UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington, D.C.
20549





FORM
10-Q




(Mark
One)




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





For the
quarterly period ended November 30, 2008




OR




[_]
            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 of
              incorporation
      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)





(Issuer’s
telephone number): (760) 547-2700





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 whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See definitions of “large accelerated filer,” “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.  (Check one):








Large accelerated
      filer [  ]
            Accelerated filer
      [X]
            Non-accelerated
      filer [  ]
            Smaller reporting
      company [  ]




Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).




Yes
[  ]  No [X]




On
January 2, 2009, 410,984,394 shares of common stock, par value $.00001 per share
(the issuer’s only class of voting stock) were outstanding.












INDEX




PagePART
      I. FINANCIAL INFORMATIONITEM
      1. Financial StatementsCondensed
      consolidated Balance Sheets as of November 30, 2008 (unaudited) and May
      31, 2008
            3Condensed
      consolidated Statements of Operations for the three and six months ended
      November 30, 2008 and November 30, 2007 (unaudited)
            4Condensed
      consolidated Statements of Cash Flows for the six months ended November
      30, 2008 and November 30, 2007 (unaudited)
            5Notes
      to condensed consolidated Financial Statements (unaudited)
            7-34ITEM
      2. Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
            35-52ITEM
      3. Quantitative and Qualitative Disclosures About Market
    Risk
            52ITEM
      4. Controls and Procedures
            53PART
      II. OTHER INFORMATIONITEM
      1. Legal Proceedings
            54ITEM
      1A. Risk Factors
            55ITEM
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
            55ITEM
      3. Defaults Upon Senior Securities
            56ITEM
      4. Submission of Matters to a Vote of Security Holders
            56ITEM
      5. Other Information
            57ITEM
      6. Exhibits
            57-59SIGNATURES








2




PART
I- FINANCIAL INFORMATION





Item 1. Financial
Statements


Patriot
Scientific Corporation


Condensed
Consolidated Balance Sheets




November
      30, 2008
            
            
            May
      31, 2008ASSETS
            
            (Unaudited)Current
      assets:Cash
      and cash equivalents
            
            $
            7,492,534
            
            
            $
            6,424,015Restricted
      cash and cash equivalents
            
            
            51,777
            
            
            
            51,122Marketable
      securities and short term investments
            
            
            172,455
            
            
            
            298,243Accounts
      receivable
            
            
            1,227,115
            
            
            
            538,500Accounts
      receivable - affiliated company
            
            
            31,237
            
            
            
            7,501Notes
      receivable
            
            
            33,149
            
            
            
            450,115Inventory
            
            
            957,113
            
            
            
            388,141Work-in-process
            
            
            80,030
            
            
            
            -Prepaid
      income taxes
            
            
            -
            
            
            
            222,311Deferred
      tax assets
            
            
            870,385
            
            
            
            1,390,832Prepaid
      expenses and other current assets
            
            
            291,841
            
            
            
            79,840Total
      current assets
            
            
            11,207,636
            
            
            
            9,850,620Marketable
      securities
            
            
            11,498,675
            
            
            
            12,527,675Property
      and equipment, net
            
            
            104,258
            
            
            
            68,504Goodwill
            
            
            1,636,826
            
            
            
            -Other
      intangible assets, net
            
            
            5,900,352
            
            
            
            63,299Deferred
      tax assets
            
            
            3,410,202
            
            
            
            -Other
      assets
            
            
            47,448
            
            
            
            8,190Investments
      in affiliated companies
            
            
            3,730,034
            
            
            
            2,913,614Total
      assets
            
            $
            37,535,431
            
            
            $
            25,431,902LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
            
            $
            765,658
            
            
            $
            555,690Accrued
      expenses and other
            
            
            395,891
            
            
            
            373,848Notes
      payable
            
            
            320,296
            
            
            
            -Deferred
      revenue
            
            
            31,574
            
            
            
            -Income
      taxes payable
            
            
            1,925,234
            
            
            
            -Total
      current liabilities
            
            
            3,438,653
            
            
            
            929,538Long
      term debt
            
            
            2,970,503
            
            
            
            -Deferred
      tax liabilities
            
            
            -
            
            
            
            1,085,181Total
      long term liabilities
            
            
            2,970,503
            
            
            
            1,085,181Total
      liabilities
            
            
            6,409,156
            
            
            
            2,014,719Commitments and
      contingenciesMinority
      interest
            
            
            308,327
            
            
            
            115,406Stockholders’
      equity:Preferred
      stock, $0.00001 par value; 5,000,000 shares authorized: none
      outstanding
            
            
            -
            
            
            
            -Common
      stock, $0.00001 par value: 600,000,000 shares authorized: 438,067,618
      shares issued and 411,184,394 shares outstanding at November 30, 2008 and
      500,000,000 shares authorized: 410,979,163 shares issued and 389,414,915
      shares outstanding at May 31, 2008
            
            
            4,368
            
            
            
            4,109Additional
      paid-in capital
            
            
            76,882,304
            
            
            
            70,004,814Accumulated
      deficit
            
            
            (31,486,103
            )
            
            
            (33,763,357
            )Common
      stock held in treasury, at cost – 26,883,224 shares and 21,564,248 shares
      at November 30, 2008 and May 31,
    2008,  respectively
            
            
            (13,752,279
            )
            
            
            (12,723,172
            )Accumulated
      other comprehensive loss
            
            
            (830,342
            )
            
            
            (220,617
            )Total
      stockholders’ equity
            
            
            30,817,948
            
            
            
            23,301,777Total
      liabilities and stockholders’ equity
            
            $
            37,535,431
            
            
            $
            25,431,902





See
      accompanying notes to unaudited condensed consolidated financial
      statements.




3




Patriot
Scientific Corporation


Condensed
Consolidated Statements of Operations


(Unaudited)





Three
      Months Ended
            
            
            Six
      Months EndedNovember
      30,
              2008
            
            
            November
      30,
              2007
            
            
            November
      30,
              2008
            
            
            November
      30,
              2007Revenues:Product
      sales and other
            
            $
            1,616,908
            
            
            $
            945,830
            
            
            $
            2,975,554
            
            
            $
            1,467,199License
      and service revenue
            
            
            258,353
            
            
            
            -
            
            
            
            258,353
            
            
            
            -Total
      revenues
            
            
            1,875,261
            
            
            
            945,830
            
            
            
            3,233,907
            
            
            
            1,467,199Cost
      of sales:Product
      sales and other
            
            
            700,365
            
            
            
            356,338
            
            
            
            1,284,618
            
            
            
            507,873License
      and service revenue
            
            
            165,140
            
            
            
            -
            
            
            
            165,140
            
            
            
            -Amortization
      of purchased intangibles
            
            
            211,302
            
            
            
            -
            
            
            
            211,302
            
            
            
            -Total
      cost of sales
            
            
            1,076,807
            
            
            
            356,338
            
            
            
            1,661,060
            
            
            
            507,873Gross
      profit
            
            
            798,454
            
            
            
            589,492
            
            
            
            1,572,847
            
            
            
            959,326Operating
      expenses:Research
      and development
            
            
            151,874
            
            
            
            -
            
            
            
            151,874
            
            
            
            -Selling,
      general and administrative
            
            
            2,175,788
            
            
            
            1,986,363
            
            
            
            4,106,526
            
            
            
            3,944,553Settlement
      and license expense
            
            
            -
            
            
            
            388,660
            
            
            
            -
            
            
            
            418,660Total
      operating expenses
            
            
            2,327,662
            
            
            
            2,375,023
            
            
            
            4,258,400
            
            
            
            4,363,213Operating
      loss
            
            
            (1,529,208
            )
            
            
            (1,785,531
            )
            
            
            (2,685,553
            )
            
            
            (3,403,887
            )Other
      income (expense):Interest
      and other income
            
            
            144,748
            
            
            
            301,066
            
            
            
            257,593
            
            
            
            775,591Loss
      on sale of assets
            
            
            (1,733
            )
            
            
            (924
            )
            
            
            (1,733
            )
            
            
            (1,269
            )Interest
      expense
            
            
            (16,075
            )
            
            
            -
            
            
            
            (20,762
            )
            
            
            (237
            )Gain
      on sale of subsidiary interest
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            150,000Equity
      in earnings of affiliated companies
            
            
            109,739
            
            
            
            5,486,039
            
            
            
            6,668,509
            
            
            
            4,285,497Total
      other income, net
            
            
            236,679
            
            
            
            5,786,181
            
            
            
            6,903,607
            
            
            
            5,209,582Income
      (loss) before income taxes and minority interest
            
            
            (1,292,529
            )
            
            
            4,000,650
            
            
            
            4,218,054
            
            
            
            1,805,695Provision
      (benefit) for income taxes
            
            
            (631,826
            )
            
            
            1,584,114
            
            
            
            1,747,879
            
            
            
            1,351,545Minority
      interest
            
            
            271,556
            
            
            
            -
            
            
            
            192,921
            
            
            
            -Net
      income (loss)
            
            $
            (932,259
            )
            
            $
            2,416,536
            
            
            $
            2,277,254
            
            
            $
            454,150Basic
      income (loss) per common share
            
            $
            -
            
            
            $
            0.01
            
            
            $
            0.01
            
            
            $
            -Diluted
      income (loss) per common share
            
            $
            -
            
            
            $
            0.01
            
            
            $
            0.01
            
            
            $
            -Weighted
      average number of common shares outstanding-basic
            
            
            408,791,665
            
            
            
            391,245,755
            
            
            
            398,405,637
            
            
            
            390,848,284Weighted
      average number of common shares outstanding-diluted
            
            
            408,791,665
            
            
            
            392,627,522
            
            
            
            400,232,650
            
            
            
            393,814,090


See
accompanying notes to unaudited condensed consolidated financial
statements.




4




Patriot
Scientific Corporation


Condensed
Consolidated Statements of Cash Flows


(Unaudited)




Six
      months endedNovember
      30, 2008
            
            
            November
      30, 2007Operating
      activities:Net
      income
            
            $
            2,277,254
            
            
            $
            454,150Adjustments
      to reconcile net income to net cash used in operating
      activities:Minority
      interest in variable interest entity
            
            
            192,921
            
            
            
            -Amortization
      and depreciation
            
            
            240,771
            
            
            
            22,915Non-cash
      compensation relating to issuance of stock options and vesting
      of  warrants
            
            
            279,338
            
            
            
            346,134Accrued
      interest income added to investments and notes receivable
            
            
            (7,958
            )
            
            
            (641
            )Equity
      in earnings of affiliated companies
            
            
            (6,668,509
            )
            
            
            (4,285,497
            )Loss
      on sale of assets
            
            
            1,733
            
            
            
            1,269Value
      of stock issued in connection with legal settlement
            
            
            -
            
            
            
            100,000Write-off
      of patent costs
            
            
            21,527
            
            
            
            -Deferred
      income taxes
            
            
            (1,382,218
            )
            
            
            (10,098,363
            )Gain
      on VIE sale of portion of subsidiary interest
            
            
            -
            
            
            
            (150,000
            )Reversal
      of tax effect of exercise of options
            
            
            -
            
            
            
            (25,645
            )Changes
      in operating assets and liabilities, net of effects of
      acquisition:Accounts
      receivable
            
            
            (587,436
            )
            
            
            (279,244
            )Receivable
      from affiliated company
            
            
            (23,736
            )
            
            
            -Inventory
            
            
            (568,972
            )
            
            
            (266,153
            )Work-in-process
            
            
            (68,372
            )
            
            
            -Prepaid
      expenses and other current assets
            
            
            (3,781
            )
            
            
            179,695Prepaid
      income taxes
            
            
            222,311
            
            
            
            2,070,981Accounts
      payable and accrued expenses
            
            
            117,027
            
            
            
            (1,352,136
            )Deferred
      revenue
            
            
            31,574
            
            
            
            -Income
      taxes payable
            
            
            1,925,234
            
            
            
            5,446,572Net
      cash used in operating activities
            
            
            (4,001,292
            )
            
            
            (7,835,963
            )Investing
      activities:Proceeds
      from sales of short-term investments
            
            
            321,931
            
            
            
            6,800,159Purchases
      of short-term investments
            
            
            (195,967
            )
            
            
            (15,080,791
            )Proceeds
      from sale of restricted investments
            
            
            -
            
            
            
            52,500Purchases
      of property and equipment
            
            
            (16,039
            )
            
            
            (17,566
            )Proceeds
      from sale of property and equipment
            
            
            -
            
            
            
            125Proceeds
      from VIE sale of portion of subsidiary interest
            
            
            -
            
            
            
            100,000Issuance
      of note receivable
            
            
            (33,000
            )
            
            
            -Cash
      received from repayment of note receivable
            
            
            50,243
            
            
            
            -Purchases
      of convertible notes receivable
            
            
            (667,750
            )
            
            
            -Investments
      in affiliated companies
            
            
            (1,546,500
            )
            
            
            -Distributions
      from affiliated company
            
            
            7,648,589
            
            
            
            7,738,072Cash
      paid in purchase acquisition, net of cash acquired
            
            
            (2,546,477
            )
            
            
            -Net
      cash provided by (used in) investing activities
            
            
            3,015,030
            
            
            
            (407,501
            )Financing
      activities:Proceeds
      from exercise of common stock warrants and options
            
            
            5,000
            
            
            
            18,200Repurchase
      of warrants
            
            
            -
            
            
            
            (2,760,900
            )Payments
      on notes payable
            
            
            (175,594
            )
            
            
            -Issuance
      of notes payable
            
            
            3,250,000
            
            
            
            -Repurchase
      of common stock for treasury
            
            
            (1,029,107
            )
            
            
            (3,042,921
            )Tax
      effect of exercise of options granted under APB 25
            
            
            4,482
            
            
            
            -Net
      cash provided by (used in) financing activities
            
            
            2,054,781
            
            
            
            (5,785,621
            )Net
      increase (decrease) in cash and cash equivalents
            
            
            1,068,519
            
            
            
            (14,029,085
            )Cash
      and cash equivalents, beginning of period
            
            
            6,424,015
            
            
            
            21,605,428Cash
      and cash equivalents, end of period
            
            $
            7,492,534
            
            
            $
            7,576,343Supplemental
      Disclosure of Cash Flow Information:Cash
      payments for interest
            
            $
            20,762
            
            
            $
            237Cash
      payments for income taxes
            
            $
            976,985
            
            
            $
            3,958,000





5





Patriot
Scientific Corporation


Condensed
Consolidated Statements of Cash Flows


(Unaudited)





Six
      months endedNovember
      30, 2008
            
            
            November
      30, 2007Supplemental
      Disclosure of  Non-Cash Investing and Financing
      Activities:Cashless
      exercise of stock options
            
            $
            -
            
            
            $
            10Cashless
      exercise of warrants
            
            $
            -
            
            
            $
            25Note
      receivable issued in connection with VIE sale of portion of subsidiary
      interest
            
            $
            -
            
            
            $
            50,000Conversion
      of note receivable to preferred stock – Avot Media, Inc.
            
            $
            250,000
            
            
            $
            -Insurance
      premium financed with a note payable
            
            $
            210,888
            
            
            $
            -Deferred
      tax benefit related to unrealized loss on investments in marketable
      securities charged to other comprehensive income
            
            $
            (419,275
            )
            
            $
            -Conversion
      of notes receivable plus accrued interest  in connection with
      Crossflo Systems, Inc. acquisition
            
            $
            824,600
            
            
            $
            -Common
      stock issued in connection with Crossflo Systems, Inc.
      acquisition
            
            $
            6,582,214
            
            
            $
            -




See
accompanying notes to unaudited condensed consolidated financial
statements.


6


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements




1.  Basis
of Presentation and Summary of Significant Accounting Policies





The
unaudited condensed consolidated financial statements of Patriot Scientific
Corporation (the “Company”, “we”, “us” or “our”) presented herein have been
prepared pursuant to the rules of the Securities and Exchange Commission (“SEC”)
for quarterly reports on Form 10-Q and do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States of America. These financial statements should be read in conjunction with
our audited consolidated financial statements and notes thereto included in our
Report on Form 10-K for our fiscal year ended May 31, 2008.





In the
opinion of management, the interim condensed consolidated financial statements
reflect all adjustments of a normal recurring nature necessary for a fair
presentation of the results for the interim periods
presented.  Operating results for the six month period ended November
30, 2008 are not necessarily indicative of the results that may be expected for
the year ending May 31, 2009.





Basis
of Consolidation


The
condensed consolidated balance sheet at May 31, 2008 and the condensed
consolidated statements of operations for the three and six months ended
November 30, 2007 include our accounts and those of our majority owned inactive
subsidiaries, Metacomp, Inc. and Plasma Scientific Corporation and the variable
interest entity (“VIE”) for which we are the primary beneficiary. All
significant intercompany accounts and transactions have been
eliminated.





The
condensed consolidated balance sheet at November 30, 2008 and the condensed
consolidated statements of operations for the three and six months ended
November 30, 2008 include our accounts and those of our wholly owned subsidiary
Crossflo Systems, Inc. (“Crossflo) and our majority owned inactive subsidiary
Plasma Scientific Corporation and the VIE for which we are the primary
beneficiary. All significant intercompany accounts and transactions have been
eliminated.  During September 2008, we dissolved our majority owned
inactive subsidiary, Metacomp, Inc.





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(R)”). 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(R) were adopted as of December 31, 2003, for our interests
in all VIEs. Beginning with the quarter ended May 31, 2007, we consolidated
Holocom, Inc. (formerly known as Scripps Secured Data, Inc.) (“Holocom”) as
Holocom was deemed a VIE and we determined that we were the primary beneficiary
of Holocom.




