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, 2007




OR




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





For
      the
      transition period from ___________ to _______________




Commission
      File Number 0-22182




PATRIOT
      SCIENTIFIC
      CORPORATION


(Exact
      name of registrant as specified in its charter)





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





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





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





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




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




Large
      accelerated filer o                                                                Accelerated
      filer x                                                      Non-accelerated
      filer o




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




Yes o  No
x




On
      January 4, 2008, 391,472,101 shares of common stock, par value $.00001 per
      share
      (the issuer’s only class of voting stock) were outstanding.










INDEX








PagePART
                I. FINANCIAL
                INFORMATIONITEM
                1. Financial StatementsCondensed
                consolidated Balance Sheets as of November 30, 2007 (unaudited) and
                May
                31, 2007
            3Condensed
                consolidated Statements of Operations for the three and six months
                ended
                November 30, 2007 and 2006 (unaudited)
            4Condensed
                consolidated Statements of Cash Flows for the six months ended November
                30, 2007 and 2006 (unaudited)
            5Notes
                to Condensed consolidated Financial Statements (unaudited)
            6-21ITEM
                2. Management’s Discussion and Analysis of Financial Condition and Results
                of Operations
            22-32ITEM
                3. Quantitative and Qualitative Disclosures About Market
                Risk
            32ITEM
                4. Controls and Procedures
            32PART
                II. OTHER
                INFORMATIONITEM
                1. Legal Proceedings
            33ITEM
                1A. Risk Factors
            33ITEM
                2. Unregistered Sales of Equity Securities and Use of
                Proceeds
            33ITEM
                3. Defaults Upon Senior Securities
            33ITEM
                4. Submission of Matters to a Vote of Security Holders
            34ITEM
                5. Other Information
            34ITEM
                6. Exhibits
            34-36SIGNATURES




2


PART
      I-
      FINANCIAL INFORMATION





Item
      1. Financial Statements





Patriot
      Scientific
      Corporation


Condensed
      Consolidated Balance
      Sheets





November
                30,
              2007
            
            
            May
                31,
              2007ASSETS
            
            (Unaudited)Current
                assets:Cash
                and cash equivalents
            
            $
            7,576,343
            
            
            $
            21,605,428Restricted
                cash and cash equivalents
            
            
            50,487
            
            
            
            102,346Marketable
                securities and short term investments
            
            
            12,629,946
            
            
            
            4,349,314Accounts
                receivable
            
            
            421,050
            
            
            
            352,390Receivable
                from affiliated company
            
            
            210,584
            
            
            
            -Note
                receivable
            
            
            50,000
            
            
            
            -Inventory
            
            
            312,514
            
            
            
            46,361Prepaid
                income taxes
            
            
            -
            
            
            
            2,070,981Deferred
                tax assets
            
            
            1,051,653
            
            
            
            2,439,975Prepaid
                expenses and other current assets
            
            
            256,135
            
            
            
            431,840Total
                current assets
            
            
            22,558,712
            
            
            
            31,398,635Property
                and equipment,
                net
            
            
            80,374
            
            
            
            85,518Other
                assets,
                net
            
            
            8,190
            
            
            
            8,190Investment
                in affiliated
                company
            
            
            -
            
            
            
            2,883,969Patents
                and trademarks,
                net of accumulated amortization of $613,246 and $607,657
            
            
            32,728
            
            
            
            38,317$
            22,680,004
            
            
            $
            34,414,629LIABILITIES
                AND STOCKHOLDERS’
                EQUITYCurrent
                liabilities:Accounts
                payable
            
            $
            455,141
            
            
            $
            934,298Accrued
                expenses and other
            
            
            213,518
            
            
            
            1,086,496Income
                taxes payable
            
            
            5,446,572
            
            
            
            -Total
                current liabilities
            
            
            6,115,231
            
            
            
            2,020,794Distributions
                in excess
                of  investment in affiliated company
            
            
            568,605
            
            
            
            -Deferred
                tax
                liabilities
            
            
            736,259
            
            
            
            12,222,944Total
                liabilities
            
            
            7,420,095
            
            
            
            14,243,738Commitments
                and
                contingenciesMinority
                Interest
            
            
            -
            
            
            
            -Stockholders’
                equity:Preferred
                stock, $0.00001 par value; 5,000,000 shares authorized: none
                outstanding
            
            
            -
            
            
            
            -Common
                stock, $0.00001 par value: 500,000,000 shares authorized: 410,638,449
                shares issued and 391,472,101 shares outstanding at November 30,
                2007 and
                406,668,661 shares issued and 393,201,134 shares outstanding at May
                31,
                2007
            
            
            4,106
            
            
            
            4,066Additional
                paid-in capital
            
            
            69,828,330
            
            
            
            72,150,581Accumulated
                deficit
            
            
            (42,697,528
            )
            
            
            (43,151,678
            )Common
                stock held in treasury, at cost – 19,166,348 shares and 13,467,527 shares
                at November 30, 2007 and May 31,
                2007,  respectively
            
            
            (11,874,999
            )
            
            
            (8,832,078
            )Total
                stockholders’ equity
            
            
            15,259,909
            
            
            
            20,170,891$
            22,680,004
            
            
            $
            34,414,629





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, 2007
              
              
              November
                  30, 2006
              
              
              November
                  30, 2007
              
              
              November
                  30, 2006Revenues:Product
                  sales and other
              
              $
              945,830
              
              
              $
              18,500
              
              
              $
              1,467,199
              
              
              $
              44,875Cost
                  of sales
              
              
              356,338
              
              
              
              -
              
              
              
              507,873
              
              
              
              -Gross
                  profit
              
              
              589,492
              
              
              
              18,500
              
              
              
              959,326
              
              
              
              44,875Operating
                  expenses:Selling,
                  general and administrative
              
              
              1,986,363
              
              
              
              1,736,422
              
              
              
              3,944,553
              
              
              
              4,468,946Settlement
                  and license expense
              
              
              388,660
              
              
              
              6,300,000
              
              
              
              418,660
              
              
              
              6,300,000Total
                  operating expenses
              
              
              2,375,023
              
              
              
              8,036,422
              
              
              
              4,363,213
              
              
              
              10,768,946Operating
                  loss
              
              
              (1,785,531
              )
              
              
              (8,017,922
              )
              
              
              (3,403,887
              )
              
              
              (10,724,071
              )Other
                  income (expense):Interest
                  and other income
              
              
              301,066
              
              
              
              181,131
              
              
              
              775,591
              
              
              
              307,898Loss
                  on sale of assets
              
              
              (924
              )
              
              
              -
              
              
              
              (1,269
              )
              
              
              (543
              )Interest
                  expense
              
              
              -
              
              
              
              -
              
              
              
              (237
              )
              
              
              -Gain
                  on sale of subsidiary interest
              
              
              -
              
              
              
              -
              
              
              
              150,000
              
              
              
              -Equity
                  in earnings of affiliated company
              
              
              5,486,039
              
              
              
              6,674,793
              
              
              
              4,285,497
              
              
              
              18,744,991Total
                  other income, net
              
              
              5,786,181
              
              
              
              6,855,924
              
              
              
              5,209,582
              
              
              
              19,052,346Income
                  (loss) before income taxes
              
              
              4,000,650
              
              
              
              (1,161,998
              )
              
              
              1,805,695
              
              
              
              8,328,275Provision
                  for income taxes
              
              
              1,584,114
              
              
              
              720,000
              
              
              
              1,351,545
              
              
              
              4,220,000Net
                  income (loss)
              
              $
              2,416,536
              
              
              $
              (1,881,998
              )
              
              $
              454,150
              
              
              $
              4,108,275Basic
                  income per common share
              
              $
              0.01
              
              
              $
              -
              
              
              $
              -
              
              
              $
              0.01Diluted
                  income per common share
              
              $
              0.01
              
              
              $
              -
              
              
              $
              -
              
              
              $
              0.01Weighted
                  average number of common shares outstanding-basic
              
              
              391,245,755
              
              
              
              378,817,682
              
              
              
              390,848,284
              
              
              
              373,800,101Weighted
                  average number of common shares outstanding-diluted
              
              
              392,627,522
              
              
              
              378,817,682
              
              
              
              393,814,090
              
              
              
              419,862,437




See
                accompanying notes to
                unaudited condensed consolidated financial
                statements.


4


Patriot
      Scientific
      Corporation


Condensed
      Consolidated Statements of
      Cash Flows


(Unaudited)




Six
                months
                endedNovember
                30,
                2007
            
            
            November
                30,
                2006Operating
                activities:Net
                income
            
            $
            454,150
            
            
            $
            4,108,275Adjustments
                to reconcile net income to net cash used in operating
                activities:Amortization
                and depreciation
            
            
            22,915
            
            
            
            21,288Expense
                related to extension of expiration date of stock options
            
            
            -
            
            
            
            324Non
                cash compensation relating to issuance of stock options and vesting
                of  warrants
            
            
            346,134
            
            
            
            1,773,102Accrued
                interest income added to investments
            
            
            (641
            )
            
            
            (1,258
            )Equity
                in earnings of affiliated company
            
            
            (4,285,497
            )
            
            
            (18,744,991
            )Loss
                on sale of assets
            
            
            1,269
            
            
            
            543Value
                of stock issued in connection with legal settlement
            
            
            100,000
            
            
            
            -Deferred
                income taxes
            
            
            (10,098,363
            )
            
            
            -Gain
                on VIE sale of portion of subsidiary interest
            
            
            (150,000
            )
            
            
            -Reversal
                of tax effect of exercise of options
            
            
            (25,645
            )
            
            
            -Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            (279,244
            )
            
            
            (3,325
            )Inventory
            
            
            (266,153
            )
            
            
            -Prepaid
                and other assets
            
            
            179,695
            
            
            
            172,921Prepaid
                income taxes
            
            
            2,070,981
            
            
            
            -Accounts
                payable and accrued expenses
            
            
            (1,352,136
            )
            
            
            (390,512
            )Accrued
                contested fee payable
            
            
            -
            
            
            
            5,960,000Income
                taxes payable
            
            
            5,446,572
            
            
            
            4,154,600Net
                cash used in operating activities
            
            
            (7,835,963
            )
            
            
            (2,949,033
            )Investing
                activities:Proceeds
                from sales of short-term investments
            
            
            6,800,159
            
            
            
            4,024,395Purchases
                of short-term investments
            
            
            (15,080,791
            )
            
            
            (4,158,346
            )Proceeds
                from sale of restricted investments
            
            
            52,500
            
            
            
            -Purchases
                of property and equipment
            
            
            (17,566
            )
            
            
            (5,947
            )Proceeds
                from sale of property and equipment
            
            
            125
            
            
            
            -Proceeds
                from VIE sale of portion of subsidiary interest
            
            
            100,000
            
            
            
            -Investment
                in debt securities
            
            
            -
            
            
            
            (350,000
            )Distributions
                from affiliated company
            
            
            7,738,072
            
            
            
            15,099,267Net
                cash provided by (used in) investing activities
            
            
            (407,501
            )
            
            
            14,609,369Financing
                activities:Proceeds
                from exercise of common stock warrants and options
            
            
            18,200
            
            
            
            97,850Repurchase
                of warrants
            
            
            (2,760,900
            )
            
            
            -Repurchase
                of common stock for treasury
            
            
            (3,042,921
            )
            
            
            (4,024,395
            )Net
                cash used in financing activities
            
            
            (5,785,621
            )
            
            
            (3,926,545
            )Net
                increase (decrease) in cash
                and cash equivalents
            
            
            (14,029,085
            )
            
            
            7,733,791Cash
                and cash equivalents,
                beginning of period
            
            
            21,605,428
            
            
            
            3,984,240Cash
                and cash equivalents, end
                of period
            
            $
            7,576,343
            
            
            $
            11,718,031Supplemental
                Disclosure of Cash
                Flow Information:Cash
                payments for interest
            
            $
            237
            
            
            $
            -Cash
                payments for income taxes
            
            $
            3,958,000
            
            
            $
            65,400Supplemental
                Disclosure
                of  Non-Cash Investing and Financing
                Activities:Cashless
                exercise of warrants
            
            $
            25
            
            
            $
            225Cashless
                exercise of stock options
            
            $
            10
            
            
            $
            -Note
                receivable issued in connection with VIE sale of portion of subsidiary
                interest
            
            $
            50,000
            
            
            $
            -




See
                accompanying notes to
                unaudited condensed consolidated financial
                statements.




