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 August 31, 2010
  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)
 
 (Registrant’s telephone number, including area code): (760) 547-2700
 
 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x   NO o
  Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES o   NO o
  Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
  Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
Smaller reporting company o(do not check if smaller reporting company)
  Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o   No x
  On October 8, 2010, 408,157,768 shares of common stock, par value $0.00001 per share were outstanding.
  
 
  INDEX
  PagePART I. FINANCIAL INFORMATIONITEM 1. Financial StatementsCondensed consolidated Balance Sheets as of August 31, 2010 (unaudited) and May 31, 2010
3Condensed consolidated Statements of Operations for the three months ended August 31, 2010 and August 31, 2009 (unaudited)
4Condensed consolidated Statements of Cash Flows for the three months ended August 31, 2010 and August 31, 2009 (unaudited)
5Notes to condensed consolidated Financial Statements (unaudited)
6-26ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
27-37ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
37-38ITEM 4. Controls and Procedures
38PART II. OTHER INFORMATIONITEM 1. Legal Proceedings
39ITEM 1A. Risk Factors
39ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
39-40ITEM 3. Defaults Upon Senior Securities
40ITEM 4. Removed and Reserved
40ITEM 5. Other Information
40ITEM 6. Exhibits
40-41SIGNATURES
42
 
 
 
    
 2
 
 PART I- FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 Patriot Scientific Corporation
 Condensed Consolidated Balance Sheets
 
 August 31, 2010


May 31, 2010ASSETS

(Unaudited)Current assets:Cash and cash equivalents

$
9,507,050


$
10,340,110Restricted cash and cash equivalents


20,732



20,705Current portion of marketable securities


4,557,590



12,105Accounts receivable


156,000



149,504Accounts receivable - affiliated company


37,848



7,010Notes receivable, net


62,500



1,116,382Work-in-process


-



136,637Prepaid income taxes


928,670



930,272Current portion of deferred tax assets


440,718



472,707Prepaid expenses and other current assets


193,834



231,718Total current assets


15,904,942



13,417,150Marketable securities, net of current portion


-



5,133,835Property and equipment, net


30,855



37,099Goodwill


642,981



642,981Other intangible assets, net


1,653,333



1,722,222Deferred tax assets, net of current portion


7,104,912



5,911,732Other assets


87,695



43,033Investment in affiliated company


-



507,629Total assets

$
25,424,718


$
27,415,681LIABILITIES AND STOCKHOLDERS’ EQUITYCurrent liabilities:Accounts payable

$
293,192


$
493,519Accrued expenses and other


170,165



292,004Deferred revenue


69,202



156,084Current portion of long-term debt, including accrued interest


2,638,740



-Total current liabilities


3,171,299



941,607Distributions in excess of  investment in affiliated company


652,074



-Long-term debt, including accrued interest, net of current portion


-



3,122,144Total long-term liabilities


652,074



3,122,144Total liabilities


3,823,373



4,063,751Commitments and contingenciesStockholders’ equity:Preferred stock, $0.00001 par value; 5,000,000 shares authorized: none outstanding


-



-Common stock, $0.00001 par value: 600,000,000 shares authorized: 438,167,618 shares issued and 408,372,771 shares outstanding at August 31, 2010 and 438,167,618 shares issued and 408,821,071 shares outstanding at May 31, 2010


4,381



4,381Additional paid-in capital


77,297,579



77,241,227Accumulated deficit


(41,562,068
)


(39,561,669
)Common stock held in treasury, at cost – 29,794,847 shares and 29,346,547 shares at August 31, 2010 and May 31, 2010,  respectively


(14,138,547
)


(14,085,015
)Accumulated other comprehensive loss


-



(246,994
)Total stockholders’ equity


21,601,345



23,351,930Total liabilities and stockholders’ equity

$
25,424,718


$
27,415,681
 
 See accompanying notes to unaudited condensed consolidated financial statements.
 
 3
 
 Patriot Scientific Corporation
 Condensed Consolidated Statements of Operations
 (Unaudited)
 
 Three months endedAugust 31, 2010


August 31, 2009Revenues:License and service revenue

$
94,055


$
97,035Cost of sales:License and service revenue


23,415



31,983Amortization of purchased intangibles


68,889



206,688Total cost of sales


92,304



238,671Gross profit (loss)


1,751



(141,636
)Operating expenses:Research and development


230,484



314,197Selling, general and administrative


1,355,769



1,927,795Total operating expenses


1,586,253



2,241,992Operating loss


(1,584,502
)


(2,383,628
)Other income (expense):Interest and other income


18,299



42,928Interest expense


(16,597
)


(20,640
)Impairment of investment in affiliated company


-



(680,292
)Gain on sale of Vigilys business line


60,000



-Realized loss on sale of marketable securities


(648,740
)


-Equity in loss of affiliated companies


(1,159,703
)


(264,558
)Total other expense, net


(1,746,741
)


(922,562
)Loss before income taxes


(3,331,243
)


(3,306,190
)Benefit for income taxes


(1,330,844
)


(1,321,111
)Net loss

$
(2,000,399
)

$
(1,985,079
)Basic loss per common share

$
-


$
-Diluted loss per common share

$
-


$
-Weighted average number of common shares outstanding - basic


405,739,165



407,484,967Weighted average number of common shares outstanding - diluted


405,739,165



407,484,967
 
 See accompanying notes to unaudited condensed consolidated financial statements
   4
 
 Patriot Scientific Corporation
 Condensed Consolidated Statements of Cash Flows
 (Unaudited)
  Three months endedAugust 31, 2010


August 31, 2009Operating activities:Net loss

$
(2,000,399
)

$
(1,985,079
)Adjustments to reconcile net loss to net cash used in operating activities:Amortization and depreciation


75,133



222,402Share-based compensation relating to issuance of stock options


58,434



38,212Accrued interest income added to investments and notes receivable


(11,740
)


(701
)Equity in loss of affiliated companies


1,159,703



264,558Realized loss on sale of marketable securities


648,740



-Gain on sale of Vigilys business line


(60,000
)


-Impairment of investment in affiliated company


-



680,292Deferred income taxes


(1,330,362
)


(1,400,295
)Changes in operating assets and liabilities:Accounts receivable


(6,496
)


43,354Receivable from affiliated company


(30,838
)


2,122Work-in-process


136,637



(61,786
)Prepaid expenses and other assets


53,222



36,332Prepaid income taxes


1,602



79,184Accounts payable and accrued expenses


(305,570
)


(214,259
)Deferred revenue


(86,882
)


(2,237
)Net cash used in operating activities


(1,698,816
)


(2,297,901
)Investing activities:Proceeds from sales of marketable securities


355,775



787,546Purchases of property and equipment


-



(67,295
)Repayment of note receivable


1,065,595



-Issuance of note receivable


-



(55,000
)Investments in affiliated companies


-



(32,500
)Distributions from affiliated company


-



3,666,828Net cash provided by investing activities


1,421,370



4,299,579Financing activities:Repurchase of common stock for treasury


(53,532
)


(5,513
)Tax effect of expiration/cancellation/exercise of stock options


(2,082
)


-Payment on note payable


(500,000
)


-Net cash used in financing activities


(555,614
)


(5,513
)Net (decrease) increase in cash and cash equivalents


(833,060
)


1,996,165Cash and cash equivalents, beginning of period


10,340,110



6,206,868Cash and cash equivalents, end of period

$
9,507,050


$
8,203,033Supplemental Disclosure of Cash Flow Information:Cash payments for interest

$
121,184


$
-Cash payments for income taxes

$
-


$
-Supplemental Disclosure of  Non-Cash Investing and Financing Activities:Unrealized recovery on investments in marketable securities charged to other comprehensive income adjusted for deferred tax benefit

$
-


$
(164,823
)Reversal of unrealized loss charged to other comprehensive income at May 31, 2010 adjusted for deferred tax benefit due to recognition of loss in current period

$
246,994


$
-
 
 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”, “PTSC”, “Patriot”, “we”, “us” or “our”) presented herein have been prepared pursuant to the rules of the Securities and Exchange Commission (“SEC”) for quarterly reports on Form 10-Q and do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America. These financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto included in our Report on Form 10-K for our fiscal year ended May 31, 2010.
 
 In the opinion of management, the interim condensed consolidated financial statements reflect all adjustments of a normal recurring nature necessary for a fair presentation of the results for the interim period presented.  Operating results for the three month period ended August 31, 2010 are not necessarily indicative of the results that may be expected for the year ending May 31, 2011.
 
 Basis of Consolidation
 
 The condensed consolidated balance sheet at August 31, 2010 includes our accounts and those of our wholly owned subsidiary Patriot Data Solutions Group, Inc. (“PDSG”) which includes Crossflo Systems, Inc. (“Crossflo”), and our inactive subsidiary Plasma Scientific Corporation.  All significant intercompany accounts and transactions have been eliminated.  In August 2010, we sold the Vigilys business line.
 
 The condensed consolidated balance sheet at May 31, 2010 includes our accounts and those of our wholly owned subsidiary PDSG which includes Crossflo, the business line of Vigilys and our inactive subsidiary Plasma Scientific Corporation.  All significant intercompany accounts and transactions have been eliminated.  In January 2010, we sold the assets of Verras Medical, Inc.
 
 The condensed consolidated statement of operations for the three months ended August 31, 2010 includes our accounts, and those of our wholly owned subsidiary PDSG which includes Crossflo, the business line of Vigilys (until August 2010) and our inactive subsidiary Plasma Scientific Corporation.  All significant intercompany accounts and transactions have been eliminated.
 
 The condensed consolidated statement of operations for the three months ended August 31, 2009 includes our accounts, and those of our wholly owned subsidiary PDSG which includes Crossflo, the assets of Verras Medical, Inc., the business line of Vigilys and our inactive subsidiary Plasma Scientific Corporation.  All significant intercompany accounts and transactions have been eliminated.
 
 Investments in Marketable Securities
 
 We determine the appropriate classification of our investments at the time of purchase and reevaluate such designation at each balance sheet date.  Our investments in marketable securities have been classified and accounted for as available-for-sale based on management’s investment intentions relating to these securities.  Available-for-sale marketable securities are stated at fair market value.  Unrealized gains and losses, net of deferred taxes, are recorded as a component of other comprehensive income (loss).  We follow the authoritative guidance to assess whether our investments with unrealized loss positions are other than temporarily impaired.  Realized gains and losses and declines in value judged to be other than temporary are determined based on the specific identification method and are reported in other expense, net in the condensed consolidated statements of operations.
 
 6
  Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
 
 Investments in Affiliated Companies
 
 We have a 50% interest in Phoenix Digital Solutions, LLC (“PDS”) (see Note 8). 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 which is presented in the condensed consolidated statements of operations in the caption “Equity in loss of affiliated companies” and also is adjusted by contributions to and distributions from PDS.
 
 Effective June 1, 2010, we adopted new authoritative guidance for consolidation of variable interest entities.  The adoption of this guidance did not have a material effect on our condensed consolidated financial statements.
 
 We had a 39.4% interest in Talis (see Note 8).  Prior to the write-off of our investment in Talis during the quarter ended August 31, 2009, we were accounting for our investment using the equity method of accounting.  Under the equity method of accounting, the investment, originally recorded at cost, was adjusted to recognize our share of net earnings or losses of the investee and was presented in the consolidated statements of operations in the caption “Equity in loss of affiliated companies”  In December 2009,  Talis was dissolved.
  We own 100% of the preferred stock of Holocom (see Note 8). During the year ended May 31, 2010, we wrote off our investment in the preferred stock of Holocom of approximately $435,000.  Prior to impairment, this investment was accounted for at cost since we did not have the ability to exercise significant influence over the operating and financial policies of Holocom.
  We review our investments in these affiliated companies to determine whether events or changes in circumstances indicate that the carrying amounts may not be recoverable. The primary factors we consider in our determination are the financial condition, operating performance and near term prospects of the investees. If the decline in value is deemed to be other than temporary, we would recognize an impairment loss.
 
