ended May 31, 2006 and 2005:




**May
                31, 2006**
            
            **May
                31, 2005**Estimated
                dividends
            None
            
            NoneExpected
                volatility
            101
                - 229%
            
            161
                - 266%Risk-free
                interest rate
            3.5
                - 5.1%
            
            1.3
                - 4.4%Expected
                term (years)
            2
                -
                7
            
            2
                -
                7





**Revenue
      Recognition**


We
      recognize revenue from the sale of our product upon shipment to the customer,
      at
      which time title transfers and we have no further obligations. Fees for
      maintenance or support are recorded on a straight-line basis over the underlying
      period of performance. Revenue from technology license agreements is recognized
      at the time we enter into a contract and provide the customer with the licensed
      technology. At this point, we have performed all of our obligations under
      contract, the rights to our technology have been transferred and no significant
      performance obligations remain.




SSDI
      recognizes revenue upon shipment of its product and recognizes revenue on its
      short-term installation contracts as time and materials costs are
      incurred.





SSDI
      maintains an agreement with a distributor which accounts for the majority of
      SSDI’s product sales. This agreement provides for a limited product warranty for
      a period of one year from the date of sale to the end user. The warranty does
      not cover damage to the product after it has been delivered to the distributor.
      SSDI’s agreement with the distributor also allows the distributor the right to
      stock rotation whereby the distributor, on a six month basis, may return product
      for replacement products of the distributor’s choosing provided that the
      aggregate price of the replacement products is equal to the price of the
      original products returned. Such stock rotations shall not exceed 10% of the
      distributor’s purchases from SSDI in the prior twelve month period for any year
      and any single rotation shall not exceed 6% of the total rotational allowance
      for that year. The first stock rotation shall not occur before February
      2008.





**Shipping
      and Handling**


EITF
      Issue No. 00-10, *Accounting
      for Shipping and Handling Fees and Costs* , ** requires
      shipping and handling fees billed to customers to be classified as revenue
      and
      shipping and handling costs to be classified as either cost of sales or
      disclosed in the notes to the financial statements. SSDI includes shipping
      and
      handling fees billed to customers in net sales. Shipping and handling costs
      associated with inbound freight are included in cost of sales.





**Research
      and Development Costs**


Research
      and development costs are expensed as incurred.





**Advertising**


We
      expense advertising costs as incurred. There were no advertising expenses for
      the years ended May 31, 2007 and 2006. Advertising expense was approximately
      $14,000 for the year ended May 31, 2005.


F-12


**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





**Income
      Taxes**


We
      account for income taxes under SFAS No. 109, ** *Accounting
      for Income Taxes* (“SFAS
      No. 109”) . 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.





**Net
      Income (Loss) Per Share**


We
      apply
      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 reflects the
      potential dilution of securities that could share in the earnings (loss) of
      an
      entity. At May 31, 2007, potential common shares of 330,000 related to our
      outstanding warrants and options were not included in the calculation of diluted
      income per share as they had an anti-dilutive effect. At May 31, 2006, potential
      common shares of 2,295,000 related to our outstanding warrants and options
      were
      not included in the calculation of diluted income per share as they had an
      anti-dilutive effect. At May 31, 2005, potential common shares of 143,826,204
      related to our outstanding convertible debentures, warrants and options were
      not
      included in the calculation of diluted loss per share as they had an
      anti-dilutive effect.




**Year
                Ended May 31, 2007**Numerator
                (Income)
            
            Denominator
                (Shares)
            
            Per
                Share AmountBasic
                EPS:Net
                income
            
            $
            23,691,187
            
            
            378,036,989
            
            $
            0.06Diluted
                EPS:Effect
                ofdilutivesecurities:Options
                andwarrants
            
            
            -
            
            
            35,562,384Income
                available to common shareholders
            
            $
            23,691,187
            
            
            413,599,373
            
            $
            0.06


F-13


**Patriot
        Scientific Corporation**
 **Notes
        to Consolidated Financial Statements (Continued)**




**Year
                Ended May 31, 2006**Numerator
                (Income)
            
            Denominator
                (Shares)
            
            Per
                Share AmountBasic
                EPS:Net
                income
            
            $
            28,672,688
            
            
            316,100,499
            
            $
            0.09Diluted
                EPS:Interest
                onconvertibledebentures
            
            
            458,467Effect
                ofdilutivesecurities:Options
                andwarrants
            
            
            -
            
            
            80,273,769Convertibledebentures
            
            
            -
            
            
            16,588,905Income
                available to common shareholders
            
            $
            29,131,155
            
            
            412,963,173
            
            $
            0.07








**Year
                Ended May 31, 2005**Numerator
                (Loss)
            
            Denominator
                (Shares)
            
            Per
                Share AmountBasic
                EPS:Net
                loss
            
            $
            (10,518,704
            )
            
            222,495,047
            
            $
            (0.05
            )Diluted
                EPS:
            
            
            -
            
            
            -Loss
                available to common shareholders
            
            $
            (10,518,704
            )
            
            222,495,047
            
            $
            (0.05
            )





**Use
      of Estimates**


The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America requires management to make
      estimates and assumptions that affect the reported amounts of assets and
      liabilities and disclosure of contingent assets and liabilities at the date
      of
      the consolidated financial statements and the reported amounts of revenues
      and
      expenses during the reporting period. Significant estimates made by management
      are, among others, the realizability of accounts receivable, valuation of
      inventory, recoverability of long-lived assets, and valuation of stock options,
      warrants, derivative liabilities, and deferred tax assets. Actual results could
      differ from those estimates.





**Minority
      Interest**


Minority
      interest in our consolidated financial statements results from the accounting
      for the acquisition of a noncontrolling interest in SSDI. Noncontrolling
      interest represents a partially owned subsidiary’s income, losses, and
      components of other comprehensive income which should be attributed to the
      controlling and noncontrolling interests or other parties with a right or
      obligation that affects the attribution of comprehensive income or loss, on
      the
      basis of their contractual rights or obligations, if any, otherwise, on the
      basis of ownership interests.


F-14




**Patriot
        Scientific Corporation**
 **Notes
        to Consolidated Financial Statements (Continued)**


The
      noncontrolling interest in SSDI, which we are required to consolidate as we
      are
      the primary beneficiary, has been reduced to zero due to the initial allocation
      of losses prior to the period in which we were required to consolidate. If
      a
      noncontrolling interest has been reduced to zero, the primary beneficiary must
      absorb any losses that are in excess of the value of the noncontrolling
      interest’s equity. For the period in which we are required to consolidate, March
      27, 2007 through May 31, 2007 we absorbed $169,913 of SSDI’s losses as we are
      the primary beneficiary. The noncontrolling interest in any future profits will
      not be presented until all prior losses have been recovered.





**Stock
      Based Compensation**





***Change
      in Accounting Principle***




Effective
      June 1, 2006, we adopted SFAS No. 123(R), *Share-Based
      Payment* ,
      which
      establishes standards for the accounting of transactions in which an entity
      exchanges its equity instruments for goods or services, primarily focusing
      on
      accounting for transactions where an entity obtains employee services in
      share-based payment transactions. SFAS No. 123(R) requires a public entity
      to measure the cost of employee services received in exchange for an award
      of
      equity instruments, including stock options, based on the grant-date fair value
      of the award and to recognize it as compensation expense over the period the
      employee is required to provide service in exchange for the award, usually
      the
      vesting period. SFAS No. 123(R) supersedes our previous accounting under
      Accounting Principles Board Opinion (“APB”) No. 25, *Accounting
      for Stock Issued to Employees* ,
      for the
      period beginning June 1, 2006. In March 2005, the SEC issued Staff Accounting
      Bulletin (“SAB”) No. 107, *Share-Based
      Payment* ,
      relating to SFAS No. 123(R). We have applied the provisions of SAB No. 107
      in
      our adoption of SFAS No. 123(R). Stock-based awards to non-employees are
      accounted for using the fair value method in accordance with SFAS No. 123, *Accounting
      for Stock Based Compensation.*




We
      adopted SFAS No. 123(R) using the modified prospective transition method, which
      requires the application of the accounting standard as of June 1, 2006, the
      first day of our fiscal year 2007. Our consolidated financial statements as
      of
      May 31, 2007 reflect the impact of adopting SFAS No. 123(R). In accordance
      with
      the modified prospective transition method, our consolidated financial
      statements for prior periods have not been restated to reflect, and do not
      include, the impact of SFAS No. 123(R). SFAS No. 123(R) requires us to estimate
      the fair value of share-based payment awards on the date of grant using an
      option-pricing model. The value of the portion of the award that is ultimately
      expected to vest is recognized as expense over the requisite service periods
      in
      our consolidated statement of operations. Prior to the adoption of SFAS No.
      123(R), we accounted for stock-based awards to employees and directors using
      the
      intrinsic value method in accordance with APB No. 25 as allowed under SFAS
      No.
      123. Under the intrinsic value method, no employee stock-based compensation
      expense had been recognized in our consolidated statements of operations, other
      than as related to option grants to employees and directors below the fair
      market value of the underlying stock at the date of grant.




Stock-based
      compensation expense recognized during the period is based on the value of
      the
      portion of share-based payment awards that is ultimately expected to vest during
      the period. Stock-based compensation expense recognized in our consolidated
      statement of operations for the year ended May 31, 2007 included compensation
      expense for share-based payment awards granted prior to, but not yet vested
      as
      of May 31, 2006 based on the grant date fair value estimated in accordance
      with the pro forma provisions of SFAS No. 123 and compensation expense for
      the
      share-based payment awards granted subsequent to May 31, 2006 based on the
      grant date fair value estimated in accordance with the provisions of SFAS No.
      123(R). As stock-based compensation expense recognized in the consolidated
      statement of operations for the year ended May 31, 2007 is based on awards
      ultimately expected to vest, it has been reduced for estimated forfeitures.
      SFAS
      No. 123(R) requires forfeitures to be estimated at the time of grant and
      revised, if necessary, in subsequent periods if actual forfeitures differ from
      those estimates. The estimated average forfeiture rate for the year ended
      May 31, 2007, of approximately 5% was based on historical forfeiture
      experience and estimated future employee forfeitures. The estimated pricing
      term
      of option grants for the year ended May 31, 2007 was five years. In our pro
      forma information required under SFAS No. 123(R) for the periods prior to fiscal
      2007, we accounted for forfeitures as they occurred.


