UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington, D.C.
20549





FORM
10-Q





(Mark
One)




[X]
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934
              For
      the quarterly period ended November 30, 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)





(Registrant’s
telephone number, including area code): (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 has submitted electronically and posted on
its corporate Website, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). YES
[  ]   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.




Large
accelerated filer
[  ]                              
Accelerated filer
[X]                              
Non-accelerated filer [  ] (do not check if smaller reporting
company)




Smaller
reporting company [  ]




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




Yes
[  ]  No [X]




On
January 7, 2010, 410,093,076 shares of common stock, par value $0.00001 per
share, were outstanding.












INDEX








PagePART
      I. FINANCIAL INFORMATIONITEM
      1. Financial StatementsCondensed
      consolidated Balance Sheets as of November 30, 2009 (unaudited) and May
      31, 2009
            
            3Condensed
      consolidated Statements of Operations for the three and six months ended
      November 30, 2009 and November 30, 2008 (unaudited)
            
            4Condensed
      consolidated Statements of Cash Flows for the three and six months ended
      November 30, 2009 and November 30, 2008 (unaudited)
            
            5Notes
      to condensed consolidated Financial Statements (unaudited)
            
            7-38ITEM
      2. Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
            
            39-55ITEM
      3. Quantitative and Qualitative Disclosures About Market
    Risk
            
            55-56ITEM
      4. Controls and Procedures
            
            56-57PART
      II. OTHER INFORMATIONITEM
      1. Legal Proceedings
            
            57ITEM
      1A. Risk Factors
            
            57ITEM
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
            
            57-58ITEM
      3. Defaults Upon Senior Securities
            
            58ITEM
      4. Submission of Matters to a Vote of Security Holders
            
            58ITEM
      5. Other Information
            
            58ITEM
      6. Exhibits
            
            58-60SIGNATURES











2




PART
I- FINANCIAL INFORMATION





Item 1. Financial
Statements


Patriot
Scientific Corporation


Condensed
Consolidated Balance Sheets





November
      30,
              2009
            
            
            May
      31,
              2009ASSETS
            
            (Unaudited)Current
      assets:Cash
      and cash equivalents
            
            $
            11,573,153
            
            
            $
            6,206,868Restricted
      cash and cash equivalents
            
            
            20,654
            
            
            
            52,163Marketable
      securities
            
            
            379,486
            
            
            
            58,292Accounts
      receivable
            
            
            19,055
            
            
            
            168,402Accounts
      receivable - affiliated company
            
            
            385
            
            
            
            5,467Notes
      receivable
            
            
            503,333
            
            
            
            447,810Work-in-process
            
            
            65,253
            
            
            
            27,279Prepaid
      income taxes
            
            
            199,699
            
            
            
            506,526Current
      portion of deferred tax assets
            
            
            137,912
            
            
            
            285,472Prepaid
      expenses and other current assets
            
            
            175,653
            
            
            
            306,457Total
      current assets
            
            
            13,074,583
            
            
            
            8,064,736Marketable
      securities
            
            
            7,393,878
            
            
            
            10,598,389Property
      and equipment, net
            
            
            120,890
            
            
            
            85,475Goodwill
            
            
            642,981
            
            
            
            1,739,249Other
      intangible assets, net
            
            
            1,860,000
            
            
            
            5,803,639Deferred
      tax assets, net of current portion
            
            
            5,763,805
            
            
            
            2,843,677Other
      assets
            
            
            41,608
            
            
            
            51,507Investments
      in affiliated companies
            
            
            435,182
            
            
            
            4,540,280Total
      assets
            
            $
            29,332,927
            
            
            $
            33,726,952LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
            
            $
            198,267
            
            
            $
            414,843Accrued
      expenses and other
            
            
            616,374
            
            
            
            593,330Deferred
      revenue
            
            
            20,116
            
            
            
            26,311Total
      current liabilities
            
            
            834,757
            
            
            
            1,034,484Distributions
      in excess of  investment in affiliated company
            
            
            151,494
            
            
            
            -Long
      term debt, including accrued interest
            
            
            3,081,846
            
            
            
            3,041,577Total
      long term liabilities
            
            
            3,233,340
            
            
            
            3,041,577Total
      liabilities
            
            
            4,068,097
            
            
            
            4,076,061Commitments and
      contingenciesStockholders’
      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 410,149,523 shares outstanding at November 30, 2009;
      438,067,618 shares issued and 410,354,054 shares outstanding at May 31,
      2009
            
            
            4,380
            
            
            
            4,380Additional
      paid-in capital
            
            
            77,156,258
            
            
            
            77,008,332Accumulated
      deficit
            
            
            (37,613,548
            )
            
            
            (32,881,848
            )Common
      stock held in treasury, at cost – 27,918,095 shares and 27,713,564 shares
      at November 30, 2009 and May 31,
    2009,  respectively
            
            
            (13,890,894
            )
            
            
            (13,850,659
            )Accumulated
      other comprehensive loss
            
            
            (391,366
            )
            
            
            (629,314
            )Total
      stockholders’ equity
            
            
            25,264,830
            
            
            
            29,650,891Total
      liabilities and stockholders’ equity
            
            $
            29,332,927
            
            
            $
            33,726,952





See
accompanying notes to unaudited condensed consolidated financial
statements.








3





Patriot
Scientific Corporation


Condensed
Consolidated Statements of Operations


(Unaudited)





Three
      Months Ended
            
            
            Six
      Months EndedNovember
      30, 2009
            
            
            November
      30, 2008
            
            
            November
      30, 2009
            
            
            November
      30, 2008Revenues:Product
      sales and other
            
            $
            -
            
            
            $
            1,616,908
            
            
            $
            -
            
            
            $
            2,975,554License
      and service revenue
            
            
            66,416
            
            
            
            258,353
            
            
            
            163,451
            
            
            
            258,353Total
      revenues
            
            
            66,416
            
            
            
            1,875,261
            
            
            
            163,451
            
            
            
            3,233,907Cost
      of sales:Product
      sales and other
            
            
            -
            
            
            
            700,365
            
            
            
            -
            
            
            
            1,284,618License
      and service revenue
            
            
            40,204
            
            
            
            165,140
            
            
            
            72,187
            
            
            
            165,140Amortization
      of purchased intangibles
            
            
            206,688
            
            
            
            211,302
            
            
            
            413,376
            
            
            
            211,302Impairment
      of purchased intangibles
            
            
            3,530,263
            
            
            
            -
            
            
            
            3,530,263
            
            
            
            -Total
      cost of sales
            
            
            3,777,155
            
            
            
            1,076,807
            
            
            
            4,015,826
            
            
            
            1,661,060Gross
      profit (loss)
            
            
            (3,710,739
            )
            
            
            798,454
            
            
            
            (3,852,375
            )
            
            
            1,572,847Operating
      expenses:Research
      and development
            
            
            540,557
            
            
            
            151,874
            
            
            
            854,754
            
            
            
            151,874Selling,
      general and administrative
            
            
            2,011,030
            
            
            
            2,177,521
            
            
            
            3,938,825
            
            
            
            4,108,259Impairment
      of goodwill
            
            
            1,096,268
            
            
            
            -
            
            
            
            1,096,268
            
            
            
            -Total
      operating expenses
            
            
            3,647,855
            
            
            
            2,329,395
            
            
            
            5,889,847
            
            
            
            4,260,133Operating
      loss
            
            
            (7,358,594
            )
            
            
            (1,530,941
            )
            
            
            (9,742,222
            )
            
            
            (2,687,286
            )Other
      income (expense):Interest
      and other income
            
            
            25,847
            
            
            
            144,748
            
            
            
            68,774
            
            
            
            257,593Interest
      expense
            
            
            (19,629
            )
            
            
            (16,075
            )
            
            
            (40,269
            )
            
            
            (20,762
            )Impairment
      of investment in affiliated companies
            
            
            (433,333
            )
            
            
            -
            
            
            
            (1,113,625
            )
            
            
            -Equity
      in earnings of affiliated companies, net
            
            
            3,736,918
            
            
            
            109,739
            
            
            
            3,472,360
            
            
            
            6,668,509Total
      other income, net
            
            
            3,309,803
            
            
            
            238,412
            
            
            
            2,387,240
            
            
            
            6,905,340Income
      (loss) before income taxes and minority interest
            
            
            (4,048,791
            )
            
            
            (1,292,529
            )
            
            
            (7,354,982
            )
            
            
            4,218,054Provision
      (benefit) for income taxes
            
            
            (1,302,171
            )
            
            
            (631,826
            )
            
            
            (2,623,282
            )
            
            
            1,747,879Minority
      interest
            
            
            -
            
            
            
            271,556
            
            
            
            -
            
            
            
            192,921Net
      income (loss)
            
            $
            (2,746,620
            )
            
            $
            (932,259
            )
            
            $
            (4,731,700
            )
            
            $
            2,277,254Basic
      income (loss) per common share
            
            $
            (0.01
            )
            
            $
            -
            
            
            $
            (0.01
            )
            
            $
            0.01Diluted
      income (loss) per common share
            
            $
            (0.01
            )
            
            $
            -
            
            
            $
            (0.01
            )
            
            $
            0.01Weighted
      average number of common shares outstanding-basic
            
            
            407,429,202
            
            
            
            408,791,665
            
            
            
            407,457,238
            
            
            
            398,405,637Weighted
      average number of common shares outstanding-diluted
            
            
            407,429,202
            
            
            
            408,791,665
            
            
            
            407,457,238
            
            
            
            400,232,650




See
accompanying notes to unaudited condensed consolidated financial
statements





4





Patriot
Scientific Corporation


Condensed
Consolidated Statements of Cash Flows


(Unaudited)


Six
      months endedNovember
      30,
              2009
            
            
            November
      30,
              2008Operating
      activities:Net
      income (loss)
            
            $
            (4,731,700
            )
            
            $
            2,277,254Adjustments
      to reconcile net income (loss) to net cash used in operating
      activities:Minority
      interest in variable interest entity
            
            
            -
            
            
            
            192,921Impairment
      of intangibles
            
            
            3,530,263
            
            
            
            -Impairment
      of goodwill
            
            
            1,096,268
            
            
            
            -Amortization
      and depreciation
            
            
            446,503
            
            
            
            240,771Non-cash
      compensation relating to issuance of stock options and vesting
      of  warrants
            
            
            147,926
            
            
            
            279,338Accrued
      interest income added to investments and notes receivable
            
            
            (657
            )
            
            
            (7,958
            )Equity
      in earnings of affiliated companies
            
            
            (3,472,360
            )
            
            
            (6,668,509
            )Impairment
      of investment in affiliated companies
            
            
            1,113,625
            
            
            
            -Loss
      on sale of assets
            
            
            965
            
            
            
            1,733Write-off
      of patent costs
            
            
            -
            
            
            
            21,527Deferred
      income taxes
            
            
            (2,930,109
            )
            
            
            (1,382,218
            )Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            149,347
            
            
            
            (587,436
            )Receivable
      from affiliated company
            
            
            5,082
            
            
            
            (23,736
            )Inventory
            
            
            -
            
            
            
            (568,972
            )Work-in-process
            
            
            (37,974
            )
            
            
            (68,372
            )Prepaid
      expenses and other current assets
            
            
            140,703
            
            
            
            (3,781
            )Prepaid
      income taxes
            
            
            306,827
            
            
            
            222,311Accounts
      payable and accrued expenses
            
            
            (153,263
            )
            
            
            117,027Deferred
      revenue
            
            
            (6,195
            )
            
            
            31,574Income
      taxes payable
            
            
            -
            
            
            
            1,925,234Net
      cash used in operating activities
            
            
            (4,394,749
            )
            
            
            (4,001,292
            )Investing
      activities:Proceeds
      from sales of marketable securities
            
            
            3,278,806
            
            
            
            321,931Purchases
      of marketable securities
            
            
            -
            
            
            
            (195,967
            )Proceeds
      from sale of restricted investments
            
            
            31,643
            
            
            
            -Purchases
      of property and equipment
            
            
            (69,507
            )
            
            
            (16,039
            )Issuance
      of note receivable
            
            
            (55,000
            )
            
            
            (33,000
            )Cash
      received from repayment of note receivable
            
            
            -
            
            
            
            50,243Purchases
      of convertible notes receivable
            
            
            -
            
            
            
            (667,750
            )Investments
      in affiliated companies
            
            
            (112,500
            )
            
            
            (1,546,500
            )Distributions
      from affiliated company
            
            
            6,727,827
            
            
            
            7,648,589Cash
      paid in purchase acquisition, net of cash acquired
            
            
            -
            
            
            
            (2,546,477
            )Net
      cash provided by investing activities
            
            
            9,801,269
            
            
            
            3,015,030Financing
      activities:Proceeds
      from exercise of common stock warrants and options
            
            
            -
            
            
            
            5,000Payments
      on note payable
            
            
            -
            
            
            
            (175,594
            )Issuance
      of notes payable
            
            
            -
            
            
            
            3,250,000Repurchase
      of common stock for treasury
            
            
            (40,235
            )
            
            
            (1,029,107
            )Tax
      effect of exercise of options granted prior to fair value
      reporting
            
            
            -
            
            
            
            4,482Net
      cash provided by (used in) financing activities
            
            
            (40,235
            )
            
            
            2,054,781Net
      increase in cash and cash equivalents
            
            
            5,366,285
            
            
            
            1,068,519Cash
      and cash equivalents, beginning of period
            
            
            6,206,868
            
            
            
            6,424,015Cash
      and cash equivalents, end of period
            
            $
            11,573,153
            
            
            $
            7,492,534Supplemental
      Disclosure of Cash Flow Information:Cash
      payments for interest
            
            $
            -
            
            
            $
            20,762Cash
      payments for income taxes
            
            $
            -
            
            
            $
            976,985








5




Patriot
Scientific Corporation


Condensed
Consolidated Statements of Cash Flows


(Unaudited)


Six
      months endedNovember
      30,
              2009
            
            
            November
      30,
              2008Supplemental
      Disclosure of  Non-Cash Investing and Financing
      Activities:Conversion
      of note receivable to preferred stock – Avot Media, Inc.
            
            $
            -
            
            
            $
            250,000Insurance
      premium financed with a note payable
            
            $
            -
            
            
            $
            210,888Unrealized
      loss (recovery) on investments in marketable securities charged to other
      comprehensive income adjusted for deferred tax benefit
            
            $
            (237,948
            )
            
            $
            609,725Conversion
      of notes receivable plus accrued interest in connection with Crossflo
      Systems, Inc. acquisition
            
            $
            -
            
            
            $
            824,600Common
      stock issued in connection with Crossflo Systems, Inc.
      acquisition
            
            $
            -
            
            
            $
            6,582,214





See
accompanying notes to unaudited condensed consolidated financial
statements.
  6








Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


1.  Basis
of Presentation and Summary of Significant Accounting Policies





The
unaudited condensed consolidated financial statements of Patriot Scientific
Corporation (the “Company”, “PTSC”, “Patriot”, “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,
2009.





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 period presented.  Operating results for the six month period
ended November 30, 2009 are not necessarily indicative of the results that may
be expected for the year ending May 31, 2010.  We have evaluated
subsequent events through January 11, 2010, the filing date of this Form 10-Q,
and determined that no subsequent events have occurred that would require
recognition in the condensed consolidated financial statements or disclosure in
the notes thereto other than as disclosed in the accompanying notes.





Reclassifications





We have
reclassified our loss on fixed assets as presented in the Other income (expense)
section of our 2009 financial statements to selling, general and administrative
expenses.  Such reclassifications have no impact on our financial
position or results of operations.