 The inability of Talis to meet its business plan and to raise capital and the general economic environment were indicators of impairment on our investment; accordingly, at August 31, 2009, management determined that our investment in Talis was impaired by approximately $680,000.  We have recorded this as an impairment of investment in affiliated company on our condensed consolidated statement of operations for the three months ended August 31, 2009.
 
 Comprehensive Income (Loss)
 
 Comprehensive income (loss) includes unrealized gains and losses which are excluded from the condensed consolidated statements of operations.
 
 Revenue Recognition
 
 Revenue from technology license agreements is recognized at the time a contract is entered into, the license method is determined (paid-in-advance or on-going royalty), and the customer is provided with the licensed technology, if applicable.
  7
 Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
 
 Revenue Recognition (continued)
 
 PDSG sells software and services to end users primarily through relationships with systems integrators and prime contractors.  PDSG recognizes revenue in accordance with authoritative guidance for the software industry.  PDSG’s revenue is derived primarily from the following sources: (i) software licensing, (ii) related professional services, and (iii) post contract customer support (“PCS”) agreements.  PCS agreements typically include software updates, on a when and if available basis, telephone and Internet access to technical support personnel. Software updates provide customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period.
 
 PDSG’s contracts with customers, including systems integrators and prime contractors, are multiple element arrangements which contain professional services that are considered essential to the functionality of the other elements of the arrangement.  PDSG accounts for revenue on these arrangements according to authoritative guidance for contract accounting. Under this guidance, PDSG recognizes revenue based on progress towards contract completion measured by actual hours incurred in relation to the estimate of total expected hours. PDSG measures these revenues by applying the contract-specific estimated percentage of completion to the total contract amount for software and professional services.  PDSG routinely updates the estimates of future hours for agreements in process and reports any cumulative effects of such adjustments in current operations. PDSG immediately recognizes any loss expected on these contracts when it is projected that loss is probable.
 
 On June 1, 2010 we adopted new authoritative guidance on a prospective basis for revenue arrangements containing multiple deliverables.  This guidance requires us to allocate PDSG’s revenues to all deliverables based on their relative selling price using a specific hierarchy.  The hierarchy is as follows:  vendor-specific objective evidence (“VSOE”), third-party evidence of selling price (“TPE”) or best estimate of selling price (“BESP”).
 
 When a sale involves multiple elements, PDSG allocates the entire fee from the arrangement to each respective element based on VSOE of fair value and recognizes revenue when each element’s revenue recognition criteria are met. VSOE of fair value for each element is established based on the price charged when the same element is sold separately.  PDSG has established VSOE for its CDX software licenses and PCS based on historical stand-alone sales to third parties or from the stated renewal rates contained in the customer contracts.  PCS is recognized on a straight-line basis over the support period.
 
 PDSG has not yet demonstrated VSOE for the professional services that are rendered in conjunction with its software license sales.  In accordance with the hierarchy we would attempt to establish the selling price of professional services using TPE.  PDSG’s product contains significant differentiation such that the comparable pricing of products with similar functionality cannot be obtained.  PDSG is typically not able to obtain TPE for professional services.
 
 When we are unable to establish selling prices using VSOE or TPE, we use BESP.  The objective of BESP is to determine the price at which PDSG would transact a sale if professional services were sold on a stand-alone basis.  BESP is generally used for offerings that are not typically sold on a stand-alone basis or for highly customized offerings which is the case with PDSG’s professional services deliverable.
 
 Due to the fact that the majority of PDSG’s contracts require significant customization of software, we are recognizing revenue for the CDX software licenses and professional services over the customization period using contract accounting which reflects continuous release of control of the software to the customer. The adoption of this guidance did not have a material effect on our condensed consolidated financial statements.
 
 8
 Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
  Research and Development
 
 Research and development costs are expensed as incurred and primarily include payroll and related benefit costs and contractor fees.
 
 Earnings Per Share
 
 Basic earnings (loss) per share includes no dilution and is computed by dividing income (loss) available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings (loss) per share reflects the potential dilution of securities that could share in the earnings (loss) of  an entity.
  As a result of our net loss for the three months ended August 31, 2010 and 2009, we have excluded certain equity-based instruments from the diluted loss per share calculation as their inclusion would have had an anti-dilutive effect. Had we reported net income for this period, an additional 779,994 and 970,000 shares of common stock, respectively, would have been included in the number of shares used to calculate diluted earnings per share for the three months ended August 31, 2010 and 2009. Options and warrants in the amount of approximately 5.7 million shares and 10.8 million shares of common stock were excluded from the computation of diluted shares for the three months ended August 31, 2010 and 2009, respectively, as their inclusion would have had an anti-dilutive effect.
 
 In connection with our acquisition of Crossflo, which is now a part of  PDSG, we issued escrow shares that are contingent upon certain representations and warranties made by Crossflo at the time of the merger agreement (see Note 11).  We exclude these escrow shares from the basic earnings (loss) per share calculations and include the escrowed shares in the diluted earnings per share calculations.
 
 Share-Based Compensation
 
 Share-based compensation expense recognized during the three months ended August 31, 2010 and 2009 is based on the grant date fair value of the portion of share-based payment awards ultimately expected to vest during the year.  As share-based compensation expense recognized in the condensed consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures.  Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.  Forfeiture rates are based on historical forfeiture experience and estimated future employee forfeitures.
 
 2. Goodwill and Other Intangible Assets
 
 Goodwill originating from acquisitions is not amortized and is tested for impairment on an annual basis and between annual tests based on certain circumstances.
 
 Purchased intangible assets were being amortized over a period of 9 months to 10 years.  After impairment, the technology of PDSG is currently being amortized over 81 months.
  9
  Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
  Goodwill and Other Intangible Assets (continued)
 The following table presents details of our other intangible assets and related accumulated amortization balances, which were recorded as a result of business combinations and asset purchases:
  Estimated











Net Carrying

ValueLife in


Allocated


Accumulated





August 31,Years


Value


Amortization


Impairment


2010Technologies and processes


6.75


$
1,860,000


$
(206,667
)

$
-


$
1,653,333
 
 
 Estimated











Net Carrying

ValueLife in


Allocated


Accumulated





May 31,Years


Value


Amortization


Impairment


2010Customer contracts –open orders


0.75


$
63,600


$
(63,600
)


-


$
-Customer relationships


5.00



65,000



(11,064
)


(53,936
)


-Maintenance agreements


4.00



75,400



(23,565
)


(51,835
)


-Trademarks/names


10.00



124,500



(11,972
)


(112,528
)


-Technologies and processes


5.00–8.00



6,136,900



(1,102,714
)


(3,311,964
)


1,722,222$
6,465,400


$
(1,212,915
)


(3,530,263
)

$
1,722,222
 
 Management’s plan of restructuring on October 5, 2009 and the continuing inability of PDSG to meet its business plan were indicators of potential impairment on our intangible assets. Accordingly, during the fiscal year ended May 31, 2010, it was determined that intangibles were impaired by approximately $3,530,000.  We have recorded this as an impairment of purchased intangibles on our consolidated statement of operations for the fiscal year ended May 31, 2010.
 
 The amortization expense related to intangible assets was as follows:
 
 Three Months

Ended


Three Months

EndedAugust 31, 2010


August 31, 2009Amortization of intangible assets included in:Cost of sales

$
68,889


$
206,688Selling, general and administrative expense


-



-Total

$
68,889


$
206,688
 
 
  10
 
 Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
  Goodwill and Other Intangible Assets (continued)
 
 At August 31, 2010 the estimated future amortization expense of intangible assets is estimated to be as follows:
 
 Year2011 (remaining nine months)

$
206,6672012


275,5562013


275,5562014


275,5562015


275,556Thereafter


344,442Total expected future amortization

$
1,653,333
 
 Changes in the net carrying amount of goodwill are as follows:
 
 Balance, June 1, 2009

$
1,739,249Impairment of Verras goodwill


(196,512
)Impairment of Vigilys goodwill


(110,004
)Impairment of Crossflo goodwill


(789,752
)Balance May 31, 2010


642,981Balance August 31, 2010

$
642,981
 
 The inability of PDSG to meet its business plan and the general economic environment were indicators of potential impairment on our goodwill at May 31, 2010; accordingly, it was determined that goodwill was impaired by approximately $1,096,000.  We recorded this as an impairment of goodwill on our consolidated statement of operations for the fiscal years ended May 31, 2010.
 
 At August 31, 2010 the carrying amount of goodwill is $642,981.
 
 3. Cash and Cash Equivalents
 
 We consider all highly liquid investments with original maturities of three months or less to be cash equivalents.
 
 Restricted cash and cash equivalents at August 31, 2010 and May 31, 2010 consist of a savings account required to be held as collateral for our corporate credit card.
 
 4.  Investments in Marketable Securities
 
 At August 31, 2010, our current portion of marketable securities in the amount of $4,557,590 includes accrued interest receivable of $6,330 on our auction rate securities (“ARS”) which is receivable semi-annually according to the terms specified in each ARS instrument.  This value is reported at cost, which approximates fair market value.  The amount also consists of the par value of our ARS of approximately $5.2 million adjusted for realized loss of $648,740 at August 31, 2010.  We have reclassified our ARS as adjusted for realized loss to short term based on terms of our confidential settlement agreement with Deutsche Bank  (see Note 11). On September 29, 2010 we received the ARS proceeds from Deutsche Bank under terms of the agreement (see Note 13).
  11
  Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
 
 Investments in Marketable Securities (continued)
 
 At May 31, 2010, our current portion of marketable securities in the amount of $12,105 includes accrued interest receivable on our auction rate securities which is receivable semi-annually according to the terms specified in each auction rate security instrument.  This value is reported at cost, which approximates fair market value.
 
 We follow authoritative guidanceto account for our financial assets and liabilities at fair value.  Under this authoritative guidance we are required to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. We determine fair value based on quoted prices when available or through the use of alternative approaches, such as discounting the expected cash flows using market interest rates commensurate with the credit quality and duration of the investment or valuations by third party professionals. The three levels of inputs that we may use to measure fair value are:
 
 Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
 
 Level 2: Quoted prices in markets that are not active or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability; and
 
 Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported by little or no market activity).
 
 The following table represents our financial instruments subject to fair value measurement and the valuation approach applied to each class of security:
 
 Quoted Prices in

Active Markets

Level 1


Significant

Other

Observable

Inputs

Level 2


Significant

Unobservable

Inputs

Level 3


Balance as of

August 31, 2010Auction rate securities

$
—


$
—


$
4,551,260


$
4,551,260
 
 
 
 
 
 
 
 12
 
 Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
 
 Investments in Marketable Securities (continued)
 
 For those financial instruments with significant Level 3 inputs, the following table summarizes the activity for the period by investment type for the three months ended August 31, 2010:
 
 Fair Value MeasurementsUsing

Significant

Unobservable Inputs (Level 3)Description

Auction

Rate

Securities


TotalBeginning balance

$
5,133,835


$
5,133,835Transfers in to Level 3


—



—Total realized/unrealized recovery (losses):Realized loss included in earnings


(648,740
)


(648,740
)Reversal of unrealized losses included in other comprehensive income (loss)


416,165



416,165Settlements


(350,000
)


(350,000
)Ending balance at August 31, 2010

$
4,551,260


$
4,551,260Settlements


(4,551,260
)


(4,551,260
)Ending balance as of the date of this filing

$
-


$
-Total amount of unrealized losses for the three months ended August 31, 2010 included in accumulated other comprehensive loss (before taxes) attributable to the change in fair market value relating to assets still held at the reporting date

$
-


$
-
 
 All realized gains or losses related to financial instruments whose fair value is determined based on Level 3 inputs are included in other income. All unrealized gains or losses related to financial instruments whose fair value is determined based on Level 3 inputs are included in other comprehensive income (loss).
 
 At August 31, 2010 the  Level 3 fair value of our ARS consists of the par value of approximately $5.2 million adjusted for realized loss of $648,740, recorded as “Realized loss on sale of marketable securities” in the accompanying condensed consolidated statement of operations at August 31, 2010.
 