7




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements




Investments
in Marketable Securities


We
account for our investments in marketable securities in accordance with
Statement of Financial Accounting Standards (“SFAS”) No. 115, Accounting for Certain Investments
in Debt and Equity Securities, and FASB Staff Position (“FSP”) SFAS No.
115-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments.  We determine the appropriate classification of
our investments at the time of purchase and reevaluate such designation at each
balance sheet date.  Our investments in marketable securities have
been classified and accounted for as available-for-sale based on management’s
investment intentions relating to these
securities.  Available-for-sale marketable securities are stated at
market value based on valuation by Houlihan Smith & Company,
Inc..  Unrealized gains and losses, net of deferred taxes, are
recorded as a component of other comprehensive income (loss).  We
follow the guidance provided by Emerging Issues Task Force (“EITF”) Issue No.
03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments, to assess whether our investments with unrealized loss
positions are other than temporarily impaired.  Realized gains and
losses and declines in value judged to be other than temporary are determined
based on the specific identification method and are reported in other income
(expense), net in the condensed consolidated statements of
operations.





Investments
in Affiliated Companies


We have a
50% interest in Phoenix Digital Solutions, LLC (“PDS”) (see Note 11). 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
companies”.





We have a
37.40% interest in Talis Data Systems, LLC (“Talis”) (see Note
11).  We account for our investment using the equity method of
accounting pursuant to paragraph 8 of AICPA Statement of Position 78-9, Accounting for Investments in Real
Estate Ventures (which has applicability to non-real estate entities as
well) as our membership share of this limited liability company is more than
minor.  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
companies”.





We own
37.1% of the preferred stock of Avot Media, Inc. (“Avot”) (see Note
11).  This investment is accounted for at cost since we do not have
the ability to exercise significant influence over the operating and financial
policies of Avot.





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





Comprehensive
Income


Comprehensive
income includes unrealized gains and losses which are excluded from the
condensed consolidated statements of operations in accordance with SFAS No. 130,
Reporting Comprehensive
Income.  For the six months ended November 30, 2008, this
amount included unrealized losses on investments classified as
available-for-sale.  The amount is presented net of tax-related
benefits of $419,275.




8





Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Revenue
Recognition


Historically
we recognized revenue from the sale of our microprocessor chips upon shipment to
the customer, at which time title transferred and we had no further
obligations.  We discontinued the sale of our microprocessor chips
during the first fiscal quarter of 2009. Revenue from technology license
agreements is recognized at the time a contract is entered into, the license
method is determined (paid-in-advance or on-going royalty), and the customer is
provided with the licensed technology, if applicable.  Fees for
maintenance or support are recorded on a straight-line basis over the underlying
period of performance.





Crossflo
sells software and services to end users primarily through relationships with
systems integrators and prime contractors.  Crossflo recognizes
revenue in accordance with Statement of Position No. 97-2,Software Revenue
Recognition, and all related amendments and interpretations
(“SOP 97-2”).  Crossflo’s revenue is derived primarily from the
following sources: (i) software licensing, (ii) related professional
services, and (iii) post contract customer support (PCS)
agreements.  PCS agreements typically include software updates, on a
when and if available basis, telephone and internet access to technical support
personnel. Software updates provide customers with rights to unspecified
software product upgrades and to maintenance releases and patches released
during the term of the support period. Revenue for support services is
recognized on a straight-line basis over the support period.





When a
sale involves multiple elements, Crossflo allocates the entire fee from the
arrangement to each respective element based on its Vendor Specific Objective
Evidence (“VSOE”) of fair value and recognizes revenue when each element’s
revenue recognition criteria are met. VSOE of fair value for each element is
established based on the price charged when the same element is sold
separately.  Crossflo has not yet demonstrated VSOE for the
professional services that are rendered in conjunction with its software license
sales.  Accordingly, we have combined their presentation on our condensed
consolidated statements of operations under the caption “License and service
revenue”.





The
majority of Crossflo’s contracts with customers, including systems integrators
and prime contractors,  are multiple element arrangements which contain
professional services that are considered essential to the functionality of the
other elements of the arrangement.  Crossflo accounts for revenue
recognition on  these arrangements according to the provisions of
AICPA Statement of Position (SOP) 81-1,Accounting for
Performance of Construction-Type and Certain Production-Type Contracts.
Under SOP 81-1, Crossflo recognizes revenue based on progress towards contract
completion measured by actual hours incurred in relation to the estimate of
total expected hours. Crossflo measures SOP 81-1 revenues by applying the
contract-specific estimated percentage of completion to the total contract
amount for software and professional services.  Crossflo routinely
updates the estimates of future hours for agreements in process and reports
any cumulative effects of such adjustments in current operations. Crossflo
immediately recognizes any loss expected on these contracts when it is projected
that loss is probable.





In
certain situations where Crossflo’s customer contracts contain acceptance
criteria or other conditions that are deemed adverse to the probability for
collection, revenues recognized are limited by the amount of cash already
collected.





Holocom
recognizes revenue upon shipment of its product or upon receipt of its product
by the customer when shipped FOB destination and recognizes revenue on its
short-term installation contracts as time and materials costs are
incurred.





Holocom
maintains agreements with stocking distributors. These agreements provide 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. Holocom’s stocking distributor agreements also
allow limited rights to periodic stock rotation.  These rotation
rights allow for the exchange of a percentage of distributor inventory for
replacement products of the distributor’s choosing. At November 30, 2008,
Holocom has
evaluated the potential for rotated product and has provided for the estimated
impact in the accounting records.




9


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements
 Revenue
Recognition (continued)


Sales
through large distributors account for the majority of Holocom’s product
revenues, with a majority of sales to Anixter and Graybar Electric Company, Inc.
during the six months ended November 30, 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. Holocom 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.





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.  For the three and six months ended
November 30, 2008, 8,980,000 potentially dilutive common shares 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.  For the three
and six months ended November 30, 2007, 5,495,000 potentially dilutive common
shares 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.





In
connection with our acquisition of Crossflo, we issued escrow shares that are
contingent upon certain representations and warranties made by Crossflo at the
time of the merger agreement (see Note 2).  These escrow shares will
be released one year from September 1, 2008, the closing date of the
merger.  In accordance with SFAS No. 128, we exclude these escrow
shares from the basic earnings (loss) per share calculations and include the
escrowed shares in the diluted earnings per share
calculations.







Three
      Months Ended November 30, 2008Numerator
      (Loss)
              
              
              Denominator
      (Shares)
              
              
              Per
      Share AmountBasic
      EPS:Net loss
              
              $
              (932,259
              )
              
              
              408,791,665
              
              
              $
              -Diluted
      EPS:Effect
      of dilutive securities:Options and
    warrants
              
              
              -
              
              
              
              -Loss
      available to common shareholders
              
              $
              (932,259
              )
              
              
              408,791,665
              
              
              $
              -




10




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Net
Income (Loss) Per Share (continued)







Three
      Months Ended November 30, 2007Numerator
      (Income)
            
            
            Denominator
      (Shares)
            
            
            Per
      Share AmountBasic
      EPS:Net income
            
            $
            2,416,536
            
            
            
            391,245,755
            
            
            $
            0.01Diluted
      EPS:Effect
      of dilutive securities:Options and
    warrants
            
            
            -
            
            
            
            1,381,767Income
      available to common shareholders
            
            $
            2,416,536
            
            
            
            392,627,522
            
            
            $
            0.01




Six
      Months Ended November 30,2008Numerator
      (Income)
            
            
            Denominator
      (Shares)
            
            
            Per
      Share AmountBasic
      EPS:Net income
            
            $
            2,277,254
            
            
            
            398,405,637
            
            
            $
            0.01Diluted
      EPS:Effect
      of dilutive securities:Options and
    warrants
            
            
            -
            
            
            
            443,559Add:
      escrow shares
            
            
            -
            
            
            
            1,383,454Income
      available to common shareholders
            
            $
            2,277,254
            
            
            
            400,232,650
            
            
            $
            0.01




Six
      Months Ended November 30, 2007Numerator
      (Income)
            
            
            Denominator
      (Shares)
            
            
            Per
      Share AmountBasic
      EPS:Net income
            
            $
            454,150
            
            
            
            390,848,284
            
            
            $
            -Diluted
      EPS:Effect
      of dilutive securities:Options
    andwarrants
            
            
            -
            
            
            
            2,965,806Income
      available to common shareholders
            
            $
            454,150
            
            
            
            393,814,090
            
            
            $
            -




11




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Minority
Interest





Minority
interest in our consolidated financial statements results from the accounting
for the acquisition of a noncontrolling interest in Holocom. 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.




The
noncontrolling interest in Holocom, which we are required to consolidate as we
are the primary beneficiary, had 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
Holocom’s losses as we are the primary beneficiary.  For the fiscal
year ended May 31, 2008, Holocom had net income of $285,319 after
taxes.  Under the provisions of FIN 46 (R), we are able to recover our
absorbed losses before allocating income to the noncontrolling
interest.  At May 31, 2008, the minority interest presented in our
consolidated financial statements is $115,406, the amount of Holocom’s fiscal
2008 net income after tax less our absorbed losses during fiscal
2007.





For the
six months ended November 30, 2008, the minority interest was $192,921 which
represents the amount of Holocom’s net income after taxes on a consolidated
basis.  The minority interest in the income for the six months is
added to the May 31, 2008 balance of $115,406 for a total of $308,327 as
presented in our condensed consolidated balance sheet at November 30,
2008.





Stock-Based
Compensation





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 condensed
consolidated statements of operations for the three  and six months
ended November 30, 2007 included compensation expense for the share-based
payment awards granted subsequent to May 31, 2007 based on the grant date
fair value estimated in accordance with the provisions of SFAS No. 123(R),Share-Based Payment.
Stock-based compensation expense recognized in our condensed consolidated
statements of operations for the three and six months ended November 30, 2008
included compensation expense for share-based payment awards granted prior to
May 31, 2008 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 condensed consolidated statements of operations 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 three
and six months ended November 30, 2008 and 2007 of approximately 5% was
based on historical forfeiture experience and estimated future employee
forfeitures. The estimated pricing term of option grants for the three and six
months ended November 30, 2008 and 2007 was five years.





Summary
of Assumptions and Activity





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




12




Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements








Summary
of Assumptions and Activity





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 three and six months
ended November 30, 2008 and 2007 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.





Three
      Months
                            EndedNovember
      30,
                          2008
                          (Unaudited)
                        
                        Six
      Months
                          Ended
                          November
      30,
                          2008
                          (Unaudited)
                        
                        Three
      Months
                            EndedNovember
      30,
                          2007
                          (Unaudited)
                        
                        Six
      Months
                          Ended
                          November
      30,
                          2007
                          (Unaudited)Expected
      term
                        
                        
                        5
                        years
                        
                        
                        5
                        years
                        
                        
                        5
                        years
                        
                        
                        4.4
                        yearsExpected
      volatility
                        
                        
                        124-125
                        %
                        
                        
                        124-125
                        %
                        
                        
                        127
                        %
                        
                        
                        127-128
                        %Risk-free
      interest rate
                        
                        
                        2.51-3.00
                        %
                        
                        
                        2.51–3.23
                        %
                        
                        
                        4.21
                        %
                        
                        
                        4.21
      – 4.96
                        %Expected
      dividends
                        
                        
                        2.92
                        %
                        
                        
                        2.92
                        %
                        
                        
                        2.82
                        %
                        
                        
                        2.82
                        %





A summary
of option activity as of November 30, 2008 and changes during the six months
then ended, is presented below:





Shares
            
            
            Weighted
      Average
              Exercise
      Price
            
            
            Weighted
      Average Remaining Contractual Term (Years)
            
            
            Aggregate
      Intrinsic
              ValueOptions
      outstanding at June 1, 2008
            
            
            8,195,000
            
            
            $
            0.44Options
      granted
            
            
            1,650,000
            
            
            $
            0.23Options
      exercised
            
            
            (100,000
            )
            
            $
            0.05Options
      forfeited
            
            
            (35,000
            )
            
            $
            0.74Options
      outstanding at November 30, 2008
            
            
            9,710,000
            
            
            $
            0.40
            
            
            
            3.59
            
            
            $
            13,950Options
      vested and expected to vest at November 30, 2008
            
            
            7,399,092
            
            
            $
            0.41
            
            
            
            3.43
            
            
            $
            13,950Options
      exercisable at November 30, 2008
            
            
            5,291,837
            
            
            $
            0.46
            
            
            
            2.90
            
            
            $
            13,950




13




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements




Stock-Based
Compensation (continued)




The
weighted average grant date fair value of options granted during the six months
ended November 30, 2007 and 2008 was $0.35 and $0.17 per option,
respectively.  The total intrinsic value of options exercised during
the six months ended November 30, 2007 and 2008 was $513,550 and $11,000,
respectively, based on the differences in market prices on the dates of exercise
and the option exercise prices.





The
aggregate intrinsic value represents the differences in market price at the
close of the quarter ($0.13 per share on November 28, 2008) and the exercise
price of outstanding, in-the-money options (those options with exercise prices
below $0.13) on November 28, 2008.





As of
November 30, 2008, there was approximately $736,000 of total unrecognized
compensation cost  related to Patriot employee stock option
compensation arrangements.  That cost is expected to be recognized on
a straight-line basis over the next 45 months.  Approximately $583,000
of the total unrecognized compensation cost relates to 2,000,000 performance
options granted to our CEO and 200,000 performance options granted to our V.P of
Business Development.  We are not currently recognizing compensation
cost relating to these option grants as we have determined that it is not
currently probable that the vesting conditions in the grants will be
met.  When such vesting conditions are probable to be met, we will
record the compensation cost for the grants.





As of
November 30, 2008, there was approximately $231,000 of total unrecognized
compensation cost  related to Crossflo employee stock option
compensation arrangements.  That cost is expected to be recognized on
a straight-line basis over the next 57 months.  On September 1, 2008,
Crossflo’s existing stock option plan was cancelled and stock options from our
2006 stock option plan were issued to retained Crossflo employees in conjunction
with their new employment agreements.





The
following table summarizes employee and director stock-based compensation
expense for Patriot and employee stock-based compensation for Crossflo related
to stock options under SFAS No. 123(R) for the three and six months ended
November 30, 2008 and 2007, which was recorded as follows:





Three
              Months
              Ended
              November
              30,
      2008
            
            
            Six
              Months
              Ended
              November
              30,
      2008
            
            
            Three
              Months
              Ended
              November
              30,
      2007
            
            
            Six
              Months
              Ended
              November
              30,
      2007Research
      and development - Crossflo
            
            $
            378
            
            
            $
            378
            
            
            $
            -
            
            
            $
            -Selling,
      general and administrative expense - Crossflo
            
            
            15,569
            
            
            
            15,569
            
            
            
            -
            
            
            
            -Selling,
      general and administrative expense - Patriot
            
            
            141,810
            
            
            
            249,979
            
            
            
            63,221
            
            
            
            346,134Total
            
            $
            157,757
            
            
            $
            265,926
            
            
            $
            63,221
            
            
            $
            346,134




14




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Recent
Accounting Pronouncements





In
September 2006, the FASB issued SFAS No. 157, Fair Value
Measurements.  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. In
February 2008, the FASB released FASB Staff Position 157-2, Effective Date of FASB StatementNo. 157,which
delayed the effective date of SFAS No. 157 for all nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair
value in the financial statements on a recurring basis (at least annually) until
the fiscal year beginning June 1, 2009.  On June 1, 2008, we adopted
SFAS No. 157 for financial assets and liabilities.  The adoption did
not have a material effect on our results of operations and financial
position.  We are in the process of evaluating the impact of adoption
of SFAS No. 157 for nonfinancial assets and liabilities, but do not anticipate
that the adoption will have a material impact on our consolidated financial
statements.





In
February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial
Assets and Financial Liabilities. 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.  We have elected not to measure eligible
financial assets and liabilities at fair value.  Accordingly, the
adoption of SFAS No. 159 did not have a material impact on our results of
operations and financial position.





In
December 2007, the FASB issued SFAS No. 141(R), Business Combinations. SFAS
No. 141(R) requires acquiring entities in a business combination to recognize
the assets acquired and liabilities assumed in the transaction; establishes the
acquisition-date fair value as the measurement objective for all assets acquired
and liabilities assumed; and requires the acquirer to disclose to investors the
information it needs to evaluate and understand the nature and financial effect
of the business combination. SFAS No. 141(R) is effective in fiscal years
beginning after December 15, 2008. We expect to adopt SFAS No. 141(R) on June 1,
2009.  We are currently assessing the impact the adoption of SFAS No.
141(R) will have on our consolidated financial statements.





In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements. SFAS No. 160 requires entities to
report noncontrolling (minority) interests in subsidiaries as equity in the
consolidated financial statements. SFAS No. 160 is effective in fiscal
years beginning after December 15, 2008. We expect to adopt SFAS No. 160 on June
1, 2009.  We are currently assessing the impact the adoption of SFAS
No. 160 will have on our consolidated financial statements.





In
March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities, an amendment of
FASB Statement No. 133 Accounting for Derivative
Instruments and Hedging Activities (“SFAS No. 161”) requires
entities to provide greater transparency about how and why an entity uses
derivative instruments, how derivative instruments and related hedged items are
accounted for under SFAS No. 133, and how derivative instruments and
related hedged items affect an entity’s financial position, results of
operations, and cash flows. The statement is effective for financial statements
issued for fiscal years and
interim periods beginning after November 15, 2008.  We expect to
adopt SFAS No. 161 on June 1, 2009. We are currently assessing the impact the
adoption of SFAS No. 161 will have on our consolidated financial
statements.