Basis
of Consolidation





The
condensed consolidated balance sheets at November 30, 2009 and May 31, 2009 and
the condensed consolidated statement of operations for the three and six months
ended November 30, 2009 include our accounts and those of our wholly owned
subsidiary Patriot Data Solutions Group, Inc. (“PDSG”) which includes our
acquisitions of Crossflo Systems, Inc., the assets of Verras Medical, Inc., and
the business line Vigilys and our inactive subsidiary Plasma Scientific
Corporation.  All significant intercompany accounts and transactions
have been eliminated.





The
condensed consolidated statements of operations for the three and six months
ended November 30, 2008 include our accounts and those of our wholly owned
subsidiary Crossflo which is now part of PDSG, our majority owned inactive
subsidiary Plasma Scientific Corporation and the variable interest entity
(“VIE”) for which we were the primary beneficiary.  During September
2008, we dissolved our majority owned inactive subsidiary, Metacomp, Inc. All
significant intercompany accounts and transactions have been
eliminated





Consolidation
of Affiliate





We have
adopted the authoritative guidance for identifying VIEs and determining when we
should include  the assets, liabilities, noncontrolling interests and
results of activities of a VIE in our 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.






7


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements




Consolidation of Affiliate
(continued)





We are
required to consolidate a VIE if we have an ownership, contractual or other
financial interest in the VIE that obligates us to absorb a majority of the risk
of loss from the VIE’s activities, or we are 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.





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.  During July 2008, Holocom obtained a credit facility for up
to $300,000 from a third party, the credit facility term extended to May 1,
2009, and was guaranteed by us.  As a result of our guarantee on the
third party credit facility, we maintained a variable interest in
Holocom.  Upon expiration of the credit facility on May 1, 2009, we
deconsolidated Holocom as we are no longer deemed to be the primary
beneficiary.  We are now recording our investment in Holocom under the
cost method (see Note 11).





Investments
in Marketable Securities





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 fair 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 authoritative guidance 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 presented in the condensed
consolidated statements of operations in the caption “Equity in earnings of
affiliated companies.”





We have a
39.4% interest in Talis Data Systems, LLC (“Talis”) (see Note
11).  Prior to the write-off of our investment in Talis during the
quarter ended August 31, 2009, we were accounting for our investment using the
equity method of accounting.  Under the equity method of accounting,
the investment, originally recorded at cost, was adjusted to recognize our share
of net earnings or losses of the investee and was presented in the condensed
consolidated statements of operations in the caption “Equity in earnings of
affiliated companies.”  Talis is currently in the process of
dissolution.








8


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Investments
in Affiliated Companies (continued)





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 own
100% of the preferred stock of Holocom.  This investment has
historically been accounted for at cost since we do not have the ability to
exercise significant influence over the operating and financial policies of
Holocom. Due to a re-consideration event on May 1, 2009, this investment is
carried at cost plus the effects of deconsolidation of this variable interest
entity on our November 30, 2009 condensed consolidated balance
sheet.





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.





Avot is
currently undergoing negotiations for the sale of its business.  As a
result of preliminary proposals from potential acquirers we expect to receive
payment for our note receivable with Avot, but do not expect there will be
adequate consideration to liquidate the carrying value of our preferred stock
investment.  Accordingly, at November 30, 2009 we have written-off $433,333
which represents the remaining fair value of our preferred stock investment in
Avot.  We have recorded this as an impairment of investment in affiliated
companies on our condensed consolidated statements of operations for the three
and six months ended November 30, 2009.





Comprehensive
Income (Loss)





Comprehensive
income (loss) includes unrealized gains and losses which are excluded from the
condensed consolidated statements of operations.  For the six months
ended November 30, 2009, this amount included unrealized losses on investments
classified as available-for-sale.  The amount is presented net of
tax-related benefits of $157,541.





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 quarter of fiscal 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.





PDSG
sells software and services to end users primarily through relationships with
systems integrators and prime contractors.  PDSG recognizes revenue in
accordance with authoritative guidance for the software
industry.  PDSG’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.






9





Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial Statements






Revenue
Recognition (continued)





When a
sale involves multiple elements, PDSG 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.  PDSG 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 PDSG’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.  PDSG accounts for revenue on these
arrangements according to authoritative guidance for contract accounting. Under
this guidance, PDSG recognizes revenue based on progress towards contract
completion measured by actual hours incurred in relation to the estimate of
total expected hours. PDSG measures these revenues by applying the
contract-specific estimated percentage of completion to the total contract
amount for software and professional services.  PDSG routinely updates
the estimates of future hours for agreements in process and reports any
cumulative effects of such adjustments in current operations. PDSG immediately
recognizes any loss expected on these contracts when it is projected that loss
is probable.





In
certain situations where PDSG’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.





Prior to
its deconsolidation, Holocom recognized revenue upon shipment of its product or
upon receipt of its product by the customer when shipped FOB destination and
recognized revenue on its short-term installation contracts as time and
materials costs were incurred.





Holocom
maintained agreements with stocking distributors. These agreements provided for
a limited product warranty for a period of one year from the date of sale to the
end user. The warranty did not cover damage to the product after it was
delivered to the distributor. Holocom’s stocking distributor agreements also
allowed limited rights to periodic stock rotation.  These rotation
rights allowed for the exchange of a percentage of distributor inventory for
replacement products of the distributor’s choosing.




Research
and Development





Research
and development costs are expensed as incurred and primarily include payroll and
related benefit costs and contractor fees.





Shipping
and Handling





Shipping
and handling fees billed to customers are required to be classified as revenue,
and shipping and handling costs are required to be classified as either cost of
sales or disclosed in the notes to the financial statements. Holocom included
shipping and handling fees billed to customers in net sales. Holocom included
shipping and handling costs associated with inbound freight and unreimbursed
shipping to customers in cost of sales.








10




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements





Net
Income (Loss) Per Share





Basic
earnings (loss) per share includes no dilution and is computed by dividing
income (loss) available to common stockholders by the weighted-average number of
common shares outstanding for the period. Diluted earnings (loss) per share
reflects the potential dilution of securities that could share in the earnings
(loss) of  an entity.  For the three and six months ended
November 30, 2009, all potential common shares related to our outstanding
warrants and options totaling approximately 7,877,496 shares were excluded in
the calculation of diluted loss per share as they could have had an
anti-dilutive effect.  For the three and six months ended November 30,
2008, 8,980,000 potentially dilutive common shares related to our outstanding
warrants and options were excluded in the calculation of diluted income per
share as they could have had an anti-dilutive effect.





In
connection with our acquisition of Crossflo, which is now a part
of  PDSG, we issued escrow shares that are contingent upon certain
representations and warranties made by Crossflo at the time of the merger
agreement (see Note 15).  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.





The
following presents a reconciliation of the denominator used in the earnings per
share calculation for the six months ended November 30, 2008:





Denominator
      shares
            
            
            398,405,637Effect
      of dilutive securities:Options
      and warrants
            
            
            443,559Add:  escrow
      shares
            
            
            1,383,454Total
            
            
            400,232,650





Minority
Interest





Minority
interest in our condensed consolidated financial statements resulted 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 (loss) 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.


For the
three and six months ended November 30, 2008, the minority interest allocated
$271,556 and $192,921, respectively, represented the entire amount of Holocom’s
net income after taxes on a consolidated basis.





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.  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. Forfeitures are estimated at the time of grant and revised, if
necessary, in subsequent periods if actual forfeitures differ from those
estimates. The estimated average forfeiture rate for the three and six months
ended November 30, 2009 of approximately  5% was based on
historical forfeiture experience and estimated future employee forfeitures. The
estimated expected term of option grants for the three and six months ended
November 30, 2009 was five years.





11




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
six months ended November 30, 2009 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
              November
      30,
              2009
              (Unaudited)
            
            Six
      Months
              Ended
              November
      30,
              2009
              (Unaudited)
            
            Three
      Months
              Ended
              November
      30,
              2008
              (Unaudited)
            
            Six
      Months
              Ended
              November
      30,
              2008
              (Unaudited)Expected
      term
            
            5
            years
            
            5
            years
            
            5
            years
            
            5
            yearsExpected
      volatility
            
            117
            %
            
            116-117
            %
            
            124-125
            %
            
            124-125
            %Risk-free
      interest rate
            
            2.19
            %
            
            2.19–2.55
            %
            
            2.51-3.00
            %
            
            2.51–3.23
            %





A summary
of option activity as of November 30, 2009 and changes during the six months
then ended, is presented below:





Shares
            
            
            Weighted
              Average
              Exercise
              Price
            
            
            Weighted
              Average
              Remaining
              Contractual
              Term
              (Years)
            
            
            Aggregate
              Intrinsic
              ValueOptions
      outstanding at June 1, 2009
            
            
            10,210,000
            
            
            $
            0.39Options
      granted
            
            
            270,000
            
            
            $
            0.17Options
      exercised
            
            
            -
            
            
            $
            -Options
      forfeited
            
            
            (2,902,504
            )
            
            $
            0.34Options
      outstanding at November 30, 2009
            
            
            7
      7,577,496
            
            
            $
            0.40
            
            
            
            1.76
            
            
            $
            81,250Options
      vested and expected to vest at November 30, 2009
            
            
            7,530,923
            
            
            $
            0.40
            
            
            
            1.74
            
            
            $
            81,250Options
      exercisable at November 30, 2009
            
            
            6,646,042
            
            
            $
            0.43
            
            
            
            1.41
            
            
            $
            58,900






12




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements




Stock-Based
Compensation (continued)




The
weighted average grant date fair value of options granted during the six months
ended November 30, 2009 and 2008 was $0.14 and $0.17 per option,
respectively.  The total intrinsic value of options exercised during
the six months ended November 30, 2008 was $11,000 based on the differences in
market prices on the dates of exercise and the option exercise
prices.  There were no
options exercised during the six months ended November 30, 2009.


The
aggregate intrinsic value represents the differences in market price at the
close of the quarter ($0.18 per share on November 30, 2009) and the exercise
price of outstanding, in-the-money options (those options with exercise prices
below $0.18) on November 30, 2009.


As of
November 30, 2009, there was $106,922 of total unrecognized compensation cost
related to employee stock option compensation arrangements.  That cost
is expected to be recognized on a straight-line basis over the next 39
months.





The
following table summarizes employee and director stock-based compensation
expense for Patriot and employee stock-based compensation for PDSG for the three
and six months ended November 30, 2009 and 2008, which was recorded as
follows:


Three
              Months
              Ended
              November 30,
                2009
            
            
            Six
              Months
              Ended
              November
      30,
                2009
            
            
            Three
              Months
              Ended
              November
      30,
                2008
            
            
            Six
              Months
              Ended
              November
      30,
                2008Research
      and development - PDSG
            
            $
            3,366
            
            
            $
            4,548
            
            
            $
            378
            
            
            $
            378Selling,
      general and administrative expense - PDSG
            
            
            10,849
            
            
            
            25,676
            
            
            
            15,569
            
            
            
            15,569Selling,
      general and administrative expense - Patriot
            
            
            104,511
            
            
            
            124,635
            
            
            
            141,810
            
            
            
            249,979Total
            
            $
            118,726
            
            
            $
            154,859
            
            
            $
            157,757
            
            
            $
            265,926





On
October 5, 2009, our CFO was appointed interim CEO and his unvested options were
immediately vested by our Compensation Committee.  Accordingly, we
recorded $97,679 of non-cash stock-based compensation expense in connection with
the immediate vesting of these options.





During
the three and six months ended November 30, 2008, Holocom recognized $6,706 and
$13,411, respectively, of employee, consultant and director stock-based
compensation expense.





Recent
Accounting Pronouncements





In June
2009, the FASB revised the authoritative guidance for the consolidation of
variable interest entities.  The objective of this authoritative
guidance is to improve financial reporting by enterprises involved with variable
interest entities.  The revised authoritative guidance is effective as
of the beginning of each reporting entity’s first annual reporting period that
begins after November 15, 2009.  We expect to adopt this guidance on
June 1, 2010 and have not determined the effect of the adoption on our
consolidated financial statements.





13




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Recent
Accounting Pronouncements (continued)





In
July 2009, the FASB revised the authoritative guidance relating to software
revenue recognition to exclude all tangible products containing both software
and non-software components that function together to deliver the product’s
essential functionality. The revised authoritative guidance is effective for
revenue arrangements entered into or materially modified in fiscal years
beginning on or after June 15, 2010 and shall be applied on a prospective
basis. Earlier application is permitted as of the beginning of an entity’s
fiscal year provided it has not previously issued financial statements for any
period within that year. We expect to adopt this guidance on June 1, 2011 and
have not determined the effect of the adoption on our consolidated financial
statements.





In
September 2009, the FASB revised the authoritative guidance for revenue
arrangements with multiple deliverables.  This revised authoritative
guidance requires companies to allocate revenue in arrangements involving
multiple deliverables based on the estimated selling price of each deliverable,
even though such deliverables are not sold separately either by  the
company itself or other vendors. This revised authoritative guidance eliminates
the requirement that all undelivered elements must have objective and reliable
evidence of fair value before a company can recognize the portion of the overall
arrangement fee that is attributable to items that already have been delivered.
As a result, the new guidance may allow some companies to recognize revenue on
transactions that involve multiple deliverables earlier than under current
requirements. This revised authoritative guidance is effective for revenue
arrangements entered into or materially modified in fiscal years beginning on or
after December 15, 2009. Early adoption is permitted at the beginning of a
company’s fiscal year. We expect to adopt this guidance on June 1, 2010 and have
not determined the effect of the adoption 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 inter-agency and cross-domain data sharing
which  allows end users to selectively share information and rapidly
connect disparate data sources across multiple platforms.





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.








14




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Acquisitions
(continued)





This
transaction was accounted for in accordance with FASB guidance for 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  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 (0.75 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).  During the quarter ended November
30, 2009 intangibles were impaired and the fair value of Crossflo’s technology
was reduced to $1,860,000 (see Note 3).





15




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





Goodwill
in the amount of $1,668,630 was assigned to the Crossflo
segment.  This amount is not deductible for income tax
purposes.  During the fiscal year ended May 31, 2009 goodwill was
impaired by approximately $236,000.  During the quarter ended November
30, 2009 goodwill was impaired by approximately $1,096,000 (see Note
3).





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 the former stockholders of Crossflo 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.  Please see Note 15 for the status of the escrow
shares.








16


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Acquisitions
(continued)





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.





Three
      Months EndedNovember 30,
              2008
            
            
            Six
      Months EndedNovember 30,
              2008Revenue
            
            $
            1,875,261
            
            
            $
            3,459,531Net
      income (loss)
            
            $
            (932,259
            )
            
            $
            1,375,934Earnings
      per common share—basic
            
            $
            -
            
            
            $
            -Earnings
      per common share—diluted
            
            $
            -
            
            
            $
            -





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.





This
transaction was accounted for in accordance with FASB guidance for 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
            
            
            3,466








17


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Acquisitions
(continued)





Identifiable
      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  using estimates and assumptions determined by
management.  The fair values of the customer relationships,
trademarks/names and technology were determined using an income
approach.





Pursuant
to the purchase agreement, Crossflo paid Verras $80,288 on December 3, 2008, and
the remaining $400,000 was due in four equal installments on the three, six,
nine and twelve month anniversaries of the closing date.  The
remaining liability of $100,000 under this agreement was included in accrued
expenses on our condensed consolidated balance sheet at November 30,
2009.  On December 1, 2009, Crossflo paid Verras the final $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 had a
weighted-average useful life of approximately 7 years.  The intangible
assets that made up that amount included 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 was
assigned a 15 year life and amortized for income tax purposes.