 The following table summarizes unrealized losses on our investments in marketable securities based on an independent third-party valuation at May 31, 2010:
 
 As of May 31, 2010Amortized

Cost


Gross

Unrealized

Losses


Estimated

Fair

ValueShort-termAccrued interest - auction rate securities

$
12,105


$
—


$
12,105Long-termAuction rate securities


5,550,000



(416,165
)


5,133,835Total

$
5,562,105


$
(416,165
)

$
5,145,940
    13
  Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
  Investments in Marketable Securities (continued)
  At May 31, 2010, we held four investments that were in an unrealized loss position.  The following table presents the amortized cost and fair value of our investments in marketable securities classified as available-for-sale at May 31, 2010 by contractual maturity:
  May 31, 2010Amortized

Cost

Fair

ValueMaturityGreater than two years

$
5,550,000


$
5,133,835
 
 As of August 31, 2010 and May 31, 2010, we held auction rate securities with a par value totaling approximately $5.2 and $5.6 million, respectively, which failed to sell at auction.  In the event we needed to access funds invested in these auction rate securities we would not have been able to liquidate these securities until (i) a future auction of these securities was successful, (ii) they were refinanced and redeemed by the issuers, or (iii) a buyer was found outside of the auction process.  The investments consisted of student loan auction rate instruments issued by various state agencies pursuant to the Federal Family Educational Loan Program (“FFELP”).  These instruments were insured by the various state educational agencies and were guaranteed by the Department of Education as an insurer of last resort.  We had the intent and the ability to hold these investments until the anticipated recovery period.
 
 As a result of temporary declines in the fair value of our auction rate securities, which we attribute to liquidity issues rather than credit issues, we recorded an unrealized loss of $246,994 in other comprehensive loss at May 31, 2010 which represented the gross valuation adjustment of $416,165, net of the related tax benefit of $169,171.
 
 Due to the uncertainty surrounding the timing of a market recovery, we classified our auction rate securities as long- term investments in our condensed consolidated balance sheet as of May 31, 2010.
  During September 2010, we reached a confidential settlement agreement with Deutsche Bank (see Note 11).  Under terms of the agreement, we transferred approximately $5.2 million in illiquid  auction rate securities instruments to Deutsche Bank for a substantial portion of the face value of the securities, and if the instruments are redeemed by a certain date then we will receive the full face amount of the instruments.  On October 4, 2010, we received proceeds from Deutsche Bank of $4,557,590 (see Note 13).
 
 During June 2008, we obtained a credit facility for as long as needed, which provided for financing up to 50% of the par value balance of our outstanding auction rate securities on that date. The facility was collateralized by the full value of the outstanding auction rate securities, required no origination fee, and bore interest at the federal funds rate plus 3% (see Note 9).  On September 20, 2010 we paid $2,642,954, which consisted of the balance on the credit facility at August 31, 2010 plus interest through September 20, 2010.
 
 5. Accounts Receivable
 
 Trade accounts receivable at August 31, 2010 and May 31, 2010 is $156,000 and $149,504, respectively, which relates entirely to PDSG. No allowance for doubtful accounts has been recorded at August 31, 2010 or May 31, 2010.
 
    14
  Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
  Accounts Receivable (continued)
 
 At August 31, 2010 and May 31, 2010, accounts receivable from our investee PDS was $37,848 and $7,010, respectively.  These balances represent reimbursements we submit to PDS for our legal and related costs incurred in various legal matters of which we are listed as co-defendant with Technology Properties Limited (“TPL”).
 
 6. Notes Receivable
 
 Technology Properties Limited, LLC
 
 On December 24, 2009, we entered into a secured note receivable with TPL for $950,000, intended to cover its operating costs including the furtherance of Moore Microprocessor Patent (“MMP”) portfolio licensing, which was due and payable on or before July 12, 2010.  Terms of the note required interest payable at the rate of 10%.  The note was secured by TPL’s portion of its license receivable distribution accounted for as license fees receivable on the May 31, 2010 balance sheet of PDS (see Note 8).  At May 31, 2010 the balance of the note receivable was $991,382, including accrued interest receivable of $41,382.  The note named both TPL and PDS individually both jointly and severally liable to pay us.  Accordingly, on July 15, 2010, PDS paid us $1,003,095 which included the principal balance of the note plus interest of $53,095 through July 15, 2010.
 
 On January 12, 2010, we entered into an unsecured note receivable with TPL for $1,000,000, intended to cover its operating costs including the furtherance of MMP portfolio licensing, which was due and payable on or before February 28, 2010.  Terms of the note requires interest payable at the rate of 10%.  As of the date of this filing, TPL is in default (see Note 11).  During the third quarter of fiscal 2010, the $1,013,151 balance of the note receivable including accrued interest through February 28, 2010, was fully reserved for.
 
 Index for Clinical Excellence, Ltd.
 
 On January 25, 2010, the assets of Verras were sold for $250,000.  At closing we received $62,500 and a non-interest bearing promissory note for $187,500 from Index for Clinical Excellence, Ltd.  Terms of the note require payment on each of the three, six and nine month anniversaries of the closing date.  Due to the nominal amount of the note and its short term duration interest income was not separately accounted for.  During April 2010 we received $62,500 and during July 2010 we received $62,500 consisting of the three  and six month anniversary payments on the note.  At May 31, 2010 the balance of the note was $125,000 and at August 31, 2010 the balance of the note is $62,500.
 
 7. Work-In-Process
 
 At August 31, 2010, cumulative billings on PDSG’s contracts in process totaled $284,000 and cumulative revenue recognized on these contracts totaled $247,156.  The difference in these amounts represent billings in excess of work-in-process and are shown at net of $36,844 due to their immateriality.  We have recorded this amount as a component of accrued expenses and other on our condensed consolidated balance sheet at August 31, 2010.
 
 At May 31, 2010, work-in-process consisting of recognized revenue on PDSG’s current contracts was $264,637 and invoices to customers were $128,000.  These amounts are shown as work-in-process on our condensed consolidated balance sheet at May 31, 2010 at net of $136,637 due to their immateriality.
 
  
 15
  Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
  8. Investments in Affiliated Companies
 
 Phoenix Digital Solutions, LLC
 
 On June 7, 2005, we entered into a Master Agreement (the “Master Agreement”) with TPL, and Charles H. Moore (“Moore”), the co-inventor of the technology which is the subject of the MMP Portfolio of microprocessor patents, pursuant to which the parties resolved all legal disputes between them. Pursuant to the Master Agreement, we and TPL entered into the Limited Liability Company Operating Agreement of PDS (the “LLC Agreement”) into which we and Moore contributed our rights to certain of our technologies.
 
 We and TPL each own 50% of the membership interests of PDS, and each of us has the right to appoint one member of the three member management committee. The two appointees are required to select a mutually acceptable third member of the management committee. Pursuant to the LLC Agreement, we and TPL agreed to establish a working capital fund for PDS of $4,000,000, of which our contribution was $2,000,000. The working capital fund increases to a maximum of $8,000,000 as license revenues are achieved. We and TPL are obligated to fund future working capital requirements at the discretion of the management committee of PDS in order to maintain working capital of not more than $8,000,000. Neither we nor TPL are required to contribute more than $2,000,000 in any fiscal year. Distributable cash and allocation of profits and losses will be allocated to the members in the priority defined in the LLC Agreement. PDS has committed to pay a quarterly amount ranging between $500,000 and $1,000,000 (based upon a percentage of the working capital fund balance of PDS) for supporting efforts to secure licensing agreements by TPL on behalf of PDS. During the three months ended August 31, 2010 and 2009, PDS expensed $0 and $500,000, respectively, pursuant to this commitment (see Note 11).
 
 PDS reimburses TPL for payment of all legal and third-party expert fees and other related third-party costs and other expenses.  During the three months ended August 31, 2010 and 2009, PDS expensed $615,585 and $2,295,208, respectively, pursuant to the agreement.  These expenses are recorded in the accompanying statements of operations presented below.
 
 On August 17, 2009, the management committee of PDS resolved to pay TPL $500,000 per quarter beginning on June 1, 2009 and continuing through May 31, 2010 relating to TPL’s special work and effort regarding the MMP litigation and U.S. Patent Office re-examinations.  On June 1, 2009, TPL received $500,000 from PDS pursuant to this agreement, this amount is included in the legal and third-party expert fees listed above.
 
 During April 2010, we filed two separate actions against TPL in the Superior Courts of San Diego and Santa Clara counties.  We and TPL had been in negotiations to restructure our relationship, however those negotiations failed and the litigation is proceeding (see Note 11).
 
 On July 15, 2010, we received payment from PDS of $1,003,095 consisting of principal and interest through July 15, 2010 on our $950,000 secured note with TPL for which PDS was jointly and severally liable.  This amount has been recorded as a note receivable from TPL on PDS’ balance sheet on July 15, 2010.  Due to TPL’s inability to pay the note, it has been fully reserved for at July 15, 2010 and the allowance has been recorded as “Reserve for loan loss and uncollectable receivable” on PDS’ statement of operations for the three months ended August 31, 2010.
 
 During June 2010, PDS advanced Alliacense $410,000 to fund payroll and rent obligations.  Due to non-payment by Alliacense, this amount has been fully reserved for at August 31, 2010 and the allowance has been recorded as “Reserve for loan loss and uncollectable receivable” on PDS’ statement of operations for the three months ended August 31, 2010.
 
  16
  Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
  Investments in Affiliated Companies (continued)
 
 We are accounting for our investment in PDS under the equity method of accounting, and accordingly have recorded our share of PDS’ net loss during the three months ended August 31, 2010 and 2009 of $1,159,703 and $242,851, respectively, as a decrease in our investment.  Cash distributions received from PDS during  the three months ended August 31, 2010 and 2009 of $0 and $3,666,828, respectively were recorded as reductions in our investment.
 
 During the three months ended August 31, 2010, our share of loss in PDS exceeds our investment in PDS by $652,074.  Such amount has been recorded as “Distributions in excess of investment in affiliated company” on our condensed consolidated balance sheet at August 31, 2010, due to our and TPL’s obligation to fund the working capital of PDS at the discretion of PDS’ management committee.  We have recorded our share of PDS’ net loss for the three months ended August 31, 2010 and 2009 as “Equity in loss of affiliated companies” in the accompanying condensed consolidated statements of operations.
 
 During the three months ended August 31, 2010 and 2009, TPL entered into licensing agreements with third parties, pursuant to which PDS received aggregate proceeds of $0 and $2,327,655, respectively.
 
 At August 31, 2010, PDS had accounts payable balances of approximately $2,039,000 and $38,000  to TPL and PTSC, respectively.  At May 31, 2010, PDS had accounts payable balances of approximately $1,724,000 and $7,000 to TPL and PTSC, respectively.
 
 Variable Interest Entity Disclosures
 
 At October 1, 2010, PDS’ cash and cash equivalents balance was $342,481.  Management has concluded that PDS’ equity investment at risk is insufficient to finance its activities as the volume of license revenue has not supported litigation costs independent of additional working capital funding.  As of the date of this filing, PDS is a variable interest entity (“VIE”) of which we are not the primary beneficiary and therefore will not consolidate PDS’ financials with our own as we cannot direct the licensing activity of TPL on behalf of PDS.
 
 We have not provided financial support to PDS other than required capital contributions and we are not contractually obligated to provide financial support to PDS other than to fund the working capital account at the discretion of PDS’ management committee.  In the event we, and not TPL, provide working capital funding to PDS we would consolidate PDS’ financials with our own as our ownership in PDS would be greater than 50%.
 
 Our variable interest in PDS consists of 50% of PDS’ Members Deficit or ($652,074) at August 31, 2010.  We are unable to quantify our maximum exposure to loss associated with this VIE as we may incur future capital funding requirements.
 
