UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington, D.C.
20549





FORM
10-Q





(Mark
One)




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





For the
quarterly period ended February 28, 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 ofincorporation
      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.






Large accelerated
      filer o
            Accelerated filer
      x
            Non-accelerated
      filer  (do not check if smaller reporting company) o
            Smaller reporting
      company o




Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No x




On April
5, 2010, 409,283,580 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 February 28, 2010 (unaudited) and May
      31, 2009
            3Condensed
      consolidated Statements of Operations for the three and nine months ended
      February 28, 2010 and February 28, 2009 (unaudited)
            4Condensed
      consolidated Statements of Cash Flows for the nine months ended February
      28, 2010 and February 28, 2009 (unaudited)
            5Notes
      to condensed consolidated Financial Statements (unaudited)
            7-39ITEM
      2. Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
            40-57ITEM
      3. Quantitative and Qualitative Disclosures About Market
    Risk
            57-58ITEM
      4. Controls and Procedures
            58-59PART
      II. OTHER INFORMATIONITEM
      1. Legal Proceedings
            59ITEM
      1A. Risk Factors
            59ITEM
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
            59-60ITEM
      3. Defaults Upon Senior Securities
            60ITEM
      4. Removed and Reserved
            60ITEM
      5. Other Information
            60-61ITEM
      6. Exhibits
            62SIGNATURES
            63





2





PART
I - FINANCIAL INFORMATION





Item 1. Financial
Statements




Patriot
Scientific Corporation


Condensed
Consolidated Balance Sheets





February
      28, 2010
            
            
            May
      31, 2009ASSETS
            
            (Unaudited)Current
      assets:Cash
      and cash equivalents
            
            $
            8,549,041
            
            
            $
            6,206,868Restricted
      cash and cash equivalents
            
            
            20,680
            
            
            
            52,163Marketable
      securities
            
            
            9,611
            
            
            
            58,292Accounts
      receivable
            
            
            211,055
            
            
            
            168,402Accounts
      receivable - affiliated company
            
            
            2,043
            
            
            
            5,467Notes
      receivable, net
            
            
            1,658,049
            
            
            
            447,810Work-in-process
            
            
            -
            
            
            
            27,279Prepaid
      income taxes
            
            
            511,573
            
            
            
            506,526Current
      portion of deferred tax assets
            
            
            897,301
            
            
            
            285,472Prepaid
      expenses and other current assets
            
            
            95,262
            
            
            
            306,457Total
      current assets
            
            
            11,954,615
            
            
            
            8,064,736Marketable
      securities
            
            
            7,391,031
            
            
            
            10,598,389Property
      and equipment, net
            
            
            46,167
            
            
            
            85,475Goodwill
            
            
            642,981
            
            
            
            1,739,249Other
      intangible assets, net
            
            
            1,791,111
            
            
            
            5,803,639Deferred
      tax assets, net of current portion
            
            
            5,691,285
            
            
            
            2,843,677Other
      assets
            
            
            41,045
            
            
            
            51,507Investments
      in affiliated companies
            
            
            519,385
            
            
            
            4,540,280Total
      assets
            
            $
            28,077,620
            
            
            $
            33,726,952LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
            
            $
            161,984
            
            
            $
            414,843Accrued
      expenses and other
            
            
            396,171
            
            
            
            593,330Deferred
      revenue
            
            
            145,517
            
            
            
            26,311Total
      current liabilities
            
            
            703,672
            
            
            
            1,034,484Long
      term debt, including accrued interest
            
            
            3,101,634
            
            
            
            3,041,577Total
      liabilities
            
            
            3,805,306
            
            
            
            4,076,061Commitments and
      contingenciesStockholders’
      equity:Preferred
      stock, $0.00001 par value; 5,000,000 shares authorized: none
      outstanding
            
            
            -
            
            
            
            -Common
      stock, $0.00001 par value: 600,000,000 shares authorized: 438,167,618
      shares issued and 409,396,676 shares outstanding at February 28, 2010;
      438,067,618 shares issued and 410,354,054 shares outstanding at May 31,
      2009
            
            
            4,381
            
            
            
            4,380Additional
      paid-in capital
            
            
            77,229,054
            
            
            
            77,008,332Accumulated
      deficit
            
            
            (38,551,819
            )
            
            
            (32,881,848
            )Common
      stock held in treasury, at cost – 28,770,942 shares and 27,713,564 shares
      at February 28, 2010 and May 31,
    2009,  respectively
            
            
            (14,016,223
            )
            
            
            (13,850,659
            )Accumulated
      other comprehensive loss
            
            
            (393,079
            )
            
            
            (629,314
            )Total
      stockholders’ equity
            
            
            24,272,314
            
            
            
            29,650,891Total
      liabilities and stockholders’ equity
            
            $
            28,077,620
            
            
            $
            33,726,952





See
accompanying notes to unaudited condensed consolidated financial
statements.




3





Patriot
Scientific Corporation
 Condensed
Consolidated Statements of Operations
 (Unaudited)


Three
      Months Ended
            
            
            Nine
      Months EndedFebruary
      28, 2010
            
            
            February
      28, 2009
            
            
            February
      28, 2010
            
            
            February
      28, 2009Revenues:Product
      sales and other
            
            $
            -
            
            
            $
            1,193,378
            
            
            $
            -
            
            
            $
            4,168,932License
      and service revenue
            
            
            183,474
            
            
            
            216,823
            
            
            
            346,925
            
            
            
            475,177Total
      revenues
            
            
            183,474
            
            
            
            1,410,201
            
            
            
            346,925
            
            
            
            4,644,109Cost
      of sales:Product
      sales and other
            
            
            -
            
            
            
            534,555
            
            
            
            -
            
            
            
            1,819,172License
      and service revenue
            
            
            19,915
            
            
            
            89,195
            
            
            
            92,102
            
            
            
            254,335Amortization
      of purchased intangibles
            
            
            68,889
            
            
            
            223,902
            
            
            
            482,265
            
            
            
            435,204Impairment
      of purchased intangibles
            
            
            -
            
            
            
            -
            
            
            
            3,530,263
            
            
            
            -Total
      cost of sales
            
            
            88,804
            
            
            
            847,652
            
            
            
            4,104,630
            
            
            
            2,508,711Gross
      profit (loss)
            
            
            94,670
            
            
            
            562,549
            
            
            
            (3,757,705
            )
            
            
            2,135,398Operating
      expenses:Research
      and development
            
            
            361,742
            
            
            
            117,781
            
            
            
            1,216,496
            
            
            
            269,655Selling,
      general and administrative
            
            
            1,254,359
            
            
            
            2,088,100
            
            
            
            5,193,184
            
            
            
            6,196,360Impairment
      of goodwill
            
            
            -
            
            
            
            -
            
            
            
            1,096,268
            
            
            
            -Total
      operating expenses
            
            
            1,616,101
            
            
            
            2,205,881
            
            
            
            7,505,948
            
            
            
            6,466,015Operating
      loss
            
            
            (1,521,431
            )
            
            
            (1,643,332
            )
            
            
            (11,263,653
            )
            
            
            (4,330,617
            )Other
      income (expense):Interest
      and other income
            
            
            50,396
            
            
            
            63,257
            
            
            
            119,170
            
            
            
            320,850Interest
      expense
            
            
            (19,788
            )
            
            
            (27,396
            )
            
            
            (60,057
            )
            
            
            (48,158
            )Gain
      on sale of Verras Medical, Inc. assets
            
            
            182,397
            
            
            
            -
            
            
            
            182,397
            
            
            
            -Reserve
      for loan loss
            
            
            (1,013,151
            )
            
            
            -
            
            
            
            (1,013,151
            )
            
            
            -Impairment
      of investment in affiliated companies
            
            
            -
            
            
            
            -
            
            
            
            (1,113,625
            )
            
            
            -Equity
      in earnings (loss) of affiliated companies, net
            
            
            385,697
            
            
            
            (921,883
            )
            
            
            3,858,057
            
            
            
            5,746,626Total
      other income (expense), net
            
            
            (414,449
            )
            
            
            (886,022
            )
            
            
            1,972,791
            
            
            
            6,019,318Income
      (loss) before income taxes
            
            
            (1,935,880
            )
            
            
            (2,529,354
            )
            
            
            (9,290,862
            )
            
            
            1,688,701Provision
      (benefit) for income taxes
            
            
            (997,609
            )
            
            
            (1,111,374
            )
            
            
            (3,620,891
            )
            
            
            636,505Net
      income (loss)
            
            
            (938,271
            )
            
            
            (1,417,980
            )
            
            
            (5,669,971
            )
            
            
            1,052,196Less:
      income attributable to noncontrolling interest
            
            
            -
            
            
            
            71,367
            
            
            
            -
            
            
            
            264,290Net
      income (loss) attributable to PTSC
            
            $
            (938,271
            )
            
            $
            (1,489,347
            )
            
            $
            (5,669,971
            )
            
            $
            787,906Basic
      income (loss) per common share
            
            $
            -
            
            
            $
            -
            
            
            $
            (0.01
            )
            
            $
            -Diluted
      income (loss) per common share
            
            $
            -
            
            
            $
            -
            
            
            $
            (0.01
            )
            
            $
            -Weighted
      average number of common shares outstanding-basic
            
            
            407,006,768
            
            
            
            408,030,851
            
            
            
            407,308,729
            
            
            
            401,578,784Weighted
      average number of common shares outstanding-diluted
            
            
            407,006,768
            
            
            
            408,030,851
            
            
            
            407,308,729
            
            
            
            404,026,257





See
accompanying notes to unaudited condensed consolidated financial
statements.
  4
  Patriot
Scientific Corporation


Condensed
Consolidated Statements of Cash Flows


(Unaudited)




Nine
      months endedFebruary
      28, 2010
            
            
            February
      28, 2009Operating
      activities:Net
      income (loss)
            
            $
            (5,669,971
            )
            
            $
            787,906Adjustments
      to reconcile net income (loss) to net cash used in operating
      activities:Noncontrolling
      interest in variable interest entity
            
            
            -
            
            
            
            264,290Impairment
      of intangibles
            
            
            3,530,263
            
            
            
            -Impairment
      of goodwill
            
            
            1,096,268
            
            
            
            -Amortization
      and depreciation
            
            
            526,426
            
            
            
            486,015Share-based
      compensation relating to issuance of stock options and vesting
      of  warrants
            
            
            213,273
            
            
            
            324,380Accrued
      interest income added to investments and notes receivable
            
            
            (31,050
            )
            
            
            (8,287
            )Equity
      in earnings of affiliated companies
            
            
            (3,858,057
            )
            
            
            (5,746,626
            )Impairment
      of investment in affiliated companies
            
            
            1,113,625
            
            
            
            -Gain
      on sale of Verras Medical, Inc. assets
            
            
            (182,397
            )
            
            
            -Loss
      on sale of assets
            
            
            965
            
            
            
            1,733Write-off
      of patent costs
            
            
            -
            
            
            
            21,527Deferred
      income taxes
            
            
            (3,615,844
            )
            
            
            (1,762,371
            )Reserve
      for loan loss
            
            
            1,013,151
            
            
            
            -Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            (43,405
            )
            
            
            (144,377
            )Receivable
      from affiliated company
            
            
            3,424
            
            
            
            (2,400
            )Inventory
            
            
            -
            
            
            
            (593,660
            )Work-in-process
            
            
            27,279
            
            
            
            (84,784
            )Prepaid
      expenses and other current assets
            
            
            221,657
            
            
            
            74,893Prepaid
      income taxes
            
            
            (5,047
            )
            
            
            222,311Accounts
      payable and accrued expenses
            
            
            (389,961
            )
            
            
            (182,544
            )Deferred
      revenue
            
            
            119,206
            
            
            
            52,055Income
      taxes payable
            
            
            -
            
            
            
            1,027,213Net
      cash used in operating activities
            
            
            (5,930,195
            )
            
            
            (5,262,726
            )Investing
      activities:Proceeds
      from sales of marketable securities
            
            
            3,648,681
            
            
            
            1,582,287Purchases
      of marketable securities
            
            
            -
            
            
            
            (102,629
            )Proceeds
      from sale of restricted investments
            
            
            31,643
            
            
            
            -Purchases
      of property and equipment
            
            
            (72,669
            )
            
            
            (23,681
            )Issuance
      of notes receivable
            
            
            (2,005,000
            )
            
            
            (133,000
            )Proceeds
      on sale of Verras Medical, Inc. assets
            
            
            62,500
            
            
            
            -Cash
      received from repayment of note receivable
            
            
            -
            
            
            
            50,243Purchases
      of convertible notes receivable
            
            
            -
            
            
            
            (667,750
            )Investments
      in affiliated companies
            
            
            (612,500
            )
            
            
            (1,546,500
            )Distributions
      from affiliated company
            
            
            7,377,827
            
            
            
            7,648,589Cash
      paid in purchase acquisition, net of cash acquired
            
            
            -
            
            
            
            (2,677,105
            )Net
      cash provided by investing activities
            
            
            8,430,482
            
            
            
            4,130,454Financing
      activities:Proceeds
      from exercise of common stock warrants and options
            
            
            7,450
            
            
            
            5,000Payments
      on note payable
            
            
            -
            
            
            
            (416,393
            )Issuance
      of notes payable
            
            
            -
            
            
            
            3,250,000Repurchase
      of common stock for treasury
            
            
            (165,564
            )
            
            
            (1,095,944
            )Tax
      effect of exercise of options granted prior to fair value
      reporting
            
            
            -
            
            
            
            4,482Net
      cash provided by (used in) financing activities
            
            
            (158,114
            )
            
            
            1,747,145Net
      increase in cash and cash equivalents
            
            
            2,342,173
            
            
            
            614,873Cash
      and cash equivalents, beginning of period
            
            
            6,206,868
            
            
            
            6,424,015Cash
      and cash equivalents, end of period
            
            $
            8,549,041
            
            
            $
            7,038,888Supplemental
      Disclosure of Cash Flow Information:Cash
      payments for interest
            
            $
            -
            
            
            $
            48,158Cash
      payments for income taxes
            
            $
            -
            
            
            $
            1,143,785





See accompanying notes to unaudited
condensed consolidated financial statements.




5





Patriot
Scientific Corporation


Condensed
Consolidated Statements of Cash Flows


(Unaudited)




Nine
      months endedFebruary
      28, 2010
            
            
            February
      28, 2009Supplemental
      Disclosure of  Non-Cash Investing and Financing
      Activities:Conversion
      of note receivable to preferred stock – Avot Media, Inc.
            
            $
            -
            
            
            $
            250,000Insurance
      premium financed with a note payable
            
            $
            -
            
            
            $
            210,888Unrealized
      recovery on investments in marketable securities charged to other
      comprehensive income adjusted for deferred tax benefit
            
            $
            236,235
            
            
            $
            568,499Conversion
      of notes receivable plus accrued interest in connection with Crossflo
      Systems, Inc. acquisition
            
            $
            -
            
            
            $
            824,600Common
      stock issued in connection with Crossflo Systems, Inc.
      acquisition
            
            $
            -
            
            
            $
            6,582,214Conversion
      of note receivable plus accrued interest in connection with Verras
      Medical, Inc. acquisition
            
            $
            -
            
            
            $
            33,154




See
accompanying notes to unaudited condensed consolidated financial
statements.
 
