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 February 28, 2009




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 the 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 April
3, 2009, 410,664,229 shares of common stock, par value $.00001 per share were
outstanding.







INDEX





PagePART
      I. FINANCIAL INFORMATIONITEM
      1. Financial StatementsCondensed
      consolidated Balance Sheets as of February 28, 2009 (unaudited) and May
      31, 2008
            3Condensed
      consolidated Statements of Operations for the three and nine months ended
      February 28, 2009 and February 29, 2008 (unaudited)
            4Condensed
      consolidated Statements of Cash Flows for the nine months ended February
      28, 2009 and February 29, 2008 (unaudited)
            5Notes
      to condensed consolidated Financial Statements (unaudited)
            7-36ITEM
      2. Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
            37-54ITEM
      3. Quantitative and Qualitative Disclosures About Market
    Risk
            54ITEM
      4. Controls and Procedures
            55PART
      II. OTHER INFORMATIONITEM
      1. Legal Proceedings
            56ITEM
      1A. Risk Factors
            57ITEM
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
            57ITEM
      3. Defaults Upon Senior Securities
            57ITEM
      4. Submission of Matters to a Vote of Security Holders
            57ITEM
      5. Other Information
            57ITEM
      6. Exhibits
            58-60SIGNATURES
            61




2





PART
I- FINANCIAL INFORMATION


Item 1. Financial
Statements


Patriot
Scientific Corporation


Condensed
Consolidated Balance Sheets


February
      28, 2009
            
            
            May
      31, 2008ASSETS
            
            (Unaudited)Current
      assets:Cash
      and cash equivalents
            
            $
            7,038,888
            
            
            $
            6,424,015Restricted
      cash and cash equivalents
            
            
            51,998
            
            
            
            51,122Marketable
      securities and short term investments
            
            
            68,797
            
            
            
            298,243Accounts
      receivable
            
            
            809,056
            
            
            
            538,500Accounts
      receivable - affiliated company
            
            
            9,901
            
            
            
            7,501Notes
      receivable
            
            
            100,067
            
            
            
            450,115Inventory
            
            
            981,801
            
            
            
            388,141Work-in-process
            
            
            96,442
            
            
            
            -Prepaid
      income taxes
            
            
            -
            
            
            
            222,311Deferred
      tax assets
            
            
            831,170
            
            
            
            1,390,832Prepaid
      expenses and other current assets
            
            
            213,731
            
            
            
            79,840Total
      current assets
            
            
            10,201,851
            
            
            
            9,850,620Marketable
      securities
            
            
            10,318,249
            
            
            
            12,527,675Property
      and equipment, net
            
            
            94,783
            
            
            
            68,504Goodwill
            
            
            1,865,142
            
            
            
            -Other
      intangible assets, net
            
            
            5,982,691
            
            
            
            63,299Deferred
      tax assets
            
            
            3,801,222
            
            
            
            -Other
      assets
            
            
            46,885
            
            
            
            8,190Investments
      in affiliated companies
            
            
            2,808,150
            
            
            
            2,913,614Total
      assets
            
            $
            35,118,973
            
            
            $
            25,431,902LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
            
            $
            506,462
            
            
            $
            555,690Accrued
      expenses and other
            
            
            730,095
            
            
            
            373,848Notes
      payable
            
            
            50,000
            
            
            
            -Deferred
      revenue
            
            
            52,055
            
            
            
            -Income
      taxes payable
            
            
            1,027,213
            
            
            
            -Total
      current liabilities
            
            
            2,365,825
            
            
            
            929,538Long
      term debt, including accrued interest
            
            
            3,025,421
            
            
            
            -Deferred
      tax liabilities
            
            
            -
            
            
            
            1,085,181Total
      long term liabilities
            
            
            3,025,421
            
            
            
            1,085,181Total
      liabilities
            
            
            5,391,246
            
            
            
            2,014,719Commitments and
      contingenciesMinority
      interest
            
            
            379,696
            
            
            
            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 410,664,229 shares outstanding at February 28, 2009 and
      500,000,000 shares authorized: 410,979,163 shares issued and 389,414,915
      shares outstanding at May 31, 2008
            
            
            4,380
            
            
            
            4,109Additional
      paid-in capital
            
            
            76,927,334
            
            
            
            70,004,814Accumulated
      deficit
            
            
            (32,975,451
            )
            
            
            (33,763,357
            )Common
      stock held in treasury, at cost – 27,403,389 shares and 21,564,248 shares
      at February 28, 2009 and May 31,
    2008,  respectively
            
            
            (13,819,116
            )
            
            
            (12,723,172
            )Accumulated
      other comprehensive loss
            
            
            (789,116
            )
            
            
            (220,617
            )Total
      stockholders’ equity
            
            
            29,348,031
            
            
            
            23,301,777Total
      liabilities and stockholders’ equity
            
            $
            35,118,973
            
            
            $
            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
            
            
            Nine
      Months EndedFebruary
      28,2009
            
            
            February
      29,2008
            
            
            February
      28,2009
            
            
            February
      29,2008Revenues:Product
      sales and other
            
            $
            1,193,378
            
            
            $
            801,284
            
            
            $
            4,168,932
            
            
            $
            2,268,484License
      and service revenue
            
            
            216,823
            
            
            
            -
            
            
            
            475,177
            
            
            
            -Total
      revenues
            
            
            1,410,201
            
            
            
            801,284
            
            
            
            4,644,109
            
            
            
            2,268,484Cost
      of sales:Product
      sales and other
            
            
            534,555
            
            
            
            345,084
            
            
            
            1,819,172
            
            
            
            852,958License
      and service revenue
            
            
            89,195
            
            
            
            -
            
            
            
            254,335
            
            
            
            -Amortization
      of purchased intangibles
            
            
            223,902
            
            
            
            -
            
            
            
            435,204
            
            
            
            -Total
      cost of sales
            
            
            847,652
            
            
            
            345,084
            
            
            
            2,508,711
            
            
            
            852,958Gross
      profit
            
            
            562,549
            
            
            
            456,200
            
            
            
            2,135,398
            
            
            
            1,415,526Operating
      expenses:Research
      and development
            
            
            117,781
            
            
            
            -
            
            
            
            269,655
            
            
            
            -Selling,
      general and administrative
            
            
            2,088,100
            
            
            
            1,364,077
            
            
            
            6,194,627
            
            
            
            5,308,631Settlement
      and license expense
            
            
            -
            
            
            
            417,740
            
            
            
            -
            
            
            
            836,400Total
      operating expenses
            
            
            2,205,881
            
            
            
            1,781,817
            
            
            
            6,464,282
            
            
            
            6,145,031Operating
      loss
            
            
            (1,643,332
            )
            
            
            (1,325,617
            )
            
            
            (4,328,884
            )
            
            
            (4,729,505
            )Other
      income (expense):Interest
      and other income
            
            
            63,257
            
            
            
            318,284
            
            
            
            320,850
            
            
            
            1,093,876Loss
      on sale of assets
            
            
            -
            
            
            
            (2,242
            )
            
            
            (1,733
            )
            
            
            (3,511
            )Interest
      expense
            
            
            (27,396
            )
            
            
            -
            
            
            
            (48,158
            )
            
            
            (237
            )Gain
      on sale of subsidiary interest
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            150,000Equity
      in earnings (loss) of affiliated companies
            
            
            (921,883
            )
            
            
            11,696,265
            
            
            
            5,746,626
            
            
            
            15,981,763Total
      other income (expense), net
            
            
            (886,022
            )
            
            
            12,012,307
            
            
            
            6,017,585
            
            
            
            17,221,891Income
      (loss) before income taxes and minority interest
            
            
            (2,529,354
            )
            
            
            10,686,690
            
            
            
            1,688,701
            
            
            
            12,492,386Provision
      (benefit) for income taxes
            
            
            (1,111,374
            )
            
            
            4,394,505
            
            
            
            636,505
            
            
            
            5,746,050Minority
      interest
            
            
            71,367
            
            
            
            -
            
            
            
            264,290
            
            
            
            -Net
      income (loss)
            
            $
            (1,489,347
            )
            
            $
            6,292,185
            
            
            $
            787,906
            
            
            $
            6,746,336Basic
      income (loss) per common share
            
            $
            -
            
            
            $
            0.02
            
            
            $
            -
            
            
            $
            0.02Diluted
      income (loss) per common share
            
            $
            -
            
            
            $
            0.02
            
            
            $
            -
            
            
            $
            0.02Weighted
      average number of common shares outstanding-basic
            
            
            408,030,851
            
            
            
            391,472,101
            
            
            
            401,578,784
            
            
            
            391,055,464Weighted
      average number of common shares outstanding-diluted
            
            
            408,030,851
            
            
            
            395,666,621
            
            
            
            404,026,257
            
            
            
            396,382,070





See
accompanying notes to unaudited condensed consolidated financial
statements.