 PDS’ balance sheets at August 31, 2010 and May 31, 2010 and statements of operations for the three months ended August 31, 2010 and 2009 are as follows:
 
 
 
 
 17
 
 Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
 Investments in Affiliated Companies (continued)
 
 Balance Sheets
 
 ASSETS:
 August 31,

2010


May 31,

2010Cash and cash equivalents

$
832,958


$
779,932Prepaid expenses


-



25,000Licenses receivable


-



2,000,000Total assets

$
832,958


$
2,804,932
 
 LIABILITIES AND MEMBERS’ EQUITY (DEFICIT):
 
 August 31,

2010


May 31,

2010Related party payables and accrued expenses

$
2,137,106


$
1,777,884LLC tax payable


-



11,790Members’ equity (deficit)


(1,304,148)



1,015,258Total liabilities and members’ equity (deficit)

$
832,958


$
2,804,932
 
 Statements of Operations
 
 Three Months Ended

August 31,2010


2009Revenues

$
-


$
2,327,655Operating expenses


906,560



2,813,664Operating loss


(906,560
)


(486,009
)Reserve for loan loss and uncollectable receivable


(1,413,095
)


-Interest income


250



307Net loss

$
(2,319,405
)

$
(485,702
)
 
 Talis Data Systems, LLC
 
 We had a 39.4% interest in Talis.  The inability of Talis to meet its business plan, to raise capital, and the general economic environment were indicators of impairment on our investment, accordingly at August 31, 2009, management determined that our investment in Talis was impaired by approximately $680,000.  We have recorded this as an impairment of investment in affiliated company on our condensed consolidated statement of operations for the three months ended August 31, 2009.
 
 We were accounting for our investment in Talis under the equity method of accounting.  We had recorded our share of Talis’ net loss of $21,706 during the two months ended July 31, 2009 as “Equity in loss of affiliated companies” in the accompanying condensed consolidated statements of operations for the two months ended July 31, 2009.  The carrying value of our investment in Talis after impairment was zero at August 31, 2009.  During the third quarter of fiscal 2010, Talis was dissolved.
  18
  Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
  Investments in Affiliated Companies (continued)
 
 Due to the immaterial nature of Talis’ operations, no condensed financial statement information is presented herein.
 
 Scripps Secured Data, Inc. (d/b/a Holocom, Inc.)
  We own 100% of the preferred stock of Holocom. During May 31, 2010 we wrote off our investment in the preferred stock of Holocom amounting to approximately $435,000.  Prior to impairment, this investment was accounted for at cost since we did not have the ability to exercise significant influence over the operating and financial policies of Holocom.
 
 9.   Note Payable
 
 On October 14, 2008, we borrowed $3,000,000 on our credit facility with Wedbush, the proceeds of which was included in cash and cash equivalents at August 31, 2010 and May 31, 2010.  The facility was collateralized by the full value of the outstanding auction rate securities, required no origination fee and bore interest at the federal funds rate plus 3%.  The amount we could borrow on the facility was limited by the Financial Industry Regulatory Authority (“FINRA”).  At August 31, 2010 and May 31, 2010, the balance on the facility of $2,638,740 and $3,122,144, respectively, included accrued interest of $17,557 and $122,144, respectively, at an approximate average monthly rate of 2.7% and 2.6%, respectively.  During June 2010, we paid $500,000 on the credit facility.  On September 20, 2010 we paid $2,642,954, the balance on the credit facility at August 31, 2010 plus interest through September 20, 2010, accordingly, we have classified the note balance plus accrued interest as short-term at August 31, 2010.
 
 10.   Stockholders’ Equity
 
 Comprehensive Loss
 
 Comprehensive loss includes unrealized losses on certain investments classified as available-for-sale, net of tax, which are excluded from our condensed consolidated statements of operations. Due to the subsequent settlement of our ARS, we reversed the unrealized loss of $246,994 (adjusted for deferred tax benefit) as of August 31, 2010.  Comprehensive loss for the three months ended August 31, 2009 was as follows:
 
 Three Months EndedAugust 31, 2009Net loss

$
(1,985,079
)Unrealized holding gain (losses) on investments, net of taxes

99,167Total comprehensive loss

$
(1,885,912
)
 
   
 19
 
 Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
  Stockholders’ Equity (continued)
 
 Share Repurchases
 
 During July 2006, we commenced our Board of Director approved stock buyback program in which we repurchase our outstanding common stock from time to time on the open market.  As part of the program we purchased 448,300 and 50,000 shares of our common stock at an aggregate cost of $53,531 and $5,513 during the three months ended August 31, 2010 and 2009, respectively.
 
 Equity Transactions
 
 The following table summarizes equity transactions during the three months ended August 31, 2010:
  Common Stock


Additional


AccumulatedShares


Amounts


Paid-in Capital


Deficit


Treasury StockBalance June 1, 2010


408,821,071


$
4,381


$
77,241,227


$
(39,561,669
)

$
(14,085,015
)Share-based compensation


-



-



58,434



-



-Tax effect of stock option expirations/cancellations


-



-



(2,082
)


-



-Repurchase of common stock for treasury


(448,300
)


-



-



-



(53,532
)Net loss


-



-



-



(2,000,399
)


-Balance August 31, 2010


408,372,771


$
4,381


$
77,297,579


$
(41,562,068
)

$
(14,138,547
)
 
 Stock Optionsand Warrant Activity
 
 As of August 31, 2010, we had 275,000 options outstanding pursuant to our 2001 Stock Option Plan exercisable at a range of $0.47 to $0.86 per share expiring through 2012; and 5,087,803 options outstanding pursuant to our 2006 Stock Option Plan exercisable at a range of $0.09 to $0.70 per share expiring through 2015.  Some of the options outstanding under the 2006 Stock Option Plan are not presently exercisable and are subject to meeting certain vesting criteria.
 
 During the three months ended August 31, 2010, we recorded $58,434 of share-based compensation expense related to vesting of stock options, including $5,458 related to PDSG.  During the three months ended August 31, 2009, we recorded $38,212 of share-based compensation expense related to vesting of stock options and warrants, including $16,008 related to PDSG.
 
 As of August 31, 2010, we had warrants outstanding to purchase 325,000 common shares at exercise prices ranging from $0.15 to $1.00 per share, expiring at various dates through 2011.  No warrants were issued, exercised or expired during the three months ended August 31, 2010.
 
 Share-based Compensation
 
 Summary of Assumptions and Activity
 
 The fair value of share-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.
  20
  Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
 Stockholders’ Equity (continued)
 
 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 months ended August 31, 2010 is based on the historical volatilities of our common stock.  These factors could change  in the future, affecting the determination of share-based compensation expense in future periods.
 
 Three Months Ended

August 31,

2010

(Unaudited)

Three Months Ended

August 31,

2009

(Unaudited)Expected term


5

years


5

yearsExpected volatility


106

%


117

%Risk-free interest rate


2.17

%


2.55

%
 A summary of option activity as of August 31, 2010 and changes during the three months then ended, is presented below:
 
 Shares


Weighted Average

Exercise

Price


Weighted Average Remaining Contractual Term

(Years)


Aggregate Intrinsic

ValueOptions outstanding at June 1, 2010


5,637,917


$
0.42Options granted


650,000


$
0.10Options exercised


-


$
-Options forfeited


(925,114
)

$
0.16Options outstanding at August 31, 2010


5,362,803


$
0.43



2.35


$
25,850Options vested and expected to vest at August 31, 2010


5,202,235


$
0.43



2.33


$
25,850Options exercisable at August 31, 2010


4,841,666


$
0.45



2.21


$
22,000
  The weighted average grant date fair value of options granted during the three months ended August 31, 2010 and 2009 was $0.08 per option.  There were no options exercised during the three months ended August 31, 2010 or 2009.
 The aggregate intrinsic value represents the differences in market price at the close of the quarter ($0.13 per share on August 31, 2010) and the exercise price of outstanding, in-the-money options (those options with exercise prices below $0.13) on August 31, 2010.
   21
  Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
  Stockholders’ Equity (continued)
 
 As of August 31, 2010, there was $42,997 of total unrecognized compensation cost, net of forfeitures, related to employee stock option compensation arrangements.  That cost is expected to be recognized on a straight-line basis over the next 33 months.
 The following table summarizes employee and director share-based compensation expense for Patriot and employee share-based compensation for PDSG for the three months ended August 31, 2010 and 2009, which was recorded as follows:
 Three Months

Ended


Three Months

EndedAugust 31, 2010


August 31, 2009Research and development – PDSG

$
586


$
1,181Selling, general and administrative expense - PDSG


4,872



14,827Selling, general and administrative expense - Patriot


52,976



20,124Total

$
58,434


$
36,132
 
 During the three months ended August 31, 2009, we expensed $2,080 relating to warrants issued during the period.  We incurred no such expense during the three months ended August 31, 2010.
 
 11.  Commitments and Contingencies
 
 Litigation
 
 Patent Litigation
 
 On February 8, 2008, we, TPL and Alliacense Ltd. were named as defendants in separate lawsuits filed in the United States District Court for the Northern District of California by HTC Corporation, and Acer, Inc., and affiliated entities of each of them.
 
 The Acercase seeks declaratory relief that its products do not infringe enforceable claims of the '336, ‘749, '148 patents and US 5,530,890 (the “890 patent”). The HTCcase similarly seeks declaratory relief that its products do not infringe enforceable claims of those patents.  We allege counterclaims for patent infringement of the '336, '749, '148 and '890 patents against Acer and HTC.  On June 16, 2009, District Court Judge Jeremy Fogel stayed the HTCand Acer actions until September 18, 2009.  The stay has been lifted and the cases are in the discovery and claims construction phase.
 
 On December 1, 2008, we, TPL and Alliacense, Ltd. were named as defendants in a lawsuit filed in the United States District Court for the Northern District of California by Barco, N.V.  The Barco case seeks declaratory relief that its products do not infringe enforceable claims of the '749 and '890 patents.  We allege counterclaims for patent infringement of our '749, '890 and '336 patents.  On June 22, 2009, Judge Fogel also stayed the Barco case until September 18, 2009.  That stay has been lifted and the case is deemed related to the Acer and HTC cases.  The case is now in the discovery and claims construction phase.
   22
  Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
  Commitments and Contingencies (continued)
 
 On April 29, 2009, we, TPL, and Alliacense Ltd., were named as defendants in a lawsuit filed in the United States District Court for the Southern District of New York by Sirius XM Radio, Inc.  The Sirius case seeks declaratory relief that its products do not infringe enforceable claims of our '749, '584, '890, '336 and '148 patents, and additionally two patents of TPL's "fast logic" portfolio which do not involve us.  The Sirius case was deemed related to the Acer, HTC and Barcocases.  A settlement of the Sirius action has been finalized and that action was dismissed on July 30, 2010.
 
 Deutsche Bank Arbitration
 
 On October 16, 2008, we initiated binding arbitration claims before FINRA against Deutsche Bank Securities, Inc., and affiliates ("DBSI") based on advisory services provided to us resulting in our purchases of auction rate securities ("ARS") and the failure of the ARS market in February 2008.  We experienced a loss of liquidity and other damages as a result and allege DBSI engaged in negligence and nondisclosure in providing us services. Our arbitration and litigation with DBSI settled on September 14, 2010. Under the terms of the confidential settlement agreement, we transferred approximately $5.2 million in illiquid auction rate securities instruments to DBSI in exchange for the payment of a substantial portion of the face value of the securities, and if the instruments are redeemed by a certain date, then we will receive the full face amount of the instruments.
 
 DBSI's parent, Deutsche Bank AG, denied being required to arbitrate the dispute with DBSI before FINRA, and so we filed an action against Deutsche Bank AG in the United States District Court for the Southern District of California based on its liability with respect to our investments in ARS.  A stay of this action has been in place through the FINRA arbitration with DBSI.  With the settlement of the FINRA arbitration, the claims against Deutsche Bank AG are being dismissed.
 