F-15




**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





***Summary
      of Assumptions and Activity***




The
      following table illustrates the effect on net income (loss) and net income
      (loss) per share for the years ended May 31, 2006 and 2005 as if we had applied
      the fair value recognition provisions of SFAS No. 123 to options granted under
      our stock option plans. For purposes of this pro forma disclosure, the fair
      value of the options is estimated using the Black-Scholes option-pricing model
      and amortized on a straight-line basis to expense over the options' vesting
      period:


**Year
                  Ended**
                **May****31, 2006**
              
              **Year
                  Ended**
                **May****31, 2005**Net
                  income (loss) - as reported
              
              $
              28,672,688
              
              $
              (10,518,704
              )Add:
                  Share-based employee compensation included in net income, net of
                  tax
                  effects
              
              
              120,000
              
              
              -Deduct:
                  Share-based employee compensation expense determined under fair
                  value
                  method, net of tax effects
              
              
              (1,639,913
              )
              
              (138,883
              )Net
                  income (loss) - pro forma
              
              $
              27,152,775
              
              $
              (10,657,587
              )Net
                  income (loss) per common share - as reportedBasic
              
              $
              0.09
              
              $
              (0.05
              )Diluted
              
              $
              0.07
              
              $
              (0.05
              )Net
                  income (loss) per common share - pro formaBasic
              
              $
              0.09
              
              $
              (0.05
              )Diluted
              
              $
              0.07
              
              $
              (0.05
              )




The
      fair
      value of stock-based awards to employees and directors is calculated using
      the
      Black-Scholes option pricing model, even though this model was developed to
      estimate the fair value of freely tradable, fully transferable options without
      vesting restrictions, which differ significantly from our stock options. The
      Black-Scholes model also requires subjective assumptions, including future
      stock
      price volatility and expected time to exercise, which greatly affect the
      calculated values. The expected term of options granted is derived from
      historical data on employee exercises and post-vesting employment termination
      behavior. The risk-free rate selected to value any particular grant is based
      on
      the U.S. Treasury rate that corresponds to the pricing term of the grant
      effective as of the date of the grant. The expected volatility for the years
      ended May 31, 2007, 2006 and 2005 is based on the historical volatilities of
      our
      common stock. These factors could change in the future, affecting the
      determination of stock-based compensation expense in future
      periods.


F-16




**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





**Year
                Ended**
              **May
                31, 2007**
            
            **Year
                Ended**
              **May
                31, 2006**
            
            **Year
                Ended**
              **May
                31, 2005**Expected
                term
            
            
            4.8
                years
            
            
            4.6
                years
            
            
            1.9
                yrsExpected
                volatility
            
            
            146
                - 156%
            
            
            115
                - 158%
            
            
            121
                - 129%Risk-free
                interest rate
            
            
            4.78
                - 5.00%
            
            
            3.78
                - 4.93%
            
            
            3.37
                - 3.98%Expected
                dividends
            
            
            -
            
            
            -
            
            
            -







A
      summary
      of option activity as of May 31, 2007 and changes during year then ended, is
      presented below:




**Shares**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**
            
            **Weighted**
              **Average**
              **Remaining**
              **Contractual**
              **Term****(Years)**
            
            **Aggregate**
              **Intrinsic**
              **Value**Options
                outstanding at June 1, 2006
            
            
            5,460,000
            
            $
            0.34Options
                granted
            
            
            2,800,000
            
            $
            0.39Options
                exercised
            
            
            (515,000
            )
            $
            0.08Options
                expired
            
            
            (500,000
            )
            $
            0.09Options
                outstanding and exercisable at May 31, 2007
            
            
            7,245,000
            
            $
            0.40
            
            
            2.95
            
            $
            1,394,300






The
      aggregate intrinsic value set forth in the above table represents the total
      pre-tax intrinsic value, based on the closing price of our stock which was
      $0.51
      as of May 31, 2007, and assumes all optionees had exercised their options as
      of
      that date.




The
      weighted average grant date fair value of options granted during the year ended
      May 31, 2007 was $0.91 per option. The total intrinsic value of options
      exercised during the year ended May 31, 2007 was $290,100.




As
      of May
      31, 2007, there was no unrecognized compensation cost related to employee and
      director stock option compensation arrangements. The total fair value of shares
      vested during the year ended May 31, 2007 was approximately
      $2,356,000.




As
      a
      result of adopting SFAS No. 123(R) on June 1, 2006, our income before
      provision for income taxes and net income for the year ended May 31, 2007 was
      approximately $885,456 lower than if we had continued to account for share-based
      compensation under APB No. 25. Basic and diluted net income per share
      for the year ended May 31, 2007 were not affected by the adoption of
      SFAS No. 123(R).




The
      following table summarizes employee stock-based compensation expense related
      to
      stock options under SFAS No. 123(R) for the year ended May 31, 2007, which
      was
      allocated as follows:




**Year
                  Ended**
                **May
                  31, 2007**Employee
              stock-based
              compensation expense included in:Selling,
                general and administrative
            
            $
            2,356,000


F-17




**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





**Recent
      Accounting Pronouncements**


In
      July
      2006, the FASB issued Interpretation No. 48, *Accounting
      for Uncertainty in Income Taxes - an interpretation of FASB Statement No.
      109* (“FIN
      48”). This interpretation clarifies the application of SFAS No. 109, *Accounting
      for Income Taxes* ,
      by
      defining criteria that an individual tax position must meet for any part of
      the
      benefit of that position to be recognized in a company’s financial statements
      and also provides guidance on measurement, derecognition, classification,
      interest and penalties, accounting in interim periods, disclosure and
      transition. FIN 48 is effective for fiscal years beginning after December 15,
      2006. We expect to adopt FIN 48 on June 1, 2007. We are currently assessing
      the
      impact the adoption of FIN 48 will have on our consolidated financial
      statements.




In
      September 2006, the FASB issued SFAS No. 157, *Fair
      Value Measurements* (“SFAS
      No. 157”).  SFAS No. 157 defines fair value, establishes a framework for
      measuring fair value in generally accepted accounting principals and expands
      disclosures about fair value measurements.  The statement does not require
      new fair value measurements, but is applied to the extent that other accounting
      pronouncements require or permit fair value measurements.  The statement
      emphasizes that fair value is a market-based measurement that should be
      determined based on the assumptions that market participants would use in
      pricing an asset or liability.  Companies that have assets and liabilities
      measured at fair value will be required to disclose information that enables
      the
      users of its financial statements to access the inputs used to develop those
      measurements.  The reporting entity is encouraged, but not required, to
      combine the fair value information disclosed under this statement with the
      fair
      value information disclosed under other accounting pronouncements.  SFAS
      No. 157 is effective for fiscal years beginning after November 15, 2007. We
      expect to adopt SFAS No. 157 on June 1, 2008.  We are currently assessing
      the impact the adoption of SFAS No. 157 will have on our consolidated financial
      statements.




In
      September 2006, the SEC staff issued SAB No. 108, *Considering
      the Effects of Prior Year Misstatements when Quantifying Misstatements in
      Current Year Financial Statements* .
      SAB No.
      108 was issued in order to eliminate the diversity in practice surrounding
      how
      public companies quantify financial statement misstatements. SAB No. 108
      requires that registrants quantify errors using both a balance sheet and income
      statement approach and evaluate whether either approach results in a misstated
      amount that, when all relevant quantitative and qualitative factors are
      considered, is material. The adoption of this statement did not have a
      significant impact on our consolidated financial condition or results of
      operations.




In
      February 2007, the FASB issued SFAS No. 159, *The
      Fair Value Option for Financial Assets and Financial Liabilities* (“SFAS
      No. 159”). SFAS No. 159 permits entities to choose to measure at fair value many
      financial instruments and certain other items that are not currently required
      to
      be measured at fair value. The objective is to improve financial reporting
      by
      providing entities with the opportunity to mitigate volatility in reported
      earnings caused by measuring related assets and liabilities differently without
      having to apply complex hedge accounting provisions. SFAS No. 159 also
      establishes presentation and disclosure requirements designed to facilitate
      comparisons between entities that choose different measurement attributes for
      similar types of assets and liabilities. SFAS No. 159 does not affect
      any existing accounting literature that requires certain assets and liabilities
      to be carried at fair value. SFAS No. 159 does not establish
      requirements for recognizing and measuring dividend income, interest income,
      or
      interest expense. This statement does not eliminate disclosure requirements
      included in other accounting standards. SFAS No. 159 is effective in
      fiscal years beginning after November 15, 2007. We expect to adopt SFAS No.
      159 on June 1, 2008. We are in the process of evaluating the provisions of
      the
      statement, but do not anticipate that the adoption of SFAS No. 159 will have
      a
      material impact on our consolidated financial statements.


F-18




**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





**3.
      Accounts Receivable**





Trade
      accounts receivable at May 31, 2007 is $352,390, of which $348,890 is held
      by
      SSDI. No allowance for doubtful accounts has been recorded.





**4.
      Inventory**





Inventory
      at May 31, 2007, consisted of raw materials of $46,361.





**5.
      Property and Equipment**





Property
      and equipment consisted of the following at May 31, 2007 and 2006:





2007
            
            2006Computer
                equipment and software
            
            $
            42,270
            
            $
            33,587Furniture
                and fixtures
            
            
            72,454
            
            
            37,336114,724
            
            
            70,923Less
                accumulated depreciation and amortization
            
            
            (29,206
            )
            
            (6,917
            )Net
                property and equipment
            
            $
            85,518
            
            $
            64,006




Depreciation
      and amortization expense related to property and equipment was $24,352, $24,591
      and $46,026 for the years ended May 31, 2007, 2006 and 2005,
      respectively.