During
the quarter ended November 30, 2009 the intangible assets and goodwill of Verras
were written-off through impairment charges (see Note 3).





Proforma
Financial Information





Due to
the immaterial nature of Verras’ operations, proforma financial statement
information is not  presented.





Vigilys





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 $197,004.





Allocation
      of purchase consideration:Identifiable
      intangible assets acquired:Customer
      relationships
            
            $
            29,000Trademarks/names
            
            
            14,500Technology
            
            
            43,500Goodwill
            
            
            110,004Total
      assets acquired
            
            $
            197,004








18


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements





The fair
values assigned to identifiable intangible assets acquired were based on an
appraisal  using estimates and assumptions determined by
management.  The fair values of the customer relationships,
trademarks/names and technology were determined using an income
approach.





None of
our acquired intangible assets were assigned to research and development
assets.  The acquired intangible assets of $87,000 had a
weighted-average useful life of approximately 7 years.  The intangible
assets that made up that amount included customer relationships of $29,000 (5
year weighted-average useful life), trademarks/names of $14,500 (10 year
weighted-average useful life) and technology of $43,500 (5 year weighted-average
useful life).





Goodwill
in the amount of $110,004 was assigned to Vigilys.  This amount was
assigned a 15 year life and amortized for income tax purposes.





During
the quarter ended November 30, 2009 the intangible assets and goodwill of
Vigilys were written-off through impairment charges (see Note 3).





Proforma
Financial Information





Due to
the immaterial nature of Vigilys’ operations, proforma financial statement
information is not presented.





3.
Goodwill and Other Intangible Assets





Goodwill
originating from acquisitions is not amortized and is tested for impairment on
an annual basis and between annual tests based on certain
circumstances.





Purchased
intangible assets were being amortized over a period of 9 months to 10
years.  After impairment, the technology of PDSG is currently being
amortized over 81 months.





The
following table presents details of our other intangible assets and related
accumulated amortization balances, which were recorded as a result of business
combinations and asset purchases:





EstimatedLife in Years
            
            
            AllocatedValue
            
            
            AccumulatedAmortization
            
            
            Impairment
            
            
            Net
      Carrying ValueNovember 30, 2009Customer
      contracts–open orders
            
            
            0.75
            
            
            $
            63,600
            
            
            $
            (63,600
            )
            
            $
            -
            
            
            $
            -Customer
      relationships
            
            
            5
            
            
            
            65,000
            
            
            
            (11,064
            )
            
            
            (53,936
            )
            
            
            -Maintenance
      agreements
            
            
            4
            
            
            
            75,400
            
            
            
            (23,565
            )
            
            
            (51,835
            )
            
            
            -Trademarks/names
            
            
            10
            
            
            
            124,500
            
            
            
            (11,972
            )
            
            
            (112,528
            )
            
            
            -Technologies
      and processes
            
            
            5–8
            
            
            
            6,136,900
            
            
            
            (964,936
            )
            
            
            (3,311,964
            )
            
            
            1,860,000$
            6,465,400
            
            
            $
            (1,075,137
            )
            
            $
            $(3,530,263
            )
            
            $
            1,860,000








19


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements
 
 Goodwill and Other Intangible
Assets (continued)





EstimatedLife
      in Years
            
            AllocatedValue
            
            
            AccumulatedAmortization
            
            
            Net
      Carrying ValueMay 31, 2009Customer
      contracts  – open orders
            0.75
            
            $
            63,600
            
            
            $
            (63,600
            )
            
            $
            -Customer
      relationships
            5.00
            
            
            65,000
            
            
            
            (4,566
            )
            
            
            60,434Maintenance
      agreements
            4.00
            
            
            75,400
            
            
            
            (14,139
            )
            
            
            61,261Trademarks/names
            10.00
            
            
            124,500
            
            
            
            (5,744
            )
            
            
            118,756Technologies
      and processes
            5.00–8.00
            
            
            6,136,900
            
            
            
            (573,712
            )
            
            
            5,563,188$
            6,465,400
            
            
            $
            (661,761
            )
            
            $
            5,803,639





We have
included the amortization expense and related impairment charges on intangible
assets that relate to products sold in cost of sales.  We have
included amortization expense associated with Holocom’s patents in selling,
general and administrative expense on our condensed consolidated statement of
operations for the three and six months ended November 30,
2008.





The
amortization expense related to intangible assets was as follows:





Three
              Months
              Ended
              November 30,
              2009
            
            
            Six
              Months
              Ended
              November 30,
              2009
            
            
            Three
              Months
              Ended
              November 30,
              2008
            
            
            Six
              Months
              Ended
              November 30,
              2008Amortization
      of intangible assets included in:Cost
      of sales
            
            $
            206,688
            
            
            $
            413,376
            
            
            $
            211,302
            
            
            $
            211,302Selling,
      general and administrative expense
            
            
            -
            
            
            
            -
            
            
            
            759
            
            
            
            1,518Total
            
            $
            206,688
            
            
            $
            413,376
            
            
            $
            212,061
            
            
            $
            212,820





At
November 30, 2009 the estimated future amortization expense of intangible assets
is estimated to be as follows:





Year2010
      (remaining six months)
            
            $
            137,7782011
            
            
            275,5562012
            
            
            275,5562013
            
            
            275,5562014
            
            
            275,556Thereafter
            
            
            619,998Total
      expected future amortization
            
            $
            1,860,000








20




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements




Goodwill and Other Intangible
Assets (continued)





Changes
in the net carrying amount of goodwill are as follows:





Balance,
      June 1, 2008
            
            $
            -Goodwill
      of Crossflo acquired
            
            
            1,668,630Goodwill
      of Verras acquired
            
            
            196,512Goodwill
      of Vigilys acquired
            
            
            110,004Impairment
      of Crossflo goodwill
            
            
            (235,897
            )Balance,
      May 31, 2009
            
            
            1,739,249Impairment
      of Verras goodwill
            
            
            (196,512
            )Impairment
      of Vigilys goodwill
            
            
            (110,004
            )Impairment
      of Crossflo goodwill
            
            
            (789,752
            )Balance
      November 30, 2009
            
            $
            642,981





The
inability of PDSG to meet its business plan and the general economic environment
were indicators of potential impairment on our goodwill and intangible assets,
accordingly at May 31, 2009, management obtained a third party valuation of
PDSG’s goodwill and intangibles from Vantage Point Advisors,
Inc.  Based on the results of the valuation, it was determined that
goodwill was impaired by approximately $236,000.  We recorded this as
an impairment of goodwill on our consolidated statement of income for the fiscal
year ended May 31, 2009.





Management’s
plan of restructuring on October 5, 2009 and the continuing inability of PDSG to
meet its business plan were indicators of potential impairment on our goodwill
and intangible assets. Accordingly, at November 30, 2009, management obtained a
third party valuation of PDSG’s goodwill and intangibles from Vantage Point
Advisors, Inc.  Based on the results of the valuation, it was
determined that goodwill was impaired by approximately $1,096,000 and
intangibles were impaired by approximately $3,530,000.  We recorded
these as impairments of goodwill and purchased intangibles on our condensed
consolidated statements of operations for the three and six months ended
November 30, 2009.





4.
Cash, Cash Equivalents and Short-Term Investments





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





Restricted
cash and cash equivalents at November 30, 2009 consist of a savings account
required to be held  as collateral for our corporate credit card
account.





Restricted
cash and cash equivalents at May 31, 2009 consist of two savings accounts
required to be held as collateral for corporate credit card
accounts.





At
November 30, 2009 our short-term investments in the amount of $379,486 includes
accrued interest receivable on our auction rate securities in the amount of
$29,486 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.  Additionally, $350,000 in
auction rate securities redeemed at par value on December 1, 2009 have been
recorded in our short-term investments at November 30, 2009.





At May
31, 2009, our short-term investments in the amount of $58,292, consists of
accrued interest receivable on our auction rate securities.  This
value is reported at cost, which approximates fair market value.








21




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements




5.  Fair
Value Measurements





We follow
authoritative guidanceto account for our
financial assets and liabilities at fair value.  Under this
authoritative guidance we are required 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. The three levels of
inputs that we may use to measure fair value are:





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





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





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





The
following table represents our financial instruments subject to fair value
measurement and the valuation approach applied to each class of
security:





Quoted
      Prices in Active Markets
              Level
      1
            
            
            Significant
      Other Observable Inputs
              Level
      2
            
            
            Significant
              Unobservable
      Inputs
              Level
      3
            
            
            Balance
      as of
              November
      30, 2009Auction
      rate securities
            
            $
            —
            
            
            $
            —
            
            
            $
            7,743,878
            
            
            $
            7,743,878





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
$656,122.  We have recorded an unrealized loss of $391,366 in
accumulated other comprehensive loss at November 30, 2009, which represents the
gross valuation adjustment of $656,122, net of the related tax benefit of
$264,756. These securities are classified as “available-for-sale” 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 $7,393,878 of these auction rate securities as
long-term assets on the condensed consolidated balance
sheets.  $350,000 of the auction rate securities redeemed at par value
on December 1, 2009 have been classified as short term marketable securities on
the condensed consolidated balance sheet at November 30, 2009.








22




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Fair
Value Measurements (continued)





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





(Unaudited)
            
            Fair Value Measurements Using Significant
              Unobservable
      Inputs (Level 3)Description
            
            Auction
      Rate
              Securities
            
            
            TotalBeginning
      balance, May 31, 2009
            
            $
            11,650,000
            
            
            $
            11,650,000Transfers
      in to Level 3
            
            
            —
            
            
            
            —Total
      realized/unrealized losses:
            
            
            —
            
            
            
            —Included
      in earnings
            
            
            —
            
            
            
            —Included
      in comprehensive income (loss)
            
            
            (656,122
            )
            
            
            (656,122
            )Settlements
            
            
            (3,250,000
            )
            
            
            (3,250,000
            )Ending
      balance, November 30, 2009
            
            $
            7,743,878
            
            
            $
            7,743,878Total
      recovery of previously unrealized losses for the six months ended November
      30, 2009 included in other comprehensive income (loss) attributable to the
      change in fair market value relating to assets still held at the reporting
      date
            
            $
            395,489
            
            
            $
            395,489





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





6.
Accounts Receivable





Trade
accounts receivable consisted of the following:





November
      30,
              2009
            
            
            May
      31,
              2009PTSC
            
            $
            -
            
            
            $
            1,708PDSG
            
            
            19,055
            
            
            
            166,694Total
            
            $
            19,055
            
            
            $
            168,402





No
allowance for doubtful accounts was necessary at November 30, 2009 or May 31,
2009.





At
November 30, 2009 and May 31, 2009, accounts receivable from our investee PDS
was $385 and $5,467, 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.








23


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


7.
Notes Receivable





On
February 24, 2009, we received a promissory note receivable from Avot for
principal of $100,000.  Interest at the rate of 8% accrued on the note
until its maturity date of August 24, 2009.





On March
12, 2009, we entered into a secured revolving note receivable with Avot for
$500,000.  The note bears interest at a rate of 8% and was due
December 12, 2009. The note is secured by the assets of Avot.  Upon
entering into the secured revolving loan note, the short term note we received
from Avot on February 24, 2009 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, April 1,
2009, May 11, 2009 and June 22, 2009, we advanced $115,000, $115,000, $115,000
and $55,000, respectively, to Avot under terms of the note. At November 30, 2009
the balance of the note receivable was $503,333, including accrued interest
receivable of $3,333.  On December 12, and December 30, 2009 we
granted Avot forbearances on the note which currently extend through January 31,
2010 as Avot is currently in negotiations for the sale of its business (see Note
17).





At May
31, 2009, the balance of the note receivable was $447,810, including accrued
interest receivable of $2,810 recognized during the year ended May 31,
2009.





8.
Work-In-Process





Work-in-process
at November 30, 2009  and May 31, 2009 consists of $65,253 and
$27,279, respectively,  which represents the excess of recognized
revenue over invoices to customers on PDSG’s current contracts in
progress.





9.
Investments in Marketable Securities





The
following table shows the cost, cumulative unrealized losses and fair value of
our investments in marketable securities with unrealized losses that are not
deemed to be other-than-temporarily impaired, aggregated by investment category
and length of time that individual securities have been in a continuous
unrealized loss position at November 30, 2009 and May 31, 2009.  As
stated in Note 5, the fair value of our  investments is based on
valuations by Houlihan Smith & Company, Inc. at November 30, 2009 and May
31, 2009:





As
      of November 30, 2009Twelve
      Months or GreaterCost
            
            
            Cumulative
              Unrealized
              Losses
            
            
            Estimated
              Fair
              ValueShort-termAccrued
      interest - auction rate securities
            
            $
            29,486
            
            
            $
            —
            
            
            $
            29,486Auction
      rate securities
            
            
            350,000
            
            
            
            —
            
            
            
            350,000Total
            
            
            379,486
            
            
            
            —
            
            
            
            379,486Long-termAuction
      rate securities
            
            
            8,050,000
            
            
            
            (656,122
            )
            
            
            7,393,878Total
            
            $
            8,429,486
            
            
            $
            (656,122
            )
            
            $
            7,773,364








24





Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Investments in Marketable
Securities(continued)





As
      of May 31, 2009Twelve
      Months or GreaterCost
            
            
            Cumulative
              Unrealized
              Losses
            
            
            Estimated
              Fair
              ValueShort-termAccrued
      interest - auction rate securities
            
            $
            58,292
            
            
            $
            —
            
            
            $
            58,292Long-termAuction
      rate securities
            
            
            11,650,000
            
            
            
            (1,051,611
            )
            
            
            10,598,389Total
            
            $
            11,708,292
            
            
            $
            (1,051,611
            )
            
            $
            10,656,681





Auction Rate
Securities.The unrealized losses on our auction rate
securities are caused by the uncertainty that these securities will settle or
that we may have to redeem them for less than par value in the event we needed
immediate access to these funds.  As of November 30, 2009 and May 31,
2009, we held auction rate securities with a par value totaling approximately
$8.4 million and $11.7 million, respectively, that failed to sell at auction or
be redeemed.  During June 2009, auction rate securities with a par
value of $750,000 were redeemed by the issuers at par value.  In
September 2009, auction rate securities with a par value of $2,500,000 were
redeemed by the issuer at par value.  In December 2009, auction rate
securities with a par value of $350,000 were redeemed by the issuers at par
value (see Note 17). In the event we need to access funds invested in these
auction rate securities we would not be able to liquidate these securities until
(i) a future auction of these securities is successful, (ii) they are refinanced
and redeemed by the issuers, or (iii) a buyer is found outside of the auction
process.  The investments consist of student loan auction rate
instruments issued by various state agencies pursuant to the Federal Family
Educational Loan Program (“FFELP”).  These investments are of high
credit quality and the AAA credit ratings of the investments have been
reaffirmed since November 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 do not intend to sell our auction rate
securities before we are able to recover our cost basis and it is more likely
than not that we will not have to sell our auction rate securities before
recovery of our cost basis.





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 November 30, 2009, except the auction rate
securities redeemed in December 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 $391,366 in other comprehensive loss at November 30, 2009, which represents
the gross valuation adjustment of $656,122, net of the related tax benefit of
$264,756.  At May 31, 2009, we recorded an unrealized loss of $629,314
in accumulated other comprehensive loss, which represents the gross valuation
adjustment of $1,051,611, net of the related tax benefit of
$422,297.





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.