 Crossflo Systems, Inc. Litigation
 
 Under the terms of our Agreement and Plan of Merger (the "Merger Agreement") with Crossflo, and certain of its principal officers, an escrow account was established to hold back approximately 10% of the merger consideration payable to the shareholders of Crossflo (the "Escrow Merger Consideration").  We contend that certain representations and warranties made by Crossflo and certain of its principal officers in the Merger Agreement were false when made, and were false as of the closing of the merger.  We submitted a demand to the escrow agent on August 31, 2009 not to release the Escrow Merger Consideration to the Crossflo shareholders and to instead return it to us.  A sufficient number of Crossflo shareholders have opposed our demand that the escrow consideration has not been released to either side.
 
 On August 31, 2009, we initiated an arbitration proceeding before the American Arbitration Association against the three Crossflo principal officers who were signatories to the Merger Agreement alleging they provided false representations and warranties in the Merger Agreement and alleging nondisclosure of information about Crossflo during the due diligence process leading up to the merger.  Those three principal officers deny our claims and have filed counterclaims.  Briefing to determine the scope of counterclaims to be arbitrated is pending before the arbitrator.  The arbitration is scheduled to begin February 13, 2011.
 
 
 
 
 23
  Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
 Commitments and Contingencies (continued)
 
 TPL Litigation
 
 On April 12, 2010, we filed an action against TPL in San Diego Superior Court for breach of a promissory note of $1 million issued to us by TPL on January 12, 2010 and which became due and payable on February 28, 2010.  TPL has filed an answer and various defenses denying the claim.
 
 On April 22, 2010 we filed a second action against TPL and Alliacense LLC in Santa Clara Superior Court alleging claims for breach of contract, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, and interference with contract, constructive fraud, for preliminary and permanent injunctions and for an accounting.  The Action stemmed from TPL's notification of a license written in April 2010 which included a license of the MMP patents and other patent to use portfolios and technologies co-owned and potentially owned by TPL in the future.  We objected to the amount of license consideration allocated to the MMP patent license as too low relative to the other license components.
 
 On April 26, 2010, the Court granted our application for a Temporary Restraining Order ("TRO") precluding TPL from executing any license of the MMP patents without providing us five business days' notice of the proposed MMP license and any other proposed license with the licensor, in order to allow us time to seek redress if we are dissatisfied by the proposed licenses.  At that time, TPL filed motions to seal the file and to bar press releases commenting on the contents of the court file, and a motion to compel private arbitration of the dispute.
 
 TPL stipulated on August 3, 2010 that the TRO already in place would become a Preliminary Injunction.  On August 12, 2010, the Court considered defendants’ request to seal the file indefinitely and to compel private arbitration of the dispute and denied both Motions.  On September 30, 2010 the Court agreed to redaction of the court file at TPL’s request for commercially sensitive data such as dollar amounts of licenses, percentage allocation to MMP licenses and other such confidential data.
 
 401(k) Plan
 
 Patriot and PDSG have retirement plans that comply with Section 401(k) of the Internal Revenue Code. All employees are eligible to participate in the plans. Patriot matches 50% of each participant’s voluntary contributions, subject to a maximum contribution of 6% of the participant’s compensation. Patriot’s participants vest 33% per year over a three year period in their contributions. Patriot’s matching contributions during the three months ended August 31, 2010 and 2009 were $3,165 and $6,020, respectively.  PDSG does not match participant voluntary contributions.
 
 Guarantees and Indemnities
 
 We have made certain guarantees and indemnities, under which we may be required to make payments to a guaranteed or indemnified party. We indemnify our directors, officers, employees and agents to the  maximum extent permitted under the laws of the State of Delaware and California for PDSG. In connection with our facility leases, we have indemnified our lessors for certain claims arising from the use of the facilities. The duration of the guarantees and indemnities varies, and in many cases is indefinite. These guarantees and indemnities do not provide for any limitation of the maximum potential future payments we could be obligated to make. Historically, we have not been obligated to make any payments for these obligations and no liabilities have been recorded for these guarantees and indemnities in the accompanying condensed consolidated balance sheets.
 
 24
  Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
  Commitments and Contingencies (continued)
 
 Pursuant to the acquisition of Crossflo, we have agreed to indemnify the former owners of Crossflo for certain claims or losses resulting from any untrue, allegedly untrue or misleading statement made in a registration statement, prospectus or similar document.
 
 Escrow Shares
 
 On August 31, 2009 we gave notice to the former shareholders of Crossflo and Union Bank of California (the “Escrow Agent”) under Section 2.5 of the Agreement and Plan of Merger between us and Crossflo (the “Agreement”), outlining damages incurred by us in conjunction with the acquisition of Crossflo, and seeking the return of 2,844,630 shares of our common stock held by the Escrow Agent.  Subsequently, former shareholders of Crossflo representing a majority of the escrowed shares responded in protest to our claim, delaying the release of the escrowed shares until a formal resolution is reached.  In the event we fail to prevail in our claim against the escrowed shares, we may be obligated to deposit into escrow approximately $256,000 of cash consideration due to the decline in our average stock price over the one year escrow period, calculated in accordance with the Section 2.5 of the Agreement.  We have evaluated the potential for loss regarding our claim and believe that we will prevail.  Accordingly, we have not recorded a contingent liability for this matter.
 
 12. Segment Information
 
 We acquired PDSG in a series of transactions in the second, third and fourth quarters of fiscal 2009 and consolidate our wholly-owned subsidiary PDSG in our condensed consolidated financial statements.  PDSG provides data sharing services and products to the public sector.  There is no inter-segment revenue and the accounting policies for segment reporting are the same as for us as a whole.
 
 This reportable segment is a strategic business unit that is managed separately because it requires different technology and marketing strategies.
 
 The “all other” category includes the results for Patriot Scientific Corporation.
 
 Operating segment net revenue, operating loss and loss before taxes for the three months ended August 31, 2010 and 2009 were as follows:
 
 Three Months EndedAugust 31,

2010


August 31,

2009Net revenue:PDSG

$
94,055


$
97,035All other


-



-Total net revenue

$
94,055


$
97,035Operating loss:PDSG

$
(600,258
)

$
(1,466,181
)All other


(984,244
)


(917,447
)Total operating loss

$
(1,584,502
)

$
(2,383,628
)
 
  25
 Patriot Scientific Corporation
 Notes to Unaudited Condensed Consolidated Financial Statements
  Segment Information (continued)
 
 Three Months EndedAugust 31,

2010


August 31,

2009Loss before taxes:PDSG

$
(540,258
)

$
(1,456,845
)All other


(2,790,985
)


(1,849,345
)Total loss before taxes

$
(3,331,243
)

$
(3,306,190
)
 
 Operating segment total assets at August 31, 2010 and May 31, 2010 were as follows:
 
 August 31, 2010


May 31, 2010Total assets:PDSG

$
7,226,034


$
7,227,033All other


18,198,684



20,188,648Total assets

$
25,424,718


$
27,415,681
 
 All PDSG sales were to unaffiliated customers within the United States, with the exception of a hosting arrangement with a customer in Japan.
 
 Accounts receivable concentration information for PDSG as of August 31, 2010 and May 31, 2010  and sales concentration information for the three months ended August 31, 2010 and 2009 were as follows:
 
 Three months ended

August 31, 2010


August 31,

2010


Three months ended

August 31, 2009


May 31,

2010Sales


% of sales


% of A/R


Sales


% of sales


% of A/RCustomer A

$
55,367



59
%


100
%

$
28,880



30
%


22
%Customer B


-----



-----



-----


$
33,050



34
%


72
%Customer C


-----



-----



-----


$
11,337



12
%


-----Customer D

$
19,511



21
%


-----



-----



-----



-----
 
 13.  Subsequent Events
 
 During the period September 1, 2010 through October 8, 2010, we purchased 215,003 shares of our common stock at an aggregate cost of $24,465 pursuant to our stock buyback program.
 
 On September 20, 2010 we paid $2,642,954 to Wedbush to settle our outstanding loan balance in full.
 On September 29, 2010 we received proceeds of $4,557,590 from Deutsche Bank in connection with our ARS settlement.  We realized a loss of $648,740 on the settlement.
   26
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 THE FOLLOWING DISCUSSION AND THE REST OF THIS QUARTERLY REPORT ON FORM 10-Q INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO OUR FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW UNDER THE SUB-HEADING, "RISK FACTORS". SEE ALSO OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED MAY 31, 2010.
 
 Overview
 
 In June 2005, we entered into a series of agreements with TPL and others to facilitate the pursuit of unlicensed users of our intellectual property. We intend to continue our joint venture with TPL to pursue license agreements with unlicensed users of our technology. We believe that utilizing the option of working through TPL, as compared to creating and using our own licensing team for those activities, avoids a competitive devaluation of our principal assets and is a prudent way to achieve the desired results as we seek to obtain fair value from users of our intellectual property.  In April 2010, we filed an action against TPL regarding TPL’s management of the MMP portfolio.
 
 During fiscal 2010 and through the date of this filing we and TPL each contributed $580,000 to fund the working capital of PDS.  We expect the contributions to continue in the future due to the working capital demands of PDS.  Additionally, we have loaned TPL an aggregate of $1,950,000, evidenced by a secured note in the principal amount of $950,000 and an unsecured note in the principal amount of $1,000,000 intended to cover its operating costs including the furtherance of licensing our MMP Portfolio of microprocessor patents.  At February 28, 2010, we reserved $1,013,151 against the unsecured $1,000,000 note receivable which includes accrued interest.  In April 2010, we filed suit against TPL for breach of contract regarding the $1,000,000 note non-payment.  On July 15, 2010, we received $1,003,095 consisting of principal and accrued interest through July 15, 2010 on the $950,000 secured note.
 
 On October 5, 2009, we announced a reorganization of PDSG and our management.  On January 25, 2010, we sold the Iameter assets and during August 2010, we sold the Vigilys business line.  As a result of our reorganization and PDSG’s continued inability to meet its business plan, we have incurred impairment charges for our intangibles and goodwill in the PDSG segment of our business.  We continue to fund the day to day operating costs of PDSG while continuing to reduce expenses.  Our merger and acquisition activities have ceased since our October 2009 reorganization.
 
 Cash shortfalls and liquidity issues currently experienced by PDS and TPL, and continued negative cash flows incurred by PDSG, will have an adverse effect on our liquidity.  Accordingly, we are in the process of examining alternatives that could allow for the partnering or divestiture of PDSG.  If successful, these measures may provide for a further reduction in expenses and cash use, or additionally in the event of divestiture, cash proceeds.
 
 We are currently in litigation with TPL arising from the April 2010 actions filed for breach of the Commercialization Agreement and TPL’s default on the $1,000,000 unsecured note.  See Part II, Item 1. “Legal Proceedings” as well as Part II, Item 1A. “Risk Factors” in this Quarterly Report for more information.
 
 Critical Accounting Policies and Estimates
 
 Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, which require us to make estimates and judgments that significantly affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Actual results could differ from those estimates, and such differences could affect the results of operations reported in future periods. We believe the following critical accounting policies affect our most significant estimates and judgments used in the preparation of our consolidated financial statements.
  27
 
 1.
Revenue Recognition
 
 Revenue from technology license agreements is recognized at the time a contract is entered into, the license method is determined (paid-in-advance or on-going royalty), and the customer is provided with the licensed technology, if applicable.
 
 PDSG sells software and services to end users primarily through relationships with systems integrators and prime contractors.  PDSG recognizes revenue in accordance with authoritative guidance for the software industry.  PDSG’s revenue is derived primarily from the following sources: (i) software licensing, (ii) related professional services, and (iii) post contract customer support (“PCS”) agreements.  PCS agreements typically include software updates, on a when and if available basis, telephone and Internet access to technical support personnel. Software updates provide customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period.
 
 PDSG’s contracts with customers, including systems integrators and prime contractors, are multiple element arrangements which contain professional services that are considered essential to the functionality of the other elements of the arrangement.  PDSG accounts for revenue on these arrangements according to authoritative guidance for contract accounting. Under this guidance, PDSG recognizes revenue based on progress towards contract completion measured by actual hours incurred in relation to the estimate of total expected hours. PDSG measures these revenues by applying the contract-specific estimated percentage of completion to the total contract amount for software and professional services.  PDSG routinely updates the estimates of future hours for agreements in process and reports any cumulative effects of such adjustments in current operations. PDSG immediately recognizes any loss expected on these contracts when it is projected that loss is probable.
 