**6.
      License Agreements**





In
      February 2005, we entered into two separate licensing agreements with one
      customer for our patent portfolio and Ignite microprocessor technology. The
      aggregate amount of the two licenses was $3,050,000, of which $2,950,000 was
      for
      licensing fees and $100,000 was for maintenance services. Maintenance under
      the
      agreement is expected to be provided over a period not to exceed four years.
      Maintenance revenue recognized during the years ended May 31, 2007, 2006 and
      2005 was $25,000, $25,000 and $6,250, respectively. The payment terms of the
      agreements required aggregate payments of $300,000 at the time of execution,
      three quarterly payments of $750,000 each on April 1, August 15, and November
      15, 2005 and one final payment of $500,000 on February 15, 2006. The $500,000
      payment due on February 15, 2006 was paid in March 2006. Total payments received
      in fiscal 2005 amounted to $1,050,000 and total payments received in fiscal
      2006
      amounted to $2,000,000. The agreements also provide for the future payment
      of
      royalties to us based on sales of product using the Ignite licensed technology.
      In connection with this license agreement, we became obligated to the
      co-inventor of the patent portfolio technology for $207,600 pursuant to a July
      2004 agreement under which we were obligated to pay a percentage of all patent
      portfolio licensing proceeds to the co-inventor. The amount due under that
      license was payable in four installments of $51,900. The co-inventor of the
      patent portfolio technology filed a lawsuit against us seeking damages and/or
      enforcement of the 2004 agreement. We challenged the enforceability of the
      agreement by counterclaim in that action. On February 14, 2007, a settlement
      of
      the litigation was finalized. Terms of the settlement required us to pay
      $3,400,000 in cash on February 14, 2007 and $3,000,000 on May 1, 2007, which
      amounted to approximately the debt claimed by Fish to be owed to him under
      the
      July 2004 agreement. In addition, the settlement required us to make a donation
      of $15,000 on February 14, 2007 on behalf of Russell H. Fish III (“Fish”) to
      Maasai Power and Education Project, Inc., and to pay Fish the equivalent of
      4%
      of 50% of the next $100 million of gross license fees as they are collected
      by
      Phoenix Digital and as distributions are made to us, after excluding the first
      $20 million collected by Phoenix Digital after December 1, 2006. Our commitment
      to make payments to Fish related to such future license revenues will not exceed
      $2 million. A liability for gross license fees due of approximately $797,000
      is
      included in accrued expenses in the accompanying consolidated balance sheet
      at
      May 31, 2007. During the year ended May 31, 2007, we recorded approximately
      $7,525,000 related to settlement and license expenses.


F-19




**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





**7.
      Investment in Affiliated Company/License Agreement**





On
      June
      7, 2005, we entered into a Master Agreement (the “Master Agreement”) with
      Technology Properties Limited Inc., a California corporation (“TPL”), and
      Charles H. Moore (“Moore”), the co-inventor of certain of our technology,
      pursuant to which we, TPL and Moore resolved all legal disputes between us.
      Pursuant to the Master Agreement, we and TPL entered into the Limited Liability
      Company Operating Agreement of Phoenix Digital (the “LLC Agreement”) into which
      we and Moore contributed our rights to certain of our technologies. We believe,
      based upon consultation with our attorneys, it was not required by applicable
      law or other existing agreements to obtain approval for the contribution of
      the
      license rights to Phoenix Digital from stockholders or any parties other than
      our various warrant holders.





We
      and
      TPL each own 50% of the membership interests of Phoenix Digital, and each of
      us
      have the right to appoint one member of the three member management committee.
      The two appointees are required to select a mutually acceptable third member
      of
      the management committee. Pursuant to the LLC Agreement, we and TPL agreed
      to
      establish a working capital fund for Phoenix Digital of $4,000,000, of which
      our
      contribution was $2,000,000. The working capital fund increases to a maximum
      of
      $8,000,000 as license revenues are achieved. We and TPL are obligated to fund
      future working capital requirements at the discretion of the management
      committee of Phoenix Digital in order to maintain working capital of not more
      than $8,000,000. Neither we nor TPL are required to contribute more than
      $2,000,000 in any fiscal year. Distributable cash and allocation of profits
      and
      losses will be allocated to the members in the priority defined in the LLC
      Agreement. Phoenix Digital has committed to pay a quarterly amount ranging
      between $500,000 and $1,000,000 (based upon a percentage of the working capital
      fund balance of Phoenix Digital) for supporting efforts to secure licensing
      agreements by the other member on behalf of Phoenix Digital. During the years
      ended May 31, 2007 and 2006, Phoenix Digital paid $3,871,602 and $2,500,000,
      respectively, to TPL pursuant to this commitment.





We
      are
      accounting for our investment in Phoenix Digital under the equity method of
      accounting, and accordingly have recorded our initial contribution of $2,000,000
      and our share of Phoenix Digital’s net income of $48,965,084 and $27,848,363,
      during the years ended May 31, 2007 and 2006, respectively, as an increase
      in
      our investment. Cash distributions of $50,034,029 and $25,895,449 received
      from
      Phoenix Digital during the years ended May 31, 2007 and 2006, respectively,
      have
      been recorded as a reduction in our investment. Our investment in Phoenix
      Digital is $2,883,969 at May 31, 2007 and has been recorded as “Investment in
      Affiliated Company”. We have recorded our share of Phoenix Digital’s net income
      as “Equity in Earnings of Affiliated Company” in the accompanying consolidated
      statements of operations for years ended May 31, 2007 and 2006.





Concurrently
      with forming Phoenix Digital, we entered into a license agreement with a third
      party pursuant to which we received $10,000,000, this amount was recorded as
      license revenue during the year ended May 31, 2006. In connection with entering
      into the license agreement and forming Phoenix Digital, we incurred various
      cash
      and non-cash expenses. Direct, incremental cash costs incurred with the
      transactions included $170,000 paid to a committee of our board of directors
      for
      their efforts in consummating the transactions, approximately $1,328,000 paid
      to
      certain of our warrant holders to obtain their approval of the agreement and
      release of their lien and blocking rights. Additionally, $960,000 was paid
      to
      the co-inventor of the technology.


F-20




**Patriot
        Scientific Corporation**
 **Notes
        to Consolidated Financial Statements (Continued)**


We
      also
      granted new warrants and agreed to re-price other outstanding warrants in order
      to obtain the necessary approvals from certain security interest holders as
      well
      as to obtain the release of their security interests in our intellectual
      property, and to finalize the LLC Agreement. We granted a warrant to TPL to
      acquire up to 3,500,000 shares of our common stock at a per share price of
      $0.125. The warrant has a term of seven years. At the date of grant, the right
      to acquire 1,400,000 common shares vested. The right to acquire the remaining
      2,100,000 shares will vest in 700,000 increments only upon our common stock
      attaining a per share stock price of $0.50, $0.75 and $1.00. On February 21,
      2006, February 22, 2006 and March 1, 2006 the rights to acquire the remaining
      700,000 share increments vested as our stock price reached $0.50, $0.75 and
      $1.00, respectively. As additional consideration to the warrant holders for
      providing approval for the transaction, we agreed to reset the per share
      exercise price of approximately 35,000,000 warrants to $0.015 for which the
      warrant holders also conveyed other warrants to acquire 12,000,000 shares back
      to us. Further, we issued additional warrants to acquire approximately 290,000
      shares of our common stock at a per share price of $0.03. The warrants issued
      and re-priced were valued using a Monte Carlo simulation model and the following
      assumptions: volatility of 101% to 229%, no dividends, risk-free interest rates
      of approximately 3.5% to 5.1%, and contractual terms ranging from two to seven
      years. The fair value of the warrants issued and re-priced in excess of
      previously recorded expense was approximately $83,000 and the fair value of
      the
      reconveyed warrants was approximately $622,000. These amounts, together with
      the
      direct, incremental cash costs previously described, are recorded as an expense
      and included in settlement and license expense in the year ended May 31,
      2006.





During
      the years ended May 31, 2007 and 2006, Phoenix Digital entered into licensing
      agreements with third parties, pursuant to which it received aggregate proceeds
      of $110,879,000 and $60,000,000, respectively.





The
      condensed balance sheets and statements of income of Phoenix Digital at May
      31,
      2007 and 2006 and for the years then ended are as follows:





**Condensed
      Balance Sheets**





ASSETS:





2007
            
            2006Cash
            
            $
            6,989,847
            
            $
            7,765,708Prepaid
                expenses
            
            
            175,000
            
            
            15,000Total
                assets
            
            $
            7,164,847
            
            $
            7,780,708





LIABILITIES
      AND MEMBERS’ EQUITY:





Accounts
                payable and accrued expenses
            
            $
            1,385,118
            
            $
            148,762Income
                taxes payable
            
            
            11,790
            
            
            -Members’
                equity
            
            
            5,767,939
            
            
            7,631,946Total
                liabilities and members’ equity
            
            $
            7,164,847
            
            $
            7,780,708




**Condensed
      Statements of Income**





Revenues
            
            $
            110,878,985
            
            $
            60,000,000Operating
                expenses
            
            
            12,189,575
            
            
            4,486,955Operating
                income
            
            
            98,689,410
            
            
            55,513,045Interest
                income
            
            
            421,407
            
            
            183,682Income
                before income taxes
            
            
            99,110,817
            
            
            55,696,727Provision
                for income taxes
            
            
            11,790
            
            
            -Net
                income
            
            $
            99,099,027
            
            $
            55,696,727




F-21




**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





**8.
      Consolidated Variable Interest Entity**





On
      February 2, 2007, we invested an aggregate of $370,000 in SSDI for 2,100,000
      shares of convertible preferred stock. This represents all of SSDI’s preferred
      stock and a 46% ownership interest in SSDI, a California corporation that
      manufactures products that protect information transmitted over secure networks.
      The investment consisted of certain assets contributed by us to SSDI valued
      at
      $250,000 and cash of $120,000. The shares are convertible at our option into
      shares of SSDI’s common stock on a one-to-one basis. The convertible preferred
      stock entitles us to receive non-cumulative dividends at the per annum rate
      of
      $0.04 per share, when and if declared by the Board of Directors of SSDI. The
      investment in SSDI’s convertible preferred stock also entitles us to a
      liquidation preference of $0.40 per share, plus an amount equal to all declared
      but unpaid dividends.




On
      March
      27, 2007, we entered into an 18 month revolving line of credit with SSDI for
      a
      maximum amount of $500,000. The line of credit matures on September 27, 2008.
      If
      we do not provide notice to SSDI at least 90 days prior to the maturity date,
      the maturity date automatically extends 12 months. The line of credit is
      collateralized by all assets presently owned or hereafter acquired by SSDI.
      The
      carrying value of the collateral is approximately $323,341 at May 31, 2007.
      The
      creditors of SSDI do not have recourse to our other assets. On March 28, 2007,
      we advanced $150,000 under terms of the agreement, and on April 16, 2007 we
      advanced $100,000 under terms of the agreement.




The
      line
      of credit carries a floating interest rate which is defined as the prime rate
      as
      announced by Bank of America. At May 31, 2007, the interest rate on the note
      was
      8.25%. SSDI is required to make minimum monthly payments on the line consisting
      of unpaid and accrued interest on the first day of the month following the
      initial advance.




As
      a
      result of the line of credit, we have a variable interest in SSDI, a variable
      interest entity, and we have determined that we are the primary beneficiary
      as
      we absorb more than half of the variable interest entity’s expected losses.
      FIN46(R), *Consolidation
      of Variable Interest Entities* ,
      requires us to consolidate SSDI as long as we are deemed to be the primary
      beneficiary. The equity interests of SSDI not owned by us are reported as a
      minority interest in our May 31, 2007 consolidated balance
      sheet.