 6


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements





1.  Basis
of Presentation and Summary of Significant Accounting Policies





The
unaudited condensed consolidated financial statements of Patriot Scientific
Corporation (the “Company”, “PTSC”, “Patriot”, “we”, “us” or “our”) presented
herein have been prepared pursuant to the rules of the Securities and Exchange
Commission (“SEC”) for quarterly reports on Form 10-Q and do not include all of
the information and footnotes required by accounting principles generally
accepted in the United States of America. These financial statements should be
read in conjunction with our audited consolidated financial statements and notes
thereto included in our Report on Form 10-K for our fiscal year ended May 31,
2009.





In the opinion of management, the
interim condensed consolidated financial statements reflect all adjustments of a
normal recurring nature necessary for a fair presentation of the results for the
interim period presented.  Operating results for the nine month period
ended February 28, 2010 are not necessarily indicative of the results that may
be expected for the year ending May 31, 2010.  We have evaluated
subsequent events through the filing date of this Form 10-Q, and determined that
no subsequent events have occurred that would require recognition in the
condensed consolidated financial statements or disclosure in the notes thereto
other than as disclosed in the accompanying notes.





Reclassifications





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





Basis
of Consolidation





The
condensed consolidated balance sheet at February 28, 2010 includes our accounts
and those of our wholly owned subsidiary Patriot Data Solutions Group, Inc.
(“PDSG”) which includes our acquisitions of Crossflo Systems, Inc., the business
line 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 balance sheet at May 31, 2009 and the condensed
consolidated statements of operations for the three and nine months ended
February 28, 2010 include our accounts and those of our wholly owned subsidiary
PDSG which includes Crossflo Systems, Inc., the assets of Verras Medical, Inc.
(until January 2010), and the business line Vigilys and our inactive subsidiary
Plasma Scientific Corporation.  All significant intercompany accounts
and transactions have been eliminated. Noncontrolling interest (previously shown
as minority interest) are reported below net income (loss) under the heading
“Income attributable to noncontrolling interests” in the condensed consolidated
statements of operations.  In January 2010, we sold the assets of
Verras Medical, Inc.  The operating results of Verras Medical from
June 2009 through the date of sale are included in the three and nine months
ended February 28, 2010 results.





The
condensed consolidated statements of operations for the three and nine months
ended February 28, 2009 include our accounts and those of our wholly owned
subsidiary Crossflo which is now part of PDSG, our majority owned inactive
subsidiary Plasma Scientific Corporation and the variable interest entity
(“VIE”) for which we were the primary beneficiary.  During September
2008, we dissolved our majority owned inactive subsidiary, Metacomp, Inc. All
significant intercompany accounts and transactions have been
eliminated.  Noncontrolling interest (previously shown as minority
interest) are reported below net income (loss) under the heading “Income
attributable to noncontrolling interests” in the condensed consolidated
statements of operations.




7


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Consolidation
of Affiliate





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





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





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





Beginning
with the quarter ended May 31, 2007, we consolidated Holocom, Inc.
(formerly known as Scripps Secured Data, Inc.) (“Holocom”) as Holocom was deemed
a VIE and we determined that we were the primary beneficiary of
Holocom.  During July 2008, Holocom obtained a credit facility for up
to $300,000 from a third party, the credit facility term extended to May 1,
2009, and was guaranteed by us.  As a result of our guarantee on the
third party credit facility, we maintained a variable interest in
Holocom.  Upon expiration of the credit facility on May 1, 2009, we
deconsolidated Holocom as we are no longer deemed to be the primary
beneficiary.  We are now recording our investment in Holocom under the
cost method (see Note 11).





Investments
in Marketable Securities





We
determine the appropriate classification of our investments at the time of
purchase and reevaluate such designation at each balance sheet
date.  Our investments in marketable securities have been classified
and accounted for as available-for-sale based on management’s investment
intentions relating to these securities.  Available-for-sale
marketable securities are stated at fair market value based on valuation by
Houlihan Smith & Company, Inc.  Unrealized gains and losses, net
of deferred taxes, are recorded as a component of other comprehensive income
(loss).  We follow the authoritative guidance to assess whether our
investments with unrealized loss positions are other than temporarily
impaired.  Realized gains and losses and declines in value judged to
be other than temporary are determined based on the specific identification
method and are reported in other income (expense), net in the condensed
consolidated statements of operations.





Investments
in Affiliated Companies





We have a
50% interest in Phoenix Digital Solutions, LLC (“PDS”) (see Note 11). This
investment is accounted for using the equity method of accounting since the
investment provides us the ability to exercise significant influence, but not
control, over the investee. Significant influence is generally deemed to exist
if we have an ownership interest in the voting stock of the investee of between
20% and 50%, although other factors, such as representation on the investee’s
board of directors, are considered in determining whether the equity method of
accounting is appropriate. Under the equity method of accounting, the
investment, originally recorded at cost, is adjusted to recognize our share of
net earnings or losses of the investee and is presented in the condensed
consolidated statements of operations in the caption “Equity in earnings (loss)
of affiliated companies, net.”




8
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Investments
in Affiliated Companies (continued)





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





We owned
37.1% of the preferred stock of Avot Media, Inc. (“Avot”) (see Note
11).  Prior to the write-off of our investment in Avot during the
quarter ended November 30, 2009, we were accounting for our investment at cost
since we did not have the ability to exercise significant influence over the
operating and financial policies of Avot.  During March 2010, Avot
sold substantially all of its assets and we collected our note receivable and
accrued interest (see Note 17).





We own
100% of the preferred stock of Holocom.  This investment has
historically been accounted for at cost since we do not have the ability to
exercise significant influence over the operating and financial policies of
Holocom. Due to a re-consideration event on May 1, 2009 (see Note 12), this
investment is carried at cost plus the effects of deconsolidation of this
variable interest entity on our condensed consolidated balance sheet since such
date.





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





Comprehensive
Income (Loss)





Comprehensive
income (loss) includes unrealized gains and losses which are excluded from the
condensed consolidated statements of operations.  For the nine months
ended February 28, 2010, this amount included unrealized losses on investments
classified as available-for-sale.  The amount is presented net of
tax-related benefits of $156,407.





Revenue
Recognition





Historically,
we recognized revenue from the sale of our microprocessor chips upon shipment to
the customer, at which time title transferred and we had no further
obligations.  We discontinued the sale of our microprocessor chips
during the first quarter of fiscal 2009.





Revenue
from technology license agreements is recognized at the time a contract is
entered into, the license method is determined (paid-in-advance or on-going
royalty), and the customer is provided with the licensed technology, if
applicable.  Fees for maintenance or support are recorded on a
straight-line basis over the underlying period of performance.


9
 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.
Revenue for support services is recognized on a straight-line basis over the
support period.





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





The
majority of PDSG’s contracts with customers, including systems integrators and
prime contractors, are multiple element arrangements which contain professional
services that are considered essential to the functionality of the other
elements of the arrangement.  PDSG accounts for revenue on these
arrangements according to authoritative guidance for contract accounting. Under
this guidance, PDSG recognizes revenue based on progress towards contract
completion measured by actual hours incurred in relation to the estimate of
total expected hours. PDSG measures these revenues by applying the
contract-specific estimated percentage of completion to the total contract
amount for software and professional services.  PDSG routinely updates
the estimates of future hours for agreements in process and reports any
cumulative effects of such adjustments in current operations. PDSG immediately
recognizes any loss expected on these contracts when it is projected that loss
is probable.





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





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





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





Research
and Development





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





10
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Shipping
and Handling





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





Net
Income (Loss) Per Share





Basic
earnings (loss) per share includes no dilution and is computed by dividing
income (loss) available to common stockholders by the weighted-average number of
common shares outstanding for the period. Diluted earnings (loss) per share
reflects the potential dilution of securities that could share in the earnings
(loss) of  an entity.




As a
result of our net loss for the three and nine months ended February 28, 2010, 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 these periods, an additional 2.9 million and 3.1
million shares of common stock would have been included in the number of shares
used to calculate diluted earnings per share in each of the three and nine
months ended February 28, 2010, respectively. Options and warrants in the amount
of 6.1 million shares of common stock were excluded from the computation of
diluted shares for the three and nine months ended February 28, 2010, as their
inclusion would have had an anti-dilutive effect.




As a
result of our net loss for the three months ended February 28, 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 3.1 million shares of
common stock would have been included in the number of shares used to calculate
diluted earnings per share for the three months ended February 28, 2009. Options
and warrants in the amount of 10.5 million shares and 9 million shares
of common stock were excluded from the computation of diluted shares for the
three and nine months ended February 28, 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 15).  We exclude these escrow shares from the
basic earnings (loss) per share calculations and include the escrowed shares in
the diluted earnings per share calculations.





The
following presents a reconciliation of the denominator used in the earnings per
share calculation for the nine months ended February 28, 2009:





Denominator
      shares
            
            
            401,578,784Effect
      of dilutive securities:Options
      and warrants
            
            
            582,313Add:  escrow
      shares
            
            
            1,865,160Total
            
            
            404,026,257





11
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Noncontrolling
Interest





In fiscal
2010, we adopted authoritative guidance which requires us to present
noncontrolling interest (previously shown as minority interest) in our condensed
consolidated financial statements under the heading “Income attributable to
noncontrolling interest” instead of separately presented as a reduction to net
income.  Such noncontrolling interest resulted from the accounting for
the acquisition of a noncontrolling interest in Holocom. Noncontrolling interest
represents a partially owned subsidiary’s income, losses, and components of
other comprehensive income (loss) which should be attributed to the controlling
and noncontrolling interests or other parties with a right or obligation that
affects the attribution of comprehensive income or loss, on the basis of their
contractual rights or obligations, if any, otherwise, on the basis of ownership
interests.





For the
three and nine months ended February 28, 2009, the noncontrolling interest
allocated $71,367 and $264,290, respectively, represented the entire amount of
Holocom’s net income after taxes on a consolidated basis.





Stock-Based
Compensation





Stock-based
compensation expense recognized during the period is based on the grant date
fair value of the portion of share-based payment awards ultimately expected to
vest during the period.  As stock-based compensation expense
recognized in the condensed consolidated statements of operations is based on
awards ultimately expected to vest, it has been reduced for estimated
forfeitures. Forfeitures are estimated at the time of grant and revised, if
necessary, in subsequent periods if actual forfeitures differ from those
estimates. The estimated average forfeiture rate for the three and nine months
ended February 28, 2010 of approximately  5% was based on
historical forfeiture experience and estimated future employee forfeitures. The
estimated expected term of option grants for the three and nine months ended
February 28, 2010 was five years.





Summary
of Assumptions and Activity





The fair
value of stock-based awards to employees and directors is calculated using the
Black-Scholes option pricing model, even though this model was developed to
estimate the fair value of freely tradable, fully transferable options without
vesting restrictions, which differ significantly from our stock options. The
Black-Scholes model also requires subjective assumptions, including future stock
price volatility and expected time to exercise, which greatly affect the
calculated values. The expected term of options granted is derived from
historical data on employee exercises and post-vesting employment termination
behavior. The risk-free rate selected to value any particular grant is based on
the U.S. Treasury rate that corresponds to the pricing term of the grant
effective as of the date of the grant. The expected volatility for the three and
nine months ended February 28, 2010 is based on the historical volatilities of
our common stock.  These factors could change  in the
future, affecting the determination of stock-based compensation expense in
future periods.





Three
      MonthsEnded
              February
      28,2010
              (Unaudited)
            
            Nine
      Months Ended
              February
      28, 2010
              (Unaudited)
            
            Three
      MonthsEnded
              February
      28,2009
              (Unaudited)
            
            Nine
      Months Ended
              February
      28, 2009
              (Unaudited)Expected
      term
            
            5
            years
            
            5
            years
            
            5
            years
            
            5
            yearsExpected
      volatility
            
            116
            %
            
            116-117
            %
            
            120-125
            %
            
            120-125
            %Risk-free
      interest rate
            
            2.14
            %
            
            2.14–2.55
            %
            
            1.67-1.75
            %
            
            1.67–3.23
            %


12
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements
 Stock-Based
Compensation (continued)
 
 A summary
of option activity as of February 28, 2010 and changes during the nine months
then ended, is presented below:





Shares
            
            
            Weighted
              Average
              Exercise
              Price
            
            
            Weighted
              Average
              Remaining
      Contractual
              Term
              (Years)
            
            
            Aggregate
              Intrinsic
              ValueOptions
      outstanding at June 1, 2009
            
            
            10,210,000
            
            
            $
            0.39Options
      granted
            
            
            670,000
            
            
            $
            0.18Options
      exercised
            
            
            (100,000
            )
            
            $
            0.07Options
      forfeited
            
            
            (4,979,061
            )
            
            $
            0.33Options
      outstanding at February 28, 2010
            
            
            5,800,939
            
            
            $
            0.42
            
            
            
            2.18
            
            
            $
            20,009Options
      vested and expected to vest at February 28, 2010
            
            
            5,764,455
            
            
            $
            0.42
            
            
            
            2.17
            
            
            $
            20,009Options
      exercisable at February 28, 2010
            
            
            5,071,259
            
            
            $
            0.45
            
            
            
            1.91
            
            
            $
            7,609




The
weighted average grant date fair value of options granted during the nine months
ended February 28, 2010 and 2009 was $0.15 and $0.16 per option,
respectively.  The total intrinsic value of options exercised during
the nine months ended February 28, 2010 and 2009, was $9,550 and $11,000,
respectively, based on the differences in market prices on the dates of exercise
and the option exercise prices.


The
aggregate intrinsic value represents the differences in market price at the
close of the quarter ($0.16 per share on February 28, 2010) and the exercise
price of outstanding, in-the-money options (those options with exercise prices
below $0.16) on February 28, 2010.


As of
February 28, 2010, there was $83,644 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 39 months.


13
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Stock-Based
Compensation (continued)
 
 The
following table summarizes employee and director stock-based compensation
expense for Patriot and employee stock-based compensation for PDSG for the three
and nine months ended February 28, 2010 and 2009, which was recorded as
follows:


Three
      Months Ended
            
            
            Nine
      Months Ended
            
            
            Three
      Months Ended
            
            
            NineMonths
      EndedFebruary 28,
      2010
            
            
            February
      28, 2010
            
            
            February28,
      2009
            
            
            February
      28, 2009Research
      and development - PDSG
            
            $
            14,061
            
            
            $
            18,609
            
            
            $
            397
            
            
            $
            774Selling,
      general and administrative expense - PDSG
            
            
            18,800
            
            
            
            44,476
            
            
            
            16,189
            
            
            
            31,759Selling,
      general and administrative expense - Patriot
            
            
            31,628
            
            
            
            156,263
            
            
            
            34,659
            
            
            
            281,866Total
            
            $
            64,489
            
            
            $
            219,348
            
            
            $
            51,245
            
            
            $
            314,399





During
the three and nine months ended February 28, 2009, Holocom recognized $(8,283)
and $5,129, respectively, of employee, consultant and director stock-based
compensation expense.





Recent
Accounting Pronouncements





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





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





In
September 2009, the FASB revised the authoritative guidance for revenue
arrangements with multiple deliverables.  This revised authoritative
guidance requires companies to allocate revenue in arrangements involving
multiple deliverables based on the estimated selling price of each deliverable,
even though such deliverables are not sold separately either by  the
company itself or other vendors. This revised authoritative guidance eliminates
the requirement that all undelivered elements must have objective and reliable
evidence of fair value before a company can recognize the portion of the overall
arrangement fee that is attributable to items that already have been delivered.
As a result, the new guidance may allow some companies to recognize




14
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Recent
Accounting Pronouncements (continued)





revenue
on transactions that involve multiple deliverables earlier than under current
requirements. This revised authoritative guidance is effective for revenue
arrangements entered into or materially modified in fiscal
years beginning on or after December 15, 2009. Early adoption is permitted at
the beginning of a company’s fiscal year. We will adopt this guidance on June 1,
2010 and have not determined the effect of the adoption on our consolidated
financial statements.