 On June 1, 2010 we adopted new authoritative guidance on a prospective basis for revenue arrangements containing multiple deliverables.  This guidance requires us to allocate PDSG’s revenues to all deliverables based on their relative selling price using a specific hierarchy.  The hierarchy is as follows:  vendor-specific objective evidence (“VSOE”), third-party evidence of selling price (“TPE”) or best estimate of selling price (“BESP”).
 
 When a sale involves multiple elements, PDSG allocates the entire fee from the arrangement to each respective element based on VSOE of fair value and recognizes revenue when each element’s revenue recognition criteria are met. VSOE of fair value for each element is established based on the price charged when the same element is sold separately.  PDSG has established VSOE for its CDX software licenses and PCS based on historical stand-alone sales to third parties or from the stated renewal rates contained in the customer contracts.  PCS is recognized on a straight-line basis over the support period.
 
 PDSG has not yet demonstrated VSOE for the professional services that are rendered in conjunction with its software license sales.  In accordance with the hierarchy we would attempt to establish the selling price of professional services using TPE.  PDSG’s product contains significant differentiation such that the comparable pricing of products with similar functionality cannot be obtained.  PDSG is typically not able to obtain TPE for professional services.
 
 When we are unable to establish selling prices using VSOE or TPE, we use BESP.  The objective of BESP is to determine the price at which PDSG would transact a sale if professional services were sold on a stand-alone basis.  BESP is generally used for offerings that are not typically sold on a stand-alone basis or for highly customized offerings which is the case with PDSG’s professional services deliverable.
 
 Due to the fact that the majority of PDSG’s contracts require significant customization of software, we are recognizing revenue for the CDX software licenses and professional services over the customization period using contract accounting which reflects continuous release of control of the software to the customer. The adoption of this guidance did not have a material effect on our condensed consolidated financial statements.
 
 28
  2.
Assessment of Contingent Liabilities
 
 We are involved in various legal matters, disputes, and patent infringement claims which arise in the ordinary course of our business. We accrue for any estimated losses at the time when we can make a reliable estimate of such loss and it is probable that it has been incurred. By their very nature, contingencies are difficult to estimate. We continually evaluate information related to all contingencies to determine that the basis on which we have recorded our estimated exposure is appropriate.
 
 3.
Stock Options and Warrants
 
 We follow authoritative guidance which establishes standards for the accounting of transactions in which an entity exchanges its equity instruments for goods or services, primarily focusing on accounting for transactions where an entity obtains employee services in share-based payment transactions. We are required to measure the cost of employee services received in exchange for an award of equity instruments, including stock options, based on the grant-date fair value of the award and to recognize it as compensation expense over the period the employee is required to provide service in exchange for the award, usually the vesting period.
 
 Share-based compensation expense recognized during the period is based on the grant date fair value of the portion of share-based payment awards ultimately expected to vest during the period.As share-based compensation expense recognized in the consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.  Forfeiture rates are based on historical forfeiture experience and estimated future employee forfeitures.
 
 4.
Income Taxes
 
 We must assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not likely, we must increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. We believe that a substantial majority of the deferred tax assets recorded on our balance sheet will ultimately be recovered. However, should there be a change in our ability to recover the deferred tax assets; the tax provision would increase in the period in which we determined that the recovery was not probable.
 
 We follow authoritative guidance to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes.  This authoritative guidance prescribes a recognition threshold and measurement requirement for the financial statement recognition of a tax position that has been taken or is expected to be taken on a tax return and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  Under this guidance we may only recognize tax positions that meet a “more likely than not” threshold.
 
 We follow authoritative guidance to adjust our effective tax rate each quarter to be consistent with the estimated annual effective tax rate. We are also required to record the tax impact of certain discrete items, unusual or infrequently occurring, including changes in judgment about valuation allowances and effects of changes in tax laws or rates, in the interim period in which they occur. In addition, jurisdictions with a projected loss for the year or a year-to-date loss where no tax benefit can be recognized are excluded from the estimated annual effective tax rate. The impact of such an exclusion could result in a higher or lower effective tax rate during a particular quarter, based upon the mix and timing of actual earnings versus annual projections.
  29
  5.
Investments in Affiliated Companies
 We have a 50% interest in Phoenix Digital Solutions, LLC (“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 condensed consolidated statements of operations in the caption “Equity in loss of affiliated companies.” and also is adjusted by contributions to and distributions from PDS.
 
 We had a 39.4% interest in Talis.  Prior to the write-off of our investment in Talis during the quarter ended August 31, 2009, we were accounting for our investment using the equity method of accounting.  Under the equity method of accounting, the investment, originally recorded at cost, was adjusted to recognize our share of net earnings or losses of the investee and was presented in the consolidated statements of operations in the caption “Equity in loss of affiliated companies”  In December 2009,  Talis was dissolved.
  We own 100% of the preferred stock of Holocom. During May 31, 2010 we wrote off our investment in the preferred stock of Holocom amounting to approximately $435,000.  Prior to impairment, this investment was accounted for at cost since we did not have the ability to exercise significant influence over the operating and financial policies of Holocom.
  We review our investments in these affiliated companies to determine whether events or changes in circumstances indicate that the carrying amounts may not be recoverable. The primary factors we consider in our determination are the financial condition, operating performance and near term prospects of the investees. If the decline in value is deemed to be other than temporary, we would recognize an impairment loss.
 
 6.
Business Combinations and Intangible Assets Including Goodwill
 
 We account for business combinations using the purchase method of accounting and accordingly, the assets and liabilities of the acquired entities are recorded at their estimated fair values at the acquisition date. Goodwill represents the excess of the purchase price over the fair value of net assets, including the amount assigned to identifiable intangible assets. Due to the time it takes to obtain pertinent information to finalize the acquired company’s balance sheet, it may be several quarters before we are able to finalize the initial fair value estimates. Accordingly, it is not uncommon for the initial estimates to be subsequently revised. The results of operations of acquired businesses are included in our consolidated financial statements from the acquisition date.
 
 Identifiable intangible assets with finite lives are amortized over their estimated useful lives on a straight line basis. Goodwill and intangible assets are tested for impairment on an annual basis, or sooner if an indicator of impairment occurs.
 
 Results of Operations
 
 Comparison of the Three Months Ended August 31, 2010 and Three Months Ended August 31, 2009.
 
 Consolidated:
 Three months endedAugust 31, 2010


August 31, 2009Dollars


% of

Revenue


Dollars


% of

RevenueRevenue:License and service revenue

$
94,055



100.0
%

$
97,035



100.0
%Cost of sales:License and service revenue


23,415



24.9
%


31,983



33.0
%Amortization of purchased intangibles


68,889



73.2
%


206,688



-Total cost of sales


92,304



98.1
%


238,671



-Gross profit (loss)

$
1,751



1.9
%

$
(141,636
)


-
 
  30
  PDSG
 
 Revenue consisting of software licenses and associated services relating to PDSG’s CDX product decreased from approximately $97,000 for the three months ended August 31, 2009 to approximately $94,000 for the three months ended August 31, 2010.  Cost of sales includes the direct time of PDSG employees on each project. Included in cost of sales is approximately $68,900 and $206,700, respectively, of amortization expense on purchased intangible assets for the three months ended August 31, 2010 and 2009.
 
 Revenue amounts do not include activity which resulted in losses of approximately $1,160,000 and $243,000, respectively, for the  three months ended August 31, 2010 and 2009 from our investment in PDS and losses of approximately $22,000 for the three months ended August 31, 2009 from our investment in Talis.
 
 Consolidated:
  Three months endedAugust 31, 2010


August 31, 2009Research and development

$
230,484


$
314,197
 
 PDSG
 
 Research and development costs consist of PDSG’s payroll and related expenses for software engineers as well as outside contractors retained to assist in the development of PDSG’s software product.  The primary decreases in research and development costs for the three months ended August 31, 2010 as compared to August 31, 2009 were approximately $33,000 in outside contractor costs due to completion of CDX4 and approximately $58,000 in salaries and related costs due to management’s restructuring plan implemented in October of 2009.  For the three months ended August 31, 2010 and 2009, approximately $600 and $1,200, respectively, of share-based compensation was recorded in connection with vesting of employee stock options.
 
 Consolidated:
 
 Three months endedAugust 31, 2010


August 31, 2009Selling, general and administrative

$
1,355,769


$
1,927,795
 
 Segment Results:
  Three months endedAugust 31, 2010


August 31, 2009PDSG:Selling, general and administrative

$
371,525


$
1,010,348PTSC:Selling, general and administrative

$
984,244


$
917,447
 
 PDSG
 
 Selling, general and administrative expenses decreased from approximately $1,010,000 for the three months ended August 31, 2009 to approximately $372,000 for the three months ended August 31, 2010, due to management’s restructuring plan to reduce expenses.  Decreases consisted primarily of approximately $433,400 in salaries and related expenses and approximately $113,600 in consultant expenses.  For the three months ended August 31, 2010 and 2009, approximately $5,000 and $15,000, respectively, of share-based compensation was recorded in connection with vesting of employee stock options.
  31
 
 PTSC
 
 Selling, general and administrative expenses increased from approximately $917,000 for the three months ended August 31, 2009 to approximately $984,000 for the three months ended August 31, 2010.  The increase consisted primarily of approximately $167,000 in legal expense related to our litigation with Deutsche Bank and TPL and approximately $114,000 in consulting expense related to PDSG .  These increases were offset by decreases due to management’s restructuring plan to reduce expenses of approximately $160,000 in payroll and related expenses and approximately $30,000 in public and investor relations expenses.  For the three months ended August 31, 2010 and 2009, approximately $53,000 and $22,000, respectively, of share-based compensation was recorded in connection with vesting of employee stock options.
 
 Consolidated
 
 Selling, general and administrative expenses decreased from approximately $1,928,000 for the three months ended August 31, 2009 to approximately $1,356,000 for the three months ended August 31, 2010.
 
 Consolidated:
 Three months endedAugust 31, 2010


August 31, 2009Other income (expense):Interest and other income

$
18,299


$
42,928Interest expense


(16,597
)


(20,640
)Impairment of investment in affiliated company


-



(680,292
)Gain on sale of Vigilys business line


60,000



-Realized loss on sale of marketable securities


(648,740
)


-Equity in loss of affiliated companies


(1,159,703
)


(264,558
)Total other expense, net

$
(1,746,741
)

$
(922,562
)
 
 Segment Results:
 Three months endedAugust 31, 2010


August 31, 2009PDSG:Interest and other income

$
-


$
9,336Gain on sale of Vigilys business line


60,000



-$
60,000


$
9,336PTSC:Interest and other income

$
18,299


$
33,592Interest expense


(16,597
)


(20,640
)Impairment of investment in affiliated company


-



(680,292
)Realized loss on sale of marketable securities


(648,740
)


-Equity in loss of affiliated companies


(1,159,703
)


(264,558
)Total other expense, net

$
(1,806,741
)

$
(931,898
)
 
 Consolidated
 
 Our other income and expenses for the three months ended August 31, 2010 included equity in the loss of PDS consisting of net loss after expenses in the amount of approximately $1,160,000.  Our other income and expenses for the three months ended August 31, 2009 included equity in the loss of PDS consisting of net loss after expenses in the amount of approximately $243,000 and our share of loss in Talis consisting of approximately $22,000 after expenses.  Our investment in PDS and Talis was accounted for in accordance with the equity method of accounting for investments. For the three months ended August 31, 2009, we recorded an impairment of our investment in Talis of approximately $680,000.  Interest and other income decreased from approximately $43,000 for the three months ended August 31, 2009 to approximately $18,000 for the three months ended August 31, 2010 due to declines in interest rates for our cash, cash equivalents and long term investment accounts.  During the three months ended August 31, 2010, we recorded a gain on the sale of the Vigilys business line of $60,000.  During the three months ended August 31, 2010, we realized a loss on our ARS of $648,740 according to terms of our confidential settlement agreement with Deutsche Bank.
  32
  During the three months ended August 31, 2010 and 2009, we recorded a benefit for income taxes of approximately $1,331,000 and $1,321,000, respectively related to federal and California taxes.
 