Prior
      to
      initial consolidation, we recognized a $126,746 impairment loss on our
      investment for the losses of SSDI for the period February 2007 through March
      26,
      2007.




Upon
      initial consolidation of the variable interest entity, on March 27, 2007,
      $251,146 of current assets, $43,199 of net property and equipment, $47,240
      of
      other assets, $98,331 of current liabilities and no minority interest were
      included on the consolidated balance sheet.





**9.
      Accrued Liabilities**





At
      May
      31, 2007 and 2006, accrued liabilities consisted of the following:





2007
            
            2006Accrued
                lease obligation
            
            $
            7,279
            
            $
            23,323Deferred
                maintenance fee
            
            
            43,750
            
            
            68,750Compensation
                and benefits
            
            
            75,068
            
            
            62,657Deferred
                material credit
            
            
            163,399
            
            
            -Royalties
                payable
            
            
            797,000
            
            
            -$
            1,086,496
            
            $
            154,730





F-22




**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





**10.
      Convertible Debentures**





From
      fiscal 2002 through fiscal 2005, we raised approximately $5,400,000 through
      the
      issuance of convertible debentures, having stated interest rates ranging from
      8%
      to 12%, to a limited group of investors. The convertible
      debentures entitled the debenture holders to convert the principal, and any
      accrued interest thereon, into shares of our common stock for up to two years
      from the date of issuance.




The
      debentures were initially convertible into shares of common stock at conversion
      prices ranging from approximately $0.02 to $0.10 per share. The debentures
      contained provisions which allowed for the conversion rate to be reset on a
      periodic basis based on a comparison of the market price of our common stock
      to
      the conversion price of the debentures. On the measurement dates when the market
      price was less than the conversion rate, a new conversion rate was set based
      on
      a weighted average of the market price for the ten days prior to the reset
      measurement date. As of May 31, 2005, the reset conversion rate on debentures
      outstanding ranged from $0.02 to $0.04.




Concurrent
      with the issuance of the convertible debentures, we issued 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.




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, 2007, there have been seven
      registration statements. The convertible debentures were secured by
      substantially all our assets.




The
      terms
      of the convertible debentures included certain features that are considered
      embedded derivative financial instruments, such as the conversion feature and
      a
      reset conversion feature which provided for a conversion of the debentures
      into
      shares of our common stock at a rate which was determined to be variable.
      Because the debentures were not conventional convertible debt, we were also
      required to record the related warrants at their fair values. In addition,
      under
      the provisions of EITF Issue No. 00-19, *Accounting
      for Derivative Financial Instruments Indexed to, and Potentially Settled in,
      a
      Company’s Own Stock,* as
      a
      result of entering into the convertible debenture agreements, we were required
      to classify all other non-employee warrants as derivative liabilities and record
      them at their fair values at each balance sheet date.




During
      the years ended May 31, 2006 and 2005, the value of the warrant and derivative
      liabilities increased by $2,456,736 and $7,563,564, respectively, which is
      reflected as a component of other income (expense) in the accompanying
      consolidated statements of operations.




During
      the year ended May 31, 2006, we entered into two reset agreements with the
      debenture holders to fix the conversion price of the then outstanding debentures
      at their current price. We determined that one of the debt modifications did
      not
      result in a debt extinguishment under EITF Issue No. 96-19, *Debtor’s
      Accounting for a Modification or Exchange of Debt Instruments* ,
      or EITF
      Issue No. 05-7, *Accounting
      for Modifications to Conversion Options Embedded in Debt Instruments and Related
      Issues* .
      In
      connection with the reset agreement of one of the outstanding debentures, we
      issued 7,000,000 warrants to the debenture holder as consideration for entering
      into the reset agreement. We determined that the issuance of the warrants,
      in
      connection with the reset agreement, resulted in a debt extinguishment under
      EITF Issue No. 96-19. Accordingly, we recorded the fair value of the warrants
      issued of $445,427 as a loss on debt extinguishment in the accompanying
      consolidated statements of operations for the year ended May 31,
      2006.


F-23


**Patriot
        Scientific Corporation**
 **Notes
        to Consolidated Financial Statements (Continued)**


During
      the year ended May 31, 2006, holders of debentures with a principal balance
      of
      $880,668 converted their debentures, together with accrued interest thereon
      of
      approximately $119,000, into 30,819,187 shares of our common stock. During
      the
      year ended May 31, 2005, we converted principal of $2,057,500 and related
      accrued interest of $112,436 into 64,886,139 shares of our common stock. As
      of
      May 31, 2006, all outstanding debentures were repaid or converted into shares
      of
      our common stock.




As
      a
      result of the settlement of the remaining debentures during 2006, we
      reclassified $6,743,935 related to the fair values of all outstanding warrants
      at the date of settlement to additional paid-in capital.





The
      following table presents the status and activity of our convertible debentures
      as of May 31, 2006:





Series
            Dates
                of Issuance
            Original
                Principal
            Principal
                Balance at May 31, 2006
            Conversion
                Prices
            Effective
              Registration
                Date
            Shares
                Converted as of May 31, 2006
            Warrant
                Shares IssuedInitial
            ResetA
            4/23/02-
            $1,000,000
            $-
            $0.08616-
            $0.04190-
            10/29/2002
            24,099,548
            12,859,1756/10/02
            
            
            0.10289
            0.04457B
            8/23/02-
            605,000
            -
            0.05126-
            0.04381-
            3/7/2003
            14,777,350
            11,234,8351/24/03
            
            
            0.0727
            0.04722C
            3/24/02-
            510,000
            -
            0.041-
            0.041-
            6/26/2003
            10,470,554
            9,377,9436/9/03
            
            
            0.065
            0.065D
            8/1/03-
            547,500
            -
            0.0172-
            0.0172-
            11/18/2003
            25,178,803
            22,455,35510/21/03
            
            
            0.048
            0.0477E
            12/1/03-
            1,527,500
            -
            0.0267-
            0.0267-
            6/7/2004
            46,794,618
            30,395,3925/11/04
            
            
            0.10
            0.10F
            3/23/04
            723,168
            -
            0.09
            0.09
            Not
                Registered
            20,877,430
            8,035,192G
            9/28/04-
            232,500
            -
            0.016710-
            0.01670-
            5/22/2006
            8,267,358
            8,259,6781/17/05
            
            
            0.04
            0.04G
            11/17/04-
            257,500
            -
            0.016710-
            0.01670-
            Not
                Registered
            14,107,672
            13,431,13711/18/04
            
            
            0.04
            0.04$5,403,168
            -
            
            
            
            164,573,333
            116,048,707





The
      terms
      of the convertible debentures include certain features that were considered
      embedded derivative financial instruments, such as the conversion feature and
      a
      reset conversion feature which provides for the conversion of the debentures
      into shares of our common stock at a rate which is variable. Because the
      debentures are not conventional convertible debt, we were required to record
      the
      derivative financial instruments and the warrants issued in connection with
      the
      convertible debentures at their fair values as of the issuance date of each
      of
      the debentures. No convertible debentures or warrants in connection with
      convertible debentures were issued during the year ended May 31, 2006.





We
      recorded the fair value of the derivative instruments and warrants as a debt
      discount which was amortized to interest expense over the term of the
      convertible debentures. During the years ended May 31, 2006 and 2005, we
      recorded interest expense of $412,879 and $2,152,267, respectively, related
      to
      the amortization of the debt discount. If the total fair value of the derivative
      instruments and warrants was in excess of the proceeds received on the
      convertible debentures, we recorded the excess as additional interest expense.
      We recorded additional interest expense of $563,167 during the year ended May
      31, 2005 related to the fair values of derivative instruments and warrants
      in
      excess of proceeds received. Since no convertible debentures or warrants in
      connection with convertible debentures were issued during the year ended May
      31,
      2006, no excess fair value was recorded during fiscal 2006.


F-24




**Patriot
        Scientific Corporation**
 **Notes
        to Consolidated Financial Statements (Continued)**


**11.
      Stockholders’ Equity**





During
      July 2006, we commenced our Board of Director approved stock buyback program
      in
      which we repurchase our outstanding common stock from time to time on the open
      market. As part of the program we purchased 13,467,527 shares of our common
      stock at an aggregate cost of $8,832,078 during the year ended May 31,
      2007.




During
      February 2007, we announced dividends of $0.02 per share to shareholders and
      qualified warrant holders of record as of March 6, 2007. The dividend of
      $8,114,774 was paid on April 9, 2007. During this time, we announced a
      semi-annual dividend policy contingent upon our financial condition, other
      possible applications of available resources, and relevant business
      considerations.





***Private
      Stock Offerings***





On
      July
      22, 2005, 625,000 shares of common stock valued at $0.13 per share (based on
      the
      fair value on the date of issuance) were issued to the co-inventor of certain
      technology. The Company recorded an expense of $81,250 in connection with the
      issuance of these shares.





On
      March
      21, 2006, 193,548 shares of common stock valued at $1.53 per share (based on
      the
      fair value on the date of issuance) were issued to a former debenture holder
      in
      connection with a dispute regarding the number of shares of common stock issued
      upon conversion. The Company recorded an expense of $296,129 in connection
      with
      the issuance of these shares.





During
      fiscal 2005, 4,625,000 restricted shares of common stock were issued to a group
      of individual investors in exchange for $453,250. Additionally, the Company
      issued 796,000 shares of common stock, valued at $58,800, to a vendor in
      exchange for services, which was included in selling, general and administrative
      expenses.





During
      February 2006, the Company announced a dividend of $0.02 per share of common
      stock for stockholders of record and qualified warrant holders as of February
      24, 2006. The dividend of $8,114,378 was paid in March 2006. In March 2006,
      the
      Company announced a dividend of $0.04 per share of common stock for stockholders
      of record and qualified warrant holders as of March 31, 2006. The dividend
      of
      $16,583,959 was paid in April 2006 .




***Warrants***





At
      May
      31, 2005, we had warrants outstanding to purchase 109,122,581 shares of common
      stock at exercise prices ranging from approximately $0.02 to $0.065 per share
      expiring at various dates through 2012. During fiscal 2005, we issued warrants
      to purchase 29,021,363 shares of common stock at exercise prices ranging from
      $0.02 to $0.08 per share and issued 38,358,511 shares of common stock on the
      exercise of warrants at exercise prices ranging from $0.02 to $0.05 per
      share.





