##### Table of Contents



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 quarterly period ended February 28, 2002
|--- | --------------------------------------------------------------------------------------------------------------------------------------

OR



|[   ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ___________________ to ___________________
|----- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

Commission File Number 0-22182

PATRIOT SCIENTIFIC CORPORATION

(Exact name of registrant as specified in its charter)


|                                                               |  |                          
|-------------------------------------------------------------- |  | -------------------------
|Delaware                                                       |  | 84-1070278               
|(State or other jurisdiction of
incorporation or organization) |  | (I.R.S. Empl. Ident. No.)

10989 Via Frontera, San Diego, California 92127

(Address of principal executive offices, ZIP Code)


(858) 674-5000

(Registrants telephone number, including area code)


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

Indicate the number of shares outstanding of each of the issuers classes of
common equity, as of the latest practicable date:

|                                |  |                                
|------------------------------- |  | -------------------------------
|Common Stock, $.00001 par value |  | 81,465,757                     
|(Class)                         |  | (Outstanding at April 12, 2002)



---

TABLE OF CONTENTS



|                              |                                                                                                |                                            |  |  |  |  |  | 
|----------------------------- | ---------------------------------------------------------------------------------------------- | ------------------------------------------ |  |  |  |  |  | 
|PART I- FINANCIAL INFORMATION
|                              | Item 1. Financial Statements                                                                  
|                              |                                                                                                | CONSOLIDATED BALANCE SHEETS               
|                              |                                                                                                | CONSOLIDATED STATEMENTS OF OPERATIONS     
|                              |                                                                                                | CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                              |                                                                                                | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                              | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
|                              | Item 3. Quantitative and Qualitative Disclosure About Market Risk                             
|PART II. OTHER INFORMATION   
|                              | Item 1. Legal Proceedings                                                                     
|                              | Item 2. Changes in Securities                                                                 
|                              | Item 6. Exhibits and Reports on Form 8-K                                                      
|SIGNATURES                   



---



##### Table of Contents



PATRIOT SCIENTIFIC CORPORATION
INDEX

|                              |                                                                                               |                                                                                                                         |    |       |      | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------- | -- | ----- | ---- | 
|                              |                                                                                               |                                                                                                                         |    | Page 
|                              |                                                                                               |                                                                                                                         |    |      
|PART I. FINANCIAL INFORMATION |                                                                                               |                                                                                                                         |    |      
|                             
|                              | Item 1. Financial Statements:                                                                 |                                                                                                                         |    |       |     
|                             
|                              |                                                                                               | Consolidated Balance Sheets as of February 28, 2002 (unaudited)
and May 31, 2001                                        |    |       | 3    | 
|                             
|                              |                                                                                               | Consolidated Statements of Operations for the three months and
nine months ended February 28, 2002 and 2001 (unaudited) |    |       | 4    | 
|                             
|                              |                                                                                               | Consolidated Statements of Cash Flows for the nine months ended
February 28, 2002 and 2001 (unaudited)                  |    |       | 5    | 
|                             
|                              |                                                                                               | Notes to Unaudited Consolidated Financial Statements                                                                    |    |       | 6-17 | 
|                             
|                              | Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations |                                                                                                                         |    | 18-29 |     
|                             
|                              | Item 3. Quantitative and Qualitative Disclosure About Market Risk                             |                                                                                                                         |    | 30    |     
|                             
|PART II. OTHER INFORMATION    |                                                                                               |                                                                                                                         | 30 |      
|                             
|                              | Item 1. Legal Proceedings                                                                     |                                                                                                                         |    | 30    |     
|                              | Item 2. Changes in Securities                                                                 |                                                                                                                         |    | 30    |     
|                              | Item 3. Defaults upon Senior Securities                                                       |                                                                                                                         |    | *     |     
|                              | Item 4. Submission of Matters to a Vote of Security Holders                                   |                                                                                                                         |    | *     |     
|                              | Item 5. Other Information                                                                     |                                                                                                                         |    | *     |     
|                              | Item 6. Exhibits and Reports on Form 8-K                                                      |                                                                                                                         |    | 31    |     
|                             
|SIGNATURES                    |                                                                                               |                                                                                                                         | 31 |      



| |  |  | No information provided due to inapplicability of the item.
| | - |  | -----------------------------------------------------------



2



---



##### Table of Contents






PART I- FINANCIAL INFORMATION




Item 1. Financial Statements




PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED BALANCE SHEETS

|                                                      |                                                                                                                  |   |              |             |         |   |           |             |  
|----------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------- | - | ------------ | ----------- | ------- | - | --------- | ----------- | -
|                                                      |                                                                                                                  |   | February 28, |             | May 31,
|                                                      |                                                                                                                  |   | 2002         |             | 2001   
|                                                      |                                                                                                                  |   |              |             |        
|                                                      |                                                                                                                  |   | (Unaudited)  |             |         |   |          
|ASSETS (Note 5)                                      
|Current assets:                                       |                                                                                                                  |   |              |             |         |   |           |            
|                                                      | Cash and cash equivalents                                                                                        |   | $            | 9,606       |         |   | $         | 464,350     |  
|                                                      | Accounts receivable, net of allowance
of $124,600 and $54,000 for uncollectible accounts                         |   |              | 10,838      |         |   |           | 188,982     |  
|                                                      | Inventories (Note 4)                                                                                             |   |              |            |         |   |           | 223,393     |  
|                                                      | Prepaid expenses                                                                                                 |   |              | 262,244     |         |   |           | 73,185      |  
|                                                      |                                                                                                                  |   |              |             |         |   |           |            
|Total current assets                                  |                                                                                                                  |   | 282,688      |             |         |   | 949,910   |            
|Property and equipment, net                           |                                                                                                                  |   | 372,239      |             |         |   | 423,528   |            
|Other assets, net                                     |                                                                                                                  |   | 67,182       |             |         |   | 16,667    |            
|Patents and trademarks, net (Note 5)                  |                                                                                                                  |   | 106,493      |             |         |   | 153,588   |            
|                                                      |                                                                                                                  |   |              |             |         |   |           |            
|                                                      |                                                                                                                  | $ | 828,602      |             |         | $ | 1,543,693 |            
|                                                      |                                                                                                                  |   |              |             |         |   |           |            
|                                                     
|LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)       
|                                                     
|Current liabilities:                                  |                                                                                                                  |   |              |             |         |   |           |            
|                                                      | Notes payable, net of unamortized debt discount
of $485,754 (Note 5)                                             |   | $            | 726,446     |         |   | $         |            |  
|                                                      | Accounts payable                                                                                                 |   |              | 312,379     |         |   |           | 434,838     |  
|                                                      | Accrued liabilities                                                                                              |   |              | 252,338     |         |   |           | 186,467     |  
|                                                      | Current portion of capital lease obligation                                                                      |   |              | 4,836       |         |   |           |            |  
|                                                      |                                                                                                                  |   |              |             |         |   |           |            
|Total current liabilities                             |                                                                                                                  |   | 1,295,999    |             |         |   | 621,305   |            
|Long term capital lease obligation                    |                                                                                                                  |   | 18,120       |             |         |   |          |            
|Commitments and contingencies (Notes 5, 6, 7 and 9)   |                                                                                                                  |   |              |             |         |   |           |            
|Stockholders equity (deficit) (Notes 5, 6, 7 and 8): |                                                                                                                  |   |              |             |         |   |           |            
|                                                      | Preferred stock, $.00001 par value; 5,000,000 shares
authorized none outstanding                                 |   |              |            |         |   |           |            |  
|                                                      | Common stock, $.00001 par value; 100,000,000 shares
authorized; issued and outstanding 74,213,637 and 57,535,411 |   |              | 742         |         |   |           | 575         |  
|                                                      | Additional paid-in capital                                                                                       |   |              | 39,778,679  |         |   |           | 37,320,503  |  
|                                                      | Accumulated deficit                                                                                              |   |              | (40,184,938 | )       |   |           | (36,318,690 | )
|                                                      | Note receivable (Note 8)                                                                                         |   |              | (80,000     | )       |   |           | (80,000     | )
|                                                      |                                                                                                                  |   |              |             |         |   |           |            
|Total stockholders equity (deficit)                  |                                                                                                                  |   | (485,517     | )           |         |   | 922,388   |            
|                                                      |                                                                                                                  |   |              |             |         |   |           |            
|                                                      |                                                                                                                  | $ | 828,602      |             |         | $ | 1,543,693 |            
|                                                      |                                                                                                                  |   |              |             |         |   |           |            

See accompanying summary of accounting policies and notes to unaudited
consolidated financial statements.


3Table of Contents




PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

|                                                                                |                                     |   |                    |          |                   |   |              |         |              |   |            |           |   |   |            |           |  
|------------------------------------------------------------------------------- | ----------------------------------- | - | ------------------ | -------- | ----------------- | - | ------------ | ------- | ------------ | - | ---------- | --------- | - | - | ---------- | --------- | -
|                                                                                |                                     |   | Three Months Ended |          | Nine Months Ended
|                                                                                |                                     |   |                    |          |                  
|                                                                                |                                     |   | February 28,       |          | February 28,      |   | February 28, |         | February 28,
|                                                                                |                                     |   | 2002               |          | 2001              |   | 2002         |         | 2001        
|                                                                                |                                     |   |                    |          |                   |   |              |         |             
|Net sales                                                                       |                                     | $ | 4,620              |          |                   | $ | 66,045       |         |              | $ | 326,509    |           |   | $ | 242,769    |          
|Cost of sales:                                                                  |                                     |   |                    |          |                   |   |              |         |              |   |            |           |   |   |            |          
|                                                                                | Product costs                       |   |                    | 2,194    |                   |   |              | 107,661 |              |   |            | 242,772   |   |   |            | 355,081   |  
|                                                                                | Inventory obsolescence              |   |                    |         |                   |   |              |        |              |   |            | 149,433   |   |   |            |          |  
|                                                                                |                                     |   |                    |          |                   |   |              |         |              |   |            |           |   |   |            |          
|Cost of sales                                                                   |                                     |   | 2,194              |          |                   |   | 107,661      |         |              |   | 392,205    |           |   |   | 355,081    |          
|Gross profit (loss)                                                             |                                     |   | 2,426              |          |                   |   | (41,616      | )       |              |   | (65,696    | )         |   |   | (112,312   | )        
|Operating expenses:                                                             |                                     |   |                    |          |                   |   |              |         |              |   |            |           |   |   |            |          
|                                                                                | Research and development            |   |                    | 257,795  |                   |   |              | 546,782 |              |   |            | 1,129,042 |   |   |            | 1,628,954 |  
|                                                                                | Selling, general and
administrative |   |                    | 709,334  |                   |   |              | 776,805 |              |   |            | 2,101,746 |   |   |            | 1,726,350 |  
|                                                                                |                                     |   |                    |          |                   |   |              |         |              |   |            |           |   |   |            |          
|                                                                                |                                     |   | 967,129            |          |                   |   | 1,323,587    |         |              |   | 3,230,788  |           |   |   | 3,355,304  |          
|                                                                                |                                     |   |                    |          |                   |   |              |         |              |   |            |           |   |   |            |          
|Operating loss                                                                  |                                     |   | (964,703           | )        |                   |   | (1,365,203   | )       |              |   | (3,296,484 | )         |   |   | (3,467,616 | )        
|                                                                                |                                     |   |                    |          |                   |   |              |         |              |   |            |           |   |   |            |          
|Other income (expenses):                                                        |                                     |   |                    |          |                   |   |              |         |              |   |            |           |   |   |            |          
|                                                                                | Interest income                     |   |                    | 15       |                   |   |              | 12,509  |              |   |            | 378       |   |   |            | 44,135    |  
|                                                                                | Interest expense                    |   |                    | (295,988 | )                 |   |              |        |              |   |            | (570,142  | ) |   |            | (2,416    | )
|                                                                                |                                     |   |                    |          |                   |   |              |         |              |   |            |           |   |   |            |          
|                                                                                |                                     |   | (295,973           | )        |                   |   | 12,509       |         |              |   | (569,764   | )         |   |   | 41,719     |          
|                                                                                |                                     |   |                    |          |                   |   |              |         |              |   |            |           |   |   |            |          
|Net loss                                                                        |                                     | $ | (1,260,676         | )        |                   | $ | (1,352,694   | )       |              | $ | (3,866,248 | )         |   | $ | (3,425,897 | )        
|                                                                                |                                     |   |                    |          |                   |   |              |         |              |   |            |           |   |   |            |          
|Basic and diluted loss
per common share                                         |                                     | $ | (0.02              | )        |                   | $ | (0.03        | )       |              | $ | (0.06      | )         |   | $ | (0.07      | )        
|                                                                                |                                     |   |                    |          |                   |   |              |         |              |   |            |           |   |   |            |          
|Weighted average number of
common shares outstanding
during the period (Note 1) |                                     |   | 71,500,223         |          |                   |   | 53,878,508   |         |              |   | 64,288,474 |           |   |   | 52,588,169 |          
|                                                                                |                                     |   |                    |          |                   |   |              |         |              |   |            |           |   |   |            |          

See accompanying summary of accounting policies and notes to unaudited
consolidated financial statements.