 We recorded a net loss for the three months ended August 31, 2010 and 2009 of $2,000,399 and $1,985,079.
 
 Liquidity and Capital Resources
 
 Liquidity
 
 Our cash and short-term investment balances increased from approximately $10,352,000 as of May 31, 2010  to approximately $14,065,000 as of August 31, 2010. We also have restricted cash balances amounting to approximately $21,000 as of May 31, 2010 and August 31, 2010. Total current assets increased from approximately $13,417,000 as of May 31, 2010 to approximately $15,905,000 as of August 31, 2010. Total current liabilities amounted to approximately $942,000 and approximately $3,171,000 as of May 31, 2010 and August 31, 2010, respectively. The change in our current position as of August 31, 2010 as compared with May 31, 2010 results in part from collection of our $950,000 note receivable plus accrued interest and our re-classification of our auction rate securities and debt balance to short-term as a result of our September 2010 settlement with Deutsche Bank.
 
 During June 2008, we obtained a credit facility for as long as needed, which provided for financing based on the par value balance of our outstanding auction rate securities. The facility was collateralized by the full value of the outstanding auction rate securities, required no origination fee, and bore interest at the federal funds rate plus 3%.  On October 14, 2008, we borrowed $3,000,000 on the credit facility.  During June 2010, we repaid $500,000 on the credit facility and on September 20, 2010 we paid $2,642,954, the balance on the credit facility at August 31, 2010 plus interest through September 20, 2010.
 
 Current global economic conditions have resulted in increased volatility in the financial markets.  The cost of accessing the credit markets has increased as many lenders and institutional investors have increased interest rates, enacted tighter lending standards, and reduced or ceased to provide funding to borrowers.  Adverse changes in the economy could limit our ability to obtain financing from debt or equity sources or could adversely affect the terms on which we may be able to obtain any such financing.  Currently, we have sufficient resources to fund our operations through at least the next twelve months.
 
 Cash shortfalls currently experienced by PDS and TPL, and continued negative cash flows incurred by PDSG, will have an adverse effect on our liquidity.  Accordingly, we are in the process of examining alternatives that could allow for the partnering or divestiture of PDSG.  If successful, these measures may provide for a further reduction in expenses and cash use, or additionally in the event of divestiture, cash proceeds.
 
 While our current liquid cash resources as of August 31, 2010, are expected to provide the funds necessary to support our operations through at least the next twelve months, the cash flows from our interest in PDS represents our primary significant source of cash generation.  In the event of a continued decrease or interruption in MMP Portfolio licensing we will incur a significant reduction to our cash position as the revenues from our PDSG subsidiary are insufficient to cover the costs of their operations and the costs of Patriot Scientific Corporation as a whole.  While our cash position has been enhanced as a result of our September 2010 auction rate securities settlement with Deutsche Bank, PDS did not receive any license revenue during the three months ended August 31, 2010.  It is highly unlikely that we would be able to obtain any additional sources of financing to supplement our cash and net short-term investment position (as reduced by our line-of-credit) of $11,425,900 at August 31, 2010.
   33
 
 Cash Flows From Operating Activities
 
 Cash used in operating activities was approximately $1,699,000 and $2,298,000 for the three months ended August 31, 2010 and 2009, respectively. The principal components of the current period amount were: loss in earnings of affiliated company of approximately $1,160,000, realized loss on sale of marketable securities of approximately $649,000 and work-in-process of approximately $137,000. These increases were offset by: net loss of approximately $2,000,000, changes in deferred income taxes of approximately $1,330,000 and changes in accounts payable and accrued expenses of approximately $306,000. The change in results over the prior period is mainly attributable to the current period loss in PDS as compared to the three months ended August 31, 2009 and our realized loss on sale of marketable securities.
 
 Cash Flows From Investing Activities
 
 Cash provided by investing activities was approximately $1,421,000 and $4,300,000 for the three months ended August 31, 2010 and 2009, respectively. We received no distributions from PDS for the three months ended August 31, 2010.  Cash provided by investing activities during the current period was mainly attributable to our collection of our $950,000 note receivable plus interest and proceeds from sales of marketable securities of approximately $356,000.
 
 Cash Flows From Financing Activities
 
 Cash used in financing activities for the three months ended August 31, 2010 and 2009 was approximately $556,000 and $6,000, respectively.  For the three months ended August 31, 2010, cash of approximately $54,000 was used to purchase common stock for treasury and we paid $500,000 on our note with Wedbush.
 
 Capital Resources
 
 Our current resources as of August 31, 2010 are expected to provide the funds necessary to support our operations through at least the next twelve months.
 
 Contractual Obligations and Commitments
 
 During the three months ended August 31, 2010 we did not enter into any material contractual obligations or commitments.
 
 Recent Accounting Pronouncements
 
 During the three months ended August 31, 2010, there were no recent issuances of accounting pronouncements as compared to those described in our Annual Report on Form 10-K for the fiscal year ended May 31, 2010, that are of significance, or have potential material significance to us.
 
 Risk Factors
 
 We urge you to carefully consider the following discussion of risks as well as other information regarding our common stock. We believe the following to be our most significant risk factors as of the date this report is being filed. The risks and uncertainties described below are not the only ones we face.  Please refer to our risk factors contained in our Form 10-K for the year ended May 31, 2010 for additional risk factors.
 
 We Have Initiated Legal Proceedings Against Our Joint Venture Partner Which Could Adversely Affect Our Relationship With Them And Our Receipt Of Licensing Revenues.
 
 Under our joint venture arrangement with TPL, TPL is responsible for the licensing and enforcement of our microprocessor patent portfolio.  In April 2010 we filed two actions against TPL (and with respect to one action, another defendant) alleging breach of a $1 million promissory note issued to us by TPL and other causes of action.  Because we are wholly dependent on TPL to secure licensing revenues with respect to our microprocessor patent portfolio, which revenues have represented substantially all of our income since June 2005, the commencement of these adversarial proceedings against TPL could have an adverse affect on our continued relationship with TPL and its ability to effectively negotiate licenses or enforce our rights with respect to our microprocessor patent portfolio, which in turn could adversely affect our revenues and financial condition.
  34
  We Have Reported Licensing Income In Prior Fiscal Years Which May Not Be Indicative Of Our Future Income.
 
 We have entered into license agreements through our joint venture with TPL and have reported licensing income as a result of this activity for the fiscal years 2006 to 2010. Because of the uncertain nature of the negotiations that lead to license revenues, pending litigation with companies which we allege have infringed on our patent portfolio, the possibility of legislative action regarding patent rights, potential adverse outcomes associated with the U. S. Patent and Trademark Office (“USPTO”) re-examinations, and the possible effect of new judicial interpretations of patent laws, we may not receive revenues from such agreements in the future consistent with amounts received in the past, and we may not receive future revenues from license agreements at all.
 
 We Are Dependent Upon A Joint Venture In Which Our Role Is Of A Passive Nature For Substantially All Of Our Income.
 
 In June 2005, we entered into a joint venture with TPL, pursuant to which TPL is responsible for the licensing and enforcement of our microprocessor patent portfolio. This joint venture has been the source of substantially all of our income since June 2005. Therefore, in light of the absence of significant revenue from other sources, we should be regarded as entirely dependent on the success or failure of the licensing and prosecution efforts of TPL on behalf of the joint venture, and the ability of TPL to obtain capital when necessary to fund its operations.  In December 2009 and January 2010, we provided operational funding by loaning TPL $950,000 and $1,000,000, respectively.  The $1,000,000 note which was due to be repaid by February 28, 2010 is currently in default, and we have provided a full allowance against this receivable.  On July 15, 2010, we received $1,003,095 from PDS for payment on the $950,000 note issued in December 2009 plus accrued interest. We do not anticipate making additional loans to TPL, and its ability to access liquidity from other sources is not certain.
 
 A Successful Challenge To Our Intellectual Property Rights Could Have A Significant And Adverse Effect On Us.
 
 A successful challenge to our ownership of our technology or the proprietary nature of our intellectual property could materially damage our business prospects. We rely on a combination of patents, trademarks, copyrights, trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. With respect to our core technologies, we currently have seven U.S. patents, one European patent, and one Japanese patent issued. Any issued patent may be challenged and invalidated. Patents may not be issued for any of our pending applications. Any claims allowed from existing or pending patents may not be of sufficient scope or strength to provide significant protection for our products. Patents may not be issued in all countries where our products can be sold so as to provide meaningful protection or any commercial advantage to us. Our competitors may also be able to design around our patents.
 
 Vigorous protection and pursuit of intellectual property rights or positions characterize the fiercely competitive semiconductor industry, which has resulted in significant and often protracted and expensive litigation. Therefore, our competitors and others may assert that our technologies or products infringe on their patents or proprietary rights. Persons we believe are infringing our patents are likely to vigorously defend their actions and assert that our patents are invalid. Problems with patents or other rights could result in significant costs, limit future license revenue, and impair or hinder our acquisition strategy. If infringement claims against us are deemed valid or if our infringement claims are successfully opposed, we may not be able to obtain appropriate licenses on acceptable terms or at all. Litigation could be costly and time-consuming but may be necessary to protect our future patent and/or technology license positions or to defend against infringement claims.  From time to time parties have petitioned the USPTO to re-examine certain of our patents. An adverse decision in litigation or in the re-examination process could have a very significant and adverse effect on our business.
 
 We have been named as co-defendants in multiple lawsuits regarding the MMP Portfolio.  See footnote 11 to our condensed consolidated financial statements and Part II, Item 1. “Legal Proceedings” in this quarterly report on Form 10-Q for more information.
  35
 Disruptions In The Debt And Equity Markets Will Have An Adverse Affect On Our Ability To Obtain Funding.
 
 The debt and equity markets have been experiencing volatility and disruption for several fiscal periods.  These issues, along with significant write-offs in the financial services sector, the re-pricing of credit risk, and the current weak economic conditions have made, and will likely continue to make, it difficult to obtain funding.  The cost of accessing the credit markets has increased as many lenders and institutional investors have increased interest rates, enacted tighter lending standards, and reduced or ceased to provide funding to borrowers.  Adverse changes in the economy could limit our ability to obtain financing from debt or equity sources or could adversely affect the terms on which we may be able to obtain any such financing for our operating activities.  See Part I – Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Liquidity.” in this quarterly report on Form 10-Q for more information.
  Unstable Market And Economic Conditions May Have Serious Adverse Consequences On Our Business.
 
 Our general business strategy may be adversely affected by the recent economic downturn and volatile business environment and continued unpredictable and unstable market conditions. A prolonged or profound economic downturn may result in adverse changes to our sales and pricing, which would harm our operating results. Failure to secure any necessary financing in a timely manner and on favorable terms could have a material adverse effect on our growth strategy, financial performance and stock price and could require us to delay or abandon development plans. There is also a possibility that our stock price may decline further, due in part to the volatility of the stock market and the general economic downturn
  Changes In Our Relationships With Companies In Which We Hold Less Than A Majority Interest Could Change The Way We Account For Such Interests In The Future.
 
 For our investment accounted for under the equity method (PDS), we record as part of other income or expense our share of the increase or decrease in the equity of this company in which we have invested.  Prior to the impairment, we accounted for our investment in Holocom on the cost basis.  It is possible that, in the future, our relationships and/or our interests in or with this equity method investee and our cost basis investee could change. Such potential future changes could result in deconsolidation or consolidation of such entities, as the case may be, which could result in changes in our reported results.
 
 If A Large Number Of Our Shares Are Sold All At Once Or In Blocks, The Market Price Of Our Shares Would MostLikely Decline.
 