4





Patriot
Scientific Corporation


Condensed
Consolidated Statements of Cash Flows


(Unaudited)




Nine
      months endedFebruary
      28,2009
            
            
            February
      29,2008Operating
      activities:Net
      income
            
            $
            787,906
            
            
            $
            6,746,336Adjustments
      to reconcile net income to net cash used in operating
      activities:Minority
      interest in variable interest entity
            
            
            264,290
            
            
            
            -Amortization
      and depreciation
            
            
            486,015
            
            
            
            36,454Non-cash
      compensation relating to issuance of stock options and vesting
      of  warrants
            
            
            324,380
            
            
            
            407,652Accrued
      interest income added to investments and notes receivable
            
            
            (8,287
            )
            
            
            (959
            )Equity
      in earnings of affiliated companies
            
            
            (5,746,626
            )
            
            
            (15,981,763
            )Loss
      on disposal of assets
            
            
            1,733
            
            
            
            3,513Value
      of stock issued in connection with legal settlement
            
            
            -
            
            
            
            100,000Write-off
      of patent costs
            
            
            21,527
            
            
            
            -Deferred
      income taxes
            
            
            (1,762,371
            )
            
            
            (9,473,195
            )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
      acquisitions:Accounts
      receivable
            
            
            (144,377
            )
            
            
            (45,584
            )Receivable
      from affiliated company
            
            
            (2,400
            )
            
            
            (3,616
            )Inventory
            
            
            (593,660
            )
            
            
            (269,594
            )Work-in-process
            
            
            (84,784
            )
            
            
            -Prepaid
      expenses and other current assets
            
            
            74,893
            
            
            
            250,896Prepaid
      income taxes
            
            
            222,311
            
            
            
            2,070,981Accounts
      payable and accrued expenses
            
            
            (182,544
            )
            
            
            (1,425,157
            )Deferred
      revenue
            
            
            52,055
            
            
            
            -Income
      taxes payable
            
            
            1,027,213
            
            
            
            3,982,909Net
      cash used in operating activities
            
            
            (5,262,726
            )
            
            
            (13,776,772
            )Investing
      activities:Proceeds
      from sales of marketable securities
            
            
            1,582,287
            
            
            
            6,800,159Purchases
      of short-term investments
            
            
            (102,629
            )
            
            
            (18,072,953
            )Proceeds
      from sale of restricted investments
            
            
            -
            
            
            
            52,500Purchases
      of property and equipment
            
            
            (23,681
            )
            
            
            (20,411
            )Proceeds
      from sale of property and equipment
            
            
            -
            
            
            
            125Costs
      incurred for patents and trademarks
            
            
            -
            
            
            
            (7,344
            )Proceeds
      from VIE sale of portion of subsidiary interest
            
            
            -
            
            
            
            100,000Issuance
      of notes receivable
            
            
            (133,000
            )
            
            
            -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
            
            
            
            16,666,800Cash
      paid in Crossflo acquisition, net of cash acquired
            
            
            (2,578,281
            )
            
            
            -Cash
      paid in Verras Medical acquisition, net of cash acquired
            
            
            (98,824
            )
            
            
            -Net
      cash provided by investing activities
            
            
            4,130,454
            
            
            
            5,518,876Financing
      activities:Proceeds
      from exercise of common stock warrants and options
            
            
            5,000
            
            
            
            18,200Repurchase
      of warrants
            
            
            -
            
            
            
            (2,760,900
            )Payments
      on notes payable
            
            
            (416,393
            )
            
            
            -Issuance
      of notes payable
            
            
            3,250,000
            
            
            
            -Repurchase
      of common stock for treasury
            
            
            (1,095,944
            )
            
            
            (3,042,921
            )Tax
      effect of exercise of options granted under APB 25
            
            
            4,482
            
            
            
            -Net
      cash provided by (used in) financing activities
            
            
            1,747,145
            
            
            
            (5,785,621
            )Net
      increase (decrease) in cash and cash equivalents
            
            
            614,873
            
            
            
            (14,043,517
            )Cash
      and cash equivalents, beginning of period
            
            
            6,424,015
            
            
            
            21,605,428Cash
      and cash equivalents, end of period
            
            $
            7,038,888
            
            
            $
            7,561,911




5


Patriot
Scientific Corporation


Condensed
Consolidated Statements of Cash Flows


(Unaudited)





Nine
      months endedFebruary
      28,2009
            
            
            February
      29,2008Supplemental
      Disclosure of Cash Flow Information:Cash
      payments for interest
            
            $
            48,158
            
            
            $
            237Cash
      payments for income taxes
            
            $
            1,143,785
            
            
            $
            9,191,000Supplemental
      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
            
            $
            (390,927
            )
            
            $
            -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
            
            
            $
            -Conversion
      of note receivable plus accrued interest in connection with Verras
      Medical, Inc. acquisition
            
            $
            33,154
            
            
            $
            -




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 three and nine-month periods
ended February 28, 2009 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 nine months ended
February 29, 2008 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 February 28, 2009 and the condensed
consolidated statements of operations for the three and nine months ended
February 28, 2009 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 condensed
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 (“SOP”) 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 condensed consolidated
statements 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 (Loss)


Comprehensive
income (loss) 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 nine months ended February 28, 2009, this
amount included unrealized losses on investments classified as
available-for-sale.  The amount is presented net of tax-related
benefits of $390,927.


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 AICPA SOP No. 97-2,Software Revenue
Recognition, and all related amendments and
interpretations.  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
on  these arrangements according to the provisions of 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 February 28, 2009,
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 during the nine months ended February 28, 2009.





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 and unreimbursed shipping to customers 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 months ended February 28,
2009, all potential common shares related to our outstanding warrants and
options totaling 10,530,000 shares were not included in the calculation of
diluted loss per share as they had an anti-dilutive effect.  For the
nine months ended February 28, 2009, 8,950,000 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 nine months ended February 29, 2008,
3,320,000 potentially dilutive common shares and 3,420,000 potentially dilutive
common shares, respectively, 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 February 28, 2009Numerator
      (Income)
              
              
              Denominator
      (Shares)
              
              
              Per
      Share AmountBasic
      EPS:Net loss
              
              $
              (1,489,347
              )
              
              
              408,030,851
              
              
              $
              -Diluted
      EPS:Effect
      of dilutive securities:Options and
    warrants
              
              
              -
              
              
              
              -Loss
      available to common shareholders
              
              $
              (1,489,347
              )
              
              
              408,030,851
              
              
              $
              -


10


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Net
Income (Loss) Per Share (continued)





Three
      Months Ended February 29, 2008Numerator
      (Income)
            
            
            Denominator
      (Shares)
            
            
            Per
      Share AmountBasic
      EPS:Net income
            
            $
            6,292,185
            
            
            
            391,472,101
            
            
            $
            0.02Diluted
      EPS:Effect
      of dilutive securities:Options and
    warrants
            
            
            -
            
            
            
            4,194,520Income
      available to common shareholders
            
            $
            6,292,185
            
            
            
            395,666,621
            
            
            $
            0.02








Nine
      Months Ended February 28, 2009Numerator
      (Income)
            
            
            Denominator
      (Shares)
            
            
            Per
      Share AmountBasic
      EPS:Net income
            
            $
            787,906
            
            
            
            401,578,784
            
            
            $
            -Diluted
      EPS:Effect
      of dilutive securities:Options and
    warrants
            
            
            -
            
            
            
            582,313Add:
      escrow shares
            
            
            -
            
            
            
            1,865,160Income
      available to common shareholders
            
            $
            787,906
            
            
            
            404,026,257
            
            
            $
            -








Nine
      Months Ended February 29, 2008Numerator
      (Income)
            
            
            Denominator
      (Shares)
            
            
            Per
      Share AmountBasic
      EPS:Net income
            
            $
            6,746,336
            
            
            
            391,055,464
            
            
            $
            0.02Diluted
      EPS:Effect
      of dilutive securities:Options and
    warrants
            
            
            -
            
            
            
            5,326,606Income
      available to common shareholders
            
            $
            6,746,336
            
            
            
            396,382,070
            
            
            $
            0.02




11


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Minority
Interest





Minority
interest in our condensed 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. From the date in which we were required to
begin consolidating Holocom, 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
condensed 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
nine months ended February 28, 2009, the minority interest was $264,290 which
represents the amount of Holocom’s net income after taxes on a consolidated
basis.  The minority interest in the income for the nine months is
added to the May 31, 2008 balance of $115,406 for a total of $379,696 as
presented in our condensed consolidated balance sheet at February 28,
2009.





Stock-Based
Compensation





Stock-based
compensation expense recognized during the period is based on the grant date
fair value of the portion of share-based payment awards ultimately expected to
vest during the period in accordance with the provisions of SFAS No.
123(R),Share-Based Payment.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 nine months ended
February 28, 2009 and February 29, 2008 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 nine months ended
February 28, 2009 and February 29, 2008 was five years.


12


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements




Stock-Based
Compensation (continued)




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
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
nine months ended February 28, 2009 and February 29, 2008 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
                                              Ended
                                            
                                            Nine
      MonthsEnded
                                            
                                            Three
      Months
                                              Ended
                                            
                                            Nine
      MonthsEndedFebruary
      28,2009
                                              (Unaudited)
                                            
                                            February
      28, 2009 (Unaudited)
                                            
                                            February
      29,2008
                                              (Unaudited)
                                            
                                            February
      29, 2008
                                              (Unaudited)Expected
      term
                                            
                                            5
                                            years
                                            
                                            5
                                            years
                                            
                                            5
                                            years
                                            
                                            5
                                            yearsExpected
      volatility
                                            
                                            120-125
                                            %
                                            
                                            120-125
                                            %
                                            
                                            124
                                            %
                                            
                                            124-128
                                            %Risk-free
      interest rate
                                            
                                            1.67-1.75
                                            %
                                            
                                            1.67–3.23
                                            %
                                            
                                            2.5
                                            %
                                            
                                            2.5
      – 4.96
                                            %Expected
      dividends
                                            
                                            2.82
                                            %
                                            
                                            2.82
                                            %
                                            
                                            2.82
                                            %
                                            
                                            2.82
                                            %





A summary
of option activity as of February 28, 2009 and changes during the nine 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
            
            
            1,950,000
            
            
            $
            0.21Options
      exercised
            
            
            (100,000
            )
            
            $
            0.05Options
      forfeited
            
            
            (65,000
            )
            
            $
            0.50Options
      outstanding at February 28, 2009
            
            
            9,980,000
            
            
            $
            0.40
            
            
            
            3.38
            
            
            $
            2,550Options
      vested and expected to vest at February 28, 2009
            
            
            7,667,832
            
            
            $
            0.40
            
            
            
            3.24
            
            
            $
            2,550Options
      exercisable at February 28, 2009
            
            
            5,536,632
            
            
            $
            0.45
            
            
            
            2.74
            
            
            $
            2,550




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 nine months
ended February 29, 2008 and February 28, 2009 was $0.32 and $0.16 per option,
respectively.  The total intrinsic value of options exercised during
the nine months ended February 29, 2008 and February 28, 2009 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 ($0.10 per share on February 27, 2009) and the exercise
price of outstanding, in-the-money options (those options with exercise prices
below $0.10) on February 27, 2009.