5




Patriot
      Scientific
      Corporation


Notes
      to Unaudited Condensed
      Consolidated Financial Statements




1.  Basis
      of Presentation
      and Summary of Significant Accounting Policies





The
      unaudited condensed consolidated financial statements of Patriot Scientific
      Corporation (the “Company”, “we”, “us” or “our”) presented herein have been
      prepared pursuant to the rules of the Securities and Exchange Commission (“SEC”)
      for quarterly reports on Form 10-Q and do not include all of the information
      and
      footnotes required by accounting principles generally accepted in the United
      States of America. These financial statements should be read in conjunction
      with
      our audited consolidated financial statements and notes thereto included in
      our
      Report on Form 10-K for our fiscal year ended May 31, 2007.





In
      the
      opinion of management, the interim condensed consolidated financial statements
      reflect all adjustments of a normal recurring nature necessary for a fair
      presentation of the results for the interim periods
      presented.  Operating results for the six month period ended November
      30, 2007 are not necessarily indicative of the results that may be expected
      for
      the year ending May 31, 2008.





Basis
      of
      Consolidation


The
      condensed consolidated statement of operations for the three and six months
      ended November 30, 2006 includes our accounts and those of our majority owned
      subsidiaries, Metacomp, Inc. and Plasma Scientific Corporation. The condensed
      consolidated balance sheet at May 31, 2007 and the condensed consolidated
      financial statements as of and for the three and six months ended November
      30,
      2007 include our accounts, those of our majority owned subsidiaries that are
      not
      considered variable interest entities (“VIE”s) and all VIEs for which we are the
      primary beneficiary. All significant intercompany accounts and transactions
      have
      been eliminated.





Consolidation
      of
      Affiliate


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





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





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





FIN
      46
      was effective immediately for VIEs created after January 31, 2003. The
      provisions of FIN 46, as revised, were adopted as of December 31, 2003, for
      our
      interests in all VIEs. Beginning with the quarter ended May 31, 2007, we
      consolidated Scripps Secured Data, Inc. (“SSDI”) as SSDI was deemed a VIE and we
      determined that we were the primary beneficiary of SSDI.





Investment
      in Affiliated
      Company


We
      have a
      50% interest in Phoenix Digital Solutions, LLC (see Note 5). This investment
      is
      accounted for using the equity method of accounting since the investment
      provides us the ability to exercise significant influence, but not control,
      over
      the investee. Significant influence is generally deemed to exist if we have
      an
      ownership interest in the voting stock of the investee of between 20% and 50%,
      although other factors, such as
      representation on the investee’s board of directors, are considered in
      determining whether the equity method of accounting is appropriate. Under the
      equity method of accounting, the investment, originally recorded at cost, is
      adjusted to recognize our share of net earnings or losses of the investee and
      is
      recognized in the consolidated statements of operations in the caption “Equity
      in earnings (loss) of affiliated company”.





6




Patriot
      Scientific
      Corporation


Notes
      to Unaudited Condensed
      Consolidated Financial Statements








Investment
      in Affiliated Company,
      continued




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





Revenue
      Recognition


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





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





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





Shipping
      and
      Handling


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





Net
      Income (Loss) Per
      Share


We
      apply
      Statement of Financial Accounting Standards (“SFAS”) No. 128, Earnings Per Share, for the
      calculation of "Basic" and "Diluted" earnings per share. Basic earnings per
      share includes no dilution and is computed by dividing income available to
      common stockholders by the weighted average number of common shares outstanding
      for the period. Diluted earnings per share reflects the potential dilution
      of
      securities that could share in the earnings of an entity.  For the
      three months and six months ended November 30, 2007, 5,495,000 potentially
      dilutive common shares related to our outstanding warrants and options were
      not
      included in the calculation of diluted income per share as they had an
      anti-dilutive effect.  For the three months ended November 30, 2006,
      40,690,194 potentially dilutive common shares related to our outstanding
      warrants and options were not included in the calculation of diluted loss per
      share as they had an anti-dilutive effect. For the six months ended November
      30,
      2006, 100,000 potentially dilutive common shares related to our outstanding
      warrants and options were not included in the calculation of diluted income
      per
      share as they had an anti-dilutive effect.


7




Patriot
      Scientific
      Corporation


Notes
      to Unaudited Condensed
      Consolidated Financial Statements





Net
      Income (Loss) Per Share,
      continued





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





Three
                Months Ended November 30,
                2006Numerator
                (Loss)
            
            
            Denominator
                (Shares)
            
            
            Per
                Share AmountBasic
                EPS:Net
                loss
            
            $
            (1,881,998
            )
            
            
            378,817,682
            
            
            $
            -Diluted
                EPS:Effect
                of dilutive securities:Options
                and
                warrants
            
            
            -
            
            
            
            -Loss
                available to common shareholders
            
            $
            (1,881,998
            )
            
            
            378,817,682
            
            
            $
            -





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





Six
                Months Ended November 30,
                2006Numerator
                (Income)
            
            
            Denominator
                (Shares)
            
            
            Per
                Share AmountBasic
                EPS:Net
                income
            
            $
            4,108,275
            
            
            
            373,800,101
            
            
            $
            0.01Diluted
                EPS:Effect
                of dilutive securities:Options
                and
                warrants
            
            
            -
            
            
            
            46,062,336Income
                available to common shareholders
            
            $
            4,108,275
            
            
            
            419,862,437
            
            
            $
            0.01




8




Patriot
      Scientific
      Corporation


Notes
      to Unaudited Condensed
      Consolidated Financial Statements




Minority
      Interest


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





The
      noncontrolling interest in SSDI, which we are required to consolidate as we
      are
      the primary beneficiary, has been reduced to zero due to the initial allocation
      of losses prior to the period in which we were required to consolidate. If
      a
      noncontrolling interest has been reduced to zero, the primary beneficiary must
      absorb any losses that are in excess of the value of the noncontrolling
      interest’s equity. For the period in which we are required to consolidate, March
      27, 2007 through November 30, 2007 we absorbed $45,864 of SSDI’s losses as we
      are the primary beneficiary. The noncontrolling interest in any future profits
      will not be presented until all prior losses have been recovered.




Stock-Based
      Compensation


On
      June
      1, 2006, we adopted the provisions of SFAS No. 123(R), Share-Based Payment, which
      establishes standards for the accounting of transactions in which an entity
      exchanges its equity instruments for goods or services, primarily focusing
      on
      accounting for transactions where an entity obtains employee services in
      share-based payment transactions. SFAS No. 123(R) requires a public entity
      to measure the cost of employee services received in exchange for an award
      of
      equity instruments, including stock options, based on the grant-date fair value
      of the award and to recognize it as compensation expense over the period the
      employee is required to provide service in exchange for the award, usually
      the
      vesting period. Stock-based awards to non-employees are accounted for using
      the
      fair value method in accordance with SFAS No. 123, Accounting for Stock Based
      Compensation.




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




Stock-based
      compensation expense recognized during the period is based on the value of
      the
      portion of share-based payment awards that is ultimately expected to vest during
      the period. Stock-based compensation expense recognized in our condensed
      consolidated statement of operations for the six months ended November 30,
      2006
      included compensation expense for share-based payment awards granted prior
      to,
      but not yet vested as of May 31, 2006 based on the grant date fair value
      estimated in accordance with the pro forma provisions of SFAS No. 123 and
      compensation expense for the share-based payment awards granted subsequent
      to
      May 31, 2006 based on the grant date fair value estimated in accordance
      with the provisions of SFAS No. 123(R). Stock-based compensation expense
      recognized in our condensed consolidated statement of operations for the six
      months ended November 30, 2007 included compensation expense for share-based
      payment awards granted subsequent to May 31, 2007 based on the grant date
      fair value estimated in accordance with the provisions of SFAS No. 123(R).
      As
      stock-based compensation expense recognized in the condensed consolidated
      statements of operations is based on awards ultimately expected to vest, it
      has
      been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures
      to
      be estimated at the time of grant and revised, if necessary, in subsequent
      periods if actual forfeitures differ from those estimates. The estimated average
      forfeiture rate for the three and six months ended November 30, 2007 and
      2006, of approximately 5% was based on historical forfeiture experience and
      estimated future employee forfeitures. The estimated pricing term of option
      grants for the three and six months ended November 30, 2007 and 2006 was five
      years.


9




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, 2007 and 2006 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
            
            Six
                Months
              Ended
            
            Three
                Months
              Ended
            
            Six
                Months
              EndedNovember
                30,
              2007
              (Unaudited)
            
            November
                30,
              2007
              (Unaudited)
            
            November
                30,
              2006
              (Unaudited)
            
            November
                30,
              2006
              (Unaudited)Expected
                term
            
            
            5
            
            years
            
            
            4.4
            
            years
            
            
            5
            
            years
            
            
            5
            
            yearsExpected
                volatility
            
            
            127
            
            %
            
            
            127-128
            
            %
            
            
            156
            
            %
            
            
            156
            
            %Risk-free
                interest rate
            
            
            4.21
            
            %
            
            
            4.21
                – 4.96
            
            %
            
            
            4.80
            
            %
            
            
            4.80
                – 5.00
            
            %Expected
                dividends
            
            
            2.82
            
            %
            
            
            2.82
            
            %
            
            
            -
            
            
            
            
            -





A
        summary
        of option activity as of November 30, 2007 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, 2007
            
            
            7,245,000
            
            
            $
            0.40Options
                granted
            
            
            2,975,000
            
            
            $
            0.47Options
                exercised
            
            
            (1,107,846
            )
            
            $
            0.16Options
                forfeited
            
            
            (1,017,154
            )
            
            $
            0.16Options
                outstanding at November 30, 2007
            
            
            8,095,000
            
            
            $
            0.49
            
            
            
            3.62
            
            
            $
            1,237,700Options
                vested and expected to vest at November 30, 2007
            
            
            7,982,500
            
            
            $
            0.49
            
            
            
            3.61
            
            
            $
            1,222,325Options
                exercisable at November 30, 2007
            
            
            5,845,000
            
            
            $
            0.49
            
            
            
            3.24
            
            
            $
            930,200




10




Patriot
      Scientific
      Corporation


Notes
      to Unaudited Condensed
      Consolidated Financial Statements


Stock-Based
        Compensation,
        continued




The
      weighted average grant date fair value of options granted during the six months
      ended November 30, 2007 and 2006 was $0.35 and $0.99 per option, respectively.
      The total intrinsic value of options exercised during the six months ended
      November 30, 2007 and 2006 was $513,550 and $169,500, respectively, based on
      the
      differences in market prices on the dates of exercise and the option exercise
      prices.