4



---



##### Table of Contents






PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

|                                                  |                                                                         |                                                                                        |                                       |            |                   |         |                   |            |         |          |  
|------------------------------------------------- | ----------------------------------------------------------------------- | -------------------------------------------------------------------------------------- | ------------------------------------- | ---------- | ----------------- | ------- | ----------------- | ---------- | ------- | -------- | -
|                                                  |                                                                         |                                                                                        |                                       |            | Nine Months Ended
|                                                  |                                                                         |                                                                                        |                                       |            |                  
|                                                  |                                                                         |                                                                                        |                                       |            | February 28, 2002 |         | February 28, 2001
|                                                  |                                                                         |                                                                                        |                                       |            |                   |         |                  
|Increase (Decrease) in Cash and Cash Equivalents  |                                                                         |                                                                                        |                                       |            |                   |         |                   |           
|Operating activities:                             |                                                                         |                                                                                        |                                       |            |                   |         |                   |           
|                                                  | Net loss                                                                |                                                                                        | $                                     | (3,866,248 | )                 |         | $                 | (3,425,897 | )      
|                                                  | Adjustments to reconcile net loss
to cash used in operating activities: |                                                                                        |                                       |            |                   |         |                   |            |        
|                                                  |                                                                         | Amortization and depreciation                                                          |                                       |            | 180,187           |         |                   |            | 180,529 |         
|                                                  |                                                                         | Provision for doubtful accounts                                                        |                                       |            | 70,600            |         |                   |            | 20,000  |         
|                                                  |                                                                         | Provision for inventory obsolescence                                                   |                                       |            | 149,433           |         |                   |            |        |         
|                                                  |                                                                         | Issuance of common stock and options for services                                      |                                       |            | 49,500            |         |                   |            | 83,629  |         
|                                                  |                                                                         | Non-cash interest expense related to warrants and
settlement of debt with common stock |                                       |            | 546,425           |         |                   |            |        |         
|                                                  |                                                                         | Changes in:                                                                            |                                       |            |                   |         |                   |            |         |         
|                                                  |                                                                         |                                                                                        | Accounts receivable                   |            |                   | (46,614 | )                 |            |         | (80,156  | )
|                                                  |                                                                         |                                                                                        | Inventories                           |            |                   | 73,960  |                   |            |         | (201,800 | )
|                                                  |                                                                         |                                                                                        | Prepaid and other assets              |            |                   | (53,526 | )                 |            |         | (44,380  | )
|                                                  |                                                                         |                                                                                        | Accounts payable and accrued expenses |            |                   | (56,588 | )                 |            |         | (214,400 | )
|                                                  |                                                                         |                                                                                        |                                       |            |                   |         |                   |           
|Net cash used in operating activities             |                                                                         |                                                                                        | (2,952,871                            | )          |                   |         | (3,682,475        | )         
|                                                  |                                                                         |                                                                                        |                                       |            |                   |         |                   |           
|Investing activities:                             |                                                                         |                                                                                        |                                       |            |                   |         |                   |           
|                                                  | Note receivable (Note 8)                                                |                                                                                        |                                       |           |                   |         |                   | (80,000    | )      
|                                                  | Web site development costs                                              |                                                                                        |                                       |           |                   |         |                   | (25,000    | )      
|                                                  | Purchase of property and equipment                                      |                                                                                        |                                       | (47,429    | )                 |         |                   | (121,289   | )      
|                                                  |                                                                         |                                                                                        |                                       |            |                   |         |                   |           
|Net cash used in investing activities             |                                                                         |                                                                                        | (47,429                               | )          |                   |         | (226,289          | )         
|                                                  |                                                                         |                                                                                        |                                       |            |                   |         |                   |           
|Financing activities:                             |                                                                         |                                                                                        |                                       |            |                   |         |                   |           
|                                                  | Proceeds from the issuance of short term notes payable                  |                                                                                        |                                       | 1,440,000  |                   |         |                   |           |        
|                                                  | Proceeds from the issuance of common stock                              |                                                                                        |                                       | 879,605    |                   |         |                   | 1,972,570  |        
|                                                  | Payments for capital lease obligations                                  |                                                                                        |                                       | (2,040     | )                 |         |                   |           |        
|                                                  | Proceeds from sales of accounts receivable                              |                                                                                        |                                       | 154,158    |                   |         |                   |           |        
|                                                  | Proceeds from exercise of common stock
warrants and options             |                                                                                        |                                       | 73,833     |                   |         |                   |           |        
|                                                  |                                                                         |                                                                                        |                                       |            |                   |         |                   |           
|Net cash provided by financing activities         |                                                                         |                                                                                        | 2,545,556                             |            |                   |         | 1,972,570         |           
|                                                  |                                                                         |                                                                                        |                                       |            |                   |         |                   |           
|Net decrease in cash and cash equivalents         |                                                                         |                                                                                        | (454,744                              | )          |                   |         | (1,936,194        | )         
|Cash and cash equivalents, beginning of period    |                                                                         |                                                                                        | 464,350                               |            |                   |         | 2,100,242         |           
|                                                  |                                                                         |                                                                                        |                                       |            |                   |         |                   |           
|Cash and cash equivalents, end of period          |                                                                         | $                                                                                      | 9,606                                 |            |                   | $       | 164,048           |           
|                                                  |                                                                         |                                                                                        |                                       |            |                   |         |                   |           
|Supplemental Disclosure of Cash Flow Information: |                                                                         |                                                                                        |                                       |            |                   |         |                   |           
|                                                  | Cash payments for interest                                              |                                                                                        | $                                     | 17,232     |                   |         | $                 | 2,416      |        
|                                                  | Warrants and options issued for prepaid services                        |                                                                                        | $                                     | 57,500     |                   |         | $                 | 16,916     |        
|                                                  | Common stock issued for prepaid services                                |                                                                                        | $                                     | 198,000    |                   |         | $                 |           |        
|                                                  | Capital lease obligation                                                |                                                                                        | $                                     | 24,996     |                   |         | $                 |           |        
|                                                  | Issuance of shares of common stock in payment
of notes payable          |                                                                                        | $                                     | 227,800    |                   |         | $                 |           |        
|                                                  | Debt discount                                                           |                                                                                        | $                                     | 834,929    |                   |         | $                 |           |        
|                                                  |                                                                         |                                                                                        |                                       |            |                   |         |                   |           

See accompanying summary of accounting policies and notes to unaudited
consolidated financial statements.



5



---



##### Table of Contents






PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. BASIS OF PRESENTATION

The consolidated financial statements of Patriot Scientific Corporation
(Patriot) presented herein have been prepared pursuant to the rules of the
Securities and Exchange Commission 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 statements
should be read in conjunction with our audited financial statements and notes
thereto for the year ended May 31, 2001.

In the opinion of management, the interim financial statements reflect all
adjustments of a normal recurring nature necessary for a fair statement of the
results for interim periods. Operating results for the three and nine month
periods are not necessarily indicative of the results that may be expected for
the year.

Loss Per Share

We follow Standard of Financial Accounting Standards (SFAS) No. 128,
Earnings per Share. Under SFAS No. 128, basic loss per share is calculated
as loss available to common stockholders divided by the weighted average number
of common shares outstanding. Diluted loss per share is calculated as net loss
divided by the diluted weighted average number of common shares. The diluted
weighted average number of common shares is calculated using the treasury stock
method for common stock issuable pursuant to outstanding stock options and
common stock warrants. Common stock options and warrants of 13,840,170 and
7,101,482 for the three and nine months ended February 28, 2002 and 2001,
respectively, were not included in diluted loss per share for the periods as
the effect was antidilutive due to our recording losses in each of those
periods. As discussed in Note 5, subsequent to February 28, 2002, we issued
warrants to purchase 12,888,800 shares of our common stock and cancelled a
warrant to purchase 3,630,940 shares of our common stock. See Notes 5 and 7
for discussion of commitments to issue additional shares of common stock and
warrants.

Sale of Accounts Receivable

We follow SFAS No. 140, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities, a replacement of SFAS No. 125.
SFAS No. 140 provides consistent standards for distinguishing transfers of
financial assets that are sales from transfers that are secured borrowings. A
factoring line we have established with a bank enables us to sell selected
accounts receivable invoices to the bank with full recourse against us. These
transactions qualify for a sale of assets since (1) we have transferred all of
our rights, title and interest in the selected accounts receivable invoices to
the bank, (2) the bank may pledge, sell or transfer the selected accounts
receivable invoices, and (3) we have no effective control over the selected
accounts receivable invoices since we may not redeem the invoices sold previous
to the invoices being greater than 90 days past due. Under SFAS
No. 140, after
a transfer of financial assets, an entity recognizes the financial and
servicing assets it controls and the liabilities it has incurred, derecognizes
financial assets when control has been surrendered, and derecognizes
liabilities when extinguished. During the first nine months of fiscal 2002, we
sold $192,697 of our accounts receivable to a bank under a factoring agreement
for $154,158. Pursuant to the provisions of SFAS No. 140, we reflected the
transactions as sales of assets and established a receivable from the bank for
the retained amount less the costs of the transactions and less any anticipated
future loss in the value of the retained asset. The retained amount was equal
to 20% of the total accounts receivable invoices sold to the bank less 1% of
the total invoices as an administrative fee and 1.75% per month of the total
outstanding accounts receivable invoices as a finance fee. The estimated
future loss reserve for each receivable included in the estimated value of the
retained asset was based on the payment history of the accounts receivable
customer. As of February 28, 2002, there were no qualifying accounts
receivable invoices available to factor resulting in no balance outstanding
under the factoring line and $400,000 remaining available for future factoring
of accounts receivable invoices.



6



---



##### Table of Contents



Patriot Scientific CorporationNotes to Consolidated Financial Statements (Continued)
Reclassifications

Certain items in the unaudited February 28, 2001 financial statements have been
reclassified to conform to the
current presentation.

2. RECENT ACCOUNTING PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities, amended by
SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities-Deferral of
the Effective Date of FASB No. 133, and SFAS No. 138, Accounting
for Certain Derivative Instruments and Certain Hedging Activities which
requires companies to record derivatives on the balance sheet as assets or
liabilities, measured at fair market value. Gains or losses resulting from
changes in the values of those derivatives would be accounted for depending on
the use of the derivative and whether it qualifies for hedge accounting. The
key criterion for hedge accounting is that the hedging relationship must be
highly effective in achieving offsetting changes in fair value or cash flows.
SFAS No. 133 was effective for us on June 1, 2001. The adoption of this
statement had no material impact on our financial statements.

In June 2001, the FASB issued SFAS No. 141, Business Combinations and SFAS
No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires the use
of the purchase method of accounting and prohibits the use of the
pooling-of-interests method of accounting for business combinations initiated
after June 30, 2001. SFAS No. 141 also requires that companies recognize
acquired intangible assets apart from goodwill if the acquired intangible
assets meet certain criteria. SFAS No. 141 applies to all business combinations
initiated after June 30, 2001 and for purchase business combinations completed
on or after July 1, 2001. It also requires, upon adoption of SFAS No. 142, that
companies reclassify the carrying amounts of intangible assets and goodwill
based on the criteria in SFAS No. 141.

SFAS No. 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS No. 142 requires that companies identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS No. 142. SFAS No. 142 is required to be
applied in fiscal years beginning after December 15, 2001 to all goodwill and
other intangible assets recognized at that date, regardless of when those
assets were initially recognized. SFAS No. 142 requires companies to complete a
transitional goodwill impairment test six months from the date of adoption.
Companies are also required to reassess the useful lives of other intangible
assets within the first interim quarter after adoption of SFAS No. 142.

Our previous business combinations were accounted for using the
pooling-of-interests method. The pooling-of-interests method does not result in
the recognition of acquired goodwill or other intangible assets. As a result,
the adoption of SFAS No. 141 and No. 142 will not affect the results of past
acquisition transactions. However, all future business combinations will be
accounted for under the purchase method, which may result in the recognition of
goodwill and other intangible assets, some of which will be recognized through
operations, either by amortization or impairment charges, in the future. We
will be required to reassess the useful lives of our intangible assets within
the first fiscal quarter of 2003.

In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS No. 143 requires the fair value of a liability for an asset
retirement obligation to be recognized in the period in which it is incurred if
a reasonable estimate of fair value can be made. The associated asset
retirement costs are capitalized as part of the carrying amount of the
long-lived asset. SFAS No. 143 is effective for the fiscal year ending May 31,
2003. We believe the adoption of this statement will have no material impact
on our financial statements.



7



---



##### Table of Contents



Patriot Scientific CorporationNotes to Consolidated Financial Statements (Continued)

In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. SFAS No. 144 requires that those long-lived
assets be measured at the lower of carrying amount or fair value less cost to
sell, whether reported in continuing operations or in discontinued operations.
Therefore, discontinued operations will no longer be measured at net realizable
value or include amounts for operating losses that have not yet occurred. SFAS
No. 144 is effective for financial statements issued for fiscal years beginning
after December 15, 2001 and, generally, is to be applied prospectively.

3. MANAGEMENTS PLAN

Our consolidated financial statements are presented on the going concern basis,
which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. Our ability to continue as a
going concern is contingent upon our obtaining sufficient financing to sustain
our operations. We incurred a net loss of $3,866,248, $4,968,903 and
$7,488,708 and negative cash flow from operations of $2,952,871, $4,839,180 and
$3,483,050 in the nine months ended February 28, 2002 and the years ended May
31, 2001 and 2000, respectively. At February 28, 2002, we had deficit working
capital of $1,013,311 and cash and cash equivalents of $9,606. We have
historically funded our operations primarily through the issuance of securities
and debt financings. Cash and cash equivalents decreased $454,744 during the
nine months ended February 28, 2002.