In
January 2010, the FASB revised the authoritative guidance for fair value
measurements and disclosures.  This revised authoritative guidance
requires companies to: disclose separately the amounts of significant transfers
in and out of Level 1 and Level 2 fair value measurements, describe the reasons
for the transfers and in the reconciliation for Level 3 fair value measurements
companies are to present separately information about purchases, sales,
issuances, and settlements on a gross basis.  The revised
authoritative guidance for Level 1 and 2 fair value measurements is effective
for interim and annual reporting periods beginning after December 15, 2009 and
the revised authoritative guidance for Level 3 fair value measurements is
effective for fiscal years beginning after December 15, 2010 and interim periods
within those fiscal years with early application permitted.  We
adopted this guidance on February 28, 2010.  The  adoption
did not have an effect on our consolidated financial statements.





On
February 24, 2010, the FASB revised the authoritative guidance for subsequent
events recognition and disclosure requirements. Among the various amendments,
the FASB eliminated the requirement for companies who are SEC filers to disclose
a date through which subsequent events have been evaluated in both issued and
revised financial statements.  The revised authoritative guidance is
effective upon issuance.  We adopted this guidance on February 24,
2010.





2.
Acquisitions





Crossflo





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





The
aggregate purchase price was $10,257,604, including $2,850,790 of cash, $824,600
of convertible notes and common stock valued at $6,582,214.  The value
of the 26,988,455 shares issued was based on the average closing price of our
common stock on the Electronic Bulletin Board as reported by NASDAQ over the ten
trading days immediately preceding September 1, 2008.





This
transaction was accounted for in accordance with FASB guidance for business
combinations and we have allocated the total purchase price to tangible and
identifiable intangible assets acquired and liabilities assumed based on their
estimated fair values.





15
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Acquisitions
(continued)





Purchase
      consideration:Price
      per share
            
            $
            0.24389Number
      of common shares issued
            
            
            26,988,455Value
      of shares issued
            
            
            6,582,214Cash
      paid, including acquisition costs
            
            
            2,850,790Principal
      and interest on convertible notes
            
            
            824,600$
            10,257,604





Allocation
      of purchase consideration:Tangible
      assets acquired:Cash
            
            $
            272,509Accounts
      receivable
            
            
            101,179Work-in-process
            
            
            11,658Deferred
      tax assets
            
            
            2,173,443Property
      and equipment
            
            
            49,399Prepaid
      expenses and other
            
            
            36,590Identifiable
      intangible assets acquired:Customer
      contracts – open orders
            
            
            63,600Maintenance
      agreements
            
            
            75,400Technologies
      and processes
            
            
            5,932,400Goodwill
            
            
            1,668,630Total
      assets acquired
            
            
            10,384,808Liabilities
      assumed:Current
      liabilities
            
            
            (127,204
            )$
            10,257,604





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





None of
our acquired intangible assets were assigned to research and development
assets.  The acquired intangible assets of $6,071,400 had a
weighted-average useful life of approximately 8 years.  The intangible
assets that made up that amount included customer contracts of $63,600 (0.75
year weighted-average useful life), maintenance agreements of $75,400 (4 year
weighted-average useful life) and technologies and processes of $5,932,400 (8
year weighted-average useful life).  During the quarter ended November
30, 2009 intangibles were impaired and the fair value of Crossflo’s technology
was reduced to $1,860,000 (see Note 3).





Goodwill
in the amount of $1,668,630 was assigned to the Crossflo
segment.  This amount is not deductible for income tax
purposes.  During the fiscal year ended May 31, 2009 goodwill was
impaired by approximately $236,000.  During the quarter ended November
30, 2009 goodwill was impaired by approximately $790,000 (see Note
3).





16
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Acquisitions
(continued)





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





The
deferred tax asset was calculated as follows:





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





The
deferred tax liability was calculated as follows:





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





The terms
of the merger agreement provided that additional purchase consideration of
2,844,630 shares of  our common stock (“Escrow Shares”) be deposited
with a third party escrow agent.  Per the Escrow Agreement, one year
following the closing date, the Escrow Shares shall be disbursed as follows:
first to Patriot to cover transaction expenses incurred in excess of estimated
transaction expenses at closing and for damages incurred as a result of any
breach of Crossflo’s representations, warranties and covenants made at closing;
next to the former stockholders of Crossflo in accordance with terms of the
Escrow Agreement; and lastly any shares remaining in the account shall be
returned to Patriot.  In the event that there is not an adequate
number of shares remaining in the escrow account one year from closing to
satisfy distribution to Crossflo stockholders in accordance with the terms of
the Escrow Agreement, Patriot is required to make up any difference in
cash.  Please see Note 15 for the status of the escrow
shares.





Proforma
Financial Information





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





17
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Acquisitions
(continued)





Nine
      Months EndedFebruary 28,2009Revenue
            
            $
            4,869,733Net
      loss
            
            $
            (113,414
            )Earnings
      per common share—basic
            
            $
            -Earnings
      per common share—diluted
            
            $
            -





Verras
Medical, Inc.





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





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





This
transaction was accounted for in accordance with FASB guidance for business
combinations and we have allocated the total purchase price to tangible and
identifiable intangible assets acquired based on their estimated fair
values.





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





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





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




18


Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial Statements


Acquisitions
(continued)





Pursuant
to the purchase agreement, Crossflo paid Verras $80,288 on December 3, 2008, and
the remaining $400,000 was paid in four equal installments on the three, six,
nine and twelve month anniversaries of the closing date.





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





Goodwill
in the amount of $196,512 was assigned to Verras.





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





On
January 25, 2010, the assets of Verras were sold for $250,000 and we recognized
a $182,397 gain upon disposal.  At closing we received $62,500 and a
non-interest bearing promissory note for $187,500.  Terms of the note
require payment on each of the three, six and nine month anniversaries of the
closing date.  Due to the immaterial nature of Verras, we have not
separately disclosed the disposal as discontinued operations in our condensed
consolidated statements of operations for the three and nine months ended
February 28, 2010.





Sale
      of Verras assets and resulting gain:Sales
      proceeds
            
            $
            250,000Assets
      sold:Trade
      accounts receivable
            
            
            752Fixed
      assets
            
            
            66,851Total
      value of assets sold
            
            
            67,603Gain
            
            $
            182,397





Proforma
Financial Information





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





Vigilys





On March
27, 2009, Crossflo acquired the VigilysTM Tactical Operating System (“Vigilys”)
business line from Kratos Defense & Security Solutions, Inc. for total cash
consideration of $197,004.





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




19
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Acquisitions
(continued)





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





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





Goodwill
in the amount of $110,004 was assigned to Vigilys.





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





Proforma
Financial Information





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





3.
Goodwill and Other Intangible Assets





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





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





The
following tables present 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
            
            
            
            
            February
      28,Years
            
            Value
            
            Amortization
            
            Impairment
            
            2010Customer
      contracts–open orders
            0.75
            
            $
            63,600
            
            $
            (63,600
            )
            $
            -
            
            $
            -Customer
      relationships
            5
            
            
            65,000
            
            
            (11,064
            )
            
            (53,936
            )
            
            -Maintenance
      agreements
            4
            
            
            75,400
            
            
            (23,565
            )
            
            (51,835
            )
            
            -Trademarks/names
            10
            
            
            124,500
            
            
            (11,972
            )
            
            (112,528
            )
            
            -Technologies
      and processes
            5–8
            
            
            6,136,900
            
            
            (1,033,825
            )
            
            (3,311,964
            )
            
            1,791,111$
            6,465,400
            
            $
            (1,144,026
            )
            $
            (3,530,263
            )
            $
            1,791,111





20
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Goodwill and Other Intangible
Assets (continued)





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





We have
included the amortization expense and related impairment charges on intangible
assets that relate to products sold in cost of sales.  We have
included amortization expense associated with Holocom’s patents in selling,
general and administrative expense on our condensed consolidated statement of
operations for the three and nine months ended February 28,
2009.





The
amortization expense related to intangible assets was as follows:





Three
      Months Ended
            
            
            Nine
      Months Ended
            
            
            Three
      Months Ended
            
            
            NineMonths
      EndedFebruary 28,
      2010
            
            
            February
      28, 2010
            
            
            February
      28, 2009
            
            
            February28,
      2009Amortization
      of intangible assets included in:Cost
      of sales
            
            $
            68,889
            
            
            $
            482,265
            
            
            $
            223,902
            
            
            $
            435,204Selling,
      general and administrative expense
            
            
            -
            
            
            
            -
            
            
            
            759
            
            
            
            2,277Total
            
            $
            68,889
            
            
            $
            482,265
            
            
            $
            224,661
            
            
            $
            437,481





At
February 28, 2010 the estimated future amortization expense of intangible assets
is estimated to be as follows:





Year2010
      (remaining three months)
            
            $
            68,8892011
            
            
            275,5562012
            
            
            275,5562013
            
            
            275,5562014
            
            
            275,556Thereafter
            
            
            619,998Total
      expected future amortization
            
            $
            1,791,111


21
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Goodwill and Other Intangible
Assets (continued)





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





Balance,
      June 1, 2008
            
            $
            -Goodwill
      of Crossflo acquired
            
            
            1,668,630Goodwill
      of Verras acquired
            
            
            196,512Goodwill
      of Vigilys acquired
            
            
            110,004Impairment
      of Crossflo goodwill
            
            
            (235,897
            )Balance,
      May 31, 2009
            
            
            1,739,249Impairment
      of Verras goodwill
            
            
            (196,512
            )Impairment
      of Vigilys goodwill
            
            
            (110,004
            )Impairment
      of Crossflo goodwill
            
            
            (789,752
            )Balance
      February 28, 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 and intangible assets,
accordingly at May 31, 2009, it was determined that goodwill was impaired by
approximately $236,000.  We recorded this as an impairment of goodwill
on our consolidated statement of income for the fiscal year ended May 31,
2009.





Management’s
plan of restructuring on October 5, 2009 and the continuing inability of PDSG to
meet its business plan were indicators of potential impairment on our goodwill
and intangible assets. Accordingly, at November 30, 2009, it was determined that
goodwill was impaired by approximately $1,096,000 and intangibles were impaired
by approximately $3,530,000.  We recorded these as impairments of
goodwill and purchased intangibles on our condensed consolidated statements of
operations for the nine months ended February 28, 2010.





4.
Cash, Cash Equivalents and Short-Term Investments





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





Restricted
cash and cash equivalents at February 28, 2010 consist of a savings account
required to be held  as collateral for our corporate credit card
account.





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





At
February 28, 2010 our short-term investments in the amount of $9,611 consists of
accrued interest receivable on our auction rate securities 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.





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





22
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


5.  Fair
Value Measurements





We follow
authoritative guidanceto account for our
financial assets and liabilities at fair value.  Under this
authoritative guidance we are required to maximize the use of observable inputs
and minimize the use of unobservable inputs when measuring fair value. We
determine fair value based on quoted prices when available or through the use of
alternative approaches, such as discounting the expected cash flows using market
interest rates commensurate with the credit quality and duration of the
investment or valuations by third party professionals. The three levels of
inputs that we may use to measure fair value are:





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





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





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





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





Quoted
      Prices in Active Markets
              Level
      1
            
            
            Significant
      Other Observable Inputs
              Level
      2
            
            
            Significant
              Unobservable
      Inputs
              Level
      3
            
            
            Balance
      as of
              February
      28, 2010Auction
      rate securities
            
            $
            —
            
            
            $
            —
            
            
            $
            7,391,031
            
            
            $
            7,391,031





The
valuation of these securities is based on Level 3 unobservable inputs which
consist of recommended fair values provided by Houlihan Smith & Company,
Inc.  As a result of the estimated fair value, we have determined that
there is a temporary impairment in the valuation of these securities of
$658,969.  We have recorded an unrealized loss of $393,079 in
accumulated other comprehensive loss at February 28, 2010, which represents the
gross valuation adjustment of $658,969, net of the related tax benefit of
$265,890. These securities are classified as “available-for-sale” and the
unrealized loss is included in other comprehensive income in the current period.
Due to the uncertainty related to the liquidity in the auction rate security
market, we have classified $7,391,031 of these auction rate securities as
long-term assets on the condensed consolidated balance sheet at February 28,
2010.





23
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Fair
Value Measurements (continued)





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





(Unaudited)
            
            Fair Value Measurements Using
              Significant
              Unobservable
      Inputs (Level 3)Description
            
            Auction
              Rate
              Securities
            
            
            TotalBeginning
      balance, May 31, 2009
            
            $
            11,650,000
            
            
            $
            11,650,000Transfers
      in to Level 3
            
            
            —
            
            
            
            —Total
      realized/unrealized losses:
            
            
            —
            
            
            
            —Included
      in earnings
            
            
            —
            
            
            
            —Included
      in comprehensive income (loss)
            
            
            (658,969
            )
            
            
            (658,969
            )Settlements
            
            
            (3,600,000
            )
            
            
            (3,600,000
            )Ending
      balance, February 28, 2010
            
            $
            7,391,031
            
            
            $
            7,391,031Total
      recovery of previously unrealized losses for the nine months ended
      February 28, 2010 included in other comprehensive loss attributable to the
      change in fair market value relating to assets still held at the reporting
      date
            
            $
            392,642
            
            
            $
            392,642





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 loss.





6.
Accounts Receivable





Trade
accounts receivable consisted of the following:





February
      28, 2010
            
            
            May
      31, 2009PTSC
            
            $
            -
            
            
            $
            1,708PDSG
            
            
            211,055
            
            
            
            166,694Total
            
            $
            211,055
            
            
            $
            168,402





No
allowance for doubtful accounts was necessary at February 28, 2010 or May 31,
2009.





At
February 28, 2010 and May 31, 2009, accounts receivable from our investee PDS
was $2,043 and $5,467, respectively.  These balances represent
reimbursements we submit to PDS for our legal and related costs incurred in
various legal matters of which we are listed as co-defendant with Technology
Properties Limited (“TPL”).


24
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


7.
Notes Receivable





Avot
Media, Inc.





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





On March
12, 2009, we entered into a secured revolving note receivable with Avot for
$500,000.  The note bore interest at a rate of 8% and was due December
12, 2009. The note was secured by the assets of Avot.  Upon entering
into the secured revolving loan note, the short term note we received from Avot
on February 24, 2009 was cancelled and the principal amount of $100,000 was
classified as an initial advance on the revolving loan note.  Under
terms of the note, not more than one request for advances shall be made within a
single month.  On March 13, 2009, April 1, 2009, May 11, 2009 and June
22, 2009, we advanced $115,000, $115,000, $115,000 and $55,000, respectively, to
Avot under terms of the note.  On December 12,
2009,  December 30, 2009 and February 18, 2010 we granted Avot
forbearances on the note which extended through March 5, 2010 to accommodate
Avot during the solicitation of its business for a capital raise or sale which
concluded with a March 2010 sale of substantially all of Avot’s assets and our
collection of $503,111 on the note receivable principal and interest (see Note
17). At February 28, 2010 the balance of the note receivable was $503,111,
including accrued interest receivable of $3,111.