As of
February 28, 2009, there was approximately $716,000 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 42 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
February 28, 2009, there was approximately $224,000 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 58 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 nine months ended
February 28, 2009 and February 29, 2008, which was recorded as
follows:





Three
      Months Ended
            
            
            Nine
      Months Ended
            
            
            Three
      Months Ended
            
            
            NineMonths
      EndedFebruary 28,
      2009
            
            
            February
      28, 2009
            
            
            February29,
      2008
            
            
            February
      29, 2008Research
      and development - Crossflo
            
            $
            397
            
            
            $
            774
            
            
            $
            -
            
            
            $
            -Selling,
      general and administrative expense - Crossflo
            
            
            16,189
            
            
            
            31,759
            
            
            
            -
            
            
            
            -Selling,
      general and administrative expense - Patriot
            
            
            34,659
            
            
            
            281,866
            
            
            
            61,517
            
            
            
            407,652Total
            
            $
            51,245
            
            
            $
            314,399
            
            
            $
            61,517
            
            
            $
            407,652










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 principles
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 FSP 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
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 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.





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.


15


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Recent
Accounting Pronouncements (continued)





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
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.  The adoption of this standard as of
December 15, 2008 did not have a material impact on our consolidated
financial statements.





2.
Acquisitions





Crossflo





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 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 $10,257,604, including $2,850,790 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.


16


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Acquisitions
(continued)





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
              
              
              2,850,790Principal
      and interest on convertible notes
              
              
              824,600$
              10,257,604





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
                
                
                1,668,630Total
      assets acquired
                
                
                10,384,808Liabilities
      assumed:Current
      liabilities
                
                
                (127,204
                )$
                10,257,604





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 8 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 $1,668,630 was assigned to the Crossflo
segment.  This amount is not deductible for income tax
purposes.


17


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Acquisitions
(continued)





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.





Proforma
Financial Information





The
financial information in the table below summarizes the combined results of
operations of Patriot and Crossflo, on a pro forma basis, as though the
companies had been combined as of the beginning of the periods presented. The
pro forma financial information is presented for informational purposes only and
is not indicative of the results of operations that would have been achieved if
the acquisition had taken place at the beginning of the periods presented. Such
pro forma financial information is based on the historical financial statements
of Patriot and Crossflo. This pro forma financial information is based on
estimates and assumptions, which have been made solely for purposes of
developing such pro forma information, including, without limitation, purchase
accounting adjustments. The pro forma financial information presented below also
includes amortization based on the valuation of Crossflo’s identifiable
intangible assets resulting from the acquisition. The pro forma financial
information does not reflect any synergies or operating cost reductions that may
be achieved from the combined operations.


18


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Acquisitions
(continued)





Three
      Months Ended
            
            Nine
      Months EndedFebruary 29,
              2008
            
            February 28,
              2009
            
            February 29,
              2008Revenue
            
            $
            916,777
            
            
            $
            4,869,733
            
            
            $
            2,610,723Net
      income (loss)
            
            $
            5,431,500
            
            
            $
            (113,414
            )
            
            $
            4,404,301Earnings
      per common share—basic
            
            $
            0.01
            
            
            $
            -
            
            
            $
            0.01Earnings
      per common share—diluted
            
            $
            0.01
            
            
            $
            -
            
            
            $
            0.01




Verras
Medical, Inc.





On
December 1, 2008, Crossflo acquired the assets of Verras Medical, Inc.
(“Verras”).  Verras does business as Iameter and under the Iameter
name provides a healthcare software tool called SherlockTM for hospitals and
physician groups to assess the quality of care delivery against state and
federal healthcare standards to help realize quality improvements and reduced
costs.





The
aggregate purchase price was $536,225, including $503,071 of cash and $33,154 of
note receivable conversion (see Note 7).





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 based on their estimated fair values.





Purchase
      consideration:Cash
      paid, including acquisition costs
              
              $
              103,071Non-interest
      bearing payable
              
              
              400,000Conversion
      of note receivable into cash consideration
              
              
              33,154$
              536,225





Allocation
      of purchase consideration:Tangible
      assets acquired:Cash
              
              $
              4,247Accounts
      receivable
              
              
              25,000Property
      and equipment
              
              
              3,466Identifiable
      intangible assets acquired:Customer
      relationships
              
              
              36,000Trademarks/names
              
              
              110,000Technology
              
              
              161,000Goodwill
              
              
              196,512Total
      assets acquired
              
              $
              536,225





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
relationships, trademarks/names and technology were determined using an income
approach.


19


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Acquisitions
(continued)





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.  This liability is
included in accrued expenses on our condensed consolidated balance sheet at
February 28, 2009.  On March 1, 2009, Crossflo paid Verras $100,000
pursuant to the agreement.





None of
our acquired intangible assets were assigned to research and development
assets.  The acquired intangible assets of $307,000 have a
weighted-average useful life of approximately 7 years.  The intangible
assets that make up that amount include customer relationships of $36,000 (5
year weighted-average useful life), trademarks/names of $110,000 (10 year
weighted-average useful life) and technology of $161,000 (5 year
weighted-average useful life).





Goodwill
in the amount of $196,512 was assigned to Verras.  This amount will be
assigned a 15 year life and amortized for income tax purposes.





Proforma
Financial Information





Due to
the immaterial nature of Verras’ operations, no proforma financial statement
information will be presented.





3.
Goodwill and Other Intangible Assets





In
accordance with SFAS No. 142, goodwill originating from the acquisitions 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 10
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
      Carrying ValueEstimated
              
              Allocated
              
              
              Accumulated
              
              
              February
      28,Life
      in Years
              
              Value
              
              
              Amortization
              
              
              2009Customer
      contracts  – open orders
              0.75
              
              $
              63,600
              
              
              $
              (42,402
              )
              
              $
              21,198Customer
      relationships
              5.00
              
              
              36,000
              
              
              
              (1,800
              )
              
              
              34,200Maintenance
      agreements
              4.00
              
              
              75,400
              
              
              
              (9,426
              )
              
              
              65,974Trademarks/names
              10.00
              
              
              110,000
              
              
              
              (2,750
              )
              
              
              107,250Technologies
      and processes
              5.00–8.00
              
              
              6,093,400
              
              
              
              (378,826
              )
              
              
              5,714,574Patents
              14.00-20.00
              
              
              47,801
              
              
              
              (8,306
              )
              
              
              39,495$
              6,426,201
              
              
              $
              (443,510
              )
              
              $
              5,982,691




20


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Goodwill
and Other Intangible Assets (continued)





Future
amortization is estimated to be as follows:





Year2009
            
            $
            224,6582010
            
            
            813,8402011
            
            
            813,8402012
            
            
            813,8402013
            
            
            799,693Thereafter
            
            
            2,516,820





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




The
changes in the carrying amount of goodwill for the period ended February 28,
2009 are as follows (see Note 2):





Balance,
      June 1, 2008
            
            $
            -Goodwill
      of Crossflo acquired (see Note 2)
            
            
            1,668,630Goodwill
      of Verras acquired (see Note 2)
            
            
            196,512Balance,
      February 28, 2009
            
            $
            1,865,142




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 February 28, 2009 consist of two savings accounts
required to be held as collateral for corporate credit card
accounts.





At
February 28, 2009, Patriot’s short-term investments in the amount of $68,797
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.  This value is reported at cost, which
approximates fair market value.





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


21


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Fair
Value Measurements (continued)





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
              February 28,
      2009Auction
      rate securities
            
            $
            —
            
            
            $
            —
            
            
            $
            10,318,249
            
            
            $
            10,318,249




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
$1,331,751.  We have recorded an unrealized loss of $789,116 in
accumulated other comprehensive loss at February 28, 2009, which represents the
gross valuation adjustment of $1,331,751, net of the related tax benefit of
$542,635. 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.





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
              
              
              
              12,900,000Total
      realized/unrealized losses:Included
      in earnings
              
              
              —
              
              
              
              —Included
      in comprehensive income (loss)
              
              
              (1,331,751
              )
              
              
              (1,331,751
              )Purchases,
      issuances and settlements
              
              
              (1,250,000
              )
              
              
              (1,250,000
              )Ending
      balance
              
              $
              10,318,249
              
              
              $
              10,318,249Total
      amount of unrealized losses for the nine months ended February 28, 2009
      included in other comprehensive income (loss) attributable to the change
      in fair market value relating to assets still held at the reporting
      date
              
              $
              (959,426
              )
              
              $
              (959,426
              )





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).


22


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





6.
Accounts Receivable





Trade
accounts receivable consisted of the following:





February
      28, 2009
            
            
            May
      31, 2008PTSC
            
            $
            -
            
            
            $
            26,959Holocom
            
            
            662,426
            
            
            
            511,541Crossflo
            
            
            146,630
            
            
            
            -Total
            
            $
            809,056
            
            
            $
            538,500





No
allowance for doubtful accounts was necessary at February 28, 2009 or May 31,
2008.





At
February 28, 2009 and May 31, 2008, accounts receivable from our investee PDS
was $9,901 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.





7.
Notes Receivable





On
February 24, 2009, we received a promissory note from Avot for principal of
$100,000.  Interest at the rate of 8% accrues on the note until its
maturity date of August 24, 2009.  At February 28, 2009, accrued
interest on the note is $67.  On March 12, 2009, we entered into a
revolving line of credit facility for $500,000 with Avot (see Note 17) which
replaced the February 24, 2009 note and for which the February 24, 2009 note
served as an initial advance.





On
October 28, 2008, we received a promissory note from Verras for principal of
$33,000.  Interest in the amount of $154 at the rate 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 2).




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 (see Note 12).





8.
Inventory





Inventory
at February 28, 2009 and May 31, 2008, consisted of Holocom’s raw materials of
$415,699 and $245,731, respectively, and finished goods of $566,102 and
$142,410, respectively.





Work-in-process
at February 28, 2009 consists of $96,442 which represents the excess of
recognized revenue over invoices to customers on Crossflo’s current contracts in
progress.