As of April 12, 2002, we have 81,465,757 shares of common stock outstanding,
5,513,985 common shares reserved for the issuance of shares on the exercise of
stock options, and 21,962,915 common shares reserved for the issuance of shares
on the exercise of warrants. The total shares outstanding and reserved are in
excess of our total authorized shares of 100,000,000 by a total of 8,942,657
shares. Accordingly, the issuance of this amount of shares on the exercise of
warrants is subject to our shareholders increasing the number of authorized
shares. We have scheduled a special meeting of shareholders for May 6, 2002 to
request the increase in the authorized number of common shares from
100,000,0000 to 200,000,000.

We estimate our current cash requirements to sustain our operations for the
next twelve months through February 2003 to be $2.6 million. Since we are
attempting to sell the communications product line, we are assuming that there
will be no communications product revenue beyond what was recognized during our
first three fiscal quarters of 2002 that ended on February 28, 2002. We also
have a note payable to Swartz of $1,212,000 at February 28, 2002. In addition
to limitations based on trading volume and market price of the common stock,
our ability to obtain equity financing under the $25 million equity line of
credit (see Note 6) is dependent on our having registered an adequate number of
shares to sell to Swartz Private Equity, LLC (Swartz). As of February 28,
2002, we have 14,100,000 registered shares remaining to sell to Swartz under
the registration statement that became effective on November 5, 2001. On April
11, 2002, the accumulated trading volume of our common stock for the first put
under the $25 million equity line of credit equaled 47 million shares. If
Swartz exercises their right to purchase 30% of the trading volume, then the
first put would be complete, the number of registered shares would be
exhausted and $1,073,340 would be available to offset the Amended Secured
Promissory Note. At Swartzs discretion, they may elect to purchase a minimum
of 20% of the trading volume which would mean the first put would continue
beyond April 11, 2002, however, at the current market price and assuming
adequate market volume, we estimate that by May 2002, we will need to register
additional shares under the current registration statement or complete a
proposed private placement that is being negotiated. We will need to get
shareholder approval to increase the authorized number of shares to be able to
accomplish the additional share registration required under either the $25
million equity line of credit or the proposed private placement that is being
negotiated.

The terms of the $25 million equity line of credit, including limitations on
the amount of shares that can be sold to Swartz based on the trading volume and
market price of the common stock, and a proposed private placement, may not
provide funds sufficient to meet our cash requirements. In addition, there is
no assurance that we will obtain the necessary shareholder approval to increase
the authorized shares or that we will complete the proposed private placement
being negotiated. On November 5, 2001, we entered into a secured note payable
and a waiver and agreement with Swartz whereby Swartz is able to advance us
monies previous to the close of the first put under the $25 million equity line
of credit. As of February 28, 2002, we have received an aggregate of
$1,440,000 principal


8Table of Contents

Patriot Scientific CorporationNotes to Consolidated Financial Statements (Continued)

against this note of which, on November 9, 2001, $227,800 was applied to the
final put under the $30 million equity line of credit (see Note 5). Subsequent
to February 28, 2002, we have received an additional $350,000 against the note
which may be applied against the first and future puts under the $25 million
equity line of credit and an initial advance of $125,000 against a new private
placement which is still being negotiated. As of March 12, 2002, we entered
into four additional similar waivers with Swartz under which we are committed
to put and Swartz is committed to purchase, subject to volume limitations, up
to 14.1 million shares of our common stock. These waivers are discussed
further in Note 6. In order to meet our cash requirements, we may need to
receive additional advances from Swartz, secure short-term debt, private
placement debt and/or equity financings with individual or institutional
investors. In addition to the cost reduction plan implemented during the
second fiscal quarter, including the reduction in personnel, we may need to
make additional cost reductions if our cash requirements cannot be met from
external sources. Based on the above assumptions, we expect that the funds
available from the first put under the $25 million equity line of credit will
not be adequate to repay the note to Swartz. Unless additional shares of
common stock are registered, we will not be able to sell additional shares
under the $25 million equity line of credit. As a result, we expect that the
$2.6 million requirement will be provided by:



| |  |  | an advance from Swartz of $350,000 which was funded subsequent to
the quarter ended February 28, 2002;                                                                                                                                                                                                                                                                                            
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | an initial advance of $125,000 against a new private placement
which is still being negotiated;                                                                                                                                                                                                                                                                                                   
|
| |  |  | additional funds under the $25 million equity line of credit- only
if the shareholders approve increasing our shares of common stock, we
are successful in registering additional shares of common stock,
limitations based on trading volume and market price of the common
stock allow adequate funding, and such available funding exceeds the
remaining balance of the note payable to Swartz;
|
| |  |  | proceeds from the exercise of outstanding stock options and warrants; and                                                                                                                                                                                                                                                                                                                         
|
| |  |  | additional debt and/or equity financings.                                                                                                                                                                                                                                                                                                                                                         

In addition, we have formulated additional cost reduction plans which can be
implemented if the required funds are not obtainable. We also have remaining a
$400,000 accounts receivable factoring agreement with our bank; however, we
have no eligible accounts receivable to factor as of February 28, 2002.

We anticipate our future revenue to be derived primarily from the sale of
licenses and royalties. To receive this revenue, we may require additional
equipment, fabrication, components and supplies during the next twelve months
to support potential customer requirements and further develop our
technologies. Product introductions such as those currently underway for the
Ignite I and JUICEtechnology may require significant product launch, marketing
personnel and other expenditures that cannot be currently estimated. Further,
if expanded development is commenced or new generations of microprocessor
technology are accelerated beyond current plans, additional expenditures we
cannot currently estimate, may be required. It is possible therefore, that
higher levels of expenditures may be required than we currently contemplate
resulting from changes in development plans or as
required to support new developments or commercialization activities or
otherwise.

We have initiated an acquisition program which, if successful, may require
additional funding. Currently we are reviewing one target candidate, Aspect
Semiquip International. We are attempting to secure financing for this
acquisition should the conclusion of our due diligence review indicate that the
acquisition could benefit us.

Based on our current plan and assumptions, we anticipate that we will be able
to meet our cash requirements for the next twelve months. We anticipate
meeting our cash needs as follows:



9



---



##### Table of Contents



Patriot Scientific CorporationNotes to Consolidated Financial Statements (Continued)

|                |                                                                                    |                                    |                                          |            |         |           | 
|--------------- | ---------------------------------------------------------------------------------- | ---------------------------------- | ---------------------------------------- | ---------- | ------- | --------- | 
|Cash available: |                                                                                    |                                    |                                          |           
|                | Cash available at February 28, 2002                                                |                                    | $                                        | 9,606      |        
|                | Subsequent advances                                                                |                                    |                                          |            |        
|                |                                                                                    | Swartz                             |                                          |            | 350,000 |          
|                |                                                                                    | Private placement being negotiated |                                          |            | 125,000 |          
|                |                                                                                    |                                    |                                          |           
|                |                                                                                    |                                    | Available cash under existing agreements |            | $       | 484,606   | 
|                |                                                                                    |                                    |                                          |           
|Cash needs:     |                                                                                    |                                    |                                          |           
|                | Estimated needs                                                                    |                                    | $                                        | 2,600,000  |        
|                | Note payable to Swartz at April 12, 2002                                           |                                    |                                          | 1,562,200  |        
|                |                                                                                    |                                    |                                          |           
|                |                                                                                    |                                    | Total                                    |            |         | 4,162,200 | 
|                | Estimated proceeds from first put under
Equity Line of Credit based on 30% advance |                                    |                                          | (1,073,340 | )      
|                |                                                                                    |                                    |                                          |           
|                |                                                                                    |                                    | Required funds from external sources     |            | $       | 3,088,860 | 
|                |                                                                                    |                                    |                                          |           

As shown above, we need to obtain $3,088,860. Any additional funding under the
existing $25 million equity line of credit is dependent on many factors,
including the increase in our authorized common stock. However, if we are not
able to meet our current plan to obtain approval to increase our authorized
common shares, there can be no assurance that any funds required during the
next twelve months or thereafter can be generated from sales of common stock
under the existing $25 million equity line of credit or that we will be able
to secure additional debt or equity financing. The lack of additional capital
could force us to substantially curtail or cease operations and would,
therefore, have a material adverse effect on our business. Further, there can
be no assurance that we will be able to timely receive shareholder approval to
increase the number of authorized shares or that required funds, if available,
will be available on attractive terms or that they will not have a
significantly dilutive effect on our existing shareholders. As such, there is
substantial doubt about our ability to continue as a going concern. The
consolidated financial statements do not include any adjustments to reflect the
possible future effects on the recoverability and classification of assets or
the amounts and classification of liabilities that may result from our possible
inability to continue as a going concern

4. INVENTORIES

Inventories were stated at cost (determined primarily by the weighted average
cost method which approximated cost on a first-in, first-out basis) not in
excess of market value. Due to the winding down of revenue from the
communications product line and the shift in emphasis to the sale of
microprocessor intellectual property through the issuance of licenses as
opposed to the sale of silicon based microprocessors and related products, as
of February 28, 2002, we have set up a reserve for obsolescence for the
remaining inventory balance.



10



---



##### Table of Contents



Patriot Scientific CorporationNotes to Consolidated Financial Statements (Continued)

Inventories at February 28, 2002 and May 31, 2001, consisted of the following:

|                         |  |                   |          |              |  |   |          |  
|------------------------ |  | ----------------- | -------- | ------------ |  | - | -------- | -
|                         |  | February 28, 2002 |          | May 31, 2001
|                         |  |                   |          |             
|                         |  | (unaudited)       |          |              |  |  
|Component parts          |  | $                 | 303,348  |              |  | $ | 343,430  |  
|Work in process          |  |                   |         |              |  |   | 20,000   |  
|Finished goods           |  |                   | 108,085  |              |  |   | 121,963  |  
|                         |  |                   |          |              |  |   |          |  
|                         |  |                   | 411,433  |              |  |   | 485,393  |  
|Reserve for obsolescence |  |                   | (411,433 | )            |  |   | (262,000 | )
|                         |  |                   |          |              |  |   |          |  
|                         |  | $                 |         |              |  | $ | 223,393  |  
|                         |  |                   |          |              |  |   |          |  

5. NOTE PAYABLE

On November 5, 2001, we entered into a Secured Promissory Note with Swartz.
The note was to mature on November 5, 2002. The initial amount of the note was
$565,000 and had an interest rate of 5% per annum. Upon mutual agreement
between Swartz and ourselves, Swartz may advance additional amounts under the
note. Interest
payments were due monthly starting January 1, 2002 and were to be paid in cash.
Principal amounts equal to at least 20% of the dollar trading volume for our
common stock for the twenty trading day period immediately preceding the date
of such payment were due initially monthly starting January 1, 2002 and could
be paid by an offset against amounts due to us from Swartz as a result of
common shares put to Swartz under the $25 million equity line of credit as
discussed below. On January 28, 2002, we entered into an agreement with Swartz
that extended the principal payments until June 1, 2002. As part of the
consideration for additional advances and deferral of principal payments on the
notes, we agreed to issue warrants to Swartz enabling them to purchase common
stock equal to 20% of any common stock we issue to parties other than Swartz
after January 28, 2002 for a period of five years unless the price of our
common stock exceeds $1 per share then no additional warrants will be issued.
The warrants issued are not registered with the SEC but do contain piggyback
and demand registration rights under certain conditions.

At February 28, 2002, $1,440,000 had been advanced against the note of which an
offset of $227,800 had been applied against the final put under the $30
million equity line of credit leaving a balance of $1,212,200 at February 28,
2002.

Also on November 5, 2001, we entered into a waiver and agreement with Swartz
whereby Swartz is able to advance us multiple funds previous to the close of
the first put under a $25 million equity line of credit as discussed in Note 6.
Under this waiver, as well as subsequent waivers (see Note 6) we were
committed to put, subject to volume limitations up to 10 million shares of our
common stock. Pursuant to these waivers, we agreed to issue additional
purchase warrant shares to be equal to the number of shares issued under the
first put. Under the waivers, the purchase warrant shares were to be issued to
Swartz as restricted shares subject to piggyback registration rights and were
subject to repricings on each six month anniversary if 110% of the lowest
closing bid price for the five days previous to the anniversary date was less
than the initial or subsequent reset exercise prices. On January 7, 2002, we
issued an interim warrant to purchase 3,630,940 shares of our common stock at
an exercise price of $0.10 per common share which was exercisable at the
earlier of ninety days or the close of the first put under the $25 million
equity line of credit. The warrant to purchase up to 3,630,940 shares of our
common stock issued to Swartz was valued using the Black-Scholes pricing model
and the estimated fair value was recorded as debt discount. In addition, the
warrants issuable to purchase up to 6,369,060 shares of our common stock were
valued using the Black-Scholes pricing model based on the expected fair value
at issuance and the estimated fair value was also recorded as debt discount.
See Note 6 for discussion of the terms of the warrants. Also in connection
with closing the $25 million equity line of credit, we issued to Swartz a
commitment warrant to purchase 900,000 shares of our common stock as discussed
further in Note 6. This warrant was valued on the issuance date using the
Black-Scholes pricing model and the value was recorded as a debt discount. All
debt discounts are to be amortized as additional interest expense over the
projected term of the note payable. As of February 28, 2002, $834,929 has been
reflected


11Table of Contents

Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)

as debt discount of which $285,357 and $349,175 was amortized to interest
expense during the three and nine months ended February 28, 2002.

|                                                              |                             |  |  |          |   |   |           |          |  
|------------------------------------------------------------- | --------------------------- |  |  | -------- | - | - | --------- | -------- | -
|Advances against the note as of February 28, 2002             |                             |  |  |          |   | $ | 1,440,000 |         
|Less amount applied against $30 million equity line of credit |                             |  |  |          |   |   | (227,800  | )       
|Less debt discount                                            |                             |  |  |          |   |   |           |         
|                                                              | Total                       |  |  | 834,929  |   |   |           |          |  
|                                                              | Amount amortized to expense |  |  | (349,175 | ) |   |           | (485,754 | )
|                                                              |                             |  |  |          |   |   |           |         
|Note payable at February 28, 2002                             |                             |  |  |          |   | $ | 726,446   |         
|                                                              |                             |  |  |          |   |   |           |         

On November 9, 2001, an offset of $227,800 from the sale of 2,500,000 shares of
common stock was applied against the final put under the $30 million equity
line of credit discussed below. The excess of the market value of the
underlying 2,500,000 shares of common stock over the principal reduction of
$227,800 was recorded as additional interest expense of $197,250 during the
nine months ended February 28, 2002.