The
        aggregate intrinsic value represents the differences in market price at the
        close of the quarter ($0.61 per share on November 30, 2007) and the exercise
        price of outstanding, in the money options (those options with exercise prices
        below $0.61) on November 30, 2007.





As
        of
        November 30, 2007, there was approximately $662,167 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 58 months.




The
      following table summarizes employee stock-based compensation expense related
      to
      stock options under SFAS No. 123(R) for the three and six months ended November
      30, 2007 and 2006, which was recorded as follows:




Three
                Months
                Ended
            
            
            Six
                Months
              Ended
            
            
            Three
                Months
                Ended
            
            
            SixMonths
              EndedNovember 30,
                2007
            
            
            November
                30,
                2007
            
            
            November
                30,
                2006
            
            
            November
                30,
                2006Selling,
                general and administrative expense
            
            $
            63,221
            
            
            $
            346,134
            
            
            $
            194,000
            
            
            $
            1,770,000





Recent
      Accounting
      Pronouncements





In
      July
      2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income
      Taxes - an interpretation of FASB Statement No. 109 (“FIN 48”). This
      interpretation clarifies the application of SFAS No. 109, Accounting for Income Taxes,
      by defining criteria that an individual tax position must meet for any part
      of
      the benefit of that position to be recognized in a company’s financial
      statements and also provides guidance on measurement, derecognition,
      classification, interest and penalties, accounting in interim periods,
      disclosure and transition. We adopted FIN 48 on June 1, 2007 and did not record
      any cumulative effect adjustment to retained earnings as a result of adopting
      FIN 48.  Interest and penalties, if any, related to unrecognized tax
      benefits are recorded in income tax expense.  As of June 1, 2007, we
      are subject to U.S. Federal income tax examinations for the tax years May 31,
      1991 through May 31, 2007, and we are subject to state and local income tax
      examinations for the tax years May 31, 1999 through May 31, 2007 due to the
      carryover of net operating losses from previous years.





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


11


Patriot
        Scientific
        Corporation
 Notes
        to Unaudited Condensed
        Consolidated Financial Statements





Recent
      Accounting Pronouncements,
      continued





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





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





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





2.
      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.





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





During
      the quarter ended November 30, 2007 we had short-term investments in auction
      rate securities of  approximately $7.5 million.  Auction
      rate securities generally have long-stated maturities of 20 to 40
      years.  These securities have certain economic characteristics of
      short-term investments due to a rate-setting mechanism and the ability to
      liquidate them through a Dutch auction process that occurs on pre-determined
      intervals of less than 90 days.  Due to the frequent resetting of
      interest rates, the carrying value of auction rate securities approximates
      fair
      value.


12




Patriot
      Scientific
      Corporation


Notes
      to Unaudited Condensed
      Consolidated Financial Statements




3.
      Inventory





Inventory
      at November 30, 2007, consisted of raw materials of $87,462 and finished goods
      of $225,052.





4.
      License
      Agreements





In
      February 2005, we entered into two separate licensing agreements with one
      customer for our patent portfolio and Ignite microprocessor technology. The
      aggregate amount of the two licenses was $3,050,000, of which $2,950,000 was
      for
      licensing fees and $100,000 was for maintenance services. Maintenance under
      the
      agreement is expected to be provided over a period not to exceed four years.
      Maintenance revenue recognized during six months ended November 30, 2007 and
      2006 was $12,500 and $12,500, respectively. The payment terms of the agreements
      required aggregate payments of $300,000 at the time of execution, three
      quarterly payments of $750,000 each on April 1, August 15, and November 15,
      2005
      and one final payment of $500,000 on February 15, 2006. The $500,000 payment
      due
      on February 15, 2006 was paid in March 2006. Total payments received in fiscal
      2005 amounted to $1,050,000, and total payments received in fiscal 2006 amounted
      to $2,000,000. The agreements also provide for the future payment of royalties
      to us based on sales of product using the Ignite licensed technology. In
      connection with this license agreement, we became obligated to the co-inventor
      of the patent portfolio technology for $207,600 pursuant to a July 2004
      agreement under which we were obligated to pay a percentage of all patent
      portfolio licensing proceeds to the co-inventor. The amount due under that
      license was payable in four installments of $51,900. The co-inventor of the
      patent portfolio technology filed a lawsuit against us seeking damages and/or
      enforcement of the July 2004 agreement. We challenged the enforceability of
      the
      agreement by counterclaim in that action. On February 14, 2007, a settlement
      of
      the litigation was finalized. Terms of the settlement required us to pay
      $3,400,000 in cash on February 14, 2007 and $3,000,000 on May 1, 2007, which
      amounted to approximately the debt claimed by the co-inventor to be owed to
      him
      under the July 2004 agreement. In addition, the settlement required us to make
      a
      donation of $15,000 on February 14, 2007 on behalf of Russell H. Fish III
      (“Fish”) to Maasai Power and Education Project, Inc., and to pay Fish the
      equivalent of 4% of 50% of the next $100 million of gross license fees as they
      are collected by Phoenix Digital and as distributions are made to us, after
      excluding the first $20 million collected by Phoenix Digital after December
      1,
      2006. Our commitment to make payments to Fish related to such future license
      revenues will not exceed $2 million. During the six months ended November 30,
      2007, we recorded $418,660 in settlement and license expenses relating to
      royalty payments due to the Fish parties.





5.
      Investment in Affiliated
      Company/License Agreement





On
      June
      7, 2005, we entered into a Master Agreement (the “Master Agreement”) with
      Technology Properties Limited Inc., a California corporation (“TPL”), and
      Charles H. Moore (“Moore”), the co-inventor of certain of our technology,
      pursuant to which we, TPL and Moore resolved all legal disputes between us.
      Pursuant to the Master Agreement, we and TPL entered into the Limited Liability
      Company Operating Agreement of Phoenix Digital (the “LLC Agreement”) into which
      we and Moore contributed our rights to certain of our technologies.





We
      and
      TPL each own 50% of the membership interests of Phoenix Digital, 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 Phoenix Digital of $4,000,000, of which
      our
      contribution was $2,000,000. The working capital fund increases to a maximum
      of
      $8,000,000 as license revenues are achieved. We and TPL are obligated to fund
      future working capital requirements at the discretion of the management
      committee of Phoenix Digital in order to maintain working capital of not more
      than $8,000,000. Neither we nor TPL are required to contribute more than
      $2,000,000 in any fiscal year. Distributable cash and allocation of profits
      and
      losses will be allocated to the members in the priority defined in the LLC
      Agreement.


13




Patriot
      Scientific
      Corporation


Notes
      to Unaudited Condensed
      Consolidated Financial Statements




Investment
      in Affiliated
      Company/License Agreement, continued





Phoenix
      Digital has committed to pay a quarterly amount ranging between $500,000 and
      $1,000,000 (based upon a percentage of the working capital fund balance of
      Phoenix Digital) for supporting efforts to secure licensing agreements by the
      other member on behalf of Phoenix Digital. During the six months ended November
      30, 2007 and 2006, Phoenix Digital paid $1,374,000 and $1,968,000, respectively,
      to TPL pursuant to this commitment.





We
      are
      accounting for our investment in Phoenix Digital under the equity method of
      accounting, and accordingly have recorded our share of Phoenix Digital’s net
      income of $4,285,497 during the six months ended November 30, 2007 and our
      share
      of Phoenix Digital’s net income of $18,744,991 during the six months ended
      November 30, 2006 as an increase in our investment. Cash distributions of
      $7,738,072 received from Phoenix Digital during the six months ended November
      30, 2007 and cash distributions of $15,099,267 received from Phoenix Digital
      during the six months ended November 30, 2006 have been recorded as a reduction
      in our investment. During the three months ended November 30, 2007, Phoenix
      Digital distributed earnings in excess of the carrying amount of our investment
      of $568,605 at November 30, 2007.  Such amount has been recorded as
“Distributions in Excess of Investment in Affiliated Company” due to our and
      TPL’s obligation to fund the working capital of Phoenix Digital at the
      discretion of Phoenix Digital’s management committee. We have recorded our share
      of Phoenix Digital’s net income as “Equity in Earnings of Affiliated Company” in
      the accompanying consolidated statements of operations for the six months ended
      November 30, 2007 and November 30, 2006. At November 30, 2007 we have recorded
      $210,584 as amounts receivable from affiliated company for reimbursement due
      to
      us of legal fees and related costs for the patent litigation (see Note
      8).





During
      the six months ended November 30, 2007, Phoenix Digital entered into licensing
      agreements with third parties, pursuant to which it received aggregate proceeds
      of $20,933,000.  During the six months ended November 30, 2006,
      Phoenix Digital entered into licensing agreements with third parties, pursuant
      to which it received aggregate proceeds of $32,699,000.  License
      proceeds of $8,850,000 relating to an additional license agreement signed in
      November 2006 were received in January 2007.  Phoenix Digital had
      recorded this amount as a license receivable.





The
      condensed balance sheets and statements of operations of Phoenix Digital at
      November 30, 2007 and 2006 and for the six months then ended are as
      follows:





Condensed
      Balance
      Sheets





ASSETS:


2007
            
            
            2006Cash
            
            $
            4,629,045
            
            
            $
            7,731,427License
                fees receivable
            
            
            -
            
            
            
            8,850,000Prepaid
                expenses
            
            
            95,000
            
            
            
            15,000Total
                assets
            
            $
            4,724,045
            
            
            $
            16,596,427





LIABILITIES
      AND MEMBERS’ EQUITY:





Accounts
                payable and accrued expenses
            
            $
            5,849,465
            
            
            $
            1,172,314Income
                taxes payable
            
            
            11,790
            
            
            
            -Members’
                equity
            
            
            (1,137,210
            )
            
            
            15,424,113Total
                liabilities and members’ equity
            
            $
            4,724,045
            
            
            $
            16,596,427




14




Patriot
      Scientific
      Corporation


Notes
      to Unaudited Condensed
      Consolidated Financial Statements






Investment
      in
      Affiliated Company/License Agreement, continued




Condensed
      Statements of
      Operations





2007
            
            
            2006Revenues
            
            $
            20,933,000
            
            
            $
            41,549,000Operating
                expenses
            
            
            13,598,760
            
            
            
            4,271,666Operating
                income
            
            
            7,334,240
            
            
            
            37,277,334Interest
                income
            
            
            112,585
            
            
            
            212,648Net
                income
            
            $
            7,446,825
            
            
            $
            37,489,982





6.
      Consolidated Variable Interest
      Entity





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





On
      March
      27, 2007, we entered into an 18 month revolving line of credit with SSDI for
      a
      maximum amount of $500,000. The line of credit matures on September 27, 2008.
      If
      we do not provide notice to SSDI at least 90 days prior to the maturity date,
      the maturity date automatically extends 12 months. The line of credit is
      collateralized by all assets presently owned or hereafter acquired by SSDI.
      The
      carrying value of the collateral is approximately $547,390 at November 30,
      2007.
      The creditors of SSDI do not have recourse to our other assets. On March 28,
      2007, we advanced $150,000 under terms of the agreement, on April 16, 2007
      we
      advanced $100,000 under terms of the agreement and on September 4, 2007 we
      advanced $100,000 under terms of the agreement.





The
      line
      of credit carries a floating interest rate which is defined as the prime rate
      as
      announced by Bank of America. At November 30, 2007, the interest rate on
      the note was 7.50%; On December 11, 2007, the interest rate on the note was
      7.25%. SSDI is required to make minimum monthly payments on the line consisting
      of unpaid and accrued interest on the first day of the month following the
      initial advance.