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





Technology
Properties Limited, LLC





On
December 24, 2009, we entered into a secured note receivable with TPL for
$950,000, intended to cover operating costs including the furtherance of MMP
portfolio licensing, which is due and payable on or before July 12,
2010.  Terms of the note require interest payable at the rate of
10%.  The note is secured by TPL’s portion of its license receivable
distribution currently accounted for as license fees receivable on the February
28, 2010 balance sheet of PDS (see Note 11).  At February 28, 2010 the
balance of the note receivable was $967,438, including accrued interest
receivable of $17,438.





On
January 12, 2010, we entered into an unsecured note receivable with TPL for
$1,000,000, intended to cover operating costs including the furtherance of MMP
portfolio licensing, which was due and payable on or before February 28,
2010.  Terms of the note required interest payable at the rate of
10%.  As of the date of this filing, TPL is in default (see Note
17).  At February 28, 2010, the $1,013,151 balance of the note
receivable including accrued interest, 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.





25
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


8.
Work-In-Process





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





At
February 28, 2010 billings in excess of work-in-process was $23,490 which
represents the excess of invoices to customers over recognized revenue on PDSG’s
current contracts in progress.  We have recorded this amount as a
component of accrued expenses and other on our condensed consolidated balance
sheet at February 28, 2010.





9.
Investments in Marketable Securities





The
following tables show the cost, cumulative unrealized losses and fair value of
our investments in marketable securities with unrealized losses that are not
deemed to be other-than-temporarily impaired, aggregated by investment category
and length of time that individual securities have been in a continuous
unrealized loss position at February 28, 2010 and May 31, 2009.  As
stated in Note 5, the fair value of our  investments is based on
valuations by Houlihan Smith & Company, Inc. at February 28, 2010 and May
31, 2009:





As
      of February 28, 2010
              
              Twelve
      Months or GreaterCost
            
            
            Cumulative
              Unrealized
              Losses
            
            
            Estimated
              Fair
              ValueShort-termAccrued
      interest - auction rate securities
            
            $
            9,611
            
            
            $
            —
            
            
            $
            9,611Long-termAuction
      rate securities
            
            
            8,050,000
            
            
            
            (658,969
            )
            
            
            7,391,031Total
            
            $
            8,059,611
            
            
            $
            (658,969
            )
            
            $
            7,400,642





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





26
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Investments in Marketable
Securities(continued)





Auction Rate
Securities.The unrealized losses on our auction rate
securities are caused by the uncertainty that these securities will settle or
that we may have to redeem them for less than par value in the event we need
immediate access to these funds.  As of February 28, 2010 and May 31,
2009, we held auction rate securities with a par value totaling approximately $8
million and $11.7 million, respectively, that failed to sell at auction or be
redeemed.  During June 2009, auction rate securities with a par value
of $750,000 were redeemed by the issuers at par value.  In September
2009, auction rate securities with a par value of $2,500,000 were redeemed by
the issuer at par value.  In December 2009, auction rate securities
with a par value of $350,000 were redeemed by the issuers at par value. In the
event we need to access funds invested in these auction rate securities we would
not be able to liquidate these securities until (i) a future auction of these
securities is successful, (ii) they are refinanced and redeemed by the issuers,
or (iii) a buyer is found outside of the auction process.  The
investments consist of student loan auction rate instruments issued by various
state agencies pursuant to the Federal Family Educational Loan Program
(“FFELP”).  These investments are of high credit quality and the AAA
credit ratings of the investments have been reaffirmed since February
2010.  These instruments are collateralized in excess of the
underlying obligations, are insured by the various state educational agencies,
and are guaranteed by the Department of Education as an insurer of last
resort.  We do not intend to sell our auction rate securities before
we are able to recover our cost basis and it is more likely than not that we
will not have to sell our auction rate securities before recovery of our cost
basis.





Due to
the uncertainty surrounding the timing of a market recovery, we have classified
our auction rate securities as long-term investments in our condensed
consolidated balance sheet as of February 28, 2010.  As a result of
temporary declines in the fair value of our auction rate securities, which we
attribute to liquidity issues rather than credit issues, we have recorded an
unrealized loss of $393,079 in other comprehensive loss at February 28, 2010,
which represents the gross valuation adjustment of $658,969, net of the related
tax benefit of $265,890.  At May 31, 2009, we recorded an unrealized
loss of $629,314 in accumulated other comprehensive loss, which represents the
gross valuation adjustment of $1,051,611, net of the related tax benefit of
$422,297.


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





During
June 2008, we obtained a credit facility from Wedbush Morgan Securities, Inc.
(“Wedbush”) for as long as needed, which provides for financing up to 50% of the
par value balance of our outstanding auction rate securities. The facility is
collateralized by the full value of the outstanding auction rate securities,
required no origination fee, and when drawn upon will bear interest at the
federal funds rate plus 3%.  On October 14, 2008, we borrowed
$3,000,000 on the credit facility, the proceeds of which is included in cash and
cash equivalents at February 28, 2010 (see Note 13).





10.
License Agreements





In
February 2005, we entered into two separate licensing agreements with one
customer for our patent portfolio and Ignite microprocessor technology. The
aggregate amount of the two licenses was $3,050,000, of which $2,950,000 was for
licensing fees and $100,000 was for maintenance services. Maintenance under the
agreement was expected to be provided over a period not to exceed four years,
which ended in February 2009. Maintenance revenue recognized during the three
and nine months ended February 28, 2009 was approximately $6,250 and $18,750,
respectively.


27
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


11.
Investments in Affiliated Companies





Phoenix
Digital Solutions, LLC





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





We and
TPL each own 50% of the membership interests of PDS, and each of us has the
right to appoint one member of the three member management committee. The two
appointees are required to select a mutually acceptable third member of the
management committee. Pursuant to the LLC Agreement, we and TPL agreed to
establish a working capital fund for PDS of $4,000,000, of which our
contribution was $2,000,000. The working capital fund increases to a maximum of
$8,000,000 as license revenues are achieved. We and TPL are obligated to fund
future working capital requirements at the discretion of the management
committee of


PDS in
order to maintain working capital of not more than $8,000,000. Neither we nor
TPL are required to contribute more than $2,000,000 in any fiscal
year.  During the quarter ended November 30, 2009 we and TPL each
contributed $80,000 to PDS for working capital requirements.  In
December 2009, we and TPL each contributed $500,000 to PDS for working capital
requirements.  Distributable cash and allocation of profits and losses
will be allocated to the members in the priority defined in the LLC
Agreement.





Pursuant
to the June 2005 Master 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 nine months ended February 28,
2010 and 2009, PDS expensed $1,500,000 and $2,369,114, respectively, pursuant to
this commitment.





PDS
reimburses TPL for payment of all legal and third-party expert fees, other
related third-party costs and expenses, and certain internally generated costs
as approved on August 17, 2009 and more fully described below.  During
the nine months ended February 28, 2010 and 2009, PDS expensed $3,590,714 and
$2,830,264, respectively, pursuant to the agreement.





On
November 13, 2008, the management committee of PDS resolved to pay TPL 3% of the
gross licensing revenue received by PDS for the period June 1, 2008 through May
31, 2009, as reimbursement for certain expenses incurred by TPL in connection
with TPL’s activities related to a possible amendment of patent laws in the
United States.  The aggregate reimbursement under this resolution was
not to exceed $1,000,000 for the period June 1, 2008 through May 31,
2009.  From November 2008 to May 31, 2009, PDS expensed $571,500
pursuant to this resolution.





On August
17, 2009, the management committee of PDS resolved to pay TPL $500,000 per
quarter beginning on June 1, 2009 and continuing through May 31, 2010 relating
to TPL’s special work and effort regarding the MMP litigation and U.S. Patent
Office re-examinations.  In the event that PDS has insufficient funds
to make such payments, we are required to advance half of the quarterly amount
to PDS.  Our advance to PDS will be without interest and must be
repaid to us no later than May 31, 2010.  In August 2009, TPL received
two $500,000 payments from PDS pursuant to this agreement, the first of which is
in dispute. At November 30, 2009, $500,000 was accrued by PDS pursuant to
this agreement and funded to TPL by PDS in December 2009.  At February
28, 2010 $500,000 was accrued by PDS pursuant to this
agreement.  These amounts are included in the legal and third-party
expert fees, other related third-party costs and expenses, and certain
internally generated costs listed above.  As of the date of this
filing, we have not advanced any funds to PDS under this resolution and do not
anticipate any advances to PDS through May 31, 2010, the termination date of
this resolution.




28
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements




Investments
in Affiliated Companies (continued)




Based on
our analysis of current authoritative accounting guidance with respect to our
investment in PDS, including the notes receivable to TPL described in Note 7, we
continue to account for our investment in PDS under the equity method of
accounting, and accordingly have recorded our share of PDS’ net income during
the three months ended February 28, 2010, of $385,697 as an increase in our
investment. We have recorded our share of PDS’ net loss during the three months
ended February 28, 2009, of $751,021 as a decrease in our
investment.  We have recorded our share of PDS’ net income during the
nine months ended February 28, 2010 and 2009, of $3,879,764 and $6,121,970,
respectively,  as an increase in our investment.  Cash
distributions received from PDS during the nine months ended February 28, 2010
and 2009 of $7,377,827 and $7,648,589, respectively, have been recorded as a
reduction in our investment. Our investment in PDS is $84,203 at February 28,
2010 and has been recorded as “Investments in Affiliated
Companies”.  We have recorded our share of PDS’ net income for the
three and nine months ended February 28, 2010 and 2009 as “Equity in earnings
(loss) of affiliated companies, net” in the accompanying condensed consolidated
statements of operations.





During
the three months ended February 28, 2010 and 2009, TPL entered into licensing
agreements with third parties, pursuant to which PDS recorded aggregate proceeds
of $1,875,000 and $290,000, respectively.





During
the nine months ended February 28, 2010 and 2009, TPL entered into licensing
agreements with third parties, pursuant to which PDS recorded aggregate proceeds
of $12,898,655 and $19,340,000, respectively. $2,000,000 of these proceeds are
to be received in July 2010 and accordingly have been recorded as licenses
receivable on the February 28, 2010 condensed balance sheet of PDS.





At
February 28, 2010, PDS had accounts payable  and accrued expense
balances of approximately $1,982,000 and $2,000  to TPL and PTSC,
respectively.  At May 31, 2009, PDS had accounts payable balances of
approximately $1,482,000 and $5,500 to TPL and PTSC, respectively.





PDS’
condensed balance sheets at February 28, 2010 and May 31, 2009 and statements of
operations for the three and nine months ended February 28, 2010 and 2009 are as
follows:





Condensed
Balance Sheets





ASSETS:


February
      28, 2010
            
            
            May
      31, 2009Cash
      and cash equivalents
            
            $
            152,720
            
            
            $
            1,343,582Licenses
      receivable
            
            
            2,000,000
            
            
            
            6,148,750Total
      assets
            
            $
            2,152,720
            
            
            $
            7,492,332





29
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements





Investments
in Affiliated Companies (continued)





LIABILITIES
AND MEMBERS’ EQUITY:





February
      28, 2010
            
            
            May
      31, 2009Accounts
      payable and accrued expenses
            
            $
            1,984,314
            
            
            $
            1,487,799Members’
      equity
            
            
            168,406
            
            
            
            6,004,533Total
      liabilities and members’ equity
            
            $
            2,152,720
            
            
            $
            7,492,332





Condensed
Statements of Operations





Three
      Months Ended
            
            
            Nine
      Months EndedFebruary
      28, 2010
            
            
            February
      28, 2009
            
            
            February
      28, 2010
            
            
            February
      28, 2009Revenues
            
            $
            1,875,000
            
            
            $
            290,000
            
            
            $
            12,898,655
            
            
            $
            19,340,000Operating
      expenses
            
            
            1,103,621
            
            
            
            1,807,244
            
            
            
            5,139,522
            
            
            
            5,893,877Operating
      income (loss)
            
            
            771,379
            
            
            
            (1,517,244
            )
            
            
            7,759,133
            
            
            
            13,446,123Interest
      and other income
            
            
            15
            
            
            
            15,202
            
            
            
            395
            
            
            
            58,580Net
      income (loss)
            
            $
            771,394
            
            
            $
            (1,502,042
            )
            
            $
            7,759,528
            
            
            $
            13,504,703





Talis
Data Systems, LLC





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





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





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





The
inability of Talis to meet its business plan, raise capital, and the general
economic environment were indicators of impairment on our investment,
accordingly at August 31, 2009, it was determined that our investment in Talis
was impaired by approximately $680,000.  We have recorded this as an
impairment of investment in affiliated companies on our condensed consolidated
statement of operations for the nine months ended February 28,
2010.





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




30
 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.





Avot
Media, Inc.





During
the quarter ended August 31, 2008, we invested an aggregate of $1,300,000,
including conversion of  a note receivable in the amount of $250,000,
to obtain 14,444,444 shares of Series B preferred stock issued by Avot,
representing 53.3% of the Series B preferred stock and 37.1% of all Avot’s
preferred shares issued and outstanding.





We
reviewed the Series B Preferred Stock Purchase Agreement and related agreements
in addition to evaluating our voting rights for our investment in the preferred
stock of Avot, and as such we have concluded that we do not have the ability to
exercise significant control over Avot.  As a result, we are
accounting for our investment in Avot at cost.





During
March 2009, we entered into a revolving loan note with Avot.  At
February 28, 2010, the balance on the note receivable is $503,111 (see Note
7).





The
inability of Avot to meet its business plan, to raise capital, and the general
economic environment were indicators of impairment on our investment, it was
determined that our investment in Avot was impaired by approximately
$867,000.





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





During
the quarter ended November 30, 2009 we wrote off $433,333 which represented the
remaining fair value of our preferred stock investment in Avot.  We
have presented the $433,333 as an impairment of investment in affiliated
companies on our condensed consolidated statements of operations for the nine
months ended February 28, 2010.





During
March 2010, Avot sold substantially all of its assets and we collected our note
receivable (see Note 17).  There was not adequate consideration to redeem
any portion of our preferred stock investment which had been fully written off
during the fiscal quarters ending in May and November 2009.





31
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Investments
in Affiliated Companies (continued)





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




On
February 2, 2007, we invested an aggregate of $370,000 in convertible preferred
stock, representing all of the issued preferred stock and a 46% ownership
interest, of and in Holocom, a California corporation that manufactures products
that protect information transmitted over secure networks. The investment
consisted of certain assets we contributed to Holocom valued at $250,000 and
cash of $120,000. The investment is represented by 2,100,00 shares of
convertible preferred stock, and the shares are convertible at our option into
shares of Holocom’s common stock on a one-to-one basis. The convertible
preferred stock entitles us to receive non-cumulative dividends at the per annum
rate of $0.04 per share, when and if declared by the Board of Directors of
Holocom. The investment in Holocom’s convertible preferred stock also entitles
us to a liquidation preference of $0.40 per share, plus an amount equal to all
declared but unpaid dividends.




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




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





At
February 28, 2010, our investment in Holocom is $435,182 and has been recorded
as “Investments in Affiliated Companies” on our condensed consolidated balance
sheet at February 28, 2010.





12.
Formerly Consolidated Variable Interest Entity





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





32
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Formerly
Consolidated Variable Interest Entity (continued)





For the
three and nine months ended February 28, 2009, the noncontrolling interest
(previously reported as minority interest) allocated $71,367 and $264,290,
respectively, represented the entire amount of Holocom’s net income after taxes
on a consolidated basis.