23


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





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
February 28, 2009:





As
      of February 28, 2009Cost
            
            
            Gross
              Unrealized
              Losses
            
            
            Estimated
              Fair
              ValueShort-termAccrued
      interest - auction rate securities
            
            $
            68,797
            
            
            $
            —
            
            
            $
            68,797Long-termAuction
      rate securities
            
            
            11,650,000
            
            
            
            (1,331,751
            )
            
            
            10,318,249Total
            
            $
            11,718,797
            
            
            $
            (1,331,751
            )
            
            $
            10,387,046





As of
February 28, 2009, we held auction rate securities with a par value totaling
approximately $11.7 million that failed to sell at auction.  During
December 2008, auction rate securities with a par value of $1,250,000 were
redeemed by the issuers at par value. 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 February 2009.  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.





Due to
the uncertainty surrounding the timing of a market recovery, we have classified
our auction rate securities as long- term investments in our condensed
consolidated balance sheet as of February 28, 2009.  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 $789,116 in other comprehensive loss at February 28, 2009,
which represents the gross valuation adjustment of $1,331,751, net of the
related tax benefit of $542,635.





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 February 28, 2009 (see Note 13).


24


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





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 was expected to be provided over a period not to exceed four years;
which ended in February 2009. Maintenance revenue recognized during the three
months and nine months ended February 28, 2009 and February 29, 2008 was $6,250
and $6,250 and $18,750 and $18,750, 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.





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 nine months ended February 28, 2009 and February 29, 2008, PDS paid
$2,369,000 and $1,952,000, respectively, to TPL pursuant to this
commitment.


25


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Investments
in Affiliated Companies (continued)





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.  From November 2008 to February 28, 2009, 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 loss during the three months
ended February 28, 2009 of $751,021 as a decrease in our investment and our
share of PDS’ net income during the three months ended February 29, 2008 of
$11,696,265 as an increase in our investment.  We have recorded our
share of PDS’ net income during the nine months ended February 28, 2009 and
February 29, 2008 of $6,121,970 and $15,981,763, respectively, as an increase in
our investment. Cash distributions received from PDS during the nine months
ended February 28, 2009 and February 29, 2008 of $7,648,589 and $16,666,800,
respectively, have been recorded as a reduction in our investment. Our
investment in PDS is $995,371 at February 28, 2009 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 condensed consolidated statements of operations for the nine months
ended February 28, 2009 and February 29, 2008.





During
the three months ended February 28, 2009 and February 29, 2008, TPL entered into
licensing agreements with third parties, pursuant to which PDS received
aggregate proceeds of $290,000 and $27,918,970, respectively.





During
the nine months ended February 28, 2009 and February 29, 2008, TPL entered into
licensing agreements with third parties, pursuant to which PDS received
aggregate proceeds of $19,340,000 and $48,851,970, respectively.





At
February 28, 2009, PDS had accounts payable balances of approximately $1,686,700
and $9,900  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.





PDS’
condensed balance sheets at February 28, 2009 and May 31, 2008 and statements of
operations for the three and nine months ended February 28, 2009 and February
29, 2008 are as follows:





Condensed
Balance Sheets





ASSETS:


February
      28, 2009
            
            
            May
      31, 2008Cash
      and cash equivalents
            
            $
            3,699,060
            
            
            $
            8,260,288Total
      assets
            
            $
            3,699,060
            
            
            $
            8,260,288




26


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Investments
in Affiliated Companies (continued)





Condensed
Statements of Operations





LIABILITIES
AND MEMBERS’ EQUITY:





February
      28,2009
            
            
            May
      31,2008Accounts
      payable and accrued expenses
            
            $
            1,696,526
            
            
            $
            3,204,519LLC
      tax payable
            
            
            11,790
            
            
            
            11,790Members’
      equity
            
            
            1,990,744
            
            
            
            5,043,979Total
      liabilities and members’ equity
            
            $
            3,699,060
            
            
            $
            8,260,288






Three
      Months Ended
            
            
            Nine
      Months EndedFebruary
      28, 2009
            
            
            February
      29, 2008
            
            
            February
      28, 2009
            
            
            February
      29, 2008Revenues
            
            $
            290,000
            
            
            $
            27,918,970
            
            
            $
            19,340,000
            
            
            $
            48,851,970Operating
      expenses
            
            
            1,807,244
            
            
            
            2,735,261
            
            
            
            5,893,877
            
            
            
            16,334,021Operating
      income (loss)
            
            
            (1,517,244
            )
            
            
            25,183,709
            
            
            
            13,446,123
            
            
            
            32,517,949Interest
      and other income
            
            
            15,202
            
            
            
            64,696
            
            
            
            58,580
            
            
            
            177,281Net
      income (loss)
            
            $
            (1,502,042
            )
            
            $
            25,248,405
            
            
            $
            13,504,703
            
            
            $
            32,695,230





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, these amounts are eliminated in our
condensed consolidated financial statements.  During March 2009, we
purchased additional shares offered by Talis (see Note 17).





We are
accounting for our investment in Talis under the equity method of
accounting.  We have recorded our share of Talis’ net loss of $170,862
and $375,344 during the three and nine months ended February 28, 2009 as a
decrease in our investment.  Our investment in Talis on a consolidated
basis is $512,779 at February 28, 2009 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 condensed
consolidated statement of operations for the nine months ended February 28,
2009.





Due to
the immaterial nature of Talis’ operations, no condensed financial statement
information will be presented.


27


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Investments
in Affiliated Companies (continued)





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 February 28, 2009.





During
March 2009, we entered into a revolving loan note with Avot (see Note
17).





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.





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.


28


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Consolidated
Variable Interest Entity (continued)





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%.  At February 28, 2009, the balance on the credit
facility is $50,000.





Upon
initial consolidation of Holocom, we had determined that we were the primary
beneficiary of Holocom as we provided the sole source of financial support to
Holocom. As a result of our guarantee on the third party credit facility, which
we were not contractually required to provide, we maintain a variable interest
in Holocom as we are obligated under the guarantee to repay the third party
should Holocom default on the credit facility.  At February 28, 2009,
the carrying amount of Holocom’s assets and liabilities that we consolidate in
accordance with FIN 46 (R) are $1,782,756 and $958,456,
respectively.  None of the assets are restricted; however, the holder
of the credit facility has secured the assets of Holocom as collateral for the
facility.  The third party creditor does not have recourse to our
general credit except for our obligation to repay the balance on the facility
should Holocom default.  In the event that Holocom cannot obtain
financing from third parties, we may have to provide future funding although we
are not contractually obligated to do so.





The
equity interests of Holocom not owned by us are reported as a minority interest
in our February 28, 2009 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. From the date in
which we were initially required to consolidate Holocom, 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 condensed 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
nine months ended February 28, 2009, the minority interest was $264,290 which
represents the amount of Holocom’s net income after taxes on a consolidated
basis.  The minority interest in the income for the nine months is
added to the May 31, 2008 balance of $115,406 for a total of $379,696 as
presented in our condensed consolidated balance sheet at February 28,
2009.





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.





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 (see Note 7) 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.





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 nine months
ended February 28, 2009, Holocom granted options to purchase 42,500 shares of
its common stock  at $0.12 per
share under this plan and 59,000 shares have been
forfeited/cancelled.  At February 28, 2009, options to purchase
338,000 shares of Holocom’s common stock are outstanding, 142,350 of the
outstanding options are exercisable due to vesting provisions within the
options.





29




Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Consolidated
Variable Interest Entity (continued)





The
weighted average grant date fair value of Holocom’s options granted during the
nine months ended February 28, 2009 was $0.08 per option.





As of
February 28, 2009, there was approximately $9,679 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 28 months.





During
the nine months ended February 28, 2009, Holocom recognized $5,129 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.  The
note was paid in full during February 2009.





During
the quarter ended November 30, 2008, Holocom borrowed $250,000 on its credit
facility with a third party (see Note 12).  The balance on the
facility at February 28, 2009 is $50,000.





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 February 28,
2009.  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 February 28, 2009, the balance included accrued
interest accrued on the credit facility of $25,421 at an approximate rate of
3.25%.





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
nine months ended February 28, 2009 and February 29, 2008 was as
follows:


30


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Stockholders’
Equity (continued)





Comprehensive Income
(Loss)(continued)





Three
      Months Ended
            
            
            Nine
      Months EndedFebruary
      28, 2009
            
            
            February
      29, 2008
            
            
            February
      28, 2009
            
            
            February
      29, 2008Net
      income (loss)
            
            $
            (1,489,347
            )
            
            $
            6,292,185
            
            
            $
            787,906
            
            
            $
            6,746,336Unrealized
      holding gains (losses) on investments, net of taxes
            
            
            41,226
            
            
            
            -
            
            
            
            (568,499
            )
            
            
            -Total
      comprehensive income (loss)
            
            $
            (1,448,121
            )
            
            $
            6,292,185
            
            
            $
            219,407
            
            
            $
            6,746,336





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 5,839,141 and 5,698,821
shares of our common stock at an aggregate cost of $1,095,944 and $3,042,921
during the nine months ended February 28, 2009 and February 29, 2008,
respectively.





Equity
Transactions





The
following table summarizes equity transactions during the nine months ended
February 28, 2009:





Common
      Stock
                Additional
                
                
                AccumulatedShares
                
                
                Amounts
                Paid-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
                
                
                --
                
                
                
                -
                
                
                
                324,380
                
                
                
                -
                
                
                
                -Repurchase
      of common stock for treasury
                
                
                (5,839,141
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (1,095,944
                )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
                
                
                --
                
                
                
                -
                
                
                
                6,715
                
                
                
                -
                
                
                
                -Tax
      effect of exercise of options under APB 25
                
                
                --
                
                
                
                -
                
                
                
                4,482
                
                
                
                -
                
                
                
                -Net
      income
                
                
                --
                
                
                
                -
                
                
                
                -
                
                
                
                787,906
                
                
                
                -Balance
      February 28, 2009
                
                
                410,664,229
                
                
                $
                4,380
                
                
                $
                76,927,334
                
                
                $
                (32,975,451
                )
                
                $
                (13,819,116
                )





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.





As of
February 28, 2009, 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 6,158,000 options outstanding pursuant to
our 2006 Stock Option Plan exercisable at a range of $0.12 to $0.70 per share
expiring through 2014.  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.