As
      a
      result of the line of credit, we have a variable interest in SSDI, a variable
      interest entity, and we have determined that we are the primary beneficiary
      as
      we absorb more than half of the variable interest entity’s expected losses. FIN
      46, requires us to consolidate SSDI as long as we are deemed to be the primary
      beneficiary. The equity interests of SSDI not owned by us are reported as a
      minority interest in our November 30, 2007 condensed consolidated balance
      sheet.  As of November 30, 2007, the noncontrolling interest in SSDI,
      which we are required to consolidate as we are the primary beneficiary, has
      been
      reduced to zero due to the initial allocation of losses prior to the period
      in
      which we were required to consolidate. If a noncontrolling interest has been
      reduced to zero, the primary beneficiary must absorb any losses that are in
      excess of the value of the noncontrolling interest’s equity. For the period in
      which we are required to consolidate, March 27, 2007 through November 30, 2007
      we absorbed $45,864 of SSDI’s losses as we are the primary beneficiary. The
      noncontrolling interest in any future profits will not be presented until all
      prior losses have been recovered.


15




Patriot
      Scientific
      Corporation


Notes
      to Unaudited Condensed
      Consolidated Financial Statements





Consolidated
      Variable Interest
      Entity, continued





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





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





During
      the three months ended August 31, 2007, SSDI sold a membership interest in
      its
      subsidiary DataSecurus, LLC  to an unrelated third party for $100,000
      in cash and a $50,000 note receivable due June 2008.





7.   Stockholders’
      Equity





During
      July 2006 we commenced our Board of Director approved stock buyback program
      in
      which we repurchase our outstanding common stock from time to time on the open
      market.  As part of the program we purchased 5,698,821 and 4,874,827
      shares of our common stock at an aggregate cost of $3,042,921 and $4,024,395
      during the six months ended November 30, 2007 and 2006,
      respectively.





The
      following table summarizes equity transactions during the six months ended
      November 30, 2007:


Common
                  Stock
              
              
              Additional
                  Paid-
              
              
              Accumulated
              
              
              TreasuryShares
              
              
              Amounts
              
              
              in
                  Capital
              
              
              Deficit
              
              
              StockBalance
                  June 1, 2007
              
              
              393,201,134
              
              
              $
              4,066
              
              
              $
              72,150,581
              
              
              $
              (43,151,678
              )
              
              $
              (8,832,078
              )Exercise
                  of warrants and options at $0.05 to $0.10 per share
              
              
              250,000
              
              
              
              3
              
              
              
              18,197
              
              
              
              -
              
              
              
              -Cashless
                  exercise of options
              
              
              982,846
              
              
              
              10
              
              
              
              (10
              )
              
              
              -
              
              
              
              -Cashless
                  exercise of warrants
              
              
              2,536,942
              
              
              
              25
              
              
              
              (25
              )
              
              
              -
              
              
              
              -Issuance
                  of stock
              
              
              200,000
              
              
              
              2
              
              
              
              99,998
              
              
              
              -
              
              
              
              -Repurchase
                  of warrants
              
              
              -
              
              
              
              -
              
              
              
              (2,760,900
              )
              
              
              -
              
              
              
              -Non-cash
                  compensation
              
              
              -
              
              
              
              -
              
              
              
              346,134
              
              
              
              -
              
              
              
              -Tax
                  effect of exercise of options
              
              
              -
              
              
              
              -
              
              
              
              (25,645
              )
              
              
              -
              
              
              
              -Repurchase
                  of common stock for treasury
              
              
              (5,698,821
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (3,042,921
              )Net
                  income
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              454,150
              
              
              
              -Balance
                  November 30, 2007
              
              
              391,472,101
              
              
              $
              4,106
              
              
              $
              69,828,330
              
              
              $
              (42,697,528
              )
              
              $
              (11,874,999
              )
  During
      November 2007 we issued 200,000 shares of our common stock to a former officer
      in connection with a settlement agreement (see Note 8).





Stock
      Optionsand Warrant
      Activity




As
      of
      November 30, 2007, we had 100,000 options outstanding pursuant to our 1996
      Stock
      Option Plan exercisable at $0.07 per share expiring in 2009; 775,000 options
      outstanding pursuant to our 2001 Stock Option Plan exercisable at a range of
      $0.07 to $0.86 per share expiring through 2012; 3,350,000 options outstanding
      pursuant to our 2003 Stock Option Plan exercisable at a range of $0.05 to $0.49
      per share expiring through 2012; and 3,870,000 options outstanding pursuant
      to
      our 2006 Stock Option Plan exercisable at a range of $0.45 to $0.70 per share
      expiring through 2012.  Some of the options outstanding under these
      plans are not presently exercisable and are subject to meeting vesting
      criteria.





During
      the quarter ended November 30, 2007, we issued options to acquire 750,000 shares
      of common stock to our newly appointed chief financial officer at an exercise
      price of $0.45 per share.


16




Patriot
      Scientific
      Corporation


Notes
      to Unaudited Condensed
      Consolidated Financial Statements





Stockholders’
Equity,
      continued





During
      the six months ended November 30, 2007, directors exercised stock options to
      purchase 125,000 shares of common stock for proceeds of $11,950, and a director
      exercised stock options utilizing a share certification exchange procedure
      within our stock option plans to exercise 1,500,000 shares and receive 982,846
      new shares upon exercise.





During
      the six months ended November 30, 2007, we recorded $346,134 of non cash
      compensation expense related to stock options issued and vesting of stock
      options.





As
      of
      November 30, 2007, we had warrants outstanding to purchase 500,000 common shares
      at exercise prices ranging from $0.06 to $1.00 per share, expiring at various
      dates through 2011.  During the six months ended November 30, 2007, we
      issued no warrants to purchase shares of common stock, an investor exercised
      warrants to purchase 125,000 shares of common stock for proceeds of $6,250,
      1,898,973 warrants expired, 3,500,000 warrants were exercised utilizing the
      cashless method of exercise for 2,536,942 shares, and we repurchased 7,000,000
      warrants for $2,760,900 under terms of our warrant repurchase agreement as
      detailed below.





In
      connection with a previous debt agreement, the Company entered into an
      Antidilution Agreement (the “Antidilution Agreement”) with Swartz Private
      Equity, LLC (“Swartz”) wherein the Company was obligated to issue to Swartz
      warrants equal to 11% of the common stock issued between January 28, 2002 and
      March 11, 2002, 20% of the common stock issued between March 12, 2002 and April
      1, 2003, and after April 1, 2003, 30% of the common stock issued to any parties
      other than Swartz.  There were no warrants issued during the three
      month period ended August 31, 2006 in connection with the Antidilution
      agreement, nor were warrants issued during September 2006 in connection with
      the
      Antidilution agreement. On October 10, 2006, the Company entered into an
      Approval Rights Agreement and Termination of Antidilution Agreement and Addendum
      to Warrants (the “Termination Agreement”) with Swartz to terminate the
      Antidilution Agreement.  In consideration for entering into the
      Termination Agreement, the Company agreed that through May 31, 2008 it would
      obtain Swartz’s written approval at least 30 days prior to entering into (i) any
      acquisition of any business entity or asset of any kind where the aggregate
      number of shares of common stock and derivative securities (on a fully diluted
      basis) issued as consideration for the acquisition equals or exceeds 10% of
      the
      number of shares of common stock of the Company outstanding at the time of
      the
      acquisition (on a fully diluted basis) or (ii) any acquisition (regardless
      of
      size) by the Company of any business entity or asset of any kind that is not
      unanimously approved by the Company’s board of directors.





On
      July
      19, 2007, we entered into a warrant redemption agreement with Lincoln Ventures,
      LLC, whereby at our option, we agreed to redeem certain warrants representing
      the right to acquire an aggregate of up to 7,000,000 shares of our common stock,
      through October 2007. The warrants were redeemable in quantities not to exceed
      2,000,000 warrants in the first two calendar months and 3,000,000 in the last
      calendar month, at a price equal to the product of (a) the volume weighted
      average of the daily volume weighted average prices of our common stock for
      all
      trading days in the applicable calendar month, minus the exercise price of
      the
      warrant, multiplied by (b) the number of shares being redeemed from that
      warrant. Lincoln Ventures, LLC was prohibited from exercising any of the
      warrants as long as we remained in compliance with the agreement. Additionally,
      Lincoln Ventures, LLC was prohibited from purchasing any shares of our common
      stock on the open market during any “pricing month” defined in the agreement as
      the calendar month immediately preceding the calendar month in which we deliver
      the redemption notice to Lincoln Ventures, LLC.  As of November 30,
      2007, we repurchased all of the additional warrants pursuant to the
      agreement.


17




Patriot
      Scientific
      Corporation


Notes
      to Unaudited Condensed
      Consolidated Financial Statements





8.  Commitments
      and
      Contingencies





Litigation





Lowell
      Giffhorn
      Arbitration





On
      September 23, 2005, Lowell Giffhorn, a former executive officer
      and a former director of the Company, submitted a demand for arbitration with
      the American Arbitration Association related to the termination of
      Mr. Giffhorn's employment with the Company. Mr. Giffhorn asserted that
      the termination of his employment with the Company was unlawful, retaliatory,
      wrongful, violated public policy, violated the covenant of good faith and fair
      dealing and violated securities laws. Mr. Giffhorn sought damages of
      approximately $4,500,000 (excluding claims for punitive damages and attorney’s
      fees). On November 1, 2007, the Company and Mr. Giffhorn reached a settlement
      where Mr. Giffhorn was given $500,000 and 200,000 shares of restricted Company
      stock in exchange for a comprehensive release of all claims against the
      Company.  We have recorded these costs in selling, general and
      administrative expenses for the three and six months ended November 30,
      2007.





Patent
      Litigation





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




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





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





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





A
      Claims
      Construction Hearing was held May 3, 2007 in The United States District Court
      for the Eastern District of Texas. On June 15, 2007, the court handed down
      claims construction of the patents-in-suit, the ‘336, ‘148 and ‘584 patents.
      Based on the claims construction ruling, TPL/Patriot  proceeded with
      discovery with respect to the ‘336 and ‘148 patents. However, based on the
      claims construction ruling as to the ‘584 patent claims of “instruction groups”,
      TPL/Patriot announced on August 8, 2007, a Stipulation with ARM intended to
      expedite an appeal of that claims construction. The Stipulation was a
      declaration of non-infringement by the accused ARM products with respect to
      the
‘584 patent.  A notice of appeal to the Federal Circuit was filed with
      respect to the ARM Stipulation and the District Court’s claims construction with
      respect to the ‘584 patent.


18




Patriot
      Scientific
      Corporation


Notes
      to Unaudited Condensed
      Consolidated Financial Statements





Commitments
      and Contingencies,
      continued





On
      December 18, 2007 all remaining parties to the litigation announced that a
      resolution was reached in the patent infringement lawsuits.  The terms
      of the settlement included the grant by TPL of rights under the Moore
      Microprocessor Patent Portfolio to NEC Electronics America, Toshiba, Matsushita
      and JVC and their respective subsidiaries in the form of license
      agreements.  The parties have agreed that the details of the
      settlement are confidential.





401(k)
      Plan





We
      have a
      retirement plan that complies with Section 401(k) of the Internal Revenue Code.
      All employees are eligible to participate in the plan. We match 50% of each
      participant’s voluntary contributions, subject to a maximum contribution of 6%
      of the participant’s compensation. Participants vest 33% per year over a three
      year period in our contributions. Our matching contributions during the six
      months ended November 30, 2007 and 2006 were $3,388 and $5,607,
      respectively.