25


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





During
June 2008, we obtained a credit facility from Wedbush Morgan Securities, Inc.
(“Wedbush”) for as long as needed, which provides for financing up to 50% of the
par value balance of our outstanding auction rate securities. The facility is
collateralized by the full value of the outstanding auction rate securities,
required no origination fee, and when drawn upon will bear interest at the
federal funds rate plus 3%.  On October 14, 2008, we borrowed
$3,000,000 on the credit facility, the proceeds of which is included in cash and
cash equivalents at November 30, 2009 (see Note 13).





10.
License Agreements





In
February 2005, we entered into two separate licensing agreements with one
customer for our patent portfolio and Ignite microprocessor technology. The
aggregate amount of the two licenses was $3,050,000, of which $2,950,000 was for
licensing fees and $100,000 was for maintenance services. Maintenance under the
agreement was expected to be provided over a period not to exceed four years;
which ended in February 2009. Maintenance revenue recognized during the three
and six months ended November 30, 2008 was approximately $6,250 and $12,500,
respectively.





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.  During the quarter ended November 30, 2009 we and TPL each
contributed $80,000 to PDS for working capital requirements.  In
December 2009, we and TPL each contributed $500,000 to PDS for working capital
requirements (see Note 17).  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 TPL on behalf of PDS.
During the six months ended November 30, 2009 and 2008, PDS expensed $1,000,000
and $1,866,641, respectively, pursuant to this commitment.





PDS
reimburses TPL for payment of all legal and third-party expert fees and other
related third-party costs and other expenses.  During the six months
ended November 30, 2009 and 2008, PDS expensed $3,002,738 and $1,556,285,
respectively, pursuant to the agreement.








26


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements





On
November 13, 2008, the management committee of PDS 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 was
not to exceed $1,000,000 for the period June 1, 2008 through May 31,
2009.  From November 2008 to May 31, 2009, PDS expensed $571,500
pursuant to this resolution.





On August
17, 2009, the management committee of PDS resolved to pay TPL $500,000 per
quarter beginning on June 1, 2009 and continuing through May 31, 2010 relating
to TPL’s special work and effort regarding the MMP litigation and U.S. Patent
Office re-examinations.  In the event that PDS has insufficient funds
to make such payments, we are required to advance half of the quarterly amount
to PDS.  Our advance to PDS will be without interest and must be
repaid to us no later than May 31, 2010.  On August 25, 2009, TPL
received $500,000 from PDS pursuant to this agreement, at November 30, 2009,
$500,000 was accrued pursuant to this agreement and paid to TPL by PDS in
December 2009.  These amounts are included in the legal and
third-party expert fees listed above.  As of the date of this filing,
we have not advanced any funds to PDS under this resolution.





We are
accounting for our investment in PDS under the equity method of accounting, and
accordingly have recorded our share of PDS’ net income during the six months
ended November 30, 2009 and 2008, of $3,494,067 and $6,872,991,
respectively,  as an increase in our investment.  Cash
distributions received from PDS during the six months ended November 30, 2009
and 2008 of $6,727,827 and $7,648,589, respectively, have been recorded as a
reduction in our investment. During the six months ended November 30, 2009, PDS
distributed earnings in excess of the carrying amount of our investment of
$151,494.  Such amount has been recorded as “Distributions in excess
of investment in affiliated company” on our condensed consolidated balance sheet
at November 30, 2009, due to our and TPL’s obligation to fund the working
capital of PDS at the discretion of PDS’ management committee.  We
have recorded our share of PDS’ net income for the six months ended November 30,
2009 and 2008 as “Equity in earnings of affiliated companies” in the
accompanying condensed consolidated statements of operations.





During
the three months ended November 30, 2009 and 2008, TPL entered into licensing
agreements with third parties, pursuant to which PDS recorded aggregate proceeds
of $8,696,000 and $2,775,000, respectively. $2,000,000 of these proceeds are to
be received in July 2010 and accordingly have been recorded as licenses
receivable on the November 30, 3009 condensed balance sheet of PDS.





During
the six months ended November 30, 2009 and 2008, TPL entered into licensing
agreements with third parties, pursuant to which PDS recorded aggregate proceeds
of $11,023,655 and $19,050,000, respectively.





At
November 30, 2009, PDS had accounts payable balances of approximately $2,387,332
and $385  to TPL and PTSC, respectively.  At May 31, 2009,
PDS had accounts payable balances of approximately $1,482,000 and $5,500 to TPL
and PTSC, respectively.





PDS’
condensed balance sheets at November 30, 2009 and May 31, 2009 and statements of
income for the three and six months ended November 30, 2009 and 2008 are as
follows:








27


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements
 
 Investments
in Affiliated Companies (continued)





Condensed
Balance Sheets





ASSETS:


November
      30,
              2009
            
            
            May
      31,
              2009Cash
      and cash equivalents
            
            $
            84,729
            
            
            $
            1,343,582Licenses
      receivable
            
            
            2,000,000
            
            
            
            6,148,750Total
      assets
            
            $
            2,084,729
            
            
            $
            7,492,332





LIABILITIES
AND MEMBERS’ EQUITY (DEFICIT):


November
      30,
              2009
            
            
            May
      31,
              2009Accounts
      payable
            
            $
            2,387,717
            
            
            $
            1,487,799Members’
      equity (deficit)
            
            
            (302,988
            )
            
            
            6,004,533Total
      liabilities and members’ equity (deficit)
            
            $
            2,084,729
            
            
            $
            7,492,332





Condensed
Statements of Income





Three
      Months Ended
            
            
            Six
      Months EndedNovember
      30, 2009
            
            
            November
      30, 2008
            
            
            November
      30, 2009
            
            
            November
      30, 2008Revenues
            
            $
            8,696,000
            
            
            $
            2,775,000
            
            
            $
            11,023,655
            
            
            $
            19,050,000Operating
      expenses
            
            
            1,222,237
            
            
            
            2,144,072
            
            
            
            4,035,901
            
            
            
            4,086,632Operating
      income
            
            
            7,473,763
            
            
            
            630,928
            
            
            
            6,987,754
            
            
            
            14,963,368Interest
      income
            
            
            72
            
            
            
            14,739
            
            
            
            380
            
            
            
            43,378Net
      income
            
            $
            7,473,835
            
            
            $
            645,667
            
            
            $
            6,988,134
            
            
            $
            15,006,746





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-domaincomputer and network
security products to government, military, and enterprise customers.Talis develops and markets
PCs incorporating the company's 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 as a result of purchasing
additional membership units offered by Talis for $300,000 as well as acquiring
membership units from minority members for $196,500.  We also acquired
all of the Talis membership units previously held by Holocom for $100,000 in
cash and a reduction on their outstanding line of credit of
$219,000.





During
the fourth quarter of fiscal year 2009, we purchased an additional 185,793
membership units of Talis for $269,399 which brought our ownership share of
Talis to 38.9% at May 31, 2009.  During June 2009, we purchased 22,414
membership units for $32,500 which brings our ownership share to
39.4%.








28




Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements





Investments
in Affiliated Companies (continued)





The
inability of Talis to meet its business plan, raise capital, and the general
economic environment were indicators of impairment on our investment,
accordingly at August 31, 2009, management obtained a third party valuation of
Talis from Vantage Point Advisors, Inc.  Based on the results of the
valuation, it was determined that our investment in Talis was impaired by
approximately $680,000.  We have recorded this as an impairment of
investment in affiliated companies on our condensed consolidated statement of
operations for the six months ended November 30, 2009.





We were
accounting for our investment in Talis under the equity method of
accounting.  We had recorded our share of Talis’ net loss of $21,706
and $63,089 during the two months ended July 31, 2009 and three months ended
August 31, 2008, respectively, as a decrease in our investment.  Our
investment in Talis was $669,498 at May 31, 2009 and was recorded as
“Investments in Affiliated Companies” on our condensed consolidated balance
sheet.  We have recorded our share of Talis’ net loss as “Equity in
Earnings of Affiliated Companies” in the accompanying condensed consolidated
statements of operations for the two months ended July 31, 2009 and the three
month ended August 31, 2008.  The carrying value of our investment in
Talis after impairment is zero at August 31, 2009.  Talis is currently
in the process of dissolution.





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





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.





The
inability of Avot to meet its business plan, to raise capital, and the general
economic environment were indicators of impairment on our investment, and at May
31, 2009, management obtained a third party valuation of Avot from Vantage Point
Advisors, Inc.  Based on the results of the valuation, it was
determined that our investment in Avot was impaired by approximately
$867,000.






29


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements





Avot is
currently undergoing negotiations for the sale of its business.  As a
result of preliminary proposals from potential acquirers we expect to receive
payment for our note receivable with Avot, but do not expect there will be
adequate consideration to liquidate the carrying value of our preferred stock
investment.  Accordingly, at November 30, 2009 we have written off $433,333
which represents the remaining fair value of our preferred stock investment in
Avot.  We have recorded this as an impairment of investment in affiliated
companies on our condensed consolidated statements of operations for the three
and six months ended November 30, 2009.





In
September 2009, we entered into an agreement with Avot in which Avot will
develop a software package for PDSG’s Vigilys product.  Terms of the
agreement require PDSG to pay Avot four milestone payments of $50,000 each on
September 1, October 1, November 1 and December 1, 2009.  In
connection with the agreement, Avot issued us 1,000,000 warrants to purchase
shares of Avot’s common stock ,with an exercise price of $0.05 per share and a
36 month exercise period.  The warrants were issued in four 250,000
installments consistent with the milestone payments.  The value
attributed to the warrants was insignificant.





During
March 2009, we entered into a revolving loan note with Avot.  At
November 30, 2009, the balance on the note receivable is $503,333 (see Note
7).





Scripps
Secured Data, Inc. (d/b/a Holocom, Inc.)





On
February 2, 2007, we invested an aggregate of $370,000 in convertible preferred
stock, representing all of the issued preferred stock and a 46% ownership
interest, of and in Holocom, a California corporation that manufactures products
that protect information transmitted over secure networks. The investment
consisted of certain assets we contributed to Holocom valued at $250,000 and
cash of $120,000. The investment is represented by 2,100,00 shares of
convertible preferred stock, and 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.





We
reviewed the Preferred Stock Purchase Agreement and related agreements to
determine whether our convertible preferred stock investment in Holocom was in
substance an investment in common stock pursuant to authoritative
guidance.  We determined that, because the liquidation preference is
substantive, the subordination characteristics of the preferred stock are not
substantially similar to the subordination characteristics of Holocom’s common
stock. We also evaluated our voting rights pursuant to other agreements with
Holocom and, when considered together with authoritative guidance , we believe
that we do not have the ability to exercise significant influence over Holocom.
As a result, we are accounting for our investment in Holocom at
cost.





During
March 2007, we entered into a revolving line of credit with Holocom which caused
us to have a variable interest in Holocom and we were required to consolidate
Holocom as a variable interest entity.  Prior to initial
consolidation, we recognized a $126,746 impairment loss on our preferred stock
investment for the losses of Holocom for the period February 2007 through March
26, 2007.  During May 2009, we deconsolidated Holocom due to a
re-consideration event (see Note 12).  At November 30, 2009 and May
31, 2009, our investment in Holocom is $435,182 and has been recorded as
“Investments in Affiliated Companies” on our condensed consolidated balance
sheets at November 30, 2009  and May 31, 2009.








30


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


12. 
Formerly Consolidated Variable Interest Entity





As stated
in Note 11, in February 2007, we invested an aggregate of $370,000 in Holocom
for 2,100,000 shares of convertible preferred stock.  On March 27,
2007, we entered into an 18-month revolving line of credit with Holocom for a
maximum amount of $500,000.  As a result of the line of credit, we had
a variable interest in Holocom, a variable interest entity, and we had
determined that we were the primary beneficiary as we absorbed more than half of
the variable interest entity’s expected losses.  On August 29, 2008
Holocom paid the remaining balance due on the March 2007 line of credit and
provided us notice effectively terminating the line of credit on August 29,
2008.  During July 2008, Holocom obtained a credit facility for up to
$300,000 from a third party, the facility’s term extended to May 1, 2009, and
was guaranteed by us. As a result of our guarantee on the third party credit
facility, which we were not contractually required to provide, we maintained a
variable interest in Holocom as we are obligated under the guarantee to repay
the third party should Holocom default on the credit facility.  During
May 2009, Holocom paid the balance due on the July 2008 facility, releasing our
guarantee.  As a result of this re-consideration event, we are no
longer the sole source of financial support and the primary beneficiary for
Holocom; accordingly on May 1, 2009  we deconsolidated Holocom from
our financial results.





For the
three and six months ended November 30, 2008, the minority interest allocated
$271,556 and $192,921, respectively, represented the entire amount of
Holocom’s  net income after taxes on a consolidated
basis.





13.  Notes
Payable





On
October 14, 2008, we borrowed $3,000,000 on our credit facility with Wedbush,
the proceeds of which is included in cash and cash equivalents at November 30,
2009 and May 31, 2009.  Per requirements of The Financial Industry
Regulatory Authority (“FINRA”), the credit facility is limited to 50% of the par
value of our outstanding auction rate securities.  As of the date of
this filing, the par value of our outstanding auction rate securities was
$8,050,000, which limits our credit facility to $4,025,000.  The
facility is collateralized by the full value of the outstanding auction rate
securities, requires no origination fee and bears interest at the federal funds
rate plus 3%.  At November 30, 2009 and May 31, 2009, the balance
included accrued interest on the credit facility of $81,846 and $41,577,
respectively, at an approximate rate of 3.25%.





14.  Stockholders’
Equity





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. Comprehensive income (loss) for
the three and six months ended November 30, 2009 and 2008 was as
follows:





Three
      Months Ended
            
            
            Six
      Months EndedNovember
      30, 2009
            
            
            November
      30, 2008
            
            
            November
      30, 2009
            
            
            November
      30, 2008Net
      income (loss)
            
            $
            (2,746,620
            )
            
            $
            (932,259
            )
            
            $
            (4,731,700
            )
            
            $
            2,277,254Unrealized
      holding gain (losses) on investments, net of taxes
            
            
            138,781
            
            
            
            (521,021
            )
            
            
            237,948
            
            
            
            (609,725
            )Total
      comprehensive income (loss)
            
            $
            (2,607,839
            )
            
            $
            (1,453,280
            )
            
            $
            (4,493,752
            )
            
            $
            1,667,529








31


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements
 
 Stockholders’ Equity (continued)





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 204,531 and 5,318,976
shares of our common stock at an aggregate cost of $40,235 and $1,029,107 during
the six months ended November 30, 2009 and 2008, respectively.





Equity
Transactions





The
following table summarizes equity transactions during the six months ended
November 30, 2009:





Common
      Stock
            
            
            Additional
      Paid-
            
            
            Accumulated
            
            
            TreasuryShares
            
            
            
            Amounts
            
            
            in
      Capital
            
            
            Deficit
            
            
            StockBalance
      June 1, 2009
            
            
            410,354,054
            
            
            $
            4,380
            
            
            $
            77,008,332
            
            
            $
            (32,881,848
            )
            
            $
            (13,850,659
            )Non-cash
      compensation
            
            
            -
            
            
            
            -
            
            
            
            147,926
            
            
            
            -
            
            
            
            -Repurchase
      of common stock for treasury
            
            
            (204,531
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (40,235
            )Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (4,731,700
            )
            
            
            -Balance
      November 30, 2009
            
            
            410,149,523
            
            
            $
            4,380
            
            
            $
            77,156,258
            
            
            $
            (37,613,548
            )
            
            $
            (13,890,894
            )





Stock Optionsand Warrant
Activity





As of
November 30, 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 2012; 1,873,000 options outstanding
pursuant to our 2003 Stock Option Plan exercisable at a range of $0.10 to $0.40
per share expiring through 2010; and 4,755,496 options outstanding pursuant to
our 2006 Stock Option Plan exercisable at a range of $0.09 to $0.70 per share
expiring through 2014.