At
      May
      31, 2006, we had warrants outstanding to purchase 53,349,220 common shares
      at
      exercise prices ranging from $0.02 to $1.00 per share, expiring at various
      dates
      through 2012. Some of those outstanding warrants were not exercisable as of
      May
      31, 2006 as they are subject to meeting vesting criteria. During the year ended
      May 31, 2006, we issued warrants to purchase 12,457,049 shares of common stock,
      investors exercised warrants to purchase 8,728,544 shares of common stock for
      proceeds of $470,657 and investors exercised warrants of 44,110,139 to purchase
      41,245,473 shares of common stock on a cashless basis. During the year ended
      May
      31, 2006, we cancelled warrants to purchase 13,391,727 shares of our common
      stock. Included in the aforementioned warrants issued during the year ended
      May
      31, 2006 were warrants to purchase 300,000 shares of common stock issued to
      a
      consultant. The value of these warrants of $176,866 was recorded as an expense
      during the year ended May 31, 2006. We re-priced other warrants to purchase
      approximately 35,000,000 common shares to $0.015 during the year ended May
      31,
      2006 (see Note 7).


F-25




**Patriot
        Scientific Corporation**
 **Notes
        to Consolidated Financial Statements (Continued)**


Effective
      January 11, 2006, we entered into a warrant redemption agreement with a warrant
      holder, whereby at our option, we agreed to redeem certain warrants representing
      the right to acquire an aggregate of up to 10,000,000 shares of our common
      stock, through April 2006. The warrants may be redeemed in quantities not to
      exceed 2,000,000 warrants in any one calendar month, at a price equal to the
      product of (a) the volume weighted average of the daily volume weighted average
      prices of our common stock for all trading days in the applicable calendar
      month, minus the exercise price of the warrant, multiplied by (b) the number
      of
      shares being redeemed from that warrant. On February 3, 2006, we agreed to
      redeem 2,000,000 warrants for $252,420 and payment for the redemption occurred
      in March 2006.





Effective
      February 9, 2006, we entered into “Reset Agreements” with certain warrant
      holders and received waivers from the warrant holders with regard to certain
      terms of certain warrants held by the warrant holders. Under the terms of the
      Reset Agreements, we and the warrant holders agreed to amend the terms of (i)
      each of the warrants held by the warrant holders such that the exercise price
      of
      the warrants is no longer subject to downward resets based on the trading price
      of our common stock, and (ii) each of the debentures held by the warrant holders
      such that the conversion price of the debentures is fixed at its current level.
      No additional expense was required for the modification of the exercise price
      of
      the warrants since the new fixed price of the warrants was equal to the original
      exercise price at date of issuance or was equal to the then reset price in
      effect for which we had previously recognized an expense for the modification
      (see Note 7). Under the terms of the Reset Agreements, we and the warrant
      holders also agreed to amend all of the agreements entered into between us
      and
      the warrant holders that limit the ability of the warrant holders to be the
      beneficial owner of more than 4.99% of our common stock to be amended to provide
      that the warrant holders may not, through the exercise of warrants, the
      conversion of debentures, or otherwise, be the beneficial owner of more than
      9.99% of our common stock.





Under
      the
      terms of the waiver agreements, the warrant holders agreed to amend their rights
      under the terms of certain warrants held by each of them to receive a payment
      in
      the event of a payment of a dividend by us. Prior to entering into the waiver
      agreements, if at any time after the issuance date of the subject warrants,
      we
      made any distributions to holders of our common stock, the warrant holders
      would
      be entitled to receive a payment equal to the amount of such distribution which
      would have been payable to them had they owned the shares of common stock
      issuable upon exercise of the subject warrants as of the record date for the
      distribution. Under the terms of the waiver agreement, if the market price
      of
      our common stock on the record date for a distribution is greater than or equal
      to $0.15 per share, the payment to the warrant holders would be reduced to
      the
      amount which would be payable to the warrant holders had they engaged in a
      cashless exercise of the subject warrants as of the record date for the
      distribution. In consideration for entering into the agreements, we issued
      warrants for the right to acquire 7,000,000 shares of our common stock to one
      warrant holder and recognized a loss on debt extinguishment of $445,427 (see
      Note 10).





In
      connection with a previous debt agreement, we entered into an Antidilution
      Agreement (the “Antidilution Agreement”) with Swartz Private Equity, LLC
      (“Swartz”) wherein we were obligated to issue to Swartz warrants equal to 11% of
      the common stock issued between January 28, 2002 and March 11, 2002, 20% of
      the
      common stock issued between March 12, 2002 and April 1, 2003, and after April
      1,
      2003, 30% of the common stock issued to any parties other than Swartz. During
      the year ended May 31, 2005, we issued warrants to Swartz to purchase 7,330,548
      shares of our common stock in connection with the Antidilution Agreement. There
      were no warrants issued during the year ended May 31, 2006 in connection with
      the Antidilution agreement. On October 10, 2006, we entered into an Approval
      Rights Agreement and Termination of Antidilution Agreement and Addendum to
      Warrants (the “Termination Agreement”) with Swartz to terminate the Antidilution
      Agreement. In consideration for entering into the Termination Agreement, we
      agree to obtain Swartz’s written approval at least 30 days prior to entering
      into (i) any acquisition of any business entity or asset of any kind where
      the
      aggregate number of shares of common stock and derivative securities (on a
      fully
      diluted basis) issued as consideration for the acquisition equals or exceeds
      10%
      of the number of shares of our common stock outstanding at the time of the
      acquisition (on a fully diluted basis) or (ii) any acquisition (regardless
      of
      size) by us of any business entity or asset of any kind that is not unanimously
      approved by our board of directors.


F-26




**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





At
      May
      31, 2007, we had warrants outstanding to purchase 12,060,915 common shares
      at
      exercise prices ranging from $0.02 to $1.00 per share, expiring at various
      dates
      through 2012. Some of those outstanding warrants were not exercisable as of
      May
      31, 2007 as they are subject to meeting vesting criteria. During the year ended
      May 31, 2007, investors exercised warrants to purchase 1,272,500 shares of
      common stock for proceeds of $172,250 and investors exercised warrants of
      40,000,805 to purchase 38,681,396 shares of common stock on a cashless basis.
      During the year ended May 31, 2007, 15,000 warrants expired and 1,319,409
      warrants were cancelled due to cashless exercises.





The
      following table presents outstanding warrants at May 31, 2007, 2006 and
      2005:





2007
            
            2006
            
            2005Issued
                in conjunction with:Convertible
                debentures
            
            
            560,915
            
            
            40,769,009
            
            
            75,196,854Anti-dilution
                agreements
            
            
            **-**
            
            
            690,211
            
            
            20,813,081Equity
                lines of credit
            
            
            **-**
            
            
            **-**
            
            
            9,965,369Waiver
                agreements
            
            
            7,000,000
            
            
            7,000,000
            
            
            -Other
            
            
            4,500,000
            
            
            4,890,000
            
            
            3,147,277Total
                warrants outstanding
            
            
            12,060,915
            
            
            53,349,220
            
            
            109,122,581





***1996
      Stock Option Plan***





Effective
      March 1996, as amended, we adopted the 1996 Stock Option Plan. Under the 1996
      Stock Option Plan, which expired March 24, 2006, options to purchase up to
      4,000,000 shares of our common stock may be granted to either full or part
      time
      employees, directors and our consultants 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, 2006 and 2005,
      we granted options to purchase 50,000 and 645,000 shares of common stock,
      respectively, at market value, under the 1996 Stock Option Plan. As of May
      31,
      2007, options to purchase 100,000 shares of common stock are outstanding under
      the 1996 Stock Option Plan. The options outstanding continue to be governed
      by
      the terms of the 1996 Stock Option Plan.





***2001
      Stock Option Plan***





The
      2001
      Stock Option Plan, which expires in February 2011, provides for the granting
      of
      options to purchase up to 3,000,000 shares of our common stock to either full
      or
      part time employees, directors and our consultants 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, 2007, 2006
      and
      2005, we granted options to purchase 230,000, 145,000 and 1,150,000 shares
      of
      our common stock, respectively, at market value, under this plan. As of May
      31,
      2007, options to purchase 475,000 shares of common stock are outstanding under
      the 2001 Stock Option Plan.


F-27




**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





***2003
      Stock Option Plan***





The
      2003
      Stock Option Plan, which expires in 2013, provides for the granting of options
      to acquire up to 6,000,000 shares of our common stock to either full or part
      time employees, directors and our consultants 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 years ended May 31, 2006 and 2005,
      we granted options to purchase 1,550,000 and 1,695,000 shares of our common
      stock, respectively, at market value, under this plan. There were no grants
      made
      under the 2003 Stock Option Plan during the fiscal year ended May 31, 2007.
      As
      of May 31, 2007, options to purchase 2,050,000 shares of common stock are
      outstanding under the 2003 Stock Option Plan.





***2006
      Stock Option Plan***





The
      2006
      Stock Option Plan, which expires in 2016, provides for the granting of options
      to acquire up to 5,000,000 shares, with a limit of 3,000,000 Incentive Stock
      Option (ISO) shares of our common stock to either full or part time employees,
      directors and our consultants at a price not less than the fair market value
      on
      the date of grant. 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 2006 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, 2007 and
      2006, we granted options to purchase 1,070,000 and 2,050,000 shares of our
      common stock, respectively, under this plan, 70,000 and 192,857 shares,
      respectively, of which were ISOs. In connection with May 31, 2006 option grants,
      we recognized compensation expense of $120,000 related to options granted below
      the fair market value of our common stock at the date of grant. As of May 31,
      2007, options to purchase 3,120,000 shares of common stock are outstanding
      under
      the 2006 Stock Option Plan.





On
      June
      5, 2006, we issued options to acquire 1,500,000 shares of our common stock
      at a
      per share price of $0.165 to an officer outside of the above referenced plans.