15


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements




Recent
Accounting Pronouncements (continued)


In
April 2008, the FASB issued FSP No. 142-3, Determination of the Useful Life of
Intangible Assets,which amends the factors that must be considered in
developing renewal or extension assumptions used to determine the useful life
over which to amortize the cost of a recognized intangible asset under SFAS
No. 142, Goodwill and
Other Intangible Assets. The FSP requires an entity to consider its own
assumptions about renewal or extension of the term of the arrangement,
consistent with its expected use of the asset, and is an attempt to improve
consistency between the useful life of a recognized intangible asset under SFAS
No. 142 and the period of expected cash flows used to measure the fair
value of the asset under SFAS No. 141, Business Combinations. The
FSP is effective for fiscal years beginning after December 15, 2008, and
the guidance for determining the useful life of a recognized intangible asset
must be applied prospectively to intangible assets acquired after the effective
date. The FSP is not expected to have a significant impact on
our consolidated financial statements.





In
May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles . The statement is intended to improve financial
reporting by identifying a consistent hierarchy for selecting accounting
principles to be used in preparing financial statements that are prepared in
conformance with generally accepted accounting principles. Unlike Statement on
Auditing Standards (“SAS”) No. 69, The Meaning of Present in Conformity
With GAAP, SFAS No. 162 is directed to the entity rather than the
auditor. The statement is effective 60 days following the SEC’s approval of
the Public Company Accounting Oversight Board (“PCAOB”) amendments to AU
Section 411, The Meaning
of  Present Fairly in Conformity with GAAP, and is not expected
to have any impact on our consolidated financial statements.





In
June 2008, the FASB issued FSP EITF No. 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities.
Under the FSP, unvested share-based payment awards that contain rights to
receive non-forfeitable dividends (whether paid or unpaid) are participating
securities, and should be included in the two-class method of computing EPS. The
FSP is effective for fiscal years beginning after December 15, 2008, and
interim periods within those years, and is not expected to have a significant
impact on our consolidated financial statements.





In
October 2008, the FASB issued FSP No. FAS 157-3, Determining the Fair Value of a
Financial Asset When the Market for That Asset is Not Active, which
clarifies the application of SFAS No. 157. The FSP provides guidance in
determining the fair value of a financial asset when the market for that
financial asset is not active. The adoption of this standard as of
October 31, 2008 did not have a material impact on our consolidated
financial statements





In
December 2008, the FASB issued FSP No. FAS 140-4  and FIN
46(R)-8, Disclosures by Public
Entities (Enterprises) about Transfers of Financial Assets and Interests in
Variable Interest Entities. The FSP will require additional disclosures
about transfers of financial assets and involvement with variable interest
entities. The FSPs are effective for all reporting periods ending after
December 15, 2008 and will require additional disclosures in our
Form 10-Q for the quarter ending February 28, 2009.




16




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


2.
Acquisition





On
September 1, 2008, we acquired all of the outstanding shares of
Crossflo.  The results of Crossflo’s operations have been included in
our condensed consolidated financial statements since that
date.  Crossflo markets data sharing services and products primarily
to the public safety/government sector.  Crossflo’s flagship product
is the Crossflo DataExchange (“CDX”).  CDX is a commercial
off-the-shelf (“COTS”) middleware designed for interagency and cross-domain data
sharing which  allows end users to selectively share information and
rapidly connect disparate data sources across multiple
platforms.  Crossflo is expected to be a leading provider of data
sharing solutions for the markets it targets.





The
aggregate purchase price was $10,225,800, including $2,818,986 of cash, $824,600
of convertible notes and common stock valued at $6,582,214.  The value
of the 26,988,455 shares issued was based on the average closing price of our
common stock on the Electronic Bulletin Board as reported by NASDAQ over the ten
trading days immediately preceding September 1, 2008.





This
transaction was accounted for in accordance with SFAS No. 141, Business Combinations, and we
have allocated the total purchase price to tangible and identifiable intangible
assets acquired and liabilities assumed based on their estimated fair
values.





Purchase
      consideration:Price
      per share
            
            $
            0.24389Number
      of common shares issued
            
            
            26,988,455Value
      of shares issued
            
            
            6,582,214Cash
      paid, including acquisition costs
            
            
            2,818,986Principal
      and interest on convertible notes
            
            
            824,600$
            10,225,800


Allocation
      of purchase consideration:Tangible
      assets acquired:Cash
              
              $
              272,509Accounts
      receivable
              
              
              101,179Work-in-process
              
              
              11,658Deferred
      tax assets
              
              
              2,173,443Property
      and equipment
              
              
              49,399Prepaid
      expenses and other
              
              
              36,590Identifiable
      intangible assets acquired:Customer
      contracts – open orders
              
              
              63,600Maintenance
      agreements
              
              
              75,400Technologies
      and processes
              
              
              5,932,400Goodwill
              
              
              1,636,826Total
      assets acquired
              
              
              10,353,004Liabilities
      assumed:Current
      liabilities
              
              
              (127,204
              )$
              10,225,800




17





Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Acquisition
(continued)





The fair
values assigned to identifiable intangible assets acquired were based on an
appraisal performed by an independent third party using estimates and
assumptions determined by management.  The fair values of the customer
contracts, maintenance agreements and technologies and processes were determined
using an income approach.





None of
our acquired intangible assets were assigned to research and development
assets.  The acquired intangible assets of $6,071,400 have a
weighted-average useful life of approximately 4 years.  The intangible
assets that make up that amount include customer contracts of $63,600 (.75 year
weighted-average useful life), maintenance agreements of $75,400 (4 year
weighted-average useful life) and technologies and processes of $5,932,400 (8
year weighted-average useful life).





Goodwill
in the amount of $1,636,826 was assigned to the Crossflo
segment.  This amount is not deductible for income tax
purposes.





The
deferred tax asset is a result of purchase accounting.  The deferred
tax asset results from Crossflo’s net operating loss carryforwards that can be
used to offset consolidated taxable income in future periods, offset by the
deferred tax liability which is the result of future amortization expenses
attributable to the acquired intangible assets which will not be deductible for
income tax purposes.





The
deferred tax asset was calculated as follows:





Net
      Operating
              Loss
      Carryforward
            
            
            Tax
              Rate
            
            
            Deferred
              Tax
      AssetFederal
            
            $
            11,995,697
            
            
            
            35%
            
            
            $
            4,198,494California
            
            
            7,810,697
            
            
            
            5.746%
            
            
            
            448,802$
            19,806,394
            
            
            
            
            
            
            $
            4,647,296





The
deferred tax liability was calculated as follows:





Identifiable
      intangible assets acquired
            
            $
            6,071,400Tax
      rate
            
            
            40.746
            %$
            2,473,853





The terms
of the merger agreement provided that additional purchase consideration of
2,844,630 shares of  our common stock (“Escrow Shares”) be deposited
with a third party escrow agent.  Per the Escrow Agreement, one year
following the closing date, the Escrow Shares shall be disbursed first to:
Patriot to cover transaction expenses incurred in excess of estimated
transaction expenses at closing and for damages incurred as a result of any
breach of Crossflo’s representations, warranties and covenants made at closing,
next to Crossflo stockholders in accordance with terms of the Escrow Agreement,
lastly any shares remaining in the account shall be returned to
Patriot.  In the event that there is not an adequate number of shares
remaining in the escrow account one year from closing to satisfy distribution to
Crossflo stockholders in accordance with the terms of the Escrow Agreement,
Patriot is required to make up any difference in cash.




18




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


3.
Goodwill and Other Intangible Assets





In
accordance with SFAS No. 142, Goodwill and Other Intangible
Assets, goodwill originating from an acquisition will not be amortized
and will be tested for impairment on an annual basis and between annual tests
based on certain circumstances.





Purchased
intangible assets are being amortized over a period of 9 months to 8
years.  Holocom’s patents are being amortized over a period of 14 to
20 years.





The
following table presents details of our other intangible assets:





Net
      ValueEstimated
                
                Allocated
                
                
                Accumulated
                
                
                November
      30,Life
      in Years
                
                Value
                
                
                Amortization
                
                
                2008Customer
      contracts  – open orders
                0.75
                
                $
                63,600
                
                
                $
                (21,201
                )
                
                $
                42,399Maintenance
      agreements
                4.00
                
                
                75,400
                
                
                
                (4,713
                )
                
                
                70,687Technologies
      and processes
                8.00
                
                
                5,932,400
                
                
                
                (185,388
                )
                
                
                5,747,012Patents
                20.00
                
                
                47,801
                
                
                
                (7,547
                )
                
                
                40,254$
                6,119,201
                
                
                $
                (218,849
                )
                
                $
                5,900,352





Future
amortization is estimated to be as follows:





Year2009
              
              $
              424,1192010
              
              
              763,4402011
              
              
              763,4402012
              
              
              763,4402013
              
              
              749,293Thereafter
              
              
              2,436,620





At May
31, 2008, the intangibles balance of $63,299 related entirely to the net value
of Holocom’s patents.





4.
Cash, Cash Equivalents and Short-Term Investments





We
consider all highly liquid investments with original maturities of three months
or less to be cash equivalents.





Restricted
cash and cash equivalents at November 30, 2008 consist of two savings accounts
required to be held as collateral for corporate credit card
accounts.





At
November 30, 2008, Patriot’s short-term investments in the amount of $162,135
consist of accrued interest receivable on our auction rate securities which is
receivable semi-annually according to the terms specified in each auction rate
security instrument.  At November 30, 2008, Holocom’s short-term
investments consist of a certificate of deposit in the amount of $10,320 with a
maturity date of December 11, 2008.  These values are reported at
cost, which approximate fair market value.




19




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


5.  Fair
Value Measurements





Effective
June 1, 2008, we adopted the provisions of SFAS No. 157 to account for our
financial assets and liabilities.  SFAS No. 157 defines fair value,
establishes a framework for measuring fair value, and expands disclosures about
fair value measurements. The SFAS No. 157 framework for measuring fair value
requires an entity to maximize the use of observable inputs and minimize the use
of unobservable inputs when measuring fair value. We determine fair value based
on quoted prices when available or through the use of alternative approaches,
such as discounting the expected cash flows using market interest rates
commensurate with the credit quality and duration of the investment or
valuations by third party professionals. SFAS No. 157’s hierarchy defines three
levels of inputs that may be used to measure fair value:





Level 1:
Unadjusted quoted prices in active markets that are accessible at the
measurement date for identical, unrestricted assets or liabilities;





Level 2:
Quoted prices in markets that are not active or inputs which are observable,
either directly or indirectly, for substantially the full term of the asset or
liability; and





Level 3:
Prices or valuation techniques that require inputs that are both significant to
the fair value measurement and unobservable (i.e. supported by little or no
market activity).





The
following table represents our financial instruments subject to SFAS No. 157 and
the valuation approach applied to each class of security:





Quoted
      Prices in Active Markets
              Level
      1
            
            
            Significant
              Other
              Observable
      Inputs
              Level
      2
            
            
            Significant
              Unobservable
      Inputs
              Level
      3
            
            
            Balance
      as of
              November 30,
      2008Auction
      rate securities
            
            $
            —
            
            
            $
            —
            
            
            $
            11,660,810
            
            
            $
            11,660,810




The
valuation of these securities is based on Level 3 unobservable inputs which
consist of recommended fair values provided by Houlihan Smith & Company
Inc.  As a result of the estimated fair value, we have determined
that there is a temporary impairment in the valuation of these securities of
$1,401,325.  We have recorded an unrealized loss of $830,342 in
accumulated other comprehensive loss at November 30, 2008, which represents the
gross valuation adjustment of $1,401,325, net of the related tax benefit of
$570,983. These securities are held “available-for-sale” in conformity with SFAS
No. 115 and the unrealized loss is included in other comprehensive income in the
current period. Due to the uncertainty related to the liquidity in the auction
rate security market, we have classified these auction rate securities as
long-term assets on the condensed consolidated balance sheets.




20




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Fair
Value Measurements (continued)





For those
financial instruments with significant Level 3 inputs, the following table
summarizes the activity for the period by investment type:




(Unaudited)
            
            Fair Value Measurements Using
              Significant
              Unobservable
      Inputs (Level 3)Description
            
            Auction
              Rate
              Securities
            
            
            TotalBeginning
      balance
            
            $
            —
            
            
            $
            —Transfers
      in to Level 3
            
            
            12,900,000
            
            
            
            12,900,000Earned
      income (included in current assets)
            
            
            162,135
            
            
            
            162,135Total
      realized/unrealized losses:Included
      in earnings
            
            
            —
            
            
            
            —Included
      in comprehensive income (loss)
            
            
            (1,401,325
            )
            
            
            (1,401,325
            )Purchases,
      issuances and settlements
            
            
            —
            
            
            
            —Ending
      balance
            
            $
            11,660,810
            
            
            $
            11,660,810Total
      amount of unrealized losses for the period included in other comprehensive
      income (loss) attributable to the change in fair market
      value relating to assets still held at the reporting
    date
            
            $
            (1,029,000
            )
            
            $
            (1,029,000
            )





All
realized gains or losses related to financial instruments whose fair value is
determined based on Level 3 inputs are included in other income. All unrealized
gains or losses related to financial instruments whose fair value is determined
based on Level 3 inputs are included in other comprehensive income
(loss).





6.
Accounts Receivable





Trade
accounts receivable consisted of the following:






November
      30, 2008
            
            
            
            May
      31,
              2008PTSC
            
            $
            -
            
            
            $
            26,959Holocom
            
            
            1,008,901
            
            
            
            511,541Crossflo
            
            
            218,214
            
            
            
            -Total
            
            $
            1,227,115
            
            
            $
            538,500





No
allowance for doubtful accounts was necessary at November 30, 2008 or May 31,
2008.





At
November 30, 2008 and May 31, 2008, accounts receivable from our investee PDS
was $31,237 and $7,501, respectively.  These balances represent
reimbursements we submit to PDS for our legal and related costs incurred in
various legal matters of which we are listed as co-defendant with
TPL.




21




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements
  7.
Notes Receivable





On
October 28, 2008, we received a promissory note from Verras Medical, Inc.
(“Verras”) for principal of $33,000.  Interest of 5% accrued on the
note until December 1, 2008 at which time the note principal and accrued
interest were deducted from the cash payment at closing of the acquisition of
Verras (see Note 17).  At November 30, 2008, accrued interest on the
note is $149.





At May
31, 2008, the notes receivable balance was $450,115, which consisted of our
convertible note of $400,000 with Crossflo of which accrued interest receivable
of $115 was recognized during the year ended May 31, 2008 and a $50,000
non-interest bearing note due Holocom from an unrelated third party which
purchased a portion of Holocom’s interest in Talis Data Systems, LLC
(“Talis”).





8.
Inventory





Inventory
at November 30, 2008 and May 31, 2008, consisted of Holocom’s raw materials of
$512,591 and $245,731, respectively, and finished goods of $444,522 and
$142,410, respectively.





Work-in-process
at November 30, 2008 consists of $80,030 which represents the excess of
recognized revenue over invoices to customers on Crossflo’s current contracts in
progress.





9.
Investments in Marketable Securities





The
following table summarizes unrealized losses on our investments in marketable
securities based on the valuation by Houlihan Smith & Company Inc. at
November 30, 2008:





As
      of November 30, 2008Cost
            
            
            Gross
              Unrealized
              Losses
            
            
            Estimated
              Fair
              ValueShort-termAccrued
      interest - auction rate securities
            
            $
            162,135
            
            
            $
            —
            
            
            $
            162,135Long-termAuction
      rate securities
            
            
            12,900,000
            
            
            
            (1,401,325
            )
            
            
            11,498,675Total
            
            $
            13,062,135
            
            
            $
            (1,401,325
            )
            
            $
            11,660,810





As of
November 30, 2008, we held auction rate securities with a par value totaling
$12.9 million that failed to sell at auction.  In the event we need to
access funds invested in these auction rate securities we would not be able to
liquidate these securities until (i) a future auction of these securities is
successful, (ii) they are refinanced and redeemed by the issuers, or (iii) a
buyer is found outside of the auction process.  The investments
consist of student loan auction rate instruments issued by various state
agencies pursuant to the Federal Family Educational Loan Program
(“FFELP”).  These investments are of high credit quality and the AAA
credit ratings of the investments have been reaffirmed since November
2008.  These instruments are collateralized in excess of the
underlying obligations, are insured by the various state educational agencies,
and are guaranteed by the Department of Education as an insurer of last
resort.  We have the intent and the ability to hold these investments
until the anticipated recovery period.




22




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Investments
in Marketable Securities (continued)





Due to
the uncertainty surrounding the timing of a market recovery, we have classified
our auction rate securities as long- term investments in our consolidated
balance sheet as of November 30, 2008.  As a result of temporary
declines in the fair value of our auction rate securities, which we attribute to
liquidity issues rather than credit issues, we have recorded an unrealized loss
of $830,342 in other comprehensive loss at November 30, 2008, which represents
the gross valuation adjustment of $1,401,325, net of the related tax benefit of
$570,983.





We will
continue to evaluate the fair value of our investments in auction rate
securities each reporting period for a potential other-than-temporary
impairment.





During
June 2008, we obtained a credit facility from Wedbush Morgan Securities,
Inc. ("Wedbush") for as long as needed, which provides for financing up to
50% of the par value balance of our outstanding auction rate securities. The
facility is collateralized by the full value of the outstanding auction rate
securities, required no origination fee, and when drawn upon will bear interest
at the federal funds rate plus 3%.  On October 14, 2008, we borrowed
$3,000,000 on the credit facility, the proceeds of which is included in cash and
cash equivalents at November 30, 2008 (see Note 13).





10.
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 three months and six months ended
November 30, 2008 and 2007 was $6,250 and $6,250 and $12,500 and $12,500,
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 July 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 the co-inventor 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 PDS and as distributions are made to us, after
excluding the first $20 million collected by PDS after December 1, 2006. Our
commitment to make payments to Fish related to such future license revenues was
limited to $2 million.  In January 2008, we made the final payment
under the Fish settlement agreement.