On June
1, 2009, we issued 70,000 stock options from our 2006 Stock Option Plan with an
exercise price of $0.12 to new PDSG employees.  These options are not
presently exercisable and are subject to meeting vesting criteria.





On
November 16, 2009, we issued 200,000 stock options from our 2006 Stock Option
Plan with an exercise price of $0.19 to PDSG employees in connection with
performance initiatives.  These options are not presently exercisable
and are subject to meeting vesting criteria.





On
December 3, 2009 we issued 400,000 stock options from our 2006 Stock Option Plan
with an exercise price of $0.18 to our new director.  200,000 options
are not presently exercisable and are subject to meeting vesting
criteria.





On
December 9, 2009, a director exercised stock options to purchase 100,000 shares
of common stock for proceeds of $7,449.





During
the six months ended November 30, 2009, we recorded $147,926 of non-cash
compensation expense related to vesting of stock options and warrants, including
$30,224 related to PDSG.  During the six months ended November 30,
2008, we recorded $279,338 of non-cash compensation expense related to vesting
of stock options and warrants, including $13,411 related to Holocom and $15,947
relating to PDSG.








32





Patriot
Scientific Corporation


Notes
to Unaudited Condensed Consolidated Financial
Statements





Stockholders’ Equity
(continued)





As of
November 30, 2009, we had warrants outstanding to purchase 300,000 common shares
at exercise prices ranging from $0.20 to $1.00 per share, expiring at various
dates through 2011.  No warrants were issued or exercised during the
six months ended November 30, 2009.  On November 9, 2009, we gave
notice to our current investor relations firm of our intent to cancel our
contract within 30 days.  Accordingly, the 250,000 warrants granted
under contract that were not vested were cancelled.  In connection
with the cancellation of the unvested warrants we reversed approximately $10,400
of non-cash compensation previously recorded.





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.





The Asustekcase sought
declaratory relief that its products do not infringe enforceable claims of the
'336 and '584 patents and US 5,440,749 (the “749 patent”). The Asustekcase also sought 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.  On December 22, 2008, we announced that
Asustek had purchased a MMP Portfolio license.





The Acercase seeks declaratory
relief that its products do not infringe enforceable claims of the '336, '584,
‘749, '148 patents and US 5,530,890 (the “890 patent”). The HTCcase similarly seeks
declaratory relief that its products do not infringe enforceable claims of those
patents.  We allege counterclaims for patent infringement of the '336,
'749, '148 and '890 patents against Acer and HTC.  On June 16, 2009,
District Court Judge Jeremy Fogel stayed the HTCand Acer actions until September
18, 2009.  The stay has been extended through February 12,
2010.





On
December 1, 2008, we, TPL and Alliacense, Ltd. were named as defendants in a
lawsuit filed in the United States District Court for the Northern District of
California by Barco, N.V.  The Barco case seeks declaratory
relief that its products do not infringe enforceable claims of the '584, '749
and '890 patents.  We allege counterclaims for patent infringement of
our '749, '890 and '336 patents.  On June 22, 2009, Judge Fogel also
stayed the Barco case
until September 18, 2009, and that stay has been extended through February 12,
2010.





On April
29, 2009, we, TPL, and Alliacense Ltd., were named as defendants in a lawsuit
filed in the United States District Court for the Southern District of New York
by Sirius XM Radio, Inc.  The Sirius case seeks declaratory
relief that its products do not infringe enforceable claims of our '749, '584,
'890, '360 and '148 patents, and additionally two patents of TPL's "fast logic"
portfolio which do not involve us.  Our Motion to Transfer the Sirius action to the United
States District Court for the Northern District of California has been briefed
to the court and set for hearing on February 16, 2010.








33


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements
 
 Commitments
and Contingencies (continued)





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 has
been selected.  Document discovery has been initiated.  Some
instruments have been repurchased by the issuers since the claim was filed
(see  Note 17).  The arbitration is expected to be scheduled
in Spring 2010.





DBSI's
parent, Deutsche Bank AG, denied being required to arbitrate the dispute with
DBSI before FINRA, and so we filed an action against Deutsche Bank AG in the
United States District Court for the Southern District of California based on
its liability with respect to our investments in ARS.  A stay of this
action will likely be in place through the FINRA arbitration with
DBSI.





Crossflo
Systems, Inc. Litigation





Under the
terms of our Agreement and Plan of Merger (the "Merger Agreement") with
Crossflo, and certain of its principal officers, an escrow account was
established to hold back approximately 10% of the merger consideration payable
to the shareholders of Crossflo (the "Escrow Merger
Consideration").  We contend that certain representations and
warranties made by Crossflo and certain of its principal officers in the Merger
Agreement were false when made, and were false as of the closing of the
merger.  We submitted a demand to the escrow agent on August 31, 2009
not to release the Escrow Merger Consideration to the Crossflo shareholders and
to instead return it to us.  A sufficient number of Crossflo
shareholders have opposed our demand that the escrow consideration has not been
released to either side.





On August
31, 2009, we initiated an arbitration proceeding before the American Arbitration
Association against the three Crossflo principal officers who were signatories
to the Merger Agreement for having provided false representations and warranties
in the Merger Agreement and for nondisclosure of information about Crossflo
during the due diligence process leading up to the merger.  Those
three principal officers deny our claims.  An arbitration date has not
yet been set.





401(k)
Plan





Patriot
and PDSG 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 six months ended November 30, 2009 and 2008
were $11,625 and $6,457, respectively.  PDSG 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 PDSG. 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.




34


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.





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 PDSG until
March 1, 2010.  In connection with the acquisition of Vigilys, a
retention bonus is to be paid to a key employee who remains with PDSG until
March 27, 2010.  The projected liability for such bonuses is
$75,000.  These liabilities are being accrued ratably over the
retention periods.





By the
terms of his employment contract our CFO, who also currently serves as our
interim CEO, is eligible to earn an annual bonus equivalent to 50% of his base
salary.  In connection with management’s restructuring plan on October 5,
2009 our Compensation Committee determined that this bonus would be payable at
the end of the interim period.  The projected liability for such bonus is
$145,875 and has been recorded on our condensed consolidated balance sheet in
“accrued expenses and other” at November 30, 2009.





Escrow
Shares





On August
31, 2009, we gave notice to the former shareholders of Crossflo and Union Bank
of California (the “Escrow Agent”) under Section 2.5 of the Agreement and Plan
of Merger between us and Crossflo (the “Agreement”), outlining damages incurred
by us in conjunction with the acquisition of Crossflo, and seeking the return of
2,844,630 shares of our common stock held by the Escrow Agent. 
Subsequently, former shareholders of Crossflo representing a majority of the
escrowed shares responded in protest to our claim, delaying the release of the
escrowed shares until a formal resolution is reached.  In the event we fail
to prevail in our claim against the escrowed shares, we may be obligated to
deposit into escrow approximately $256,000 of cash consideration due to the
decline in our average stock price over the one year escrow period, calculated
in accordance with the Section 2.5 of the Agreement.  We have evaluated the
potential for loss regarding our claim and believe that we will prevail. 
Accordingly, we have not recorded a contingent liability for this
matter.





Severance
Payments





In
connection with management’s restructuring plan, on October 7, 2009, we entered
into a Separation Agreement with our former CEO which requires us to pay his
base salary for the next seven months in exchange for a general release of
claims against us.  At November 30, 2009, the current balance of the
liability is $116,254 and we have recorded the liability on our condensed
consolidated balance sheet in “accrued expenses and other”.








35


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


16. 
Segment Information





Holocom
began operations in February 2007 and we consolidated Holocom in our
consolidated financial statements commencing in March 2007.  Due to a
re-consideration event we deconsolidated Holocom May 1, 2009 (see Note 12).
Holocom was an operating segment as revenue was 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 was no inter-segment revenue, and the accounting policies for segment
reporting were the same as for us as a whole.





We
acquired PDSG in a series of transactions in the second, third and fourth
quarters of fiscal 2009 and consolidate our wholly-owned subsidiary PDSG in our
consolidated financial statements.  PDSG 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.





Operating
segment net revenue, operating loss and income (loss) before taxes and minority
interest for the three and six months ended November 30, 2009 and 2008 were as
follows:





Three
      Months Ended
            
            
            Six
      Months EndedNovember
      30, 2009
            
            
            November
      30, 2008
            
            
            November
      30, 2009
            
            
            November
      30, 2008Net
      revenue:Holocom
            
            $
            -
            
            
            $
            1,610,658
            
            
            $
            -
            
            
            $
            2,930,024PDSG
            
            
            66,416
            
            
            
            258,353
            
            
            
            163,451
            
            
            
            258,353All
      other
            
            
            -
            
            
            
            6,250
            
            
            
            -
            
            
            
            45,530Total
      net revenue
            
            $
            66,416
            
            
            $
            1,875,261
            
            
            $
            163,451
            
            
            $
            3,233,907Operating
      income (loss):Holocom
            
            $
            -
            
            
            $
            342,621
            
            
            $
            -
            
            
            $
            460,140PDSG
            
            
            (6,213,347
            )
            
            
            (907,788
            )
            
            
            (7,679,529
            )
            
            
            (907,788
            )All
      other
            
            
            (1,145,247
            )
            
            
            (965,774
            )
            
            
            (2,062,693
            )
            
            
            (2,239,638
            )Total
      operating loss
            
            $
            (7,358,594
            )
            
            $
            (1,530,941
            )
            
            $
            (9,742,222
            )
            
            $
            (2,687,286
            )Income
      (loss) before taxes and minority interest:Holocom
            
            $
            -
            
            
            $
            342,708
            
            
            $
            -
            
            
            $
            457,267PDSG
            
            
            (6,213,347
            )
            
            
            (904,802
            )
            
            
            (7,670,193
            )
            
            
            (904,802
            )All
      other
            
            
            2,164,556
            
            
            
            (730,435
            )
            
            
            315,211
            
            
            
            4,665,589Total
      income (loss)before
      taxesand minority interest
            
            $
            (4,048,791
            )
            
            $
            (1,292,529
            )
            
            $
            (7,354,982
            )
            
            $
            4,218,054








36


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Segment
Information (continued)





Operating
segment total assets at November 30, 2009 and May 31, 2009 were as
follows:





November
      30,
              2009
            
            
            May
      31,
              2009Total
      assets:PDSG
            
            $
            6,377,243
            
            
            $
            10,067,007All
      other
            
            
            22,955,684
            
            
            
            23,659,945Total
      assets
            
            $
            29,332,927
            
            
            $
            33,726,952




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





Sales
concentration information for Holocom for the six months ended November 30, 2008
was as follows:





Six
      months ended
              November
      30, 2008Sales
            
            
            %
      of salesCustomer
      A
            
            $
            1,497,128
            
            
            
            51
            %Customer
      B
            
            $
            401,808
            
            
            
            14
            %Customer
      C
            
            $
            583,196
            
            
            
            20
            %





Accounts
receivable concentration information for PDSG as of November 30, 2009 and May
31, 2009  and sales concentration information for the six months ended
November 30, 2009 and 2008 were as follows:





Six
      months ended
              November
      30, 2009
            
            
            November
      30, 2009
            
            
            Six
      months ended
              November
      30, 2008
            
            
            May
      31, 2009Sales
            
            
            %
      of sales
            
            
            %
      of A/R
            
            
            Sales
            
            
            %
      of sales
            
            
            %
      of A/RCustomer
      A
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            $
            220,424
            
            
            
            85
            %
            
            
            60
            %Customer
      B
            
            $
            34,465
            
            
            
            21
            %
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Customer
      C
            
            $
            61,440
            
            
            
            38
            %
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            14
            %Customer
      D
            
            $
            19,732
            
            
            
            12
            %
            
            
            5
            %
            
            
            -
            
            
            
            -
            
            
            
            5
            %





17.  Subsequent
Events





During
the period December 1, 2009 through January 8, 2010, we purchased 156,447 shares
of our common stock at an aggregate cost of $26,245 pursuant to our stock
buyback program.





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





On
December 1, 2009, $350,000 of our ARS was redeemed by the issuers at
par.





On
December 3, 2009, we issued 400,000 stock options from our 2006 Stock Option
Plan with an exercise price of $0.18 to our new director.  200,000
options are not presently exercisable and are subject to meeting vesting
criteria.





On
December 8, 2009, we and TPL each made a $500,000 capital contribution to
PDS.  The capital contribution was used to remit indirect and special
litigation support payments to TPL.






37


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements
 
 Subsequent
Events (continued)





On
December 9, 2009, a director exercised stock options to purchase 100,000 shares
of common stock for proceeds of $7,449.





On
December 12, 2009 our note receivable with Avot became due.  We have
granted Avot a temporary forbearance until January 31, 2010 while Avot is in
negotiations for the sale of its business.





On
December 22, 2009, we paid Avot the final $50,000 installment pursuant to the
development agreement with PDSG.





On
December 24, 2009 we loaned $950,000 to TPL, to cover operating costs in
furtherance of MMP portfolio licensing, which is due and payable on or before
July 12, 2010.  Terms of the loan require interest payable at the rate
of 10%, and the loan is secured by TPL’s portion of its license receivable
distribution currently accounted for as license fees receivable on the November
30, 2009 balance sheet of PDS (see Note 11).







38





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





THE
FOLLOWING DISCUSSION AND THE REST OF  THIS REPORT ON FORM 10-Q
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, 2009.





Overview





In June
2005, we entered into a series of agreements with Technology Properties Limited
(“TPL”) and others to facilitate the pursuit of unlicensed users of our
intellectual property. We intend to continue our joint venture with TPL to
pursue license agreements with unlicensed users of our technology. We believe
that utilizing the option of working through TPL, as compared to creating and
using our own 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.





During
the quarter ended November 30, 2009 and through the date of this filing we and
TPL each contributed $580,000 to fund the working capital of Phoenix Digital
Solutions, LLC (“PDS”).  We expect the contributions to continue in
the future due to the working capital demands of PDS.  Additionally,
through the date of this filing we have loaned TPL $950,000 to cover operating
costs in furtherance of MMP portfolio licensing.





On
October 5, 2009, we announced a reorganization of Patriot Data Solutions Group,
Inc. (“PDSG”) and our management.  On November 12, 2009, we announced
our intent to divest the Iameter portfolio of data analysis and software
programs.  As a result of our reorganization and PDSG’s continued
inability to meet its business plan, we have incurred impairment charges for our
intangibles and goodwill in the PDSG segment of our business.  We
continue to fund the day to day operating costs of PDSG while continuing to
reduce expenses.





Cash
shortfalls currently experienced by PDS and TPL, and continued negative cash
flows incurred by PDSG, will have an adverse effect on our
liquidity.  Accordingly, we are in the process of examining
alternatives that could allow for the partnering or divestiture of
PDSG.  If successful, these measures may provide for a further
reduction in expenses and cash use, or additionally in the event of divestiture,
cash proceeds.





Critical
Accounting Policies and Estimates





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





1. 
Revenue Recognition





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.






39





Our
wholly-owned subsidiary PDSG sells software and services to end users primarily
through relationships with systems integrators and prime
contractors.  PDSG’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,
and 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, PDSG 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.  PDSG 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 consolidated statements
of operations under the caption “License and service revenue.”