On March 12, 2002, we replaced and superceded the Secured Promissory Note with
Swartz with an Amended Secured Promissory Note and Agreement with an effective
date of October 9, 2001 and an Addendum to Amended Secured Promissory Note
dated March 12, 2002. The amended note matures on October 9, 2002 and amounts
outstanding under the note bear interest at the rate of 5% per annum. Upon
mutual agreement between Swartz and ourselves, Swartz may advance additional
amounts under the amended note. Per the addendum to the amended note,
principal and interest payments are deferred until October 9, 2002.

As part of the consideration for entering into the above amended note, we
agreed to issue warrants to Swartz related to each advance against the note.
In connection with each advance, we shall issue to Swartz a warrant to purchase
a number of shares of common stock equal to the amount of the advance
multiplied by 8.25 at an initial exercise price equal to the lesser of the
factor of (a) the average of the volume weighted average price per share, as
defined by Bloomberg L.P., for each trading day in the period beginning on the
date of the previous advance and ending on the trading day immediately
preceding the date of the current advance multiplied by .70 or (b) the volume
weighted average price per share minus $0.05.

The amended note also gives to Swartz the right of first refusal and rights to
participate in subsequent debt or equity transactions entered into by us
through March 15, 2003. On March 12, 2002, the warrant to purchase 3,630,940
shares of our common stock was cancelled and we issued warrants to purchase
10,000,650 shares of our common stock in accordance with the amended note
agreement. In addition, if after March 12, 2002, we issue common stock to any
parties other than Swartz, we are obligated to issue to Swartz warrants equal
to 20% of the common stock so issued. For accounting purposes the above
warrant exchange is considered a subsequent event and will be accounted for in
the fourth fiscal quarter.

Subsequent to February 28, 2002, we received additional advances aggregating
$350,000 and issued warrants to purchase additional shares of our common stock
aggregating 2,888,150.

The note is secured by our assets.

6. INVESTMENT AGREEMENT

$30 Million Equity Line of Credit Agreement

In May 2000, we entered into an investment agreement with Swartz. The
investment agreement entitled us , at our option, to issue and sell our common
stock for up to an aggregate of $30 million from time to time during a
three-year period through June 23, 2003, subject to certain conditions
including among other items (1) an effective registration statement must be on
file with the SEC registering the resale of the common shares, and (2) a
limitation


12Table of Contents

Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)

on the number of common shares that can be sold to Swartz within a 30 day time
period based on the trading volume
of the stock. Swartz purchased the common stock from us at a discount. If the
market price was less than $1.00 per share, the discount was $.10 per share; if
the market price was between $1.00 to $1.99 per share, the discount was 10%;
and if the market price was $2.00 or greater, the discount was 7%. In
addition to the common stock
purchased, Swartz received warrants to purchase an additional 15% of the common
stock equal to 110% of the
market price as determined during the pricing period, subject to further
semi-annual price adjustments if the price of our common stock goes down.

The registration statement went effective on June 23, 2000. Since the
inception of the agreement through February 28, 2002, we received proceeds of
$4,381,601 from the sale of 12,000,000 shares of common stock . Per the terms
of the investment agreement, through February 28, 2002, we issued eight
five-year warrants for 1,200,000 shares of common stock exercisable initially
at prices ranging from $0.26 to $1.562.

On September 24, 2001, we entered into a waiver and agreement with Swartz
whereby Swartz was able to advance us $227,800 prior to the close of the final
put under the $30 million equity line of credit. The waiver and agreement
extended the time of the put beyond twenty days and redefined the price of the
put to be the lesser of the factor of (a) the volume weighted average price
per share, as defined by Bloomberg L.P., for each day of the put multiplied by
..70 or (b) the volume weighted average price per share minus $0.05 multiplied
by 20% of the acceptable daily volume as defined in the waiver. At the
discretion of Swartz the 20% daily volume limitation could be increased up to
30% of the daily volume. In addition, the waiver included the issuance of a
purchase warrant to purchase 2,125,000 shares of common stock at an initial
exercise price of $0.0911. The purchase warrant shares were issued to Swartz
as restricted shares subject to piggyback registration rights and are subject
to repricings on each six month anniversary if 110% of the lowest closing bid
price for the five days previous to the anniversary date is less than the
initial or subsequent reset exercise prices. See Note 7 for further
information on the warrants.

$25 Million Equity Line of Credit Agreement

Overview.On September 17, 2001, we entered into another investment agreement
with Swartz. This investment agreement entitles us to issue and sell our
common stock to Swartz for up to an aggregate of $25 million from time to time
during a three-year period following the effective date of the registration
statement, November 5, 2001. This is also referred to as a put right.

Put Rights.In order to invoke a put right, we must have an effective
registration statement on file with the SEC registering the resale of the
common shares which may be issued as a consequence of the invocation of that
put right. Additionally, we must give at least ten but not more than twenty
business days advance notice to Swartz of the date on which we intend to
exercise a particular put right, and we must indicate the number of shares of
common stock we intend to sell to Swartz. At our option, we may also designate
a maximum dollar amount of common stock (not to exceed $3 million) which we
will sell to Swartz during the put and/or a minimum purchase price per common
share at which Swartz may purchase shares during the put. The number of common
shares sold to Swartz may not exceed 20% of the aggregate daily reported
trading volume during each of two consecutive ten business day periods
beginning on the business day immediately following the day we invoke the put
right.

The price Swartz will pay for each share of common stock sold in a put is equal
to the lesser of (i) the market price for each of the two consecutive ten
business day periods beginning on the business day immediately following the
day we invoke the put right minus $0.10, or (ii) X percent of the market price
for each of the two ten day periods, where, X is equal to 90% if the market
price is below $2.00 and 93% if market price is equal to or greater than $2.00.
Market price is defined as the lowest closing bid price for the common stock
during each of the two consecutive ten business day periods. However, the
purchase price may not be less than the designated minimum per share price, if
any, that we indicate in our notice.

Warrants.We issued to Swartz a commitment warrant to purchase up to 900,000
shares of our common stock concurrent with the execution of the investment
agreement. This warrant is exercisable through September 17, 2006


13Table of Contents

Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)

at an initial exercise price of $0.22. The commitment warrant exercise price
is subject to being reset, if the price of
our common stock is lower than the initial exercise price, on any six month
anniversary of its issuance.

Limitations and Conditions Precedent to Our Put Rights.We may not initiate a
put if, as of the proposed date of
such put:



| |  |  | we have issued shares of our common stock that have
been paid for by Swartz and the amount of proceeds we have
received is equal to the maximum offering amount;                                                                                                             
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the registration statement covering the resale of the
shares becomes ineffective or unavailable for use;                                                                                                                                                                     
|
| |  |  | our common stock is not actively trading on the OTC
Bulletin Board, the Nasdaq Small Cap Market, the Nasdaq National
Market, the American Stock Exchange, or the New York Stock
Exchange, or is suspended or delisted with respect to the trading
on such market or exchange.

If any of the following events occur during the pricing period for a put, the
volume accrual shall cease. For the put, the pricing period shall be adjusted
to end 10 business days after the date that we notify Swartz of the event, and
any minimum price per share we specified shall not apply to the put:



| |  |  | we have announced or implemented a stock split or
combination of our common stock between the advanced put notice
date and the end of the pricing period;                                        
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | we have paid a common stock dividend or made any other
distribution of our common stock between the advanced put notice
date and the end of the pricing period;                                  
|
| |  |  | we have made a distribution to the holders of our
common stock or of all or any portion of our assets or evidences
of indebtedness between the put notice date and the end of the
pricing period;
|
| |  |  | control between the advance put notice date and the end
of the pricing period;                                                                                                                   
|
| |  |  | the registration statement covering the resale of the
shares becomes ineffective or unavailable for use, or our stock
becomes delisted for trading on our then primary exchange; or              
|
| |  |  | we discover the existence of facts that cause us to
believe that the registration statement contains an untrue
statement or omits to state a material fact.                                      

Short Sales.Swartz and its affiliates are prohibited from engaging in short
sales of our common stock unless they
have received a put notice and the amount of shares involved in a short sale
does not exceed the number of shares specified in the put notice.

Shareholder Approval.We may currently issue more than 20% of our outstanding
shares under the investment agreement. If we become listed on the Nasdaq Small
Cap Market or Nasdaq National Market, then we must get
shareholder approval to issue more than 20% of our outstanding shares. Since
we are currently a bulletin board company, we do not need shareholder approval.

Termination of Investment Agreement.We may also terminate our right to
initiate further puts or terminate the investment agreement by providing Swartz
with notice of such intention to terminate; however, any such termination will
not affect any other rights or obligations we have concerning the investment
agreement or any related agreement.

Restrictive Covenants.During the term of the investment agreement and for a
period of two months thereafter, we are prohibited from certain transactions.
These include the issuance of any debt or equity securities in a private
transaction which are convertible or exercisable into shares of common stock at
a price based on the trading price of the common stock at any time after the
initial issuance of such securities or with a fixed conversion or exercise
price subject to adjustment without obtaining Swartzs prior written approval.

Right of First Refusal.Swartz has a right of first refusal to purchase any
variable priced securities offered by us in



14



---



##### Table of Contents



Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)

any private transaction which closes on or prior to two months after the
termination of the investment agreement and
a right of participation for any equity securities offered by us in any private
transaction which closes on or prior to two months after the termination of the
investment agreement.

Swartzs Right of Indemnification.We are obligated to indemnify Swartz
(including their stockholders, officers, directors, employees and agents) from
all liability and losses resulting from any misrepresentations or breaches we
made in connection with the investment agreement, our registration rights
agreement, other related agreements, or the registration statement.

Waiver and Agreement.On November 5, 2001, December 6, 2001, January 2, 2002,
and February 6, 2002, we entered into four waivers and agreements with Swartz
whereby Swartz was able to advance us multiple funds previous to the close of
the first put of up to 10 million shares of common stock under this $25 million
equity line of credit. The waivers and agreements extended the time of the put
beyond twenty days and redefined the price of the put to be the lesser of the
factor of (a) the volume weighted average price per share, as defined by
Bloomberg L.P., for each day of the put multiplied by .70 or (b) the volume
weighted average price per share minus $0.05 multiplied by 20% of the
acceptable daily volume as defined in the waiver. At the discretion of Swartz
the 20% daily volume limitation could be increased up to 30% of the daily
volume. In addition, the waivers included the commitment to issue additional
purchase warrant shares to be equal to the number of shares issued under the
first put. Under these waivers, the purchase warrant shares were to be issued
to Swartz as restricted shares subject to piggyback registration rights and
were subject to repricings on each six month anniversary if 110% of the lowest
closing bid price for the five days previous to the anniversary date is less
than the initial or subsequent reset exercise prices. On January 7, 2002, we
issued an interim warrant to purchase 3,630,940 shares of our common stock at
an exercise price of $0.10. The interim warrant was exercisable the earlier of
90 days or the close of the first put under the $25 million equity line of
credit. As discussed in Note 5, as of February 28, 2002, warrants to purchase
an additional 6,369,060 shares of our common stock were issuable to Swartz.

On March 12, 2002, we entered into an amended waiver and agreement with Swartz
which replaced and superseded the previous waivers and agreements discussed
above. This amended waiver and agreement extended the time of the put beyond
twenty days and redefined the price of the put to be the lesser of the factor
of (a) the volume weighted average price per share, as defined by Bloomberg
L.P., for each day of the put multiplied by .70 or (b) the volume weighted
average price per share minus $0.05 multiplied by 20% of the acceptable daily
volume as defined in the waiver. At the discretion of Swartz, the 20% daily
volume limitation may be increased up to 30% of the daily
volume. In addition, the amended waiver and agreement increased the intended
put share amount for the first put to 14,100,000 shares, which is the total
number of shares we have registered so far under the $25 million equity line of
credit. On March 12, 2002, we cancelled the interim warrant to purchase
3,630,940 shares of our common stock as a result of entering into the amended
secured note payable on March 12, 2002 as discussed in Note 5.