23




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements





11.
Investments in Affiliated Companies





Phoenix
Digital Solutions, LLC





On June
7, 2005, we entered into a Master Agreement (the “Master Agreement”) with
Technology Properties Limited, a California corporation (“TPL”), and Charles H.
Moore (“Moore”), the co-inventor of the technology which is the subject of the
MMP Portfolio of microprocessor patents, pursuant to which the parties resolved
all legal disputes between them. Pursuant to the Master Agreement, we and TPL
entered into the Limited Liability Company Operating Agreement of PDS (the “LLC
Agreement”) into which we and Moore contributed our rights to certain of our
technologies.





We and
TPL each own 50% of the membership interests of PDS, and each of us 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, we and TPL agreed to
establish a working capital fund for PDS 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 PDS 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. PDS
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 PDS) for
supporting efforts to secure licensing agreements by the other member on behalf
of PDS. During the six months ended November 30, 2008 and 2007, PDS paid
$1,867,000 and $1,374,000, respectively, to TPL pursuant to this
commitment.





On
November 13, 2008, PDS’ management committee resolved to pay TPL 3% of the gross
licensing revenue received by PDS for the period June 1, 2008 through May 31,
2009, as reimbursement for certain expenses incurred by TPL in connection with
TPL’s activities related to a possible amendment of patent laws in the United
States.  The aggregate reimbursement under this resolution shall not
exceed $1,000,000 for the period June 1, 2008 through May 31,
2009.  After May 31, 2009, PDS’ management committee will consider the
extension of the reimbursement program, but is not committed at this time to
extend the program.  During November 2008, PDS paid $571,500 to TPL
pursuant to this resolution.





We are
accounting for our investment in PDS under the equity method of accounting, and
accordingly have recorded our share of PDS’ net income during the six months
ended November 30, 2008 and 2007 of $6,872,991 and $4,285,497, respectively, as
an increase in our investment. Cash distributions received from PDS during the
six months ended November 30, 2008 and 2007 of $7,648,589 and $7,738,072,
respectively, have been recorded as a reduction in our investment. Our
investment in PDS is $1,746,394 at November 30, 2008 and has been recorded as
“Investments in Affiliated Companies”.  We have recorded our share of
PDS’ net income as “Equity in Earnings of Affiliated Companies” in the
accompanying consolidated statements of operations for the six months ended
November 30, 2008 and 2007.





During
the three months ended November 30, 2008 and 2007, TPL entered into licensing
agreements with third parties, pursuant to which PDS received aggregate proceeds
of $2,775,000 and $19,433,000, respectively.





During
the six months ended November 30, 2008 and 2007, TPL entered into licensing
agreements with third parties, pursuant to which PDS received aggregate proceeds
of $19,050,000 and $20,933,000, respectively.





At
November 30, 2008, PDS had accounts payable balances of approximately $485,000
and $31,000  to TPL and PTSC, respectively.  At May 31,
2008, PDS had accounts payable balances of approximately $3,197,000 and $7,500
to TPL and PTSC, respectively.




24




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Investments
in Affiliated Companies (continued)





PDS’
condensed balance sheets at November 30, 2008 and May 31, 2008 and statements of
operations for the three and six months ended November 30, 2008 and 2007 are as
follows:





Condensed
Balance Sheets





ASSETS:


November
      30, 2008
            
            
            May
      31,
              2008Cash
            
            $
            4,020,337
            
            
            $
            8,260,288Total
      assets
            
            $
            4,020,337
            
            
            $
            8,260,288





LIABILITIES
AND MEMBERS’ EQUITY:


November
      30, 2008
            
            
            
            May
      31,
              2008Accounts
      payable and accrued expenses
            
            $
            515,761
            
            
            $
            3,204,519Income
      taxes payable
            
            
            11,790
            
            
            
            11,790Members’
      equity
            
            
            3,492,786
            
            
            
            5,043,979Total
      liabilities and members’ equity
            
            $
            4,020,337
            
            
            $
            8,260,288





Condensed
Statements of Operations





Three
      Months Ended
            
            
            Six
      Months EndedNovember
      30, 2008
            
            
            November
      30, 2007
            
            
            November
      30, 2008
            
            
            November
      30, 2007Revenues
            
            $
            2,775,000
            
            
            $
            19,433,000
            
            
            $
            19,050,000
            
            
            $
            20,933,000Operating
      expenses
            
            
            2,144,072
            
            
            
            9,632,216
            
            
            
            4,086,632
            
            
            
            13,598,760Operating
      income
            
            
            630,928
            
            
            
            9,800,784
            
            
            
            14,963,368
            
            
            
            7,334,240Interest
      income
            
            
            14,739
            
            
            
            47,124
            
            
            
            43,378
            
            
            
            112,585Net
      income
            
            $
            645,667
            
            
            $
            9,847,908
            
            
            $
            15,006,746
            
            
            $
            7,446,825





Talis
Data Systems, LLC





On May
16, 2008, we paid $400,000 to acquire a 15.09% share in Talis, a company that
produces multi-domain computer and network security products to government,
military, and enterprise customers. Talis develops and markets PCs incorporating
its Datagent security device, a patented, hardware based data security solution
that avoids the vulnerability of software–based approaches.





On August
1, 2008, we increased our investment in Talis to 37.4% as a result of purchasing
additional shares offered by Talis for $300,000 as well as acquiring shares from
minority shareholders for $196,500.  We also acquired all of the Talis
shares previously held by Holocom for $100,000 in cash and a reduction on their
outstanding line of credit of $219,000.




25




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Investments
in Affiliated Companies (continued)





We are
accounting for our investment in Talis under the equity method of
accounting.  We have recorded our share of Talis’ net loss of $204,482
during the six months ended November 30, 2008 as a decrease in our
investment.  Our investment in Talis on a consolidated basis is
$683,640 at November 30, 2008 and has been recorded as “Investments in
Affiliated Companies”.  We have recorded our share of Talis’ net loss
as “Equity in Earnings of Affiliated Companies” in the accompanying consolidated
statement of operations for the six months ended November 30, 2008.





Avot
Media, Inc.





During
the quarter ended August 31, 2008, we invested an aggregate of $1,300,000,
including conversion of  a note receivable in the amount of $250,000,
to obtain 14,444,444 shares of Series B preferred stock issued by Avot,
representing 53.3% of the Series B preferred stock and 37.1% of all Avot’s
preferred shares issued and outstanding.  The Series B preferred
shares are convertible at our option into shares of Avot’s common stock
utilizing a conversion rate which consists of the original issue price of the
Series B shares divided by the conversion price of $0.09 per
share.  The conversion price is subject to adjustment from time to
time for recapitalizations and as otherwise set forth in Avot’s Articles of
Incorporation.  Each share of preferred stock will automatically
convert to common shares, utilizing the conversion rate: (i) immediately prior
to the closing of a firm commitment underwritten initial public offering (“IPO”)
provided that (a) the offering price per share is not less than $1.00, (b) the
aggregate gross proceeds to Avot are not less than $25,000,000 and (c) Avot’s
common stock will be listed or admitted to trading on any national securities
association registered pursuant to Section 15A of the Securities Exchange Act of
1934, as amended, upon effectiveness of the IPO, or (ii) upon receipt by Avot of
written request for such conversion from the holders of a majority of the
preferred stock then outstanding.  All preferred shares are entitled
to receive non-cumulative dividends if and when declared by the Board of
Directors of Avot.  The Series B preferred shares are entitled to
receive a liquidation preference of $0.09 per share adjusted from time to time
for recapitalizations, plus an amount equal to all declared but unpaid
dividends.





We
reviewed the Series B Preferred Stock Purchase Agreement and related agreements
in addition to evaluating our voting rights for our investment in the preferred
stock of Avot, and as such we have concluded that we do not have the ability to
exercise significant control over Avot.  As a result, we are
accounting for our investment in Avot at cost.  Our investment in Avot
is $1,300,000 and has been recorded as “Investments in Affiliated Companies” on
our condensed consolidated balance sheet at November 30, 2008.





12.
Consolidated Variable Interest Entity





On
February 2, 2007, we invested an aggregate of $370,000 in Holocom for 2,100,000
shares of convertible preferred stock. This represents all of Holocom’s
preferred stock and a 46% ownership interest in Holocom, a California
corporation that manufactures products that protect information transmitted over
secure networks. The investment consisted of certain assets contributed by us to
Holocom valued at $250,000 and cash of $120,000. The shares are convertible at
our option into shares of Holocom’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 Holocom. The investment in Holocom’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.




26





Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements





Consolidated
Variable Interest Entity (continued)





On March
27, 2007, we entered into an 18-month revolving line of credit with Holocom for
a maximum amount of $500,000. The line of credit matured on September 27, 2008.
If we did not provide notice to Holocom at least 90 days prior to the maturity
date, the maturity date would have automatically extended 12 months. On June 18,
2008, we gave Holocom notice under terms of the line of credit that we would not
be extending the maturity date by the additional twelve month period provided
for in the line of credit. As a result, the line of credit would have
terminated, and full payment of any outstanding balance would have been due on
September 27, 2008.  On August 29, 2008 Holocom paid $75,000, the
remaining balance due on the line of credit and provided us notice effectively
terminating the line of credit on August 29, 2008.





During
July 2008, Holocom obtained a credit facility for up to $300,000 from a third
party, at an interest rate based on the Wall Street Journal Prime plus 1%
(floating) with a floor of 6%.  The credit facility term extends to
May 1, 2009, and is guaranteed by us.  During the quarter ended
November 30, 2008, Holocom borrowed $250,000 on the credit facility at an
interest rate of 6%.





As a
result of our guarantee on the third party credit facility, we maintain a
variable interest in Holocom, 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. FIN 46(R) requires us to consolidate Holocom
as long as we are deemed to be the primary beneficiary. The equity interests of
Holocom not owned by us are reported as a minority interest in our November 30,
2008 and May 31, 2008 condensed consolidated balance sheets.  As of
May 31, 2007, the noncontrolling interest in Holocom, which we are required to
consolidate as we are the primary beneficiary, was 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 were initially
required to consolidate, March 27, 2007 through May 31, 2007 we absorbed
$169,913 of Holocom’s losses as we are the primary beneficiary.  For
the fiscal year ended May 31, 2008, Holocom  had net income of
$285,319 after taxes.  Under the provisions of FIN 46 (R), we are able
to recover our absorbed losses before allocating income to the noncontrolling
interest.  At May 31, 2008 the minority interest presented in our
consolidated financial statements is $115,406, the amount of Holocom’s fiscal
2008 net income after taxes less our absorbed losses during fiscal
2007.





For the
six months ended November 30, 2008, the minority interest was $192,921 which
represents the amount of Holocom’s net income after taxes on a consolidated
basis.  The minority interest in the income for the six months is
added to the May 31, 2008 balance of $115,406 for a total of $308,327 as
presented in our condensed consolidated balance sheet at November 30,
2008.




Prior to
initial consolidation, we recognized a $126,746 impairment loss on our
investment for the losses of Holocom 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.





During
the three months ended August 31, 2007, Holocom sold a membership interest in
DataSecurus, LLC  (now known as Talis) to an unrelated third party for
$100,000 in cash and a $50,000 note receivable due June 1, 2008.  On
June 1, 2008, Holocom assigned this note receivable to us and we agreed to
reduce the amount of our line of credit with Holocom by the amount of the
note.  On June 26, 2008 we were paid in full by the third party
debtor.




27




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Consolidated
Variable Interest Entity (continued)





Holocom
has a 2007 Stock Option Plan that covers its employees, directors, and
consultants and provides for the granting of options to acquire up to 460,000
shares of Holocom’s common stock.  The options under this plan are not
tied to our common stock and do not have a dilutive effect on our
shareholders.  Any option granted under the plan must be exercised
within ten years of the date they are granted.  During the six months
ended November 30, 2008, Holocom granted options to purchase 42,500 shares of
its common stock at $0.12 per share under this plan and 36,750 shares have been
forfeited/cancelled.  At November 30, 2008, options to purchase
360,250 shares of Holocom’s common stock are outstanding, 95,100 of the
outstanding options are exercisable due to vesting provisions within the
options.





The
weighted average grant date fair value of Holocom’s options granted during the
six months ended November 30, 2008 was $0.08 per option.





As of
November 30, 2008, there was approximately $11,482 of total unrecognized
compensation cost related  to employee stock option compensation
arrangements.  That cost is expected to be recognized by Holocom on a
straight-line basis over the next 31 months.





During
the six months ended November 30, 2008, Holocom recognized $13,412 of employee,
consultant and director stock-based compensation expense related to stock
options under SFAS No. 123(R).





13.   Notes
Payable





Short
term





On June
18, 2008, we financed a portion of our Directors and Officers insurance premium
in the amount of $210,888.  The financed balance includes interest
charges of $4,487 at an annual percentage rate of 5.16%.  The note is
due on March 1, 2009 and requires monthly payments of $23,432.  At
November 30, 2008, the balance on the note was $70,296.





During
the current quarter, Holocom borrowed $250,000 on their credit facility with a
third party (see Note 12).





Long
term





On
October 14, 2008, we borrowed $3,000,000 on our credit facility with Wedbush,
the proceeds of which is included in cash and cash equivalents at November 30,
2008.  The credit facility is limited to $6,450,000 per requirements
of The Financial Industry Regulatory Authority (FINRA).  The facility
is collateralized by the full value of the outstanding auction rate securities,
requires no origination fee and bears interest at the federal funds rate plus
3%.  At November 30, 2008, the balance consisted of interest accrued
on the credit facility of $13,578 at an approximate rate of 4.50%, less the
semi-annual interest payment of $43,075 received on one of the auction rate
securities instruments which was recorded as a repayment of outstanding
borrowings on the credit facility.




28





Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements
  14.   Stockholders’
Equity





On
October 30, 2008, our shareholders approved an amendment to our Certificate of
Incorporation to increase the number of authorized shares of our common stock
from 500,000,000 to 600,000,000.





Comprehensive Income
(Loss)




Comprehensive
income (loss) includes unrealized gains and losses on certain investments
classified as available-for-sale, net of tax, which are excluded from
our condensed consolidated statements of operations in accordance with SFAS
No. 130, Reporting
Comprehensive Income. Comprehensive income for the three  and
six months ended November 30, 2008 and 2007 was as follows:





Three
      Months Ended
            
            
            Six
      Months EndedNovember
      30, 2008
            
            
            November
      30, 2007
            
            
            November
      30, 2008
            
            
            November
      30, 2007Net
      income (loss)
            
            $
            (932,259
            )
            
            $
            2,416,536
            
            
            $
            2,277,254
            
            
            $
            454,150Unrealized
      holding losses on investments, net of taxes
            
            
            (521,021
            )
            
            
            -
            
            
            
            (609,725
            )
            
            
            -Total
      comprehensive income (loss)
            
            $
            (1,453,280
            )
            
            $
            2,416,536
            
            
            $
            1,667,529
            
            
            $
            454,150





Share
Repurchases





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 5,318,976 and 5,698,821
shares of our common stock at an aggregate cost of $1,029,107 and $3,042,921
during the six months ended November 30, 2008 and 2007,
respectively.





Equity
Transactions





The
following table summarizes equity transactions during the six months ended
November 30, 2008:




Common
      Stock
            
            
            Additional
      Paid-
            
            
            
            AccumulatedShares
            
            
            
            Amounts
            
            
            
            in
      Capital
            
            
            
            Deficit
            
            
            
            Treasury
      StockBalance
      June 1, 2008
            
            
            389,414,915
            
            
            $
            4,109
            
            
            $
            70,004,814
            
            
            $
            (33,763,357
            )
            
            $
            (12,723,172
            )Non-cash
      compensation
            
            
            --
            
            
            
            -
            
            
            
            279,338
            
            
            
            -
            
            
            
            -Repurchase
      of common stock for treasury
            
            
            (5,318,976
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (1,029,107
            )Exercise
      of options at $0.05 per share
            
            
            100,000
            
            
            
            1
            
            
            
            4,999
            
            
            
            -
            
            
            
            -Issuance
      of stock in connection with acquisition
            
            
            26,988,455
            
            
            
            270
            
            
            
            6,581,944
            
            
            
            -
            
            
            
            -Dissolution
      of subsidiary
            
            
            --
            
            
            
            (12
            )
            
            
            6,727
            
            
            
            -
            
            
            
            -Tax
      effect of exercise of options under APB 25
            
            
            --
            
            
            
            -
            
            
            
            4,482
            
            
            
            -
            
            
            
            -Net
      income
            
            
            --
            
            
            
            -
            
            
            
            -
            
            
            
            2,277,254
            
            
            
            -Balance
      November 30, 2008
            
            
            411,184,394
            
            
            $
            4,368
            
            
            $
            76,882,304
            
            
            $
            (31,486,103
            )
            
            $
            (13,752,279
            )





Stock Optionsand Warrant
Activity




On
October 30, 2008 our shareholders approved an increase in the number of shares
authorized under our 2006 Stock Option Plan from 5,000,000 to
10,000,000.




29




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Stockholders’
Equity (continued)





As of
November 30, 2008, we had 100,000 options outstanding pursuant to our 1996 Stock
Option Plan exercisable at $0.07 per share expiring in 2009; 849,000 options
outstanding pursuant to our 2001 Stock Option Plan exercisable at a range of
$0.10 to $0.86 per share expiring through 2013; 2,873,000 options outstanding
pursuant to our 2003 Stock Option Plan exercisable at a range of $0.10 to $0.40
per share expiring through 2013; and 5,888,000 options outstanding pursuant to
our 2006 Stock Option Plan exercisable at a range of $0.15 to $0.70 per share
expiring through 2013.  Some of the options outstanding under these
plans are not presently exercisable and are subject to meeting vesting
criteria.





During
the quarter ended November 30, 2008, a director exercised stock options to
purchase 100,000 shares of common stock for proceeds of $5,000.