 Most of our shareholders are not restricted in the price at which they can sell their shares. Shares sold at a price below the current market price at which our Common Stock is trading may cause the market price of our Common Stock to decline.
 
 The Market For Our Stock Is Subject To Rules Relating To Low-Priced Stock (“Penny Stock”) Which May Limit Our Ability To Raise Capital.
 
 Our Common Stock is currently listed for trading in the FINRA OTC Bulletin 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.
   36
 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
 
 The primary objective of our investment activities is to maintain surplus cash in accounts that provide a high level of funds accessibility in large, respected financial institutions with asset safety as a primary consideration. Accordingly, we maintain our cash and cash equivalents with high quality financial institutions. Amounts deposited with these institutions may exceed federal depository insurance limits.
 
 Cash and Cash Equivalents
 
 We maintain cash and cash equivalents in institutional money market accounts. In general, money market funds are not subject to interest rate risk because the interest paid on these funds fluctuates with the prevailing interest rate.
 
 Our commercial checking account was linked to a sweep account. This sweep account was maintained by our financial institution in an offshore account located in the Cayman Islands. This sweep account was a deposit liability of our financial institution, the funds were not insured by the Federal Deposit Insurance Corporation (“FDIC”); in liquidation the funds would have had a lesser preference than deposits held in the United States, and the funds were subject to cross-border risks.  In August 2010, we discontinued the sweep function associated with our commercial checking account.
 
 Auction Rate Securities
 
 Our exposure to market risk for changes in interest rates related primarily to our auction rate securities.  During the fiscal year ended May 31, 2009, investment banks were reporting an inability to successfully obtain subscribers for high credit quality auction rate securities.  At August 31, 2010, we held such auction rate securities with a par value totaling approximately $5.2 million that failed to sell at auction.  During June 2010, auction rate securities with a par value of $350,000 were redeemed by the issuers at par.  In the event we needed to access funds invested in these auction rate securities we would not have been able to liquidate these securities until a future auction of these securities was successful, they were refinanced and redeemed by the issuers, or a buyer was found outside of the auction process.  During September 2010, we reached a confidential settlement with Deutsche Bank (seefootnote 11 to our condensed consolidated financial statements) and we received proceeds from Deutsche Bank on September 29, 2010 (see footnote 13 to our condensed consolidated financial statements).  The investments consisted of student loan auction rate instruments issued by various state agencies pursuant to the Federal Family Educational Loan Program (“FFELP”).  These instruments were insured by the various state educational agencies and were guaranteed by the Department of Education as an insurer of last resort.
   37
  We have reclassified the par value of our ARS as adjusted for realized losses to short term in our condensed consolidated balance sheet as of August 31, 2010 based on terms of our confidential settlement agreement with Deutsche Bank (see footnote 11 to our condensed consolidated financial statements).
  During June 2008, we obtained a credit facility which provided for financing of the par value balance of our outstanding auction rate securities based on collateral limits set by FINRA. The facility was collateralized by the full value of the outstanding auction rate securities, required no origination fee, and bore interest at the federal funds rate plus 3%.  On October 14, 2008, we drew $3,000,000 on the credit facility.  During June 2010, we paid $500,000 on the credit facility.  On September 20, 2010 we paid $2,642,954, the balance on the credit facility at August 31, 2010 plus interest through September 20, 2010, accordingly, we have classified the note balance plus accrued interest as short-term at August 31, 2010.
 
 Item 4. Controls and Procedures
 
 Quarterly Evaluation of Disclosure Controls and Procedures
  As required by Rule 13a-15(b) under the Exchange Act, as of August 31, 2010, 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 Interim Chief Executive Officer and our Chief Financial Officer.
  Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including the Interim 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 August 31, 2010, our management, with the participation of our Interim Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective.
  Changes in Internal Control over Financial Reporting
  There were no significant 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.
    38
 PART II- OTHER INFORMATION
 
 Item 1. Legal Proceedings
 
 Patent Litigation
 
 Our patent litigation with TPL and Alliacense Ltd. in the United States District Court for the Northern District of California against Acer, Inc., HTC Corporation and affiliated entities, as described in Item 3 – “Legal Proceedings” in our Annual Report on Form 10-K for the year ended May 31, 2010 ("Annual Report"), is still ongoing, but there have been no material developments in such litigation since our Annual Report.
 
 Our patent litigation with TPL and Alliacense Ltd. in the United States District Court for the Northern District of California against Barco, N.V., as described in Item 3 – “Legal Proceedings” in our Annual Report, is still ongoing, but there have been no material developments in such litigation since our Annual Report.
 
 Deutsche Bank Arbitration
 
 Our arbitration claims before FINRA against Deutsche Bank Securities, Inc. and affiliates, as described in Item 3 – “Legal Proceedings” in our Annual Report, has been settled (see footnote 11 to our condensed consolidated financial statements).
 
 Crossflo Systems, Inc. Litigation
 
 Our arbitration claims before the American Arbitration Association against the three Crossflo principal officers who were signatories to the Merger Agreement as described in Item 3 – “Legal Proceedings” in our Annual Report, is still ongoing, but there have been no material developments in such arbitration since our Annual Report.
 
 TPL Litigation
 
 Our actions against TPL in San Diego Superior Court for breach of a promissory note of $1 million and our actions against TPL and Alliacense LLC in Santa Clara Superior Court alleging claims for breach of contract, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, and interference with contract, constructive fraud, for preliminary and permanent injunctions and for an accounting as described in Item 3 – “Legal Proceedings” in our Annual Report, are still ongoing, but there have been no material developments in such litigation since our Annual Report.
 
 Item 1A. Risk Factors
 
 Please see Part I, Item 2, above, for our risk factors.
 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
 On April 28, 2006, our Board of Directors authorized a stock repurchase program.  We commenced the program in July 2006 and plan to repurchase outstanding shares of our common stock on the open market from time to time.  As part of the program, we purchased 448,300 shares of our common stock at an aggregate cost of $53,531 during the three months ended August 31, 2010.
 
 
 39
 
 Following is a summary of all repurchases by us of our common stock during the three month period ended August 31, 2010:
 
 Period

Total

Number of

Shares

Purchased


Average Price

Paid per

Share


Total Number of

Shares Purchased as

Part of Publicly

Announced Plans or ProgramsJune 1 – 30, 2010


174,000


$
0.09



174,000July 1 – 31, 2010


94,400


$
0.11



94,400August 1 – 31, 2010


179,900


$
0.15



179,900Total


448,300


$
0.12



448,300
 
 The repurchase plan has no maximum number of shares or dollar amount and is solely at the discretion of the Board of Directors.  The repurchase plan has no set expiration date.
 
 Item 3. Defaults Upon Senior Securities
 
 None.
 
 Item 4. Removed and Reserved
 
 Item 5. Other Information
 
 None.
 
 Item 6. Exhibits
 
 Those exhibits marked with an asterisk (*) refer to exhibits filed herewith. The other exhibits are incorporated herein by reference, as indicated in the following list.
  Exhibit No.
Document2.1
Agreement and Plan of Merger dated August 4, 2008, among Patriot Scientific Corporation, PTSC Acquisition 1 Corp, Crossflo Systems, Inc. and the Crossflo principal officers, incorporated by reference to Exhibit 99.1 to our Current Report on Form 8-K filed August 11, 2008 (Commission file No. 000-22182)3.1
Original Articles of incorporation of Patriot Scientific Corporation’s predecessor, Patriot Financial Corporation, incorporated by reference to Exhibit 3.1 to Registration Statement on Form S-18, (Commission file No. 33-23143-FW)3.2
Articles of Amendment of Patriot Financial Corporation, as filed with the Colorado Secretary of State on July 21, 1988, incorporated by reference to Exhibit 3.2 to Registration Statement on Form S-18, (Commission file No. 33-23143-FW)3.3
Certificate of Incorporation of Patriot Scientific Corporation, as filed with the Delaware Secretary of State on March 24, 1992, incorporated by reference to Exhibit 3.3 to our Current Report on Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)3.3.1
Certificate of Amendment to the Certificate of Incorporation of Patriot Scientific Corporation, as filed with the Delaware Secretary of State on April 18, 1995, incorporated by reference to Exhibit 3.3.1 to our Annual Report on Form 10-KSB for the fiscal year ended May 31, 1995 (Commission file No. 000-22182)  3.3.2
Certificate of Amendment to the Certificate of Incorporation of Patriot Scientific Corporation, as filed with the Delaware Secretary of State on June 24, 1997, incorporated by reference to Exhibit 3.3.2 to our Annual Report on Form 10-KSB for the fiscal year ended May 31, 1997, filed July 18, 1997 (Commission file No. 000-22182)3.3.3
Certificate of Amendment to the Certificate of Incorporation of Patriot Scientific Corporation, as filed with the Delaware Secretary of State on April 28, 2000, incorporated by reference to Exhibit 3.3.3 to Registration Statement on Form S-3 filed May 5, 2000 (Commission file No. 333-36418)   40
  3.3.4
Certificate of Amendment to the Certificate of Incorporation of Patriot Scientific Corporation, as filed with the Delaware Secretary of State on May 6, 2002, incorporated by reference to Exhibit 3.3.4 to our Quarterly Report on Form 10-Q for the quarterly period ended February 28, 2009, filed April 9, 2009 (Commission file No. 000-22182)3.3.5
Certificate of Amendment to the Certificate of Incorporation of Patriot Scientific Corporation,  as filed with the Delaware Secretary of State on October 16, 2003, incorporated by reference to Exhibit 3.3.5 to Registration Statement on Form SB-2 filed May 21, 2004 (Commission file No. 333-115752)3.3.6
Certificate of Amendment to the Certificate of Incorporation of Patriot Scientific Corporation, as filed with the Delaware Secretary of State on April 29, 2005, incorporated by reference to Exhibit 3.3.6 to our Quarterly Report on Form 10-Q for the quarterly period ended February 28, 2009, filed April 9, 2009 (Commission file No. 000-22182)3.3.7
Certificate of Amendment to the Certificate of Incorporation of Patriot Scientific Corporation, as filed with the Delaware Secretary of State on November 14, 2005, incorporated by reference to Exhibit 3.3.7  to our Quarterly Report on Form 10-Q for the quarterly period ended February 28, 2009, filed April 9, 2009 (Commission file No. 000-22182)3.3.8
Certificate of Amendment to the Certificate of Incorporation of Patriot Scientific Corporation, as filed with the Delaware Secretary of State on March 18, 2009, incorporated by reference to Exhibit 3.3.8 to our Annual Report on Form 10-K for the year ended May 31, 2009, filed August 14, 2009 (Commission file No. 000-22182)3.4
Articles and Certificate of Merger of Patriot Financial Corporation into Patriot Scientific Corporation dated May 1, 1992, with Agreement and Plan of Merger attached thereto as Exhibit A, incorporated by reference to Exhibit 3.4 to our Current Report on Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)3.5
Certificate of Merger issued by the Delaware Secretary of State on May 8, 1992, incorporated by reference to Exhibit 3.5 to our Current Report on Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)3.6
Certificate of Merger issued by the Colorado Secretary of State on May 12, 1992, incorporated by reference to Exhibit 3.6 to our Current Report on Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)3.7
Bylaws of the Company, incorporated by reference to Exhibit 3.7 to our Current Report on Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)31.1*
Certification of Clifford L. Flowers, Interim CEO, pursuant to Rule 13a-14(a)/15d-14(a)31.2*
Certification of Clifford L. Flowers, CFO, pursuant Rule 13a-14(a)/15d-14(a)32.1*
Certification of Clifford L. Flowers, CFO and Interim CEO, pursuant to Section 1350 of Chapter 63 Title 18 of the United States Code
 
 
 41
 
 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:  October 12, 2010
PATRIOT SCIENTIFIC CORPORATIONBy:
/S/ CLIFFORD L. FLOWERSClifford L. FlowersInterim Chief Executive Officer and Chief Financial Officer

(Duly Authorized and Principal Financial Officer)
        
  42