7. STOCKHOLDERS EQUITY (DEFICIT)

The following table summarizes equity transactions during the nine months ended
February 28, 2002:

|                                                                 |  |        |            |         |  |   |            |  
|---------------------------------------------------------------- |  | ------ | ---------- | ------- |  | - | ---------- | -
|                                                                 |  | Common |            |         |  |  
|                                                                 |  | Shares |            | Dollars
|                                                                 |  |        |            |        
|Balance June 1, 2001                                             |  |        | 57,535,411 |         |  | $ | 37,321,078 |  
|Warrants and options issued for services                         |  |        |           |         |  |   | 57,500     |  
|Cancellation of options issued for prepaid services              |  |        |           |         |  |   | (10,574    | )
|Non-cash interest and debt discount
related to warrants (Note 5) |  |        |           |         |  |   | 1,032,179  |  
|Issuance of common stock                                         |  |        | 14,236,560 |         |  |   | 1,107,405  |  
|Issuance of common stock for services                            |  |        | 2,200,000  |         |  |   | 198,000    |  
|Exercise of common stock warrants and options                    |  |        | 241,666    |         |  |   | 73,833     |  
|                                                                 |  |        |            |         |  |   |            |  
|Balance February 28, 2002                                        |  |        | 74,213,637 |         |  | $ | 39,779,421 |  
|                                                                 |  |        |            |         |  |   |            |  



15



---



##### Table of Contents



Patriot Scientific CorporationNotes to Consolidated Financial Statements (Continued)

At February 28, 2002, we had 82,500 options outstanding pursuant to our 1992
ISO Stock Option Plan exercisable at $1.325 per share expiring in 2005; 100,000
options outstanding pursuant to our 1992 NSO Stock Option Plan
exercisable at $1.325 per share expiring beginning in 2005; 1,617,905 options
outstanding pursuant to our 1996 Stock Option Plan exercisable at a range of
$0.32 to $1.41 per share expiring beginning in 2001 through 2005; and 2,965,000
options outstanding pursuant to our 2001 Stock Option Plan exercisable at a
range of $0.11 to $0.70 per share expiring beginning in 2006 through 2007.

Some of the options outstanding under these plans are not presently exercisable
and are subject to meeting vesting criteria.

The 2001 Stock Option Plan was approved by our shareholders at our annual
meeting on October 11, 2001. The market price of our stock on October 11,
2001, the measurement date, was $0.17. As the exercise prices of the options
under the 2001 Stock Option Plan granted before the approval date exceeded the
market value of our stock on the measurement date, there was no compensation
recorded for the grants made prior to approval.

At February 28, 2002, we had warrants outstanding exercisable into 9,074,765
common shares at exercise prices ranging from $0.048 to $1.12 per share
expiring beginning in 2002 through 2007. During the nine months ended
February 28, 2002, we issued warrants to purchase 7,794,242 shares of common
stock of which warrants to purchase 7,644,242 shares of common stock are
subject to repricings at the six month anniversary of the issuance of the
warrant. At each anniversary date the warrants will be repriced to the lesser
of the initial exercise price or 110% of the lowest closing bid price of our
common stock for the five trading days ending on such six month
anniversary date of the date of issuance. As of February 28, 2002, warrants
to purchase 2,252,219 shares of common stock with initial exercise prices
ranging from $0.26 to $1.09 have been repriced to exercise prices ranging from
$0.077 to $0.22.

As discussed in Note 5, subsequent to February 28, 2002, we cancelled the
warrant to purchase 3,630,940 shares of our common stock and issued warrants
to acquire 12,888,800 shares of our common stock. As a result, as of April
12, 2002, warrants to purchase 8,942,657 shares of our common stock are
subject to our shareholders approving an increase in the amount of our
authorized common stock. We have a shareholders meeting scheduled for May 6,
2002 at which time, we will seek approval to increase our authorized shares
from 100,000,000 shares to 200,000,000
shares.

As of February 28, 2002, as a result of the trading volume of our common
stock, Swartz was committed under the waiver agreements to the $25 million
equity line of credit (see Note 6) to purchase at least 6,847,880 shares of
our common stock which have been reflected as outstanding at February 28,
2002. These shares have been reflected in stockholders equity (deficit) at
par value as the first put has not closed and the sales price is not known
(see Note 6 for discussion). These shares are included in the weighted
average number of shares in calculating the loss per share. As of April 8,
2002, as a result of the trading volume of our common stock, Swartz is
committed to purchase at least 2,450,620 additional shares of our common stock
under the waiver agreement to the $25 million equity line of credit.

See Note 5 for discussion of warrants issued subsequent to February 28, 2002
and commitments to issue additional warrants.

In December 2001, we entered into a series of agreements with iCapital
Corporation (iCapital) and several principals of iCapital whereby they will
provide consulting services through December 2002 to help structure financing,
provide innovative capital resources, identify and assist with merger and
acquisition opportunities and advise us on other strategic decisions. In
January 2002, based on meeting several performance criteria, we issued to
iCapital and the principals of iCapital 2,200,000 shares of our common stock as
compensation for the consulting
services. During the three and nine months ended February 28, 2002, we
recorded $198,000, the value of the common stock on the day it was issued, as a
prepaid expense and additional paid-in capital and amortized to expense


16Table of Contents

Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)

$49,500 as non-cash compensation.

8. NOTE RECEIVABLE

In June 2000, we entered into a three-year, $80,000 Secured Promissory Note
Receivable with an individual who was, at the time of the issuance of the note,
an executive officer of Patriot. On September 25, 2000, he requested and was
relieved of his duties as an executive officer and director of Patriot. The
note bears interest at the rate of 6% per annum with interest payments due
semi-annually and the principal due at the maturity of the note. The
individual pledged 100,000 shares of our common stock that he held on the date
of issuance as security for this note.

9. LEGAL PROCEEDINGS

In January 1999, we were sued in the Superior Court of San Diego County,
California by the Fish Family Trust, a co-inventor of the original ShBoom
technology. The suit also named as defendants nanoTronics and Gloria Felcyn on
behalf of the Falk Family Trust. The suit sought a judgment for damages, a
rescission of the Technology Transfer Agreement and a restoration of the
technology to the co-inventor. In March 1999, we joined with nanoTronics and
Gloria Felcyn and filed our response and cross-complaint against the Fish
Family Trust. In November 2000, the judge issued a summary ruling in favor of
the defendants on all counts. The Fish Family Trust filed an appeal in
January 2001. Management believes that it is unlikely that the appellate court
will overturn the trial courts ruling and that the resolution of the appeal
process will have no impact on our financial position or cash flows.

A former employee had filed a claim in arbitration seeking the right to
exercise terminated options. We have settled with the former employee without
the necessity of going to arbitration. The amount of the settlement was
$37,500 which is payable in four equal monthly payments starting in April 2002.
The settlement was accrued during the quarter ended February 28, 2002.

In September 2001, an action was filed against us in the Superior Court of San
Diego County, California by Richard G. Blum, our former Chairman, President and
Chief Executive Officer. Mr. Blum contends that he was wrongfully terminated
on August 5, 2001 in violation of his employment agreement dated December 1,
2000. He seeks damages for the alleged breach of his employment agreement, age
discrimination, as well as other related claims.

Management denies Mr. Blums claims and contends it exercised its business
judgment for legitimate nondiscriminatory reasons. In accordance with his
employment agreement, we may be obligated to pay him between $0 and $368,000 as
severance pay. We intend to vigorously defend our position in this case.

In October 2001, an action was filed against us in the Superior Court of San
Diego County, California by Daniel Beach, a former marketing and sales
consultant whose contract we terminated in August 2001. Mr. Beach contends
that we breached both a written and an oral contract, that we did not perform
on certain promises, and that we made false and misleading representations in
addition to other claims. Management denies Mr. Beachs claims and we intend
to vigorously defend our position in this case.



17



---



##### Table of Contents






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

THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO
OUR FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM
THOSE CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A
VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW UNDER THE SUB-HEADING,
FUTURE PERFORMANCE AND RISK FACTORS. SEE ALSO OUR ANNUAL REPORT ON FORM
10-KSB FOR THE YEAR ENDED MAY 31, 2001.

Our results of operations have been and may continue to be subject to
significant variations. The results for a particular period may vary due to a
number of factors. These include:



| |  |  | Our major product line has had limited revenues                                                                                                                                             
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | We have incurred significant losses and may continue to do so                                                                                                                               
|
| |  |  | Our independent certified public accountants have added an
explanatory paragraph to their opinion in which they expressed
substantial doubt about our ability to continue as a going concern
|
| |  |  | The price and the trading volume of our common stock have an
effect on the amount of capital we can raise                                                                                   
|
| |  |  | We will require additional financing                                                                                                                                                        
|
| |  |  | We will need to increase our authorized shares                                                                                                                                              
|
| |  |  | Large block sales of our stock may decrease the price of our stock                                                                                                                          
|
| |  |  | We may be impacted as a result of terrorism                                                                                                                                                 
|
| |  |  | Our products may not be completed on time                                                                                                                                                   
|
| |  |  | The market in which we operate is highly competitive                                                                                                                                        
|
| |  |  | Protection of our intellectual property is limited; there is a risk of claims for infringement                                                                                              
|
| |  |  | Our products are dependent on the Internet and Java                                                                                                                                         
|
| |  |  | Our stock is subject to penny-stock rules                                                                                                                                                   

Critical Accounting Policies

We believe that the following represent our critical accounting policies:

Property, Equipment and Depreciation

Property and equipment are stated at cost. Depreciation is computed over
the estimated useful life of three to five years using the straight-line
method. Long-lived assets and certain identifiable intangibles to be held and
used by the Company are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. We continuously evaluate the recoverability of our long-lived
assets based on estimated future cash flows from and the estimated fair value
of such long-lived assets, and provide for impairment if such undiscounted cash
flows are insufficient to recover the carrying amount of the long-lived asset.

Patents and Trademarks

Patents and trademarks are carried at cost less accumulated amortization
and are amortized over their estimated useful lives of four years. The carrying
value of patents and trademarks is periodically reviewed and impairments, if
any, are recognized when the expected future benefit to be derived from an
individual intangible asset is less than its carrying value.

Research and Development Costs

Research and development costs are expensed as incurred.



18



---



##### Table of Contents



Use of Estimates

The preparation of financial statements in conformity with accounting
principles generally accepted in the
United States of America requires management to make estimates and assumptions
that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the consolidated financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates. During the nine months ended February 28, 2002,
based upon information then available, we revised our estimates regarding the
recovery of our inventories. As a result, we increased existing reserves for
obsolescence by $149,433.

Results of Operations for the Three Months Ended February 28, 2002 and February
28, 2001

Net sales. Total net sales for the third fiscal quarter ended February
28, 2002 decreased 93.0% to $4,620 from $66,045 for the corresponding period of
the previous fiscal year. This decrease was due to the final buys on our
matured communication products having been substantially completed. We
informed our customers that we would no longer be manufacturing these products
after this last buy opportunity and are attempting to find a buyer for this
group of products. We are currently expending our efforts on marketing and
sale of our microprocessor technology. The microprocessor technology generated
minimal revenue during the second fiscal quarter ended February 28, 2002. We
anticipate that future revenue will be derived from up front license fees and
royalties as a result of the shift in focus to the commercialization of our
microprocessor and related technology intellectual property. Previously we
focused primarily on the sale of silicon products. We cannot estimate when
significant revenue will be generated from the microprocessor technology.

Cost of sales. Cost of sales as a percentage of net sales decreased to
47.5% in the third fiscal quarter ended February 28, 2002 compared to 163.0%
for the corresponding period of the previous fiscal year. This significant
decrease was due to minimal sales during the third quarter enabling us to make
use of previously written off inventory. The write-down of the inventory to
zero during the second fiscal quarter was a result of not being able to find a
buyer for the communication product line and our decision to focus future
company revenue on the sale of licenses and intellectual property related to
our microprocessor technology versus the sale of microprocessor silicon and
related products. The winding down of the communication product line does not
impair any of our other assets.

Research and development expenses decreased 52.8% from $546,782 for the
third fiscal quarter ended February 28, 2001 compared to $257,795 for the third
fiscal quarter ended February 28, 2002. This decrease was due to a reduction
in consulting services compared to the previous fiscal year related to the
development of a new soft core version of the microprocessor technology in the
amount of $42,575, a reduction in payroll expense as a result of downsizing the
department by six individuals during the second and third fiscal quarters in an
amount of
$180,892, a reduction in the maintenance fees for support of the Java virtual
machine and tool expense related thereto in the amount of $20,490, and a
general reduction in expenses related to the reduced sales activities.

Selling, general and administrative expenses decreased 9.5% to $709,334
for the third fiscal quarter ended February 28, 2002 compared to $776,805 for
the third fiscal quarter ended February 28, 2001. This decrease was due
primarily to recognizing consulting expense of $49,500 as discussed in Note 7
to the unaudited consolidated financial statements and accrued settlement costs
of $37,500 as discussed in Note 9 to the unaudited consolidated financial
statements during the third fiscal quarter offset by a reduction in personnel
and consulting costs related to executive, marketing and sales activities in
the amount of $191,358 as a result of downsizing the company during the second
fiscal quarter; and a general reduction in expenses related to the reduced
sales activities.

Other expense for the third fiscal quarter ended February 28, 2002,
$295,973, compared to other income of $12,509 for the corresponding period of
the previous fiscal year. This change resulted primarily from the recognition
of non-cash interest expense of $285,357 related to the amortization of the
debt discount associated with the issuance of warrants under a secured note
payable in the third fiscal quarter ended February 28, 2002 compared to the
recognition of $12,509 of interest income during the corresponding period of
the previous fiscal year.

Results of Operations for the Nine months Ended February 28, 2002 and February
28, 2001

Net sales. Total net sales for the first nine months ended February 28,
2002 increased 34.5% to $326,509



19



---



##### Table of Contents



from $242,769 for the corresponding period of the previous fiscal year. This
increase was due to the final buys on
our matured communication products. We informed our customers that we would no
longer be manufacturing these products after this last buy opportunity and are
attempting to find a buyer for this group of products. We are
currently expending our efforts on marketing and sale of our microprocessor
technology. The microprocessor technology generated minimal revenue during the
first nine months ended February 28, 2002. We anticipate that future revenue
will be derived from up front license fees and royalties as a result of the
shift in focus to the commercialization of our microprocessor and related
technology intellectual property. Previously we focused primarily on the sale
of silicon products. We cannot estimate when significant revenue will be
generated from the microprocessor technology.