In
connection with our acquisition of Crossflo, we granted former Crossflo
employees 1,585,000 options from our 2006 Stock Option Plan exercisable at $0.23
per share expiring through 2013.  These options are not presently
exercisable and are subject to meeting vesting criteria.





New
employees of Crossflo subsequent to the acquisition date and through November
30, 2008, were granted 65,000 options from our 2006 Stock Option Plan
exercisable at $0.15 to $0.22 per share expiring through 2013.  These
options are not presently exercisable and are subject to meeting vesting
criteria.





During
the six months ended November 30, 2008, we recorded $247,206 of non-cash
compensation expense related to vesting of stock options, including $15,947
related to Crossflo and $13,412 related to Holocom.





As of
November 30, 2008, we had warrants outstanding to purchase 550,000 common shares
at exercise prices ranging from $0.20 to $1.00 per share, expiring at various
dates through 2013.  During the three months ended August 31, 2008, we
issued 250,000 warrants to purchase shares of common stock at $0.23 per share to
our institutional investor relations firm; the warrants are subject to vesting
criteria.  No warrants were exercised and no warrants expired during
the six months ended November 30, 2008.





During
the six months ended November 30, 2008, we recorded $2,773 of non-cash
compensation expense related to vesting of warrants.





15.  Commitments
and Contingencies





Litigation





Patent
Litigation





On
February 8, 2008, we, TPL and Alliacense Ltd. were named as defendants in three
separate lawsuits filed in the United States District Court for the Northern
District of California by Asustek Computer, Inc., HTC Corporation, and Acer,
Inc., and affiliated entities of each of them. On February 13, 2008, the Asustekclaims were amended
to include claims against MCM Portfolio, LLC (Alliacense and MCM Portfolio are
TPL-related entities), which do not involve us.





The Asustekcase seeks
declaratory relief that its products do not infringe enforceable claims of the
'336, '584 and '749 patents. The Asustekcase also seeks a
similar declaration with respect to two patents owned by TPL that are not a part
of the MMP Portfolio, and as such we are not engaged in this aspect of the
litigation and defense. The Acercase seeks declaratory
relief that its products do not infringe enforceable claims of the '336, '584
and '749 patents. The HTCcase similarly seeks declaratory relief that its products do not infringe
enforceable claims of those three patents and the '148 patent.




30


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Commitments
and Contingencies (continued)





On April
25, 2008, we and TPL filed five patent infringement lawsuits in the Eastern
District of Texas against HTC, Acer and Asustek. These suits allege infringement
by HTC and Acer with respect to the '336 '749 '584 and '148 patents; and by
Asustek with respect to the '336, '749 and '584 patents. On June 4, 2008, we and
TPL filed patent infringement lawsuits against those parties in the Eastern
District of Texas with respect to the ‘890 patent of the MMP
Portfolio.  The Asustekaction in the Eastern
District of Texas is inclusive of matters with respect to two patents owned by
TPL that are not  a part of the MMP Portfolio, and accordingly we are
not engaged in this aspect of the litigation and defense (collectively, these
cases are referred to as the "T-3" Litigation).





Motions
to dismiss or transfer the Northern District of California actions to the
Eastern District of Texas were heard on September 19, 2008 by U.S. District
Judge Jeremy Fogel and subsequently denied.  Whether the Texas action
will be transferred in whole or in part to Judge Fogel has not been
determined.  The discovery phase has just begun with trial expected to
be scheduled in late 2009 or early 2010.





On
December 22, 2008, we announced that Asustek had purchased a MMP Portfolio
license, leaving HTC and Acer as the remaining defendants in the above
action.





On
December 1, 2008, we, TPL and Alliascense, Ltd. were named as defendants in a
lawsuit filed in the Northern District of California by Barco,
N.V.  The Barco case seeks declaratory
relief that its products do not infringe enforceable claims of the '584, '749
and '890 patents.  We anticipate responding to the Complaint in early
2009.





Deutsche
Bank Arbitration





On
October 16, 2008, we initiated binding arbitration claims before FINRA against
Deutsche Bank  Securities, Inc., and affiliates ("DBSI") based on
advisory services provided to us resulting in our purchases of auction rate
securities ("ARS") and the failure of the ARS market in February
2008.  We experienced a  loss of liquidity and other damages
as a result, and allege DBSI engaged in negligence and nondisclosure in
providing us services.  DBSI has not yet responded to the
claim.  Some instruments have been repurchased  by the
issuers since the claim was filed.





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 six
months ended November 30, 2008 and 2007 were $6,457 and $3,388,
respectively.




31





Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Commitments
and Contingencies (continued)





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 Crossflo and Holocom. 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.




Pursuant
to the acquisition of Crossflo, we have indemnified the former owners of
Crossflo for any claims or losses resulting from any untrue, allegedly untrue or
misleading statement made in a registration statement, prospectus or similar
document. Additionally, we have agreed to indemnify the former owners of
Crossflo against losses up to a maximum of the merger consideration for damages
resulting from breach of representations or warranties in connection with the
acquisition.





Retention
Bonuses





In
connection with the acquisition of Crossflo, retention bonuses are to be paid to
individuals who were Crossflo employees pre-merger who remain with Crossflo
until March 1, 2010.  The projected liability for such bonuses is
$230,000.  The liability is being accrued ratably over the retention
period.





Escrow
Shares





As stated
in Note 2, in connection with our acquisition of Crossflo, in the event that
there is not an adequate number of shares remaining in the escrow account one
year from September 1, 2008 (the closing date of the merger agreement between
Crossflo and Patriot) to satisfy distribution to Crossflo stockholders in
accordance with the terms of the Escrow Agreement, we are required to make up
any difference in cash.





16.
Segment Information





Holocom
began operations in February 2007 and we consolidated Holocom in our
consolidated financial statements commencing in March 2007. Holocom is an
operating segment under SFAS No. 131, Disclosures About Segments of an
Enterprise, as revenue is 10% or more of the total revenue of all
operating segments.





Holocom
is engaged in the business of developing and manufacturing network-security
hardware for sale 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.





We
acquired Crossflo in September 2008 and consolidate our wholly owned subsidiary
Crossflo in our consolidated financial statements.  Management has
identified Crossflo as an operating segment of our business.





Crossflo  provides
data sharing services and products to the public sector.  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.




32





Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements




Segment
Information (continued)





Operating
segment net revenue, operating loss and income (loss) before taxes for the three
and six months ended November 30, 2008 and 2007 were as follows:





Three
      Months Ended
            
            
            Six
      Months EndedNovember
      30, 2008
            
            
            November
      30, 2007
            
            
            November
      30, 2008
            
            
            November
      30, 2007Net
      revenue:Holocom
            
            $
            1,610,658
            
            
            $
            933,280
            
            
            $
            2,930,024
            
            
            $
            1,445,144Crossflo
            
            
            258,353
            
            
            
            -
            
            
            
            258,353
            
            
            
            -All
      other
            
            
            6,250
            
            
            
            12,550
            
            
            
            45,530
            
            
            
            22,055Total
      net revenue
            
            $
            1,875,261
            
            
            $
            945,830
            
            
            $
            3,233,907
            
            
            $
            1,467,199Operating
      income (loss):Holocom
            
            $
            342,621
            
            
            $
            120,587
            
            
            $
            460,140
            
            
            $
            (25,042
            )Crossflo
            
            
            (906,055
            )
            
            
            -
            
            
            
            (906,055
            )
            
            
            -All
      other
            
            
            (965,774
            )
            
            
            (1,906,118
            )
            
            
            (2,239,638
            )
            
            
            (3,378,845
            )Total
      operating loss
            
            $
            (1,529,208
            )
            
            $
            (1,785,531
            )
            
            $
            (2,685,553
            )
            
            $
            (3,403,887
            )Income
      (loss) before taxes:Holocom
            
            $
            342,708
            
            
            $
            119,299
            
            
            $
            457,267
            
            
            $
            124,048Crossflo
            
            
            (904,802
            )
            
            
            -
            
            
            
            (904,802
            )
            
            
            -All
      other
            
            
            (730,435
            )
            
            
            3,881,351
            
            
            
            4,665,589
            
            
            
            1,681,647Total
      income (loss) before taxes
            
            $
            (1,292,529
            )
            
            $
            4,000,650
            
            
            $
            4,218,054
            
            
            $
            1,805,695





All
Holocom sales were to unaffiliated customers within the United
States.  All Crossflo sales were to unaffiliated customers within the
United States, with the exception of a hosting arrangement with a customer in
Japan.





Accounts
receivable concentration information for Holocom as of November 30, 2008 and May
31, 2008  and sales concentration information for the six months ended
November 30, 2008 and 2007 were as follows:




Six
      months ended
              November
      30, 2008
            
            
            November
              30,
      2008
            
            
            Six
      months ended
              November
      30, 2007
            
            
            May
      31,
              2008Sales
            
            
            %
      of sales
            
            
            %
      of A/R
            
            
            Sales
            
            
            %
      of sales
            
            
            %
      of A/RAnixter
            
            $
            1,497,128
            
            
            
            51
            %
            
            
            27
            %
            
            $
            730,027
            
            
            
            51
            %
            
            
            16
            %General
      Dynamics Company
            
            $
            401,808
            
            
            
            14
            %
            
            
            40
            %
            
            
            -----
            
            
            
            ----
            
            
            
            -----Graybar
      Electric Company, Inc.
            
            $
            583,196
            
            
            
            20
            %
            
            
            22
            %
            
            $
            247,723
            
            
            
            17
            %
            
            
            38
            %





Accounts
receivable concentration information for Crossflo as of November 30, 2008 and
May 31, 2008  and sales concentration information for the six months
ended November 30, 2008 and 2007 were as follows:




Six
      months ended
              November
      30, 2008
            
            
            November
              30,
      2008
            
            
            Six
      months ended
              November
      30, 2007
            
            
            May
      31,
              2008Sales
            
            
            %
      of sales
            
            
            %
      of A/R
            
            
            Sales
            
            
            %
      of sales
            
            
            %
      of A/RCustomer
      A
            
            $
            220,424
            
            
            
            85
            %
            
            
            59
            %
            
            
            -----
            
            
            
            ----
            
            
            
            -----Customer
      B
            
            $
            11,319
            
            
            
            4
            %
            
            
            24
            %
            
            
            -----
            
            
            
            ----
            
            
            
            -----




33




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


17.  Subsequent
Events





During
the period December 1, 2008 through January 2, 2009, we purchased 200,000 shares
of our common stock at an aggregate cost of $26,665 pursuant to our stock
buyback program.





On
December 1, 2008, Crossflo acquired the assets of Verras for total consideration
of $533,000.  The consideration consisted of cash of $480,288, the
reconveyance of a promissory note receivable in the principal amount of $33,000
and accrued interest of $154 (see Note 7), and the payment of certain expenses
to Verras in the amount of $19,558.  Pursuant to the purchase
agreement, Crossflo paid Verras $80,288 on December 3, 2008, and the remaining
$400,000 is due in four equal installments on the three, six, nine and twelve
month anniversaries of the closing date.  The purchase agreement also
provides for the payment of earnout consideration to Verras equal to 10% of the
revenues in excess of $5,000,000 for the period between the closing date through
December 1, 2010, up to a maximum of $500,000.  The fair values assigned to
the identifiable intangible assets acquired will be based on an appraisal
performed by an independent third party using estimates and assumptions
determined by management.




In
conjunction with the acquisition of Verras’ assets, Crossflo has hired the
employees of Verras to support its product offerings.  Two Crossflo
employees also served in officer capacities at Verras at the time of the asset
acquisition.





In
connection with the asset purchase of Verras we issued 75,000 stock options from
our 2006 Stock Option Plan with an exercise price of $0.13 to former employees
of Verras who became Crossflo employees on December 1, 2008.  These
options are not presently exercisable and are subject to meeting vesting
criteria.





On
December 1, 2008, we issued 30,000 stock options from our 2006 Stock Option Plan
with an exercise price of $0.13 to a new Crossflo employee.  These
options are not presently exercisable and are subject to meeting vesting
criteria.





As stated
in Note 15, on December 1, 2008, we, TPL and Alliascense, Ltd. were named as
defendants  in a lawsuit filed in the Northern District of California
by Barco, N.V.  The Barco case seeks declaratory
relief that its products do not infringe enforceable claims of the '584, '749
and '890 patents.





On
December 1 and 2, 2008 $1,000,000 and $250,000, respectively, of our ARS were
redeemed by the issuers.





On
December 22, 2008 Asustek purchased a MMP Portfolio license ending its
involvement in the T-3 litigation.




34




Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations





THE
FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO OUR
FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE
CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A VARIETY OF
FACTORS, INCLUDING THOSE DESCRIBED BELOW UNDER THE SUB-HEADING, "RISK FACTORS".
SEE ALSO OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED MAY 31,
2008.





Overview





In June
2005, we entered into a series of agreements with 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.





With the
proceeds generated by these licensing efforts, we are undertaking to make
investments in technologies, and acquisitions of companies operating in the
electronics technology market sector by way of i) selective expansion of our IP
portfolio, ii) pursuit of strategic minority investments in certain early-stage
revenue or technology ventures that represent a technology or capability of
interest to us, and iii) full M&A transactions.





Critical
Accounting Policies and Estimates





Our
condensed 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 condensed consolidated financial statements.





1.
            Revenue
      Recognition





Historically
we recognized revenue from the sale of our microprocessor chips upon shipment to
the customer, at which time title transferred and we had no further
obligations.  We discontinued the sale of our microprocessor chips
during the first fiscal quarter of 2009. Revenue from technology license
agreements is recognized at the time a contract is entered into, the license
method is determined (paid-in-advance or on-going royalty), and the customer is
provided with the licensed technology, if applicable.  Fees for
maintenance or support are recorded on a straight-line basis over the underlying
period of performance.





Crossflo
sells software and services to end users primarily through relationships with
systems integrators and prime contractors.  Crossflo recognizes
revenue in accordance with Statement of Position No. 97-2,Software Revenue
Recognition, and all related amendments and interpretations
(“SOP 97-2”).  Crossflo’s revenue is derived primarily from the
following sources: (i) software licensing, (ii) related professional
services, and (iii) post contract customer support (PCS)
agreements.  PCS agreements typically include software updates, on a
when and if available basis, telephone and internet access to technical support
personnel. Software updates provide customers with rights to unspecified
software product upgrades and to maintenance releases and patches released
during the term of the support period. Revenue for support services is
recognized on a straight-line basis over the support period.





When a
sale involves multiple elements, Crossflo allocates the entire fee from the
arrangement to each respective element based on its Vendor Specific Objective
Evidence (“VSOE”) of fair value and recognizes revenue when each element’s
revenue recognition criteria are met. VSOE of fair value for each element is
established based on the price charged when the same element is sold
separately.  Crossflo has not yet demonstrated VSOE for the
professional services that are rendered in conjunction with its software license
sales.  Accordingly, we have combined their presentation on our condensed
consolidated statements of operations under the caption “License and service
revenue”.





35




The
majority of Crossflo’s contracts with customers, including systems integrators
and prime contractors, are multiple element arrangements which contain
professional services that are considered essential to the functionality of the
other elements of the arrangement.  Crossflo accounts for revenue
recognition on  these arrangements according to the provisions of
AICPA Statement of Position (SOP) 81-1,Accounting for
Performance of Construction-Type and Certain Production-Type Contracts.
Under SOP 81-1, Crossflo recognizes revenue based on progress towards contract
completion measured by actual hours incurred in relation to the estimate of
total expected hours. Crossflo measures SOP 81-1 revenues by applying the
contract-specific estimated percentage of completion to the total contract
amount for software and professional services.  Crossflo routinely
updates the estimates of future hours for agreements in process and reports
any cumulative effects of such adjustments in current operations. Crossflo
immediately recognizes any loss expected on these contracts when it is projected
that loss is probable.





In
certain situations where Crossflo’s customer contracts contain acceptance
criteria or other conditions that are deemed adverse to the probability for
collection, revenues recognized are limited by the amount of cash already
collected.





Holocom
recognizes revenue upon shipment of its product or upon receipt of its product
by the customer when shipped FOB destination and recognizes revenue on its
short-term installation contracts as time and materials costs are
incurred.





Holocom
maintains agreements with stocking distributors. These agreements provide 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. Holocom’s stocking distributor agreements also
allow limited rights to periodic stock rotation.  These rotation
rights allow for the exchange of a percentage of distributor inventory for
replacement products of the distributor’s choosing. At November 30, 2008,
Holocom has evaluated the potential for rotated product and has provided for the
estimated impact in the accounting records.





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





On June
1, 2006, we adopted the provisions of Statement of Financial Accounting
Standards (“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.  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.




36




In
November 2005, FASB issued FASB Staff Position (“FSP”)No. FAS 123R-3, Transition Election Related to
Accounting for Tax Effects of Share-Based Payment Awards (“FAS
123R-3”).  We have elected to adopt the alternative transition method
provided in FAS 123R-3.  The alternative transition method includes a
simplified method to establish the beginning balance of the additional paid-in
capital pool (“APIC pool”) related to the tax effects of employee share-based
compensation, which is available to absorb tax deficiencies recognized
subsequent to the adoption of SFAS No. 123(R).




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 condensed
consolidated statement of operations for the six months ended November 30, 2007
included compensation expense for the share-based payment awards granted
subsequent to May 31, 2007 based on the grant date fair value estimated in
accordance with the provisions of SFAS No. 123(R). Stock-based compensation
expense recognized in our condensed consolidated statement of operations for the
six months ended November 30, 2008 included compensation expense for share-based
payment awards granted prior to May 31, 2008 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 condensed consolidated
statements of operations 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 six months ended November 30, 2008 and 2007 of
approximately 5% was based on historical forfeiture experience and estimated
future employee forfeitures. The estimated pricing term of option grants for the
six months ended November 30, 2008 and 2007 was five years.