31


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Stockholders’
Equity (continued)





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 February
28, 2009, were granted 190,000 options from our 2006 Stock Option Plan
exercisable at $0.13 to $0.22 per share expiring through 2014.  These
options are not presently exercisable and are subject to meeting vesting
criteria.





In
February 2009, we granted 175,000 options from our 2006 Stock Option Plan to our
employees exercisable at $0.12 per share expiring through 2014.





Subsequent
to February 28, 2009, new employees of Crossflo due to the Vigilys acquisition
were granted 165,000 options from our 2006 Stock Option Plan (see Note
17).  Additionally, Crossflo’s March new hires were granted stock
options from our 2006 Stock Option Plan subsequent to February 28, 2009 (see
Note 17).





During
the nine months ended February 28, 2009, we recorded $319,528 of non-cash
compensation expense related to vesting of stock options, including $32,533
related to Crossflo and $5,129 related to Holocom.





As of
February 28, 2009, 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 nine months ended February 28, 2009,
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 nine months ended February 28, 2009.





During
the nine months ended February 28, 2009, we recorded $4,852 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.





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


32


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Commitments
and Contingencies (continued)





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.  As a result, the Texas
Actions have been dismissed by Stipulation.  The Northern California
cases are in the early discovery phase.  The Court will likely set
trial 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.  The Barco case will have the same
or similar scheduling order as the Acer and HTCcases.





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 answered our claims and an
arbitration panel is in the process of being selected.  Document
discovery has been initiated.  Some instruments have been
repurchased  by the issuers since the claim was filed (see Note
9).





401(k)
Plan





Patriot
and Crossflo have retirement plans that comply with Section 401(k) of the
Internal Revenue Code. All employees are eligible to participate in the plans.
Patriot matches 50% of each participant’s voluntary contributions, subject to a
maximum contribution of 6% of the participant’s compensation. Patriot’s
participants vest 33% per year over a three year period in their contributions.
Patriot’s matching contributions during the nine months ended February 28, 2009
and February 29, 2008 were $10,488 and $6,724, respectively.  Crossflo
does not match participant voluntary contributions.





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 condensed consolidated
balance sheets.


33


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Commitments
and Contingencies (continued)





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.  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.





These
reportable segments are strategic business units that offer different products
and services.  They are managed separately because each business
requires different technology and marketing strategies.





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


34


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 nine months ended February 28, 2009 and February 29, 2008 were as
follows:




Three
      Months Ended
              
              
              Nine
      Months EndedFebruary
      28, 2009
              
              
              February
      29, 2008
              
              
              February
      28, 2009
              
              
              February
      29, 2008Net
      revenue:Holocom
              
              $
              1,187,128
              
              
              $
              784,447
              
              
              $
              4,117,152
              
              
              $
              2,229,592Crossflo
              
              
              216,823
              
              
              
              -
              
              
              
              475,177
              
              
              
              -All
      other
              
              
              6,250
              
              
              
              16,837
              
              
              
              51,780
              
              
              
              38,892Total
      net revenue
              
              $
              1,410,201
              
              
              $
              801,284
              
              
              $
              4,644,109
              
              
              $
              2,268,484Operating
      income (loss):Holocom
              
              $
              115,839
              
              
              $
              (44,376
              )
              
              $
              575,981
              
              
              $
              (69,418
              )Crossflo
              
              
              (1,037,586
              )
              
              
              -
              
              
              
              (1,943,642
              )
              
              
              -All
      other
              
              
              (721,585
              )
              
              
              (1,281,241
              )
              
              
              (2,961,223
              )
              
              
              (4,660,087
              )Total
      operating loss
              
              
              (1,643,332
              )
              
              $
              (1,325,617
              )
              
              $
              (4,328,884
              )
              
              $
              (4,729,505
              )Income
      (loss) before taxes:Holocom
              
              $
              116,815
              
              
              $
              (38,667
              )
              
              $
              574,084
              
              
              $
              85,381Crossflo
              
              
              (1,037,586
              )
              
              
              -
              
              
              
              (1,942,389
              )
              
              
              -All
      other
              
              
              (1,608,583
              )
              
              
              10,725,357
              
              
              
              3,057,006
              
              
              
              12,407,005Total
      income (loss) before taxes
              
              $
              (2,529,354
              )
              
              $
              10,686,690
              
              
              $
              1,688,701
              
              
              $
              12,492,386






Operating
segment total assets at February 28, 2009 and February 29, 2008 were as
follows:





February
      28, 2009
              
              
              May
      31, 2008Total
      assets:Holocom
              
              $
              1,782,756
              
              
              $
              1,383,941Crossflo
              
              
              10,153,967
              
              
              
              -All
      other
              
              
              23,182,250
              
              
              
              24,047,961Total
      assets
              
              $
              35,118,973
              
              
              $
              25,431,902




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 February 28, 2009 and May
31, 2008  and sales concentration information for the nine months
ended February 28, 2009 and February 29, 2008 were as follows:




Nine
      months ended
                February
      28, 2009
              
              February
      28, 2009
              
              Nine
      months ended
                February
      29, 2008
              
              May
      31, 2008Sales
              
              %
      of sales
              
              %
      of A/R
              
              Sales
              
              %
      of sales
              
              %
      of A/RCustomer
      A
              
              $
              1,759,561
              
              
              
              42
              %
              
              
              9
              %
              
              $
              927,647
              
              
              
              42
              %
              
              
              16
              %Customer
      B
              
              $
              661,638
              
              
              
              16
              %
              
              
              8
              %
              
              $
              491,576
              
              
              
              22
              %
              
              
              38
              %Customer
      C
              
              $
              899,540
              
              
              
              22
              %
              
              
              37
              %
              
              
              ----
              
              
              
              ----
              
              
              
              ----Customer
      D
              
              $
              155,380
              
              
              
              4
              %
              
              
              19
              %
              
              
              ----
              
              
              
              ----
              
              
              
              ----Customer
      E
              
              $
              121,830
              
              
              
              3
              %
              
              
              15
              %
              
              
              ----
              
              
              
              ----
              
              
              
              ----




35


Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements





Segment
Information (continued)





Accounts
receivable concentration information for Crossflo as of February 28, 2009 and
May 31, 2008  and sales concentration information for the nine months
ended February 28, 2009 and February 29, 2008 were as follows:





Nine
      months ended
                February
      28, 2009
              
              February
      28, 2009
              
              Nine
      months ended
                February
      29, 2008
              
              May
      31, 2008Sales
              
              %
      of sales
              
              %
      of A/R
              
              Sales
              
              %
      of sales
              
              %
      of A/RCustomer
      A
              
              $
              248,487
              
              
              
              52
              %
              
              
              ----
              
              
              
              ----
              
              
              
              ----
              
              
              
              ----Customer
      C
              
              $
              81,387
              
              
              
              17
              %
              
              
              48
              %
              
              
              ----
              
              
              
              ----
              
              
              
              ----Customer
      D
              
              $
              4,650
              
              
              
              1
              %
              
              
              12
              %
              
              
              ----
              
              
              
              ----
              
              
              
              ----Customer
      E
              
              $
              26,128
              
              
              
              6
              %
              
              
              15
              %
              
              
              ----
              
              
              
              ----
              
              
              
              ----Customer
      F
              
              $
              17,500
              
              
              
              4
              %
              
              
              12
              %
              
              
              ----
              
              
              
              ----
              
              
              
              ----





17.  Subsequent
Events





During
the period March 1, 2009 through April 3, 2009, we purchased 176,890 shares of
our common stock at an aggregate cost of $18,220 pursuant to our stock buyback
program.





On March
1, 2009, we paid Verras $100,000 pursuant to the asset purchase
agreement.





On March
27, 2009, Crossflo acquired the VigilysTM Tactical Operating System (“Vigilys”)
business line from Kratos Defense & Security Solutions, Inc. for total cash
consideration of $180,000.  The fair value assigned to the
intellectual property associated with the acquisition 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 the Vigilys assets, Crossflo has hired the
employees of Vigilys to support its product offerings and we issued 165,000
stock options from our 2006 Stock Option Plan with an exercise price of $0.10 to
former employees of Vigilys who became Crossflo employees on March 30, 2009 in
connection with their employment agreements. These options are not presently
exercisable and are subject to meeting vesting criteria.





On March
2, 2009, we issued 40,000 stock options from our 2006 Stock Option Plan with an
exercise price of $0.09 to new Crossflo employees.  These options are
not presently exercisable and are subject to meeting vesting
criteria.





On March
23, 2009, we issued 120,000 stock options from our 2006 Stock Option Plan with
an exercise price of $0.08 to a Crossflo employee in connection with the
employee’s promotion.  These options are not presently exercisable and
are subject to meeting vesting criteria.





On March
5, 2009, we purchased an additional 154,758 units of Talis for $224,399 which
brings our ownership share of Talis to 38.2%.





On March
12, 2009, we entered into a revolving loan note with Avot for
$500,000.  The note bears interest at a rate of 8% and is due December
12, 2009. The note is secured by the assets presently owned or acquired in the
future by Avot.  Upon entering into the revolving loan note, the short
term note we received from Avot on February 24, 2009 (see Note 7) was cancelled
and the principal amount of $100,000 was classified as an initial advance on the
revolving loan note.  Under terms of the note, not more than one
request for advances shall be made within a single month.  On March
13, 2009 and April 1, 2009, we advanced $115,000 and $115,000, respectively, to
Avot under terms of the note.


36


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 AICPA Statement of Position (“SOP”)
No. 97-2,Software
Revenue Recognition, and all related amendments and
interpretations.  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”.


37


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
on  these arrangements according to the provisions of 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 February 28, 2009,
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.


38


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 grant date
fair value of the portion of share-based payment awards ultimately expected to
vest during the period 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 nine months ended February 28, 2009 and February 29, 2008 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 nine months ended February 28, 2009 and February 29, 2008 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 SOP 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 condensed
consolidated statement of operations in the caption “Equity in earnings of
affiliated companies”.


39


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 February 28, 2009 and Three Months Ended February 29,
2008.