F-28




**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





A
      summary
      of the status of our stock option plans and warrants as of May 31, 2007, 2006
      and 2005 and changes during the years ended on those dates is presented
      below:




Options
            
            WarrantsShares
            
            Weighted
                Average Exercise Price
            
            Shares
            
            Weighted
                Average Exercise PriceOutstanding,
                June 1, 2004
            
            
            7,003,000
            
            $
            0.21
            
            
            121,349,420
            
            $
            0.05Granted
            
            
            3,490,000
            
            
            0.08
            
            
            29,021,363
            
            
            0.04Cancelled
            
            
            (2,675,000
            )
            
            0.31
            
            
            (2,889,691
            )
            
            0.07Exercised
            
            
            (670,000
            )
            
            0.05
            
            
            (38,358,511
            )
            
            0.03Outstanding,
                May 31, 2005
            
            
            7,148,000
            
            
            0.13
            
            
            109,122,581
            
            
            0.04Granted
            
            
            3,795,000
            
            
            0.46
            
            
            12,457,049
            
            
            0.09Cancelled
            
            
            (1,387,000
            )
            
            0.30
            
            
            (13,391,727
            )
            
            0.05Repurchased
            
            
            -
            
            
            -
            
            
            (2,000,000
            )
            
            0.02Exercised
            
            
            (4,096,000
            )
            
            0.09
            
            
            (52,838,683
            )
            
            0.03Outstanding,
                May 31, 2006
            
            
            5,460,000
            
            
            0.34
            
            
            53,349,220
            
            
            0.05Granted
            
            
            2,800,000
            
            
            0.39
            
            
            -
            
            
            -Cancelled
            
            
            (500,000
            )
            
            0.09
            
            
            (1,334,409
            )
            
            0.03Exercised
            
            
            (515,000
            )
            
            0.08
            
            
            (39,953,896
            )
            
            0.03Outstanding,
                May 31, 2007
            
            
            7,245,000
            
            $
            0.40
            
            
            12,060,915
            
            $
            0.10Exercisable,
                May 31, 2005
            
            
            5,748,000
            
            $
            0.14
            
            
            108,622,581
            
            $
            0.04Exercisable,
                May 31, 2006
            
            
            5,115,000
            
            $
            0.35
            
            
            52,849,220
            
            $
            0.05Exercisable,
                May 31, 2007
            
            
            7,245,000
            
            $
            0.40
            
            
            11,685,915
            
            $
            0.10Weighted
                average fair value of options and warrants granted during the year
                ended
                May 31, 2005
            
            
            
            
            $
            0.04
            
            
            
            
            $
            0.05Weighted
                average fair value of options and warrants granted during the year
                ended
                May 31, 2006
            
            
            
            
            $
            0.49
            
            
            
            
            $
            0.19Weighted
                average fair value of options and warrants granted during the year
                ended
                May 31, 2007
            
            
            
            
            $
            0.91
            
            
            
            
            $
            -





Included
      in the above table are certain warrants for which vesting is contingent based
      on
      various future performance measures.


F-29




**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





The
      following table summarizes information about stock options and warrants
      outstanding at May 31, 2007:


Range
                  of
                Exercise
                  Prices
              Outstanding
              ExercisableNumber
                  Outstanding
              Weighted
                Average
                  Remaining
                Contractual
                  Life (Years)
              Weighted
                Average
                Exercise
                  Price
              Number
                Exercisable
              Weighted
                Average
                Exercise
                  PriceOptions
              $
                  0.05-0.08
              325,000
              1.66
              $0.06
              325,000
              $0.060.10-0.17
              3,525,000
              1.84
              0.16
              3,525,000
              0.160.60-0.90
              3,395,000
              4.24
              0.68
              3,395,000
              0.68$
                  0.05-0.90
              7,245,000
              2.95
              $0.40
              7,245,000
              $0.40Warrants
              $
                  0.04-0.08
              8,260,915
              3.33
              $0.07
              7,885,915
              $0.070.12-1.00
              3,800,000
              4.94
              0.16
              3,800,000
              0.16$
                  0.04-1.00
              12,060,915
              3.84
              $0.10
              11,685,915
              $0.10





**12.
      Income Taxes**





The
      provision for income taxes is as follows for the years ended May
      31:





2007
            
            2006
            
            2005Current:Federal
            
            $
            -
            
            $
            -
            
            $
            -State
            
            
            972,064
            
            
            -
            
            
            -Total
                current
            
            
            972,064
            
            
            -
            
            
            -Deferred:Federal
            
            
            7,767,761
            
            
            -
            
            
            -State
            
            
            2,015,208
            
            
            -
            
            
            -Total
                deferred
            
            
            9,782,969
            
            
            -
            
            
            -Total
                provision
            
            $
            10,755,033
            
            $
            -
            
            $
            -





No
      provision for income taxes was recorded for the years ended May 31, 2006 and
      2005 due to the significant net operating loss carryforwards.





The
      reconciliation of the effective income tax rate to the Federal statutory rate
      is
      as follows for the years ended May 31:





2007
            
            2006
            
            2005Statutory
                federal income tax rate
            34.0
            %
            
            34.0
            %
            
            (34.0)
            %State
                income tax rate, net of Federal effect
            5.7
            %
            
            -
            %
            
            -
            %Other
            0.3
            %
            
            -
            %
            
            -
            %(Decrease)
                Increase in valuation allowance
            (8.7)
            %
            
            (34.0)
            %
            
            34.0
            %Effective
                income tax rate
            31.0
            %
            
            -
            %
            
            -
            %




F-30




**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





Deferred
      tax assets and liabilities reflect the net tax effect of temporary differences
      between the carrying amount of asset and liabilities for financial reporting
      purposes and amounts used for income tax purposes. Significant components of
      our
      deferred tax assets are as follows as of May 31:





2007
            
            2006
                (1)
            
            2005
                (1)Current
                deferred tax assets (liabilities):Net
                operating loss carryforwards
            
            $
            1,894,097
            
            $
            12,628,402
            
            $
            13,488,125Accruals
                and state taxes
            
            
            376,257
            
            
            214,239
            
            
            278,702Basis
                difference in fixed assets
            
            
            -
            
            
            14,881
            
            
            25,595Basis
                difference in intangibles
            
            
            -
            
            
            1,296,189
            
            
            1,652,225Investment
                in affiliated company
            
            
            -
            
            
            (11,497,984
            )
            
            -Inventory
                and other reserves
            
            
            -
            
            
            -
            
            
            41,446Credits
            
            
            242,411
            
            
            289,318
            
            
            329,583Less:
                valuation allowance
            
            
            (72,790
            )
            
            (2,945,045
            )
            
            (15,815,676
            )Total
                net deferred tax asset
            
            
            2,439,975
            
            
            -
            
            
            -Long-term
                deferred tax assets (liabilities):Investment
                in affiliated company
            
            
            (14,128,084
            )
            
            -
            
            
            -Basis
                difference in fixed assets
            
            
            (2,870
            )
            
            -
            
            
            -Basis
                difference in intangibles
            
            
            1,072,117
            
            
            -
            
            
            -Stock
                based compensation expense
            
            
            835,893
            
            
            -
            
            
            -Total
                net long-term deferred tax liability
            
            
            (12,222,944
            )
            
            -
            
            
            -Net
                deferred tax liability
            
            $
            (9,782,969
            )
            $
            -
            
            $
            -





(1)
      Certain reclassifications have been made to prior year amounts in order to
      conform to the current year presentation.





During
      fiscal year 2007, the valuation allowance relating to our deferred tax assets
      was released as we determined that we would utilize our net operating loss
      carryforwards and other deferred tax assets. For federal and state tax purposes,
      SSDI is not consolidated with our corporate income tax filings. SSDI is
      consolidated however, in the components of our net deferred tax assets and
      liabilities as indicated above. The $72,790 valuation allowance above relates
      entirely to SSDI as management has not determined that it is more likely than
      not that the deferred tax asset relating to net operating loss carryforwards
      will be realized.





At
      May
      31, 2006 and 2005, 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. The valuation
      allowance decreased by $2,872,255 and $12,870,631 during the years ended May
      31,
      2007 and 2006 respectively.





At
      May
      31, 2007, we have federal net operating loss carryforwards of approximately
      $5,339,000 that expire during the years 2008 through 2024. All losses are
      subject to certain limitations imposed under the Internal Revenue Code of 1986,
      as amended. As such, certain federal net operating loss carryforwards may expire
      unused and per year availability may be subject to change of ownership
      limitations under Internal Revenue Code Section 382.





At
      May
      31, 2007, we have federal general business credit carryforwards of $242,411.
      The
      general business credit carryforwards expire during the year 2011 through 2024.





F-31




**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





**13.
      Commitments and Contingencies**





***Litigation***





*Lowell
      Giffhorn Arbitration*




On
      September 23, 2005, Lowell Giffhorn, a former executive officer
      and a former director of the Company, submitted a demand for arbitration with
      the American Arbitration Association related to the termination of
      Mr. Giffhorn's employment with the Company. Mr. Giffhorn asserts that
      the termination of his employment with the Company was unlawful, retaliatory,
      wrongful, violated public policy, violated the covenant of good faith and fair
      dealing and violated securities laws. Mr. Giffhorn has demanded damages of
      approximately $4,500,000 (excluding claims for punitive damages and attorneys
      fees). The Company denies the allegations and believes the claims to be
      frivolous and totally devoid of merit. The Company has retained litigation
      counsel and intends to vigorously defend the claims. The amount, if any, of
      ultimate liability with respect to the foregoing cannot be determined. Despite
      the inherent uncertainties of litigation, the Company at this time does not
      believe that Mr. Giffhorn's claim will have a material adverse impact on
      its financial condition, results of operations, or cash flows.




*Patent
      Litigation*




Pursuant
      to the joint venture that the Company entered into in June 2005 with TPL (in
      settlement of inventorship/ownership litigation between the parties, and in
      return for a 50-50 sharing of net licensing and enforcement revenues), the
      Company granted TPL the complete and exclusive right to enforce and license
      its
      microprocessor patent portfolio. The Company then dismissed its patent
      infringement claims against Fujitsu Computer Systems, Inc. (“Fujitsu”);
      Matsushita Electric Corporation of America; NEC Solutions (America) Inc.
      (“NEC”); Sony Electronics Inc. (“Sony”); and Toshiba America Inc., and certain
      related entities of these **** defendants
      which had been pending in the Federal District Court for the Northern District
      of California. Thereafter, TPL, on behalf of the TPL/Patriot joint venture,
      filed patent infringement actions against certain of the foregoing defendants
      (except Sony) and their related entities in the Federal District Court for
      the
      Eastern District of Texas, which litigation is currently pending. Patriot was
      subsequently joined as a party to the litigation. Litigation is not currently
      pending with regard to Fujitsu or NEC and certain of NEC’s subsidiaries as
      listed below.




On
      August
      25 2006, ARM Ltd. and ARM, Inc. intervened as defendants, seeking a declaration
      of non-infringement of our ‘584 patent with respect to ARM processor cores
      contained within some alleged infringing chips of other defendants.


F-32




**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





In
      February 2006, a license agreement was entered into with Fujitsu regarding
      the
      Company's patent portfolio, and in connection with that transaction, litigation
      involving Fujitsu and TPL and the Company in both California and Texas was
      dismissed.




In
      February 2007, a license agreement was entered into with: NEC Corporation,
      NEC
      Corporation of America, Inc., NEC Display Solutions of America, Inc. and NEC
      Unified Solutions, Inc. In connection with that transaction, the above named
      defendants, excluding NEC Electronics America, Inc., were dismissed from the
      lawsuit.