Cost of sales. Cost of sales as a percentage of net sales decreased to
120.1% for the nine months ended February 28, 2002 compared to 146.3% for the
corresponding period of the previous fiscal year. This decrease was due to the
significant increase in net sales as a result of the last buy of communication
products as discussed above partially offset by a write-down in inventory of
$149,433. The write-down of the inventory to zero is a result of not being
able to find a buyer for the communication product line and our decision to
focus future company revenue on the sale of licenses and intellectual property
related to our microprocessor technology versus the sale of microprocessor
silicon and related products.

Research and development expenses decreased 30.7% from $1,628,954 for the
nine months ended February 28, 2001 compared to $1,129,042 for the nine months
ended February 28, 2002. This decrease was due primarily to a reduction in
consulting services compared to the previous fiscal year related to the
development of a new soft core version of the microprocessor technology in an
amount of $168,957, a reduction in payroll expense in an amount of $160,180, a
reduction in the maintenance fees for support of the Java virtual machine and
tool expense related thereto in the amount of $56,196, and a general reduction
in expenses related to the reduced sales activities.

Selling, general and administrative expenses increased 21.7% to
$2,101,746 for the nine months ended February 28, 2002 compared to $1,726,350
for the nine months ended February 28, 2001. This increase was due primarily
to an increase in personnel costs related to executive, marketing and sales
activities including several new employee positions in an amount of $210,517;
an increase in legal, accounting and shareholder expenses related to our annual
meeting, filing of a registration statement and responding to several lawsuits
filed against us during the nine months ended February 28, 2002 in an aggregate
amount of $234,150; an increase in the reserve for doubtful accounts receivable
of $50,600; and a reduction in consulting expenses in an amount of $205,864.

Other expense for the nine months ended February 28, 2002, $569,764,
compared to other income of $41,719 for the corresponding period of the
previous fiscal year. This change resulted primarily from the recognition of
non-cash interest expense of $349,175 related to the amortization of the debt
discount associated with
the issuance of warrants under the secured note payable and equity line of
credit and additional interest expense of $197,250 related to the excess of the
market price over the carrying value of the common shares sold to Swartz for
which the proceeds were applied to the note payable balance (see Note 5 to the
consolidated financial statements) in the nine months ended February 28, 2002
compared to the recognition of $44,135 of interest income during the
corresponding period of the previous fiscal year.

Liquidity and Capital Resources

In connection with their report on our consolidated financial statements
as of and for the year ended May 31, 2001, BDO Seidman, LLP, our independent
certified public accountants, expressed substantial doubt about our ability to
continue as a going concern because of recurring net losses and negative cash
flow from operations.

At February 28, 2002, we had deficit working capital of $1,013,311 and
cash and cash equivalents of $9,606. We have historically funded our
operations primarily through the issuance of securities and debt financings.
Cash and cash equivalents decreased $454,744 during the nine months ended
February 28, 2002 due to net cash used in operations of $2,952,871 and
additions to property, equipment and patents, net of $47,429 offset by funds
generated primarily from the exercise of warrants and options to purchase
common stock of $73,833, proceeds from a note payable of $1,440,000 and the
sale of common stock under an investment agreement and to individual investors
of $879,605. The net cash used in operations was $2,952,871 for the nine
months ended February 28,



20



---



##### Table of Contents



2002 compared to $3,682,475 for the corresponding period of the previous fiscal
year. The decrease in cash required in operations was due primarily to a
$271,636 difference in net loss as adjusted to reconcile to cash used in
operating activities coupled with a $275,760 difference in the cash generated
and sales of inventory between the two periods. Cash used in investing
activities was $47,429 for the nine months ended February 28, 2002 compared to
$226,289 for the corresponding period of the previous fiscal year. This
decrease in cash required for investing activities was due primarily to a note
receivable for $80,000 coupled with corporate office remodeling costs incurred
during the corresponding period of the previous fiscal year. Cash provided by
financing activities was $2,545,556 for the nine months ended February 28, 2002
compared to $1,972,570 for the corresponding period of the previous fiscal
year. This increase was primarily the result of the issuance of short term
notes payable during the current fiscal period.

As of April 12, 2002, we have 81,465,757 shares of common stock
outstanding, 5,513,985 common shares reserved for the issuance of shares on the
exercise of stock options, and 21,962,915 common shares reserved for the
issuance of shares on the exercise of warrants. The total shares outstanding
and reserved are in excess of our total authorized shares of 100,000,000 by a
total of 8,942,657 shares. Accordingly, the issuance of this amount of shares
on the exercise of warrants is subject to our shareholders increasing the
number of authorized shares. We have scheduled a special meeting of
shareholders for May 6, 2002 to request the increase in the authorized number
of common shares from 100,000,000 to 200,000,000.

We estimate our current cash requirements to sustain our operations for
the next twelve months through February 2003 to be $2.6 million. Since we are
attempting to sell the communications product line, we are assuming that there
will be no communications product revenue beyond what was recognized during our
first three fiscal quarters of 2002 that ended on February 28, 2002. We also
have a note payable to Swartz of $1,212,000 at February 28, 2002. In addition
to limitations based on trading volume and market price of the common stock,
our ability to obtain equity financing under the $25 million equity line of
credit (see Note 6 to the unaudited consolidated financial statements) is
dependent on our having registered an adequate number of shares to sell to
Swartz Private Equity, LLC (Swartz). As of February 28, 2002, we have
14,100,000 registered shares remaining to sell to Swartz under the registration
statement that became effective on November 5, 2001. On April 11, 2002, the
accumulated trading volume of our common stock for the first put under the $25
million equity line of credit equaled 47 million shares. If Swartz exercises
their right to purchase 30% of the trading volume, then the first put would be
complete, the number of registered shares would be exhausted and $1,073,340
would be available to offset the Amended Secured Promissory Note. At Swartzs
discretion, they may elect to purchase a minimum of 20% of the trading volume
which would mean the first put would continue beyond April 11, 2002, however,
at the current market price and assuming adequate market volume, we estimate
that by May 2002, we will need to register additional shares under the current
registration statement or complete a proposed private placement that is being
negotiated. We will need to get shareholder approval to increase the
authorized number of shares to be able to accomplish the additional share
registration required under either the $25 million equity line of credit or the
proposed private placement that is being negotiated.

The terms of the $25 million equity line of credit, including limitations
on the amount of shares that can be sold to Swartz based on the trading volume
and market price of the common stock, and a proposed private placement, may not
provide funds sufficient to meet our cash requirements. In addition, there is
no assurance that we will obtain the necessary shareholder approval to increase
the authorized shares or that we will complete the proposed private placement
being negotiated. On November 5, 2001, we entered into a secured note payable
and a waiver and agreement with Swartz whereby Swartz is able to advance us
monies previous to the close of the first put under the $25 million equity line
of credit. As of February 28, 2002, we have received an aggregate of
$1,440,000 principal against this note of which, on November 9, 2001, $227,800
was applied to the final put under the $30 million equity line of credit (see
Note 5 to the unaudited consolidated financial statements). Subsequent to
February 28, 2002, we have received an additional $350,000 against the note
which may be applied against the first and future puts under the $25 million
equity line of credit and an initial advance of $125,000 against a new private
placement which is still being negotiated. As of March 12, 2002, we entered
into four additional similar waivers with Swartz under which we are committed
to put and Swartz is committed to purchase, subject to volume limitations, up
to 14.1 million shares of our common stock. These waivers are discussed
further in Note 6 to the unaudited consolidated financial statements. In order
to meet our cash requirements, we may need to receive additional advances from
Swartz, secure short-term debt,



21



---



##### Table of Contents



private placement debt and/or equity financings with individual or
institutional investors. In addition to the cost reduction plan implemented
during the second fiscal quarter, including the reduction in personnel, we may
need to make additional cost reductions if our cash requirements cannot be met
from external sources. Based on the above assumptions, we expect that the
funds available from the first put under the $25 million equity line of credit
will not be adequate to repay the note to Swartz. Unless additional shares of
common stock are registered, we will not be able to sell additional shares
under the $25 million equity line of credit. As a result, we expect that the
$2.6 million requirement will be provided by:



| |  |  | an advance from Swartz of $350,000 which was funded subsequent to
the quarter ended February 28, 2002;                                                                                                                                                                                                                                                                                            
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | an initial advance of $125,000 against a new private placement
which is still being negotiated;                                                                                                                                                                                                                                                                                                   
|
| |  |  | additional funds under the $25 million equity line of credit- only
if the shareholders approve increasing our shares of common stock, we
are successful in registering additional shares of common stock,
limitations based on trading volume and market price of the common
stock allow adequate funding, and such available funding exceeds the
remaining balance of the note payable to Swartz;
|
| |  |  | proceeds from the exercise of outstanding stock options and warrants; and                                                                                                                                                                                                                                                                                                                         
|
| |  |  | additional debt and/or equity financings.                                                                                                                                                                                                                                                                                                                                                         

In addition, we have formulated additional cost reduction plans which can be
implemented if the required funds are not obtainable. We also have remaining a
$400,000 accounts receivable factoring agreement with our bank; however, we
have no eligible accounts receivable to factor as of February 28, 2002.

We anticipate our future revenue to be derived primarily from the sale of
licenses and royalties. To receive this revenue, we may require additional
equipment, fabrication, components and supplies during the next twelve months
to support potential customer requirements and further develop our
technologies. Product introductions such as those currently underway for the
Ignite I and JUICEtechnology may require significant product launch, marketing
personnel and other expenditures that cannot be currently estimated. Further,
if expanded development is commenced or new generations of microprocessor
technology are accelerated beyond current plans, additional expenditures we
cannot currently estimate, may be required. It is possible therefore, that
higher levels of expenditures may be required than we currently contemplate
resulting from changes in development plans or as
required to support new developments or commercialization activities or
otherwise.

We have initiated an acquisition program which, if successful, may require
additional funding. Currently we are reviewing one target candidate, Aspect
Semiquip International. We are attempting to secure financing for this
acquisition should the conclusion of our due diligence review indicate that the
acquisition could benefit us.

Based on our current plan and assumptions, we anticipate that we will be
able to meet our cash requirements for the next twelve months. We anticipate
meeting our cash needs as follows:


22Table of Contents

|                |                                                                                    |                                    |                                          |            |         |           | 
|--------------- | ---------------------------------------------------------------------------------- | ---------------------------------- | ---------------------------------------- | ---------- | ------- | --------- | 
|Cash available: |                                                                                    |                                    |                                          |           
|                | Cash available at February 28, 2002                                                |                                    | $                                        | 9,606      |        
|                | Subsequent advances                                                                |                                    |                                          |            |        
|                |                                                                                    | Swartz                             |                                          |            | 350,000 |          
|                |                                                                                    | Private placement being negotiated |                                          |            | 125,000 |          
|                |                                                                                    |                                    |                                          |           
|                |                                                                                    |                                    | Available cash under existing agreements |            | $       | 484,606   | 
|                |                                                                                    |                                    |                                          |           
|Cash needs:     |                                                                                    |                                    |                                          |           
|                | Estimated needs                                                                    |                                    | $                                        | 2,600,000  |        
|                | Note payable to Swartz at April 12, 2002                                           |                                    |                                          | 1,562,200  |        
|                |                                                                                    |                                    |                                          |           
|                |                                                                                    |                                    | Total                                    |            |         | 4,162,200 | 
|                | Estimated proceeds from first put under
Equity Line of Credit based on 30% advance |                                    |                                          | (1,073,340 | )      
|                |                                                                                    |                                    |                                          |           
|                |                                                                                    |                                    | Required funds from external sources     |            | $       | 3,088,860 | 
|                |                                                                                    |                                    |                                          |           

As shown above, we need to obtain $3,088,860. Any additional funding under the
existing $25 million equity line of credit is dependent on many factors,
including the increase in our authorized common stock. However, if we are not
able to meet our current plan to obtain approval to increase our authorized
common shares, there can be no assurance that any funds required during the
next twelve months or thereafter can be generated from sales of common stock
under the existing $25 million equity line of credit or that we will be able
to secure additional debt or equity financing. The lack of additional capital
could force us to substantially curtail or cease operations and would,
therefore, have a material adverse effect on our business. Further, there can
be no assurance that we will be able to timely receive shareholder approval to
increase the number of authorized shares or that required funds, if available,
will be available on attractive terms or that they will not have a
significantly dilutive effect on our existing shareholders. As such, there is
substantial doubt about our ability to continue as a going concern. The
consolidated financial statements do not include any adjustments to reflect the
possible future effects on the recoverability and classification of assets or
the amounts and classification of liabilities that may result from our possible
inability to continue as a going concern.

$25 Million Equity Line of Credit

Overview.On September 17, 2001, we entered into an investment agreement
with Swartz. The investment agreement entitles us to issue and sell our common
stock to Swartz for up to an aggregate of $25 million from time to time during
a three-year period following the effective date of the registration statement.
This is also referred to as a put right. We filed a registration statement on
Form S-1 on October 11, 2001 that was declared effective on

November 5, 2001.