Consolidated:





Three
      Months EndedFebruary
      28, 2009
              
              
              February
      29, 2008Revenues:Product
      sales and other
              
              $
              1,193,378
              
              
              $
              801,284License
      and service revenue
              
              
              216,823
              
              
              
              -Total
      revenues
              
              
              1,410,201
              
              
              
              801,284Cost
      of sales:Product
      sales and other
              
              
              534,555
              
              
              
              345,084License
      and service revenue
              
              
              89,195
              
              
              
              -Amortization
      of purchased intangibles
              
              
              223,902
              
              
              
              -Total
      cost of sales
              
              
              847,652
              
              
              
              345,084Gross
      profit
              
              $
              562,549
              
              
              $
              456,200




40


Segment
Results:





Three
      months endedFebruary
      28, 2009
            
            February
      29, 2008Holocom:
            
            Dollars
            
            
            %
      of Revenue
            
            Dollars
            
            
            %
      of RevenueRevenues
      - Product sales and other
            
            $
            1,187,128
            
            
            
            100.0
            %
            
            $
            784,447
            
            
            
            100.0
            %Cost
      of sales
            
            
            534,555
            
            
            
            45
            %
            
            
            345,084
            
            
            
            44
            %Gross
      profit
            
            $
            652,573
            
            
            
            55
            %
            
            $
            439,363
            
            
            
            56
            %Crossflo:License
      and service revenue
            
            $
            216,823
            
            
            
            100.0
            %
            
            $
            -
            
            
            
            -Cost
      of sales
            
            
            89,195
            
            
            
            41.1
            %
            
            
            -
            
            
            
            -Amortization
      of purchased intangibles
            
            
            223,902
            
            
            
            -
            
            
            
            -
            
            
            
            -Gross
      loss
            
            $
            (96,274
            )
            
            
            -
            
            
            $
            -
            
            
            
            -PTSC:Revenues
      - Product sales and other
            
            $
            6,250
            
            
            
            100.0
            %
            
            $
            16,837
            
            
            
            100.0
            %Cost
      of sales
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Gross
      profit
            
            $
            6,250
            
            
            
            100.0
            %
            
            $
            16,837
            
            
            
            100.0
            %





Holocom





During
the three months ended February 28, 2009 and February 29, 2008, we recorded
sales amounting to approximately $1,187,000 and $784,000, respectively, by our
consolidated variable interest entity, Holocom, with cost of sales amounting to
approximately $535,000 and $345,000, respectively. The increase in sales for
Holocom during the three months ended February 28, 2009 as compared to the three
months ended February 29, 2008 is primarily due to the expansion of Holocom’s
distributor network.





Crossflo





We
acquired Crossflo on September 1, 2008 and the assets of Verras on December 1,
2008.  Revenue consists of software licenses and related services
relating to Crossflo’s CDX data agent product and services provided by Verras to
medical facilities utilizing the SherlockTM software tool.  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 $223,900 of
amortization expense on purchased intangible assets.





PTSC





During
the three months ended February 28, 2009 and February 29, 2008, we recognized
maintenance fee revenues totaling $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, which ended in
February 2009.





In
addition during the three months ended February 29, 2008, we recorded sales of
approximately $10,587 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.


41


Consolidated





Our
revenues increased from approximately $800,000 for the three months ended
February 29, 2008 to approximately $1,410,000 for the three months ended
February 28, 2009. Our revenue amounts do not include loss of approximately
$751,000 and income of approximately $11,696,000, respectively,  from
our investment in PDS for the three months ended February 28, 2009 and February
29, 2008, respectively, and a loss of approximately $171,000 from our investment
in Talis for the three months ended February 28, 2009.





Three
      months endedFebruary
      28, 2009
                      
                      
                      February
      29, 2008Research
      and development
                      
                      $
                      117,781
                      
                      
                      $
                      -





Crossflo





Research
and development costs consist of Crossflo’s payroll and related expenses for
software engineers as well as outside contractors retained to assist in the
development of Crossflo’s software product.  For the three months
ended February 28, 2009, approximately $397 of non-cash compensation was
recorded in connection with vesting of employee stock options in accordance with
SFAS 123(R).





Consolidated:


Three
      months endedFebruary
      28, 2009
                      
                      
                      February
      29, 2008Selling,
      general and administrative
                      
                      $
                      2,088,100
                      
                      
                      $
                      1,364,077





Segment
Results:




Three
      months endedFebruary
      28, 2009
                    
                    
                    February
      29, 2008Holocom:Selling,
      general and administrative
                    
                    $
                    536,734
                    
                    
                    $
                    483,739Crossflo:Selling,
      general and administrative
                    
                    $
                    823,531
                    
                    
                    $
                    -PTSC:Selling,
      general and administrative
                    
                    $
                    727,835
                    
                    
                    $
                    880,338





Holocom





Selling,
general and administrative expenses increased from approximately $484,000 for
the three months ended February 29, 2008 to approximately $537,000 for the three
months ended February 28, 2009.  The increase consisted of
approximately $23,000 relating to payroll and related expenses for bonuses
granted to employees, approximately $12,000 for meals and internal events,
approximately $17,700 for royalty payments under the Earn Out Agreement, and
approximately $23,600 for legal expenses.  These increases were offset
by a decrease in marketing expenses of approximately $13,500 and travel and
related expenses of approximately $8,000.





Crossflo





Selling,
general and administrative expenses for the three months ended February 28, 2009
consist of approximately $627,000 of payroll and related expenses for the sales
and administrative employees, approximately $32,000 of travel and related
expenses for the sales employees, approximately $9,000 for sales commissions,
approximately $10,000 for sales consultants, and approximately $40,000 for rent
expense.  For the three months ended February 28, 2009, approximately
$16,000 of non-cash compensation was recorded in connection with vesting of
employee stock options in accordance with SFAS 123(R).


42


PTSC





Selling,
general and administrative expenses decreased from approximately $880,000 for
the three months ended February 29, 2008 to approximately $728,000 for the three
months ended February 28, 2009.  The decrease consisted of
approximately $76,000 in legal and accounting expense, and approximately $21,000
in public and investor relations expenses.  These decreases were
offset by increases in payroll and related expenses of approximately $18,000,
and approximately $6,000 in travel and related expenses.  For the
three months ended February 28, 2009, approximately $37,000 of non-cash
compensation was recorded in connection with vesting of employee stock options
in accordance with SFAS 123(R) as compared to approximately $62,000 for the
three months ended February 29, 2008.





Consolidated





Selling,
general and administrative expenses increased from approximately $1,364,000 for
the three months ended February 29, 2008 to approximately $2,088,000 for the
three months ended February 28, 2009, primarily due to the acquisition of
Crossflo.





Three
      months endedFebruary
      28, 2009
                    
                    
                    February
      29, 2008Settlement
      and license expense
                    
                    $
                    -
                    
                    
                    $
                    417,740





Patriot
recorded settlement and license expenses amounting to approximately $418,000 for
the three months ended February 29, 2008 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 endedFebruary
      28, 2009
                            
                            
                            February
      29, 2008Other
      income (expense):Interest
      and other income
                            
                            $
                            63,257
                            
                            
                            $
                            318,284Loss
      on sale of assets
                            
                            
                            -
                            
                            
                            
                            (2,242
                            )Interest
      expense
                            
                            
                            (27,396
                            )
                            
                            
                            -Equity
      in earnings (loss) of affiliated companies
                            
                            
                            (921,883
                            )
                            
                            
                            11,696,265Total
      other income (expense), net
                            
                            $
                            (886,022
                            )
                            
                            $
                            12,012,307





Segment
Results:




Three
      months endedFebruary
      28, 2009
                      
                      
                      February
      29, 2008Holocom:Interest
      and other income
                      
                      $
                      2,951
                      
                      
                      $
                      12,084Interest
      expense
                      
                      
                      (1,975
                      )
                      
                      
                      -Loss
      on sale of assets
                      
                      
                      -
                      
                      
                      
                      -Total
      other income, net
                      
                      $
                      976
                      
                      
                      $
                      12,084Crossflo:Interest
      and other income
                      
                      $
                      -
                      
                      
                      $
                      -Interest
      expense
                      
                      
                      -
                      
                      
                      
                      -Loss
      on sale of assets
                      
                      
                      -
                      
                      
                      
                      -Total
      other income, net
                      
                      $
                      -
                      
                      
                      $
                      -PTSC:Interest
      and other income
                      
                      $
                      60,306
                      
                      
                      $
                      306,200Interest
      expense
                      
                      
                      (25,421
                      )
                      
                      
                      -Loss
      on sale of assets
                      
                      
                      -
                      
                      
                      
                      (2,242
                      )Equity
      in earnings (loss) of affiliated companies
                      
                      
                      (921,883
                      )
                      
                      
                      11,696,265Total
      other income (expense), net
                      
                      $
                      (886,998
                      )
                      
                      $
                      12,000,223




43


Consolidated





Our other
income and expenses for the three months ended February 28, 2009 included equity
in the loss of PDS consisting of net loss after expenses in the amount of
approximately $751,000 and our share of loss in Talis consisting of
approximately $171,000 after expenses.  For the three months ended
February 29, 2008, our other income and expenses included our share of income in
PDS of approximately $11,696,000. 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 February 28, 2009 amounted
to net other expenses of approximately $886,000 compared with net other income
of approximately $12,012,000 for the three months ended February 29, 2008.
Interest income and other income decreased from approximately $318,000 for the
three months ended February 29, 2008 to approximately $63,000 for the three
months ended February 28, 2009 due to declines in interest rates for our cash,
cash equivalents and short term investment accounts.





During
the three months ended February 28, 2009 we recorded a benefit for income taxes
of approximately $1,111,000 and during the three months ended February 29, 2008,
we recorded a provision for income taxes of approximately $4,395,000 related to
federal and California taxes.





We
recorded a net loss for the three months ended February 28, 2009 of $1,489,347
compared with net income of $6,292,185 for the three months ended February 29,
2008.





Results
of Operations





Comparison
of the Nine Months Ended February 28, 2009 and Nine Months Ended February 29,
2008.