Employment
      Contracts





In
      connection with Mr. Turley’s appointment as President and Chief Executive
      Officer, and commencing on June 5, 2007, we entered into an employment
      agreement with Mr. Turley for a one-year term.  Pursuant to the
      agreement, if Mr. Turley is terminated without cause, he is entitled to his
      then
      current salary level for the remaining term of his agreement conditional upon
      the execution of a general release.




In
      connection with Mr. Flowers’ appointment as the Chief Financial Officer,
      and commencing on September 17, 2007, we entered into an employment
      agreement with Mr. Flowers for an initial 120-day term if not terminated
      pursuant to the agreement, with an extension period of one year and on a
      continuing basis thereafter.  Pursuant to the agreement, if
      Mr. Flowers is terminated without cause or resigns with good reason within
      the first two years of employment, he is entitled to receive an amount equal
      to
      his annual base salary for the greater of (i) 6 months or (ii) the
      period remaining in the extended one-year term.  If Mr. Flowers
      is terminated without cause or resigns with good reason any time after two
      years
      of continuous employment, he is entitled to receive an amount equal to 12 months
      of his annual base salary.  Mr. Flowers is also entitled to
      certain payments upon a change of control of the Company if the surviving
      corporation does not retain him. All such payments are conditional upon the
      execution of a general release.





Guarantees
      and
      Indemnities





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





Operating
      Leases





We
      have a
      non-cancelable operating lease agreement for our Carlsbad, California office
      facility. Future minimum lease payments required under the operating lease
      are
      $48,447 and $73,710 in fiscal years ended 2008 and 2009,
      respectively.


19


Patriot
        Scientific
        Corporation
 Notes
        to Unaudited Condensed
        Consolidated Financial Statements


Commitments
      and Contingencies,
      continued





SSDI
      subleases their Carlsbad, California office facility which was amended to extend
      through June 2008 with a month-to-month option until no later than December
      2008. Future minimum lease payments required under the operating lease are
      $44,324 and $7,351 in fiscal years ended 2008 and 2009,
      respectively.





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





Earn-Out
      Agreement





SSDI
      entered into an earn-out agreement with a former debt holder of Holocom
      Networks, Inc. (“Holocom Networks”) upon our contribution of the foreclosure
      sale collateral of Holocom Networks to SSDI in fiscal 2007. The agreement
      required the former debt holder to release all of his rights to any Holocom
      Networks collateral in exchange for receiving 3% of the net sales (defined
      as
      cash revenues actually received less credits or discounts and other claims
      of
      customers) of SSDI’s protected distribution system products for a period of 48
      months from the foreclosure sale date of February 2, 2007. The earn-out is
      to be
      paid each calendar quarter.  A liability for payment under this
      agreement of $9,032 is included in accrued expenses in the accompanying
      condensed consolidated balance sheet at November 30, 2007.





9.
      Segment
      Information





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





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





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





Operating
      segment net revenue, operating loss and income (loss) before taxes for the
      three
      and six months ended November 30, 2007 and 2006 were as follows:





Three
                Months Ended
            
            
            Six
                Months EndedNovember
                30, 2007
            
            
            November
                30, 2006
            
            
            November
                30, 2007
            
            
            November
                30, 2006Net
                revenue:SSDI
            
            $
            933,280
            
            
            $
            -
            
            
            $
            1,445,144
            
            
            $
            -All
                other
            
            
            12,550
            
            
            
            18,500
            
            
            
            22,055
            
            
            
            44,875Total
                net revenue
            
            $
            945,830
            
            
            $
            18,500
            
            
            $
            1,467,199
            
            
            $
            44,875Operating
                income (loss):SSDI
            
            $
            120,587
            
            
            $
            -
            
            
            $
            (25,042
            )
            
            $
            -All
                other
            
            
            (1,906,118
            )
            
            
            (8,017,922
            )
            
            
            (3,378,845
            )
            
            
            (10,724,071
            )Total
                operating loss
            
            $
            (1,785,531
            )
            
            $
            (8,017,922
            )
            
            $
            (3,403,887
            )
            
            $
            (10,724,071
            )Income
                (loss) before taxes:SSDI
            
            $
            119,299
            
            
            $
            -
            
            
            $
            124,048
            
            
            $
            -All
                other
            
            
            3,881,351
            
            
            
            (1,161,998
            )
            
            
            1,681,647
            
            
            
            8,328,275Total
                income (loss) before taxes
            
            $
            4,000,650
            
            
            $
            (1,161,998
            )
            
            $
            1,805,695
            
            
            $
            8,328,275


20




Patriot
      Scientific
      Corporation


Notes
      to Unaudited Condensed
      Consolidated Financial Statements





Segment
      Information,
      continued





All
      sales
      were to unaffiliated customers within the United States. During the six months
      ended November 30, 2007, one customer accounted for 51% of SSDI’s sales and this
      same customer accounted for 27% of SSDI’s accounts receivable at November 30,
      2007.  Another customer accounted for 17% of SSDI’s sales and this
      same customer accounted for 29% of SSDI’s accounts receivable at November 30,
      2007.





Operating
      segment total assets and depreciation and amortization as of and for the six
      months ended November 30, 2007 and 2006 were as follows:





2007
            
            
            2006Depreciation
                and amortization:SSDI
            
            $
            8,525
            
            
            $
            -All
                other
            
            
            14,390
            
            
            
            21,288Total
                depreciation and amortization
            
            $
            22,915
            
            
            $
            21,288




2007
            
            
            2006Total
                assets:SSDI
            
            $
            1,011,498
            
            
            $
            -All
                other
            
            
            21,668,506
            
            
            
            23,750,911Total
                assets
            
            $
            22,680,004
            
            
            $
            23,750,911




10.  Subsequent
      Events





On
      December 11, 2007 the interest rate on our line of credit with SSDI decreased
      to
      7.25% in accordance with the change in the prime interest rate.





On
      December 18, 2007 we received payment from Phoenix Digital Solutions for the
      amount shown as receivable from affiliated company on our November 30, 2007
      consolidated balance sheet.





On
      December 18, 2007 all remaining parties to the litigation announced that a
      resolution was reached in the patent infringement lawsuits.  The terms
      of the settlement included the grant by TPL of rights under the Moore
      Microprocessor Patent Portfolio to NEC Electronics America, Toshiba, Matsushita
      and JVC and their respective subsidiaries in the form of license
      agreements.  The parties have agreed that the details of the
      settlement are confidential.





21




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





THE
      FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO OUR
      FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE
      CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A VARIETY
      OF
      FACTORS, INCLUDING THOSE DESCRIBED BELOW UNDER THE SUB-HEADING, "RISK FACTORS"
      SEE ALSO OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED MAY 31,
      2007.





Overview





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





During
      the fiscal year ended May 31, 2006, we finalized an agreement for the
      licensing of our technology with Intel Corporation. During the fiscal years
      ended May 31, 2006 and 2007, TPL entered into licensing agreements with
      Hewlett-Packard, Fujitsu, Casio, Nikkon, Sony, Seiko Epson, Pentax, Olympus,
      Kenwood, Agilent Technologies, Schneider Electric, Lexmark, NEC, Funai Electric,
      SanDisk, Sharp and Nokia operating through our joint venture entity, Phoenix
      Digital Solutions, LLC (“PDS”).  During the six months ended November
      30, 2007, TPL entered into licensing agreements with Bull, Lego Systems, DMP
      Electronics, Denso Wave, Bossiere (Schneider) and Philips. We believe that
      these
      agreements represent validation of our position that our intellectual property
      was and is being infringed by major manufacturers and users of microprocessor
      technology.





Critical
      Accounting Policies and
      Estimates





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




1.           Revenue
      Recognition





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





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





22




2.           Assessment
      of Contingent Liabilities





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





3.           Stock
      Options and Warrants




On
      June
      1, 2006, we adopted the provisions of SFAS No. 123(R), Share-Based Payment, which
      establishes standards for the accounting of transactions in which an entity
      exchanges its equity instruments for goods or services, primarily focusing
      on
      accounting for transactions where an entity obtains employee services in
      share-based payment transactions. SFAS No. 123(R) requires a public entity
      to measure the cost of employee services received in exchange for an award
      of
      equity instruments, including stock options, based on the grant-date fair value
      of the award and to recognize it as compensation expense over the period the
      employee is required to provide service in exchange for the award, usually
      the
      vesting period.  Stock-based awards to non-employees are accounted for
      using the fair value method in accordance with SFAS No. 123, Accounting for Stock Based
      Compensation.




In
      November 2005, FASB issued FASB Staff Position No. FAS 123R-3, “Transition Election Related
      to
      Accounting for Tax Effects of Share-Based Payment Awards”
      (“FAS123R-3”).  We have elected to adopt the alternative transition
      method provided in FAS 123R-3.  The alternative transition method
      includes a simplified method to establish the beginning balance of the
      additional paid-in capital pool (“APIC pool”) related to the tax effects of
      employee share-based compensation, which is available to absorb tax deficiencies
      recognized subsequent to the adoption of SFAS No. 123(R).




Stock-based
      compensation expense recognized during the period is based on the value of
      the
      portion of share-based payment awards that is ultimately expected to vest during
      the period. Stock-based compensation expense recognized in our condensed
      consolidated statement of operations for the six months ended November 30,
      2006
      included compensation expense for share-based payment awards granted prior
      to,
      but not yet vested as of May 31, 2006 based on the grant date fair value
      estimated in accordance with the pro forma provisions of SFAS No. 123 and
      compensation expense for the share-based payment awards granted subsequent
      to
      May 31, 2006 based on the grant date fair value estimated in accordance
      with the provisions of SFAS No. 123(R). Stock-based compensation expense
      recognized in our condensed consolidated statement of operations for the six
      months ended November 30, 2007 included compensation expense for share-based
      payment awards granted subsequent to May 31, 2007 based on the grant date
      fair value estimated in accordance with the provisions of SFAS No. 123(R).
      As
      stock-based compensation expense recognized in the condensed consolidated
      statements of operations is based on awards ultimately expected to vest, it
      has
      been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures
      to
      be estimated at the time of grant and revised, if necessary, in subsequent
      periods if actual forfeitures differ from those estimates. The estimated average
      forfeiture rate for the six months ended November 30, 2007 and 2006, of
      approximately 5% was based on historical forfeiture experience and estimated
      future employee forfeitures.




Employee
      stock-based compensation expense recognized under SFAS No. 123(R) for the
      six months ended November 30, 2007 and 2006 was $346,134 and $1,770,000,
      respectively, as determined by the Black-Scholes valuation model.





4.           Patents
      and Trademarks





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


23




5.           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.





6.
            Investment
                in Affiliated Company





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





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





7.        
       Variable Interest Entity





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





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





Results
      of
      Operations





Comparison
      of the Six Months Ended
      November 30, 2007 and Six Months Ended November 30, 2006.