A
      Claims
      Construction Hearing was held May 3, 2007 in The United States District Court
      for the Eastern District of Texas. On June 15, 2007 the court handed down claims
      construction of the patents-in-suit, the ‘336, ‘148 and ‘584 patents. Based on
      the claims construction ruling, TPL/Patriot are vigorously proceeding with
      discovery in respect to the ‘336 and ‘148 patents. However, based on the claims
      construction ruling as to the ‘584 patent claims of “instruction groups”,
      TPL/Patriot announced on August 8, 2007, a Stipulation with ARM intended to
      expedite an appeal of that claims construction. The Stipulation is a declaration
      of non-infringement by the accused ARM products with respect to the ‘584 patent.
      This is intended to bolster TPL/Patriot’s efforts in the long run to enforce
      rights under the ‘584 patent. A mediation is scheduled September 25 - 27, 2007.
      Trial is scheduled to begin January 7, 2008.





***401(k)
      Plan***





We
      have a
      retirement plan that complies with Section 401(k) of the Internal Revenue Code.
      All employees are eligible to participate in the plan. We match 50% of each
      participant’s voluntary contributions, subject to a maximum contribution of 6%
      of the participant’s compensation. Participants vest 33% per year over a three
      year period in our contributions. Our matching contributions during the fiscal
      years ended May 31, 2007 and 2006 were $11,397 and $1,833, respectively.





***Employment
      Contract***





During
      the quarter ended August 31, 2005, we terminated two of our officers, each
      of
      whom had an employment contract with us. One of the officers agreed to accept
      as
      severance approximately $150,000 and to have the maturity date of options held
      by him extended for one year. Further, we agreed to accelerate the vesting
      of
      all outstanding options held by the officer and to extend their term to June
      2006. We recorded an expense of approximately $125,000 related to this option
      modification in the year ended May 31, 2006.





We
      have
      not reached an agreement with the other officer; however, we accrued
      approximately $50,000 during the year ended May 31, 2006 for amounts which
      we
      believe may be due to this individual. The former officer has filed a complaint
      against us seeking arbitration and claiming he is owed approximately $4,500,000.
      We believe the claim is without merit and we intend to vigorously defend
      ourselves. ****





***Guarantees
      and Indemnities***





We
      have
      made certain guarantees and indemnities, under which we may be required to
      make
      payments to a guaranteed or indemnified party. We indemnify our directors,
      officers, employees and agents to the maximum extent permitted under the laws
      of
      the State of Delaware and California for SSDI. In connection with our facility
      leases, we have indemnified our lessors for certain claims arising from the
      use
      of the facilities. The duration of the guarantees and indemnities varies, and
      in
      many cases is indefinite. These guarantees and indemnities do not provide for
      any limitation of the maximum potential future payments we could be obligated
      to
      make. Historically, we have not been obligated to make any payments for these
      obligations and no liabilities have been recorded for these guarantees and
      indemnities in the accompanying consolidated balance sheets.


F-33




**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





***Operating
      Leases***





We
      had a
      non-cancelable operating lease for our office and manufacturing facilities
      located in San Diego, California which expired in July 2006. In February 2006
      we
      moved our operations to our Carlsbad, California facility. Due to the move,
      we
      accrued our remaining contractual lease obligation related to the San Diego
      facilities. Rent expense for fiscal 2007, 2006 and 2005 was $620, $103,245
      and
      $180,527, respectively.





We
      have a
      non-cancelable operating lease agreement for our Carlsbad, California office
      facility. Future minimum lease payments required under the operating lease
      are
      $96,201 and $73,710 in fiscal years ended 2008 and 2009, respectively. Rent
      expense for the fiscal years ended May 31, 2007 and 2006 was $92,928 and
      $30,976, respectively.





SSDI
      subleases their Carlsbad, California office facility which expires in December
      2007. Future minimum lease payments required under the operating lease are
      $52,983 in the fiscal year ended 2008. Rent expense for the fiscal year ended
      May 31, 2007 was $15,138.





SSDI
      also
      leases office space in Annapolis, Maryland on a month to month basis at $750
      per
      month expiring February 2008. The lease may be terminated by either party with
      30 days notice.





***Earn-Out
      Agreement***





SSDI
      entered into an earn-out agreement with a former debt holder of Holocom Networks
      upon our contribution of the foreclosure sale collateral of Holocom Networks
      to
      SSDI. The agreement required the former debt holder to release all of his rights
      to any Holocom collateral in exchange for receiving 3% of the net sales (defined
      as cash revenues actually received less credits or discounts and other claims
      of
      customers) of SSDI’s protected distribution system products for a period of 48
      months from the foreclosure sale date of February 2, 2007. The earn-out is
      to be
      paid each calendar quarter.





**14.
      Segment Information**





SSDI
      began operations in February, 2007 and we consolidated SSDI in our financial
      statements in March 2007. SSDI is an operating segment under Financial
      Accounting Standards Board Statement No. 131, *Disclosures
      About Segments of an Enterprise* ,
      as
      revenue is 10% or more of the total revenue of all operating segments.





SSDI
      is
      engaged in the business of  developing
      and manufacturing network-security hardware to government, military, and other
      high-security facilities. There is no inter-segment revenue and the accounting
      policies for segment reporting are the same as for us as a whole.





The
“all
      other” category includes the results for Patriot Scientific
      Corporation.


F-34




**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





Operating
      segment net revenue, operating income (loss) and income (loss) before taxes
      for
      each of the years ended May 31 were as follows:





2007
            
            2006
            
            2005Net
                revenue:SSDI
            
            $
            558,484
            
            $
            -
            
            $
            -All
                other
            
            
            80,300
            
            
            10,309,709
            
            
            2,982,586Total
                net revenue
            
            $
            638,784
            
            $
            10,309,709
            
            $
            2,982,586Operating
                income (loss):SSDI
            
            $
            (176,432
            )
            $
            -
            
            $
            -All
                other
            
            
            (14,587,407
            )
            
            3,911,640
            
            
            87,421Total
                operating income (loss)
            
            $
            (14,763,839
            )
            $
            3,911,640
            
            $
            87,421Income
                (loss) before taxes:SSDI
            
            $
            (169,913
            )
            $
            -
            
            $
            -All
                other
            
            
            34,616,133
            
            
            28,672,688
            
            
            (10,518,704
            )Total
                income (loss) before taxes
            
            $
            34,446,220
            
            $
            28,672,688
            
            $
            (10,518,704
            )





All
      sales
      were to unaffiliated customers within the United States. During the year ended
      May 31, 2007, one customer accounted for 85% of SSDI’s product sales and this
      same customer accounted for 81% of SSDI’s accounts receivable at May 31, 2007.





Operating
      segment depreciation and amortization and total assets for each of the years
      ended May 31 were as follows:





2007
            
            2006
            
            2005Depreciation
                and amortization:SSDI
            
            $
            22,740
            
            $
            -
            
            $
            -All
                other
            
            
            42,121
            
            
            59,415
            
            
            94,353Total
                depreciation and amortization
            
            $
            64,861
            
            $
            59,415
            
            $
            94,353








2007
            
            2006
            
            2005Total
                assets:SSDI
            
            $
            642,871
            
            $
            -
            
            $
            -All
                other
            
            
            33,771,758
            
            
            12,071,667
            
            
            3,724,034Total
                assets
            
            $
            34,414,629
            
            $
            12,071,667
            
            $
            3,724,034





**15.
      Subsequent Events**





During
      the period June 1, 2007 through August 9, 2007, Phoenix Digital entered into
      license agreements with third parties, pursuant to which it received aggregate
      proceeds totaling $500,000.





During
      the period June 1, 2007 through August 1, 2007, we purchased 4,961,640 shares
      of
      our common stock at an aggregate cost of $2,725,793 pursuant to our stock
      buyback program.





On
      June
      5, 2007, our outgoing chief executive officer retired. As a result, we recorded
      a severance charge of $100,000 based on terms of his employment agreement which
      provided for salary continuation.


F-35




**Patriot
      Scientific Corporation**


**Notes
      to Consolidated Financial Statements (Continued)**





On
      June
      5, 2007, we granted stock options, from our 2003 Stock Option Plan to our
      newly-appointed chief executive officer in accordance with his employment
      contract as follows: 1,500,000 non-qualified stock options, 200,000 of which
      immediately vest, the remainder are subject to vesting provisions within the
      option and 400,000 incentive stock options, 200,000 of which immediately vest,
      the remainder are subject to vesting provisions within the option.





On
      July
      5, 2007, we received proceeds of $6,250 from the issuance of 125,000 shares
      of
      common stock in connection with the exercise of warrants.





On
      July
      19, 2007, we entered into a warrant redemption agreement with a warrant holder,
      whereby at our option, we agree to redeem certain warrants representing the
      right to acquire an aggregate of up to 7,000,000 shares of our common stock,
      through October 2007. The warrants may be redeemed in quantities not to exceed
      2,000,000 warrants in the first two calendar months and 3,000,000 in the last
      calendar month, at a price equal to the product of (a) the volume weighted
      average of the daily volume weighted average prices of our common stock for
      all
      trading days in the applicable calendar month, minus the exercise price of
      the
      warrant, multiplied by (b) the number of shares being redeemed from that
      warrant. The warrant holder is prohibited from exercising any of the warrants
      as
      long as we are in compliance with the agreement. Additionally, the warrant
      holder is prohibited from purchasing any shares of our common stock on the
      open
      market during any “pricing month” defined in the agreement as the calendar month
      immediately preceding the calendar month in which we deliver the redemption
      notice to the warrant holder. On August 1, 2007, we agreed to redeem 2,000,000
      warrants for $921,855 and payment for the redemption occurred in August
      2007 **.**





On
      August
      6, 2007, our former chief executive officer exercised 1,000,000 of the 1,500,000
      options granted to him in June 2006. The options were exercised utilizing a
      full
      payment in shares method within the grant and in accordance with the provisions
      of the payment in shares method, the officer received 656,250 new shares of
      stock.





On
      August
      7, 2007 we received proceeds of $1,750 from a director who exercised 25,000
      stock options.