Consolidated:





Nine
      Months EndedFebruary
      28, 2009
                        
                        
                        February
      29, 2008Revenues:Product
      sales and other
                        
                        $
                        4,168,932
                        
                        
                        $
                        2,268,484License
      and service revenue
                        
                        
                        475,177
                        
                        
                        
                        -Total
      revenues
                        
                        
                        4,644,109
                        
                        
                        
                        2,268,484Cost
      of sales:Product
      sales and other
                        
                        
                        1,819,172
                        
                        
                        
                        852,958License
      and service revenue
                        
                        
                        254,335
                        
                        
                        
                        -Amortization
      of purchased intangibles
                        
                        
                        435,204
                        
                        
                        
                        -Total
      cost of sales
                        
                        
                        2,508,711
                        
                        
                        
                        852,958Gross
      profit
                        
                        $
                        2,135,398
                        
                        
                        $
                        1,415,526





Segment
Results:





Nine
      months endedFebruary
      28, 2009
                      
                      
                      February
      29, 2008Holocom:
                      
                      Dollars
                      
                      
                      %
      of Revenue
                      
                      
                      Dollars
                      
                      
                      %
      of RevenueRevenues
      - Product sales and other
                      
                      $
                      4,117,152
                      
                      
                      
                      100.0%
                      
                      
                      $
                      2,229,592
                      
                      
                      
                      100.0%Cost
      of sales
                      
                      
                      1,819,172
                      
                      
                      
                      44.2%
                      
                      
                      
                      852,958
                      
                      
                      
                      38.3%Gross
      profit
                      
                      $
                      2,297,980
                      
                      
                      
                      55.8%
                      
                      
                      $
                      1,376,634
                      
                      
                      
                      61.7%Crossflo:License
      and service revenue
                      
                      $
                      475,177
                      
                      
                      
                      100.0%
                      
                      
                      $
                      -
                      
                      
                      
                      -Cost
      of sales
                      
                      
                      254,335
                      
                      
                      
                      53.5%
                      
                      
                      
                      -
                      
                      
                      
                      -Amortization
      of purchased intangibles
                      
                      
                      435,204
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Gross
      loss
                      
                      $
                      (214,362
                      )
                      
                      
                      -
                      
                      
                      $
                      -
                      
                      
                      
                      -


PTSC:Revenues
      - Product sales and other
              
              $
              51,780
              
              
              
              100.0%
              
              
              $
              38,892
              
              
              
              100.0%Cost
      of sales
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Gross
      profit
              
              $
              51,780
              
              
              
              100.0%
              
              
              $
              38,892
              
              
              
              100.0%


44


Holocom





During
the nine months ended February 28, 2009 and February 29, 2008, we recorded sales
amounting to approximately $4,117,000 and $2,230,000, respectively, by our
consolidated variable interest entity, Holocom, with cost of sales amounting to
approximately $1,819,000 and $853,000, respectively. The increase in sales for
Holocom during the nine months ended February 28, 2009 as compared to the nine
months ended February 29, 2008 is primarily due to the expansion of Holocom’s
distributor network and addition of product sales to new customers.





Crossflo





We
acquired Crossflo on September 1, 2008 and the assets of Verras on December 1,
2008.  Revenue consists of software licenses and related services
relating to Crossflo’s CDX data agent product and services provided by Verras to
medical facilities utilizing the SherlockTM software tool.  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 $435,000 of
amortization expense on purchased intangible assets.





PTSC





During
the nine months ended February 28, 2009 and February 29, 2008, we recognized
maintenance fee revenues totaling approximately $18,750 and $18,750 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, the four
year period ended in February 2009.





In
addition during the nine months ended February 28, 2009 and February 29, 2008,
we recorded sales of approximately $33,000 and $20,000, 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 $2,268,000 for the nine months ended
February 29, 2008 to approximately $4,644,000 for the nine months ended February
28, 2009. Our revenue amounts do not include income of approximately $6,122,000
and $15,982,000, respectively, from our investment in PDS for the nine months
ended February 28, 2009 and February 29, 2008, respectively,  and a
loss of approximately $375,000 from our investment in Talis for the nine months
ended February 28, 2009.





Nine
      months endedFebruary
      28, 2009
                
                
                February
      29, 2008Research
      and development
                
                $
                269,655
                
                
                $
                -





45


Crossflo





Research
and development costs consist of Crossflo’s payroll and related expenses for
software engineers as well as outside contractors retained to assist in the
development of Crossflo’s software product.  For the nine months ended
February 28, 2009, approximately $770 of non-cash compensation was recorded in
connection with vesting of employee stock options in accordance with SFAS
123(R).





Consolidated:




Nine
      months endedFebruary
      28, 2009
                
                
                February
      29, 2008Selling,
      general and administrative
                
                $
                6,194,627
                
                
                $
                5,308,631





Segment
Results:




Nine
      months endedFebruary
      28, 2009
                
                
                February
      29, 2008Holocom:Selling,
      general and administrative
                
                $
                1,721,999
                
                
                $
                1,446,052Crossflo:Selling,
      general and administrative
                
                $
                1,459,625
                
                
                $
                -PTSC:Selling,
      general and administrative
                
                $
                3,013,003
                
                
                $
                3,862,579





Holocom





Selling,
general and administrative expenses increased from approximately $1,446,000 for
the nine months ended February 29, 2008 to approximately $1,722,000 for the nine
months ended February 28, 2009.  The increase consisted of
approximately $160,000 relating to payroll, bonuses and related expenses,
approximately $24,000 for meals and internal events, approximately $46,000 for
royalty payments under the Earn Out Agreement, approximately $51,000 for legal
and professional expenses.  For the nine months ended February 28,
2009, approximately $5,000 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 $30,000.





Crossflo





We
acquired Crossflo on September 1, 2008 and the assets of Verras on December 1,
2008.  Selling, general and administrative expenses for the nine
months ended February 28, 2009 consist of approximately $1,062,000 of payroll
and related expenses for the sales and administrative employees, approximately
$90,000 of travel and related expenses for the sales employees, approximately
$20,000 for sales commissions, approximately $46,000 for consultants, and
approximately $65,000 for rent expense.  For the nine months ended
February 28, 2009, approximately $32,000 of non-cash compensation was recorded
in connection with vesting of employee stock options in accordance with SFAS
123(R).





PTSC





Selling,
general and administrative expenses decreased from approximately $3,863,000 for
the nine months ended February 29, 2008 to approximately $3,013,000 for the nine
months ended February 28, 2009.  The decrease consisted of
approximately $807,000 in legal and accounting expense, primarily due to a
settlement with a former officer of cash and stock in the prior fiscal year, a
decrease in general legal matters and capitalization of legal and accounting
fees in connection with the Crossflo acquisition, approximately $103,000 in
public and investor relations expenses, approximately $17,000 in website
expenses and approximately $33,000 in D&O insurance
expenses.  These decreases were offset by increases in payroll and
related expenses of approximately $274,000 related to officer bonuses, and
approximately $15,000 in travel and related expenses.  For the nine
months ended February 28, 2009, approximately $287,000 of non-cash compensation
was recorded in connection with vesting of employee stock options in accordance
with SFAS 123(R) as compared to approximately $408,000 for the nine months ended
February 29, 2008.


46


Consolidated





Selling,
general and administrative expenses increased from approximately $5,309,000 for
the nine months ended February 29, 2008 to approximately $6,195,000 for the nine
months ended February 28, 2009, primarily due to the acquisition of
Crossflo.





Nine
      months endedFebruary
      28, 2009
                
                
                February
      29, 2008Settlement
      and license expense
                
                $
                -
                
                
                $
                836,400





Patriot
recorded settlement and license expenses amounting to approximately $836,000 for
the nine months ended February 29, 2008 relating to royalties payable resulting
from an agreement with Fish (see Note 8 to our condensed consolidated financial
statements for more information).





Consolidated:


Nine
      months endedFebruary
      28, 2009
                    
                    
                    February
      29, 2008Other
      income (expense):Interest
      and other income
                    
                    $
                    320,850
                    
                    
                    $
                    1,093,876Loss
      on sale of assets
                    
                    
                    (1,733
                    )
                    
                    
                    (3,511
                    )Interest
      expense
                    
                    
                    (48,158
                    )
                    
                    
                    (237
                    )Gain
      on sale of subsidiary interest
                    
                    
                    -
                    
                    
                    
                    150,000Equity
      in earnings of affiliated companies
                    
                    
                    5,746,626
                    
                    
                    
                    15,981,763Total
      other income, net
                    
                    $
                    6,017,585
                    
                    
                    $
                    17,221,891





Segment
Results:


Nine
      months endedFebruary
      28, 2009
                      
                      
                      February
      29, 2008Holocom:Interest
      and other income
                      
                      $
                      5,919
                      
                      
                      $
                      23,477Interest
      expense
                      
                      
                      (4,549
                      )
                      
                      
                      (237
                      )Gain
      on sale of subsidiary interest
                      
                      
                      -
                      
                      
                      
                      150,000Total
      other income, net
                      
                      $
                      1,370
                      
                      
                      $
                      173,240Crossflo: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
                      
                      $
                      311,928
                      
                      
                      $
                      1,070,399Interest
      expense
                      
                      
                      (43,592
                      )
                      
                      
                      -Loss
      on sale of assets
                      
                      
                      -
                      
                      
                      
                      (3,511
                      )Equity
      in earnings of affiliated companies
                      
                      
                      5,746,626
                      
                      
                      
                      15,981,763Total
      other income, net
                      
                      $
                      6,014,962
                      
                      
                      $
                      17,048,651





Consolidated





Our other
income and expenses for the nine months ended February 28, 2009 included equity
in the earnings of PDS consisting of net income after expenses in the amount of
approximately $6,122,000 and our share of loss in Talis consisting of
approximately $375,000 after expenses.  For the nine months ended
February 29, 2008, our other income and expenses included our share of income in
PDS of approximately $15,982,000. 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 nine months ended February 28, 2009 amounted to
net other income of approximately $6,018,000 compared with approximately
$17,222,000 for the nine months ended February 29, 2008. Interest income and
other income decreased from approximately $1,094,000 for the nine months ended
February 29, 2008 to approximately $321,000 for the nine months ended February
28, 2009 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.


47


During
the nine months ended February 28, 2009 and February 29, 2008, we recorded a
provision for income taxes of approximately $637,000 and $5,746,000,
respectively, related to federal and California taxes.