Put Rights.In order to invoke a put right, we must have an effective
registration statement on file with the SEC registering the resale of the
common shares which may be issued as a consequence of the invocation of that
put
right. Additionally, we must give at least ten but not more than twenty
business days advance notice to Swartz of the date on which we intend to
exercise a particular put right, and we must indicate the number of shares of
common
stock we intend to sell to Swartz. At our option, we may also designate a
maximum dollar amount of common stock
(not to exceed $3 million) which we will sell to Swartz during the put and/or a
minimum purchase price per



23



---



##### Table of Contents



common share at which Swartz may purchase shares during the put. The number of
common shares sold to Swartz may not exceed 20% of the aggregate daily reported
trading volume during each of two consecutive ten business day periods
beginning on the business day immediately following the day we invoked the put
right.

The price Swartz will pay for each share of common stock sold in a put is
equal to the lesser of (i) the market price for each of the two consecutive ten
business day periods beginning on the business day immediately following the
day we invoked the put right minus $0.10, or (ii) X percent of the market price
for each of the two ten
day periods, where, X is equal to 90% if the market price is below $2.00 and
93% if market price is equal to or greater than $2.00. Market price is defined
as the lowest closing bid price for the common stock during each of the two
consecutive ten business day periods. However, the purchase price may not be
less than the designated minimum per share price, if any, that we indicated in
our notice.

For example, suppose for our first put we provide a put notice to Swartz,
and that we set the threshold price at $0.10 per share, below which we will not
sell any shares to Swartz during the pricing periods. Suppose further that the
total daily trading volume for the 20 trading days immediately preceding the
put date is 2,400,000 shares with no block trades which exceeds X shares,
where X equals the lesser of 100,001 shares or 25% of that days Trading
Volume. Under these hypothetical numbers, the maximum amount of shares that
could be sold to Swartz is as follows:



| |  |  | the total trading volume for the 20 days prior to our
put notice (2,400,000 shares) multiplied by 20% equals 480,000.
| | - |  | ---------------------------------------------------------------------------------------------------------------------

If the total daily trading volume for the 20 trading days during the actual
pricing periods was greater than 2,400,000 (like our example that follows) then
the maximum amount of shares that could be sold will be 480,000.

We issued to Swartz a commitment warrant to purchase up to 900,000 shares
of our common stock concurrent with the execution of the investment agreement.
This warrant is exercisable through September 17, 2006 at an initial exercise
price of $0.22. The commitment warrant exercise price is subject to being
reset on each six month anniversary of its issuance.

Limitations and Conditions Precedent to Our Put Rights.We may not
initiate a put if, as of the proposed date of such put:



| |  |  | we have issued shares of our common stock that have
been paid for by Swartz and the amount of proceeds we have
received is equal to the maximum offering amount;                                                                                                             
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the registration statement covering the resale of the
shares becomes ineffective or unavailable for use;                                                                                                                                                                     
|
| |  |  | our common stock is not actively trading on the OTC
Bulletin Board, the Nasdaq Small Cap Market, the Nasdaq National
Market, the American Stock Exchange, or the New York Stock
Exchange, or is suspended or delisted with respect to the trading
on such market or exchange.

If any of the following events occur during the pricing period for a put, the
volume accrual shall cease. For the put, the pricing period shall be adjusted
to end 10 business days after the date that we notify Swartz of the event, and
any minimum price per share we specified shall not apply to the put:



| |  |  | we have announced or implemented a stock split or
combination of our common stock between the advanced put notice
date and the end of the pricing period;                                        
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | we have paid a common stock dividend or made any other
distribution of our common stock between the advanced put notice
date and the end of the pricing period;                                  
|
| |  |  | we have made a distribution to the holders of our
common stock or of all or any portion of our
assets or evidences of indebtedness between the put notice date and
the end of the pricing period;



24



---



##### Table of Contents





| |  |  | we have consummated a major transaction (including a
transaction, which constitutes a change of control) between the
advance put notice date and the end of the pricing period, the
registration statement covering the resale of the shares becomes
ineffective or unavailable for use, or our stock becomes delisted
for trading on our then primary exchange; or
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | we discover the existence of facts that cause us to
believe that the registration statement contains an untrue
statement or omits to state a material fact.                                                                                                                                                                                                        

Short Sales.Swartz and its affiliates are prohibited from engaging in
short sales of our common stock
unless they have received a put notice and the amount of shares involved in a
short sale does not exceed the number of shares specified in the put notice.

Shareholder Approval. We may currently issue more than 20% of our
outstanding shares under the investment agreement. If we become listed on the
Nasdaq Small Cap Market or Nasdaq National Market, then we must get shareholder
approval to issue more than 20% of our outstanding shares. Since we are
currently a bulletin board company, we do not need shareholder approval.

Termination of Investment Agreement. We may also terminate our right to
initiate further puts or terminate the investment agreement by providing Swartz
with notice of such intention to terminate; however, any such termination will
not affect any other rights or obligations we have concerning the investment
agreement or any
related agreement.

Restrictive Covenants.During the term of the investment agreement and
for a period of two months thereafter, we are prohibited from certain
transactions. These include the issuance of any debt or equity securities in a
private transaction which are convertible or exercisable into shares of common
stock at a price based on the trading price of the common stock at any time
after the initial issuance of such securities or with a fixed conversion or
exercise price subject to adjustment without obtaining Swartzs prior written
approval.

Right of First Refusal.Swartz has a right of first refusal to purchase
any variable priced securities offered by us in any private transaction which
closes on or prior to two months after the termination of the investment
agreement and a right of participation for any equity securities offered by us
in any private transaction which closes on or prior to two months after the
termination of the investment agreement.

Swartzs Right of Indemnification.We are obligated to indemnify Swartz
(including their stockholders, officers, directors, employees and agents) from
all liability and losses resulting from any misrepresentations or breaches we
made in connection with the investment agreement, our registration rights
agreement, other related agreements, or the registration statement.

Waiver and Agreement.On November 5, 2001, December 6, 2001, January 2,
2002, and February 6, 2002, we entered into four waivers and agreements with
Swartz whereby Swartz was able to advance us multiple funds previous to the
close of the first put of up to 10 million shares of common stock under this
$25 million equity line of credit. The waivers and agreements extended the
time of the put beyond twenty days and redefined the price of the put to be the
lesser of the factor of (a) the volume weighted average price per share, as
defined by Bloomberg L.P., for each day of the put multiplied by .70 or (b) the
volume weighted average price per share minus $0.05 multiplied by 20% of the
acceptable daily volume as defined in the waiver. At the discretion of Swartz
the 20% daily volume limitation could be increased up to 30% of the daily
volume. In addition, the waivers included the commitment to issue additional
purchase warrant shares to be equal to the number of shares issued under the
first put. Under these waivers, the purchase warrant shares were to be issued
to Swartz as restricted shares subject to piggyback
registration rights and were subject to repricings on each six month
anniversary if 110% of the lowest closing bid price for the five days previous
to the anniversary date is less than the initial or subsequent reset exercise
prices. On January 7, 2002, we issued an interim warrant to purchase 3,630,940
shares of our common stock at an exercise price of $0.10. The interim warrant
was exercisable the earlier of 90 days or the close of the first put under the
$25 million equity line of credit. As discussed in Note 5 to the consolidated
financial statements, as of February
28, 2002, warrants to purchase an additional 6,369,060 shares of our common
stock were issuable to Swartz.



25



---



##### Table of Contents



On March 12, 2002, we entered into an amended waiver and agreement with
Swartz which replaced and superseded the previous waivers and agreements
discussed above. This amended waiver and agreement extended the time of the
put beyond twenty days and redefined the price of the put to be the lesser of
the factor of (a) the volume weighted average price per share, as defined by
Bloomberg L.P., for each day of the put multiplied by .70 or (b) the volume
weighted average price per share minus $0.05 multiplied by 20% of the
acceptable daily volume as defined in the waiver. At the discretion of Swartz,
the 20% daily volume limitation may be increased up to 30% of
the daily volume. In addition, the amended waiver and agreement increased the
intended put share amount for the first put to 14,100,000 shares, which is the
total number of shares we have registered so far under the $25 million
equity line of credit. On March 12, 2002, we cancelled the interim warrant to
purchase 3,630,940 shares of our
common stock as a result of entering into the amended secured note payable on
March 12, 2002 as discussed in Note 5 to the unaudited consolidated financial
statements.

Note Payable

On November 5, 2001, we entered into a Secured Promissory Note with
Swartz. The note was to mature on November 5, 2002. The initial amount of the
note was $565,000 and had an interest rate of 5% per annum. Upon mutual
agreement between Swartz and ourselves, Swartz may advance additional amounts
under the note. Interest payments were due monthly starting January 1, 2002
and were to be paid in cash. Principal amounts equal to at least 20% of the
dollar trading volume for our common stock for the twenty trading day period
immediately preceding the date of such payment were due initially monthly
starting January 1, 2002 and could be paid by an offset against amounts due to
us from Swartz as a result of common shares put to Swartz under the $25 million
equity line of credit as discussed below. On January 28, 2002, we entered into
an agreement with Swartz that extended the principal payments until June 1,
2002. As part of the consideration for additional advances and deferral of
principal payments on the notes, we agreed to issue warrants to Swartz enabling
them to purchase common stock equal to 20% of any common stock we issue to
parties other than Swartz after January 28, 2002 for a period of five years
unless the price of our common stock exceeds $1 per share then no additional
warrants will be issued. The warrants issued are not registered with the SEC
but do contain piggyback and demand registration rights under certain
conditions.

At February 28, 2002, $1,440,000 had been advanced against the note of
which an offset of $227,800 had been applied against the final put under the
$30 million equity line of credit leaving a balance of $1,212,200 at February
28, 2002.

Also on November 5, 2001, we entered into a waiver and agreement with
Swartz whereby Swartz is able to advance us multiple funds previous to the
close of the first put under a $25 million equity line of credit as discussed
in Note 6 to the unaudited consolidated financial statements. Under this
waiver as well as subsequent waivers (see Note 6 to the unaudited consolidated
financial statements) we were committed to put, subject to volume limitations,
up to 10 million shares of our common stock. Pursuant to these waivers, we
agreed to issue additional purchase warrant shares to be equal to the number of
shares issued under the first put. Under the waivers, the purchase warrant
shares were to be issued to Swartz as restricted shares subject to piggyback
registration rights and were subject to repricings on each six month
anniversary if 110% of the lowest closing bid price for the five days previous
to the anniversary date was less than the initial or subsequent reset exercise
prices. On January 7, 2002, we issued an interim warrant to purchase 3,630,940
shares of our common stock at an exercise price of $0.10 per common share which
was exercisable at the earlier of ninety days or the close of the first put
under the $25 million equity line of credit. The warrant to purchase up to
3,630,940 shares of our common stock issued to Swartz was valued using the
Black-Scholes pricing model and the estimated fair value was recorded as debt
discount. In
addition, the warrants issuable to purchase up to 6,369,060 shares of our
common stock were valued using the Black-Scholes pricing model based on the
expected fair value at issuance and the estimated fair value was also recorded
as debt discount. See Note 6 to the unaudited consolidated financial
statements for discussion of the terms of the warrants. Also in connection
with closing the $25 million equity line of credit, we issued to Swartz a
commitment warrant to purchase 900,000 shares of our common stock as discussed
further in Note 6 to the unaudited consolidated financial statements. This
warrant was valued on the issuance date using the Black-Scholes
pricing model and the value was recorded as a debt discount.



26



---



##### Table of Contents



All debt discounts are to be amortized as additional interest expense over the
projected term of the note payable. As of February 28, 2002, $876,000 has been
reflected as debt discount of which $288,400 and $352,218 was amortized to
interest expense during the three and nine months ended February 28, 2002.

|                                                              |                             |  |  |          |   |   |           |          |  
|------------------------------------------------------------- | --------------------------- |  |  | -------- | - | - | --------- | -------- | -
|Advances against the note as of February 28, 2002             |                             |  |  |          |   | $ | 1,440,000 |         
|Less amount applied against $30 million equity line of credit |                             |  |  |          |   |   | (227,800  | )       
|Less debt discount                                            |                             |  |  |          |   |   |           |         
|                                                              | Total                       |  |  | 876,000  |   |   |           |          |  
|                                                              | Amount amortized to expense |  |  | (352,218 | ) |   |           | (523,782 | )
|                                                              |                             |  |  |          |   |   |           |         
|Note payable at February 28, 2002                             |                             |  |  |          |   | $ | 688,418   |         
|                                                              |                             |  |  |          |   |   |           |         

On November 9, 2001, an offset of $227,800 from the sale of 2,500,000
shares of common stock was applied against the final put under the $30 million
equity line of credit discussed below. The excess of the market value of the
underlying 2,500,000 shares of common stock over the principal reduction of
$227,800 was recorded as additional interest expense of $197,250 during the
nine months ended February 28, 2002.

On March 12, 2002, we replaced and superceded the Secured Promissory Note
with Swartz with an Amended Secured Promissory Note and Agreement with an
effective date of October 9, 2001 and an Addendum to Amended Secured Promissory
Note dated March 12, 2002. The amended note matures on October 9, 2002 and
amounts outstanding under the note bear interest at the rate of 5% per annum.
Upon mutual agreement between Swartz and ourselves, Swartz may advance
additional amounts under the amended note. Per the addendum to the amended
note, principal and interest payments are deferred until October 9, 2002.

As part of the consideration for entering into the above amended note, we
agreed to issue warrants to Swartz related to each advance against the note.
In connection with each advance, we shall issue to Swartz a warrant to purchase
a number of shares of common stock equal to the amount of the advance
multiplied by 8.25 at an initial exercise price equal to the lesser of the
factor of (a) the average of the volume weighted average price per share, as
defined by Bloomberg L.P., for each trading day in the period beginning on the
date of the previous advance and ending on the trading day immediately
preceding the date of the current advance multiplied by .70 or (b) the volume
weighted average price per share minus $0.05.