The
majority of PDSG’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.  PDSG accounts for revenue on these
arrangements according to authoritative guidance for contract
accounting.  PDSG recognizes revenue based on progress towards
contract completion measured by actual hours incurred in relation to the
estimate of total expected hours. PDSG measures revenues by applying the
contract-specific estimated percentage of completion to the total contract
amount for software and professional services.  PDSG routinely updates
the estimates of future hours for agreements in process and reports any
cumulative effects of such adjustments in current operations. PDSG immediately
recognizes any loss expected on these contracts when it is projected that a loss
is probable.





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





Prior to
its deconsolidation on May 1, 2009, our variable interest entity, Holocom, Inc.
(“Holocom”) recognized revenue upon shipment of its product or upon receipt of
its product by the customer when shipped FOB destination and recognized revenue
on its short-term installation contracts as time and materials costs were
incurred.





2. 
Assessment of Contingent Liabilities





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





3. 
Stock Options and Warrants





We follow
authoritative guidance 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. We are required
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.




40





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.As stock-based compensation expense recognized in the consolidated
statements of operations is based on awards ultimately expected to vest, it has
been reduced for estimated forfeitures. Forfeitures are estimated at the time of
grant and revised, if necessary, in subsequent periods if actual forfeitures
differ from those estimates.  The estimated average forfeiture rate
for the six months ended November 30, 2009 and 2008 of
approximately  5% was based on historical forfeiture experience and
estimated future employee forfeitures. The estimated term of option grants for
the six months ended November 30, 2009 and 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.





We follow
authoritative guidance to reduce the diversity in practice associated with
certain aspects of measurement and recognition in accounting for income
taxes.  This authoritative guidance 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 this
guidance we may only recognize tax positions that meet a “more likely than not”
threshold.







5.





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
presented in the consolidated statements of operations in the caption “Equity in
earnings of affiliated companies.”





We have a
39.4% interest in Talis Data Systems, LLC (“Talis”).  Prior to the
write off of our investment in Talis during the quarter ended August 31, 2009,
we were accounting for our investment using the equity method of
accounting.  Under the equity method of accounting, the investment,
originally recorded at cost, was adjusted to recognize our share of net earnings
or losses of the investee and was presented in the condensed consolidated
statements of operations in the caption “Equity in earnings of affiliated
companies.”





The
inability of Talis to meet its business plan and to raise capital and the
general economic environment were indicators of impairment on our investment;
accordingly at August 31, 2009, management obtained a third party valuation of
Talis from Vantage Point Advisors, Inc.  Based on the results of the
valuation, it was determined that our investment in Talis was impaired by
approximately $680,000.  We have recorded this as an impairment of
investment in affiliated company on our condensed consolidated statement of
operations for the six months ended November 30, 2009.  Talis is
currently in the process of dissolution.





We own
37.1% of the preferred stock of Avot Media, Inc. (“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.






41





Avot is
currently undergoing negotiations for the sale of its business.  As a
result of preliminary proposals from potential acquirers we expect to receive
payment for our note receivable with Avot, but do not expect there will be
adequate consideration to liquidate the carrying value of our preferred stock
investment.  Accordingly, at November 30, 2009, we have written off
$433,333, which represents the remaining fair value of our preferred stock
investment in Avot.  We have recorded this as an impairment of investment
in affiliated companies on our condensed consolidated statements of operations
for the three and six months ended November 30, 2009.





In
September 2009, we entered into an agreement with Avot in which Avot will
develop a software package for PDSG’s Vigilys product.  In connection
with the agreement, Avot issued us 1,000,000 warrants to purchase shares of
Avot’s common stock ,with an exercise price of $0.05 per share and a 36 month
exercise period.  The value attributed to the warrants was
insignificant.





We own
100% of the preferred stock of Holocom.  This investment has
historically been accounted for at cost since we do not have the ability to
exercise significant influence over the operating and financial policies of
Holocom. Due to a re-consideration event on May 1, 2009, this investment is
carried at cost plus the effects of deconsolidation of this variable interest
entity on our November 30, 2009 condensed consolidated balance
sheet.





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.  Business
Combinations and Intangible Assets Including Goodwill





We
account for business combinations using the purchase method of accounting and
accordingly, the assets and liabilities of the acquired entities are recorded at
their estimated fair values at the acquisition date. Goodwill represents the
excess of the purchase price over the fair value of net assets, including the
amount assigned to identifiable intangible assets. Due to the time it takes to
obtain pertinent information to finalize the acquired company’s balance sheet,
it may be several quarters before we are able to finalize the initial fair value
estimates. Accordingly, it is not uncommon for the initial estimates to be
subsequently revised. The results of operations of acquired businesses are
included in our consolidated financial statements from the acquisition
date.





Identifiable
intangible assets with finite lives are amortized over their estimated useful
lives on a straight line basis. Goodwill and intangible assets are tested for
impairment on an annual basis, or sooner if an indicator of impairment
occurs.





Results
of Operations





Comparison
of the Three Months Ended November 30, 2009 and Three Months Ended November 30,
2008.





Consolidated:





Three
      Months EndedNovember
      30, 2009
            
            
            November
      30, 2008Revenues:Product
      sales and other
            
            $
            -
            
            
            $
            1,616,908License
      and service revenue
            
            
            66,416
            
            
            
            258,353Total
      revenues
            
            
            66,416
            
            
            
            1,875,261








42







Three
      Months EndedNovember
      30, 2009
            
            
            November
      30, 2008Cost
      of sales:Product
      sales and other
            
            
            -
            
            
            
            700,365License
      and service revenue
            
            
            40,204
            
            
            
            165,140Amortization
      of purchased intangibles
            
            
            206,688
            
            
            
            211,302Impairment
      of purchased intangibles
            
            
            3,530,263
            
            
            
            -Total
      cost of sales
            
            
            3,777,155
            
            
            
            1,076,807Gross
      profit (loss)
            
            $
            (3,710,739
            )
            
            $
            798,454





Segment
Results:





Three
      months endedNovember
      30, 2009
            
            
            November
      30, 2008Holocom:
            
            Dollars
            
            
            %
      of Revenue
            
            
            Dollars
            
            
            %
      of RevenueRevenues
      - Product sales and other
            
            $
            -
            
            
            
            -
            
            
            $
            1,610,658
            
            
            
            100.0
            %Cost
      of sales
            
            
            -
            
            
            
            -
            
            
            
            700,365
            
            
            
            43.5
            %Gross
      profit
            
            $
            -
            
            
            
            -
            
            
            $
            910,293
            
            
            
            56.5
            %PDSG:License
      and service revenue
            
            $
            66,416
            
            
            
            100.0
            %
            
            $
            258,353
            
            
            
            100.0
            %Cost
      of sales
            
            
            40,204
            
            
            
            60.5
            %
            
            
            165,140
            
            
            
            63.9
            %Amortization
      of purchased intangibles
            
            
            206,688
            
            
            
            -
            
            
            
            211,302
            
            
            
            -Impairment
      of purchased intangibles
            
            
            3,530,263
            
            
            
            -
            
            
            
            -
            
            
            
            -Gross
      loss
            
            $
            (3,710,739
            )
            
            
            -
            
            
            $
            (118,089
            )
            
            
            -PTSC:Revenues
      - Product sales and other
            
            $
            -
            
            
            
            -
            
            
            $
            6,250
            
            
            
            100.0
            %Cost
      of sales
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Gross
      profit
            
            $
            -
            
            
            
            -
            
            
            $
            6,250
            
            
            
            100.0
            %





Holocom





During
the three months ended November 30, 2008, we recorded sales amounting to
approximately $1,611,000 by our then consolidated variable interest entity,
Holocom, with cost of sales amounting to approximately $700,000.  Due
to a re-consideration event we deconsolidated Holocom in May 2009 and no longer
include Holocom’s revenues in our results of operations.





PDSG





We
acquired PDSG in a series of transactions in the second, third and fourth
quarters of fiscal 2009.  Revenue consists of software licenses and
associated services relating to PDSG’s CDX data agent product and the SherlockTM
software  tool for medical facilities.  Cost of sales
includes the direct time of PDSG employees on each project as well as outside
contractors.





Revenues
decreased during the three months ended November 30, 2009 as compared to the
three months ended November 30, 2008 due primarily to the inclusion in the 2008
period of amounts from a significant customer agreement not duplicated in
2009.  Also in 2009, revenue progress on contracts was slowed primarily as
a result of customer initiated delays resulting in lower than planned
revenues.  In general, revenue agreements are one time contracts that vary
in size and scope depending upon the requirements of the customer.





43





The
impairment charge for the three months ended November 30, 2009 represents the
write off of PDSG’s purchased intangibles to a fair value of $1,860,000 at
November 30, 2009.  These assets were subject to revaluation pursuant
to a reconsideration event which also drove the restructuring of PDSG initiated
in October 2009.  The impairment is primarily attributable to
management’s current assessment of reduced revenue and resultant cash flow
projections as compared to what previously had been the expectations for the
business..





PTSC





During
the three months ended November 30, 2008, we recognized maintenance fee revenues
totaling $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 was being recognized as revenue evenly over the four year period of the
license, which ended in February 2009.





Consolidated





Our
revenues decreased from approximately $1,875,000 for the three months ended
November 30, 2008 to approximately $66,000 for the three months ended November
30, 2009, primarily due to the deconsolidation of Holocom. Our revenue amounts
do not include income of approximately $251,000 and $3,737,000, respectively,
for the three months ended November 30, 2008 and 2009, respectively, from our
investment in PDS and losses of approximately $141,000 for the three months
ended November 30, 2008, from our investment in Talis.





Consolidated:


Three
      months endedNovember
      30, 2009
            
            
            November
      30, 2008Research
      and development
            
            $
            540,557
            
            
            $
            151,874





PDSG





Research
and development costs consist of PDSG’s payroll and related expenses for
software engineers as well as outside contractors retained to assist in the
development of PDSG’s software product.  For the three months ended
November 30, 2009 and 2008, approximately $3,400 and $400 of non-cash
compensation was recorded in connection with vesting of employee stock
options.  The increase in expenses for the three months ended November
30, 2009 is primarily due to the acquisition of the Vigilys employees in March
2009 and the development agreement with Avot.





Consolidated:


Three
      months endedNovember
      30, 2009
            
            
            November
      30, 2008Selling,
      general and administrative
            
            $
            2,011,030
            
            
            $
            2,177,521





Segment
Results:


Three
      months endedNovember
      30, 2009
            
            
            November
      30, 2008Holocom:Selling,
      general and administrative
            
            $
            -
            
            
            $
            567,672PDSG:Selling,
      general and administrative
            
            $
            865,783
            
            
            $
            637,825PTSC:Selling,
      general and administrative
            
            $
            1,145,247
            
            
            $
            972,024








44





Holocom





During
the three months ended November 30, 2008, we recorded selling, general and
administrative expenses amounting to approximately $568,000 by our then
consolidated variable interest entity, Holocom.  Due to a
re-consideration event we deconsolidated Holocom in May 2009 (see Note
12).





PDSG





Selling,
general and administrative expenses increased from approximately $638,000 for
the three months ended November 30, 2008, to approximately $866,000 for the
three months ended November 30, 2009, primarily due to severance payments of
approximately $101,000 and approximately $70,000 in marketing
costs.  For the three months ended November 30, 2009 and 2008,
approximately $10,850 and $15,570 of non-cash compensation was recorded in
connection with vesting of employee stock options.





PTSC





Selling,
general and administrative expenses increased from approximately $972,000 for
the three months ended November 30, 2008 to approximately $1,145,000 for the
three months ended November 30, 2009.  The increase consisted of
approximately $170,000 in legal and accounting expense and approximately
$136,000 in consulting expense.  These increases were offset by
decreases in public and investor relations expenses of  approximately
$112,000 and approximately $43,000 in travel and related
expenses.  For the three months ended November 30, 2009, approximately
$105,000 of non-cash compensation was recorded in connection with vesting of
employee stock options as compared to approximately $142,000 for the three
months ended November 30, 2008.





Consolidated





Selling,
general and administrative expenses decreased from approximately $2,178,000 for
the three months ended November 30, 2008 to approximately $2,011,000 for the
three months ended November 30, 2009.





Consolidated:


Three
      months endedNovember
      30,
              2009
            
            
            November
      30,
              2008Other
      income (expense):Interest
      and other income
            
            $
            25,847
            
            
            $
            144,748Impairment
      of investment in affiliated company
            
            
            (433,333
            )
            
            
            -Interest
      expense
            
            
            (19,629
            )
            
            
            (16,075
            )Equity
      in earnings of affiliated companies
            
            
            3,736,918
            
            
            
            109,739Total
      other income, net
            
            $
            3,309,803
            
            
            $
            238,412





Segment
Results:


Three
      months endedNovember
      30,
              2009
            
            
            November
      30,
              2008Holocom:Interest
      and other income
            
            $
            -
            
            
            $
            2,587Interest
      expense
            
            
            -
            
            
            
            (2,500
            )Total
      other income, net
            
            $
            -
            
            
            $
            87PDSG:Interest
      and other income
            
            $
            -
            
            
            $
            3,003Interest
      expense
            
            
            -
            
            
            
            (17
            )Total
      other income, net
            
            $
            -
            
            
            $
            2,986PTSC:Interest
      and other income
            
            $
            25,847
            
            
            $
            139,158Impairment
      of investment in affiliated company
            
            
            (433,333
            )
            
            
            -Interest
      expense
            
            
            (19,629
            )
            
            
            (13,558
            )Equity
      in earnings of affiliated companies
            
            
            3,736,918
            
            
            
            109,739Total
      other income, net
            
            $
            3,309,803
            
            
            $
            235,339








45





Consolidated





Our other
income and expenses for the three months ended November 30, 2009 included equity
in the income of PDS consisting of net income after expenses in the amount of
approximately $3,737,000.  For the three months ended November 30,
2008, our other income and expenses included our share of income in PDS of
approximately $251,000 and our share of loss in Talis of approximately $141,000.
The increase in income from PDS for the quarter ended November 30, 2009 as
compared to the quarter ended November 30, 2008 is due to the increase in
license revenues PDS received for the quarter ended November 30, 2009 as
compared  with license revenues received by PDS for the quarter ended
November 30, 2008.  Our investments in PDS and Talis are accounted for
in accordance with the equity method of accounting for investments. Total other
income for the three months ended November 30, 2009 amounted to net other income
of approximately $3,310,000 compared with net other income of approximately
$238,000 for the three months ended November 30, 2008. Interest income and other
income decreased from approximately $145,000 for the three months ended November
30, 2008 to approximately $26,000 for the three months ended November 30, 2009
due to declines in interest rates for our cash, cash equivalents and long term
investment accounts.  For the three months ended November 30, 2009, we
recorded an impairment of our investment in Avot of approximately
$433,000.





During
the three months ended November 30, 2009 and 2008, we recorded a benefit for
income taxes of approximately $1,302,000 and $632,000 related to federal and
California taxes.





We
recorded a net loss for the three months ended November 30, 2009 of $2,746,620
compared with a net loss of $932,259 for the three months ended November 30,
2008.





Comparison
of the Six Months Ended November 30, 2009 and Six Months Ended November 30,
2008.