4.
            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.





Additionally,
we adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income
Taxes – An Interpretation of FASB Statement No. 109,or FIN 48, on June
1, 2007, the first day of fiscal 2008.  FIN 48 seeks to reduce the
diversity in practice associated with certain aspects of measurement and
recognition in accounting for income taxes.  FIN 48 prescribes a
recognition threshold and measurement requirement for the financial statement
recognition of a tax position that has been taken or is expected to be taken on
a tax return and also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition.  Under FIN 48 we may only recognize tax positions that
meet a “more likely than not” threshold.




5.
            Investments
      in Affiliated Companies





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 companies”.





We have a
37.4% interest in Talis.  We account for our investment using the
equity method of accounting pursuant to paragraph 8 of AICPA Statement of
Position 78-9, Accounting for
Investments in Real Estate Ventures(which has applicability to non-Real
Estate accounting matters as well) as our membership share of this limited
liability company is more than minor.  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 companies”.




37




We own
37.1% of the preferred stock of Avot.  This investment is accounted
for at cost since we do not have the ability to exercise significant influence
over the operating and financial policies of Avot.





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





6.
            Variable
      Interest Entity





We own
100% of the preferred stock of Holocom. On March 27, 2007 we entered into an 18
month revolving line of credit with Holocom for a maximum amount of $500,000
which matured on September 27, 2008.  The line of credit was paid in
full on August 31, 2008.  During July 2008, Holocom obtained a credit
facility from a third party which we guaranteed. The line of credit and the
subsequent guaranty by us caused us to have a variable interest in Holocom, 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. FASB Interpretation 46, Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51(“FIN 46”) as modified by FASB
in December of 2003 (“FIN 46(R)”), requires us to consolidate Holocom 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 FIN  46(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 the Three Months Ended November 30, 2008 and Three Months Ended November 30,
2007.





Consolidated:





Three
      Months EndedNovember
      30, 2008
            
            
            November
      30, 2007Revenues:Product
      sales and other
            
            $
            1,616,908
            
            
            $
            945,830License
      and service revenue
            
            
            258,353
            
            
            
            -Total
      revenues
            
            
            1,875,261
            
            
            
            945,830Cost
      of sales:Product
      sales and other
            
            
            700,365
            
            
            
            356,338License
      and service revenue
            
            
            165,140
            
            
            
            -Amortization
      of purchased intangibles
            
            
            211,302
            
            
            
            -Total
      cost of sales
            
            
            1,076,807
            
            
            
            356,338Gross
      profit
            
            $
            798,454
            
            
            $
            589,492




38





Segment
Results:





Three
      months endedNovember
      30, 2008
            
            
            November
      30, 2007Holocom:
            
            Dollars
            
            
            %
      of Revenue
            
            
            Dollars
            
            
            %
      of RevenueRevenues
      - Product sales and other
            
            $
            1,610,658
            
            
            
            100.0
            %
            
            $
            933,280
            
            
            
            100.0
            %Cost
      of sales
            
            
            700,365
            
            
            
            43.5
            %
            
            
            356,338
            
            
            
            38.2
            %Gross
      profit
            
            $
            910,293
            
            
            
            56.5
            %
            
            $
            576,942
            
            
            
            61.8
            %Crossflo:License
      and service revenue
            
            $
            258,353
            
            
            
            100.0
            %
            
            $
            -
            
            
            
            -Cost
      of sales
            
            
            165,140
            
            
            
            63.9
            %
            
            
            -
            
            
            
            -Amortization
      of purchased intangibles
            
            
            211,302
            
            
            
            -
            
            
            
            -
            
            
            
            -Gross
      profit
            
            $
            (118,089
            )
            
            
            -
            
            
            $
            -
            
            
            
            -PTSC:Revenues
      - Product sales and other
            
            $
            6,250
            
            
            
            100.0
            %
            
            $
            12,550
            
            
            
            100.0
            %Cost
      of sales
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Gross
      profit
            
            $
            6,250
            
            
            
            100.0
            %
            
            $
            12,550
            
            
            
            100.0
            %





Holocom





During
the three months ended November 30, 2008 and 2007, we recorded sales amounting
to approximately $1,611,000 and $933,000, respectively, by our consolidated
variable interest entity, Holocom, with cost of sales amounting to approximately
$700,000 and $356,000, respectively. The increase in sales for Holocom during
the three months ended November 30, 2008 as compared to the three months ended
November 30,  2007 is primarily due to increased sales to
distributors.





Crossflo





We
acquired Crossflo on September 1, 2008.  Revenue consists of software
licenses and related services relating to Crossflo’s CDX data agent
product.  Cost of sales includes the direct time of Crossflo employees
on each project as well as outside contractors. Included in cost of sales is
approximately $211,300 of amortization expense on purchased intangible
assets.





PTSC





During
the three months ended November 30, 2008 and 2007, we recognized maintenance fee
revenues totaling approximately $6,250  and $6,250 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 three months ended November 30, 2007, we recorded sales of
approximately $6,300 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.  Our final sales of microprocessor chips
occurred during the quarter ended August 31, 2008.





Consolidated





Our
revenues increased from approximately $946,000 for the three months ended
November 30, 2007 to approximately $1,875,000 for the three months ended
November 30, 2008. Our revenue amounts do not include income of approximately
$251,000 and $5,486,000, respectively,  from our investment in PDS for
the three months ended November 30, 2008 and 2007, respectively,  and
a loss of approximately $141,000 from our investment in Talis for the three
months ended November 30, 2008.




39




Three
      months endedNovember
      30, 2008
            
            
            November
      30, 2007Research
      and development
            
            $
            151,874
            
            
            $
            -





Crossflo





We
acquired Crossflo on September 1, 2008.  Research and development
costs consist of Crossflo’s payroll and related expenses for software engineers
as well as outside contractors retained to assist in development of Crossflo’s
software product.  For the three months ended November 30, 2008,
approximately $378 of non cash compensation was recorded in connection with
vesting of employee stock options in accordance with SFAS 123(R).





Consolidated:





Three
      months endedNovember
      30, 2008
            
            
            November
      30, 2007Selling,
      general and administrative
            
            $
            2,175,788
            
            
            $
            1,986,363





Segment
Results:


Three
      months endedNovember
      30, 2008
            
            
            November
      30, 2007Holocom:Selling,
      general and administrative
            
            $
            567,672
            
            
            $
            456,355Crossflo:Selling,
      general and administrative
            
            $
            636,092
            
            
            $
            -PTSC:Selling,
      general and administrative
            
            $
            972,024
            
            
            $
            1,530,008





Holocom





Selling,
general and administrative expenses increased from approximately $456,000 for
the three months ended November 30, 2007 to approximately $568,000 for the three
months ended November 30, 2008.  The increase consisted of
approximately $91,000 relating to payroll and related expenses for bonuses
granted to employees, approximately $12,000 for meals and internal events,
approximately $7,400 for royalty payments under the earn out agreement,
approximately $5,000 for subcontractors and approximately $3,600 for legal
expenses.  For the three months ended November 30, 2008, approximately
$6,700 of non cash compensation was recorded in connection with vesting of
employee stock options in accordance with SFAS 123(R).  These
increases were offset by a decrease in travel and related expenses of
approximately $18,000.





Crossflo





We
acquired Crossflo on September 1, 2008.  Selling, general and
administrative expenses for the three months ended November 30, 2008 consist of
approximately $435,000 of payroll and related expenses for the sales and
administrative employees, approximately $58,000 of travel and related expenses
for the sales employees, approximately $11,000 for sales commissions,
approximately $19,000 for sales consultants, and approximately $26,000 for rent
expense.  For the three months ended November 30, 2008, approximately
$15,600 of non cash compensation was recorded in connection with vesting of
employee stock options in accordance with SFAS 123(R).




40




PTSC





Selling,
general and administrative expenses decreased from approximately $1,530,000 for
the three months ended November 30, 2007 to approximately $972,000 for the three
months ended November 30, 2008.  The decrease consisted of
approximately $752,000 in legal and accounting expense, primarily due to
capitalization of legal and accounting fees in connection with the Crossflo
acquisition, approximately $45,000 in public and investor relations expenses,
and approximately $63,000 in consulting expenses.  These decreases
were offset by increases in payroll and related expenses of approximately
$253,000 related to officer bonuses, and approximately $19,000 in travel and
related expenses.  For the three months ended November 30, 2008,
approximately $142,000 of non cash compensation was recorded in connection with
vesting of employee stock options in accordance with SFAS 123(R) as compared to
approximately $63,000 for the three months ended November 30, 2007.





Consolidated





Selling,
general and administrative expenses increased from approximately $1,986,000 for
the three months ended November 30, 2007 to approximately $2,176,000 for the
three months ended November 30, 2008, primarily due to the acquisition of
Crossflo and Patriot’s capitalization of transaction costs in connection with
the acquisition.





Three
      months endedNovember
      30, 2008
            
            
            November
      30, 2007Settlement
      and license expense
            
            $
            -
            
            
            $
            388,660





Patriot
recorded settlement and license expenses amounting to approximately $389,000 for
the three months ended November 30, 2007 relating to royalties payable resulting
from an agreement with Fish (see Note 10 to our condensed consolidated financial
statements for more information).





Consolidated:


Three
      months endedNovember
      30, 2008
              
              
              November
      30, 2007Other
      income (expense):Interest
      and other income
              
              $
              144,748
              
              
              $
              301,066Loss
      on sale of assets
              
              
              (1,733
              )
              
              
              (924
              )Interest
      expense
              
              
              (16,075
              )
              
              
              -Equity
      in earnings of affiliated companies
              
              
              109,739
              
              
              
              5,486,039Total
      other income, net
              
              $
              236,679
              
              
              $
              5,786,181





Segment
Results:


Three
      months endedNovember
      30, 2008
            
            
            November
      30, 2007Holocom:Interest
      and other income
            
            $
            2,587
            
            
            $
            5,507Interest
      expense
            
            
            (2,500
            )
            
            
            -Loss
      on sale of assets
            
            
            -
            
            
            
            -Total
      other income, net
            
            $
            87
            
            
            $
            5,507Crossflo:Interest
      and other income
            
            $
            3,003
            
            
            $
            -Interest
      expense
            
            
            (17
            )
            
            
            -Loss
      on sale of assets
            
            
            (1,733
            )
            
            
            -Total
      other income, net
            
            $
            1,253
            
            
            $
            -PTSC:Interest
      and other income
            
            $
            139,158
            
            
            $
            295,559Interest
      expense
            
            
            (13,558
            )
            
            
            -Loss
      on sale of assets
            
            
            -
            
            
            
            (924
            )Equity
      in earnings of affiliated companies
            
            
            109,739
            
            
            
            5,486,039Total
      other income, net
            
            $
            235,339
            
            
            $
            5,780,674




41




Consolidated





Our other
income and expenses for the three months ended November 30, 2008 included equity
in the earnings of PDS consisting of net income after expenses in the amount of
approximately $251,000 and our share of loss in Talis consisting of
approximately $141,000 after expenses.  For the three months ended
November 30, 2007, our other income and expenses included our share of income in
PDS of approximately $5,486,000. Our investments in PDS and Talis are accounted
for in accordance with the equity method of accounting for investments. Total
other income and expense for the three months ended November 30, 2008 amounted
to net other income of approximately $237,000 compared with approximately
$5,786,000 for the three months ended November 30, 2007. Interest income and
other income decreased from approximately $296,000 for the three months ended
November 30, 2007 to approximately $139,000 for the three months ended November
30, 2008 due to declines in interest rates for our cash, cash equivalents and
short term investment accounts.





During
the three months ended November 30, 2008 we recorded a benefit for income taxes
of approximately $632,000 and during the three months ended November 30, 2007,
we recorded a provision for income taxes of approximately 1,584,000 related to
federal and California taxes.





We
recorded a net loss for the three months ended November 30, 2008 of $932,259
compared with net income of $2,416,536 for the three months ended November 30,
2007.





Results
of Operations





Comparison
of the Six Months Ended November 30, 2008 and Six Months Ended November 30,
2007.





Consolidated:





Six
      Months EndedNovember
      30, 2008
            
            
            November
      30, 2007Revenues:Product
      sales and other
            
            $
            2,975,554
            
            
            $
            1,467,199License
      and service revenue
            
            
            258,353
            
            
            
            -Total
      revenues
            
            
            3,233,907
            
            
            
            1,467,199Cost
      of sales:Product
      sales and other
            
            
            1,284,618
            
            
            
            507,873License
      and service revenue
            
            
            165,140
            
            
            
            -Amortization
      of purchased intangibles
            
            
            211,302
            
            
            
            -Total
      cost of sales
            
            
            1,661,060
            
            
            
            507,873Gross
      profit
            
            $
            1,572,847
            
            
            $
            959,326





Segment
Results:


Six
      months endedNovember
      30, 2008
            
            
            November
      30, 2007Holocom:
            
            Dollars
            
            
            %
      of Revenue
            
            
            Dollars
            
            
            %
      of RevenueRevenues
      - Product sales and other
            
            $
            2,930,024
            
            
            
            100.0
            %
            
            $
            1,445,144
            
            
            
            100.0
            %Cost
      of sales
            
            
            1,284,618
            
            
            
            43.8
            %
            
            
            507,873
            
            
            
            35.1
            %Gross
      profit
            
            $
            1,645,406
            
            
            
            56.2
            %
            
            $
            937,271
            
            
            
            64.9
            %Crossflo:License
      and service revenue
            
            $
            258,353
            
            
            
            100.0
            %
            
            $
            -
            
            
            
            -Cost
      of sales
            
            
            165,140
            
            
            
            63.9
            %
            
            
            -
            
            
            
            -Amortization
      of purchased intangibles
            
            
            211,302
            
            
            
            -
            
            
            
            -
            
            
            
            -Gross
      profit
            
            $
            (118,089
            )
            
            
            -
            
            
            $
            -
            
            
            
            -




42





PTSC:Revenues
      - Product sales and other
            
            $
            45,530
            
            
            
            100.0
            %
            
            $
            22,055
            
            
            
            100.0
            %Cost
      of sales
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Gross
      profit
            
            $
            45,530
            
            
            
            100.0
            %
            
            $
            22,055
            
            
            
            100.0
            %





Holocom





During
the six months ended November 30, 2008 and 2007, we recorded sales amounting to
approximately $2,930,000 and $1,445,000, respectively, by our consolidated
variable interest entity, Holocom, with cost of sales amounting to approximately
$1,285,000 and $508,000, respectively. The increase in sales for Holocom during
the six months ended November 30, 2008 as compared to the six months ended
November 30,  2007 is primarily due to increased sales to
distributors.





PTSC





During
the six months ended November 30, 2008 and 2007, we recognized maintenance fee
revenues totaling approximately $12,500  and $12,500 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 six months ended November 30, 2008 and 2007, we recorded
sales of approximately $33,000 and $10,000, respectively, 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.  Our
final sales of microprocessor chips occurred during the quarter ended August 31,
2008.





Consolidated





Our
revenues increased from approximately $1,467,000 for the six months ended
November 30, 2007 to approximately $3,234,000 for the six months ended November
30, 2008. Our revenue amounts do not include income of approximately $6,873,000
and $4,286,000, respectively, from our investment in PDS for the six months
ended November 30, 2008 and 2007, respectively,  and a loss of
approximately $204,000 from our investment in Talis for the six months ended
November 30, 2008.





Consolidated:


Six
      months endedNovember
      30, 2008
            
            
            November
      30, 2007Selling,
      general and administrative
            
            $
            4,106,526
            
            
            $
            3,944,553





Segment
Results:


Six
      months endedNovember
      30, 2008
            
            
            November
      30, 2007Holocom:Selling,
      general and administrative
            
            $
            1,185,266
            
            
            $
            962,313Crossflo:Selling,
      general and administrative
            
            $
            636,092
            
            
            $
            -PTSC:Selling,
      general and administrative
            
            $
            2,285,168
            
            
            $
            2,982,240





Holocom





Selling,
general and administrative expenses increased from approximately $962,000 for
the six months ended November 30, 2007 to approximately $1,185,000 for the six
months ended November 30, 2008.  The increase consisted of
approximately $137,000 relating to payroll and related expenses, approximately
$12,000 for meals and internal events, approximately $29,000 for royalty
payments under the earn out agreement, approximately $25,000 for legal and
professional expenses.  For the six months ended November 30, 2008,
approximately $13,400 of non cash compensation was recorded in connection with
vesting of employee stock options in accordance with SFAS
123(R).  These increases were offset by a decrease in travel and
related expenses of approximately $22,000.




43




PTSC





Selling,
general and administrative expenses decreased from approximately $2,982,000 for
the six months ended November 30, 2007 to approximately $2,285,000 for the six
months ended November 30, 2008.  The decrease consisted of
approximately $730,000 in legal and accounting expense, primarily due to
capitalization of legal and accounting fees in connection with the Crossflo
acquisition, approximately $81,000 in public and investor relations expenses,
approximately $13,000 in website expenses and approximately $22,000 in D&O
insurance expenses.  These decreases were offset by increases in
payroll and related expenses of approximately $256,000 related to officer
bonuses, and approximately $9,000 in travel and related expenses.  For
the six months ended November 30, 2008, approximately $250,000 of non cash
compensation was recorded in connection with vesting of employee stock options
in accordance with SFAS 123(R) as compared to approximately $346,000 for the six
months ended November 30, 2007.





Consolidated





Selling,
general and administrative expenses increased from approximately $3,945,000 for
the six months ended November 30, 2007 to approximately $4,107,000 for the six
months ended November 30, 2008, primarily due to the acquisition of Crossflo and
Patriot’s capitalization of transaction costs in connection with the
acquisition.