13. Notes
Payable





On
October 14, 2008, we borrowed $3,000,000 on our credit facility with Wedbush,
the proceeds of which is included in cash and cash equivalents at February 28,
2010 and May 31, 2009.  Per requirements of The Financial Industry
Regulatory Authority (“FINRA”), the credit facility is limited to 50% of the par
value of our outstanding auction rate securities.  As of the date of
this filing, the par value of our outstanding auction rate securities was
$8,050,000, which limits our credit facility to $4,025,000.  The
facility is collateralized by the full value of the outstanding auction rate
securities, requires no origination fee and bears interest at the federal funds
rate plus 3%.  At February 28, 2010 and May 31, 2009, the balance
included accrued interest on the credit facility of $101,634 and $41,577,
respectively, at an approximate rate of 3.25%.





14. Stockholders’
Equity





Comprehensive Income
(Loss)





Comprehensive
income (loss) includes unrealized gains and losses on certain investments
classified as available-for-sale, net of tax, which are excluded from our
condensed consolidated statements of operations. Comprehensive income (loss) for
the three and nine months ended February 28, 2010 and 2009 was as
follows:





Three
      Months Ended
            
            
            Nine
      Months EndedFebruary
      28, 2010
            
            
            February
      28, 2009
            
            
            February
      28, 2010
            
            
            February
      28, 2009Net
      income (loss) attributable to PTSC
            
            $
            (938,271
            )
            
            $
            (1,489,347
            )
            
            $
            (5,669,971
            )
            
            $
            787,906Unrealized
      holding gain (losses) on investments, net of taxes
            
            
            (1,713
            )
            
            
            41,226
            
            
            
            236,235
            
            
            
            (568,499
            )Total
      comprehensive income (loss) attributable to PTSC
            
            $
            (939,984
            )
            
            $
            (1,448,121
            )
            
            $
            (5,433,736
            )
            
            $
            219,407





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 1,057,378 and 5,839,141
shares of our common stock at an aggregate cost of $165,564 and $1,095,944
during the nine months ended February 28, 2010 and 2009,
respectively.





33
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Stockholders’
Equity (continued)





Equity
Transactions





The
following table summarizes equity transactions during the nine months ended
February 28, 2010:





Common
      Stock
            
            
            Additional
      Paid-inShares
            
            
            Amounts
            
            
            Capital
            
            
            Accumulated
      Deficit
            
            
            Treasury
      StockBalance
      June 1, 2009
            
            
            410,354,054
            
            
            $
            4,380
            
            
            $
            77,008,332
            
            
            $
            (32,881,848
            )
            
            $
            (13,850,659
            )Exercise
      of stock options
            
            
            100,000
            
            
            
            1
            
            
            
            7,449
            
            
            
            -
            
            
            
            -Share-based
      compensation
            
            
            - -
            
            
            
            -
            
            
            
            213,273
            
            
            
            -
            
            
            
            -Repurchase
      of common stock for treasury
            
            
            (1,057,378
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (165,564
            )Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (5,669,971
            )
            
            
            -Balance
      February 28, 2010
            
            
            409,396,676
            
            
            $
            4,381
            
            
            $
            77,229,054
            
            
            $
            (38,551,819
            )
            
            $
            (14,016,223
            )





Stock Optionsand Warrant
Activity





As of
February 28, 2010, we had 375,000 options outstanding pursuant to our 2001 Stock
Option Plan exercisable at a range of $0.47 to $0.86 per share expiring through
2012; 850,000 options outstanding pursuant to our 2003 Stock Option Plan
exercisable at $0.163 per share expiring through 2010; and 4,575,939 options
outstanding pursuant to our 2006 Stock Option Plan exercisable at a range of
$0.09 to $0.70 per share expiring through 2014.





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





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





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





On
December 9, 2009, a director exercised stock options to purchase 100,000 shares
of common stock for proceeds of $7,450.





During
the nine months ended February 28, 2010, we recorded $213,273 of share-based
compensation expense related to vesting of stock options and warrants, including
$63,085 related to PDSG.  During the nine months ended February 28,
2009, we recorded $324,380 of share-based compensation expense related to
vesting of stock options and warrants, including $5,129 related to Holocom and
$32,533 relating to PDSG.





As of
February 28, 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.  On January 25, 2010, we issued 25,000 warrants
expiring on December 21, 2010 with an exercise price of $0.15 to a former
consultant in connection with a legal settlement.  We recorded $858 of
share-based compensation in connection with the issuance.  On November
9, 2009, we gave notice to our current investor relations firm of our intent to
cancel our contract within 30 days.  Accordingly, the 250,000 warrants
granted under contract that were not vested were cancelled.  In
connection with the cancellation of the unvested warrants we reversed
approximately $10,400 of share-based compensation previously recorded, including
$6,933 recorded during the year ended May 31, 2009.




34
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


15. Commitments
and Contingencies





Litigation





Patent
Litigation





On
February 8, 2008, we, TPL and Alliacense Ltd. were named as defendants in three
separate lawsuits filed in the United States District Court for the Northern
District of California by Asustek Computer, Inc., HTC Corporation, and Acer,
Inc., and affiliated entities of each of them.





The Asustekcase sought
declaratory relief that its products do not infringe enforceable claims of the
'336 and '584 patents and US 5,440,749 (the “749 patent”). The Asustekcase also sought a
similar declaration with respect to two patents owned by TPL that are not a part
of the MMP Portfolio, and as such we are not engaged in this aspect of the
litigation and defense.  On December 22, 2008, we announced that
Asustek had purchased a MMP Portfolio license and that case has
settled.





The Acercase seeks declaratory
relief that its products do not infringe enforceable claims of the '336, '584,
‘749, '148 patents and US 5,530,890 (the “890 patent”). The HTCcase similarly seeks
declaratory relief that its products do not infringe enforceable claims of those
patents.  We allege counterclaims for patent infringement of the '336,
'749, '148 and '890 patents against Acer and HTC.  On June 16, 2009,
District Court Judge Jeremy Fogel stayed the HTCand Acer actions until September
18, 2009.  The stay has now been lifted and the cases are proceeding
into the discovery 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 '584, '749
and '890 patents.  We allege counterclaims for patent infringement of
our '749, '890 and '336 patents.  On June 22, 2009, Judge Fogel also
stayed the Barco case
until September 18, 2009.  That stay has now been lifted and the case
is deemed related to the Acer and HTC
cases.  Discovery is now beginning in the Barco case.





On April
29, 2009, we, TPL, and Alliacense Ltd., were named as defendants in a lawsuit
filed in the United States District Court for the Southern District of New York
by Sirius XM Radio, Inc.  The Sirius case seeks declaratory
relief that its products do not infringe enforceable claims of our '749, '584,
'890, '360 and '148 patents, and additionally two patents of TPL's "fast logic"
portfolio which do not involve us.  Our Motion to Transfer the Sirius action to the United
States District Court for the Northern District of California was granted on
February 16, 2010.  The Sirius case is deemed related
to the Acer, HTC and
Barcocases.  Discovery will proceed with the other cases except that
the “fast logic” discovery phase will occur separately and later.





In the
HTC and Barco cases the parties have stipulated to non-infringement of the ‘584
patent and that patent will not be litigated in those cases.





35
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Commitments
and Contingencies (continued)





Deutsche
Bank Arbitration





On
October 16, 2008, we initiated binding arbitration claims before FINRA against
Deutsche Bank Securities, Inc., and affiliates ("DBSI") based on advisory
services provided to us resulting in our purchases of auction rate securities
("ARS") and the failure of the ARS market in February 2008.  We
experienced a loss of liquidity and other damages as a result and allege DBSI
engaged in negligence and nondisclosure in providing us
services.  DBSI has answered our claims, and an arbitration panel has
been selected.  Document discovery has been initiated.  Some
instruments have been repurchased by the issuers since the claim was filed
(see  Note 17).  The arbitration is scheduled to begin June
8, 2010.





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





Crossflo
Systems, Inc. Litigation





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





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





401(k)
Plan





Patriot
and PDSG have retirement plans that comply with Section 401(k) of the Internal
Revenue Code. All employees are eligible to participate in the plans. Patriot
matches 50% of each participant’s voluntary contributions, subject to a maximum
contribution of 6% of the participant’s compensation. Patriot’s participants
vest 33% per year over a three year period in their contributions. Patriot’s
matching contributions during the nine months ended February 28, 2010 and 2009
were $14,602 and $10,488, 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.




36
 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.





Bonuses





In
connection with the acquisition of Crossflo, retention bonuses were to be paid
to individuals who were Crossflo employees pre-merger who remain with PDSG until
March 1, 2010.  In connection with the acquisition of Vigilys, a
retention bonus is to be paid to a key employee who remains with PDSG until
March 27, 2010.  The projected liability for such bonuses is
$75,000.  These liabilities are being accrued ratably over the
retention periods.  During March 2010 retention bonuses in the amount
of $75,000 were paid to qualified key employees.





By the
terms of his employment contract, our CFO, who also currently serves as our
interim CEO, is eligible to earn an annual bonus equivalent to 50% of his base
salary.  In connection with management’s restructuring plan on October 5,
2009 our Compensation Committee determined that this bonus would be payable at
the end of the interim period.  The projected liability for such bonus is
$145,875 and has been recorded on our condensed consolidated balance sheet in
“Accrued expenses and other” at February 28, 2010.





Escrow
Shares





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





Severance
Payments





In
connection with management’s restructuring plan, on October 7, 2009, we entered
into a Separation Agreement with our former CEO which requires us to pay his
base salary for the next seven months in exchange for a general release of
claims against us.  At February 28, 2010, the current balance of the
liability is $58,471 and we have recorded the liability on our condensed
consolidated balance sheet in “Accrued expenses and other”.





37
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


16.
Segment Information





Holocom
began operations in February 2007 and we consolidated Holocom in our
consolidated financial statements commencing in March 2007.  Due to a
re-consideration event we deconsolidated Holocom May 1, 2009 (see Note 12).
Holocom was an operating segment as revenue was 10% or more of the total revenue
of all operating segments.





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





We
acquired PDSG in a series of transactions in the second, third and fourth
quarters of fiscal 2009 and consolidate our wholly-owned subsidiary PDSG in our
consolidated financial statements.  PDSG provides data sharing
services and products to the public sector.  There is no inter-segment
revenue and the accounting policies for segment reporting are the same as for us
as a whole.





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





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





Operating
segment net revenue, operating loss and income (loss) before taxes for the three
and nine months ended February 28, 2010 and 2009 were as follows:





Three
      Months Ended
            
            
            Nine
      Months EndedFebruary
      28, 2010
            
            
            February
      28, 2009
            
            
            February
      28, 2010
            
            
            February
      28, 2009Net
      revenue:Holocom
            
            $
            -
            
            
            $
            1,187,128
            
            
            $
            -
            
            
            $
            4,117,152PDSG
            
            
            183,474
            
            
            
            216,823
            
            
            
            346,925
            
            
            
            475,177All
      other
            
            
            -
            
            
            
            6,250
            
            
            
            -
            
            
            
            51,780Total
      net revenue
            
            $
            183,474
            
            
            $
            1,410,201
            
            
            $
            346,925
            
            
            $
            4,644,109Operating
      loss:Holocom
            
            $
            -
            
            
            $
            115,839
            
            
            $
            -
            
            
            $
            575,981PDSG
            
            
            (746,431
            )
            
            
            (1,037,586
            )
            
            
            (8,425,959
            )
            
            
            (1,945,375
            )All
      other
            
            
            (775,000
            )
            
            
            (721,585
            )
            
            
            (2,837,694
            )
            
            
            (2,961,223
            )Total
      operating loss
            
            $
            (1,521,431
            )
            
            $
            (1,643,332
            )
            
            $
            (11,263,653
            )
            
            $
            (4,330,617
            )Income
      (loss) before taxes:Holocom
            
            $
            -
            
            
            $
            116,815
            
            
            $
            -
            
            
            $
            574,084PDSG
            
            
            (564,033
            )
            
            
            (1,037,586
            )
            
            
            (8,234,226
            )
            
            
            (1,942,389
            )All
      other
            
            
            (1,371,847
            )
            
            
            (1,608,583
            )
            
            
            (1,056,636
            )
            
            
            3,057,006Total
      income (loss) before taxes
            
            $
            (1,935,880
            )
            
            $
            (2,529,354
            )
            
            $
            (9,290,862
            )
            
            $
            1,688,701





38
 Patriot
Scientific Corporation
 Notes
to Unaudited Condensed Consolidated Financial
Statements


Segment
Information (continued)





Operating
segment total assets at February 28, 2010 and May 31, 2009 were as
follows:





February
      28, 2010
            
            
            May
      31, 2009Total
      assets:PDSG
            
            $
            7,546,705
            
            
            $
            10,067,007All
      other
            
            
            20,530,915
            
            
            
            23,659,945Total
      assets
            
            $
            28,077,620
            
            
            $
            33,726,952





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





Sales
concentration information for Holocom for the  nine months ended
February 28, 2009 was as follows:





Nine
      months ended
              February
      28, 2009Sales
            
            
            %
      of salesCustomer
      A
            
            $
            1,759,561
            
            
            
            42%Customer
      B
            
            $
            661,638
            
            
            
            16%Customer
      C
            
            $
            899,540
            
            
            
            22%





Accounts
receivable concentration information for PDSG as of February 28, 2010 and May
31, 2009  and sales concentration information for the nine months
ended February 28, 2010 and 2009 were as follows:





Nine
      months ended
              February
      28, 2010
            February
      28,
              2010
            Nine
      months ended
              February
      28, 2009
            May
      31,
              2009Sales
            %
      of sales
            %
      of A/R
            Sales
            %
      of sales
            %
      of A/RCustomer
      A
            -----
            ----
            -----
            $248,487
            52%
            60%Customer
      B
            $13,671
            4%
            -----
            $81,387
            17%
            ----Customer
      C
            -----
            ----
            -----
            $17,500
            4%
            18%Customer
      D
            $100,254
            29%
            39%
            -----
            ----
            14%Customer
      E
            $128,231
            37%
            61%
            $17,650
            4%
            ----





17.  Subsequent
Events





During
the period March 1, 2010 through April 5, 2010, we purchased 113,096 shares of
our common stock at an aggregate cost of $16,796 pursuant to our stock buyback
program.





During
March 2010 Avot sold substantially all of its assets.  On March 17,
2010, we received $503,111 which consists of full payment of the principal and
interest on our note receivable with Avot.





On March
1, 2010, we notified TPL that it was in default of the $1,000,000 unsecured note
receivable and we demanded payment thereon.  As a result, the quarterly
advances due to TPL on March 1, 2010 pursuant to the June 2005 Master Agreement,
and the special litigation payment due to TPL by February 28, 2010 as authorized
on August 17, 2009, have not been funded through PDS.





During
March 2010, we paid $75,000 in retention bonuses to eligible PDSG employees in
connection with their employment offer letters.


39


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





CAUTIONARY NOTE REGARDING FORWARD-LOOKING
STATEMENTS




This Quarterly Report on Form 10-Q, including all
documents incorporated by reference herein, includes certain statements
constituting “forward-looking” statements within the meaning of Section 27A of
the Securities Act of 1933, as amended (the “Securities Act”), Section 21E of
theSecurities Exchange Act of 1934, as
amended (the “Exchange Act”)and the
Private Securities Litigation Reform Act of 1995, including statements
concerning our beliefs, plans, objectives, goals, expectations, anticipations,
estimates, intentions, operations, future results and prospects, and we rely on
the “safe harbor” provisions in those laws. We are including this statement for
the express purpose of availing ourselves of the protections of such safe
harbors with respect to all such forward-looking statements. The forward-looking
statements in this report reflect are our current views with respect to future
events and financial performance.  In this report, the words
“anticipates,” “believes,” “expects,” “intends,” “future,” “estimates,” “may,”
“could,” “should,” “would,” “will,” “shall,” “propose,” “continue,” “predict,”
“plan” and similar expressions are generally intended to identify certain of the
forward-looking statements. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the date
made.  Any forward-looking statement is not a guarantee of future
performance.