Consolidated:





Six
      Months EndedNovember
      30,
              2009
            
            
            November
      30,
              2008Revenues:Product
      sales and other
            
            $
            -
            
            
            $
            2,975,554License
      and service revenue
            
            
            163,451
            
            
            
            258,353Total
      revenues
            
            
            163,451
            
            
            
            3,233,907Cost
      of sales:Product
      sales and other
            
            
            -
            
            
            
            1,284,618License
      and service revenue
            
            
            72,187
            
            
            
            165,140Amortization
      of purchased intangibles
            
            
            413,376
            
            
            
            211,302Impairment
      of purchased intangibles
            
            
            3,530,263
            
            
            
            -Total
      cost of sales
            
            
            4,015,826
            
            
            
            1,661,060Gross
      profit (loss)
            
            $
            (3,852,375
            )
            
            $
            1,572,847





Segment
Results:





Six
      months endedNovember
      30, 2009
            
            
            November
      30, 2008Holocom:
            
            Dollars
            
            
            %
      of Revenue
            
            
            Dollars
            
            
            %
      of RevenueRevenues
      - Product sales and other
            
            $
            -
            
            
            
            -
            
            
            $
            2,930,024
            
            
            
            100.0
            %Cost
      of sales
            
            
            -
            
            
            
            -
            
            
            
            1,284,618
            
            
            
            43.8
            %Gross
      profit
            
            $
            -
            
            
            
            -
            
            
            $
            1,645,406
            
            
            
            56.2
            %








46








Six
      months endedNovember
      30, 2009
            
            
            November
      30, 2008PDSG:License
      and service revenue
            
            $
            163,451
            
            
            
            100.0
            %
            
            $
            258,353
            
            
            
            100.0
            %Cost
      of sales
            
            
            72,187
            
            
            
            44.2
            %
            
            
            165,140
            
            
            
            63.9
            %Amortization
      of purchased intangibles
            
            
            413,376
            
            
            
            -
            
            
            
            211,302
            
            
            
            -Impairment
      of purchased intangibles
            
            
            3,530,263
            
            
            
            -
            
            
            
            -
            
            
            
            -Gross
      loss
            
            $
            (3,852,375
            )
            
            
            -
            
            
            $
            (118,089
            )
            
            
            -PTSC:Revenues
      - Product sales and other
            
            $
            -
            
            
            
            -
            
            
            $
            45,530
            
            
            
            100.0
            %Cost
      of sales
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Gross
      profit
            
            $
            -
            
            
            
            -
            
            
            $
            45,530
            
            
            
            100.0
            %





Holocom





During
the six months ended November 30, 2008, we recorded sales amounting to
approximately $2,930,000 by our then consolidated variable interest entity,
Holocom, with cost of sales amounting to approximately
$1,285,000.  Due to a re-consideration event we deconsolidated Holocom
in May 2009 and no longer include Holocom’s revenues in our results of
operations.





PDSG





We
acquired PDSG in a series of transactions in the second, third and fourth
quarters of fiscal 2009.  Revenue consists of software licenses and
associated services relating to PDSG’s CDX data agent product and the SherlockTM
software  tool for medical facilities.  Cost of sales
includes the direct time of PDSG employees on each project as well as outside
contractors.





Revenues
decreased during the six months ended November 30, 2009 as compared to the six
months ended November 30, 2008 due primarily to the inclusion in the 2008 period
of amounts from a significant customer agreement not duplicated in 2009. 
Also in 2009, revenue progress on contracts was slowed primarily as a result of
customer initiated delays resulting in lower than planned revenues.  In
general, revenue agreements are one time contracts that vary in size and scope
depending upon the requirements of the customer.





The
impairment charge for the three months ended November 30, 2009 represents the
write off of PDSG’s purchased intangibles to a fair value of $1,860,000 at
November 30, 2009.  These assets were subject to revaluation pursuant
to a reconsideration event which also drove the restructuring of PDSG initiated
in October 2009.  The impairment is primarily attributable to
management’s current assessment of reduced revenue and resultant cash flow
projections as compared to what previously had been the expectations for the
business.





PTSC





During
the six months ended November 30, 2008, we recognized maintenance fee revenues
totaling approximately $12,500 in connection with an agreement with AMD
Corporation during the 2005 fiscal year. The agreement called for maintenance
fees totaling $100,000 connected with a license agreement for our Ignite
technology; the license fee revenue is being recognized as revenue evenly over
the four year period of the license.





In
addition during the six months ended November 30, 2008, we recorded sales of
approximately $33,000, from the sale of microprocessor chips that we no longer
market. Inventory associated with the sales of these microprocessor chips is
carried at zero value.  Our final sales of microprocessor chips
occurred during the quarter ended August 31, 2008.





47





Consolidated





Our
revenues decreased from approximately $3,234,000 for the six months ended
November 30, 2008 to approximately $163,000 for the six months ended November
30, 2009, primarily due to the deconsolidation of Holocom. Our revenue amounts
do not include income of approximately $6,873,000 and $3,494,000, respectively,
for the six months ended November 30, 2008 and 2009, respectively, from our
investment in PDS and losses of approximately $204,000 and $22,000,
respectively, for the six months ended November 30, 2008 and 2009, respectively,
from our investment in Talis.





Consolidated:





Six
      months endedNovember
      30,
              2009
            
            
            November
      30,
              2008Research
      and development
            
            $
            854,754
            
            
            $
            151,874





PDSG





We
acquired PDSG in a series of transactions in the second, third and fourth
quarters of fiscal 2009.  Research and development costs consist of
PDSG’s payroll and related expenses for software engineers as well as outside
contractors retained to assist in the development of PDSG’s software
product.  For the six months ended November 30, 2009 and 2008,
approximately $4,500 and $400 of non-cash compensation was recorded in
connection with vesting of employee stock options.  The increase in
expenses for the six months ended November 30, 2009 is primarily due to the
acquisition of the Vigilys employees in March 2009, the development agreement
with Avot and the use of outside contractors to assist with the development of
CDX 4 and the fact that the November 30, 2008 amount of approximately $152,000
represents costs from the period September 1, 2008 to November 30,
2008.





Consolidated:





Six
      months endedNovember
      30,
              2009
            
            
            November
      30,
              2008Selling,
      general and administrative
            
            $
            3,938,825
            
            
            $
            4,108,259





Segment
Results:




Six
      months endedNovember
      30,
              2009
            
            
            November
      30,
              2008Holocom:Selling,
      general and administrative
            
            $
            -
            
            
            $
            1,185,266PDSG:Selling,
      general and administrative
            
            $
            1,876,132
            
            
            $
            637,825PTSC:Selling,
      general and administrative
            
            $
            2,062,693
            
            
            $
            2,285,168





Holocom





During
the six months ended November 30, 2008, we recorded selling, general and
administrative expenses amounting to approximately $1,185,000 by our then
consolidated variable interest entity, Holocom.  Due to a
re-consideration event we deconsolidated Holocom in May 2009 (see Note
12).





PDSG





We
acquired PDSG in a series of transactions in the second, third and fourth
quarters of fiscal 2009.  Selling, general and administrative expenses
of approximately $638,000 for the six months ended November 30, 2008 represent
costs from September 1, 2008 to November 30, 2008 as compared to approximately
$1,876,000 for the six months ended November 30, 2009.  Increases are
primarily due to an increase in payroll and related costs of approximately
$692,000 resulting from the acquisition of Iameter and Vigilys after November
30, 2008, severance payments of approximately $101,000 due to restructuring,
approximately $112,000 in marketing costs and approximately $73,000 in rent
expense due to the space required for the Iameter and Vigilys acquisitions after
November 30, 2008.  For the six months ended November 30, 2009 and
2008, approximately $25,700 and $15,570 of non-cash compensation was recorded in
connection with vesting of employee stock options.




48





PTSC





Selling,
general and administrative expenses decreased from approximately $2,285,000 for
the six months ended November 30, 2008 to approximately $2,063,000 for the six
months ended November 30, 2009.  The decrease consisted of
approximately $20,000 in legal and accounting expense, approximately $128,000 in
public and investor relations expenses and $34,000 in travel and related
expenses.  These decreases were offset by increases in salaries and
related expenses of  approximately $94,000 and approximately
$46,000  in consulting expenses.  For the six months ended
November 30, 2009, approximately $125,000 of non-cash compensation was recorded
in connection with vesting of employee stock options as compared to
approximately $250,000 for the six months ended November 30, 2008.





Consolidated





Selling,
general and administrative expenses decreased from approximately $4,108,000 for
the six months ended November 30, 2008 to approximately $3,939,000 for the six
months ended November 30, 2009, primarily due to the deconsolidation of Holocom
which was offset by a full six months of PDSG expenses in the current fiscal
year.





Consolidated:


Six
      months endedNovember
      30,
              2009
            
            
            November
      30,
              2008Other
      income (expense):Interest
      and other income
            
            $
            68,774
            
            
            $
            257,593Impairment
      of investment in affiliated companies
            
            
            (1,113,625
            )
            
            
            -Interest
      expense
            
            
            (40,269
            )
            
            
            (20,762
            )Equity
      in earnings of affiliated companies
            
            
            3,472,360
            
            
            
            6,668,509Total
      other income, net
            
            $
            2,387,240
            
            
            $
            6,905,340





Segment
Results:


Six
      months endedNovember
      30,
              2009
            
            
            November
      30,
              2008Holocom:Interest
      and other income
            
            $
            -
            
            
            $
            2,968Interest
      expense
            
            
            -
            
            
            
            (2,574
            )Total
      other income, net
            
            $
            -
            
            
            $
            394PDSG:Interest
      and other income
            
            $
            9,336
            
            
            $
            3,003Interest
      expense
            
            
            -
            
            
            
            (17
            )Total
      other income, net
            
            $
            9,336
            
            
            $
            2,986PTSC:Interest
      and other income
            
            $
            59,438
            
            
            $
            251,622Impairment
      of investment in affiliated companies
            
            
            (1,113,625
            )
            
            
            -Interest
      expense
            
            
            (40,269
            )
            
            
            (18,171
            )Equity
      in earnings of affiliated companies
            
            
            3,472,360
            
            
            
            6,668,509Total
      other income, net
            
            $
            2,377,904
            
            
            $
            6,901,960








49





Consolidated





Our other
income and expenses for the six months ended November 30, 2009 included equity
in the income of PDS consisting of net income after expenses in the amount of
approximately $3,494,000 and our share of loss in Talis of approximately
$22,000.  For the six months ended November 30, 2008, our other income
and expenses included our share of income in PDS of approximately $6,873,000 and
our share of loss in Talis of approximately $204,000. The decrease in our share
of PDS’ income for the six months ended November 30, 2009 as compared to our
share of PDS’ income for the six months ended November 30, 2008 is due to the
decrease in the amount of license revenues PDS received for the six months ended
November 30, 2009 as compared to the six months ended November 30,
2008.  Our investments in PDS and Talis are accounted for in
accordance with the equity method of accounting for investments. Total other
income for the six months ended November 30, 2009 amounted to net other income
of approximately $2,387,000 compared with net other income of approximately
$6,905,000 for the six months ended November 30, 2008. Interest income and other
income decreased from approximately $258,000 for the six months ended November
30, 2008 to approximately $69,000 for the six months ended November 30, 2009 due
to declines in interest rates for our cash, cash equivalents and long term
investment accounts.  For the six months ended November 30, 2009, we
recorded an impairment of our investments in Talis of approximately $680,000 and
Avot of approximately $433,000.





During
the six months ended November 30, 2009 we recorded a benefit for income taxes of
approximately $2,623,000 and during the six months ended November 30, 2008, we
recorded a provision for income taxes of approximately $1,748,000 related to
federal and California taxes.





We
recorded a net loss for the six months ended November 30, 2009 of $4,731,700
compared with net income of $2,277,254 for the six months ended November 30,
2008.





Liquidity
and Capital Resources





Liquidity





Our cash
and short-term investment balances increased from approximately $6,265,000 as of
May 31, 2009  to approximately $11,953,000 as of November 30, 2009. We
also have restricted cash balances amounting to approximately $52,000 as of May
31, 2009 and $21,000 as of November 30, 2009. Total current assets increased
from approximately $8,065,000 as of May 31, 2009 to approximately
$13,075,000  as of November 30, 2009. Total current liabilities
amounted to approximately $1,034,000 and approximately $835,000 as of May 31,
2009 and November 30, 2009, respectively. The change in our current position as
of November 30, 2009 as compared with May 31, 2009 results in part from our
receipt of approximately $6,728,000 in distributions from PDS and $3,250,000 of
auction rate securities redemptions at par value.





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 $4,025,000, 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 equity sources or could adversely
affect the terms on which we may be able to obtain any such
financing.





Cash
shortfalls currently experienced by PDS and TPL, and continued negative cash
flows incurred by PDSG, will have an adverse effect on our
liquidity.  Accordingly, we are in the process of examining
alternatives that could allow for the partnering or divestiture of
PDSG.  If successful these measures may provide for a further
reduction in expenses and cash use, or additionally in the event of divestiture,
cash proceeds.  Currently, we have sufficient resources to fund our
operations through at least the next twelve months.




50




Cash
Flows From Operating Activities





Cash used
in operating activities for the six months ended November 30, 2009 was
approximately $4,395,000 as compared with cash used in operating activities for
the six months ended November 30, 2008 of approximately $4,001,000. The
principal components of the current period amount were: impairment
of  investment in affiliated company of approximately $1,114,000,
impairment of intangibles and goodwill of approximately $4,627,000 and
amortization and depreciation of approximately $447,000.  These
increases were offset by: net loss of approximately $4,732,000, equity in
earnings of affiliates of approximately $3,472,000 and changes in deferred
income taxes of approximately $2,930,000.  The change in results over
the prior period is mainly attributable to the current period impairments, and
the income in PDS for the six months ended November 30, 2009 being approximately
half of the income provided by PDS during the six months ended November 30,
2008.





Cash
Flows From Investing Activities





Cash
provided by investing activities was approximately $9,801,000 and $3,015,000 for
the six months ended November 30, 2009 and 2008, respectively. While we
experienced a decrease in distributions received from PDS for the six months
ended November 30, 2009 as compared to the six months ended November 30, 2008,
the increase in cash provided by investing activities was mainly attributable to
the redemption of our auction rate securities at a par value of $3,250,000 and a
decrease in investments in affiliated companies.  Cash used during the
six months ended November 30, 2009 included approximately $70,000 in purchases
of fixed assets, approximately $33,000 in purchases of Talis membership units,
approximately $55,000 in note receivable advances to Avot and a $80,000 capital
contribution to PDS.





Cash
Flows From Financing Activities





Cash used
in financing activities for the six months ended November 30, 2009 was
approximately $40,000 as compared to cash provided by financing activities for
the six months ended November 30, 2008 of approximately
$2,055,000.  For the six months ended November 30, 2009, cash of
approximately $40,000 was used to purchase common stock for
treasury.  In the six months ended November 30, 2008 we received
proceeds from our note with Wedbush, these proceeds were offset by approximately
$1,029,000 used to purchase common stock for treasury to provide cash from
financing activities of approximately $2,000,000.





Capital
Resources





Our
current resources as of November 30, 2009 are expected to provide the funds
necessary to support our operations through at least the next twelve
months.





Contractual
Obligations and Commitments





In
September 2009, we entered into an agreement with Avot in which Avot will
develop a software package for PDSG’s Vigilys product.  Terms of the
agreement require PDSG to pay Avot four milestone payments of $50,000 each on
September 1, October 1, November 1 and December 1, 2009.  In
connection with the agreement, Avot issued us 1,000,000 warrants to purchase
shares of Avot’s common stock ,with an exercise price of $0.05 per share and a
36 month exercise period.  The warrants were issued in four 250,000
installments consistent with the milestone payments.  On December 22,
2009, PDSG paid Avot the final $50,000 pursuant to terms of the
agreement.