Six
      months endedNovember
      30, 2008
            
            
            November
      30, 2007Settlement
      and license expense
            
            $
            -
            
            
            $
            418,660





Patriot
recorded settlement and license expenses amounting to approximately $419,000 for
the six months ended November 30, 2007 relating to royalties payable resulting
from an agreement with Fish (see Note 8 to our condensed consolidated financial
statements for more information).





Consolidated:


Six
      months endedNovember
      30, 2008
            
            
            November
      30, 2007Other
      income (expense):Interest
      and other income
            
            $
            257,593
            
            
            $
            775,591Loss
      on sale of assets
            
            
            (1,733
            )
            
            
            (1,269
            )Interest
      expense
            
            
            (20,762
            )
            
            
            (237
            )Gain
      on sale of subsidiary interest
            
            
            -
            
            
            
            150,000Equity
      in earnings of affiliated companies
            
            
            6,668,509
            
            
            
            4,285,497Total
      other income, net
            
            $
            6,903,607
            
            
            $
            5,209,582




44




Segment
Results:


Six
      months endedNovember
      30, 2008
            
            
            November
      30, 2007Holocom:Interest
      and other income
            
            $
            2,968
            
            
            $
            11,393Interest
      expense
            
            
            (2,574
            )
            
            
            (237
            )Gain
      on sale of subsidiary interest
            
            
            -
            
            
            
            150,000Total
      other income, net
            
            $
            394
            
            
            $
            161,156Crossflo:Interest
      and other income
            
            $
            3,003
            
            
            $
            -Interest
      expense
            
            
            (17
            )
            
            
            -Loss
      on sale of assets
            
            
            (1,733
            )
            
            
            -Total
      other income, net
            
            $
            1,253
            
            
            $
            -PTSC:Interest
      and other income
            
            $
            251,622
            
            
            $
            764,198Interest
      expense
            
            
            (18,171
            )
            
            
            -Loss
      on sale of assets
            
            
            -
            
            
            
            (1,269
            )Equity
      in earnings of affiliated companies
            
            
            6,668,509
            
            
            
            4,285,497Total
      other income, net
            
            $
            6,901,960
            
            
            $
            5,048,426





Consolidated





Our other
income and expenses for the six months ended November 30, 2008 included equity
in the earnings of PDS consisting of net income after expenses in the amount of
approximately $6,873,000 and our share of loss in Talis consisting of
approximately $204,000 after expenses.  For the six months ended
November 30, 2007, our other income and expenses included our share of income in
PDS of approximately $4,285,000. Our investments in PDS and Talis are accounted
for in accordance with the equity method of accounting for investments. Total
other income and expense for the six months ended November 30, 2008 amounted to
net other income of approximately $6,902,000 compared with approximately
$5,048,000 for the six months ended November 30, 2007. Interest income and other
income decreased from approximately $764,000 for the six months ended November
30, 2007 to approximately $252,000 for the six months ended November 30, 2008
due to declines in interest rates for our cash, cash equivalents and short term
investment accounts. Holocom recognized $150,000 of other income in connection
with the sale of a portion of its interest in Talis Data Systems,
LLC.





During
the six months ended November 30, 2008 and 2007, we recorded a provision for
income taxes of approximately $1,748,000 and $1,352,000, respectively, related
to federal and California taxes.





We
recorded net income for the six months ended November 30, 2008 of $2,277,254
compared with net income of $454,150 for the six months ended November 30,
2007.





Liquidity
and Capital Resources





Liquidity





Our cash
and short-term investment balances increased from approximately $6,722,000 as of
May 31, 2008  to approximately $7,665,000 as of November 30, 2008. We
also have restricted cash balances amounting to approximately $51,000 as of May
31, 2008 and approximately $52,000 as of November 30, 2008. Total current assets
increased from approximately $9,851,000 as of May 31, 2008 to approximately
$11,208,000  as of November 30, 2008. Total current liabilities
amounted to approximately $930,000 and approximately $3,439,000 as of May 31,
2008 and November 30, 2008, respectively. The change in our current position as
of November 30, 2008 as compared with May 31, 2008 results in part from our
receipt of approximately $7,649,000 in distributions from PDS, recording a
liability for income taxes of approximately $1,925,000 and an increase in our
deferred tax assets of approximately $520,000.





45




During
June 2008, we obtained a credit facility for as long as needed, which provides
for financing up to 50% of the par value balance of our outstanding auction rate
securities. The facility is collateralized by the full value of the outstanding
auction rate securities, required no origination fee, and when drawn upon will
bear interest at the federal funds rate plus 3%.  On October 14, 2008,
we borrowed $3,000,000 on the credit facility.  The amount we can
borrow against our collateral, currently $6,450,000, is limited by
FINRA.





Current
global economic conditions have resulted in increased volatility in the
financial markets.  The cost of accessing the credit markets has
increased as many lenders and institutional investors have increased interest
rates, enacted tighter lending standards, and reduced or ceased to provide
funding to borrowers.  Adverse changes in the economy could limit our
ability to obtain financing from debt or capital sources or could adversely
affect the terms on which we may be able to obtain any such
financing.  Currently, we have sufficient resources to fund our
operations through at least the next twelve months.





Cash
Flows From Operating Activities





Cash used
in operating activities for the six months ended November 30, 2008 was
approximately $4,001,000 as compared with cash used in operating activities for
the six months ended November 30, 2007 of approximately $7,836,000. The
principal components of the current period amount were: net income of
approximately $2,277,000 and a change in income taxes payable of approximately
$1,925,000.  These increases were partially offset by: equity in
earnings of affiliates of approximately $6,669,000, change in deferred taxes of
approximately $1,382,000 and changes in accounts receivable and inventory of
approximately $587,000 and $569,000, respectively.





Cash
Flows From Investing Activities





Cash
provided by investing activities was approximately $3,015,000 for the six months
ended November 30, 2008 as compared to cash used in investing activities of
approximately $408,000 for the six months ended November 30, 2007. The increase
was primarily due to distributions received from PDS for the six months ended
November 30, 2008 of approximately $7,649,000.  Cash used during the
six months ended November 30, 2008 included approximately $668,000 in purchases
of Crossflo and Avot convertible notes, approximately $1,050,000 in purchases of
Avot preferred stock and approximately $497,000 in purchases of Talis LLC
membership units and approximately $2,546,000 in the acquisition of
Crossflo.





Cash
Flows From Financing Activities





Cash
provided by financing activities for the six months ended November 30, 2008 was
approximately $2,055,000 as compared to cash used in financing activities of
approximately $5,786,000 for the six months ended November 30,
2007.   For the six months ended November 30, 2008, cash of
approximately $1,029,000 was used to purchase common stock for treasury and cash
of approximately $176,000 was used to pay our notes payable.  Cash
received from financing activities during the six months ended November 30, 2008
consisted of $3,000,000 received on our LOC and $250,000 received by Holocom on
their line of credit facility.





Capital
Resources





Our
current position as of November 30, 2008 is expected to provide the funds
necessary to support our operations through at least the next twelve
months.




46





Contractual
Obligations and Commitments





A summary
of our outstanding contractual obligations at November 30, 2008 is as
follows:




Contractual
              Cash
      Obligations
            
            Total
              Amounts
              Committed
            
            
            1-3
      Years
            
            
            3-6
      YearsOperating
      leases - facilities
            
            $
            569,009
            
            
            $
            559,969
            
            
            $
            9,040Repayments
      of short term debt
            
            $
            320,296
            
            
            $
            320,296
            
            
            $
            -Repayments
      of long term debt
            
            $
            2,977,347
            
            
            $
            -
            
            
            $
            2,977,347Retention
      bonus payments to former Crossflo employees
            
            $
            230,000
            
            
            $
            230,000
            
            
            $
            -





Our line
of credit facility with a current balance of $3,000,000 does not have a
specified maturity date and terms of the agreement state the credit facility is
available to us “as long as needed” subject to the collateral value of our
ARS.





Recent
Accounting Pronouncements





In
September 2006, the FASB issued SFAS No. 157, Fair Value
Measurements.  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. In
February 2008, the FASB released FASB Staff Position 157-2, Effective Date of FASB StatementNo. 157,which
delayed the effective date of SFAS No. 157 for all nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair
value in the financial statements on a recurring basis (at least annually) until
the fiscal year beginning June 1, 2009.  On June 1, 2008, we adopted
SFAS No. 157 for financial assets and liabilities.  The adoption did
not have a material effect on our results of operations and financial
position.  We are in the process of evaluating the impact of adoption
of SFAS No. 157 for nonfinancial assets and liabilities, but do not anticipate
that the adoption will have a material impact on our consolidated financial
statements.





In
February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial
Assets and Financial Liabilities. 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.  We have elected not to measure eligible financial assets
and liabilities at fair value.  Accordingly, the adoption of SFAS No.
159 did not have a material impact on our results of operations and financial
position.





47




In
December 2007, the FASB issued SFAS No. 141(R), Business Combinations. SFAS
No. 141(R) requires acquiring entities in a business combination to recognize
the assets acquired and liabilities assumed in the transaction; establishes the
acquisition-date fair value as the measurement objective for all assets acquired
and liabilities assumed; and requires the acquirer to disclose to investors the
information it needs to evaluate and understand the nature and financial effect
of the business combination. SFAS No. 141(R) is effective in fiscal years
beginning after December 15, 2008. We expect to adopt SFAS No. 141(R) on June 1,
2009.  We are currently assessing the impact the adoption of SFAS No.
141(R) will have on our consolidated financial statements.





In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements. SFAS No. 160 requires entities to
report noncontrolling (minority) interests in subsidiaries as equity in the
consolidated financial statements. SFAS No. 160 is effective in fiscal
years beginning after December 15, 2008. We expect to adopt SFAS No. 160 on June
1, 2009.  We are currently assessing the impact the adoption of SFAS
No. 160 will have on our consolidated financial statements.





In
March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities, an amendment of
FASB Statement No. 133 Accounting for Derivative
Instruments and Hedging Activities (“SFAS No. 161”) requires
entities to provide greater transparency about how and why an entity uses
derivative instruments, how derivative instruments and related hedged items are
accounted for under SFAS No. 133, and how derivative instruments and
related hedged items affect an entity’s financial position, results of
operations, and cash flows. The statement is effective for financial statements
issues for fiscal years and interim periods beginning after November 15,
2008.  We expect to adopt SFAS No. 161 on June 1, 2009. We are
currently assessing the impact the adoption of SFAS No. 161 will have on our
consolidated financial statements.





In
April 2008, the FASB issued FSP No. 142-3, Determination of the Useful Life of
Intangible Assetswhich amends the factors that must be considered in
developing renewal or extension assumptions used to determine the useful life
over which to amortize the cost of a recognized intangible asset under SFAS
No. 142, Goodwill and
Other Intangible Assets. The FSP requires an entity to consider its own
assumptions about renewal or extension of the term of the arrangement,
consistent with its expected use of the asset, and is an attempt to improve
consistency between the useful life of a recognized intangible asset under SFAS
No. 142 and the period of expected cash flows used to measure the fair
value of the asset under SFAS No. 141, Business Combinations. The
FSP is effective for fiscal years beginning after December 15, 2008, and
the guidance for determining the useful life of a recognized intangible asset
must be applied prospectively to intangible assets acquired after the effective
date. The FSP is not expected to have a significant impact on
our consolidated financial statements.





In
May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles (“SFAS No. 162”). The statement is intended to
improve financial reporting by identifying a consistent hierarchy for selecting
accounting principles to be used in preparing financial statements that are
prepared in conformance with generally accepted accounting principles. Unlike
Statement on Auditing Standards (“SAS”) No. 69, The Meaning of Present in Conformity
With GAAP, SFAS No. 162 is directed to the entity rather than the
auditor. The statement is effective 60 days following the SEC’s approval of
the Public Company Accounting Oversight Board (“PCAOB”) amendments to AU
Section 411, The Meaning
of  Present Fairly in Conformity with GAAP, and is not expected
to have any impact on our consolidated financial statements.





In
June 2008, the FASB issued FSP EITF No. 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities.
Under the FSP, unvested share-based payment awards that contain rights to
receive non-forfeitable dividends (whether paid or unpaid) are participating
securities, and should be included in the two-class method of computing EPS. The
FSP is effective for fiscal years beginning after December 15, 2008, and
interim periods within those years, and is not expected to have a significant
impact on our consolidated financial statements.





48




In
October 2008, the FASB issued FSP No. FAS 157-3, Determining the Fair Value of a
Financial Asset When the Market for That Asset is Not Active, which
clarifies the application of SFAS No. 157. The FSP provides guidance in
determining the fair value of a financial asset when the market for that
financial asset is not active. The adoption of this standard as of
October 31, 2008 did not have a material impact on our consolidated
financial statements





In
December 2008, the FASB issued FSP No. FAS 140-4  and FIN
46(R)-8, Disclosures by Public
Entities (Enterprises) about Transfers of Financial Assets and Interests in
Variable Interest Entities. The FSP will require additional disclosures
about transfers of financial assets and involvement with variable interest
entities. The FSPs are effective for all reporting periods ending after
December 15, 2008 and will require additional disclosures in our
Form 10-Q for the quarter ending February 28, 2009.





Risk
Factors





We urge
you to carefully consider the following discussion of risks as well as other
information regarding our common stock. 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 The First Quarter Of Fiscal 2009, And For
The Fiscal Years 2008, 2007 and 2006 Which May Not Be Indicative Of Our Future
Income
 
 We have
entered into license agreements, directly and through our joint venture with TPL
and have reported substantial income as a result of this activity in the first
quarter of fiscal 2009, and for the fiscal years 2008, 2007 and 2006. 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,
petitions with the U. S. Patent and Trademark Office to re-examine certain of
our patents, and the possible effect of new judicial interpretations 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 For Substantially All Of Our Income In Which
Our Role Is Of A Passive Nature





In June
of 2005, we entered into a joint venture with TPL, pursuant to which TPL is
responsible for the licensing and enforcement of our microprocessor patent
portfolio. This joint venture has been the source of virtually all of our income
since June of 2005. Therefore, in light of the absence of significant revenue
from other sources, we should be regarded as entirely dependent on the success
or failure of the licensing and prosecution efforts of TPL on behalf of the
joint venture.





We
May Not Be Successful In Identifying Acquisition Candidates And If We Undertake
Acquisitions, They Could Increase Our Costs Or Liabilities And Impair Our
Revenue And Operating Results.




One of
our strategies is to pursue growth through acquisitions. We may not be able to
identify suitable acquisition candidates at prices that we consider appropriate.
If we do identify an appropriate acquisition candidate, we may not be able to
successfully negotiate the terms of the acquisition or finance the acquisition
on terms that are satisfactory to us. Negotiations of potential acquisitions and
the integration of acquired business operations could disrupt our business
by diverting management attention from day-to-day operations. Acquisitions of
businesses or other material operations may require debt or equity financing,
resulting in leverage or dilution of ownership. We may encounter increased
competition for acquisitions, which may increase the price of our
acquisitions.




Integration
of acquisitions requires significant management time and financial resources.
Any failure to properly integrate and manage businesses we acquire could
seriously harm our operating results. In addition, acquired companies
may not perform as well as we expect, and we may fail to realize
anticipated benefits. In connection with acquisitions, we may issue common stock
that would dilute our current stockholders’ ownership and incur debt and other
costs which may cause our quarterly operating results to vary significantly. The
dilution of our current stockholders’ ownership may be exacerbated if our per
share stock price is depressed and common stock is issued in connection with
acquisitions.




49




If we are
unable to successfully integrate companies we may acquire, our revenue and
operating results could suffer. The integration of such businesses into our
operations may result in unforeseen operating difficulties, may absorb
significant management attention and may require significant financial resources
that would otherwise be available for other business purposes. These
difficulties of integration may require us to coordinate geographically
dispersed organizations, integrate personnel with disparate business backgrounds
and reconcile different corporate cultures. In addition, we may not be
successful in achieving anticipated synergies from these
acquisitions.  We may experience increased attrition, including, but
not limited to, key employees of the acquired companies, during and following
the integration of acquired companies that could reduce our future
revenue.




In
addition, we may need to record write-downs from future impairments of
identified intangible assets and goodwill, which could reduce our future
reported earnings. Acquired companies may have liabilities or adverse operating
issues that we fail to discover through due diligence prior to the acquisition.
In particular, to the extent that prior owners of any acquired businesses or
properties failed to comply with or otherwise violated applicable laws or
regulations, or failed to fulfill their contractual obligations to their
customers or clients, we, as the successor owner, may be financially responsible
for these violations and failures and may suffer reputational harm or otherwise
be adversely affected. The discovery of any material liabilities associated with
our acquisitions could cause us to incur additional expenses and cause a
reduction in our operating profits.





Disruptions
in the Debt and Capital Markets Will Have an Adverse Affect on Our Ability to
Obtain Funding





The debt
and capital markets have been experiencing extreme volatility and disruption for
more than twelve months.  These issues, along with significant
write-offs in the financial services sector, the re-pricing of credit risk, and
the current weak economic conditions have made, and will likely continue to
make, it difficult to obtain funding.  The cost of accessing the
credit markets has increased as many lenders and institutional investors have
increased interest rates, enacted tighter lending standards, and reduced or
ceased to provide funding to borrowers.  Adverse changes in the
economy could limit our ability to obtain financing from debt or capital sources
or could adversely affect the terms on which we may be able to obtain any such
financing  in the event we need to finance our share repurchases and
acquisitions.  See “Part I – Item 2. “Management’s Discussion and
Analysis of Financial Condition and Results of Operations-Liquidity and Capital
Resources-Liquidity.”





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 Holocom to which we have guaranteed third party debt. 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
investments  accounted for under the equity method (PDS and Talis), we
record as part of other income or expense our share of the increase or decrease
in the equity of these companies in which we have invested. Our investment in
Avot is recorded at cost basis.  It is possible that, in the future,
our relationships and/or our interests in or with this consolidated entity,
equity method investees and cost basis 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.