These forward-looking statements are subject to certain
risks and uncertainties, and actual results may differ materially from those in
the forward-looking statements as a result of various factors, including, but
not limited to:




-the uncertainty of the effect of
pending legislation;




-the uncertainty of patent and
proprietary rights;




-uncertainty as to royalty
payments and indemnification risks;




-trading risks of low-priced
stocks; and




-other risks and uncertainties
discussed herein and in our other Securities and Exchange Commission (“SEC”)
filings that could cause our actual results to differ materially from our
historical results or those we anticipate.




You should read this report completely with the
understanding that our actual results may differ materially from what we
expect.  Unless required by law, we undertake no obligation to
publicly release the result of any revision of these forward-looking statements
to reflect events or circumstances after the date they are made or to reflect
the occurrence of unanticipated events.





Overview





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





Through
the date of this filing we and TPL each contributed $580,000 to fund the working
capital of Phoenix Digital Solutions, LLC (“PDS”).  We expect the
contributions to continue in the future due to the working capital demands of
PDS.  Additionally, we have loaned TPL $1,950,000 intened to cover
operating costs including the furtherance of licensing our MMP Portfolio of
microprocessor patents.  At February 28, 2010, we have reserved
$1,013,151 against the $1,000,000 note receivable which includes accrued
interest.




40




On
October 5, 2009, we announced a reorganization of Patriot Data Solutions Group,
Inc. (“PDSG”) and our management.  On November 12, 2009, we announced
our intent to divest the Iameter portfolio of data analysis and software
programs; and on January 25, 2010, we sold the Iameter assets.  As a
result of our reorganization and PDSG’s continued inability to meet its business
plan, we have incurred impairment charges for our intangibles and goodwill in
the PDSG segment of our business.  We continue to fund the day to day
operating costs of PDSG while continuing to reduce expenses.





Cash
shortfalls 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.





Critical
Accounting Policies and Estimates





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





1.Revenue
Recognition





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





Our
wholly-owned subsidiary PDSG sells software and services to end users primarily
through relationships with systems integrators and prime
contractors.  PDSG’s revenue is derived primarily from the following
sources: (i) software licensing, (ii) related professional services,
and (iii) post contract customer support (“PCS”) agreements.  PCS
agreements typically include software updates, on a when and if available basis,
and telephone and Internet access to technical support personnel. Software
updates provide customers with rights to unspecified software product upgrades
and to maintenance releases and patches released during the term of the support
period. Revenue for support services is recognized on a straight-line basis over
the support period.





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





The
majority of PDSG’s contracts with customers, including systems integrators and
prime contractors, are multiple element arrangements which contain professional
services that are considered essential to the functionality of the other
elements of the arrangement.  PDSG accounts for revenue on these
arrangements according to authoritative guidance for contract
accounting.  PDSG recognizes revenue based on progress towards
contract completion measured by actual hours incurred in relation to the
estimate of total expected hours. PDSG measures revenues by applying the
contract-specific estimated percentage of completion to the total contract
amount for software and professional services.  PDSG routinely updates
the estimates of future hours for agreements in process and reports any
cumulative effects of such adjustments in current operations. PDSG immediately
recognizes any loss expected on these contracts when it is projected that a loss
is probable.




41




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





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





2.Assessment of Contingent
Liabilities





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





3.Stock Options and
Warrants





We follow
authoritative guidance which establishes standards for the accounting of
transactions in which an entity exchanges its equity instruments for goods or
services, primarily focusing on accounting for transactions where an entity
obtains employee services in share-based payment transactions. We are required
to measure the cost of employee services received in exchange for an award of
equity instruments, including stock options, based on the grant-date fair value
of the award and to recognize it as compensation expense over the period the
employee is required to provide service in exchange for the award, usually the
vesting period.





Stock-based
compensation expense recognized during the period is based on the grant date
fair value of the portion of share-based payment awards ultimately expected to
vest during the period.As stock-based compensation expense recognized in the consolidated
statements of operations is based on awards ultimately expected to vest, it has
been reduced for estimated forfeitures. Forfeitures are estimated at the time of
grant and revised, if necessary, in subsequent periods if actual forfeitures
differ from those estimates.  The estimated average forfeiture rate
for the nine months ended February 28, 2010 and 2009 of
approximately  5% was based on historical forfeiture experience and
estimated future employee forfeitures. The estimated term of option grants for
the nine months ended February 28, 2010 and 2009 was five years.





4.Income Taxes





We must
assess the likelihood that we will be able to recover our deferred tax assets.
If recovery is not likely, we must increase our provision for taxes by recording
a valuation allowance against the deferred tax assets that we estimate will not
ultimately be recoverable. We believe that a substantial majority of the
deferred tax assets recorded on our balance sheet will ultimately be recovered.
However, should there be a change in our ability to recover the deferred tax
assets; the tax provision would increase in the period in which we determined
that the recovery was not probable.





We follow
authoritative guidance to reduce the diversity in practice associated with
certain aspects of measurement and recognition in accounting for income
taxes.  This authoritative guidance prescribes a recognition threshold
and measurement requirement for the financial statement recognition of a tax
position that has been taken or is expected to be taken on a tax return and also
provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition.  Under this
guidance we may only recognize tax positions that meet a “more likely than not”
threshold.




42




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.




5.Investments in Affiliated
Companies


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





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





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, it was determined that our investment in Talis
was impaired by approximately $680,000.  We have recorded this as an
impairment of investment in affiliated company on our condensed consolidated
statement of operations for the nine months ended February 28,
2010.  As of the date of this filing Talis has been
dissolved.





We owned
37.1% of the preferred stock of Avot Media, Inc. (“Avot”).  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
Avot.





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





During
the quarter ended November 30, 2009, we wrote off $433,333, which represented
the remaining fair value of our preferred stock investment in Avot.  We
have presented this as an impairment of investment in affiliated companies on
our condensed consolidated statements of operations for the nine months ended
February 28, 2010.





During
March 2010, Avot sold substantially all of its assets. 
We  received payment for our note receivable with Avot, but there was
not adequate consideration to reimburse us for any portion of our preferred
stock investment which had been fully written off  during the fiscal
quarters ending in May and November 2009.





We own
100% of the preferred stock of Holocom.  This investment has
historically been accounted for at cost since we do not have the ability to
exercise significant influence over the operating and financial policies of
Holocom. Due to a re-consideration event on May 1, 2009, this investment is
carried at cost plus the effects of deconsolidation of this variable interest
entity on our February 28, 2010 condensed consolidated balance
sheet.




43




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.





At
February 28, 2010, our investment in Holocom is $435,182 and has been recorded
as “Investments in affiliated companies” on our condensed consolidated balance
sheet at February 28, 2010.





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 February 28, 2010 and Three Months Ended February 28,
2009.





Consolidated:





Three
      Months EndedFebruary
      28, 2010
            
            
            February
      28, 2009Revenues:Product
      sales and other
            
            $
            -
            
            
            $
            1,193,378License
      and service revenue
            
            
            183,474
            
            
            
            216,823Total
      revenues
            
            
            183,474
            
            
            
            1,410,201Cost
      of sales:Product
      sales and other
            
            
            -
            
            
            
            534,555License
      and service revenue
            
            
            19,915
            
            
            
            89,195Amortization
      of purchased intangibles
            
            
            68,889
            
            
            
            223,902Total
      cost of sales
            
            
            88,804
            
            
            
            847,652Gross
      profit
            
            $
            94,670
            
            
            $
            562,549





Segment
Results:


Three
      months endedFebruary
      28, 2010
            
            
            February
      28, 2009% of
            
            
            
            
            
            % ofHolocom:
            
            Dollars
            
            
            Revenue
            
            
            Dollars
            
            
            RevenueRevenues
      - Product sales and other
            
            $
            -
            
            
            
            -
            
            
            $
            1,187,128
            
            
            
            100.0%Cost
      of sales
            
            
            -
            
            
            
            -
            
            
            
            534,555
            
            
            
            45%Gross
      profit
            
            $
            -
            
            
            
            -
            
            
            $
            652,573
            
            
            
            55%




44




Three
      months endedFebruary
      28, 2010
            
            
            February
      28, 2009PDSG:License
      and service revenue
            
            $
            183,474
            
            
            
            100.0%
            
            
            $
            216,823
            
            
            
            100.0%Cost
      of sales
            
            
            19,915
            
            
            
            10.9%
            
            
            
            89,195
            
            
            
            41.1%Amortization
      of purchased intangibles
            
            
            68,889
            
            
            
            37.6%
            
            
            
            223,902
            
            
            
            -Gross
      profit (loss)
            
            $
            94,670
            
            
            
            51.5%
            
            
            $
            (96,274
            )
            
            
            -PTSC:Revenues
      - Product sales and other
            
            $
            -
            
            
            
            -
            
            
            $
            6,250
            
            
            
            100.0%Cost
      of sales
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Gross
      profit
            
            $
            -
            
            
            
            -
            
            
            $
            6,250
            
            
            
            100.0%





Holocom





During
the three months ended February 28, 2009, we recorded sales amounting to
approximately $1,187,000 by our then consolidated variable interest entity,
Holocom, with cost of sales amounting to approximately $535,000.  Due
to a re-consideration event we deconsolidated Holocom in May 2009 and no longer
include Holocom’s revenues in our results of operations.





PDSG





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





Revenues
decreased during the three months ended February 28, 2010 as compared to the
three months ended February 28, 2009 due primarily to elimination of Iameter
service revenues as in January 2010 we sold the Iameter assets.  In
general, revenue agreements are one time contracts that vary in size and scope
depending upon the requirements of the customer.





Cost of
sales decreased during the three months ended February 28, 2010, as compared to
the three months ended February 28, 2009, due to decreases in the direct time
incurred by PDSG employees on projects.  Amortization of purchased
intangibles decreased during the three months ended February 28, 2010, as
compared to the three months ended February 28, 2009, due to our write off of
PDSG’s intangibles during the quarter ended November 30, 2009.





PTSC





During
the three months ended February 28, 2009, we recognized maintenance fee revenues
totaling $6,250 in connection with an agreement with AMD Corporation during the
2005 fiscal year. The agreement called for maintenance fees totaling $100,000
connected with a license agreement for our Ignite technology; the license fee
revenue was being recognized as revenue evenly over the four year period of the
license, which ended in February 2009.





Consolidated





Our
revenues decreased from approximately $1,410,000 for the three months ended
February 28, 2009, to approximately $183,000 for the three months ended February
28, 2010, primarily due to the deconsolidation of Holocom.  Our
revenue amounts do not include loss of approximately $751,000 and income of
approximately $386,000, respectively, from our investment in PDS for the three
months ended February 28, 2009, and February 28, 2010, respectively, and a loss
of approximately $171,000 from our investment in Talis for the three months
ended February 28, 2009.




45




Consolidated:


Three
      months endedFebruary
      28, 2010
            
            
            February
      28, 2009Research
      and development
            
            $
            361,742
            
            
            $
            117,781





PDSG





Research
and development costs consist of PDSG’s payroll and related expenses for
software engineers as well as outside contractors retained to assist in the
development of PDSG’s software product.  For the three months ended
February 28, 2010 and 2009, approximately $14,100 and $400 of share-based
compensation was recorded in connection with vesting of employee stock
options.  The increase in expenses for the three months ended February
28, 2010 is primarily due to the acquisition of the Vigilys employees in March
2009, and the development agreement with Avot.





Consolidated:




Three
      months endedFebruary
      28, 2010
            
            
            February
      28, 2009Selling,
      general and administrative
            
            $
            1,254,359
            
            
            $
            2,088,100





Segment
Results:


Three
      months endedFebruary
      28, 2010
            
            
            February
      28, 2009Holocom:Selling,
      general and administrative
            
            $
            -
            
            
            $
            536,734PDSG:Selling,
      general and administrative
            
            $
            479,359
            
            
            $
            823,531PTSC:Selling,
      general and administrative
            
            $
            775,000
            
            
            $
            727,835





Holocom





During
the three months ended February 28, 2009, we recorded selling, general and
administrative expenses amounting to approximately $537,000 by our then
consolidated variable interest entity, Holocom.  Due to a
re-consideration event we deconsolidated Holocom in May 2009 (see Note 12 to the
Unaudited Condensed Consolidated Financial Statements).





PDSG





Selling,
general and administrative expenses decreased from approximately $824,000 for
the three months ended February 28, 2009, to approximately $479,000 for the
three months ended February 28, 2010, primarily due to management’s
restructuring plan to reduce personnel and operating costs.  For the
three months ended February 28, 2010 and 2009, approximately $19,000 and $16,000
of share-based compensation was recorded in connection with vesting of employee
stock options.





PTSC





Selling,
general and administrative expenses increased from approximately $728,000 for
the three months ended February 28, 2009 to approximately $775,000 for the three
months ended February 28, 2010.  The primary increases were
approximately $80,000 in legal and accounting expense, approximately $70,000 in
consulting fees and approximately $17,000 in expenses related to our January
shareholder meeting.  These increases were offset primarily by
decreases in salaries and related expenses of approximately $98,000 and various
sundry items.  For the three months ended February 28, 2010,
approximately $32,500 of share-based compensation was recorded in connection
with vesting of employee stock options as compared to approximately $36,700 for
the three months ended February 28, 2009.




46


Consolidated





Selling,
general and administrative expenses decreased from approximately $2,088,000 for
the three months ended February 28, 2009 to approximately $1,254,000 for the
three months ended February 28, 2010.





Consolidated:


Three
      months endedFebruary
      28, 2010
            
            
            February
      28, 2009Other
      income (expense):Interest
      and other income
            
            $
            50,396
            
            
            $
            63,257Interest
      expense
            
            
            (19,788
            )
            
            
            (27,396
            )Gain
      on sale of Iameter
            
            
            182,397
            
            
            
            -Reserve
      for loan loss
            
            
            (1,013,151
            )
            
            
            -Equity
      in earnings (loss) of affiliated companies
            
            
            385,697
            
            
            
            (921,883
            )Total
      other expense, net
            
            $
            (414,449
            )
            
            $
            (886,022
            )





Segment
Results:


Three
      months endedFebruary
      28, 2010
            
            
            February
      28, 2009Holocom:Interest
      and other income
            
            $
            -
            
            
            $
            2,951Interest
      expense
            
            
            -
            
            
            
            (1,975
            )Total
      other income, net
            
            $
            -
            
            
            $
            976PDSG:Interest
      and other income
            
            $
            -
            
            
            $
            -Interest
      expense
            
            
            -
            
            
            
            -Gain
      on sale of Iameter
            
            
            182,397
            
            
            
            -Total
      other income, net
            
            $
            182,397
            
            
            $
            -PTSC:Interest
      and other income
            
            $
            50,396
            
            
            $
            60,306Interest
      expense
            
            
            (19,788
            )
            
            
            (25,421
            )Reserve
      for loan loss
            
            
            (1,013,151
            )
            
            
            -Equity
      in earnings (loss) of affiliated companies
            
            
            385,697
            
            
            
            (921,883
            )Total
      other expense, net
            
            $
            (596,846
            )
            
            $
            (886,998
            )





Consolidated





Our other
income and expenses for the three months ended February 28, 2010, included
equity in the income of PDS consisting of net income after expenses in the
amount of approximately $386,000.  For the three months ended February
28, 2009, our other income and expenses included our share of loss in PDS of
approximately $751,000 and our share of loss in Talis of approximately $171,000.
The increase in income from PDS for the quarter ended February 28, 2010, as
compared to the quarter ended February 28, 2009, is due to the increase in
license revenues PDS received for the quarter ended February 28, 2010, as
compared  with license revenues received by PDS for the quarter ended
February 28, 2009.  Our investment in PDS is, and our investment in
Talis was, accounted for in accordance with the equity method of accounting for
investments. Total other income for the three months ended February 28, 2010,
amounted to net other expense of approximately $414,000 compared with net other
expense of approximately $886,000 for the three months ended February 28, 2009.
Interest income and other income decreased from approximately $63,000 for the
three months ended February 28, 2009, to approximately $50,000 for the three
months ended February 28, 2010, due to declines in interest rates for our cash,
cash equivalents and long term investment accounts.  For the three
months ended February 28, 2010, we recorded a reserve for loan loss of
approximately $1,013,000 on our note receivable with TPL, LLC which was due
February 28, 2010.  For the three months ended February 28, 2010, we
recorded a gain on our sale of the Iameter portfolio of assets of approximately
$182,000.