Our
      revenues increased from approximately $45,000 for the six months ended November
      30, 2006 to approximately $1,467,000 for the six months ended November 30,
      2007.
      Our revenue amounts do not include income of approximately $18,745,000 from
      our
      investment in Phoenix Digital Solutions, LLC for the six months ended November
      30, 2006, or income of approximately $4,285,000 from our investment in Phoenix
      Digital Solutions, LLC for the six  months ended November 30,
      2007.  During the six months ended November 30, 2007 we recorded sales
      amounting to approximately $1,445,000 by our consolidated variable interest
      entity, SSDI, with cost of sales amounting to approximately $508,000. During
      the
      six months ended November 30, 2006 and 2007, we recognized maintenance fee
      revenues totaling approximately $12,500 and $12,500 in connection with an
      agreement with AMD Corporation during the 2005 fiscal year. The agreement called
      for maintenance fees totaling $100,000 connected with a license agreement for
      our Ignite technology; the license fee revenue is being recognized as revenue
      evenly over the four year period of the license. In addition during the six
      months ended November 30, 2007, we recorded sales of approximately $9,600 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.  During the six months ended November 30, 2006, we recorded
      sales of approximately $32,000 relating to the microprocessor
      chips.


24





Selling,
      general and administrative expenses decreased from approximately $4,469,000
      for
      the six months ended November 30, 2006 to approximately $3,945,000 for the
      six
      months ended November 30, 2007.  Legal expenses increased by
      approximately $63,000 for the six months ended November 30, 2007 compared with
      the six months ended November 30, 2006 and accounting expenses decreased by
      approximately $228,000 for the six months ended November 30, 2007 compared
      with
      the six months ended November 30, 2006 the decrease was primarily due to
      restatement expenses incurred during the six months ended November 30, 2006.
      Salary costs and related expenses included non-cash expenses associated with
      the
      fair value of options granted during the period in accordance with SFAS No.
      123R.  During the six months ended November 30, 2007, options were
      granted to our newly-appointed chief executive officer and chief financial
      officer pursuant to terms of their employment contracts, those option grants
      plus the related vesting on the grants resulted in non-cash compensation expense
      of approximately $233,000.  On August 16, 2007 options were granted to
      certain employees and a newly-appointed director resulting in non-cash
      compensation of approximately $113,000.  During the six months ended
      November 30, 2006, 1,500,000 options were granted to our then chief executive
      officer resulting in a non-cash compensation expense amounting to approximately
      $1,527,000 and options were granted to employees resulting in non-cash
      compensation of approximately $184,000.  Board of director fees
      amounting to approximately $212,000 were paid during the six months ended
      November 30, 2007 as compared to $150,000 paid for the six months ended November
      30, 2006.  Other salary expenses increased by approximately $632,000
      for the six months ended November 30, 2007 as compared with the six months
      ended
      November 30, 2006 including approximately $595,000 in salaries and related
      expenses for SSDI during the six months ended November 30, 2007. Salary expenses
      for the parent company including wages, payroll taxes, employee benefits and
      expenses connected with 401(k) employer matching increased by approximately
      $38,000 during the six months ended November 30, 2007 as compared with the
      six
      months ended November 30, 2006.  Travel and related expenses for the
      six months ended November 30, 2007 increased by approximately $99,000 due to
      expenses for SSDI being combined with the parent company.  Consulting
      expenses increased by approximately $33,000 for the six months ended November
      30, 2007 as compared to the six months ended November 30, 2006 due to one time
      fees for evaluations of our various technologies and expenses associated with
      our production of materials for the upcoming litigation.  Offsetting
      the increases in selling, general and administrative expenses for the six months
      ended November 30, 2007 as compared to the six months ended November 30, 2006,
      were decreases amounting to approximately $85,000 for public relations
      expenses.





Settlement
      and license expenses amounting to $419,000 were recorded for the six months
      ended November 30, 2007 relating to royalties payable resulting from an
      agreement with Fish (see Note 4 to our condensed consolidated financial
      statements for more information).  For the six months ended November
      30, 2006, $6,300,000 was recorded related to the Fish agreement.





Our
      other
      income and expenses for the six months ended November 30, 2007 and 2006 included
      equity in the earnings of PDS. The investment is accounted for in accordance
      with the equity method of accounting for investments. Our investment in PDS
      for
      the six months ended November 30, 2007  provided net income after
      expenses in the amount of approximately $4,285,000 as compared to net income
      after expenses of $18,745,000 for the six months ended November 30, 2006.Total other income and
      expense for the six  months ended November 30, 2007 amounted to net
      other income of approximately $5,210,000 compared with total other income and
      expense for the six months ended November 30, 2006 of net other income amounting
      to approximately $19,052,000. Interest income and other income increased from
      approximately $308,000 for the six months ended November 30, 2006 to
      approximately $776,000 for the six months ended November 30, 2007 as interest
      bearing account balances increased from cash received as distributions from
      our
      investment in PDS and we recognized other income of approximately $227,000
      in
      connection with our reimbursement request billings to PDS for our prior period
      legal expenses incurred in connection with the patent
      litigation.  During the six months ended November 30, 2007, SSDI
      recognized $150,000 of other income in connection with the sale of a portion
      of
      its interest in Holocom MultiDomain Computers, LLC, now known as DataSecurus,
      LLC.


25





During
      the six months ended November 30, 2006, we recorded a provision for income
      taxes
      of $4,220,000 related to federal and California taxes.  During the six
      months ended November 30, 2007, we recorded a provision for income taxes of
      approximately $1,351,000 related to federal and California
      taxes.  Also, during the quarters ended November 30, 2006, and
      November 30, 2007, we utilized approximately $34,300,000 and $5,600,000,
      respectively, of our available federal net operating loss
      carry-forwards.  At November 30, 2007 we have utilized all of our
      remaining available federal net operating loss
      carry-forwards.   At May 31, 2007, we had utilized all of our
      state net operating loss carry-forwards of approximately
      $17,822,000.





We
      recorded net income for the six months ended November 30, 2006 of $4,108,275
      compared with net income of $454,150 for the six months ended November 30,
      2007.





Comparison
      of the Three Months Ended
      November 30, 2007 and Three Months Ended November 30, 2006.





Our
      revenues increased from approximately $19,000 for the three months ended
      November 30, 2006 to approximately $946,000 for the three months ended November
      30, 2007. Our revenue amounts do not include income of approximately $6,675,000
      from our investment in Phoenix Digital Solutions, LLC (“PDS”)for the three
      months ended November 30, 2006, or income of approximately $5,486,000 from
      our
      investment in Phoenix Digital Solutions, LLC for the three months ended November
      30, 2007.  During the three months ended November 30, 2007 we recorded
      sales amounting to approximately $933,000 by our consolidated variable interest
      entity, SSDI, with cost of sales amounting to approximately $356,000. During
      the
      three months ended November 30, 2006 and 2007, we recognized maintenance fee
      revenues totaling approximately $6,250 and $6,250 in connection with an
      agreement with AMD Corporation during the 2005 fiscal year. The agreement called
      for maintenance fees totaling $100,000 connected with a license agreement for
      our Ignite technology; the license fee revenue is being recognized as revenue
      evenly over the four year period of the license. In addition during the three
      months ended November 30, 2007, we recorded sales of approximately $6,300 from
      the sale of microprocessor chips that we no longer market. Inventory associated
      with the sales of these microprocessor chips is carried at zero
      value.  During the three months ended November 30, 2006, we recorded
      sales of approximately $12,250 relating to the microprocessor
      chips.





Selling,
      general and administrative expenses increased from approximately $1,736,000
      for
      the three months ended November 30, 2006 to approximately $1,986,000 for the
      three months ended November 30, 2007.  Legal expenses increased by
      approximately $190,000 for the three months ended November 30, 2007 compared
      with the three months ended November 30, 2006 and accounting expenses decreased
      by approximately $298,000 for the three months ended November 30, 2007 compared
      with the three months ended November 30, 2006.  The decrease was
      primarily due to restatement expenses incurred during the three months ended
      November 30, 2006. Salary costs and related expenses included non-cash expenses
      associated with the fair value of options granted during the period in
      accordance with SFAS No. 123R.  During the three months ended November
      30, 2007, options were granted to our newly-appointed chief financial officer
      pursuant to terms of his employment contract, those option grants plus the
      related vesting on the grants resulted in non-cash compensation expense of
      approximately $38,000.  During the three months ended November 30,
      2006, options were granted to employees resulting in non-cash compensation
      of
      approximately $184,000.  Board of director fees amounting to
      approximately $114,000 were paid during the three months ended November 30,
      2007
      as compared to $90,000 paid for the three months ended November 30,
      2006.  Other salary expenses increased by approximately $261,000 for
      the three months ended November 30, 2007 as compared with the three months
      ended
      November 30, 2006 including approximately $288,000 in salaries and related
      expenses for SSDI during the three months ended November 30, 2007. Salary
      expenses for the parent company including wages, payroll taxes, employee
      benefits and expenses connected with 401(k) employer matching decreased by
      approximately $27,000 during the three months ended November 30, 2007 as
      compared with the three months ended November 30, 2006.  Travel and
      related expenses for the three months ended November 30, 2007 increased by
      approximately $56,000, an increase of approximately $9,000 for the parent
      company and an increase of $47,000 for SSDI.


26




Settlement
      and license expenses amounting to $389,000 were recorded for the three months
      ended November 30, 2007 relating to royalties payable resulting from an
      agreement with Fish (see Note 4 to our condensed consolidated financial
      statements for more information).  For the three months ended November
      30, 2006, $6,300,000 was recorded related to the Fish agreement.





Our
      other
      income and expenses for the three months ended November 30, 2007 and 2006
      included equity in the earnings of PDS. The investment is accounted for in
      accordance with the equity method of accounting for investments. Our investment
      in PDS for the three months ended November 30, 2007  provided net
      income after expenses in the amount of approximately $5,486,000 as compared
      to
      net income after expenses of $6,675,000 for the three months ended November
      30,
      2006.Total other
      income and expense for the three months ended November 30, 2007 amounted to
      net
      other income of approximately $5,786,000 compared with total other income and
      expense for the three months ended November 30, 2006 of net other income
      amounting to approximately $6,856,000. Interest income and other income
      increased from approximately $181,000 for the three months ended November 30,
      2006 to approximately $301,000 for the three months ended November 30, 2007
      as
      interest bearing account balances increased from cash received as distributions
      from our investment in PDS.





Liquidity
      and Capital
      Resources





Liquidity





Our
      cash,
      marketable securities and short-term investment balances decreased from
      approximately $25,955,000 as of May 31, 2007 to approximately $20,206,000 as
      of
      November 30, 2007. We also have restricted cash balances amounting to
      approximately $102,000 as of May 31, 2007 and approximately $50,000 as of
      November 30, 2007. Total current assets decreased from approximately $31,399,000
      as of May 31, 2007 to approximately $22,559,000 as of November 30, 2007. Total
      current liabilities amounted to approximately $2,021,000 and approximately
      $6,115,000 as of May 31, 2007 and November 30, 2007, respectively. The change
      in
      our current position as of November 30, 2007 as compared with May 31, 2007
      results in part from our utilization of cash to repurchase warrants and to
      purchase treasury stock, which amounted to $5,804,000, while not receiving
      cash
      distributions from PDS during the three months ended August 31,
      2007.  Additionally, during the six months ended November 30, 2007, we
      utilized our remaining federal net operating losses for income tax purposes,
      resulting in a current tax liability of approximately $5,447,000 and causing
      our
      prepaid income taxes and deferred tax assets at May 31, 2007 to be reclassified
      to the current tax liability.  Total cash paid for income taxes during
      the six months ended November 30, 2007 was $3,958,000.  We also used
      $500,000 for the settlement of arbitration with  a former executive
      officer and director of the Company.