F-36


**Phoenix
      Digital Solutions, LLC**







**INDEX
      TO FINANCIAL STATEMENTS**




**Page**Report
                  of Independent Registered Public Accounting Firm
              
              F-38Financial
                  Statements:Balance
                  Sheets
              
              F-39Statementsof
                  Income
              
              F-40Statementsof
                  Members’ Equity
              
              F-41Statements
                  of Cash Flows
              
              F-42Notes
                  to Financial Statements
              
              F-43


F-37




**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**




To
      the
      Members


Phoenix
      Digital Solutions, LLC




We
      have
      audited the accompanying balance sheets of Phoenix Digital Solutions, LLC (the
      "Company") as of May 31, 2007 and 2006, and the related statements of income,
      members' equity and cash flows for each of the years in the two year period
      ended May 31, 2007. 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 standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audits 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 consolidated 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 financial position of Phoenix Digital Solutions, LLC
      as
      of May 31, 2007 and 2006, and the results of its operations and its cash
      flows for each of the years in the two year period ended May 31, 2007 in
      conformity with accounting principles generally accepted in the United States
      of
      America.











/s/
      KMJ
      Corbin & Company LLP


Irvine,
      California


August
      14, 2007


F-38


**Phoenix
      Digital Solutions, LLC**


**Balance
      Sheets**








**May
                31,**
            
            **2007**
            
            **2006****ASSETS**Current
                assets:Cash
            
            $
            6,989,847
            
            $
            7,765,708Prepaid
                expenses
            
            
            175,000
            
            
            15,000Total
                current assets
            
            $
            7,164,847
            
            $
            7,780,708**LIABILITIES
                AND MEMBERS’ EQUITY**Current
                liabilities:Accounts
                payable
            
            $
            1,225,118
            
            $
            148,762Accrued
                expenses
            
            
            160,000
            
            
            -Income
                tax payable
            
            
            11,790
            
            
            -Total
                current liabilities
            
            
            1,396,908
            
            
            148,762**Commitments
                and Contingencies (Note 4)**Members’
                equity
            
            
            5,767,939
            
            
            7,631,946Total
                liabilities and members’ equity
            
            $
            7,164,847
            
            $
            7,780,708







*See
      accompanying notes to financial statements.*


F-39


**Phoenix
      Digital Solutions, LLC**


**Statements
      of Income**








**Years
                Ended May 31,**
            
            **2007**
            
            **2006**License
                revenues
            
            $
            110,878,985
            
            $
            60,000,000Operating
                expenses:General
                and administrative
            
            
            12,189,575
            
            
            4,486,955Operating
                income
            
            
            98,689,410
            
            
            55,513,045Other
                income:Interest
                income
            
            
            421,407
            
            
            183,682Income
                before income taxes
            
            
            99,110,817
            
            
            55,696,727Provision
                for income taxes
            
            
            11,790
            
            
            -Net
                income
            
            $
            99,099,027
            
            $
            55,696,727





*See
      accompanying notes to financial statements.*


F-40


**Phoenix
      Digital Solutions, LLC**


**Statements
      of Members’ Equity**







Balance
                May 31, 2005
            
            $
            -Contributions
            
            
            4,000,000Net
                income
            
            
            55,696,727Distributions
            
            
            (52,064,781
            )Balance
                May 31, 2006
            
            
            7,631,946Contributions
            
            
            -Net
                income
            
            
            99,099,027Distributions
            
            
            (100,963,034
            )Balance
                May 31, 2007
            
            $
            5,767,939







*See
      accompanying notes to financial statements.*


F-41


**Phoenix
      Digital Solutions, LLC**


**Statements
      of Cash Flows**







**Years
                Ended May 31,**
            
            **2007**
            
            **2006****Operating
                activities:**Net
                income
            
            $
            99,099,027
            
            $
            55,696,727Adjustments
                to reconcile net income to net cash provided by operating
                activities:Changes
                in operating assets and liabilities:Prepaid
                expenses
            
            
            (160,000
            )
            
            (15,000
            )Accounts
                payable and accrued expenses
            
            
            1,236,356
            
            
            148,762Income
                tax payable
            
            
            11,790
            
            
            -Net
                cash provided by operating activities
            
            
            100,187,173
            
            
            55,830,489**Financing
                activities:**Contributions
                from members
            
            
            -
            
            
            4,000,000Distributions
                to members
            
            
            (100,963,034
            )
            
            (52,064,781
            )Net
                cash used in financing activities
            
            
            (100,963,034
            )
            
            (48,064,781
            )**Net
                increase (decrease) in cash**
            
            
            (775,861
            )
            
            7,765,708**Cash,**beginning
                of year
            
            
            7,765,708
            
            
            -**Cash,
                end of year**
            
            $
            6,989,847
            
            $
            7,765,708**Supplemental
                Disclosure of Cash Flow Information**Cash
                payments for income taxes
            
            $
            13,390
            
            $
            12,590








*See
      accompanying notes to financial statements.*


F-42


**Phoenix
      Digital Solutions, LLC**


**Notes
      to Financial Statements**







**1.
      Organization and Business**





Phoenix
      Digital Solutions, LLC (the “Company”), is a Delaware limited liability company
      organized on June 7, 2005. Through a commercialization agreement dated June
      7,
      2005, the Company holds the rights to certain patents of its members. The
      Company receives license fees from license agreements entered into between
      licensees and a member of the Company, and distributes license fee proceeds
      to
      its members.





**2.
      Summary of Significant Accounting Policies**





**Limited
      Liability Company Operating Agreement**


As
      a
      limited liability company, each member’s liability is limited to the capital
      invested. Allocation of profits, losses and distributions is in accordance
      with
      the terms as defined in the operating agreement.





The
      Company is treated as a partnership for federal income tax purposes.
      Consequently, federal income taxes are not payable by the Company. The Company’s
      net income or loss is allocated among the members in accordance with the
      operating agreement of the Company and members are taxed individually on their
      share of the Company’s earnings. The State of California assesses a limited
      liability company a fee based on the Company’s income in addition to a flat
      limited liability company tax, accordingly the financial statements reflect
      a
      provision for the California taxes.





**Use
      of Estimates**


The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America requires management to make
      estimates and assumptions that affect the reported amounts and disclosures.
      Accordingly, actual results could differ from those estimates.





**Revenue
      Recognition**


The
      Company recognizes revenue upon receipt of the license proceeds from the
      licensee at which time all obligations of the Company have been performed under
      the license agreements.





**Financial
      Instruments and Concentrations of Credit Risk**


Financial
      instruments that potentially subject the Company to concentrations of credit
      risk consist principally of cash.





The
      Company’s balance of cash maintained with its bank exceeds the Federal Deposit
      Insurance Corporation’s insured limit of $100,000. The Company limits its
      exposure of loss by maintaining its cash with financially stable financial
      institutions.


F-43




**Phoenix
      Digital Solutions, LLC**


**Notes
      to Financial Statements (Continued)**





**3.
      Formation and Commercialization Agreement**





The
      Company has two members: Technology Properties Limited Inc., (“TPL”), and
      Patriot Scientific Corporation (“PTSC”). Each member owns 50% of the membership
      interests of the Company. Each member has the right to appoint one member of
      the
      three member management committee. The two appointees are required to select
      a
      mutually acceptable third member of the management committee. Pursuant to the
      LLC Agreement, the members agreed to establish a working capital fund for the
      Company of $4,000,000, of which each member contributed $2,000,000. The working
      capital fund increases to a maximum of $8,000,000 as license revenues are
      achieved. The members are obligated to fund future working capital requirements
      at the discretion of the management committee of the Company in order to
      maintain working capital of not more than $8,000,000. Neither member is required
      to contribute more than $2,000,000 in any fiscal year. Distributable cash and
      allocation of profits and losses will be allocated to the members in the
      priority defined in the LLC Agreement.





On
      June
      7, 2005, the Company entered into a Commercialization Agreement with TPL and
      PTSC. This Commercialization Agreement allows TPL to commercialize the patent
      portfolio by entering into settlement and/or license agreements, suing in the
      name of TPL, PTSC, the Company and Charles Moore, and manage the use of the
      patent portfolio by third parties.





Under
      terms of the Commercialization Agreement, the Company is required to pay a
      quarterly amount ranging between $500,000 and $1,000,000 (based upon a
      percentage of the working capital fund balance) to TPL for TPL’s supporting
      efforts to secure licensing agreements for the Company. During the years ended
      May 31, 2007 and 2006, the Company paid $3,871,602 and $2,500,000, respectively,
      to TPL pursuant to the agreement. The Company is also required to reimburse
      TPL
      for payment of all legal and third-party expert fess and other related third
      party costs and expenses. During the years ended May 31, 2007 and 2006, the
      Company paid $5,914,000 and $1,021,357, respectively, to TPL pursuant to the
      agreement.





**4.
      Commitments and Contingencies**





***Guarantees
      and Indemnities***





Under
      the
      LLC Operating Agreement, the Company indemnifies its members, managers, officers
      and employees from any damages and liabilities by reason of their management
      or
      involvement in the affairs of the Company as long as the indemnitee acted in
      good faith and in the best interests of the Company.





Under
      the
      Commercialization Agreement, the Company and PTSC hold harmless TPL and its
      representatives with respect to all claims of any nature by or on behalf of
      the
      Company and PTSC related to the preparation, execution and delivery of the
      Commercialization Agreement.




The
      duration of the guarantees and indemnities
      varies, and in many cases is indefinite. These guarantees and indemnities do
      not
      provide for any limitation of the maximum potential future payments the Company
      could be obligated to make. Historically, the Company has not been obligated
      to
      make any payments for these obligations and no liabilities have been recorded
      for these guarantees and indemnities in the accompanying balance
      sheets.


F-44


SIGNATURES








Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange
      Act of 1934, the Registrant has duly caused this report to be signed on its
      behalf by the undersigned, thereunto duly authorized.




DATED:
                August 14, 2007
            PATRIOT
                SCIENTIFIC CORPORATION
              
              /S/
                JAMES L.
                TURLEY
              James
                L. Turley
              President,
                Chief Executive Officer and
                Director





Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed below by the following persons on behalf of the Registrant and in the
      capacities and on the dates indicated.




Signature
            Title
            Date/S/
                JAMES L.
                TURLEY
              James
                L. Turley
            President,
                Chief Executive Officer and Director
            August
                14, 2007/S/
                THOMAS J.
                SWEENEY
              Thomas
                J. Sweeney
            Chief
                Financial Officer and Principal Accounting Officer
            August
                14, 2007/S/
                DAVID H.
                POHL
              David
                H. Pohl
            Chairman
            August
                14, 2007/S/
                CARLTON M.
                JOHNSON
              Carlton
                M. Johnson
            Director
            August
                14, 2007/S/
                GLORIA H.
                FELCYN
              Gloria
                H. Felcyn
            Director
            August
                14, 2007/S/
                HELMUT FALK,
                JR.
              Helmut
                Falk, Jr.
            Director
            August
                14, 2007








33