47





During
the three months ended February 28, 2010, and 2009, we recorded a benefit for
income taxes of approximately $998,000 and $1,111,000 related to federal and
California taxes.





We
recorded a net loss for the three months ended February 28, 2010, of $938,271
compared with a net loss of $1,489,347 for the three months ended February 28,
2009.





Comparison
of the Nine Months Ended February 28, 2010 and Nine Months Ended February 28,
2009.





Consolidated:





Nine
      Months EndedFebruary
      28, 2010
            
            
            February
      28, 2009Revenues:Product
      sales and other
            
            $
            -
            
            
            $
            4,168,932License
      and service revenue
            
            
            346,925
            
            
            
            475,177Total
      revenues
            
            
            346,925
            
            
            
            4,644,109Cost
      of sales:Product
      sales and other
            
            
            -
            
            
            
            1,819,172License
      and service revenue
            
            
            92,102
            
            
            
            254,335Amortization
      of purchased intangibles
            
            
            482,265
            
            
            
            435,204Impairment
      of purchased intangibles
            
            
            3,530,263
            
            
            
            -Total
      cost of sales
            
            
            4,104,630
            
            
            
            2,508,711Gross
      profit (loss)
            
            $
            (3,757,705
            )
            
            $
            2,135,398





Segment
Results:


Nine
      months endedFebruary
      28, 2010
            
            
            February
      28, 2009Holocom:
            
            Dollars
            
            
            %
      of Revenue
            
            
            Dollars
            
            
            %
      of RevenueRevenues
      - Product sales and other
            
            $
            -
            
            
            
            -
            
            
            $
            4,117,152
            
            
            
            100.0%Cost
      of sales
            
            
            -
            
            
            
            -
            
            
            
            1,819,172
            
            
            
            44.2%Gross
      profit
            
            $
            -
            
            
            
            -
            
            
            $
            2,297,980
            
            
            
            55.8%PDSG:License
      and service revenue
            
            $
            346,925
            
            
            
            100.0%
            
            
            $
            475,177
            
            
            
            100.0%Cost
      of sales
            
            
            92,102
            
            
            
            26.6%
            
            
            
            254,335
            
            
            
            53.5%Amortization
      of purchased intangibles
            
            
            482,265
            
            
            
            -
            
            
            
            435,204
            
            
            
            -Impairment
      of purchased intangibles
            
            
            3,530,263
            
            
            
            -
            
            
            
            -
            
            
            
            -Gross
      loss
            
            $
            (3,757,705
            )
            
            
            -
            
            
            $
            (214,362
            )
            
            
            -PTSC:Revenues
      - Product sales and other
            
            $
            -
            
            
            
            -
            
            
            $
            51,780
            
            
            
            100.0%Cost
      of sales
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Gross
      profit
            
            $
            -
            
            
            
            -
            
            
            $
            51,780
            
            
            
            100.0%





Holocom





During
the nine months ended February 28, 2009, we recorded sales amounting to
approximately $4,117,000 by our then consolidated variable interest entity,
Holocom, with cost of sales amounting to approximately
$1,819,000.  Due to a re-consideration event we deconsolidated Holocom
in May 2009 and no longer include Holocom’s revenues in our results of
operations.





48





PDSG





We
acquired PDSG in a series of transactions in the second, third and fourth
quarters of fiscal 2009.  Revenue consists of software licenses and
associated services relating to PDSG’s CDX data agent product and the SherlockTM
software  tool for medical facilities.  In January 2010 we
sold the Iameter portfolio which included the SherlockTM software tool for
medical facilities.  Cost of sales includes the direct time of PDSG
employees on each project as well as outside contractors.





Revenues
decreased during the nine months ended February 28, 2010, as compared to the
nine months ended February 28, 2009, due primarily to the inclusion in the
fiscal year 2009 period of amounts from a significant customer agreement not
duplicated in the fiscal year 2010.  Also in 2010, revenue progress on
contracts was slowed primarily as a result of customer initiated delays
resulting in lower than planned revenues.  In general, revenue agreements
are one time contracts that vary in size and scope depending upon the
requirements of the customer.





The
impairment charge for the nine months ended February 28, 2010, represents the
write off of PDSG’s purchased intangibles to a fair value of $1,860,000 at
November 30, 2009.  These assets were subject to revaluation pursuant
to a reconsideration event which also drove the restructuring of PDSG initiated
in October 2009.  The impairment is primarily attributable to
management’s current assessment of reduced revenue and resultant cash flow
projections as compared to what previously had been the expectations for the
business.


PTSC





During
the nine months ended February 28, 2009, we recognized maintenance fee revenues
totaling approximately $19,000 in connection with an agreement with AMD
Corporation during the 2005 fiscal year. The agreement called for maintenance
fees totaling $100,000 connected with a license agreement for our Ignite
technology; the license fee revenue was being recognized as revenue evenly over
the four year period of the license, the four year period ended in February
2009.





In
addition during the nine months ended February 28, 2009, we recorded sales of
approximately $33,000, from the sale of microprocessor chips that we no longer
market. Inventory associated with the sales of these microprocessor chips is
carried at zero value.  Our final sales of microprocessor chips
occurred during the quarter ended August 31, 2008.





Consolidated





Our
revenues decreased from approximately $4,644,000 for the nine months ended
February 28, 2009, to approximately $347,000 for the nine months ended February
28, 2010, primarily due to the deconsolidation of Holocom. Our revenue amounts
do not include income of approximately $6,122,000 and $3,880,000, respectively,
for the nine months ended February 28, 2009 and 2010, respectively, from our
investment in PDS and losses of approximately $375,000 and $22,000,
respectively, for the nine months ended February 28, 2009 and 2010,
respectively, from our investment in Talis.





Consolidated:


Nine
      months endedFebruary
      28, 2010
            
            
            February
      28, 2009Research
      and development
            
            $
            1,216,496
            
            
            $
            269,655





PDSG





We
acquired PDSG in a series of transactions in the second, third and fourth
quarters of fiscal 2009.  Research and development costs consist of
PDSG’s payroll and related expenses for software engineers as well as outside
contractors retained to assist in the development of PDSG’s software
product.  For the nine months ended February 28, 2010 and 2009,
approximately $19,000 and $1,000 of share-based compensation was recorded in
connection with vesting of employee stock options.  The increase in
expenses for the nine months ended February 28, 2010, is primarily due to the
acquisition of the Vigilys employees in March 2009, the development agreement
with Avot and the use of outside contractors to assist with the development of
CDX 4.




49


Consolidated:


Nine
      months endedFebruary
      28, 2010
            
            
            February
      28, 2009Selling,
      general and administrative
            
            $
            5,193,184
            
            
            $
            6,196,360




Segment
Results:


Nine
      months endedFebruary
      28, 2010
            
            
            February
      28, 2009Holocom:Selling,
      general and administrative
            
            $
            -
            
            
            $
            1,721,999PDSG:Selling,
      general and administrative
            
            $
            2,355,490
            
            
            $
            1,461,358PTSC:Selling,
      general and administrative
            
            $
            2,837,694
            
            
            $
            3,013,003





Holocom





During
the nine months ended February 28, 2009, we recorded selling, general and
administrative expenses amounting to approximately $1,722,000 by our then
consolidated variable interest entity, Holocom.  Due to a
re-consideration event we deconsolidated Holocom in May 2009 (see Note 12 to the
Unaudited Condensed Consolidated Financial Statements).





PDSG





We
acquired PDSG in a series of transactions in the second, third and fourth
quarters of fiscal 2009.  Selling, general and administrative expenses
of approximately $1,461,000 for the nine months ended February 28, 2009,
represent costs from September 1, 2008, to February 28, 2009, as compared to
approximately $2,355,000 for the nine months ended February 28,
2010.  Increases are primarily due to an increase in payroll and
related costs of approximately $387,000 resulting from the acquisition of
Iameter and Vigilys after November 30, 2008, severance payments of approximately
$101,000 due to restructuring, approximately $107,000 in marketing costs and
approximately $100,000 in rent and utilities expenses due to the space required
for the Iameter and Vigilys acquisitions after November 30, 2008.  For
the nine months ended February 28, 2010 and 2009, approximately $44,000 and
$32,000 of share-based compensation was recorded in connection with vesting of
employee stock options.





PTSC





Selling,
general and administrative expenses decreased from approximately $3,013,000 for
the nine months ended February 28, 2009, to approximately $2,838,000 for the
nine months ended February 28, 2010.  The decrease consisted primarily
of approximately $111,000 in public and investor relations expenses and $42,000
in travel and related expenses.  These decreases were offset primarily
by increases in consulting expenses of approximately $116,000 due to ongoing
partnering evaluations for PDSG and approximately $60,000 in legal and
accounting expenses.  For the nine months ended February 28, 2010,
approximately $150,000 of share-based compensation was recorded in connection
with vesting of employee stock options as compared to approximately $287,000 for
the nine months ended February 28, 2009.





50





Consolidated





Selling,
general and administrative expenses decreased from approximately $6,196,000 for
the nine months ended February 28, 2009, to approximately $5,193,000 for the
nine months ended February 28, 2010, primarily due to the deconsolidation of
Holocom.





Consolidated:


Nine
      months endedFebruary
      28, 2010
            
            
            February
      28, 2009Other
      income (expense):Interest
      and other income
            
            $
            119,170
            
            
            $
            320,850Interest
      expense
            
            
            (60,057
            )
            
            
            (48,158
            )Gain
      on sale of Verras Medical, Inc. assets
            
            
            182,397
            
            
            
            -Reserve
      for loan losses
            
            
            (1,013,151
            )
            
            
            -Impairment
      of investment in affiliated companies
            
            
            (1,113,625
            )
            
            
            -Equity
      in earnings of affiliated companies
            
            
            3,858,057
            
            
            
            5,746,626Total
      other income, net
            
            $
            1,972,791
            
            
            $
            6,019,318





Segment
Results:


Nine
      months endedFebruary
      28, 2010
            
            
            February
      28, 2009Holocom:Interest
      and other income
            
            $
            -
            
            
            $
            5,919Interest
      expense
            
            
            -
            
            
            
            (4,549
            )Total
      other income, net
            
            $
            -
            
            
            $
            1,370PDSG:Interest
      and other income
            
            $
            9,336
            
            
            $
            3,003Gain
      on sale of Verras Medical, Inc. assets
            
            
            182,397
            
            
            
            -Interest
      expense
            
            
            -
            
            
            
            (17
            )Total
      other income, net
            
            $
            191,733
            
            
            $
            2,986PTSC:Interest
      and other income
            
            $
            109,834
            
            
            $
            311,928Interest
      expense
            
            
            (60,057
            )
            
            
            (43,592
            )Reserve
      for loan losses
            
            
            (1,013,151
            )
            
            
            -Impairment
      of investment in affiliated companies
            
            
            (1,113,625
            )
            
            
            -Equity
      in earnings of affiliated companies
            
            
            3,858,057
            
            
            
            5,746,626Total
      other income, net
            
            $
            1,781,058
            
            
            $
            6,014,962





Consolidated





Our other
income and expenses for the nine months ended February 28, 2010, included equity
in the income of PDS consisting of net income after expenses in the amount of
approximately $3,880,000 and our share of loss in Talis of approximately
$22,000.  For the nine months ended February 28, 2009, our other
income and expenses included our share of income in PDS of approximately
$6,122,000 and our share of loss in Talis of approximately $375,000. The
decrease in our share of PDS’ income for the nine months ended February 28,
2010, as compared to our share of PDS’ income for the nine months ended February
28, 2009, is due to the decrease in the amount of license revenues PDS received
for the nine months ended February 28, 2010, as compared to the nine months
ended February 28, 2009.  Our investment in PDS is, and our investment
in Talis was, accounted for in accordance with the equity method of accounting
for investments. Total other income for the nine months ended February 28, 2010,
amounted to net other income of approximately $1,973,000 compared with net other
income of approximately $6,019,000 for the nine months ended February 28, 2009.
Interest income and other income decreased from approximately $321,000 for the
nine months ended February 28, 2009, to approximately $119,000 for the nine
months ended February 28, 2010, due to declines in interest rates for our cash,
cash equivalents and long term investment accounts.  For the nine
months ended February 28, 2010, we recorded an impairment of our investments in
Talis of approximately $680,000 and Avot of approximately
$433,000.  For the nine months ended February 28, 2010, we
recorded  a reserve for loan loss of approximately $1,013,000 on our
note receivable with TPL, LLC which was due February 28, 2010.  For
the nine months ended February 28, 2010, we recorded a gain on our sale of the
Iameter portfolio of assets of approximately $182,000.




51




During
the nine months ended February 28, 2010, we recorded a benefit for income taxes
of approximately $3,621,000 and during the nine months ended February 28, 2009,
we recorded a provision for income taxes of approximately $637,000 related to
federal and California taxes.





We
recorded a net loss for the nine months ended February 28, 2010, of $5,669,971
compared with net income of $787,906 for the nine months ended February 28,
2009.





Liquidity
and Capital Resources





Liquidity





Our cash
and cash-equivalents and short-term investment balances increased from
approximately $6,265,000 as of May 31, 2009,  to approximately
$8,559,000 as of February 28, 2010. We also had restricted cash balances
amounting to approximately $52,000 as of May 31, 2009, and $21,000 as of
February 28, 2010. Total current assets increased from approximately $8,065,000
as of May 31, 2009, to approximately $11,955,000  as of February 28,
2010. Total current liabilities amounted to approximately $1,034,000 and
approximately $704,000 as of May 31, 2009, and February 28, 2010, respectively.
The change in our current position as of February 28, 2010, as compared with May
31, 2009, results in part from our receipt of approximately $7,378,000 in
distributions from PDS, issuances of collectible notes receivable of
approximately $1,193,000 and $3,600,000 of auction rate securities redemptions
at par value.





During
June 2008, we obtained a credit facility for as long as needed, which provides
for financing up to 50% of the par value balance of our outstanding auction rate
securities. The facility is collateralized by the full value of the outstanding
auction rate securities, required no origination fee, and when drawn upon will
bear interest at the federal funds rate plus 3%.  On October 14, 2008,
we borrowed $3,000,000 on the credit facility.  The amount we can
borrow against our collateral, currently $4,025,000, is limited by the Financial
Industry Regulatory Authority (“FINRA”) (see Note 13 to the Unaudited Condensed
Consolidated Financial Statements).