Cash
      Flows From Operating
      Activities





Cash
      used
      in operating activities for the six months ended November 30, 2007 was
      approximately $7,836,000 as compared with cash used in operating activities
      for
      the six months ended November 30, 2006 of approximately $2,949,000. The
      principal components of the current period amount were: net income of
      approximately $454,000, change in refundable income taxes of approximately
      $2,071,000 and a change in income  taxes payable of approximately
      $5,447,000.  These increases were partially offset by: equity in
      earnings of PDS of $4,285,000, change in deferred taxes of approximately
      $10,098,000, and changes in accounts payable and accrued expenses of
      approximately $1,352,000.





Cash
      Flows From Investing
      Activities





Cash
      used
      in investing activities was approximately $408,000 for the six months ended
      November 30, 2007 as compared to cash provided by investing activities of
      approximately $14,609,000 for the six months ended November 30, 2006. The
      decrease was primarily due to a reduction of distributions received from our
      investment in affiliate from $15,099,000 in 2006 to $7,738,000 in
      2007.  Cash used during the six months ended November 30, 2007 also
      included $8,281,000 in net purchases of short-term investments and purchases
      of
      fixed assets of approximately $18,000.  The cash used during the six
      months ended November 30, 2007 was partially offset by proceeds of $100,000
      received  by SSDI for the sale of a membership interest in
      DataSecurus, LLC and proceeds of $52,500 received from collateral accounts
      held
      on former officers’ credit cards that were cancelled.


27




Cash
      Flows From Financing
      Activities





Cash
      used
      in financing activities for the six months ended November 30, 2007 was
      approximately $5,786,000 as compared to approximately $3,927,000 for the six
      months ended November 30, 2006 primarily due to payments of approximately
      $3,043,000 to repurchase shares of our common stock for treasury and warrant
      repurchases of approximately $2,761,000 for the six months ended November 30,
      2007. The cash used during the six months ended November 30, 2007 was partially
      offset by cash received of approximately $18,000 from the exercise of common
      stock options and warrants.





Capital
      Resources





Our
      current position as of November 30, 2007 is expected to provide the funds
      necessary to support our operations through at least the next twelve
      months.





Contractual
      Obligations and
      Committments





A
      summary
      of our outstanding contractual obligations at November 30, 2007 is as
      follows:




Contractual
              Cash
                Obligations
            
            Total
              Amounts
              Committed
            
            
            1-3
              YearsOperating
                leases - facilities
            
            $
            176,082
            
            
            $
            176,082





Recent
      Accounting
      Pronouncements





In
      July
      2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty
      in Income
      Taxes - an interpretation of FASB Statement No. 109 (“FIN 48”). This
      interpretation clarifies the application of SFAS No. 109, Accounting for Income Taxes,
      by defining criteria that an individual tax position must meet for any part
      of
      the benefit of that position to be recognized in a company’s financial
      statements and also provides guidance on measurement, derecognition,
      classification, interest and penalties, accounting in interim periods,
      disclosure and transition.  We adopted FIN 48 on June 1, 2007 and did
      not record any cumulative effect adjustment to retained earnings as a result
      of
      adopting FIN 48.  Interest and penalties, if any, related to
      unrecognized tax benefits are recorded in income tax expense.  As of
      June 1, 2007, we are subject to U.S. Federal income tax examinations for the
      tax
      years May 31, 1991 through May 31, 2007, and we are subject to state and local
      income tax examinations for the tax years May 31, 1999 through May 31, 2007
      due
      to the carryover of net operating losses from prior years.





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


28





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





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





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





Risk
      Factors





We
      urge
      you to carefully consider the following discussion of risks as well as other
      information regarding our common stock. We believe the following to be our
      most
      significant risk factors as of the date this report is being filed. The risks
      and uncertainties described below are not the only ones we face.





We
      Have Reported Substantial Income
      In 2006 and 2007 Which May Not Be Indicative Of Our Future
      Income





During
      fiscal 2007 and 2006, we entered into license agreements, directly and through
      our joint venture with Technology Properties Limited. Because of the uncertain
      nature of the negotiations that lead to license revenues, pending litigation
      with companies which we allege have infringed on our patent portfolio, the
      possibility of legislative action regarding patent rights, and the possible
      effect of new judicial interpretation of patent laws, we cannot predict the
      amount of future revenues from such agreements, or whether there will be future
      revenues from license agreements at all.





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





In
      June
      of 2005, we entered into a joint venture with Technology Properties Limited,
      pursuant to which Technology Properties Limited is responsible for the licensing
      and enforcement of our microprocessor patent portfolio. This joint venture
      has
      been the source of virtually all of our income since June of 2005. Therefore,
      in
      light of the absence of significant revenue from other sources, we should be
      regarded as entirely dependent on the success or failure of the licensing and
      prosecution efforts of Technology Properties Limited on behalf of the joint
      venture. Sales of our microprocessor products and data security products have
      resulted in limited revenues. Our other product lines are no longer being
      actively marketed, and also only generate limited and sporadic
      sales.


29




Our
      Limited Sales And
      Marketing Capabilities Have
      Affected Our
      Revenue





We
      currently have limited marketing capabilities and may need to hire additional
      sales and marketing personnel. We may not be able to recruit, train, or retain
      qualified personnel to sell and market our products. We also may not be able
      to
      develop a successful sales and marketing strategy. We also have very limited
      marketing experience. Any marketing efforts we undertake may not be successful
      and may not result in any significant sales of our products.





We
      May Experience Difficulties In The
      Completion Of Our Development Stage Products





Our
      technologies and products are in various stages of development. We do not
      currently have in-house development personnel, nor have we retained independent
      researchers. Therefore, our development stage products may not be completed
      on a
      timely basis or at all. Additionally, even if we do recommence our development
      activities, our development stage products may not be completed due to the
      inherent risks of new product and technology development, limitations on
      financing, competition, obsolescence, the absence or loss of key personnel
      and
      other factors. Although we have licensed some of our technology at its current
      stage of development, we may not continue to be able to do so and any revenues
      generated from licensing may not be sufficient to support operations at their
      current level. Also, unanticipated technical obstacles can arise at any time
      and
      result in lengthy and costly delays or in a determination that further
      development is not feasible.





Changes
      In Our Relationships With
      Companies In Which We Hold Less Than A Majority Interest Could Change The Way
      We
      Account For Such Interests In The Future.





We
      hold a
      minority interest in a company (Scripps Secured Data, Inc.) to which we provide
      financing. Under the applicable provisions of accounting principles generally
      accepted in the United States of America, including FIN 46(R), we currently
      consolidate the financial statements and results of operations of this company
      into our consolidated financial statements and results of operations, and record
      the equity interest that we do not own as a minority interest. For our other
      investment (Phoenix Digital Solutions, LLC), accounted for under the equity
      method, we record as part of other income or expense our share of the increase
      or decrease in the equity of the company in which we have invested. It is
      possible that, in the future, our relationships and/or our interests in or
      with
      this consolidated entity and equity method investee could change. Such potential
      future changes could result in deconsolidation or consolidation of such
      entities, as the case may be, which could result in changes in our reported
      results.





We
      Have Settled A Legal Dispute Which
      Could Affect Our Future Results Of Operations And Working Capital
      Position





We
      were
      sued by a co-inventor of the technology underlying our microprocessor patent
      portfolio with regard to proceeds we received as a consequence of recently
      signed license agreements. On February 14, 2007, we finalized a settlement
      of
      this litigation. This settlement required us to pay the co-inventor $6,400,000
      and requires us to pay up to $2,000,000 from the proceeds we receive from future
      licensing transactions. As of the date of this filing, we have paid $1,582,000
      of the $2,000,000 obligation for future licensing transaction proceeds required
      under the settlement agreement. These payments have resulted, and will result,
      in a reduction of our net income in the current fiscal year and future quarters
      until our obligations under the settlement have been fulfilled.


30


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





A
      successful challenge to our ownership of our technology or the proprietary
      nature of our intellectual property would materially damage our business
      prospects. We rely on a combination of patents, trademarks, copyrights, trade
      secret laws, confidentiality procedures and licensing arrangements to protect
      our intellectual property rights. We currently have 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 increase the
      cost of our products or delay or preclude new product development and
      commercialization by us, and limit future license revenue. If infringement
      claims against us are deemed valid or if our infringement claims are
      successfully opposed, we may not be able to obtain appropriate licenses on
      acceptable terms or at all. Litigation could be costly and time-consuming but
      may be necessary to protect our future patent and/or technology license
      positions or to defend against infringement claims.  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
      would have a very significant and adverse effect on our business.





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





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





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





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





Our
      common stock is currently listed for trading in the National Association of
      Securities Dealers (“NASD”) Over-The-Counter Bulletin (“OTC”) Board Market and
      is subject to the “penny stock rules” adopted pursuant to Section 15(g) of the
      Exchange Act. In general, the penny stock rules apply to non-NASDAQ or
      non-national stock exchange companies whose common stock trades at less than
      $5.00 per share or which have tangible net worth of less than $5,000,000
      ($2,000,000 if the company has been operating for three or more years). Such
      rules require, among other things, that brokers who trade “penny stock” on
      behalf of persons other than “established customers” complete certain
      documentation, make suitability inquiries of investors and provide investors
      with certain information concerning trading in the security, including a risk
      disclosure document, quote information, broker’s commission information and
      rights and remedies available to investors in penny stocks. Many brokers have
      decided not to trade “penny stock” because of the requirements of the penny
      stock rules, and as a result, the number of broker-dealers willing to act as
      market makers in such securities is limited. The “penny stock rules,” therefore,
      may have an adverse impact on the market for our common stock and may affect
      our
      ability to raise additional capital if we decide to do so.


31





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





Our
      exposure to market risk for changes in interest rates relates primarily to
      our
      short-term investments.  At November 30, 2007 approximately $7.5
      million of our short-term investment balance consisted of
      auction  rate securities.  The auction rate securities are
      adjustable-rate securities with interest rates that are reset periodically
      by
      bidders through Dutch auctions generally conducted every 7 to 90 days by a
      trust
      company or broker/dealer on behalf of the issuer.  We believe these
      securities are highly liquid investments through the related auctions; however,
      the collateralizing securities have long-term maturities.  All of our
      auction rate securities are rated AAA by Moody’s, Fitch and S & P
      ratings.  Our short-term investments are intended to establish a
      high-quality portfolio that preserves principal, meets liquidity needs, avoids
      inappropriate concentrations and delivers an appropriate yield in relationship
      to our investment guidelines.





Item
      4. Controls and
      Procedures





Evaluation
      of Disclosure Controls
      and Procedures




As
      required by Rule 13a-15(e) under the Exchange Act, as of November 30,
      2007, the end of the period to which this quarterly report relates, we have
      carried out an evaluation of the effectiveness of the design and operation
      of
      our disclosure controls and procedures.  This evaluation was carried
      out under the supervision and with the participation of our management,
      including our Chief Executive Officer and our Chief Financial
      Officer.




Disclosure
      controls and procedures are controls and other procedures that are designed
      to
      ensure that information required to be disclosed in our report filed or
      submitted under the Exchange Act is recorded, processed, summarized and
      reported, within the time periods specified in the Securities and Exchange
      Commission’s rules and forms.  Disclosure controls and procedures
      include, without limitation, controls and procedures designed to ensure that
      information required to be disclosed in our reports filed under the Exchange
      Act
      is accumulated and communicated to management, including the Chief Executive
      Officer and Chief Financial Officer as appropriate, to allow timely decisions
      regarding required disclosure. Management recognizes that any controls and
      procedures, no matter how well designed and operated, can provide only
      reasonable assurance of achieving their objectives, and management necessarily
      applies its judgment in evaluating the cost-benefit relationship of possible
      controls and procedures.  Based on the evaluation of our disclosure
      controls and procedures as of November 30, 2007, our Chief Executive
      Officer and Chief Financial Officer concluded that, as of such date, our
      disclosure controls and procedures were effective.