We
recorded net income for the nine months ended February 28, 2009 of $787,906
compared with net income of $6,746,336 for the nine months ended February 29,
2008. The reason for our decline in net income as compared with the prior period
is due to the decline in our share of income from PDS.





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 $7,108,000 as of February 28, 2009. We
also have restricted cash balances amounting to approximately $51,000 as of May
31, 2008 and approximately $52,000 as of February 28, 2009. Total current assets
increased from approximately $9,851,000 as of May 31, 2008 to approximately
$10,202,000  as of February 28, 2009. Total current liabilities
amounted to approximately $930,000 and approximately $2,366,000 as of May 31,
2008 and February 28, 2009, respectively. The change in our current position as
of February 28, 2009 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 $1,027,000  and a decrease
in our deferred tax assets of approximately $560,000.





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 (see
Note 13).





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 nine months ended February 28, 2009 was
approximately $5,263,000 as compared with cash used in operating activities for
the nine months ended February 29, 2008 of approximately $13,777,000. The
principal components of the current period amount were: net income of
approximately $788,000 and a change in income taxes payable of approximately
$1,027,000.  These increases were offset by: equity in earnings of
affiliates of approximately $5,747,000, change in deferred taxes of
approximately $1,762,000 and changes in accounts receivable and inventory of
approximately $145,000 and $594,000, respectively.


48


Cash
Flows From Investing Activities





Cash
provided by investing activities was approximately $4,130,000 and $5,519,000 for
the nine months ended February 28, 2009 and February 29, 2008, respectively. The
decrease was primarily due to a decrease in distributions received from PDS for
the nine months ended February 28, 2009.  Cash used during the nine
months ended February 28, 2009 included approximately $668,000 in purchases of
Crossflo and Avot convertible notes, approximately $1,050,000 in purchases of
Avot preferred stock, approximately $497,000 in purchases of Talis membership
units and approximately $2,578,000 in the acquisition of Crossflo and
approximately $499,000 in the acquisition of the assets of Verras.





Cash
Flows From Financing Activities





Cash
provided by financing activities for the nine months ended February 28, 2009 was
approximately $1,747,000 as compared to cash used in financing activities of
approximately $5,786,000 for the nine months ended February 29,
2008.   For the nine months ended February 28, 2009, cash of
approximately $1,096,000 was used to purchase common stock for treasury and cash
of approximately $416,000 was used to pay notes payable.  Cash
received from financing activities during the nine months ended February 28,
2009 consisted of $3,000,000 received on our line of credit and $250,000
received by Holocom on their line of credit facility.





Capital
Resources





Our
current position as of February 28, 2009 is expected to provide the funds
necessary to support our operations through at least the next twelve
months.





Contractual
Obligations and Commitments





A summary
of our outstanding contractual obligations at February 28, 2009 is as
follows:




Contractual
              Cash
      Obligations
            
            Total
      Amounts
              Committed
            
            
            1-3
      Years
            
            
            3-6
      YearsOperating
      leases - facilities
            
            $
            500,766
            
            
            $
            491,727
            
            
            $
            9,039Repayments
      of short term debt
            
            $
            50,000
            
            
            $
            50,000
            
            
            $
            -Repayments
      of long term debt
            
            $
            3,025,421
            
            
            $
            -
            
            
            $
            3,025,421Retention
      bonus payments to former Crossflo employees
            
            $
            230,000
            
            
            $
            230,000
            
            
            $
            -Payments
      to Verras for asset acquisition
            
            $
            400,000
            
            
            $
            400,000
            
            
            $
            -





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 principles
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 FSP 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.


49


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 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. 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.


50


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
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.  The adoption of this standard as of
December 15, 2008 did not have a material impact on our consolidated
financial statements.





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.  Please refer to our risk factors contained in our Form 10-K for
the year ended May 31, 2008 for additional factors.





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.


51


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.




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.


52


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





A
successful challenge to our ownership of our technology or the proprietary
nature of our intellectual property would materially damage our business
prospects. We rely on a combination of patents, trademarks, copyrights, trade
secret laws, confidentiality procedures and licensing arrangements to protect
our intellectual property rights. We currently have 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. These actions have been dismissed
by Stipulation. 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 approximately $11.7 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 the Financial Industry Regulatory Authority (“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.


53


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





Our
common stock is currently listed for trading in the 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.


54


Auction
Rate Securities





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 February 28,
2009, we held such auction rate securities with a par value totaling $11.7
million that failed to sell at auction. During December 2008,
auction rate securities with a par value of $1,250,000 were redeemed by the
issuers at par value.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 February 2009.  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
February 28, 2009, the fair value of our auction rate securities was estimated
at $10.3 million based on a valuation by Houlihan Smith & Company,
Inc.  We recorded the net temporary valuation adjustment of $789,116
in other comprehensive income, which represents the gross valuation adjustment
of $1,331,751, net of the related tax benefit of $542,635.  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 nine
months ended February 28, 2009.





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 February 28,
2009.





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 February 28,
2009, 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.


55


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 February 28, 2009, our Chief Executive
Officer and Chief Financial Officer concluded that, as of such date, our
disclosure controls and procedures were effective.




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.  As a result, the Texas
Actions have been dismissed by Stipulation.  The Northern California
cases are in the early discovery phase.  The Court will likely set
trial 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.


56


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.  The Barco case will have the same
or similar scheduling order as the Acer and HTCcases.





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 answered our claims and an
arbitration panel is in the process of being selected.  Document
discovery has been initiated.  Some instruments have been
repurchased  by the issuers since the claim was filed (see Note
9).





Item
1A. Risk Factors





Please
see Part I, Item 2, above, for our risk factors.





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 5,839,141 shares of our
common stock at an aggregate cost of $1,095,994 during the nine months ended
February 28, 2009.





Following
is a summary of all repurchases by us of our common stock during the three month
period ended February 28, 2009:





Period
            
            Total
      Number of Shares Purchased
            
            Average
      Price Paid per Share
            
            Total
      Number of Shares Purchased as Part of Publicly Announced Plans or
      ProgramsDecember
      1 – 31, 2008
            
            
            200,000
            
            
            $
            0.13
            
            
            
            200,000January
      1 – 31, 2009
            
            
            250,750
            
            
            $
            0.13
            
            
            
            250,750February
      1 – 28, 2009
            
            
            69,415
            
            
            $
            0.11
            
            
            
            69,415Total
            
            
            520,165
            
            
            $
            0.13
            
            
            
            520,165





Item
3. Defaults Upon Senior Securities





None.





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





None.





Item
5. Other Information





None.


57


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)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)





58





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, 20023.3.5
            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)3.3.6*
            Certificate
      of Amendment to the Certificate of Incorporation of the Company, as filed
      with the Delaware Secretary of State on April 29, 20053.3.7*
            Certificate
      of Amendment to the Certificate of Incorporation of the Company, as filed
      with the Delaware Secretary of State on November 14,
20053.4
            Articles and
      Certificate of Merger of Patriot Financial Corporation into the Company
      dated May 1, 1992, with Agreement and Plan of Merger attached thereto
      as Exhibit A, incorporated by reference to Exhibit 3.4 to Form
      8-K dated May 12, 1992 (Commission file No. 33-23143-FW)3.5
            Certificate
      of Merger issued by the Delaware Secretary of State on May 8, 1992,
      incorporated by reference to Exhibit 3.5 to Form 8-K dated
      May 12, 1992 (Commission file No. 33-23143-FW)3.6
            Certificate
      of Merger issued by the Colorado Secretary of State on May 12, 1992,
      incorporated by reference to Exhibit 3.6 to Form 8-K dated
      May 12, 1992 (Commission file No. 33-23143-FW)3.7
            Bylaws
      of the Company, incorporated by reference to Exhibit 3.7 to Form 8-K
      dated May 12, 1992 (Commission file No. 33-23143-FW)4.1
            Specimen
      common stock certificate, incorporated by reference to Exhibit 4.1
      Form 8-K dated May 12, 1992 (Commission file No.
      33-23143-FW)4.2
            1996
      Stock Option Plan of the Company dated March 25, 1996 and approved by
      the Shareholders on May 17, 1996, incorporated by reference to
      Exhibit 10.13 to Pre-Effective Amendment No. 2 to Registration
      Statement on Form SB-2 filed May 23, 1996 (Commission file No.
      333-01765)4.3
            2001
      Stock Option Plan of the Company dated February 21, 2001 incorporated
      by reference to Exhibit 4.19 to Registration Statement on Form S-8
      filed March 26, 2001 (Commission file No. 333-57602)4.4
            2003
      Stock Option Plan of the Company dated July 2, 2003 incorporated by
      reference to Exhibit 4.27 to Registration Statement on Form S-8 filed
      September 4, 2003 (Commission file No. 333-108489)4.5
            2006
      Stock Option Plan of the Company dated March 31, 2006 incorporated by
      reference to Exhibit 4.19 to Registration Statement on Form S-8 filed
      June 20, 2006 (Commission file No. 333-135156)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)





59





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







60


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:  April 9,
      2009
            PATRIOT
      SCIENTIFIC CORPORATION
              
              /S/
      FREDERICK C. GOERNER
              
              Frederick
      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. GOERNER
              Frederick
      C. Goerner
            
            President
      and Chief Executive Officer
            April
      9, 2009/S/
      CLIFFORD L. FLOWERS
              Clifford
      L. Flowers
            
            Chief
      Financial Officer and Principal Accounting Officer
            April
      9, 2009/S/
      CARLTON M. JOHNSON
              Carlton
      M. Johnson
            
            Director
            April
      9, 2009/S/
      GLORIA H. FELCYN
              Gloria
      H. Felcyn
            
            Director
            April
      9, 2009/S/
      HELMUT FALK, JR.
              Helmut
      Falk, Jr.
            
            Director
            April
      9, 2009/S/
      HARRY L. TREDENNICK
              Harry
      L. Tredennick
            
            Director
            April
      9, 2009/S/
      DONALD E. SCHROCK
              Donald
      E. Schrock
            
            Director
            April
      9, 2009






61