A
Successful Challenge To Our Intellectual Property Rights Could Have A
Significant And Adverse Effect On Us




50




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 seven U.S. patents, one
European patent, and one Japanese patent issued. Any issued patent may be
challenged and invalidated. Patents may not be issued for any of our pending
applications. Any claims allowed from existing or pending patents may not be of
sufficient scope or strength to provide significant protection for our products.
Patents may not be issued in all countries where our products can be sold so as
to provide meaningful protection or any commercial advantage to us. Our
competitors may also be able to design around our patents.





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





On
December 18, 2007 we announced that a resolution was reached in two patent
infringement lawsuits in the U.S. District Courts in the Eastern District of
Texas and the Northern District of California.  There are no
assurances that the resolution will favorably impact, or that it will not
impair, our ability to assert our technology rights in the future.





During
the quarter ended February 29, 2008, we were named as co-defendants in three
separate lawsuits regarding the MMP Portfolio. On December 1, 2008 we were named
as co-defendants in a lawsuit regarding the MMP Portfolio.  See
footnote 15 to our condensed consolidated financial statements and Part II, Item
1. Legal Proceedings in this Report on Form 10-Q.





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





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





A
Significant Portion Of Our Investments Are Currently Illiquid Which May Impact
Our Acquisition Strategy And/Or Operating Results





Our
long-term investment in marketable securities balance consists of auction rate
securities with a par value of $12.9 million, which at present are highly
illiquid. In the event we need immediate access to these funds, we will not be
able to sell these investments at par value. These instruments are expected to
remain illiquid until a future auction of these investments is successful,
buyers are found outside of the auction process, or they are redeemed by the
issuing agencies. We have partially offset the consequences of this illiquidity
by securing a line of credit collateralized by the auction rates securities,
however the amount we can borrow against our collateral is limited by FINRA. In
the event these securities are deemed to be permanently impaired, we will be
required to take a charge to operations in recognition of this
impairment.





The
Market For Our Stock Is Subject To Rules Relating To Low-Priced Stock (“Penny
Stock”) Which May Limit Our Ability To Raise Capital




51




Our
common stock is currently listed for trading in the Financial Industry
Regulatory Authority (“FINRA”) 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.





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
3. 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 and cash equivalents with high quality
financial institutions. Amounts deposited with these institutions may exceed
federal depository insurance limits.





Cash
and Cash Equivalents





We
maintain cash and cash equivalents 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.





Auction
Rate Securities




52




Our
exposure to market risk for changes in interest rates relates primarily to our
auction rate securities.  During the quarter ended February 29, 2008,
investment banks were reporting an inability to successfully obtain subscribers
for high credit quality auction rate securities.  As of November 30,
2008, we held such auction rate securities with a par value totaling $12.9
million that failed to sell at auction. In the event we need to access funds
invested in these auction rate securities we will not be able to liquidate these
securities until a future auction of these securities is successful, they are
refinanced and redeemed by the issuers, or a buyer is found outside of the
auction process.  The investments consist of student loan auction rate
instruments issued by various state agencies pursuant to the Federal Family
Educational Loan Program (“FFELP”).  These investments are of high
credit quality and the AAA credit ratings of the investments have been
reaffirmed since November 2008.  These instruments are collateralized
in excess of the underlying obligations, are insured by the various state
educational agencies, and are guaranteed by the Department of Education as an
insurer of last resort.





At
November 30, 2008, the fair value of our auction rate securities was estimated
at $11.5 million based on a valuation by Houlihan Smith & Company,
Inc.  We recorded the net temporary valuation adjustment of $830,342
in other comprehensive income, which represents the gross valuation adjustment
of $1,401,325, net of the related tax benefit of $570,983.  We have
concluded that the unrealized losses on these investments are temporary because
(i) we believe that the decline in market value and absence of liquidity that
has occurred is due to general market conditions, (ii) the auction rate
securities continue to be of a high credit quality and interest is paid as due
and (iii) we have the intent and ability to hold these investments until a
recovery in market value occurs.  Since this valuation adjustment is
deemed to be temporary, it did not affect our earnings for the three and six
months ended November 30, 2008.





We are
not currently able to predict how long these investments will remain illiquid,
and as such, they have been classified as long-term investments in marketable
securities in the accompanying consolidated balance sheet at November 30,
2008.





The fair
value of our long-term investments in marketable securities could change
significantly in the future and we may be required to record
other-than-temporary impairment charges or additional unrealized losses in
future periods.





We do not
believe that the illiquidity of these investments will materially impact our
ability to fund our working capital needs, capital expenditures or other
business requirements.





During
June 2008 we obtained a credit facility which provides for financing up to 50%
of the par value balance of our outstanding auction rate securities. The
facility is collateralized by the full value of the outstanding auction rate
securities, required no origination fee, and when drawn upon will bear interest
at the federal funds rate plus 3%.  On October 14, 2008 we drew
$3,000,000 on the credit facility.





Item
4. Controls and Procedures





Quarterly
Evaluation of Disclosure Controls and Procedures




As
required by Rule 13a-15(e) under the Exchange Act, as of November 30,
2008, the end of the period to which this quarterly report relates, we have
carried out an evaluation of the effectiveness of the design and operation of
our disclosure controls and procedures.  This evaluation was carried
out under the supervision and with the participation of our management,
including our Chief Executive Officer and our Chief Financial
Officer.




Disclosure
controls and procedures are controls and other procedures that are designed to
ensure that information required to be disclosed in our report filed or
submitted under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the Securities and Exchange
Commission’s rules and forms.  Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed in our reports filed under the Exchange Act
is accumulated and communicated to management, including the Chief Executive
Officer and Chief Financial Officer as appropriate, to allow timely decisions
regarding required disclosure. Management recognizes that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving their objectives, and management necessarily
applies its judgment in evaluating the cost-benefit relationship of possible
controls and procedures.  Based on the evaluation of our disclosure
controls and procedures as of November 30, 2008, our Chief Executive
Officer and Chief Financial Officer concluded that, as of such date, our
disclosure controls and procedures were effective.




53




Changes
in Internal Control over Financial Reporting




There
were no changes to our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our most
recently completed fiscal quarter that materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.




PART
II- OTHER INFORMATION





Item
1. Legal Proceedings





Patent
Litigation





On
February 8, 2008, we, TPL and Alliacense Ltd. were named as defendants in three
separate lawsuits filed in the United States District Court for the Northern
District of California by Asustek Computer, Inc., HTC Corporation, and Acer,
Inc., and affiliated entities of each of them. On February 13, 2008, the Asustekclaims were amended
to include claims against MCM Portfolio, LLC (Alliacense and MCM Portfolio are
TPL-related entities), which do not involve us.





The Asustekcase seeks
declaratory relief that its products do not infringe enforceable claims of the
'336, '584 and '749 patents. The Asustekcase also seeks a
similar declaration with respect to two patents owned by TPL that are not a part
of the MMP Portfolio, and as such we are not engaged in this aspect of the
litigation and defense. The Acercase seeks declaratory
relief that its products do not infringe enforceable claims of the '336, '584
and '749 patents. The HTCcase similarly seeks declaratory relief that its products do not infringe
enforceable claims of those three patents and the '148 patent.





On April
25, 2008, we and TPL filed five patent infringement lawsuits in the Eastern
District of Texas against HTC, Acer and Asustek. These suits allege infringement
by HTC and Acer with respect to the '336 '749 '584 and '148 patents; and by
Asustek with respect to the '336, '749 and '584 patents. On June 4, 2008, we and
TPL filed patent infringement lawsuits against those parties in the Eastern
District of Texas with respect to the ‘890 patent of the MMP
Portfolio.  The Asustekaction in the Eastern
District of Texas is inclusive of matters with respect to two patents owned by
TPL that are not  a part of the MMP Portfolio, and accordingly we are
not engaged in this aspect of the litigation and defense (collectively, these
cases are referred to as the "T-3" Litigation).





Motions
to dismiss or transfer the Northern District of California actions to the
Eastern District of Texas were heard on September 19, 2008 by U.S. District
Judge Jeremy Fogel and subsequently denied.  Whether the Texas action
will be transferred in whole or in part to Judge Fogel has not been
determined.  The discovery phase has just begun with trial expected to
be scheduled in late 2009 or early 2010.





On
December 1, 2008, we, TPL and Alliascense, Ltd. were named as defendants in a
lawsuit filed in the Northern District of California by Barco,
N.V.  The Barco case seeks declaratory
relief that its products do not infringe enforceable claims of the '584, '749
and '890 patents.  We anticipate responding to the Complaint in early
2009.





On
December 22, 2008, we announced that Asustek had purchased a MMP Portfolio
license, leaving HTC and Acer as the remaining defendants in the above
action.





Deutsche
Bank Arbitration




54




On
October 16, 2008, we initiated binding arbitration claims before FINRA against
Deutsche Bank  Securities, Inc., and affiliates ("DBSI") based on
advisory services provided to us resulting in our purchases of auction rate
securities ("ARS") and the failure of the ARS market in February
2008.  We experienced a  loss of liquidity and other damages
as a result, and allege DBSI engaged in negligence and nondisclosure in
providing us services.  DBSI has not yet responded to the
claim.  Some instruments have been repurchased  by the
issuers since the claim was filed.





Item
1A. Risk Factors





Please
see Part I, Item 2, above, for our risk factors.  Following are the
material updates to the risk factors previously disclosed in our Report on Form
10-K.





Disruptions
in the Debt and Capital Markets Will Have an Adverse Affect on Our Ability to
Obtain Funding





The debt
and capital markets have been experiencing extreme volatility and disruption for
more than twelve months.  These issues, along with significant
write-offs in the financial services sector, the re-pricing of credit risk, and
the current weak economic conditions have made, and will likely continue to
make, it difficult to obtain funding.  The cost of accessing the
credit markets has increased as many lenders and institutional investors have
increased interest rates, enacted tighter lending standards, and reduced or
ceased to provide funding to borrowers.  Adverse changes in the
economy could limit our ability to obtain financing from debt or capital sources
or could adversely affect the terms on which we may be able to obtain any such
financing  in the event we need to finance our share repurchases and
acquisitions.  See “Part I – Item 2. “Management’s Discussion and
Analysis of Financial Condition and Results of Operations-Liquidity and Capital
Resources-Liquidity.”





Item
2. Unregistered Sales of Equity Securities and Use of Proceeds





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.  As part of the program, we purchased 5,318,976 shares of our
common stock at an aggregate cost of $1,029,107 during the six months ended
November 30, 2008.





Following
is a summary of all repurchases by the Company of its common stock during the
six month period ended November 30, 2008:







Period
            
            
            Total
              Number
      of
              Shares
              Purchased
            
            
            
            Average
      Price
              Paid
      per
              Share
            
            
            
            Total
      Number of Shares Purchased as Part of Publicly Announced Plans or
      ProgramsJune
      1 – 30, 2008
            
            
            605,000
            
            
            $
            0.25
            
            
            
            605,000July
      1 – 31, 2008
            
            
            1,361,160
            
            
            $
            0.18
            
            
            
            1,361,160August
      1 – 31, 2008
            
            
            401,000
            
            
            $
            0.26
            
            
            
            401,000September
      1 – 30, 2008
            
            
            1,245,875
            
            
            $
            0.21
            
            
            
            1,245,875October
      1 – 31, 2008
            
            
            889,276
            
            
            $
            0.17
            
            
            
            889,276November
      1 – 30, 2008
            
            
            816,665
            
            
            $
            0.14
            
            
            
            816,665Total
            
            
            5,318,976
            
            
            $
            0.19
            
            
            
            5,318,976




55




On
September 2, 2008 we issued 17,583,235 shares of our common stock to the
exchange agent in connection with the Crossflo acquisition.  The
shares were valued at $0.24389 per share based on the provisions of the merger
agreement and the value was allocated among the assets as set forth in Note 2 to
our consolidated financial statements.





On
September 2, 2008 we issued 2,844,630 shares of our common stock to the escrow
agent in connection with the Crossflo acquisition.  The shares were
valued at $0.24389 per share based on the provisions of the merger agreement and
the value was allocated among the assets as set forth in Note 2 to our
consolidated financial statements.





On
September 4, 2008, we issued 1,456,394 shares of our common stock to Crossflo’s
financial consultant  for broker services in connection with the
Crossflo acquisition.  The shares were valued at $0.24389 per share
based on the provisions of the merger agreement and the value was allocated
among the assets as set forth in Note 2 to our consolidated financial
statements.





On
September 5, 2008 we issued 4,133,267 shares of our common stock to Crossflo’s
convertible note holders in connection with the Note Conversion Agreement
associated with the Crossflo acquisition.  The shares were valued at
$0.24389 per share based on the provisions of the merger agreement and the value
was allocated among the assets as set forth in Note 2 to our consolidated
financial statements.





On
September 12, 2008 we issued 970,929 shares of our common stock to Crossflo’s
convertible note holders in connection with the Note Conversion Agreement
associated with the Crossflo acquisition.  The shares were valued at
$0.24389 per share based on the provisions of the merger agreement and the value
was allocated among the assets as set forth in Note 2 to our consolidated
financial statements.





Item
3. Defaults Upon Senior Securities





None.





Item
4. Submission of Matters to a Vote of Security Holders





At our
fiscal 2008 Annual Meeting of Shareholders held on October 30, 2008, the
following individuals were elected to the Board of Directors of the Company:
Carlton M. Johnson, Jr., Helmut Falk, Jr., Gloria H. Felcyn, Harry L.
Tredennick, III and Donald E. Schrock.





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





1.
            Proposal
      to increase the number of shares authorized under our 2006 Stock Option
      Plan from 5,000,000 to 10,000,000:




Votes
      For
            
            Votes
      Against
            
            Votes
      Abstaining54,347,836
            
            37,927,311
            
            1,099,112








2.
            Proposal
      to amend our Certificate of Incorporation to increase the number of
      authorized shares of common stock, $0.00001 par value, from 500,000,000 to
      600,000,000:




Votes
      For
            
            Votes
      Against
            
            Votes
      Abstaining196,810,597
            
            101,410,329
            
            3,399,098





56




3.
            Proposal
      to ratify management’s selection of KMJ Corbin & Company LLP as
      our independent auditors:




Votes
      For
            
            Votes
      Against
            
            Votes
      Abstaining283,568,815
            
            10,416,382
            
            7,634,826








4.
            Election
      of Directors:





Director
            
            Votes
      For
            
            Votes
      Abstaining
              and/or
      AgainstCarlton
      M. Johnson, Jr.
            
            252,726,778
            
            48,893,246Helmut
      Falk, Jr.
            
            257,753,650
            
            43,866,374Gloria
      H. Felcyn
            
            252,907,727
            
            48,712,297Harry
      L. Tredennick, III
            
            269,970,235
            
            31,649,788Donald
      E. Schrock
            
            272,890,341
            
            28,729,682





Item
5. Other Information





None.





Item
6. Exhibits





Those
exhibits marked with an asterisk (*) refer to exhibits filed herewith. The other
exhibits are incorporated herein by reference, as indicated in the following
list.




Exhibit No.
            Document2.1
            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)2.5
            Agreement
      and Plan of Merger dated August 4, 2008, among the Company, PTSC
      Acquisition 1 Corp, Crossflo Systems, Inc. and the Crossflo principal
      officers, incorporated by reference to Exhibit 99.1 to Form 8-K filed
      August 11, 2008 (Commission file No. 000-22182)




57




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)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)




58




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)10.1
            Employment
      Agreement dated September 17, 2007 by and between the Company and Clifford
      L. Flowers, incorporated by reference to Exhibit 10.1 to Form 8-K filed
      September 19, 2007 (Commission file No. 000-22182)10.2
            Employment
      Agreement dated February 29, 2008 by and between the Company and Frederick
      C. Goerner, incorporated by reference to Exhibit 99.1 to Form 8-K filed
      May 20, 2008 (Commission file No. 000-22182)23.1*
            Consent
      of Independent Valuation Firm31.1*
            Certification
      of Frederick C. Goerner, CEO, pursuant to Rule
      13a-14(a)/15d-14(a)31.2*
            Certification
      of Clifford L. Flowers, CFO, pursuant Rule
    13a-14(a)/15d-14(a)32.1*
            Certification
      of Frederick C. Goerner, CEO, pursuant to Section 1350 of Chapter 63 Title
      18 of the United States Code32.2*
            Certification
      of Clifford L. Flowers, CFO, pursuant to Section 1350 of Chapter 63 Title
      18 of the United States Code




59




SIGNATURES




Pursuant
to the requirements 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:  January 9,
      2009
            PATRIOT
      SCIENTIFIC CORPORATION
              
              /S/
      FREDERICK C. GOERNER
              
              /s/
      Frederick C. GoernerFrederick C.
      Goerner

              
              Chief
      Executive Officer





In
accordance with the Exchange Act, 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/
      FREDERICK C. GOERNERFrederick
      C. Goerner
            President
      and Chief Executive Officer
            January
      9, 2009/S/
      CLIFFORD L. FLOWERSClifford
      L. Flowers
            Chief
      Financial Officer and Principal Accounting Officer
            January
      9, 2009/S/
      CARLTON M. JOHNSONCarlton M. Johnson
            Director
            January
      9, 2009/S/
      GLORIA H. FELCYNGloria
      H. Felcyn
            Director
            January
      9, 2009/S/
      HELMUT FALK, JR.Helmut
      Falk, Jr.
            Director
            January
      9, 2009/S/
      HARRY L. TREDENNICKHarry
      L. Tredennick
            Director
            January
      9, 2009/S/
      DONALD E. SCHROCKDonald
      E. Schrock
            Director
            January
      9, 2009