By the
terms of his employment contract our CFO, who also currently serves as our
interim CEO, is eligible to earn an annual bonus equivalent to 50% of his base
salary.  In connection with management’s restructuring plan on October 5,
2009, our Compensation Committee determined that this bonus would be payable at
the end of the interim period.  The projected liability for such bonus is
$145,875.


In
connection with management’s restructuring plan, On October 7, 2009 we entered
into a Separation Agreement with our former CEO which requires us to pay his
base salary for the next seven months (through May 2010) in exchange for a
general release of claims against us.  At November 30, 2009, the
current balance of the liability is $116,254.





51





Recent
Accounting Pronouncements





In June
2009, the FASB revised the authoritative guidance for the consolidation of
variable interest entities.  The objective of this authoritative
guidance is to improve financial reporting by enterprises involved with variable
interest entities.  The revised authoritative guidance is effective as
of the beginning of each reporting entity’s first annual reporting period that
begins after November 15, 2009.  We expect to adopt this guidance on
June 1, 2010 and have not determined the effect of the adoption on our
consolidated financial statements.





In
July 2009, the FASB revised the authoritative guidance relating to software
revenue recognition to exclude all tangible products containing both software
and non-software components that function together to deliver the product’s
essential functionality. The revised authoritative guidance is effective for
revenue arrangements entered into or materially modified in fiscal years
beginning on or after June 15, 2010 and shall be applied on a prospective
basis. Earlier application is permitted as of the beginning of an entity’s
fiscal year provided it has not previously issued financial statements for any
period within that year. We expect to adopt this guidance on June 1, 2011 and
have not determined the effect of the adoption on our consolidated financial
statements.





In
September 2009, the FASB revised the authoritative guidance for revenue
arrangements with multiple deliverables.  This revised authoritative
guidance requires companies to allocate revenue in arrangements involving
multiple deliverables based on the estimated selling price of each deliverable,
even though such deliverables are not sold separately either by  the
company itself or other vendors. This revised authoritative guidance eliminates
the requirement that all undelivered elements must have objective and reliable
evidence of fair value before a company can recognize the portion of the overall
arrangement fee that is attributable to items that already have been delivered.
As a result, the new guidance may allow some companies to recognize revenue on
transactions that involve multiple deliverables earlier than under current
requirements. This revised authoritative guidance is effective for revenue
arrangements entered into or materially modified in fiscal years beginning on or
after December 15, 2009. Early adoption is permitted at the beginning of a
company’s fiscal year. We expect to adopt this guidance on June 1, 2010 and have
not determined the effect of the adoption 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, 2009 for additional factors.





We Have Reported Income
For The Fiscal Years 2009, 2008 and 2007 Which May Not Be Indicative Of Our
Future Income





We have
entered into license agreements through our joint venture with TPL and have
reported income as a result of this activity for the fiscal years 2009, 2008 and
2007. 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, potential adverse outcomes associated with USPTO re-examinations, and
the possible effect of new judicial interpretations of patent laws, we may not
receive revenues from such agreements in the future consistent with amounts
received in the past, and we may not receive future revenues from license
agreements at all.







52





We
Are Dependent Upon A Joint Venture In Which Our Role Is Of A Passive Nature For
Substantially All Of Our Income





In June
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  substantially
all of our income since June 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 and the ability of TPL to obtain capital when
necessary to fund its operations.  In December 2009 we provided
operational funding by loaning TPL $950,000.





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 could 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.  From time to time 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.





We have
been named as co-defendants in multiple lawsuits regarding the MMP
Portfolio.  See footnote 15 to our consolidated financial statements
and Part II, Item 1. “Legal Proceedings” in this Report on Form 10-Q for more
information.





Disruptions
In The Debt And Equity Markets Will Have An Adverse Affect On Our Ability To
Obtain Funding





The debt
and equity 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 equity sources
or could adversely affect the terms on which we may be able to obtain any such
financing for our operating activities and acquisitions.  See Part I –
Item 2. “Management’s Discussion and Analysis of Financial Condition and Results
of Operations-Liquidity and Capital Resources-Liquidity.” in this report on Form
10-Q for more information.




53





Unstable
Market And Economic Conditions May Have Serious Adverse Consequences On Our
Business





Our
general business strategy may be adversely affected by the recent economic
downturn and volatile business environment and continued unpredictable and
unstable market conditions. A prolonged or profound economic downturn may result
in adverse changes to our sales and pricing, which would harm our operating
results. Failure to secure any necessary financing in a timely manner and on
favorable terms could have a material adverse effect on our growth strategy,
financial performance and stock price and could require us to delay or abandon
development plans. There is also a possibility that our stock price may decline
further, due in part to the volatility of the stock market and the general
economic downturn.





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





For our
investment accounted for under the equity method (PDS), we record as part of
other income or expense our share of the increase or decrease in the equity of
this company in which we have invested. Our investment in Holocom is recorded at
cost basis.  It is possible that, in the future, our relationships
and/or our interests in or with this equity method investee and our 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.





If A Large Number Of Our Shares Are
Sold All At Once Or In Blocks, The Market Price Of Our Shares Would
MostLikely
Decline





Most of
our shareholders 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 our
Common Stock is trading may cause the market price of our Common Stock 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 $8 million as of the date of this
filing, 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.





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 Securities Exchange Act of 1934, as amended
(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.




54





Our
Share Price Could Decline As A Result Of Short Sales





When an
investor sells stock that he does not own, it is known as a short sale. The
seller, anticipating that the price of the stock will go down, intends to buy
stock to cover his sale at a later date. If the price of the stock goes down,
the seller will profit to the extent of the difference between the price at
which he originally sold it less his later purchase price. Short sales enable
the seller to profit in a down market. Short sales could place significant
downward pressure on the price of our Common Stock. Penny stocks which do not
trade on an exchange, such as our Common Stock, are particularly susceptible to
short sales.





Our
Future Success Depends In Significant Part Upon The Continued Services Of Our
Key Senior Management





Our
future success depends in significant part upon the continued services of our
key senior management personnel. The competition for highly qualified personnel
is intense, and we may not be able to retain our key managerial employees or
attract and retain additional highly qualified technical and managerial
personnel in the future. None of our employees are represented by a labor union,
and we consider our relations with our employees to be good. None of our
employees are covered by key man life insurance policies.





Item
3. Quantitative and Qualitative Disclosures About Market Risk





Interest
rate risk





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





Cash
and Cash Equivalents





We
maintain cash and cash equivalents in institutional money market accounts. In
general, money market funds are not subject to interest rate risk because the
interest paid on these funds fluctuates with the prevailing interest
rate.





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





Auction
Rate Securities





Our
exposure to market risk for changes in interest rates relates primarily to our
auction rate securities.  During the fiscal year ended May 31, 2009,
investment banks were reporting an inability to successfully obtain subscribers
for high credit quality auction rate securities.  As of the date of
this filing, we held such auction rate securities with a par value totaling $8
million that failed to sell at auction. During June 2009, September 2009 and
December 2009, auction rate securities with a par value of $750,000, $2,500,000
and $350,000, respectively, 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 November
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.




55





At
November 30, 2009, the fair value of our auction rate securities was estimated
at $7.7 million based on a valuation by Houlihan Smith & Company,
Inc.  We recorded the net temporary valuation adjustment of $391,366
in other comprehensive income, which represents the gross valuation adjustment
of $656,122, net of the related tax benefit of $264,756.  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 do not intend to sell our auction rate securities before we are
able to recover our cost basis and it is more likely than not that we will not
have to sell our auction rate securities before recovery of our cost
basis.  Since this valuation adjustment is deemed to be temporary, it
did not affect our earnings for the three and six months ended November 30, 2009
and 2008.





We are
not currently able to predict how long these investments will remain illiquid,
and as such, they have been classified as long-term investments in marketable
securities in the accompanying consolidated balance sheets at November 30, 2009
and May 31, 2009.  The December 1, 2009 auction rate securities
redeemed at par value have been classified as short term investments in
marketable securities at November 30, 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(b) under the Exchange Act, as of November 30,
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.




Disclosure
controls and procedures are controls and other procedures that are designed to
ensure that information required to be disclosed in our reports filed or
submitted under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the Securities and Exchange
Commission’s rules and forms.  Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed in our reports filed under the Exchange Act
is accumulated and communicated to management, including the Chief Executive
Officer and Chief Financial Officer as appropriate, to allow timely decisions
regarding required disclosure. Management recognizes that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving their objectives, and management necessarily
applies its judgment in evaluating the cost-benefit relationship of possible
controls and procedures.  Based on the evaluation of our disclosure
controls and procedures as of November 30, 2009, our management, with the
participation of our Chief Executive Officer and Chief Financial Officer
concluded that, as of such date, our disclosure controls and procedures were
effective.




56




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





Our
patent litigation with TPL and Alliacense Ltd. in the United States District
Court for the Northern District of California against Acer, Inc., HTC
Corporation and affiliated entities, as described in Item 3 - Legal Proceedings
in our Annual Report on Form 10-K for the year ended May 31, 2009 ("Annual
Report"), is still ongoing, but there have been no material developments in such
litigation since our Annual Report.





Our
patent litigation with TPL and Alliacense Ltd. in the United States District
Court for the Northern District of California against Barco, N.V., as described
in Item 3 - Legal Proceedings in our Annual Report, is still ongoing, but there
have been no material developments in such litigation since our Annual
Report.





Deutsche
Bank Arbitration





Our
arbitration claims before FINRA against Deutsche Bank Securities, Inc. and
affiliates, as described in Item 3 - Legal Proceedings in our Annual Report, is
still ongoing, but there have been no material developments in such arbitration
since our Annual Report.





Crossflo
Systems, Inc. Litigation





Under the
terms of our Agreement and Plan of Merger (the "Merger Agreement") with
Crossflo, and certain of its principal officers, an escrow account was
established to hold back approximately 10% of the merger consideration payable
to the shareholders of Crossflo (the "Escrow Merger
Consideration").  We contend that certain representations and
warranties made by Crossflo and certain of its principal officers in the Merger
Agreement were false when made, and were false as of the closing of the
merger.  We submitted a demand to the escrow agent on August 31, 2009
not to release the Escrow Merger Consideration to the Crossflo shareholders and
to instead return it to us.  A sufficient number of Crossflo
shareholders have opposed our demand that the escrow consideration has not been
released to either side.





On August
31, 2009, we initiated an arbitration proceeding before the American Arbitration
Association against the three Crossflo principal officers who were signatories
to the Merger Agreement for having provided false representations and warranties
in the Merger Agreement and for nondisclosure of information about Crossflo
during the due diligence process leading up to the merger.  Those
three principal officers deny our claims.  An arbitration date has not
yet been set.





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 154,531 shares of our
common stock at an aggregate cost of $34,722 during the three months ended
November 30, 2009.




57





Following
is a summary of all repurchases by us of our common stock during the three month
period ended November 30, 2009:





Period
            
            Total
      Number of Shares Purchased
            
            
            Average
      Price Paid per Share
            
            
            Total
      Number of Shares Purchased as Part of Publicly Announced Plans or
      ProgramsSeptember
      1 – 30, 2009
            
            
            -
            
            
            $
            -
            
            
            
            -October
      1 – 31, 2009
            
            
            -
            
            
            $
            -
            
            
            
            -November
      1 – 30, 2009
            
            
            154,531
            
            
            $
            0.22
            
            
            
            154,531Total
            
            
            154,531
            
            
            $
            0.22
            
            
            
            154,531





Item
3. Defaults Upon Senior Securities





None.





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





None.





Item
5. Other Information





None.





Item
6. Exhibits





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




Exhibit No.
            Document2.1
            Agreement
      and Plan of Merger dated August 4, 2008, among Patriot Scientific
      Corporation, PTSC Acquisition 1 Corp, Crossflo Systems, Inc. and the
      Crossflo principal officers, incorporated by reference to Exhibit 99.1 to
      our Current Report on Form 8-K filed August 11, 2008 (Commission file No.
      000-22182)3.1
            Original
      Articles of incorporation of Patriot Scientific Corporation’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 Patriot Scientific Corporation, as filed with the
      Delaware Secretary of State on March 24, 1992, incorporated by
      reference to Exhibit 3.3 to our Current Report on 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 Patriot Scientific
      Corporation, as filed with the Delaware Secretary of State on
      April 18, 1995, incorporated by reference to Exhibit 3.3.1 to
      our Annual Report on Form 10-KSB for the fiscal year ended
      May 31, 1995 (Commission file No. 000-22182)   58
  3.3.2
            Certificate
      of Amendment to the Certificate of Incorporation of Patriot Scientific
      Corporation, as filed with the Delaware Secretary of State on
      June 24, 1997, incorporated by reference to Exhibit 3.3.2 to our
      Annual Report on 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 Patriot Scientific
      Corporation, as filed with the Delaware Secretary of State on
      April 28, 2000, incorporated by reference to Exhibit 3.3.3 to
      Registration Statement on Form S-3 filed May 5, 2000 (Commission file
      No. 333-36418)3.3.4
            Certificate
      of Amendment to the Certificate of Incorporation of Patriot Scientific
      Corporation, as filed with the Delaware Secretary of State on May 6,
      2002, incorporated by reference to Exhibit 3.3.4 to our Quarterly Report
      on Form 10-Q for the quarterly period ended February 28, 2009, filed April
      9, 2009 (Commission file No. 000-22182)3.3.5
            Certificate
      of Amendment to the Certificate of Incorporation of Patriot Scientific
      Corporation,  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 Patriot Scientific
      Corporation, as filed with the Delaware Secretary of State on
      April 29, 2005, incorporated by reference to Exhibit 3.3.6 to our
      Quarterly Report on Form 10-Q for the quarterly period ended February 28,
      2009, filed April 9, 2009 (Commission file No. 000-22182)3.3.7
            Certificate
      of Amendment to the Certificate of Incorporation of Patriot Scientific
      Corporation, as filed with the Delaware Secretary of State on
      November 14, 2005, incorporated by reference to Exhibit
      3.3.7  to our Quarterly Report on Form 10-Q for the quarterly
      period ended February 28, 2009, filed April 9, 2009 (Commission file No.
      000-22182)3.3.8
            Certificate
      of Amendment to the Certificate of Incorporation of Patriot Scientific
      Corporation, as filed with the Delaware Secretary of State on March 18,
      2009, incorporated by reference to Exhibit 3.3.8 to our Annual Report on
      Form 10-K for the year ended May 31, 2009, filed August 14, 2009
      (Commission file No. 000-22182)3.4
            Articles and
      Certificate of Merger of Patriot Financial Corporation into Patriot
      Scientific Corporation dated May 1, 1992, with Agreement and Plan of
      Merger attached thereto as Exhibit A, incorporated by reference to
      Exhibit 3.4 to our Current Report on 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 our Current Report on
      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 our Current Report on
      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 our
      Current Report on Form 8-K dated May 12, 1992 (Commission file No.
      33-23143-FW)23.1*
            Consent
      of Independent Valuation Firm   59
  23.2*
            Consent
      of Independent Valuation Firm31.1*
            Certification
      of Clifford L. Flowers, Interim 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 Clifford L. Flowers, CFO and Interim CEO, 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:  January 11,
      2010
            PATRIOT
      SCIENTIFIC CORPORATION
              
              
              /S/
      CLIFFORD L. FLOWERSClifford
      L. Flowers
              Chief
      Financial Officer
              (Duly
      Authorized and Principal Financial
Officer)