The amended note also gives to Swartz the right of first refusal and
rights to participate in subsequent debt or equity transactions entered into by
us through March 15, 2003. On March 12, 2002, the warrant to purchase
3,630,940 shares of our common stock was cancelled and we issued warrants to
purchase 10,000,650 shares of our common stock in accordance with the amended
note agreement. In addition, if after March 12, 2002, we issue common stock to
any parties other than Swartz, we are obligated to issue to Swartz warrants
equal to 20% of the common stock so issued. For accounting purposes the above
warrant exchange is considered a subsequent event and will be accounted for in
the fourth fiscal quarter.

Subsequent to February 28, 2002, we received additional advances
aggregating $350,000 and issued warrants to purchase additional shares of our
common stock aggregating 2,888,150.

The note is secured by our assets.

New Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board (FASB) issued
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities,
amended by SFAS No. 137, Accounting for Derivative Instruments and Hedging
Activities- Deferral of the Effective Date of FASB No. 133, and SFAS No. 138,
Accounting for Certain Derivative Instruments and Certain Hedging Activities
which requires companies to record derivatives on the balance sheet as assets
or liabilities, measured at fair market value. Gains or losses resulting from
changes in the values of those derivatives would be accounted for depending on
the use of the
derivative and whether it qualifies for hedge accounting. The key criterion
for hedge accounting is that the hedging



27



---



##### Table of Contents



relationship must be highly effective in achieving offsetting changes in fair
value or cash flows. SFAS No. 133 was
effective for us on June 1, 2001. The adoption of this statement had no
material impact on our financial statements.

In June 2001, the FASB issued SFAS No. 141, Business Combinations and
SFAS No. 142, Goodwill
and Other Intangible Assets. SFAS No. 141 requires the use of the purchase
method of accounting and prohibits the use of the pooling-of-interests method
of accounting for business combinations initiated after June 30, 2001.
SFAS No. 141 also requires that companies recognize acquired intangible assets
apart from goodwill if the acquired intangible assets meet certain criteria.
SFAS No. 141 applies to all business combinations initiated after June 30,
2001 and for purchase business combinations completed on or after July 1, 2001.
It also requires, upon adoption of SFAS No. 142, that companies reclassify the
carrying amounts of intangible assets and goodwill based on the criteria in
SFAS No. 141.

SFAS No. 142 requires, among other things, that companies no longer
amortize goodwill, but instead test goodwill for impairment at least annually.
In addition, SFAS No. 142 requires that companies identify reporting units for
the purposes of assessing potential future impairments of goodwill, reassess
the useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS No. 142. SFAS No.142 is required to be
applied in fiscal years beginning after December 15, 2001 to all goodwill and
other intangible assets recognized at that date, regardless of when those
assets were initially recognized. SFAS No. 142 requires companies to complete a
transitional goodwill impairment test six months from the date of adoption.
Companies are also required to reassess the useful lives of other intangible
assets within the first interim quarter after adoption of SFAS No. 142.

Our previous business combinations were accounted for using the
pooling-of-interests method. The pooling-of-interests method does not result in
the recognition of acquired goodwill or other intangible assets. As a result,
the adoption of SFAS No. 141 and No. 142 will not affect the results of past
acquisition transactions. However, all future business combinations will be
accounted for under the purchase method, which may result in the recognition of
goodwill and other intangible assets, some of which will be recognized through
operations, either by amortization or impairment charges, in the future. We
will be required to reassess the useful lives of our intangible assets within
the first fiscal quarter of 2003.

In June 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. SFAS No. 143 requires the fair value of a liability
for an asset retirement obligation to be recognized in the period in which it
is incurred if a reasonable estimate of fair value can be made. The associated
asset retirement costs are capitalized as part of the carrying amount of the
long-lived asset. SFAS No. 143 is effective for the fiscal year ending May 31,
2003. We believe the adoption of this statement will have no material impact
on our financial statements.

In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 144 requires that those
long-lived assets be measured at the lower of carrying amount or fair value
less cost to sell, whether reported in continuing operations or in discontinued
operations. Therefore, discontinued operations will no longer be measured at
net realizable value or include amounts for operating losses that have not yet
occurred. SFAS No. 144 is effective for financial statements issued for fiscal
years beginning after December 15, 2001 and, generally, is to be applied
prospectively.

Future Performance and Risk Factors

THIS REPORT CONTAINS A NUMBER OF FORWARD-LOOKING STATEMENTS WHICH REFLECT OUR
CURRENT VIEWS WITH RESPECT TO FUTURE EVENTS AND FINANCIAL PERFORMANCE. OUR
FUTURE BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION ARE SUBJECT TO
VARIOUS RISKS AND UNCERTAINTIES, INCLUDING THOSE SUMMARIZED BELOW. READERS ARE
CAUTIONED NOT TO PLACE UNDUE RELIANCE ON FORWARD-LOOKING STATEMENTS CONTAINED
HEREIN, WHICH SPEAK ONLY AS OF THE DATE HEREOF. WE UNDERTAKE NO OBLIGATION TO
PUBLICLY REVISE THESE FORWARD-LOOKING STATEMENTS, TO REFLECT EVENTS OR
CIRCUMSTANCES THAT MAY ARISE AFTER THE DATE OF THIS REPORT.



28



---



##### Table of Contents



Since the business combination with Metacomp, effective December 1996, we
have segregated our operations into microprocessor, communication, and
radar/antenna product lines.

The status of these three major technologies is as follows:



| |  |  | Ignite I microprocessor technology. This technology is generating minor
amounts of revenue from the sale of
evaluation boards, microprocessors and initial license fees related to the
intellectual property. We have ported the VxWorks operating system and the
Sun Microsystems personalJava virtual machine to the microprocessor.
Although we anticipate the sales of licenses and royalties from the
microprocessor technology will be our main product line, it currently
accounted for less than 1% of our revenue for the nine months ended February
28, 2002.                                                                                                   
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | High-speed data communications. Revenue from this technology was
generated primarily from mature communication products that completed
their life cycles. We have decided to concentrate our efforts on the
Ignite I microprocessor technology and have discontinued the sale of
communication products subsequent to the last buys that were shipped
during the nine months ended February 28, 2002. We are currently
attempting to sell this product line. Although the communications
product line accounted for almost all of the revenue shipped during the
first nine months ended February 28, 2002, future revenue will come from
our microprocessor technologies.
|
| |  |  | Radar and antenna. We sold the gas plasma antenna technology in August
1999. Our radar technology has not generated any revenue and we have
suspended further development of this technology in order to concentrate
our resources on the Ignite I microprocessor technology.                                                                                                                                                                                                                                                                                                                                                                                             

During at least the last three years, we have focused the majority of our
efforts on the Ignite I microprocessor technology. This technology is targeted
for the embedded controller and Java language processor marketplaces.

We have experienced in the past and may experience in the future many of
the problems, delays and expenses encountered by any business in the early
stages of development, some of which are beyond our control. We have had
limited operating history, have incurred significant cumulated losses, have
only recently commenced marketing and sales of our products and have not
achieved a profitable level of operations. There can be no assurance of future
profitability. We may require additional funds in the future for operations or
to exploit our technologies. There can be no assurance that any funds required
in the future can be generated from operations or that such required funds will
be available from other potential sources. The lack of additional capital
could force us to substantially curtail or cease operations and would therefore
have a material adverse effect on our business. Further there can be no
assurance that any such required funds, if available, will be available on
attractive terms or that they will not have a significantly dilutive effect on
our existing shareholders. Our technologies are in various stages of
development. There can be no assurance that any of the technologies in
development can be completed to
commercial exploitation due to the inherent risks of new technology development
limitations on financing, competition, obsolescence, loss of key technical
personnel and other factors. Our development projects are high risk in nature,
where unanticipated technical obstacles can arise at any time and result in
lengthy and costly delays or
result in determination that further development is unfeasible. There can be
no assurance that the technologies, if completed, will achieve market
acceptance sufficient to sustain us or achieve profitable operations.

We rely primarily on patents to protect our intellectual property rights.
There can be no assurance that patents held by us will not be challenged and
invalidated, that patents will issue from any of our pending applications or
that any claims allowed from existing or pending patents will be sufficient in
scope or strength or be issued in all countries where our products can be sold
to provide meaningful protection or commercial advantage to us. Competitors
may also be able to design around our patents.

Our common shares are traded on the OTC Bulletin Board, are thinly traded
and are subject to special regulations imposed on penny stocks. Our shares
may experience significant price and volume volatility, increasing the risk of
ownership to investors.



29



---



##### Table of Contents








|Item 3. | Quantitative and Qualitative Disclosure About Market Risk
|------- | ---------------------------------------------------------

We are exposed to interest rate risk on investments of our excess cash.
The primary objective of our investment activities is to preserve capital. To
achieve this objective and minimize the exposure due to adverse shifts in
interest rates, we invest from time to time in high quality short-term maturity
commercial paper and
money market funds operated by reputable financial institutions in the United
States. Due to the nature of our investments, we believe that we do not have a
material interest rate exposure.




PART II. OTHER INFORMATION




Item 1. Legal Proceedings

In January 1999, we were sued in the Superior Court of San Diego County,
California by the Fish Family Trust, a co-inventor of the original ShBoom
technology. The suit also named as defendants nanoTronics and Gloria Felcyn on
behalf of the Falk Family Trust. The suit sought a judgment for damages, a
rescission of the Technology Transfer Agreement and a restoration of the
technology to the co-inventor. In March 1999, we joined with nanoTronics and
Gloria Felcyn and filed our response and cross-complaint against the Fish
Family Trust. In November 2000, the judge issued a summary ruling in favor of
the defendants on all counts. The Fish Family Trust filed an appeal in
January 2001. Management believes that it is unlikely that the appellate court
will overturn the trial courts ruling and that the resolution of the appeal
process will have no impact on our financial position or cash flows.

A former employee had filed a claim in arbitration seeking the right to
exercise terminated options. We have settled with the former employee without
the necessity of going to arbitration. The amount of the settlement was
$37,500 which is payable in four equal monthly payments starting in April 2002.
The settlement was accrued during the quarter ended February 28, 2002.

In September 2001, an action was filed against us in the Superior Court of
San Diego County, California by Richard G. Blum, our former Chairman, President
and Chief Executive Officer. Mr. Blum contends that he was wrongfully
terminated on August 5, 2001 in violation of his employment agreement dated
December 1, 2000. He seeks damages for the alleged breach of his employment
agreement, age discrimination, as well as other related claims. Management
denies Mr. Blums claims and contends it exercised its business judgment for
legitimate nondiscriminatory reasons. In accordance with his employment
agreement, we may be obligated to pay him between $0 and $368,000 as severance
pay. We intend to vigorously defend our position in this case.

In October 2001, an action was filed against us in the Superior Court of
San Diego County, California by Daniel Beach, a former marketing and sales
consultant whose contract we terminated in August 2001. Mr. Beach contends
that we breached both a written and an oral contract, that we did not perform
on certain promises, and that we made false and misleading representations in
addition to other claims. Management denies Mr. Beachs claims and we intend
to vigorously defend our position in this case.




Item 2. Changes in Securities

(a)  We offered and sold the following common stock, either for cash or in
consideration of services rendered as indicated below, without registration
under the Securities Act of 1933, as amended, and exemption for such sales from
registration under the Act is claimed in reliance upon the exemption provided
by Section 4(2) thereof on the basis that such offers and sales were
transactions not involving any public offering. Appropriate precautions
against transfer have been taken, including the placing of a restrictive legend
on all certificates evidencing such securities. All such sales were effected
without the aid of underwriters, and no sales commissions were paid.



30



---



##### Table of Contents



|                     |  |                  |  |        |           |                  |  |                    |        |                    |  |                |  |  |  | 
|-------------------- |  | ---------------- |  | ------ | --------- | ---------------- |  | ------------------ | ------ | ------------------ |  | -------------- |  |  |  | 
|                     |  |                  |  |        |           | Number of Common |  | Aggregate Purchase |        | Purchase Price Per
|Name                 |  | Date of Sale     |  | Shares |           | Price            |  | Share             
|                     |  |                  |  |        |           |                  |  |                   
|Robert Crawford      |  | January 22, 2002 |  |        | 400,000   |                  |  | $                  | 34,001 |                    |  | $0.085 Cash   
|William Crawford     |  | January 22, 2002 |  |        | 400,000   |                  |  | $                  | 34,000 |                    |  | $0.085 Cash   
|iCapital Corporation |  | January 25, 2002 |  |        | 1,000,000 |                  |  | $                  | 90,000 |                    |  | $0.09 Services




Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits  NONE

(b)  Reports on Form 8-K  We did not file a report on Form 8-K for the quarter
ended February 28, 2002. We did file a report on Form 8-K on March 14, 2002
announcing the appointment of a new President and Chief Executive Officer.




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.

|                     |                                                                                                                                                             |                       
|-------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------
|                     | PATRIOT SCIENTIFIC CORPORATION                                                                                                                             
|                    
|Date: April 22, 2002 | By:                                                                                                                                                         | /s/ LOWELL W. GIFFHORN
|                     |                                                                                                                                                            
|                     | Executive Vice President and
Chief Financial Officer
 
(Principal Financial and
Accounting Officer and duly
authorized to sign on behalf
of the Registrant)



31