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





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





While our
current liquid cash resources as of February 28, 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 decrease or
interruption in MMP Portfolio licensing we would 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.  Our most significant source of
additional liquid cash would likely come from our ARS positions either as a
result of redemption, successfully prevailing in our arbitration action against
Deutsche Bank Securities, Inc. and affiliates, or the liquidation of some or all
of the ARS instruments in negotiated transactions with third parties at a
discount to their par value.





52


Cash
Flows From Operating Activities





Cash used
in operating activities for the nine months ended February 28, 2010, was
approximately $5,930,000 as compared with cash used in operating activities for
the nine months ended February 28, 2009 of approximately $5,263,000. The
principal components of the current period amount were: impairment
of  investment in affiliated company of approximately $1,114,000,
impairment of intangibles and goodwill of approximately $4,627,000, reserve for
loan loss of approximately $1,013,000 and amortization and depreciation of
approximately $526,000.  These increases were offset by: net loss of
approximately $5,670,000, equity in earnings of affiliates of approximately
$3,858,000 and changes in deferred income taxes of approximately
$3,616,000.  The change in results over the prior period is mainly
attributable to impairments, changes in deferred tax assets due to the losses of
PDSG and reduction in income from PDS for the nine months ended February 28,
2010, as compared to the nine months ended February 28, 2009.





Cash
Flows From Investing Activities





Cash
provided by investing activities was approximately $8,430,000 and $4,130,000 for
the nine months ended February 28, 2010 and 2009, respectively. The increase in
cash provided by investing activities was mainly attributable to the redemption
of our auction rate securities at a par value of $3,600,000 and a decrease in
investments in affiliated companies.  Cash used during the nine months
ended February 28, 2010, included approximately $73,000 in purchases of fixed
assets, approximately $33,000 in purchases of Talis membership units, a $580,000
capital contribution to PDS and approximately $55,000 in note receivable
advances to Avot and $1,950,000 in note receivable advances to TPL.





Cash
Flows From Financing Activities





Cash used
in financing activities for the nine months ended February 28, 2010, was
approximately $158,000 as compared to cash provided by financing activities for
the nine months ended February 28, 2009 of approximately
$1,747,000.  For the nine months ended February 28, 2010, cash of
approximately $166,000 was used to purchase common stock for
treasury.  For the nine months ended February 28, 2009, cash of
approximately $1,096,000 was used to purchase common stock for treasury and cash
of approximately $416,000 was used to pay notes payable.  Cash
received from financing activities during the nine months ended February 28,
2009, consisted of $3,000,000 received on our line of credit with Wedbush and
$250,000 received by Holocom on their line of credit facility.





Capital
Resources





Our
current resources as of February 28, 2010, are expected to provide the funds
necessary to support our operations through at least the next twelve
months.





Contractual
Obligations and Commitments





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





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




53




In
connection with management’s restructuring plan, On October 7, 2009, we entered
into a Separation Agreement with our former CEO which requires us to pay his
base salary for the  seven months following his departure (through May
2010) in exchange for a general release of claims against us.  At
February 28, 2010, the current balance of the liability is $58,471.


Recent
Accounting Pronouncements





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





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





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





Risk
Factors





We urge
you to carefully consider the following discussion of risks as well as other
information regarding our common stock. We believe the following to be our most
significant risk factors as of the date this report is being filed. The risks
and uncertainties described below are not the only ones we
face.  Please refer to our risk factors contained in our Form 10-K for
the year ended May 31, 2009, for additional factors.





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





We have
entered into license agreements through our joint venture with TPL and have
reported income as a result of this activity for the fiscal years 2009, 2008 and
2007. Because of the uncertain nature of the negotiations that lead to license
revenues, pending litigation with companies which we allege have infringed on
our patent portfolio, the possibility of legislative action regarding patent
rights, potential adverse outcomes associated with USPTO re-examinations, and
the possible effect of new judicial interpretations of patent laws, we may not
receive revenues from such agreements in the future consistent with amounts
received in the past, and we may not receive future revenues from license
agreements at all.




54


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





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





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





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





The debt
and equity markets have been experiencing 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 and acquisitions.  See Part I – Item 2.
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources-Liquidity.” in this report on Form
10-Q for more information.




55


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




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





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





For our
investment accounted for under the equity method (PDS), we record as part of
other income or expense our share of the increase or decrease in the equity of
this company in which we have invested. Our investment in Holocom is recorded at
cost basis.  It is possible that, in the future, our relationships
and/or our interests in or with this equity method investee and our cost basis
investee could change. Such potential future changes could result in
deconsolidation or consolidation of such entities, as the case may be, which
could result in changes in our reported results.





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





Most of
our shareholders are not restricted in the price at which they can sell their
shares. Shares sold at a price below the current market price at which our
Common Stock is trading may cause the market price of our Common Stock to
decline.





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





Our
long-term investment in marketable securities balance consists of auction rate
securities with a par value of approximately $8 million as of the date of this
filing, which at present are highly illiquid. In the event we need immediate
access to these funds, we will not be able to sell these investments at par
value. These instruments are expected to remain illiquid until a future auction
of these investments is successful, buyers are found outside of the auction
process, or they are redeemed by the issuing agencies. We have partially offset
the consequences of this illiquidity by securing a line of credit collateralized
by the auction rates securities; however the amount we can borrow against our
collateral is limited by the FINRA. In the event these securities are deemed to
be permanently impaired, we will be required to take a charge to operations in
recognition of this impairment.





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





Our
Common Stock is currently listed for trading in the FINRA Over-The-Counter
Bulletin (“OTC”) Board Market and is subject to the “penny stock rules” adopted
pursuant to Section 15(g) of the 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.




56


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





Auction
Rate Securities





Our
exposure to market risk for changes in interest rates relates primarily to our
auction rate securities.  During the fiscal year ended May 31, 2009,
investment banks were reporting an inability to successfully obtain subscribers
for high credit quality auction rate securities.  As of the date of
this filing, we held such auction rate securities with a par value totaling $8
million that failed to sell at auction. During June 2009, September 2009 and
December 2009, auction rate securities with a par value of $750,000, $2,500,000
and $350,000, respectively, were redeemed by the issuers at par
value.  In the event we need to access funds invested in these auction
rate securities we will not be able to liquidate these securities until a future
auction of these securities is successful, they are refinanced and redeemed by
the issuers, or a buyer is found outside of the auction process.  The
investments consist of student loan auction rate instruments issued by various
state agencies pursuant to the Federal Family Educational Loan Program
(“FFELP”).  These investments are of high credit quality and the AAA
credit ratings of the investments have been reaffirmed since February
2010.  These instruments are collateralized in excess of the
underlying obligations, are insured by the various state educational agencies,
and are guaranteed by the Department of Education as an insurer of last
resort.




57




At
February 28, 2010, the fair value of our auction rate securities was estimated
at $7.4 million based on a valuation by Houlihan Smith & Company,
Inc.  We recorded the net temporary valuation adjustment of $393,079
in other comprehensive income, which represents the gross valuation adjustment
of $658,969, net of the related tax benefit of $265,890.  We have
concluded that the unrealized losses on these investments are temporary because
(i) we believe that the decline in market value and absence of liquidity that
has occurred is due to general market conditions, (ii) the auction rate
securities continue to be of a high credit quality and interest is paid as due
and (iii) we do not intend to sell our auction rate securities before we are
able to recover our cost basis and it is more likely than not that we will not
have to sell our auction rate securities before recovery of our cost
basis.  Since this valuation adjustment is deemed to be temporary, it
did not affect our earnings for the three and nine months ended February 28,
2010 and 2009.





We are
not currently able to predict how long these investments will remain illiquid,
and as such, they have been classified as long-term investments in marketable
securities in the accompanying consolidated balance sheets at February 28, 2010
and May 31, 2009.





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





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




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





Item
4. Controls and Procedures





Quarterly
Evaluation of Disclosure Controls and Procedures




As
required by Rule 13a-15(b) under the Exchange Act, as of February 28,
2010, the end of the period covered by this report, we have carried out an
evaluation of the effectiveness of our disclosure controls and procedures (as
defined by Rule 13a-15(e)).  This evaluation was carried out under the
supervision and with the participation of our management, including our Interim
Chief Executive Officer and 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 SEC’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 our 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 February 28, 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 at
the reasonable assurance level.




58




Changes
in Internal Control over Financial Reporting




After
evaluation, with the participation of our Interim Chief Executive Officer and
Chief Financial Officer, we have determined that there were no changes to our
internal control over financial reporting (as defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act) during our most
recently completed fiscal quarter that materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.




PART
II - OTHER INFORMATION





Item
1. Legal Proceedings





Patent
Litigation





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





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





Deutsche
Bank Arbitration





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





Crossflo
Systems, Inc. Litigation





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





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





Item
1A. Risk Factors





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


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




Recent sales of unregistered securities:




During the quarter ended February 28, 2010, we issued
warrants to purchase 25,000 shares of our common stock on January 25, 2010, at
an exercise price of $0.15, in order to settle a claim against us. The issuance
of such securities was made as a private placement under Section 4(2) of the
Securities Act and Rule 506 promulgated thereunder.




59


Purchases of equity securities by the issuer and
affiliated purchasers:





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 852,847 shares of our
common stock in open market transactions at an aggregate cost of $125,329 during
the three months ended February 28, 2010.





Following
is a summary of all repurchases by us of our common stock during the three month
period ended February 28, 2010:





Period
            
            Total
              Number
      of
              Shares
              Purchased
            
            
            Average
      Price
              Paid
      per
              Share
            
            
            Total
      Number of Shares Purchased as Part of Publicly Announced Plans or
      ProgramsDecember
      1 – 31, 2009
            
            
            115,312
            
            
            $
            0.17
            
            
            
            115,312January
      1 – 31, 2010
            
            
            591,335
            
            
            $
            0.14
            
            
            
            591,335February
      1 – 28, 2010
            
            
            146,200
            
            
            $
            0.14
            
            
            
            146,200Total
            
            
            852,847
            
            
            $
            0.15
            
            
            
            852,847





Item
3. Defaults Upon Senior Securities





None.





Item
4. Removed and Reserved





Item
5. Other Information





Submission
of Matters to a Vote of Security Holders





At our
fiscal 2009 Annual Meeting of Shareholders held on January 28, 2010, the
following individuals were elected to the Board of Directors of the Company:
Carlton M. Johnson, Jr., Helmut Falk, Jr., Gloria H. Felcyn, Donald E. Schrock
and Dharmesh Mistry.





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




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


Votes
      For
            
            Votes
      Against
            
            Votes
      Abstaining302,021,274
            
            26,789,475
            
            5,508,620





On July
1, 2009, the SEC approved a proposal prohibiting discretionary voting by brokers
of shares held by their customers in street name in uncontested elections of
directors effective for shareholder meetings beginning in
2010.  Brokers may continue to vote as they wish on routine matters
(such as ratification of auditors) on behalf of their beneficial owner customers
provided the customer has not given specific voting instructions to the broker
at least 10 days before a scheduled meeting.




60




The
results of the SEC’s July 2009 action are reflected in the difference between
voting totals for our ratification of auditors proposal as compared to the
voting totals for our election of directors proposal.




2.Election of
Directors:





Director
            
            Votes
      For
            
            Votes
      Abstaining
              and/or
      AgainstCarlton
      M. Johnson, Jr.
            
            47,635,901
            
            43,155,665Helmut
      Falk, Jr.
            
            48,915,455
            
            41,876,111Gloria
      H. Felcyn
            
            48,582,583
            
            42,208,983Donald
      E. Schrock
            
            67,649,501
            
            23,100,290Dharmesh
      Mistry
            
            71,319,001
            
            19,472,565





Material Changes to Procedures to Nominate
Directors




There have been no material changes to the procedures by
which security holders may recommend nominees to our Board of Directors where
such changes have been implemented after we last provided disclosure regarding
the same.




61


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)3.3.4
            Certificate
      of Amendment to the Certificate of Incorporation of Patriot Scientific
      Corporation, as filed with the Delaware Secretary of State on May 6,
      2002, incorporated by reference to Exhibit 3.3.4 to our Quarterly Report
      on Form 10-Q for the quarterly period ended February 28, 2009, filed April
      9, 2009 (Commission file No. 000-22182)3.3.5
            Certificate
      of Amendment to the Certificate of Incorporation of Patriot Scientific
      Corporation,  as filed with the Delaware Secretary of State on
      October 16, 2003, incorporated by reference to Exhibit 3.3.5 to
      Registration Statement on Form SB-2 filed May 21, 2004 (Commission
      file No. 333-115752)3.3.6
            Certificate
      of Amendment to the Certificate of Incorporation of Patriot Scientific
      Corporation, as filed with the Delaware Secretary of State on
      April 29, 2005, incorporated by reference to Exhibit 3.3.6 to our
      Quarterly Report on Form 10-Q for the quarterly period ended February 28,
      2009, filed April 9, 2009 (Commission file No.
  000-22182)3.3.7
            Certificate
      of Amendment to the Certificate of Incorporation of Patriot Scientific
      Corporation, as filed with the Delaware Secretary of State on
      November 14, 2005, incorporated by reference to Exhibit
      3.3.7  to our Quarterly Report on Form 10-Q for the quarterly
      period ended February 28, 2009, filed April 9, 2009 (Commission file No.
      000-22182)3.3.8
            Certificate
      of Amendment to the Certificate of Incorporation of Patriot Scientific
      Corporation, as filed with the Delaware Secretary of State on March 18,
      2009, incorporated by reference to Exhibit 3.3.8 to our Annual Report on
      Form 10-K for the year ended May 31, 2009, filed August 14, 2009
      (Commission file No. 000-22182)3.4
            Articles and
      Certificate of Merger of Patriot Financial Corporation into Patriot
      Scientific Corporation dated May 1, 1992, with Agreement and Plan of
      Merger attached thereto as Exhibit A, incorporated by reference to
      Exhibit 3.4 to our Current Report on Form 8-K dated May 12, 1992
      (Commission file No. 33-23143-FW)3.5
            Certificate
      of Merger issued by the Delaware Secretary of State on May 8, 1992,
      incorporated by reference to Exhibit 3.5 to our Current Report on
      Form 8-K dated May 12, 1992 (Commission file No.
      33-23143-FW)3.6
            Certificate
      of Merger issued by the Colorado Secretary of State on May 12, 1992,
      incorporated by reference to Exhibit 3.6 to our Current Report on
      Form 8-K dated May 12, 1992 (Commission file No.
      33-23143-FW)3.7
            Bylaws
      of the Company, incorporated by reference to Exhibit 3.7 to our
      Current Report on Form 8-K dated May 12, 1992 (Commission file No.
      33-23143-FW)23.1*
            Consent
      of Independent Valuation Firm31.1*
            Certification
      of Clifford L. Flowers, Interim CEO, pursuant to Rule
      13a-14(a)/15d-14(a)31.2*
            Certification
      of Clifford L. Flowers, CFO, pursuant Rule
    13a-14(a)/15d-14(a)32.1*
            Certification
      of Clifford L. Flowers, Interim CEO and CFO, pursuant to Section 1350 of
      Chapter 63 Title 18 of the United States
Code


62


SIGNATURES




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




DATED:  April 9,
      2010
            PATRIOT
      SCIENTIFIC CORPORATION
              
              /S/
      CLIFFORD L.
      FLOWERS
              Clifford
      L. Flowers
              Interim
      Chief Executive Officer and Chief Financial Officer
              (Duly
      Authorized and Principal Financial
Officer)






63