32




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





On
      December 18, 2007 all remaining parties to the litigation announced that a
      resolution was reached in the patent infringement lawsuits.  The terms
      of the settlement included the grant by TPL of rights under the Moore
      Microprocessor Patent Portfolio to NEC Electronics America, Toshiba, Matsushita
      and JVC and their respective subsidiaries in the form of license
      agreements.  The parties have agreed that the details of the
      settlement are confidential.





The
      Company had been in arbitration with Lowell Giffhorn, a former executive
      officer and a former director of the Company over matters related to the
      termination of Mr. Giffhorn's employment with the
      Company.   On November 1, 2007, the Company and Mr. Giffhorn
      reached a settlement where Mr. Giffhorn was given $500,000 and 200,000 shares
      of
      restricted Company stock in exchange for a comprehensive release of all claims
      against the Company.





Item
      1A. Risk
      Factors





No
      material changes from the risk factors contained in our 10-K for the year ended
      May 31, 2007.  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 737,181 shares of our
      common stock at an aggregate cost of $317,128 during the three months ended
      November 30, 2007.





Following
      is a summary of all repurchases by the Company of its common stock during the
      three month period ended November 30, 2007:





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, 2007
            
            368,960
            $
            0.40
            368,960October
                1 – 31, 2007
            
            368,221
            $
            0.46
            368,221November
                1 – 30, 2007
            
            -
            $
            -
            -Total
            
            737,181
            $
            0.43
            737,181





On
      November 5, 2007 we issued 200,000 shares of our common stock to a former
      officer in connection with  a legal settlement.





Item
      3. Defaults Upon Senior
      Securities





None.


33




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





At
      our
      fiscal 2007 Annual Meeting of Shareholders held on October 23, 2007, the
      following individuals were elected to the Board of Directors of the Company:
      David H. Pohl, Carlton M. Johnson, Jr., Helmut Falk, Jr., Gloria H. Felcyn,
      James L. Turley, and Harry L. Tredennick.





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




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




Votes
                For
            
            Votes
                Against
            
            Votes
                Abstaining299,939,156
            
            2,296,488
            
            8,814,305





2.
            Election
                of Directors:





Director
            
            Votes
                For
            
            Votes
                Abstaining
              and/or
                AgainstDavid
                H. Pohl
            
            292,817,894
            
            18,232,056Carlton
                M. Johnson, Jr.
            
            291,285,030
            
            19,764,920Helmut
                Falk, Jr.
            
            292,352,425
            
            18,697,525Gloria
                H. Felcyn
            
            292,268,984
            
            18,780,966James
                L. Turley
            
            300,843,675
            
            10,206,275Harry
                L. Tredennick
            
            300,916,854
            
            10,133,096





Item
      5. Other
      Information





None.





Item
      6. Exhibits





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




Exhibit No.
            Document2.1
            Agreement
                to Exchange Technology for Stock in the Company, incorporated by
                reference
                to Exhibit 2.1 to Form 8-K dated August 10, 1989 (Commission
                file No. 33-23143-FW)2.2
            Assets
                Purchase Agreement and Plan of Reorganization dated June 22, 1994,
                among the Company, nanoTronics Corporation and Helmut Falk, incorporated
                by reference to Exhibit 10.4 to Form 8-K dated July 6, 1994
                (Commission file No. 000-22182)2.2.1
            Amendment
                to Development Agreement dated April 23, 1996 between the Company and
                Sierra Systems, incorporated by reference to Exhibit 2.2.1 to
                Pre-Effective Amendment No. 1 to Registration Statement on Form SB-2
                filed April 29, 1996 (Commission file No. 333-01765)


34





2.3
            Form
                of Exchange Offer dated December 4, 1996 between the Company and
                certain shareholders of Metacomp, Inc., incorporated by reference
                to
                Exhibit 2.3 to Form 8-K filed January 9, 1997 (Commission file
                No. 000-22182)2.4
            Letter
                of Transmittal to Accompany Shares of Common Stock of Metacomp, Inc.
                Tendered Pursuant to the Exchange Offer Dated December 4, 1996,
                incorporated by reference to Exhibit 2.4 to Form 8-K filed
                January 9, 1997 (Commission file No. 000-22182)3.1
            Original
                Articles of incorporation of the Company’s predecessor, Patriot
                Financial Corporation, incorporated by reference to Exhibit 3.1 to
                registration statement on Form S-18, (Commission file No.
                33-23143-FW)3.2
            Articles of
                Amendment of Patriot Financial Corporation, as filed with the Colorado
                Secretary of State on July 21, 1988, incorporated by reference to
                Exhibit 3.2 to registration statement on Form S-18, (Commission file
                No. 33-23143-FW)3.3
            Certificate
                of Incorporation of the Company, as filed with the Delaware Secretary
                of
                State on March 24, 1992, incorporated by reference to
                Exhibit 3.3 to Form 8-K dated May 12, 1992 (Commission file No.
                33-23143-FW)3.3.1
            Certificate
                of Amendment to the Certificate of Incorporation of the Company,
                as filed
                with the Delaware Secretary of State on April 18, 1995, incorporated
                by reference to Exhibit 3.3.1 to Form 10-KSB for the fiscal year
                ended May 31, 1995 (Commission file No. 000-22182)3.3.2
            Certificate
                of Amendment to the Certificate of Incorporation of the Company,
                as filed
                with the Delaware Secretary of State on June 24, 1997, incorporated
                by reference to Exhibit 3.3.2 to Form 10-KSB for the fiscal year
                ended May 31, 1997, filed July 18, 1997 (Commission file No.
                000-22182)3.3.3
            Certificate
                of Amendment to the Certificate of Incorporation of the Company,
                as filed with the Delaware Secretary of State on April 28, 2000,
                incorporated by reference to Exhibit 3.3.3 to Registration Statement
                on Form S-3 filed May 5, 2000 (Commission file No.
                333-36418)3.3.4
            Certificate
                of Amendment to the Certificate of Incorporation of the Company,
                as filed
                with the Delaware Secretary of State on May 6, 2002, incorporated by
                reference to Exhibit 3.3.4 to Registration Statement on Form S-3
                filed June 27, 2002 (Commission file No. 333-91352)3.3.5
            Certificate
                of Amendment to the Certificate of Incorporation of the Company,
                as filed
                with the Delaware Secretary of State on October 16, 2003,
                incorporated by reference to Exhibit 3.3.5 to Registration Statement
                on Form SB-2 filed May 21, 2004 (Commission file No.
                333-115752)3.4
            Articles and
                Certificate of Merger of Patriot Financial Corporation into the Company
                dated May 1, 1992, with Agreement and Plan of Merger
                attachedthereto
                as Exhibit A, incorporated by reference to Exhibit 3.4 to Form
                8-K dated May 12, 1992 (Commission file No. 33-23143-FW)3.5
            Certificate
                of Merger issued by the Delaware Secretary of State on May 8, 1992,
                incorporated by reference to Exhibit 3.5 to Form 8-K
                datedMay 12, 1992 (Commission file No.
                33-23143-FW)


35





3.6
            Certificate
                of Merger issued by the Colorado Secretary of State on May 12, 1992,
                incorporated by reference to Exhibit 3.6 to Form 8-K dated
                May 12, 1992 (Commission file No. 33-23143-FW)3.7
            Bylaws
                of the Company, incorporated by reference to Exhibit 3.7 to Form 8-K
                dated May 12, 1992 (Commission file No. 33-23143-FW)4.1
            Specimen
                common stock certificate, incorporated by reference to Exhibit 4.1
                Form 8-K dated May 12, 1992 (Commission file No.
                33-23143-FW)





4.2
            1996
                Stock Option Plan of the Company dated March 25, 1996 and approved by
                the Shareholders on May 17, 1996, incorporated by reference to
                Exhibit 10.13 to Pre-Effective Amendment No. 2 to Registration
                Statement on Form SB-2 filed May 23, 1996 (Commission file No.
                333-01765)4.3
            2001
                Stock Option Plan of the Company dated February 21, 2001 incorporated
                by reference to Exhibit 4.19 to Registration Statement on Form S-8
                filed March 26, 2001 (Commission file No. 333-57602)4.4
            2003
                Stock Option Plan of the Company dated July 2, 2003 incorporated by
                reference to Exhibit 4.27 to Registration Statement on Form S-8 filed
                September 4, 2003 (Commission file No. 333-108489)4.5
            2006
                Stock Option Plan of the Company dated March 31, 2006 incorporated by
                reference to Exhibit 4.19 to Registration Statement on Form S-8 filed
                June 20, 2006 (Commission file No. 333-135156)4.6
            Approval
                Rights Agreement and Termination of Antidilution Agreement and Addendum
                to
                Warrants dated October 10, 2006, incorporated by reference to
                Exhibit 4.29 to Form 10-KSB for the fiscal year ended May 31,
                2006, filed on October 13, 2006 (Commission file No.
                000-22182)10.1
            Employment
                Agreement dated June 5, 2007 by and between the Company and James
                Turley,
                incorporated by reference to Exhibit 10.1 to Form 8-K filed June
                8, 2007
                (Commission file No. 000-22182)10.2
            Employment
                Agreement dated September 17, 2007 by and between the Company and
                Clifford
                Flowers, incorporated by reference to Exhibit 10.1 to Form 8-K filed
                September 19, 2007 (Commission file No. 000-22182)31.1*
            Certification
                of James L. Turley, CEO, pursuant to Rule
                13a–14(a)/15d–14(a)31.2*
            Certification
                of Clifford L. Flowers, CFO, pursuant to Rule
                13a–14(a)/15d–14(a)32.1*
            Certification
                of James L. Turley, CEO, pursuant to Section 1350 of Chapter 63 of
                Title 18 of the United States Code32.2*
            Certification
                of Clifford L. Flowers, CFO, pursuant to Section 1350 of Chapter
                63 of
                Title 18 of the United States
                Code


36


SIGNATURES




Pursuant
      to the requirements of the Securities Exchange Act of 1934, the registrant
      has
      duly caused this report to be signed on its behalf by the undersigned thereunto
      duly authorized.






DATED:  January 9,
                2008
            PATRIOT
                SCIENTIFIC CORPORATION
              
              
              /S/
                JAMES L.
                TURLEY
              James
                L. Turley
              Chief
                Executive Officer





In
      accordance with the Exchange Act, this report has been signed below by the
      following persons on behalf of the registrant and in the capacities and on
      the
      dates indicated.




Signature
            Title
            Date/S/
                JAMES L.
                TURLEY
              James
                L. Turley
            President,
                Chief Executive Officer, and Director
            January
                9, 2008/S/
                CLIFFORD L.
                FLOWERS
              Clifford
                L. Flowers
            Chief
                Financial Officer and Principal Accounting Officer
            January 9,
                2008/S/
                DAVID H.
                POHL
              David
                H. Pohl
            Chairman
            January 9,
                2008/S/
                CARLTON M.
                JOHNSON
              Carlton
                M. Johnson
            Director
            January 9,
                2008/S/
                GLORIA H.
                FELCYN
              Gloria
                H. Felcyn
            Director
            January 9,
                2008/S/
                HELMUT FALK,
                JR.
              Helmut
                Falk, Jr.
            Director
            January 9,
                2008/S/
                HARRY L.
                TREDENNICK
              Harry
                L. Tredennick
            Director
            January 9,
                2008




37